UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
X Quarterly Report Pursuant to Section 13 or 15(d) of the
-
Securities Exchange Act of 1934
_ For the quarterly period ended December 31, 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)
212-572-4200
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
- -
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer X Accelerated filer Non-accelerated filer
- - -
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
- -
At January 23, 2006, 126,983,726 shares of the registrant's Class A Common
Stock, $.01 par value, and 85,800,901 shares of the registrant's Class B Common
Stock, $.01 par value, were outstanding.
THE ESTEE LAUDER COMPANIES INC.
Index
Page
----
Part I. Financial Information
Item 1. Financial Statements
Consolidated Statements of Earnings --
Three and Six Months Ended December 31, 2005 and 2004 2
Consolidated Balance Sheets --
December 31, 2005 and June 30, 2005 3
Consolidated Statements of Cash Flows --
Six Months Ended December 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 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
Item 4. Controls and Procedures 32
Part II. Other Information
Item 1. Legal Proceedings 33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 35
Item 4. Submission of Matters to a Vote of Security Holders 35
Item 6. Exhibits 36
Signatures 37
THE ESTEE LAUDER COMPANIES INC.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Six Months Ended
December 31 December 31
---------------------- ------------------------
2005 2004 2005 2004
--------- --------- ---------- ----------
(In millions, except per share data)
Net Sales $ 1,783.9 $ 1,736.3 $ 3,281.0 $ 3,226.6
Cost of Sales 458.5 443.9 878.0 851.6
--------- --------- ---------- ----------
Gross Profit 1,325.4 1,292.4 2,403.0 2,375.0
--------- --------- ---------- ----------
Operating expenses:
Selling, general and administrative 1,073.1 1,059.7 2,045.6 1,986.0
Cost savings initiative 1.6 - 1.6 -
--------- --------- ---------- ----------
1,074.7 1,059.7 2,047.2 1,986.0
--------- --------- ---------- ----------
Operating Income 250.7 232.7 355.8 389.0
Interest expense, net 6.9 3.3 12.5 7.4
--------- --------- ---------- ----------
Earnings before Income Taxes, Minority
Interest and Discontinued Operations 243.8 229.4 343.3 381.6
Provision for income taxes 90.2 86.3 126.0 142.6
Minority interest, net of tax (3.2) (3.4) (5.1) (3.6)
--------- --------- ---------- ----------
Net Earnings from Continuing Operations 150.4 139.7 212.2 235.4
Discontinued operations, net of tax (68.7) (1.4) (72.0) (2.1)
--------- --------- ---------- ----------
Net Earnings $ 81.7 $ 138.3 $ 140.2 $ 233.3
========= ========= ========== ==========
Basic net earnings per common share:
Net earnings from continuing operations $ .70 $ .62 $ .97 $ 1.04
Discontinued operations, net of tax (.32) (.01) (.33) (.01)
--------- --------- ---------- ----------
Net earnings $ .38 $ .61 $ .64 $ 1.03
========= ========= ========== ==========
Diluted net earnings per common share:
Net earnings from continuing operations $ .70 $ .61 $ .97 $ 1.02
Discontinued operations, net of tax (.32) (.01) (.33) (.01)
--------- --------- ---------- ----------
Net earnings $ .38 $ .60 $ .64 $ 1.01
========= ========= ========== ==========
Weighted average common shares outstanding:
Basic 214.7 225.6 217.7 226.4
Diluted 216.6 229.2 220.1 230.2
See notes to consolidated financial statements.
2
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED BALANCE SHEETS
December 31 June 30
2005 2005
----------------- ----------------
(Unaudited)
($ in millions)
ASSETS
Current Assets
Cash and cash equivalents $ 370.3 $ 553.3
Accounts receivable, net 832.3 776.6
Inventory and promotional merchandise, net 726.6 768.3
Prepaid expenses and other current assets 227.6 204.4
Assets held for sale 44.8 -
---------------- ---------------
Total current assets 2,201.6 2,302.6
---------------- ---------------
Property, Plant and Equipment, net 693.2 694.2
---------------- ---------------
Other Assets
Investments, at cost or market value 11.4 12.3
Goodwill 633.1 720.6
Other intangible assets, net 73.1 71.8
Other assets, net 88.6 84.3
---------------- ---------------
Total other assets 806.2 889.0
---------------- ---------------
Total assets $ 3,701.0 $ 3,885.8
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Short-term debt $ 209.6 $ 263.6
Accounts payable 244.6 249.4
Accrued income taxes 148.0 109.9
Other accrued liabilities 923.7 874.8
Liabilities related to assets held for sale 4.8 -
---------------- ---------------
Total current liabilities 1,530.7 1,497.7
---------------- ---------------
Noncurrent Liabilities
Long-term debt 441.6 451.1
Other noncurrent liabilities 222.2 228.4
---------------- ---------------
Total noncurrent liabilities 663.8 679.5
---------------- ---------------
Minority Interest 18.9 15.8
---------------- ---------------
Stockholders' Equity
Common stock, $.01 par value; 650,000,000 shares Class A authorized; shares
issued: 162,927,202 at December 31, 2005 and 159,837,545 at June 30, 2005;
240,000,000 shares Class B authorized; shares issued and outstanding:
85,800,901 at December 31, 2005 and 87,640,901 at June 30, 2005 2.5 2.5
Paid-in capital 523.9 465.2
Retained earnings 2,257.9 2,203.2
Accumulated other comprehensive income (3.6) 9.4
---------------- ---------------
2,780.7 2,680.3
Less: Treasury stock, at cost; 35,945,026 Class A shares at
December 31, 2005 and 27,174,160 Class A shares at June 30, 2005 (1,293.1) (987.5)
---------------- ---------------
Total stockholders' equity 1,487.6 1,692.8
---------------- ---------------
Total liabilities and stockholders' equity $ 3,701.0 $ 3,885.8
================ ===============
See notes to consolidated financial statements.
3
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
December 31
------------------------------------
2005 2004
------------- --------------
(In millions)
Cash Flows from Operating Activities
Net earnings $ 140.2 $ 233.3
Adjustments to reconcile net earnings to net cash flows provided by
operating activities from continuing operations:
Depreciation and amortization 97.1 94.5
Deferred income taxes (18.6) 22.1
Minority interest, net of tax 5.1 3.6
Non-cash stock compensation 23.7 (1.3)
Excess tax benefits from stock-based compensation arrangements (4.9) -
Loss on disposal of fixed assets 2.7 6.2
Discontinued operations, net of tax 72.0 -
Other non-cash items 0.4 0.5
Changes in operating assets and liabilities
Increase in accounts receivable, net (76.0) (128.6)
Decrease (increase) in inventory and promotional merchandise, net 23.8 (15.1)
Increase in other assets, net (22.2) (6.4)
Increase (decrease) in accounts payable (1.1) 9.3
Increase in accrued income taxes 47.8 34.3
Increase in other accrued liabilities 85.6 47.4
Increase in other noncurrent liabilities 13.1 4.8
------------- --------------
Net cash flows provided by operating activities of continuing operations
388.7 304.6
------------- --------------
Cash Flows from Investing Activities
Capital expenditures (104.0) (110.0)
Acquisition of businesses, net of cash acquired (46.5) (4.6)
Proceeds from disposition of long-term investments 0.5 -
Purchases of long-term investments (0.1) (0.3)
------------- --------------
Net cash flows used for investing activities of continuing operations (150.1) (114.9)
------------- --------------
Cash Flows from Financing Activities
Increase in short-term debt, net 16.0 5.6
Repayments and redemptions of long-term debt (69.9) -
Net proceeds from stock-based compensation transactions 27.1 41.7
Excess tax benefits from stock-based compensation arrangements 4.9 -
Payments to acquire treasury stock (305.8) (187.7)
Dividends paid to stockholders (85.4) (90.1)
Distributions made to minority holders of consolidated subsidiaries (1.6) (3.0)
------------- --------------
Net cash flows used for financing activities of continuing operations (414.7) (233.5)
------------- --------------
Effect of Exchange Rate Changes on Cash and Cash Equivalents (2.0) 10.5
------------- --------------
Cash Flows used for Discontinued Operations (4.9) (0.4)
------------- --------------
Net Decrease in Cash and Cash Equivalents (183.0) (33.7)
Cash and Cash Equivalents at Beginning of Period 553.3 611.6
------------- --------------
Cash and Cash Equivalents at End of Period $ 370.3 $ 577.9
============= ==============
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 markets and sells Stila brand products, which have been
reflected as discontinued operations for the three and six-month periods ended
December 31, 2005 and 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 ("GAAP") for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by GAAP for complete financial statements. In the opinion of management
all adjustments (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, 2005.
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 six-month periods ended December 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 stock-based awards.
A reconciliation between the numerators and denominators of the basic and
diluted EPS computations is as follows:
Three Months Ended Six Months Ended
December 31 December 31
--------------------- ---------------------
2005 2004 2005 2004
--------- --------- --------- ---------
(Unaudited)
(In millions, except per share data)
Numerator:
Net earnings from continuing operations $ 150.4 $ 139.7 $ 212.2 $ 235.4
Discontinued operations, net of tax (68.7) (1.4) (72.0) (2.1)
--------- --------- --------- ---------
Net earnings $ 81.7 $ 138.3 $ 140.2 $ 233.3
========= ========= ========= =========
Denominator:
Weighted average common shares outstanding - Basic 214.7 225.6 217.7 226.4
Effect of dilutive securities: Stock options and
restricted share units 1.9 3.6 2.4 3.8
--------- --------- --------- ---------
Weighted average common shares outstanding - Diluted 216.6 229.2 220.1 230.2
========= ========= ========= =========
Basic net earnings per common share:
Net earnings from continuing operations $ .70 $ .62 $ .97 $ 1.04
Discontinued operations, net of tax (.32) (.01) (.33) (.01)
--------- --------- --------- ---------
Net earnings $ .38 $ .61 $ .64 $ 1.03
========= ========= ========= =========
Diluted net earnings per common share:
Net earnings from continuing operations $ .70 $ .61 $ .97 $ 1.02
Discontinued operations, net of tax (.32) (.01) (.33) (.01)
--------- --------- --------- ---------
Net earnings $ .38 $ .60 $ .64 $ 1.01
========= ========= ========= =========
5
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2005 and 2004, outstanding options to purchase 17.1 million
and 6.8 million shares, respectively, of Class A Common Stock were not included
in the computation of diluted EPS because the exercise prices of those options
were greater than the average market price of the common stock and their
inclusion would be anti-dilutive.
Stock-Based Compensation
As of December 31, 2005, the Company had established a number of share incentive
programs as discussed in more detail in Note 3. Prior to fiscal 2006, the
Company applied the intrinsic value method as outlined in Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"),
and related interpretations in accounting for stock options and share units
granted under these programs. Under the intrinsic value method, no compensation
expense was recognized if the exercise price of the Company's employee stock
options equaled the market price of the underlying stock on the date of the
grant. Accordingly, no compensation cost was recognized in the accompanying
consolidated statements of earnings prior to fiscal year 2006 on stock options
granted to employees, since all options granted under the Company's share
incentive programs had an exercise price equal to the market value of the
underlying common stock on the date of grant.
Effective July 1, 2005, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123(R), "Share-Based Payment" ("SFAS No. 123(R)"). This
statement replaces SFAS No. 123, "Accounting for Stock-Based Compensation"
("SFAS No. 123") and supersedes APB No. 25. SFAS No. 123(R) requires that all
stock-based compensation be recognized as an expense in the financial statements
and that such cost be measured at the fair value of the award. This statement
was adopted using the modified prospective method of application, which requires
the Company to recognize compensation expense on a prospective basis. Therefore,
prior period financial statements have not been restated. Under this method, in
addition to reflecting compensation expense for new share-based awards, expense
is also recognized to reflect the remaining service period of awards that had
been included in pro-forma disclosures in prior periods. SFAS No. 123(R) also
requires that excess tax benefits related to stock option exercises be reflected
as financing cash inflows instead of operating cash inflows. For the six months
ended December 31, 2005, this new treatment resulted in cash flows from
financing activities of $4.9 million, which reduced cash flows from operating
activities by the same amount.
Supplemental Disclosures of Cash Flow Information
Supplemental cash flow information for the six months ended December 31, 2005
and 2004 was as follows:
2005 2004
-------------- --------------
(Unaudited)
(In millions)
Cash paid during the period for interest $ 17.9 $ 10.6
============== ==============
Cash paid during the period for income taxes $ 86.6 $ 85.1
============== ==============
Incremental tax benefit from the exercise of stock options $ 2.9 $ 18.4
============== ==============
Liability associated with acquisition of business $ - $ 7.7
============== ==============
Capital lease obligations incurred $ 0.2 $ -
============== ==============
Accrued dividend equivalents $ 0.1 $ -
============== ==============
Accounts Receivable
Accounts receivable is stated net of the allowance for doubtful accounts and
customer deductions of $29.8 million and $28.9 million as of December 31, 2005
and June 30, 2005, respectively.
6
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Inventory and Promotional Merchandise
Inventory and promotional merchandise only includes inventory considered
saleable or usable in future periods, and is stated at the lower of cost or
fair-market value, with cost being determined on the first-in, first-out method.
Cost components include raw materials, componentry, direct labor and overhead
(e.g., indirect labor, utilities, depreciation, purchasing, receiving,
inspection and warehousing) as well as inbound freight. Promotional merchandise
is charged to expense at the time the merchandise is shipped to the Company's
customers.
December 31 June 30
2005 2005
------------- -------------
(Unaudited)
(In millions)
Inventory and promotional merchandise consists of:
Raw materials $ 133.3 $ 149.9
Work in process 35.7 43.2
Finished goods 388.6 403.4
Promotional merchandise 169.0 171.8
------------- -------------
$ 726.6 $ 768.3
============= =============
Property, Plant and Equipment
Property, plant and equipment, including leasehold and other improvements that
extend an asset's useful life or productive capabilities, are carried at cost
less accumulated depreciation and amortization. For financial statement
purposes, depreciation is provided principally on the straight-line method over
the estimated useful lives of the assets. Leasehold improvements are amortized
on a straight-line basis over the shorter of the lives of the respective leases
or the expected useful life of those improvements.
December 31 June 30
2005 2005
------------- -------------
(Unaudited)
(In millions)
Assets (Useful Life)
Land $ 13.6 $ 13.6
Buildings and improvements (10 to 40 years) 158.3 160.8
Machinery and equipment (3 to 10 years) 760.6 721.2
Furniture and fixtures (5 to 10 years) 109.4 109.1
Leasehold improvements 741.9 703.9
------------- -------------
1,783.8 1,708.6
Less accumulated depreciation and amortization 1,090.6 1,014.4
------------- -------------
$ 693.2 $ 694.2
============= =============
Depreciation and amortization of property, plant and equipment was $47.4 million
and $44.8 million during the three months ended December 31, 2005 and 2004,
respectively, and $92.7 million and $88.9 million during the six months ended
December 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
Goodwill and Other Intangible Assets
During the quarter ended December 31, 2005, the Company acquired a business
engaged in the wholesale distribution and retail sale of Aveda products
resulting in an increase to goodwill of $5.7 million. In addition, the Company
settled its obligation, recorded as goodwill at June 30, 2005, related to an
earn-out provision in the Company's fiscal 2000 acquisition of Jo Malone
Limited.
Repayments of Debt
During the quarter ended December 31, 2005, the Company redeemed the remaining
$68.4 million of the 2015 Preferred Stock.
Operating Leases
The Company recognizes rent expense from operating leases with periods of free
rent 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, 2005.
The components of net periodic benefit cost for the three months ended December
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 $ 5.4 $ 4.8 $ 3.0 $ 2.9 $ 1.1 $ 0.8
Interest cost 5.3 5.3 2.4 2.5 1.3 1.0
Expected return on plan
assets (6.2) (6.0) (2.8) (2.8) - -
Amortization of:
Prior service cost 0.2 0.1 0.1 0.1 - -
Actuarial loss 1.5 1.2 2.0 1.0 0.3 -
Settlements and curtailments - - - - - -
--------- ---------- --------- ---------- --------- ---------
Net periodic benefit cost $ 6.2 $ 5.4 $ 4.7 $ 3.7 $ 2.7 $ 1.8
========= ========== ========= ========== ========= =========
8
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of net periodic benefit cost for the six months ended December
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 $ 10.8 $ 9.7 $ 6.0 $ 5.7 $ 2.3 $ 1.6
Interest cost 10.6 10.6 4.9 4.9 2.5 2.0
Expected return on plan
assets (12.4) (12.0) (5.7) (5.5) - -
Amortization of:
Prior service cost 0.4 0.2 0.1 0.1 - -
Actuarial loss 3.0 2.3 4.1 2.0 0.6 -
Settlements and curtailments - - 0.2 - - -
--------- --------- --------- --------- --------- ---------
Net periodic benefit cost $ 12.4 $ 10.8 $ 9.6 $ 7.2 $ 5.4 $ 3.6
========= ========= ========= ========= ========= =========
The Company previously disclosed in its consolidated financial statements for
the fiscal year ended June 30, 2005 that it did not expect to make any cash
contributions to its U.S. pension plan but expected to contribute $19.9 million
to its international pension plans during the fiscal year ending June 30, 2006.
As of December 31, 2005, there have not been material changes to the expected
contributions for U.S. and international pension plans for the fiscal year
ending June 30, 2006.
Common Stock
During the six months ended December 31, 2005, 1,840,000 shares of the Company's
Class B Common Stock were converted into Class A Common Stock.
Management Estimates
The preparation of financial statements in conformity with GAAP 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, 2005.
With the adoption of SFAS No. 123(R) on July 1, 2005, the Company is required to
record the fair value of stock-based compensation awards as an expense. In order
to determine the fair value of stock options on the date of grant, the Company
applies the Black-Scholes option-pricing model. Inherent in this model are
assumptions related to expected stock-price volatility, option life, risk-free
interest rate and dividend yield. While the risk-free interest rate and dividend
yield are less subjective assumptions, typically based on factual data derived
from public sources, the expected stock-price volatility and option life
assumptions require a greater level of judgment which make them critical
accounting estimates.
The Company uses an expected stock-price volatility assumption that is a
combination of both current and historical implied volatilities of the
underlying stock which are obtained from public data sources. This approach is a
good predictor of future realized and implied volatilities and is directly
relevant for valuing stock options. For stock option grants issued during the
three and six months ended December 31, 2005, the Company used a weighted-
average expected stock-price volatility of 23% based upon the implied volatility
at the time of issuance.
9
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
With regard to the weighted-average option life assumption, the Company
considers the exercise behavior of past grants and models the pattern of
aggregate exercises. Patterns are determined on specific criteria of the
aggregate pool of optionees including the reaction to vesting, realizable
value, long-run exercise propensity, pent-up demand, stock run-up effect and
short-time-to-maturity effect. For stock option grants issued during the three
and six months ended December 31,2005, the Company used a weighted-average
expected option life assumption of 7 years and 8 years, respectively.
Recently Issued Accounting Standards
In September 2005, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position ("FSP") No. FAS 123(R)-1, "Classification and Measurement of
Freestanding Financial Instruments Originally Issued in Exchange for Employee
Services under FASB Statement No. 123(R)," to defer the requirement of SFAS
No. 123(R) that a freestanding financial instrument originally subject to SFAS
No. 123(R) becomes subject to the recognition and measurement requirements of
other applicable GAAP when the rights conveyed by the instrument to the holder
are no longer dependent on the holder being an employee of the entity. The
rights under stock-based payment awards issued to employees by the Company are
all dependent on the recipient being an employee of the Company. Therefore, this
FSP currently does not have an impact on the Company's consolidated financial
statements and its measurement of stock-based compensation in accordance with
SFAS No. 123(R).
In October 2005, the FASB issued FSP No. FAS 13-1, "Accounting for Rental Costs
Incurred during a Construction Period" ("FSP No. 13-1"), to give guidance to a
lessee on determining whether rental costs associated with operating leases may
be capitalized during a construction period. Specifically, the FSP stipulates
that such costs shall be (a) recognized as rental expense, (b) included in
income from continuing operations, and (c) allocated over the lease term
according to the guidance in SFAS No. 13, "Accounting for Leases," and FASB
Technical Bulletin No. 85-3, "Accounting for Operating Leases with Scheduled
Rent Increases." The guidance in FSP No. FAS 13-1 is effective for the first
reporting period beginning after December 15, 2005, with early adoption
permitted for financial statements or interim financial statements that have not
yet been issued. The Company already accounts for such rental costs in
accordance with FSP No. 13-1; therefore the issuance of this FSP will not have
an additional impact on the Company's consolidated financial statements.
In October 2005, the FASB issued FSP No. FAS 123(R)-2, "Practical Accommodation
to the Application of Grant Date as Defined in FASB Statement No. 123(R)," to
provide guidance on determining the grant date for an award as defined in SFAS
No. 123(R). This FSP stipulates that assuming all other criteria in the grant
date definition are met, a mutual understanding of the key terms and conditions
of an award to an individual employee is presumed to exist upon the award's
approval in accordance with the relevant corporate governance requirements,
provided that the key terms and conditions of an award (a) cannot be negotiated
by the recipient with the employer because the award is a unilateral grant, and
(b) are expected to be communicated to an individual recipient within a
relatively short time period from the date of approval. The Company has applied
the principles set forth in this FSP upon its adoption of SFAS No. 123(R).
In November 2005, the FASB issued FSP Nos. FAS 115-1 and FAS 124-1, "The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments,"
to give guidance on determining when investments in certain debt and equity
securities are considered impaired, whether that impairment is other than
temporary, and on measuring such impairment loss. This FSP also includes
accounting considerations subsequent to the recognition of an other-than-
temporary impairment and requires certain disclosures about unrealized losses
that have not been recognized as other-than-temporary impairments. FSP Nos. FAS
115-1 and FAS 124-1 will apply to reporting periods beginning after December 15,
2005, although earlier application is permitted. This FSP will not have a
material impact on the Company's consolidated financial statements.
In November 2005, the FASB published FSP No. FAS 123(R)-3, "Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards," to
provide an alternative transition method for accounting for the tax effects of
share-based payment awards to employees. The FASB learned, subsequent to
adoption of SFAS No. 123(R), that a number of constituents did not have the
information necessary to comply with the transition requirements of SFAS No.
123(R), and has provided an elective alternative transition method in FSP No.
FAS 123(R)-3. Entities can choose to follow either the transition guidance of
SFAS No. 123(R) or the alternative transition method described in FSP No. FAS
123(R)-3. The guidance in FSP No. FAS 123(R)-3 became effective upon
publication. The Company has applied the principles originally set forth in SFAS
No. 123(R). Therefore the guidance set forth in this FSP will not be applicable
to the Company.
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 (loss) on derivative instruments designated and qualifying
as cash-flow hedging instruments, net minimum pension liability adjustments and
cumulative translation adjustments as of the end of each period.
Comprehensive income and its components, net of tax, are as follows:
Three Months Ended Six Months Ended
December 31 December 31
---------------------- ----------------------
2005 2004 2005 2004
--------- --------- --------- ---------
(Unaudited)
(In millions)
Net earnings $ 81.7 $ 138.3 $ 140.2 $ 233.3
--------- --------- --------- ---------
Other comprehensive income (loss):
Net unrealized investment gain - 0.3 - -
Net derivative instruments gain (loss) (0.6) (5.6) 0.1 (6.7)
Translation adjustments (20.9) 68.0 (13.1) 76.3
--------- --------- --------- ---------
Other comprehensive income (loss) (21.5) 62.7 (13.0) 69.6
--------- --------- --------- ---------
Comprehensive income $ 60.2 $ 201.0 $ 127.2 $ 302.9
========= ========= ========= =========
The accumulated net gain (loss) on derivative instruments consists of the
following:
Three Months Ended Six Months Ended
December 31 December 31
----------------------- -----------------------
2005 2004 2005 2004
--------- --------- --------- ---------
(Unaudited)
(In millions)
OCI-derivative instruments, beginning of period $ 12.6 $ 9.1 $ 11.9 $ 10.2
--------- --------- --------- ---------
Gain (loss) on derivative instruments 2.1 12.5) 3.3 (13.8)
Reclassification to earnings of net (gain) loss during
the period (4.8) 4.0 (5.5) 3.7
Benefit for deferred income taxes 2.1 2.9 2.3 3.4
--------- --------- --------- ---------
Net derivative instruments gain (loss) (0.6) (5.6) 0.1 (6.7)
--------- --------- --------- ---------
OCI-derivative instruments, end of period $ 12.0 $ 3.5 $ 12.0 $ 3.5
========= ========= ========= =========
Of the $12.0 million, net of tax, derivative instrument gain recorded in OCI at
the end of the current period, $9.3 million, net of tax, related to the gain on
the settlement of treasury lock agreements upon issuance of the Company's 5.75%
Senior Notes due October 2033, which will be reclassified to earnings as an
offset to interest expense over the life of the debt, and $2.7 million, net of
tax, related to forward and option contracts which the Company will reclassify
to earnings during the next six months.
At the end of the prior period, the $3.5 million, net of tax, derivative
instrument gain recorded in OCI included $9.0 million, net of tax, related to
the gain on the settlement of treasury lock agreements upon issuance of the
Company's 5.75% Senior Notes due October 2033, which will be reclassified to
earnings as an offset to interest expense over the life of the debt. This was
offset by a $5.5 million loss, net of tax, related to forward and option
contracts, which the Company reclassified to earnings during the fiscal year
ended June 30, 2005.
11
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Stock Programs
The Company has established the Fiscal 2002 Share Incentive Plan, the Fiscal
1999 Share Incentive Plan, the Fiscal 1996 Share Incentive Plan and the
Non-Employee Director Share Incentive Plan (collectively, the "Plans"). The
Plans provide for the issuance of 40,750,000 shares to be granted in the form of
stock-based awards to key employees, consultants and non-employee directors of
the Company. As of December 31, 2005, 10,925,200 shares of Class A Common Stock
were reserved and available to be granted pursuant to the Plans. In addition,
pursuant to executive employment agreements, the Company provides for the
issuance of 11,400,000 shares to be granted in the form of stock-based awards to
certain key executives. The Company has reserved 660,400 shares of its Class A
Common Stock pursuant to such agreements as of December 31, 2005. The Company
may satisfy the obligation of its stock based compensation awards with either
new or treasury shares. The Company's stock compensation awards outstanding at
December 31, 2005 include stock options, Performance Share Units ("PSU"),
Restricted Stock Units ("RSU") and share units.
Total net stock-based compensation expense is attributable to the granting of,
and the remaining requisite service periods of, stock options, PSUs, RSUs and
share units. Compensation expense attributable to net stock-based compensation
in the three months ended December 31, 2005 was $10.4 million ($6.8 million
after tax, or $0.03 for both basic and diluted earnings per share). Compensation
expense attributable to net stock-based compensation in the six months ended
December 31, 2005 was $23.6 million ($15.5 million after tax, or $0.07 for both
basic and diluted earnings per share). As of December 31, 2005, the total
unrecognized compensation cost related to nonvested stock awards was $55.2
million and the related weighted-average period over which it is expected to be
recognized is approximately 2.6 years.
Prior to the Company's adoption of SFAS No. 123(R), SFAS No. 123 required that
the Company provide pro forma information regarding net earnings and net
earnings per common share as if compensation cost for the Company's stock-based
awards had been determined in accordance with the fair value method prescribed
therein. The Company had previously adopted the disclosure portion of SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure,"
requiring quarterly SFAS No. 123 pro forma disclosure. The pro forma charge for
compensation cost related to stock-based awards granted was recognized over the
service period. For stock options, the service period represents the period of
time between the date of grant and the date each option becomes exercisable
without consideration of acceleration provisions (e.g., retirement, change of
control, etc.).
The following table illustrates the effect on net earnings per common share as
if the fair value method had been applied to all outstanding awards for the
three and six months ended December 31, 2004:
Three Months Ended Six Months Ended
December 31, 2004 December 31, 2004
--------------------- ---------------------
(Unaudited)
($ in millions)
Net earnings, as reported $ 138.3 $ 233.3
Deduct: Total stock-based compensation expense
determined under fair value method for all awards,
net of related tax effects (6.8) (13.5)
--------------- ---------------
Pro forma net earnings $ 131.5 $ 219.8
=============== ===============
Earnings per common share:
Net earnings per common share - Basic, as reported $ .61 $ 1.03
=============== ===============
Net earnings per common share - Basic, pro forma $ .58 $ .97
=============== ===============
Net earnings per common share - Diluted, as reported $ .60 $ 1.01
=============== ===============
Net earnings per common share - Diluted, pro forma $ .57 $ .95
=============== ===============
12
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Options
A summary of the Company's stock option programs as of December 31, 2005 and
changes during the six-month period then ended is presented below:
Weighted- Aggregate Weighted-Average
Average Intrinsic Contractual Life
Exercise Value(1) Remaining in
(Unaudited)(Shares in thousands) Shares Price (in millions) Years
- ---------------------------------------- ------------- ------------------- ------------------ -------------------
Outstanding at June 30, 2005 27,344.7 $ 38.42
Granted at fair value 1,569.3 34.97
Exercised (1,252.8) 21.92
Expired (127.2) 41.18
Forfeited (100.3) 37.65
-------------
Outstanding at December 31, 2005 27,433.7 38.96 $ 32.3 5.2
============= ================== ===================
Exercisable at December 31, 2005 20,132.7 39.68 $ 29.3 4.2
============= ================== ===================
- -----------------------------
(1) The intrinsic value of a stock option is the amount by which the current
market value of the underlying stock exceeds the exercise price of the
option.
The exercise period for all stock options generally may not exceed ten years
from the date of grant. Stock option grants to individuals generally become
exercisable in three substantively equal tranches over a service period of up to
four years.
The weighted-average grant date fair value of stock options granted during the
three months ended December 31, 2005 and 2004 was $10.69 and $14.72,
respectively. The weighted-average grant date fair value of stock options
granted during the six months ended December 31, 2005 and 2004 was $11.61 and
$16.47, respectively. The total intrinsic value of stock options exercised
during the three months ended December 31, 2005 and 2004 was $3.0 million and
$41.4 million, respectively. The total intrinsic value of stock options
exercised during the six months ended December 31, 2005 and 2004 was $22.4
million and $46.0 million, respectively.
The fair value of each option grant was estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions:
Three Months Ended
December 31
---------------------------------------------
(Unaudited) 2005 2004
- ------------------------------------------------------------ -------------------- --------------------
Weighted-average expected stock-price volatility 23% 31%
Weighted-average expected option life 7 years 6 years
Average risk-free interest rate 4.2% 3.8%
Average dividend yield .9% .9%
Six Months Ended
December 31
---------------------------------------------
(Unaudited) 2005 2004
- ------------------------------------------------------------ -------------------- --------------------
Weighted-average expected stock-price volatility 23% 32%
Weighted-average expected option life 8 years 7 years
Average risk-free interest rate 4.2% 3.9%
Average dividend yield .9% .7%
In addition to awards made by the Company, stock options were assumed as part of
the October 1997 acquisition of the companies that sold jane brand products.
There were 4,100 options to acquire shares of the Company's Class A Common Stock
outstanding and exercisable as of December 31, 2005 that will expire in May
2007.
13
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Performance Share Units
During the six months ended December 31, 2005, the Company issued 111,100 PSUs,
which will be settled in stock subject to the achievement of the Company's net
sales and net earnings per share goals for the three years ending June 30, 2008.
Settlement will be made pursuant to a range of opportunities relative to the net
sales and earnings per share targets of the Company. No settlement will occur
for results below the applicable minimum threshold and additional shares shall
be issued if performance exceeds the targeted performance goals. PSUs are
accompanied by dividend equivalent rights that will be payable in cash upon
settlement of the PSU. These awards are subject to the provisions of the
agreement under which the PSUs are granted. The PSUs were valued at $35.00
representing the closing market value of the Company's Class A Common Stock on
the date of grant and generally vest at the end of the performance period. The
compensation cost of the PSUs is subject to adjustment based upon the
attainability of the target goals.
The following is a summary of the status of the Company's PSUs as of December
31, 2005 and activity during the six months then ended:
Weighted-Average
Grant Date
(Unaudited) (Shares in thousands) Shares Fair Value
- ------------------------------------------------------- -------------------- -----------------------
Nonvested at June 30, 2005 - $ -
Granted 111.1 35.00
Vested - -
Forfeited - -
-------------------- ------------------------
Nonvested at December 31, 2005 111.1 $ 35.00
==================== ========================
Restricted Stock Units
The Company issued 111,100 RSUs during the six months ended December 31, 2005.
RSUs vest in one-third increments on or about October 31, 2006, 2007 and 2008,
subject to the continued employment of the grantee. RSUs are accompanied by
dividend equivalent rights that will be payable in cash upon settlement of the
RSU. These awards are subject to the provisions of the agreement under which the
RSUs are granted. The RSUs were valued at $35.00 representing the closing market
value of the Company's Class A Common Stock on the date of grant.
The following is a summary of the status of the Company's RSUs as of December
31, 2005 and activity during the six months then ended:
Weighted-Average
Grant Date
(Unaudited) (Shares in thousands) Shares Fair Value
- ------------------------------------------------------- -------------------- -----------------------
Nonvested at June 30, 2005 - $ -
Granted 111.1 35.00
Vested - -
Forfeited - -
-------------------- ------------------------
Nonvested at December 31, 2005 111.1 $ 35.00
==================== ========================
14
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Share Units
Certain non-employee directors defer cash compensation in the form of share
units which are granted under the Non-Employee Director Share Incentive Plan and
will be converted into shares of Class A Common Stock as provided for in that
plan. Share units are accompanied by dividend equivalent rights that are
converted to additional share units when such dividends are declared. The
following is a summary of the status of the Company's share units as of December
31, 2005 and activity during the six months then ended:
Weighted-Average
Grant Date
(Unaudited) (Shares in thousands) Shares Fair Value
- ------------------------------------------------------- -------------------- -----------------------
Outstanding at June 30, 2005 7.7 $ 39.13
Granted 5.2 33.45
Dividend equivalents 0.2 33.40
Converted - -
-------------------- ------------------------
Outstanding at December 31, 2005 13.1 $ 36.79
==================== ========================
Cash Units
Certain non-employee directors defer cash compensation in the form of cash
payout share units, which are not subject to the Plans. These share units are
classified as liabilities and, as such, their fair value is adjusted to reflect
the current market value of the Company's Class A Common Stock. The Company
recorded $0.1 million and $0.3 million as compensation expense to reflect
additional deferrals and the change in the market value for the three months
ended December 31, 2005 and 2004, respectively. Compensation expense for the six
months ended December 31, 2005 was de minimis and for 2004 was $0.1 million.
Note 4 - Discontinued Operations and Assets Held For Sale
On September 30, 2005, the Company committed to a plan to sell the assets and
operations of its reporting unit that markets and sells Stila brand products and
to actively seek a buyer for the brand. Following this decision, and as a result
of our efforts to sell the assets and operations of this reporting unit during
the quarter ended December 31, 2005, the Company recorded a charge of $68.7
million (net of $14.2 million tax benefit) and $72.0 million (net of $16.2
million tax benefit) as discontinued operations for the three and six months
ended December 31, 2005, respectively. The charge reflects the anticipated loss
on the sale of the business of $65.5 million, net of tax, and the operating loss
of $3.2 million, net of tax, and $6.5 million, net of tax, for the three and six
months ended December 31, 2005, respectively. Net sales associated with the
discontinued operations were $12.1 million and $25.7 million for the three and
six months ended December 31, 2005, respectively. All statements of earnings
information for the prior periods has been restated for comparative purposes,
including the restatement of the makeup product category and each of the
geographic regions presented in Note 5.
15
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The assets and liabilities of the Stila brand are presented in the consolidated
balance sheet under captions "Assets held for sale" and "Liabilities related to
assets held for sale." The carrying amounts of the major classes of these assets
and liabilities were as follows:
December 31
2005
-------------------
(Unaudited)
(In millions)
Assets
Accounts receivable, net $ 8.0
Inventory and promotional merchandise, net 15.8
Prepaid expenses and other current assets 0.9
Property, plant and equipment, net 6.2
Goodwill 13.4
Other assets 0.5
-------------------
Assets held for sale $ 44.8
===================
Liabilities
Accounts payable $ 1.5
Other accrued liabilities 3.3
-------------------
Liabilities related to assets held for sale $ 4.8
===================
Note 5 - 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, minority interest, net interest expense and discontinued operations. 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, 2005. 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, 2005.
16
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended Six Months Ended
December 31 December 31
----------------------- ----------------------
2005 2004 2005 2004
--------- --------- --------- ---------
(Unaudited)
(In millions)
PRODUCT CATEGORY DATA
Net Sales:
Skin Care $ 644.1 $ 617.4 $ 1,167.5 $ 1,141.7
Makeup 642.3 578.4 1,247.2 1,164.1
Fragrance 407.9 458.6 701.1 770.3
Hair Care 79.2 71.6 149.6 134.7
Other 10.4 10.3 15.6 15.8
--------- --------- --------- ---------
$ 1,783.9 $ 1,736.3 $ 3,281.0 $ 3,226.6
========= ========= ========= =========
Operating Income:
Skin Care $ 132.8 $ 120.9 $ 171.6 $ 185.7
Makeup 91.8 74.6 152.3 140.4
Fragrance 17.6 27.2 16.6 49.5
Hair Care 7.5 9.3 12.8 12.1
Other 1.0 0.7 2.5 1.3
--------- --------- --------- ---------
250.7 232.7 355.8 389.0
Reconciliation:
Interest expense, net 6.9 3.3 12.5 7.4
--------- --------- --------- ---------
Earnings before income taxes, minority interest
and discontinued operations $ 243.8 $ 229.4 $ 343.3 $ 381.6
========= ========= ========= =========
GEOGRAPHIC DATA
Net Sales:
The Americas $ 878.8 $ 870.2 $ 1,759.8 $ 1,750.0
Europe, the Middle East & Africa 658.9 626.4 1,076.4 1,048.4
Asia/Pacific 246.2 239.7 444.8 428.2
--------- --------- --------- ---------
$ 1,783.9 $ 1,736.3 $ 3,281.0 $ 3,226.6
========= ========= ========= =========
Operating Income:
The Americas $ 78.0 $ 86.0 $ 158.4 $ 194.5
Europe, the Middle East & Africa 132.0 117.1 154.4 159.1
Asia/Pacific 40.7 29.6 43.0 35.4
--------- --------- --------- ---------
$ 250.7 $ 232.7 $ 355.8 $ 389.0
========= ========= ========= =========
Note 6 - Cost Savings Initiative
As part of an initiative to reduce expenses, the Company offered a voluntary
separation program to North America-based employees. During the current
quarter, the Company recorded a $1.6 million charge related to the
implementation of this cost savings initiative. This charge represents the
initial cost relating to one element of the program. Additional non-recurring
expenses of approximately $30 million have been incurred subsequent to
December 31, 2005.
17
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 from continuing operations for the three and six months ended
December 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 Six Months Ended
December 31 December 31
-------------------------- ------------------------
2005 2004 2005 2004
----------- ---------- --------- ----------
(In millions)
Net Sales
By Region:
The Americas $ 878.8 $ 870.2 $ 1,759.8 $ 1,750.0
Europe, the Middle East & Africa 658.9 626.4 1,076.4 1,048.4
Asia/Pacific 246.2 239.7 444.8 428.2
----------- ---------- --------- ----------
$ 1,783.9 $ 1,736.3 $ 3,281.0 $ 3,226.6
=========== ========== ========= ==========
By Product Category:
Skin Care $ 644.1 $ 617.4 $ 1,167.5 $ 1,141.7
Makeup 642.3 578.4 1,247.2 1,164.1
Fragrance 407.9 458.6 701.1 770.3
Hair Care 79.2 71.6 149.6 134.7
Other 10.4 10.3 15.6 15.8
----------- ---------- --------- ----------
$ 1,783.9 $ 1,736.3 $ 3,281.0 $ 3,226.6
=========== ========== ========= ==========
OPERATING INCOME
By Region:
The Americas $ 78.0 $ 86.0 $ 158.4 $ 194.5
Europe, the Middle East & Africa 132.0 117.1 154.4 159.1
Asia/Pacific 40.7 29.6 43.0 35.4
----------- ---------- --------- ----------
$ 250.7 $ 232.7 $ 355.8 $ 389.0
=========== ========== ========= ==========
By Product Category:
Skin Care $ 132.8 $ 120.9 $ 171.6 $ 185.7
Makeup 91.8 74.6 152.3 140.4
Fragrance 17.6 27.2 16.6 49.5
Hair Care 7.5 9.3 12.8 12.1
Other 1.0 0.7 2.5 1.3
----------- ---------- --------- ----------
$ 250.7 $ 232.7 $ 355.8 $ 389.0
=========== ========== ========= ==========
18
THE ESTEE LAUDER COMPANIES INC.
The following table presents certain consolidated earnings data as a percentage
of net sales:
Three Months Ended Six Months Ended
December 31 December 31
------------------------- ----------------------
2005 2004 2005 2004
-------- -------- --------- --------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 25.7 25.6 26.8 26.4
-------- -------- --------- ---------
Gross profit 74.3 74.4 73.2 73.6
-------- -------- --------- ---------
Operating expenses:
Selling, general and administrative 60.1 61.0 62.4 61.6
Cost savings initiative 0.1 - - -
-------- -------- --------- ---------
60.2 61.0 62.4 61.6
-------- -------- --------- ---------
Operating income 14.1 13.4 10.8 12.0
Interest expense, net 0.4 0.2 0.4 0.2
-------- -------- --------- ---------
Earnings before income taxes, minority interest and
discontinued operations 13.7 13.2 10.4 11.8
Provision for income taxes 5.1 5.0 3.8 4.4
Minority interest, net of tax (0.2) (0.2) (0.1) (0.1)
-------- -------- --------- ---------
Net earnings from continuing operations 8.4 8.0 6.5 7.3
Discontinued operations, net of tax (3.8) - (2.2) (0.1)
-------- -------- --------- ---------
Net earnings 4.6% 8.0% 4.3% 7.2%
======== ======== ========= =========
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. The
introduction of new products may have some cannibalizing effect on sales of
existing products, which we take into account in our business planning.
Second Quarter Fiscal 2006 as Compared with Second Quarter Fiscal 2005
Net Sales
Net sales increased 3% or $47.6 million to $1,783.9 million due to growth in our
makeup, skin care and hair care product categories, which was partially offset
by lower sales in our fragrance product category. The net increase also reflects
sales growth in all geographic regions led by Europe, the Middle East & Africa,
despite the unfavorable effect of changes in exchange rates. Excluding the
impact of foreign currency translation, net sales increased 5%.
Product Categories
Skin Care
Net sales of skin care products increased 4% or $26.7 million to $644.1 million
due primarily to new product launches. The recent launches of Perfectionist
[CP+], Re-Nutriv Ultimate Lifting Serum and Resilience Lift Extreme Ultra
Firming Cremes by Estee Lauder and Repairwear Deep Wrinkle Concentrate for Face
and Eye and Turnaround Concentrate Visible Skin Renewer and Turnaround 15-Minute
Facial by Clinique generated incremental sales of approximately $53 million.
Sales of products in Clinique's 3-Step Skin Care System, bolstered by the
introduction of Liquid Facial Soap, also contributed approximately $11 million
to the increase. These contributions to net sales were partially offset by
decreases in sales of Perfectionist Correcting Serum for Lines/Wrinkles/Age
Spots, certain Resilience Lift and Idealist products by Estee Lauder, of
approximately $27 million, collectively, and certain other existing product
lines. Excluding the impact of foreign currency translation, skin care net sales
increased 7%.
19
THE ESTEE LAUDER COMPANIES INC.
Makeup
Makeup net sales increased 11% or $63.9 million to $642.3 million primarily
reflecting growth from our makeup artist brands of approximately $46 million.
Sales growth from new products such as Repairwear Anti-Aging Makeup SPF 15 and
Colour Surge Butter Shine Lipstick by Clinique and Individualist Natural
Finish Makeup and Tender Blush by Estee Lauder contributed a combined $26
million to the category. Partially offsetting these increases were lower sales
of approximately $10 million of Superbalanced Compact Makeup SPF 20 by Clinique
and So Ingenious by Estee Lauder. Excluding the impact of foreign currency
translation, makeup net sales increased 13%.
Fragrance
Net sales of fragrance products decreased 11% or $50.7 million to $407.9 million
as we continue to be challenged in this product category. Lower sales of Estee
Lauder Beyond Paradise and Beautiful by Estee Lauder, Tommy Girl and Tommy by
Tommy Hilfiger and various fragrances from Clinique contributed approximately
$49 million to this decrease. Also contributing to the decrease were lower sales
of approximately $14 million of True Star by Tommy Hilfiger and Lauder Beyond
Paradise Men, which were launched in the first quarter of the prior fiscal year.
Partially offsetting these decreases were higher sales of DKNY Be Delicious,
incremental sales of DKNY Be Delicious Men and the initial shipments of True
Star Men by Tommy Hilfiger of approximately $37 million, collectively. Excluding
the impact of foreign currency translation, fragrance net sales decreased 9%.
Hair Care
Hair care net sales increased 11% or $7.6 million to $79.2 million, primarily
due to sales growth from Bumble and bumble and Aveda products. Bumble and bumble
sales benefited from sales growth due to new points of distribution, as well as
sales growth in both core and hair treatment products. Aveda net sales increased
as a result of sales of professional color products and the recent launch of
Damage Remedy hair care products. Foreign currency translation had a de minimis
impact on hair care net sales compared to the prior period.
Geographic Regions
Net sales in the Americas increased 1% or $8.6 million to $878.8 million. The
increase was led by growth in the makeup and hair care product categories and
overall growth in our online business, Canada and Mexico. Sales in this region
were tempered by decreased sales in certain of our core brands which are facing
challenges, particularly in the fragrance category, and business disruptions at
certain key retailers in the United States. In the current quarter, we made an
incremental provision for anticipated returns reflecting our estimate of the
expected impact of announced store closings by certain retailer groups of
approximately $13 million. Net sales in the Americas region were negatively
impacted by approximately $3 million attributable to the loss of sales to those
retail locations that remained closed during the quarter due to the hurricanes
in the southern United States. We expect disruptions to continue throughout the
remainder of the fiscal year at certain key retailers in the United States.
In Europe, the Middle East & Africa, net sales increased 5% or $32.5 million to
$658.9 million, reflecting higher net sales of approximately $34 million in our
travel retail business, the United Kingdom, Russia and Spain, all of which
benefited from the continued success of DKNY Be Delicious, the launches of
certain skin care products and a favorable holiday selling season. These
increases were partially offset by lower sales in Germany and France of
approximately $7 million, collectively, where business remains challenging. On a
local currency basis, net sales in Europe, the Middle East & Africa increased
11% which reflects the strengthening of the U.S. dollar as compared with
currencies in this region.
20
THE ESTEE LAUDER COMPANIES INC.
Net sales in Asia/Pacific increased 3% or $6.5 million to $246.2 million.
Strategic expansion in China combined with positive results in Korea and Hong
Kong, contributed approximately $16 million to sales growth in this region.
These increases were partially offset by decreases in Japan and Australia of
approximately $12 million. The decrease in Australia reflected slower
sell-through in a difficult retail environment, particularly in the fragrance
category. Japan's results were negatively impacted due to the strengthening of
the U.S. dollar against the Japanese yen. On a local currency basis, net sales
in Asia/Pacific 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 25.7% as compared
with 25.6% in the prior period. This reflected an increase in obsolescence
charges of approximately 40 basis points proportionate to the change in
inventory levels and unfavorable changes in exchange rates and higher travel
retail sales, which carry a higher cost of sales, of approximately 20 basis
points. Partially offsetting these increases was the net change in the mix of
our business within our geographic regions and product categories and the effect
of a shift in the timing of shipments of promotional goods of approximately 40
basis points, combined.
The higher price of oil has resulted in price increases in certain oil-based
chemicals, which we believe may have a slight adverse effect on our cost of
sales margin. In an ongoing effort to mitigate the impact of these increases, we
are seeking potential offsetting opportunities in other categories of material
purchases.
Since certain promotional activities are a component of sales or cost of sales
and the timing and level of promotions vary with our promotional calendar, we
have experienced, and expect to continue to experience, fluctuations in the cost
of sales percentage. In addition, future cost of sales mix may be impacted by
the inclusion of new brands which have margin and product cost structures
different from those of our existing brands.
Operating Expenses
Operating expenses decreased to 60.2% of net sales as compared with 61.0% of net
sales in the prior period. The decrease in the margin represents a 170 basis
point improvement reflecting a shift in advertising and promotional activities
to the latter part of the fiscal year and disciplined spending relative to
marketing and general and administrative activities. Also contributing 50 basis
points to this improvement was sales growth in higher margin businesses which
have a positive influence on the operating expense margin. Partially offsetting
this improvement was an increase of approximately 60 basis points from the
recognition of stock-based compensation expense as a result of the adoption of
Statement of Financial Accounting Standards ("SFAS") No. 123(R), "Share-Based
Payment" ("SFAS No. 123(R)"). The improvement in operating expense margin was
also tempered by the incremental provision for anticipated sales returns
reflecting our estimate of the expected impact of announced store closings by
certain retailer groups of 40 basis points, the repurchase of inventory from
liquidators of 20 basis points and the estimated loss of sales to those retail
locations that remained closed due to the hurricanes in the southern United
States of 10 basis points.
During the quarter, we recorded a $1.6 million charge related to the
implementation of cost savings initiatives, negatively impacting our operating
margin by 10 basis points. This charge represents the initial cost relating to
one element of the program. Additional non-recurring expenses of approximately
$30 million have been incurred subsequent to December 31, 2005. This initiative
is expected to generate cost savings for the balance of this fiscal year and for
future periods.
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
Due to growth in net sales, coupled with relatively flat cost of sales and
improved operating expense margins as previously discussed, operating income
increased 8%, or $18.0 million, to $250.7 million as compared with the prior
period. Operating margin was 14.1% of net sales in the current period as
compared with 13.4% in the prior period.
21
THE ESTEE LAUDER COMPANIES INC.
Product Categories
Operating income improved 23% or $17.2 million to $91.8 million in the makeup
product category, primarily reflecting sales growth from our makeup artist
brands as well as new product launches. Skin care operating income improved 10%
or $11.9 million to $132.8 million as a result of increased sales. These
improvements were partially offset by lower results in the fragrance product
category, which declined 35% or $9.6 million to $17.6 million reflecting lower
sales and, to a lesser extent, expenses incurred related to development of new
products and brands. Hair care operating income decreased 19% or $1.8 million to
$7.5 million reflecting expenses related to the integration of an acquired
distributor business, customer retention programs as well as start-up costs as a
result of expanded points of distribution.
Geographic Regions
Operating income in the Americas decreased 9% or $8.0 million to $78.0 million,
primarily reflecting incremental operating expenses associated with new
accounting rules for stock-based compensation and the incremental provision for
anticipated sales returns reflecting our estimate of the expected impact of
announced store closings by certain retailer groups of approximately $10 million
each. Operating results in the Americas benefited from higher sales from our
makeup artist brands and our online business. We expect disruptions to continue
throughout the remainder of the fiscal year at certain key retailers in the
United States.
In Europe, the Middle East & Africa, operating income increased 13% or $14.9
million to $132.0 million primarily due to improved results of approximately $16
million from our travel retail business, France, Germany, South Africa,
Switzerland and Spain, partially offset by declines in the United Kingdom and
Greece of approximately $5 million, collectively.
In Asia/Pacific, operating income increased 38% or $11.1 million to $40.7
million. This increase reflects improved results of approximately $12 million in
Korea, China and Japan, partially offset by lower results in Australia, Taiwan
and Malaysia of approximately $3 million.
Interest Expense, Net
Net interest expense was $6.9 million as compared with $3.3 million in the prior
period. The increase in net interest expense was primarily due to a higher level
of borrowings compared with the prior period as a result of the issuance of
commercial paper. The increased expense was slightly offset by increased
interest income related to higher investment interest rates.
Provision for Income Taxes
The provision for income taxes represents Federal, foreign, state and local
income taxes. The effective rate differs from statutory rates due to the effect
of state and local taxes, tax rates in foreign jurisdictions and certain
nondeductible expenses. The Company's effective tax rate will change from
quarter to quarter based on non-recurring and recurring factors including, but
not limited to, the geographic mix of earnings, the timing and amount of foreign
dividends, enacted tax legislation, state and local taxes, tax audit settlements
and the interaction of various global tax strategies. The effective rate for
income taxes for the three months ended December 31, 2005 was 37.0% as compared
with 37.6% in the prior period. The decrease in the effective income tax rate of
60 basis points was primarily attributable to a decrease in state and local
income tax expense (30 basis points), an increase in tax credits (20 basis
points) and miscellaneous items (10 basis points).
Discontinued Operations
On September 30, 2005, we committed to a plan to sell the assets and operations
of our reporting unit that markets and sells Stila brand products and to
actively seek a buyer for the brand. Following this decision, and as a result of
our efforts to sell the assets and operations of this reporting unit during the
quarter ended December 31, 2005, we recorded a charge of $68.7 million (net of
$14.2 million tax benefit) as discontinued operations for the three months ended
December 31, 2005. The charge reflects the anticipated loss on the sale of the
business of $65.5 million, net of tax, and the operating loss of $3.2 million,
net of tax, for the three months ended December 31, 2005. All consolidated
statements of earnings information for prior periods has been restated for
comparative purposes, including the restatement of the makeup product category
and all geographic regions data.
22
THE ESTEE LAUDER COMPANIES INC.
Six Months Fiscal 2006 as Compared with Six Months Fiscal 2005
Net Sales
Net sales increased 2% or $54.4 million to $3,281.0 million due to growth in our
makeup, skin care and hair care product categories, which was partially offset
by lower sales in our fragrance product category. The net increase also reflects
sales growth in all geographic regions led by Europe, the Middle East & Africa,
despite the unfavorable effects of changes in exchange rates. Excluding the
impact of foreign currency translation, net sales increased 3%.
Product Categories
Skin Care
Net sales of skin care products increased 2% or $25.8 million to $1,167.5
million due primarily to new product launches. The recent launches of
Perfectionist [CP+] and Resilience Lift Extreme Ultra Firming Cremes by Estee
Lauder and Repairwear Deep Wrinkle Concentrate for Face and Eye by Clinique
generated incremental sales of approximately $60 million. Sales of products in
Clinique's 3-Step Skin Care System, bolstered by the introduction of Liquid
Facial Soap, also contributed approximately $11 million to the increase. These
improvements were offset by decreases in certain Perfectionist Correcting Serum
for Lines/Wrinkles/Age Spots, Resilience Lift, White Light and Future Perfect
Anti-Wrinkle Radiance products by Estee Lauder of approximately $45 million,
collectively. Excluding the impact of foreign currency translation, skin care
net sales increased 3%.
Makeup
Makeup net sales increased 7% or $83.1 million to $1,247.2 million primarily
reflecting strong growth from our makeup artist brands as well as new product
launches, which offset challenges experienced by certain of our core brands. The
increase contributed by our makeup artist brands reflected growth from many
products including approximately $16 million from Small Eye Shadow and Fluidline
by M.A.C. Sales growth from new products included a combined $52 million of
sales of Repairwear Anti-Aging Makeup SPF 15 and Colour Surge Butter Shine
Lipstick by Clinique and Individualist Natural Finish Makeup and Tender Blush by
Estee Lauder. Offsetting these increases were lower sales of existing products,
including approximately $26 million of Superbalanced Compact Makeup SPF 20 by
Clinique and Lash XL Maximum Length Mascara by Estee Lauder. Excluding the
impact of foreign currency translation, makeup net sales increased 8%.
Fragrance
Net sales of fragrance products decreased 9% or $69.2 million to $701.1 million
as we continue to be challenged in this product category. Lower sales of Estee
Lauder Beyond Paradise, Tommy Girl and Tommy by Tommy Hilfiger and various
fragrances from Clinique contributed approximately $74 million to the decrease.
Also contributing to the decrease were lower sales of approximately $34 million
of True Star by Tommy Hilfiger and Lauder Beyond Paradise Men as we anniversary
the initial shipments of those products in the prior period. Partially
offsetting these decreases were higher sales of DKNY Be Delicious, incremental
sales of DKNY Be Delicious Men and the initial shipments of True Star Men by
Tommy Hilfiger of approximately $68 million, collectively. Excluding the impact
of foreign currency translation, fragrance net sales decreased 8%.
Hair Care
Hair care net sales increased 11% or $14.9 million to $149.6 million, primarily
due to sales growth from Bumble and bumble and Aveda products. Bumble and bumble
sales benefited from sales growth due to new points of distribution, as well as
sales growth in both core and treatment products. Aveda net sales increased as a
result of sales of professional color products and the recent launch of Damage
Remedy hair care products. Foreign currency translation had a de minimis impact
on hair care net sales compared to the prior period.
Geographic Regions
Net sales in the Americas increased 1% or $9.8 million to $1,759.8 million. The
increase was led by growth in our makeup and hair care product categories and
overall growth in our online business, Canada and Mexico. Sales in this region
were tempered by decreased sales in certain of our core brands which are facing
challenges, particularly in the fragrance category. In the current period, we
made an incremental provision for anticipated returns reflecting our estimate of
the expected impact of announced store closings by certain retailer groups of
approximately $13 million. Net sales in the Americas region were negatively
impacted by approximately $5 million attributable to the loss of sales to retail
locations that closed during the period as a result of the hurricanes in the
southern United States. We expect disruptions to continue throughout the
remainder of the fiscal year at certain key retailers in the United States.
23
THE ESTEE LAUDER COMPANIES INC.
In Europe, the Middle East & Africa, net sales increased 3% or $28.0 million to
$1,076.4 million, reflecting higher net sales of approximately $27 million in
our travel retail and distributor businesses and Russia. These increases were
partially offset by decreases in Spain, France and Italy of approximately $6
million, collectively. On a local currency basis, net sales in Europe, the
Middle East & Africa increased 6%.
During the current period, we commenced operations at a new regional inventory
center in Europe. However, unforeseen logistical issues related to start-up
activities resulted in disruptions in shipments to certain European markets
serviced from this center during the first fiscal quarter. These issues have
since been addressed and while we believe lost sales will not be fully
recovered, the inventory center is now operating as originally planned.
Net sales in Asia/Pacific increased 4% or $16.6 million to $444.8 million.
Strategic expansion in China combined with positive results in Korea and Hong
Kong, contributed approximately $26 million to sales growth in this region.
These increases were partially offset by decreases in Japan and Australia of
approximately $12 million. The decrease in Australia reflected slower
sell-through in a difficult retail environment, particularly in the fragrance
category. Japan's results were negatively impacted due to the strengthening of
the U.S. dollar against the Japanese yen. However, foreign currency translation
had a de minimis impact on Asia/Pacific net sales in this period.
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 26.8% as compared
with 26.4% in the prior period. This reflected an increase in obsolescence
charges of approximately 50 basis points proportionate to the change in
inventory levels and unfavorable changes in exchange rates and higher travel
retail sales of approximately 20 basis points. Partially offsetting these
increases was the net change in the mix of our business within our geographic
regions and product categories of approximately 30 basis points.
The higher price of oil has resulted in price increases in certain oil-based
chemicals which we believe may have a slight adverse effect on our cost of sales
margin. In an ongoing effort to mitigate the impact of these increases, we are
seeking potential offsetting opportunities in other categories of material
purchases.
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 62.4% of net sales as compared with 61.6% of net
sales in the prior period. Approximately 70 basis points were due to the
recognition of costs related to stock-based compensation as a result of the
adoption of SFAS No. 123(R). Also contributing to the increase was an adjustment
to net sales for the incremental provision for anticipated sales returns
reflecting our estimate of the expected impact of announced store closings by
certain retailer groups of 30 basis points as well as the repurchase of
inventory from liquidators and the estimated loss of sales to those retail
locations that were forced to close following the hurricanes that affected the
southern United States of 10 basis points each. In addition, the increase
reflects 10 basis points for spending to support the company-wide initiative to
upgrade our information systems. Partially offsetting these increases was sales
growth in higher margin businesses which had a positive influence on the
operating expense margin of 40 basis points and a 10 basis point improvement
reflecting a shift in advertising and promotional activities to the latter part
of the fiscal year and disciplined spending relative to marketing and general
and administrative activities.
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.
24
THE ESTEE LAUDER COMPANIES INC.
Operating Results
Due to modest growth in net sales, coupled with the increases in our cost of
sales and operating expense margins as previously discussed, operating income
decreased 9%, or $33.2 million, to $355.8 million as compared with the prior
period. Operating margin was 10.8% of net sales in the current period as
compared with 12.0% in the prior period.
Product Categories
Operating income declined 66% or $32.9 million to $16.6 million in the fragrance
product category reflecting lower sales and, to a lesser extent, expenses
incurred related to development of new products and brands. Skin care operating
income decreased 8% or $14.1 million to $171.6 million primarily reflecting
lower than anticipated net sales, coupled with spending to support new product
launches. Operating income increased 8% or $11.9 million to $152.3 million in
the makeup product category primarily reflecting sales growth from our makeup
artist brands. Hair care operating income increased 6% reflecting worldwide
sales growth.
Geographic Regions
Operating income in the Americas decreased 19% or $36.1 million to $158.4
million, primarily reflecting incremental operating expenses associated with new
accounting rules for stock-based compensation of approximately $22 million and
the incremental provision for anticipated sales returns reflecting our estimate
of the expected impact of announced store closings by certain retailer groups of
approximately $10 million. Operating results in the Americas benefited from
higher sales from our makeup artist brands and our online business. We expect
disruptions to continue throughout the remainder of the fiscal year at certain
key retailers in the United States.
In Europe, the Middle East & Africa, operating income decreased 3% or $4.7
million to $154.4 million primarily due to lower results of approximately $17
million in the United Kingdom, Spain and Greece, partially offset by improved
results in France, our travel retail business, Germany and South Africa of
approximately $13 million, collectively. Operating results were also negatively
impacted in continental Europe due to the first quarter shortfall in product
shipments from our new regional inventory center discussed above.
In Asia/Pacific, operating income increased 21% or $7.6 million to $43.0
million. This increase reflects improved results of approximately $11 million in
Korea, China and Japan, partially offset by lower results in Taiwan, Australia
and Malaysia of approximately $3 million.
Interest Expense, Net
Net interest expense was $12.5 million as compared with $7.4 million in the
prior period. The increase in net interest expense was primarily due to a higher
level of borrowings compared with the prior period as a result of the issuance
of commercial paper. The increased expense was partially offset by increased
interest income related to higher investment interest rates.
Provision for Income Taxes
The provision for income taxes represents Federal, foreign, state and local
income taxes. The effective rate differs from statutory rates due to the effect
of state and local taxes, tax rates in foreign jurisdictions and certain
nondeductible expenses. The Company's effective tax rate will change from
quarter to quarter based on non-recurring and recurring factors including, but
not limited to, the geographic mix of earnings, the timing and amount of foreign
dividends, enacted tax legislation, state and local taxes, tax audit settlements
and the interaction of various global tax strategies. The effective rate for
income taxes for the six months ended December 31, 2005 was 36.7% as compared
with 37.4% in the prior period. The decrease in the effective income tax rate of
70 basis points was primarily attributable to a decrease in state and local
income tax expense (30 basis points), an increase in tax credits (20 basis
points) and miscellaneous items (20 basis points).
25
THE ESTEE LAUDER COMPANIES INC.
Discontinued Operations
On September 30, 2005, we committed to a plan to sell the assets and operations
of our reporting unit that markets and sells Stila brand products and to
actively seek a buyer for the brand. Following this decision, and as a result of
our efforts to sell the assets and operations of this reporting unit during the
quarter ended December 31, 2005, we recorded a charge of $72.0 million (net of
$16.2 million tax benefit) as discontinued operations for the six months ended
December 31, 2005. The charge reflects the anticipated loss on the sale of the
business of $65.5 million, net of tax, and the operating loss of $6.5 million,
net of tax, for the six months ended December 31, 2005. All consolidated
statements of earnings information for prior periods has been restated for
comparative purposes, including the restatement of the makeup product category
and all geographic regions data.
Financial Condition
- -------------------
Liquidity and Capital Resources
Our principal sources of funds historically have been cash flows from operations
and borrowings under commercial paper, borrowings from the issuance of long-term
debt and committed and uncommitted credit lines provided by banks and other
lenders in the United States and abroad. At December 31, 2005, we had cash and
cash equivalents of $370.3 million compared with $553.3 million at June 30,
2005.
At December 31, 2005, our outstanding borrowings of $651.2 million included: (i)
$237.9 million of 6% Senior Notes due January 2012 consisting of $250.0 million
principal, unamortized debt discount of $0.7 million and an $11.4 million
adjustment to reflect the fair value of an outstanding interest rate swap; (ii)
$197.4 million of 5.75% Senior Notes due October 2033 consisting of $200.0
million principal and unamortized debt discount of $2.6 million; (iii) a 3.0
billion yen term loan (approximately $25.6 million at the exchange rate at
December 31, 2005), which is due in March 2006; (iv) a 1.8 million Euro note
(approximately $1.8 million at the exchange rate at December 31, 2005) payable
semi-annually through February 2008 at a variable interest rate; (v) $7.8
million of capital lease obligations; (vi) $155.8 million of outstanding
short-term commercial paper payable through January 2006 at a weighted-average
interest rate of 4.29%; and (vii) $24.9 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 December 31, 2005, we had $155.8 million of commercial paper
outstanding, which is being refinanced on a periodic basis as it matures at then
prevailing market interest rates. We also have an effective shelf registration
statement covering the potential issuance of up to an additional $300.0 million
in debt securities and $169.0 million in additional uncommitted credit
facilities, of which $24.9 million was used as of December 31, 2005.
We have an unused $600.0 million senior revolving credit facility that expires
on May 27, 2010. The facility may be used for general corporate purposes,
including financing working capital, and also as credit support for our
commercial paper program. Up to the equivalent of $250.0 million of the facility
is available for multi-currency loans. The interest rate on borrowings under the
credit facility is based on LIBOR or on the higher of prime, which is the rate
of interest publicly announced by the administrative agent, or the Federal funds
rate plus 1/2%. The credit facility has an annual fee of $0.4 million, payable
quarterly, based on our current credit ratings. As of December 31, 2005, we were
in compliance with all related financial and other restrictive covenants,
including limitations on indebtedness and liens.
In October 2005, we redeemed the remaining $68.4 million of the 2015 Preferred
Stock that was outstanding at June 30, 2005 and paid the accrued dividends
thereon.
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 30% at December 31, 2005 and
June 30, 2005.
26
THE ESTEE LAUDER COMPANIES INC.
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 $388.7
million during the six months ended December 31, 2005 as compared with net cash
provided of $304.6 million in the prior period. The improvement in cash flows
provided by operating activities primarily reflected collections of certain
domestic accounts receivable early in the fiscal year. Also reflected in the
improvement of cash flows provided by operating activities was a reduction in
global inventory levels due to concerted ongoing efforts to reduce inventory
levels, the commencement of operations in our new distribution center in Europe,
as well as improvements domestically as we anniversary the initial shipments of
our BeautyBank brands.
Net cash used for investing activities was $150.1 million during the six months
ended December 31, 2005 compared with $114.9 million in the prior period. For
both periods the use of cash primarily reflected capital expenditures, which
were slightly lower during the current period. Additional cash used for
investing activities in the current period reflects the earn-out payment related
to the fiscal 2000 acquisition of Jo Malone Limited.
Net cash used for financing activities was $414.7 million during the six months
ended December 31, 2005 compared to net cash used for financing activities of
$233.5 million in the prior period. This change from the prior period primarily
reflected the acquisition of treasury stock and the redemption of the remaining
shares of 2015 Preferred Stock.
Dividends
On November 10, 2005, the Board of Directors declared an annual dividend of $.40
per share, or $85.5 million, on our Class A and Class B Common Stock, which was
paid on December 28, 2005 to stockholders of record at the close of business on
December 9, 2005. The annual common stock dividend declared during the period
ended December 31, 2004 was $.40 per share, or $90.1 million, which was paid on
December 28, 2004 to stockholders of record at the close of business on December
10, 2004. Dividends on the 2015 Preferred Stock were $0.5 million and $0.3
million for the six months ended December 31, 2005 and 2004, respectively. These
dividends have been characterized as interest expense in the accompanying
consolidated statements of earnings for the six months ended December 31, 2005
and 2004.
Share Repurchase Program
We are authorized by the Board of Directors to repurchase up to 48.0 million
shares of Class A Common Stock in the open market or in privately negotiated
transactions, depending on market conditions and other factors. As of December
31, 2005, the cumulative total of acquired shares pursuant to the authorization
was 36.2 million, reducing the remaining authorized share repurchase balance to
11.8 million. During the first six months of fiscal 2006, we purchased
approximately 8.8 million shares for $305.8 million as outlined in the following
table:
Total Number of Maximum Number of
Shares Purchased as Shares that May
Total Number of Average Price Part of Publicly Yet Be Purchased
Period Shares Purchased Paid Per Share Announced Program(1) Under the Program
- ------------------- ------------------ ----------------- ----------------------- --------------------
July 2005 - - - 20,607,900
August 2005 - - - 20,607,900
September 2005 1,919,700 37.04 1,919,700 18,688,200
October 2005 3,726,700 35.02 3,726,700 14,961,500
November 2005 1,893,800 33.01 1,893,800 13,067,700
December 2005 1,237,800 33.71 1,237,800 11,829,900
------------------ -----------------------
Year-to-date 8,778,000 34.84 8,778,000 11,829,900
================== =======================
(1) The publicly announced repurchase program was last increased by 20.0
million shares on May 18, 2005. The initial program covering the repurchase
of 8.0 million shares was announced in September 1998 and increased by 10.0
million shares on both May 11, 2004 and October 30, 2002.
27
THE ESTEE LAUDER COMPANIES INC.
Commitments and Contingencies
In October 2005, we redeemed the remaining $68.4 million of the 2015 Preferred
Stock that was outstanding at June 30, 2005 and paid the accrued dividends
thereon.
In December 2005, we made a cash payment of $36.4 million to satisfy our
obligation related to an earn-out provision, which was part of our fiscal 2000
acquisition of Jo Malone Limited.
Contractual Obligations
Since June 30, 2005, we made additional commitments pursuant to employment
agreements of approximately $30 million, which are expected to be paid through
fiscal 2011. Furthermore, we committed to spend approximately $21 million to
support the company-wide initiative to upgrade our information systems, which is
expected to be paid through November 2006.
During the quarter, we began to implement a cost savings initiative that has
been designed to generate between $40 and $45 million in savings this fiscal
year, and approximately $75 million annually. We anticipate this multi-faceted
initiative to result in one-time costs of approximately $90 million as it is
rolled out during the fiscal year. The first phase of this project, which took
place in December 2005, resulted in a charge of approximately $1.6 million.
Subsequent to December 31, 2005 and through January 24, 2006, approximately $30
million was recorded. These charges relate to employee commitments, which will
be paid through fiscal 2008.
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, 2005.
Foreign Exchange Risk Management
We enter into forward exchange contracts to hedge anticipated transactions as
well as receivables and payables denominated in foreign currencies for periods
consistent with our identified exposures. The purpose of the hedging activities
is to minimize the effect of foreign exchange rate movements on our costs and on
the cash flows that we receive from foreign subsidiaries. Almost all foreign
currency contracts are denominated in currencies of major industrial countries
and are with large financial institutions rated as strong investment grade by a
major rating agency. We also enter into foreign currency options to hedge
anticipated transactions where there is a high probability that anticipated
exposures will materialize. The forward exchange contracts and foreign currency
options entered into to hedge anticipated transactions have been designated as
cash-flow hedges. As of December 31, 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 December 31, 2005, we had foreign currency contracts in the form of
forward exchange contracts and option contracts in the amount of $417.6 million
and $68.2 million, respectively. The foreign currencies included in forward
exchange contracts (notional value stated in U.S. dollars) are principally the
British pound ($98.0 million), Swiss franc ($61.9 million), Canadian dollar
($60.2 million), Euro ($37.5 million) and Australian dollar ($32.3 million). The
foreign currencies included in the option contracts (notional value stated in
U.S. dollars) are principally the Japanese yen ($18.2 million), Swiss franc
($14.8 million), South Korean won ($13.4 million) and Euro ($11.7 million).
28
THE ESTEE LAUDER COMPANIES INC.
Interest Rate Risk Management
We enter into interest rate derivative contracts to manage the exposure to
fluctuations of interest rates on our funded indebtedness and anticipated
issuance of debt, as well as cash investments, for periods consistent with the
identified exposures. All interest rate derivative contracts are with large
financial institutions rated as strong investment grade by a major rating
agency.
We have an interest rate swap agreement with a notional amount of $250.0 million
to effectively convert fixed interest on the existing $250.0 million 6% Senior
Notes to variable interest rates based on LIBOR. We designated the swap as a
fair-value hedge. As of December 31, 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, 2005, our average value-at-risk, calculated
for the most recent twelve months, is $5.3 million related to our foreign
exchange contracts. As of December 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 $9.0 million. There have been no significant
changes in market risk since June 30, 2005 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, 2005.
Off-Balance Sheet Arrangements
We do not maintain any off-balance sheet arrangements, transactions, obligations
or other relationships with unconsolidated entities that would be expected to
have a material current or future effect upon our financial condition or results
of operations.
Critical Accounting Policies
- ----------------------------
As disclosed in our Annual Report on Form 10-K for the fiscal year ended June
30, 2005, 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, 2005, there have been no significant changes to
the assumptions and estimates related to those critical accounting policies.
With the adoption of SFAS No. 123(R) on July 1, 2005, the Company is required to
record the fair value of stock-based compensation awards as an expense. In order
to determine the fair value of stock options on the date of grant, the Company
applies the Black-Scholes option-pricing model. Inherent in this model are
assumptions related to expected stock-price volatility, option life, risk-free
interest rate and dividend yield. While the risk-free interest rate and dividend
yield are less subjective assumptions, typically based on factual data derived
from public sources, the expected stock-price volatility and option life
assumptions require a greater level of judgment which makes them critical
accounting estimates.
We use an expected stock-price volatility assumption that is a combination of
both current and historical implied volatilities of the underlying stock which
are obtained from public data sources. This approach is a good predictor of
future realized and implied volatilities and is directly relevant for valuing
stock options. For stock option grants issued during the three and six months
ended December 31, 2005, we used a weighted-average expected stock-price
volatility of 23% based upon the implied volatility at the time of issuance.
With regard to the weighted-average option life assumption, we consider the
exercise behavior of past grants and model the pattern of aggregate exercises.
Patterns are determined on specific criteria of the aggregate pool of optionees
including the reaction to vesting, realizable value, long-run exercise
propensity, pent-up demand, stock run-up effect and short-time-to-maturity
effect. For stock option grants issued during the three and six months ended
December 31, 2005, we used a weighted-average expected option life assumption of
7 years and 8 years respectively.
29
THE ESTEE LAUDER COMPANIES INC.
While we believe the above critical estimates are based on outcomes that are
reasonably likely to occur, if we were to increase or decrease the expected
option life by 1 year and simultaneously increase or decrease the expected
volatility by 100 basis points, recognized compensation expense would have
changed approximately $0.7 million and $1.7 million in either direction for the
three and six months ended December 31, 2005, respectively.
Recently Issued Accounting Standards
- ------------------------------------
In September 2005, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position ("FSP") No. FAS 123(R)-1, "Classification and Measurement of
Freestanding Financial Instruments Originally Issued in Exchange for Employee
Services under FASB Statement No. 123(R)," to defer the requirement of SFAS No.
123(R), "Share-Based Payment," that a freestanding financial instrument
originally subject to SFAS No. 123(R) becomes subject to the recognition and
measurement requirements of other applicable GAAP when the rights conveyed by
the instrument to the holder are no longer dependent on the holder being an
employee of the entity. The rights under stock-based payment awards issued to
our employees are all dependent on the recipient being an employee of the
Company. Therefore, this FSP currently does not have an impact on our
consolidated financial statements and the measurement of stock-based
compensation in accordance with SFAS No. 123(R).
In October 2005, the FASB issued FSP No. FAS 13-1, "Accounting for Rental Costs
Incurred during a Construction Period" ("FSP No. 13-1"), to give guidance to a
lessee on determining whether rental costs associated with operating leases may
be capitalized during a construction period. Specifically, the FSP stipulates
that such costs shall be (a) recognized as rental expense, (b) included in
income from continuing operations, and (c) allocated over the lease term
according to the guidance in SFAS No. 13, "Accounting for Leases," and FASB
Technical Bulletin No. 85-3, "Accounting for Operating Leases with Scheduled
Rent Increases." The guidance in FSP No. FAS 13-1 is effective for the first
reporting period beginning after December 15, 2005, with early adoption
permitted for financial statements or interim financial statements that have not
yet been issued. We already account for such rental costs in accordance with FSP
No. 13-1; therefore the issuance of this FSP will not have an additional impact
on our consolidated financial statements.
In October 2005, the FASB issued FSP No. FAS 123 (R)-2, "Practical Accommodation
to the Application of Grant Date as Defined in FASB Statement No. 123(R)," to
provide guidance on determining the grant date for an award as defined in SFAS
No. 123(R). This FSP stipulates that assuming all other criteria in the grant
date definition are met, a mutual understanding of the key terms and conditions
of an award to an individual employee is presumed to exist upon the award's
approval in accordance with the relevant corporate governance requirements,
provided that the key terms and conditions of an award (a) cannot be negotiated
by the recipient with the employer because the award is a unilateral grant, and
(b) are expected to be communicated to an individual recipient within a
relatively short time period from the date of approval. We have applied the
principles set forth in this FSP upon our adoption of SFAS No. 123(R).
In November 2005, the FASB issued FSP Nos. FAS 115-1 and FAS 124-1, "The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments,"
to give guidance on determining when investments in certain debt and equity
securities are considered impaired, whether that impairment is other than
temporary, and on measuring such impairment loss. This FSP also includes
accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. FSP Nos. FAS 115-1 and FAS 124-1 will apply to reporting periods
beginning after December 15, 2005, although earlier application is permitted.
This FSP will not have a material impact on our consolidated financial
statements.
In November 2005, the FASB published FSP No. FAS 123(R)-3, "Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards," to
provide an alternative transition method for accounting for the tax effects of
share-based payment awards to employees. The FASB learned, subsequent to
adoption of SFAS No. 123(R), that a number of constituents did not have the
information necessary to comply with the transition requirements of SFAS No.
123(R), and has provided an elective alternative transition method in FSP No.
FAS 123(R)-3. Entities can choose to follow either the transition guidance of
SFAS No. 123(R) or the alternative transition method described in FSP No. FAS
123(R)-3. The guidance in FSP No. FAS 123(R)-3 became effective upon
publication. We have applied the principles originally set forth in SFAS No.
123(R). Therefore the guidance set forth in this FSP will not be applicable to
us.
30
THE ESTEE LAUDER COMPANIES INC.
Forward-Looking Information
- ---------------------------
We and our representatives from time to time make written or oral
forward-looking statements, including statements contained in this and other
filings with the Securities and Exchange Commission, in our press releases and
in our reports to stockholders. The words and phrases "will likely result,"
"expect," "believe," "planned," "may," "should," "could," "anticipate,"
"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 those relating to our products, 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, including those due to
natural or man-made disasters, real or perceived epidemics, or energy
costs, 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
that manufacture nearly all of our supply of a particular type of
product (i.e., focus factories) or at our distribution or inventory
centers;
(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, develop or implement new information and
distribution technologies, on a timely basis and within our cost
estimates;
31
THE ESTEE LAUDER COMPANIES INC.
(13) our ability to capitalize on opportunities for improved
efficiency, such as publicly-announced cost-savings initiatives and the
disposition of Stila, 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 terrorist attacks, retaliation and
the threat of further attacks or retaliation;
(15) the impact of repatriating certain of our foreign earnings to the
United States in connection with The American Jobs Creation Act of
2004; and
(16) additional factors as described in our filings with the Securities
and Exchange Commission, including our Annual Report on Form 10-K for
the fiscal year ended June 30, 2005.
We assume no responsibility to update forward-looking statements made herein or
otherwise.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The information required by this item is set forth in Item 2 of this Quarterly
Report on Form 10-Q under the caption "Liquidity and Capital Resources - Market
Risk" and is incorporated herein by reference.
Item 4. Controls and Procedures.
Our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) are designed to ensure that information required to be disclosed in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the rules and forms
of the Securities and Exchange Commission. The Chief Executive Officer and the
Chief Financial Officer, with assistance from other members of management, have
reviewed the effectiveness of our disclosure controls and procedures as of
December 31, 2005 and, based on their evaluation, have concluded that the
disclosure controls and procedures were effective as of such date.
As part of our global distribution strategy to establish regional inventory
centers, we continue to migrate certain storage and distribution activities to a
third party in Europe and within our Belgium facilities. In connection with
these changes, we have updated our internal controls over financial reporting.
Except as noted in the previous sentence, there have been no changes in our
internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) of the Exchange Act) that occurred during the second quarter of fiscal
2006 that has materially affected, or is reasonably likely to materially affect,
the Company's internal control over financial reporting.
32
THE ESTEE LAUDER COMPANIES INC.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
We are involved, from time to time, in litigation and other legal proceedings
incidental to our business. Management believes that the outcome of current
litigation and legal proceedings will not have a material adverse effect upon
our results of operations or financial condition. However, management's
assessment of our current litigation and other legal proceedings could change in
light of the discovery of facts with respect to legal actions or other
proceedings pending against us not presently known to us or determinations by
judges, juries or other finders of fact which are not in accord with
management's evaluation of the possible liability or outcome of such litigation
or proceedings.
On March 30, 2005, the United States District Court for the Northern District of
California entered into 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. On April 29, 2005, notices
of appeal were filed by representatives of two members of the purported class of
consumers. If the appeal is resolved satisfactorily, the Final Judgment will
result in the plaintiffs' claims being dismissed, with prejudice, in their
entirety in both the Federal and California actions. There has been no finding
or admission of any wrongdoing by us 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, we took a special
pre-tax charge of $22.0 million, or $13.5 million after-tax, equal to $.06 per
diluted common share in the fourth quarter of fiscal 2003. At December 31, 2005,
the remaining accrual balance was $17.0 million. The charge did not have a
material adverse effect on our 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
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. We have accrued an amount
which we believe would be necessary to resolve our share of this matter. If
settlement discussions are not successful, we intend 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 our consolidated financial condition.
33
THE ESTEE LAUDER COMPANIES INC.
PART II. OTHER INFORMATION
In October 2005, we received a favorable decision from the Portuguese Tax
Administration on the opposition our subsidiary filed in March 2005 to the
notice of assessment it received in December 2004. We expect similar decisions
with respect to the assessments received by the subsidiary in May 2005. The
assessments related to income for the three calendar years ended December 31,
2002 of our subsidiary, which has been operating in the Madeira Free Trade Zone
since 1989 under license from the Madeira Development Corporation. 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 included interest, amounted to 26 million Euros. At the
end of March 2005, the subsidiary filed an opposition to the assessment, which
was accepted by the Tax Administration in October 2005. On May 17 and 18, 2005,
the subsidiary received notices of assessment from the Portuguese Tax
Administration with respect to the calendar years ended December 31, 2001 and
2002. The assessments are for 21.6 million Euros and 22.4 million Euros,
respectively, to which the subsidiary filed oppositions in July 2005. In
February 2004, the subsidiary filed an appeal of a report issued by the
Portuguese Tax Authorities in January 2004 related to the matter with the
Portuguese Secretary of State for Fiscal Matters. The appeal is still pending.
While no assurance can be given as to the ultimate outcome with respect to the
two remaining assessments 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.
In September 2005, the Superior Court of California for the County of San Diego
dismissed, with leave to replead, all of the plaintiff's claims in a matter
originally brought in December 2004 by the plaintiff purporting to represent a
nationwide class of 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." Prior to the dismissal, the complaint, as amended,
named two of our subsidiaries and approximately 25 other defendants, including
manufacturers and retailers. The plaintiff sought 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. In October 2005, the plaintiff
filed a second amended complaint which states the same allegations and requests
for relief, but only names one of our subsidiaries and two retailers as
defendants. On November 18, 2005, we filed a motion to dismiss the complaint. We
intend to continue 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 our consolidated
financial condition.
In June 2005, an action was filed in the United States District Court for the
Southern District of Florida against one of our subsidiaries by a plaintiff
purporting to represent a nationwide class of individuals "who have purchased
skin care products from Defendant that have been falsely advertised to have an
'anti-aging' or youth-inducing benefit or effect." The plaintiff seeks
injunctive relief as well as compensatory and punitive damages under a number of
theories. Two of our department store customers were added as defendants in an
amended complaint filed in August 2005. In September 2005, we moved to dismiss
that complaint. As a result, plaintiff dismissed all of her original claims and
filed an amended complaint under the Florida Deceptive Trade Practices Act. We
again have filed a motion to dismiss, for which briefing was concluded in
December 2005. 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 our consolidated financial condition.
34
THE ESTEE LAUDER COMPANIES INC.
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Sales of Unregistered Securities
Shares of Class B Common Stock may be converted immediately into Class A Common
Stock on a one-for-one basis by the holder and are automatically converted into
Class A Common Stock on a one-for-one basis upon transfer to a person or entity
that is not a "Permitted Transferee" or soon after a record date for a meeting
of stockholders where the outstanding Class B Common Stock constitutes less than
10% of the outstanding shares of Common Stock of the Company. There is no cash
or other consideration paid by the holder converting the shares and,
accordingly, there is no cash or other consideration received by the Company.
The shares of Class A Common Stock issued by the Company in such conversions are
exempt from registration under the Securities Act of 1933, as amended, pursuant
to Section 3(a)(9) thereof.
During the three months ended December 31, 2005, the holders set forth in the
table converted shares of Class B Common Stock into Class A Common Stock on the
dates set forth in the table below:
Stockholder That Converted Class B
Common Stock to Class A Common Number of Shares Converted/
Stock Date of Conversion Received
- --------------------------------------- --------------------------------- --------------------------------
Ronald S. Lauder 10/18/2005 250,000
Share Repurchase Program
Information required by this item is set forth in Part I Item 2 of this
Quarterly Report on Form 10-Q under the caption "Liquidity and Capital Resources
- - Share Repurchase Program" and is incorporated herein by reference.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Stockholders of the Company was held on
November 10, 2005.
(b) The following directors were re-elected at the Annual Meeting of
Stockholders: Charlene Barshefsky, Leonard A. Lauder, Ronald S.
Lauder and Marshall Rose as Class III Directors for a term
expiring at the 2008 Annual Meeting. The Class I Directors, whose
terms expire at the 2006 Annual Meeting, are Rose Marie Bravo,
Mellody Hobson, Irvine O. Hockaday, Jr. and Barry S. Sternlicht.
The Class II Directors, whose terms expire at the 2007 Annual
Meeting, are Aerin Lauder, William P. Lauder, Richard D. Parsons
and Lynn Forester de Rothschild.
(c) (i) Each person re-elected as a director at the Annual Meeting
received the number of votes (shares Class B Common Stock are
entitled to ten votes per share) indicated beside his or her
name:
Name Votes For Votes Withheld
-------------------------- -------------------------- -------------------------
Charlene Barshefsky 926,683,276 43,031,084
Leonard A. Lauder 926,226,264 43,488,096
Ronald S. Lauder 933,624,783 36,089,577
Marshall Rose 958,387,649 11,326,711
(ii) 893,697,219 votes (shares of Class B Common Stock are
entitled to ten votes per share) were cast for and 60,833,473
votes were cast against the approval of the Amended and
Restated Fiscal 2002 Share Incentive Plan. There were 359,621
abstentions and 14,824,047 broker nonvotes.
(iii) 969,263,763 votes (shares of Class B Common Stock are
entitled to ten votes per share) were cast for and 397,978
votes were cast against the ratification of the appointment of
KPMG LLP as independent auditors of the Company for the 2006
fiscal year. There were 52,619 abstentions and no broker
nonvotes.
(d) Not applicable
35
THE ESTEE LAUDER COMPANIES INC.
PART II. OTHER INFORMATION
Item 6. Exhibits.
Exhibit
Number Description
------ -----------
10.1 The Estee Lauder Companies Inc. Amended and Restated Fiscal
2002 Share Incentive Plan (filed as exhibit 10.1 to our
Current Report on Form 8-K filed on November 17, 2005).*+
10.2 Amendment to Employment Agreement, dated as of November 16,
2005 to the Employment Agreement, dated as of July 1, 2000,
as amended as of July 1, 2002 between The Estee Lauder
Companies Inc. and Leonard A. Lauder (filed as exhibit 10.2
to our Current Report on Form 8-K filed on November 17,
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.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
THE ESTEE LAUDER COMPANIES INC.
Date: January 26, 2006 By: /s/Richard W. Kunes
-------------------
Richard W. Kunes
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
37
THE ESTEE LAUDER COMPANIES INC.
INDEX TO EXHIBITS
Exhibit
Number Description
------ -----------
10.1 The Estee Lauder Companies Inc. Amended and Restated Fiscal
2002 Share Incentive Plan (filed as exhibit 10.1 to our
Current Report on Form 8-K filed on November 17, 2005).*+
10.2 Amendment to Employment Agreement, dated as of November 16,
2005 to the Employment Agreement, dated as of July 1, 2000,
as amended as of July 1, 2002 between The Estee Lauder
Companies Inc. and Leonard A. Lauder (filed as exhibit 10.2
to our Current Report on Form 8-K filed on November 17,
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.