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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-1004
______________________
FORM 10-Q
(Mark One)
X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
_ Act of 1934
For the quarterly period ended September 30, 2005
OR
_ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from to
Commission file number: 1-14064
The Estee Lauder Companies Inc.
(Exact name of registrant as specified in its charter)
Delaware 11-2408943
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
767 Fifth Avenue, New York, New York 10153
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 212-572-4200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months(or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
- -
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
- -
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 October 21, 2005, 129,973,344 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, $.01 par value, were outstanding.
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THE ESTEE LAUDER COMPANIES INC.
Index
Page
----
Part I. Financial Information
Item 1. Financial Statements
Consolidated Statements of Earnings --
Three Months Ended September 30, 2005 and 2004 2
Consolidated Balance Sheets --
September 30, 2005 and June 30, 2005 3
Consolidated Statements of Cash Flows --
Three Months Ended September 30, 2005 and 2004 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk 28
Item 4. Controls and Procedures 28
Part II. Other Information
Item 1. Legal Proceedings 29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 31
Item 6. Exhibits 31
Signatures 32
THE ESTEE LAUDER COMPANIES INC.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended
September 30
-----------------------------------------
2005 2004
-------------- --------------
($ in millions)
Net Sales $ 1,497.1 $ 1,490.3
Cost of Sales 419.5 407.7
-------------- --------------
Gross Profit 1,077.6 1,082.6
Operating expenses:
Selling, general and administrative 972.5 926.3
-------------- --------------
Operating Income 105.1 156.3
Interest expense, net 5.6 4.1
-------------- --------------
Earnings before Income Taxes, Minority Interest and
Discontinued Operations 99.5 152.2
Provision for income taxes 35.8 56.3
Minority interest, net of tax (1.9) (0.2)
-------------- --------------
Net Earnings from Continuing Operations 61.8 95.7
Discontinued operations, net of tax (3.3) (0.7)
-------------- --------------
Net Earnings $ 58.5 $ 95.0
============== ==============
Basic net earnings per common share:
Net earnings from continuing operations $ .28 $ .42
Discontinued operations, net of tax (.02) -
-------------- --------------
Net earnings $ .26 $ .42
============== ==============
Diluted net earnings per common share:
Net earnings from continuing operations $ .28 $ .41
Discontinued operations, net of tax (.02) -
-------------- --------------
Net earnings $ .26 $ .41
============== ==============
Weighted-average common shares outstanding:
Basic 220.6 227.1
Diluted 223.6 231.2
See notes to consolidated financial statements.
-2-
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED BALANCE SHEETS
September 30 June 30
2005 2005
---------------- ---------------
(Unaudited)
($ in millions)
ASSETS
Current Assets
Cash and cash equivalents $ 389.5 $ 553.3
Accounts receivable, net 915.2 776.6
Inventory and promotional merchandise, net 814.8 768.3
Prepaid expenses and other current assets 232.1 204.4
Assets held for sale 127.8 -
---------------- ---------------
Total current assets 2,479.4 2,302.6
---------------- ---------------
Property, Plant and Equipment, net 690.8 694.2
---------------- ---------------
Other Assets
Investments, at cost or market value 11.7 12.3
Goodwill, net 629.3 720.6
Other intangible assets, net 70.8 71.8
Other assets, net 85.7 84.3
---------------- ---------------
Total other assets 797.5 889.0
---------------- ---------------
Total assets $ 3,967.7 $ 3,885.8
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Short-term debt $ 253.6 $ 263.6
Accounts payable 255.1 249.4
Accrued income taxes 121.3 109.9
Other accrued liabilities 904.0 874.8
Liabilities related to assets held for sale 6.4 -
---------------- ---------------
Total current liabilities 1,540.4 1,497.7
---------------- ---------------
Noncurrent Liabilities
Long-term debt 444.9 451.1
Other noncurrent liabilities 232.0 228.4
---------------- ---------------
Total noncurrent liabilities 676.9 679.5
---------------- ---------------
Minority Interest 16.8 15.8
---------------- ---------------
Stockholders' Equity
Common stock, $.01 par value; 650,000,000 shares Class A authorized; shares
issued: 162,513,436 at September 30, 2005 and 159,837,545 at June 30, 2005;
240,000,000 shares Class B authorized; shares issued and outstanding:
86,050,901 at September 30, 2005 and 87,640,901 at June 30, 2005 2.5 2.5
Paid-in capital 510.0 465.2
Retained earnings 2,261.7 2,203.2
Accumulated other comprehensive income 17.9 9.4
---------------- ---------------
2,792.1 2,680.3
Less: Treasury stock, at cost; 29,090,560 Class A shares at
September 30, 2005 and 27,174,160 Class A shares at June 30, 2005 (1,058.5) (987.5)
---------------- ---------------
Total stockholders' equity 1,733.6 1,692.8
---------------- ---------------
Total liabilities and stockholders' equity $ 3,967.7 $ 3,885.8
================ ===============
See notes to consolidated financial statements.
-3-
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
September 30
------------------------------------
2005 2004
------------- ------------
(In millions)
Cash Flows from Operating Activities
Net earnings $ 58.5 $ 95.0
Adjustments to reconcile net earnings to net cash flows provided by
operating activities from continuing operations:
Depreciation and amortization 47.2 46.9
Deferred income taxes (9.8) 11.3
Minority interest, net of tax 1.9 0.2
Non-cash stock compensation 13.2 (1.7)
Excess tax benefits from stock-based compensation arrangements (4.2) -
Loss on disposal of fixed assets 0.2 2.9
Discontinued operations, net of tax 3.3 -
Other non-cash items 0.2 0.2
Changes in operating assets and liabilities
Increase in accounts receivable, net (144.8) (228.1)
Increase in inventory and promotional merchandise, net (57.6) (52.8)
Increase in other assets, net (22.6) (0.2)
Increase (decrease) in accounts payable 5.8 (11.2)
Increase in accrued income taxes 19.1 7.6
Increase in other accrued liabilities 23.8 26.5
Increase in other noncurrent liabilities 4.2 5.1
------------- ------------
Net cash flows used for operating activities of continuing operations (61.6) (98.3)
------------- ------------
Cash Flows from Investing Activities
Capital expenditures (45.9) (38.4)
Acquisition of businesses, net of cash acquired - (4.3)
Proceeds from disposition of long-term investments 0.5 -
Purchases of long-term investments - (0.3)
------------- -------------
Net cash flows used for investing activities of continuing operations (45.4) (43.0)
------------- -------------
Cash Flows from Financing Activities
Increase (decrease) in short-term debt, net (9.9) 2.7
Repayments and redemptions of long-term debt (0.5) -
Net proceeds from stock-based compensation transactions 24.9 5.0
Excess tax benefits from stock-based compensation arrangements 4.2 -
Payments to acquire treasury stock (71.1) (88.3)
Distributions made to minority holders of consolidated subsidiaries (0.9) (3.0)
------------- -------------
Net cash flows used for financing activities of continuing operations (53.3) (83.6)
------------- -------------
Effect of Exchange Rate Changes on Cash and Cash Equivalents 1.0 0.6
------------- -------------
Cash Flows used for Discontinued Operations (4.5) (0.2)
------------- -------------
Net Decrease in Cash and Cash Equivalents (163.8) (224.5)
Cash and Cash Equivalents at Beginning of Period 553.3 611.6
------------- -------------
Cash and Cash Equivalents at End of Period $ 389.5 $ 387.1
============= =============
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-month periods ended September
30, 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 month periods ended September 30, 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
September 30
-------------------------------------------
2005 2004
-------------------- --------------------
(Unaudited)
($ in millions)
Numerator:
Net earnings from continuing operations $ 61.8 $ 95.7
Discontinued operations, net of tax (3.3) (0.7)
-------------------- --------------------
Net earnings $ 58.5 $ 95.0
==================== ====================
Denominator:
Weighted-average common shares outstanding - Basic 220.6 227.1
Effect of dilutive securities: Stock-based compensation 3.0 4.1
-------------------- --------------------
Weighted-average common shares outstanding - Diluted 223.6 231.2
==================== ====================
Basic net earnings per common share:
Net earnings from continuing operations $ .28 $ .42
Discontinued operations, net of tax (.02) -
-------------------- --------------------
Net earnings $ .26 $ .42
==================== ====================
Diluted net earnings per common share:
Net earnings from continuing operations $ .28 $ .41
Discontinued operations, net of tax (.02) -
-------------------- --------------------
Net earnings $ .26 $ .41
==================== ====================
-5-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of September 30, 2005 and 2004, outstanding options to purchase 14.9 million
and 6.7 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 September 30, 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
us 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 three
months ended September 30, 2005, this new treatment resulted in cash flows from
financing activities of $4.2 million, which reduced cash flows from operating
activities by the same amount.
Supplemental Disclosures of Cash Flow Information
Supplemental cash flow information for the three months ended September 30, 2005
and 2004 were as follows:
2005 2004
-------------- --------------
(Unaudited)
(In millions)
Cash paid during the period for interest $ 8.7 $ 4.5
============== ==============
Cash paid during the period for income taxes $ 24.6 $ 36.9
============== ==============
Incremental tax benefit from the exercise of stock options $ 2.6 $ 2.0
============== ==============
Liability associated with acquisition of business $ - $ 7.7
============== ==============
Capital lease obligations $ 0.2 $ -
============== ==============
Accounts Receivable
Accounts receivable is stated net of the allowance for doubtful accounts and
customer deductions of $34.1 million and $28.9 million as of September 30, 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.
September 30 June 30
2005 2005
------------- -------------
(Unaudited)
(In millions)
Inventory and promotional merchandise consists of:
Raw materials $ 130.0 $ 149.9
Work in process 38.2 43.2
Finished goods 458.4 403.4
Promotional merchandise 188.2 171.8
------------- -------------
$ 814.8 $ 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.
September 30 June 30
2005 2005
------------- -------------
(Unaudited)
(In millions)
Assets (Useful Life)
Land $ 13.7 $ 13.6
Buildings and improvements (10 to 40 years) 159.6 160.8
Machinery and equipment (3 to 10 years) 745.9 721.2
Furniture and fixtures (5 to 10 years) 110.0 109.1
Leasehold improvements 714.7 703.9
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1,743.9 1,708.6
Less accumulated depreciation and amortization 1,053.1 1,014.4
------------- -------------
$ 690.8 $ 694.2
============= =============
Depreciation and amortization of property, plant and equipment was $45.3 million
and $43.8 million during the three months ended September 30, 2005 and 2004,
respectively. Depreciation and amortization related to our manufacturing process
is included in cost of sales and all other depreciation and amortization is
included in selling, general and administrative expenses in the accompanying
consolidated statements of earnings.
-7-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Operating Leases
The Company recognizes rent expense from operating leases with periods of free
and scheduled rent increases on a straight-line basis over the applicable lease
term. The Company considers lease renewals in the useful life of its leasehold
improvements when such renewals are reasonably assured. From time to time, the
Company may receive capital improvement funding from its lessors. These amounts
are recorded as deferred liabilities and amortized over the remaining lease term
as a reduction of rent expense.
Pension and Postretirement Benefit Plans
The Company maintains pension plans covering substantially all of its full-time
employees for its U.S. operations and a majority of its international
operations. The Company also maintains a domestic postretirement benefit plan
which provides certain medical and dental benefits to eligible employees.
Descriptions of these plans are discussed in the Company's Annual Report on Form
10-K for the year ended June 30, 2005.
The components of net periodic benefit cost for the three months ended September
30, 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 $ 3.1 $ 2.7 $ 1.1 $ 0.8
Interest cost 5.3 5.3 2.5 2.4 1.3 1.0
Expected return on plan assets (6.2) (6.0) (2.9) (2.7) - -
Amortization of:
Prior service cost 0.2 0.1 - 0.1 - -
Actuarial loss 1.5 1.2 2.1 1.0 0.3 -
Settlements and
curtailments - - 0.2 - - -
---------- ---------- ---------- ---------- ---------- ----------
Net periodic benefit cost $ 6.2 $ 5.4 $ 5.0 $ 3.5 $ 2.7 $ 1.8
========== ========== ========== ========== ========== ==========
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 September 30, 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.
-8-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 is 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 months ended September 30, 2005, the Company 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, 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
months ended September 30, 2005, the Company used a weighted-average expected
option life assumption of 8 years.
-9-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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).
-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
September 30
-------------------------
2005 2004
---------- ----------
(Unaudited)
(In millions)
Net earnings $ 58.5 $ 95.0
---------- ----------
Other comprehensive income (loss):
Net unrealized investment gain (loss) - (0.3)
Net derivative instruments gain (loss) 0.7 (1.1)
Translation adjustments 7.8 8.3
---------- ----------
Other comprehensive income 8.5 6.9
---------- ----------
Comprehensive income $ 67.0 $ 101.9
========== ==========
The accumulated net gain (loss) on derivative instruments consists of the
following:
Three Months Ended
September 30
-------------------------
2005 2004
---------- ----------
(Unaudited)
(In millions)
OCI-derivative instruments, beginning of period $ 11.9 $ 10.2
---------- ----------
Gain (loss) on derivative instruments 1.2 (1.3)
Reclassification to earnings of net (gain) loss during the period (0.7) (0.3)
Benefit for deferred income taxes 0.2 0.5
---------- ----------
Net derivative instruments (gain) loss 0.7 (1.1)
---------- ----------
OCI-derivative instruments, end of period $ 12.6 $ 9.1
========== ==========
Of the $12.6 million, net of tax, derivative instrument gain recorded in OCI at
the end of the current period, $8.9 million, net of tax, related to the gain on
the settlement of 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 $3.7 million, net of
tax, related to forward and option contracts which the Company will reclassify
to earnings during the next nine months.
At the end of the prior period, the $9.1 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 and $0.1
million, 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 30,750,000 shares to be granted in the form of
stock-based awards to key employees, consultants and non-employee directors of
the Company. As of September 30, 2005, 865,200 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 September 30, 2005. The Company
may satisfy the awards upon exercise with either new or treasury shares. The
Company's stock compensation awards outstanding at September 30, 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 September 30, 2005 was $13.2 million ($8.6 million
after tax), or $0.04 for both basic and diluted earnings per share. As of
September 30, 2005, the total unrecognized compensation cost related to
nonvested stock awards was $45.2 million and the related weighted-average period
over which it is expected to be recognized is approximately 2.5 years.
Prior to the Company's adoption of SFAS No. 123(R), SFAS No. 123 required that
the Company provide pro forma information regarding net earnings and net
earnings per common share as if compensation cost for the Company's stock-based
awards had been determined in accordance with the fair value method prescribed
therein. The Company had previously adopted the disclosure portion of SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure,"
requiring quarterly SFAS No. 123 pro forma disclosure. The pro forma charge for
compensation cost related to stock-based awards granted was recognized over the
service period. For stock options, the service period represents the period of
time between the date of grant and the date each option becomes exercisable
without consideration of acceleration provisions (e.g., retirement, change of
control, etc.).
The following table illustrates the effect on net earnings per common share as
if the fair value method had been applied to all outstanding awards for the
three months ended September 30, 2004:
2004
--------------------
(Unaudited)
($ in millions)
Net earnings, as reported $ 95.0
Deduct: Total stock-based compensation expense
determined under fair value method for all awards,
net of related tax effects (6.7)
--------------------
Pro forma net earnings $ 88.3
====================
Earnings per common share:
Net earnings per common share - Basic, as reported $ .42
====================
Net earnings per common share - Basic, pro forma $ .39
====================
Net earnings per common share - Diluted, as reported $ .41
====================
Net earnings per common share - Diluted, pro forma $ .38
====================
-12-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Options
A summary of the Company's stock option programs as of September 30, 2005 and
changes during the three-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 1,523.2 35.00
Exercised (1,089.2) 22.87
Expired (44.3) 45.63
Forfeited (67.7) 37.17
-------------
Outstanding at September 30, 2005 27,666.7 38.83 $ 50.0 5.4
============= ================== ===================
Exercisable at September 30, 2005 20,321.0 39.48 $ 43.0 4.4
============= ================== ===================
_____________________________
(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 for the
three months ended September 30, 2005 and 2004 was $11.64 and $16.51,
respectively. The total intrinsic value of stock options exercised during the
three months ended September 30, 2005 and 2004 was $19.4 million and $4.6
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
September 30
---------------------------------------------
(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 September 30, 2005 that will expire in May
2007.
Performance Share Units
During the three months ended September 30, 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 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. 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.
-13-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of the status of the Company's PSUs as of September
30, 2005 and activity during the three 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 September 30, 2005 111.1 $ 35.00
==================== =======================
Restricted Stock Units
The Company issued 111,100 RSUs during the three months ended September 30,
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 RSU agreement. 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 September
30, 2005 and activity during the three 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 September 30, 2005 111.1 $ 35.00
==================== =======================
Share Units
There were 7,700 share units outstanding at September 30, 2005 and June 30,
2005, which were 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.
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 as compensation expense to reflect the change in the
market value for the three months ended September 30, 2005 and 2004.
-14-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. As a result of this decision, the
Company has reflected the operating loss of $3.3 million (net of $2.0 million
tax benefit) and $0.7 million (net of $0.3 million tax benefit)for the three
months ended September 30, 2005 and 2004, respectively, as discontinued
operations in the accompanying statements of earnings. Net sales associated with
the discontinued operations were $13.6 million and $13.8 million for the three
months ended September 30, 2005 and 2004, respectively. All statement of
earnings information for the prior period has been restated for comparative
purposes, including the restatement of the makeup product category and each of
the geographic regions presented in Note 5.
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:
September 30
2005
------------------
(Unaudited)
(In millions)
Assets
Accounts receivable, net $ 10.9
Inventory and promotional merchandise, net 17.2
Prepaid expenses and other current assets 0.7
Property, plant and equipment, net 6.2
Goodwill, net 91.4
Other intangibles, net 0.1
Other assets 1.3
------------------
Assets held for sale $ 127.8
==================
Liabilities
Accounts payable $ 1.4
Other accrued liabilities 5.0
------------------
Liabilities related to assets held for sale $ 6.4
==================
-15-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 and net interest expense. The accounting policies for the Company's
reportable segment are substantially the same as those for the consolidated
financial statements, as described in the segment data and related information
footnote included in the Company's Annual Report on Form 10-K for the year ended
June 30, 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.
Three Months Ended
September 30
-------------------------------
2005 2004
----------- ------------
(Unaudited)
(In millions)
PRODUCT CATEGORY DATA
Net Sales:
Skin Care $ 523.4 $ 524.3
Makeup 604.9 585.7
Fragrance 293.2 311.7
Hair Care 70.4 63.1
Other 5.2 5.5
----------- ------------
$ 1,497.1 $ 1,490.3
=========== ============
Operating Income:
Skin Care $ 38.8 $ 64.8
Makeup 60.5 65.8
Fragrance (1.0) 22.3
Hair Care 5.3 2.8
Other 1.5 0.6
----------- ------------
105.1 156.3
Reconciliation:
Interest expense, net 5.6 4.1
----------- ------------
Earnings before income taxes, minority interest $ 99.5 $ 152.2
and discontinued operations =========== ============
GEOGRAPHIC DATA
Net Sales:
The Americas $ 881.0 $ 879.8
Europe, the Middle East & Africa 417.5 422.0
Asia/Pacific 198.6 188.5
----------- ------------
$ 1,497.1 $ 1,490.3
=========== ============
Operating Income:
The Americas $ 80.4 $ 108.5
Europe, the Middle East & Africa 22.4 42.0
Asia/Pacific 2.3 5.8
----------- ------------
$ 105.1 $ 156.3
=========== ============
-16-
THE ESTEE LAUDER COMPANIES INC.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
---------------------
We manufacture, market and sell beauty products including those in the skin
care, makeup, fragrance and hair care categories which are distributed in over
130 countries and territories. The following is a comparative summary of
operating results for the three months ended September 30, 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
September 30
--------------------------------------
2005 2004
--------------- --------------
(In millions)
NET SALES
By Region:
The Americas $ 881.0 $ 879.8
Europe, the Middle East & Africa 417.5 422.0
Asia/Pacific 198.6 188.5
--------------- --------------
$ 1,497.1 $ 1,490.3
=============== ==============
By Product Category:
Skin Care $ 523.4 $ 524.3
Makeup 604.9 585.7
Fragrance 293.2 311.7
Hair Care 70.4 63.1
Other 5.2 5.5
--------------- --------------
$ 1,497.1 $ 1,490.3
=============== ==============
OPERATING INCOME (LOSS)
By Region:
The Americas $ 80.4 $ 108.5
Europe, the Middle East & Africa 22.4 42.0
Asia/Pacific 2.3 5.8
--------------- --------------
$ 105.1 $ 156.3
=============== ==============
By Product Category:
Skin Care $ 38.8 $ 64.8
Makeup 60.5 65.8
Fragrance (1.0) 22.3
Hair Care 5.3 2.8
Other 1.5 0.6
--------------- --------------
$ 105.1 $ 156.3
=============== ==============
-17-
THE ESTEE LAUDER COMPANIES INC.
The following table presents certain consolidated earnings data as a percentage
of net sales:
Three Months Ended
September 30
-----------------------------
2005 2004
----------- -----------
Net sales 100.0% 100.0%
Cost of sales 28.0 27.4
----------- -----------
Gross profit 72.0 72.6
Operating expenses:
Selling, general and administrative 65.0 62.1
----------- -----------
Operating income 7.0 10.5
Interest expense, net 0.4 0.3
----------- -----------
Earnings before income taxes, minority interest and discontinued 6.6 10.2
operations
Provision for income taxes 2.4 3.8
Minority interest, net of tax (0.1) -
----------- -----------
Net earnings from continuing operations 4.1 6.4
Discontinued operations, net of tax (0.2) -
----------- -----------
Net earnings 3.9% 6.4%
=========== ===========
First Quarter Fiscal 2006 as Compared with First Quarter Fiscal 2005
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.
NET SALES
Net sales increased less than 1% or $6.8 million to $1,497.1 million due to
growth in our makeup and hair care product categories, which was substantially
offset by lower sales in our fragrance product category. The net increase also
reflects sales growth in the Asia/Pacific region, partially offset by lower
sales in Europe, the Middle East & Africa. Excluding the impact of foreign
currency translation, net sales decreased slightly.
Product Categories
Skin Care
Net sales of skin care products were flat compared to the prior period. Net
sales for the quarter were $523.4 million. The recent launch of Perfectionist
[CP+] by Estee Lauder, Superdefense Triple Action Moisturizers SPF 25 by
Clinique and Modern Friction by Origins generated incremental sales of nearly
$30 million, offset by decreases in Future Perfect Anti-Wrinkle Radiance Creme
SPF 15, Perfectionist Correcting Serum for Lines/Wrinkles/Age Spots and the
Resilience Lift and White Light lines of products by Estee Lauder, Active White
Lab Solutions skin care products by Clinique and The Face Serum by La Mer of
approximately $28 million, collectively. Excluding the impact of foreign
currency translation, skin care net sales decreased 1%.
-18-
THE ESTEE LAUDER COMPANIES INC.
Makeup
Makeup net sales increased 3% or $19.2 million to $604.9 million reflecting
growth from our M.A.C brand as well as new product launches. M.A.C sales
increases reflected growth of many products in this category led by Small Eye
Shadow and Veluxe Eye Shadow of approximately $9 million, collectively. Sales
growth from new products such as Individualist Natural Finish Makeup by Estee
Lauder and Colour Surge Butter Shine TM Lipstick, Repairwear Anti-Aging Makeup
SPF 15 and Colour Surge Eye Shadow Quad by Clinique contributed a combined $26
million to the category. Partially offsetting these increases were lower sales
of approximately $19 million of Superbalanced Compact Makeup SPF 20 by Clinique
and Lash XL Maximum Length Mascara by Estee Lauder. Foreign currency translation
had a de minimis impact on makeup net sales compared to the prior period.
Fragrance
Net sales of fragrance products decreased 6% or $18.5 million to $293.2 million
as we continue to be challenged in this product category. The recent launches of
DKNY Be Delicious and DKNY Be Delicious Men, as well as the current period
launch of True Star Men by Tommy Hilfiger contributed approximately $31 million
of sales. More than offsetting this launch activity were lower sales of True
Star by Tommy Hilfiger and Lauder Beyond Paradise Men as we anniversary the
initial shipments of those products in the prior period. Lower sales of Tommy
and Tommy Girl by Tommy Hilfiger and Estee Lauder Beyond Paradise also
contributed to the decrease in sales. Collectively, these product lines
accounted for lower sales of approximately $45 million. Foreign currency
translation had a de minimis impact on fragrance net sales compared to the prior
period.
Hair Care
Hair care net sales increased 12% or $7.3 million to $70.4 million, primarily
due to sales growth from Bumble and bumble and Aveda products. Bumble and bumble
sales benefited from sales growth in our existing salon distribution and new
points of distribution, as well as the newly launched Creme de Coco shampoos and
conditioners, while Aveda net sales increased as a result of sales of new
professional color products, Pure Abundance products and the recent launch of
Damage Remedy hair care products. Excluding the impact of foreign currency
translation, hair care net sales increased 11%.
Geographic Regions
Net sales in the Americas were flat, increasing $1.2 million to $881.0 million.
Growth in this region was led by the makeup and hair care product categories of
approximately $22 million, which was offset by lower fragrance net sales as we
continue to be challenged in this product category. Net sales in this region
were also negatively impacted by the timing of product launches. In the United
States, all product categories were negatively impacted by business disruptions
at certain key retailers. We expect these disruptions to continue throughout the
remainder of the fiscal year. During the period, certain of our core brands,
which continue to be challenged, experienced lower than expected sales of
products associated with Fall promotional programs. To a lesser extent, our
business was weakened by severe weather conditions as well as rising gas prices,
which influence consumer spending habits.
In Europe, the Middle East & Africa, net sales decreased 1% or $4.5 million to
$417.5 million, primarily reflecting lower net sales in the United Kingdom,
Spain and Italy of approximately $18 million, collectively. Partially offsetting
these decreases were higher net sales of approximately $13 million in Germany,
our travel retail and distributor businesses, Portugal and Russia. On a local
currency basis, net sales in Europe, the Middle East & Africa were flat.
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 European markets serviced
from this center. These issues have since been addressed and we anticipate
operating as originally planned by the end of our second fiscal quarter.
-19-
THE ESTEE LAUDER COMPANIES INC.
Net sales in Asia/Pacific increased 5% or $10.1 million to $198.6 million. This
increase reflected higher net sales of approximately $13 million in China,
Korea, Australia, Taiwan and Hong Kong, partially offset by decreases in Japan
and Thailand of approximately $4 million. Excluding the impact of foreign
currency translation, Asia/Pacific net sales increased 2%.
We strategically stagger our new product launches by geographic market, which
may account for differences in regional sales growth.
COST OF SALES
Cost of sales as a percentage of total net sales increased to 28.0% as compared
with 27.4% in the prior period. Cost of sales as a percentage of net sales
reflected an increase in obsolescence charges of approximately 60 basis points
proportionate to the change in inventory levels and unfavorable changes in
exchange rates and promotional activities of approximately 50 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
50 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 65.0% of net sales as compared with 62.1% of net
sales in the prior period. During the current period, sales did not materialize
in accordance with our plan. However, we were already committed to certain
expense items resulting in the increase in our operating expenses as a
percentage of net sales. Selling and demonstration costs increased approximately
120 basis points. An increase of approximately 70 basis points in advertising
and promotional spending related to supporting newly launched and existing
products. Operating expenses increased approximately 90 basis points due to the
recognition of costs related to stock-based compensation as a result of the
adoption of Statement of Financial Accounting Standards ("SFAS") No. 123(R),
"Share-Based Payment" ("SFAS No. 123(R)"). Costs related to a company-wide
initiative to upgrade our information systems contributed approximately 20 basis
points to the increase.
Changes in advertising, sampling and merchandising spending result from the
type, timing and level of activities related to product launches and rollouts,
as well as the markets being emphasized.
OPERATING RESULTS
Based on the modest growth of net sales, coupled with the increases in our cost
of sales and operating expense margins as previously discussed, operating income
decreased 33%, or $51.2 million, to $105.1 million as compared with the prior
period. Operating margins were 7.0% of net sales in the current period as
compared with 10.5% in the prior period.
-20-
THE ESTEE LAUDER COMPANIES INC.
Product Categories
Operating results declined 40% or $26.0 million in skin care reflecting lower
net sales, particularly in Europe, while we continued our spending to support
this business. Fragrance operating results decreased over 100%, or $23.3
million, reflecting lower sales and continued support of our fragrances at the
counter and through advertising and promotional vehicles. Makeup results
declined 8%, or $5.3 million, reflecting challenges among certain core brands,
including a disappointing response to our Fall promotional programs, and
difficult comparisons to prior period results among our BeautyBank brands. Hair
care operating income increased 89%, or $2.5 million, primarily reflecting
improved results domestically as a result of sales growth in our existing salon
distribution.
Geographic Regions
Operating income in the Americas decreased 26% or $28.1 million to $80.4
million, primarily reflecting lower than anticipated net sales attributable to
business disruptions at certain key retailers and disappointing Fall promotional
programs. To a lesser extent, our business was affected by severe weather
conditions and rising gas prices as described above. Costs related to
stock-based compensation and the company-wide initiative to upgrade our
information systems also contributed to the decrease in operating income.
Partially offsetting these decreases were higher results from our Bumble and
bumble brand, reflecting sales growth in our existing salon distribution.
In Europe, the Middle East & Africa, operating income decreased 47% or $19.6
million to $22.4 million primarily due to lower results in Spain, the United
Kingdom, our travel retail and distributor businesses and Italy of approximately
$22 million, collectively. Improved results in France and Germany of
approximately $3 million partially offset those decreases. Operating results
were also negatively impacted in continental Europe due to a shortfall in
product shipments from our new European inventory center as discussed above.
In Asia/Pacific, operating income decreased 60% or $3.5 million to $2.3 million.
This decrease reflects lower results of approximately $4 million in Hong Kong,
China, Taiwan, Malaysia and Thailand, partially offset by higher results from
Australia and Japan of $1 million.
INTEREST EXPENSE, NET
Net interest expense was $5.6 million as compared with $4.1 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 during the current period.
PROVISION FOR INCOME TAXES
The provision for income taxes represents Federal, foreign, state and local
income taxes. The effective rate differs from statutory rates due to the effect
of state and local 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 geographical 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 September 30, 2005 was 36.0% as
compared with 37.0% in the prior period. The decrease in the effective income
tax rate of 100 basis points was primarily attributable to the tax effect of the
Company's foreign operations (30 basis points), a decrease in state & local
income tax expense (50 basis points) and an increase in tax credits (20 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. As a result of this decision, we have
reflected the operating loss of $3.3 million and $0.7 million, net of tax, for
the three months ended September 30, 2005 and 2004, respectively, as
discontinued operations in the accompanying statements of earnings. Subject to
the final negotiated sales price, we may report a gain or loss on disposal of
this business, which would also be included as a component of discontinued
operations.
-21-
THE ESTEE LAUDER COMPANIES INC.
FINANCIAL CONDITION
-------------------
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of funds historically have been cash flows from operations
and borrowings under 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 September 30, 2005, we had cash and
cash equivalents of $389.5 million compared with $553.3 million at June 30,
2005.
At September 30, 2005, our outstanding borrowings of $698.5 million included:
(i) $240.3 million of 6% Senior Notes due January 2012 consisting of $250.0
million principal, unamortized debt discount of $0.7 million and a $9.0 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) $68.4
million of 2015 Preferred Stock, which shares were redeemed on October 26, 2005;
(iv) a 3.0 billion yen term loan (approximately $26.9 million at the exchange
rate at September 30, 2005), which is due in March 2006; (v) a 1.8 million Euro
note (approximately $1.8 million at the exchange rate at September 30, 2005)
payable semi-annually through February 2008 at a variable interest rate; (vi)
$8.9 million of capital lease obligations; (vii) $133.9 million of outstanding
short-term commercial paper payable through October 2005 at an average interest
rate of 3.76%; and (viii) $20.9 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 September 30, 2005, we had $133.9 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 $169.2 million in additional uncommitted credit
facilities, of which $20.9 million was used as of September 30, 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 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 1/2% plus the
Federal funds rate. The credit facility has an annual fee of $0.4 million,
payable quarterly, based on our current credit ratings. As of September 30,
2005, we were in compliance with all related financial and other restrictive
covenants, including limitations on indebtedness and liens.
On June 28, 2005, we received a notice of exercise of the put right from the
holder of the remaining $68.4 million of the 2015 Preferred Stock. In accordance
with the terms of the preferred stock, we redeemed the remaining shares and paid
the accrued dividends thereon, on October 26, 2005.
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 29% at September 30, 2005
and 30% at June 30, 2005.
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.
-22-
THE ESTEE LAUDER COMPANIES INC.
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 used for operating activities from continuing operations was $61.6
million during the three months ended September 30, 2005 as compared with net
cash used of $98.3 million in the prior period. The improvement in cash flows
used for operating activities primarily reflected collections of certain
domestic accounts receivable early in the fiscal quarter. This improvement in
cash flows used for operating activities as compared with the prior period was
partially offset by lower net earnings. Use of operating cash in the first
fiscal quarter reflects the seasonality in our business.
Net cash used for investing activities was $45.4 million during the three months
ended September 30, 2005 compared with $43.0 million in the prior period. For
both periods the use of cash primarily reflected capital expenditures, which
were higher during the current period.
Net cash used for financing activities was $53.3 million during the three months
ended September 30, 2005 compared to net cash used for financing activities of
$83.6 million in the prior period. This change from the prior period primarily
reflected an increase in proceeds from the exercise of stock options and less
cash used for share repurchases than in the same period a year ago.
Dividends
Total dividends declared for the three months ended September 30, 2005 and 2004
represented dividends on the 2015 Preferred Stock of $0.4 million and $0.2
million, respectively. These dividends have been characterized as interest
expense in the accompanying consolidated statements of earnings for the three
months ended September 30, 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 September
30, 2005, the cumulative total of acquired shares pursuant to the authorization
was 29.3 million, reducing the remaining authorized share repurchase balance to
18.7 million. During the first three months of fiscal 2006, we purchased
approximately 1.9 million shares for $71.1 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
------------------ -----------------------
Year-to-date 1,919,700 37.04 1,919,700 18,688,200
================== =======================
(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. In early October 2005,
we purchased an additional 3.7 million shares for $130.5 million, bringing
the cumulative total of acquired shares to 33.0 million.
Commitments and Contingencies
There have been no significant changes to our commitments and contingencies as
discussed in our Annual Report on Form 10-K for the year ended June 30, 2005.
Contractual Obligations
There have been no significant changes to our contractual obligations as
discussed in our Annual Report on Form 10-K for the year ended June 30, 2005.
-23-
THE ESTEE LAUDER COMPANIES INC.
Derivative Financial Instruments and Hedging Activities
There have been no significant changes to our derivative financial instruments
and hedging activities as discussed in our Annual Report on Form 10-K for the
year ended June 30, 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 September 30, 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 September 30, 2005, we had foreign currency contracts in the form
of forward exchange contracts and option contracts in the amount of $661.3
million and $98.5 million, respectively. The foreign currencies included in
forward exchange contracts (notional value stated in U.S. dollars) are
principally the Euro ($153.5 million), Swiss franc ($120.8 million), British
pound ($117.4 million), Canadian dollar ($82.9 million) and Australian dollar
($40.8 million). The foreign currencies included in the option contracts
(notional value stated in U.S. dollars) are principally the Japanese yen ($26.5
million), Euro ($21.5 million), South Korean won ($19.7 million), and Swiss
franc ($15.6 million).
Interest Rate Risk Management
We enter into interest rate derivative contracts to manage the exposure to
fluctuations of interest rates on our funded indebtedness and anticipated
issuance of debt, as well as cash investments, for periods consistent with the
identified exposures. All interest rate derivative contracts are with large
financial institutions rated as strong investment grade by a major rating
agency.
We have an interest rate swap agreement with a notional amount of $250.0 million
to effectively convert fixed interest on the existing $250.0 million 6% Senior
Notes to variable interest rates based on LIBOR. We designated the swap as a
fair-value hedge. As of September 30, 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 $5.9 million related to our foreign
exchange contracts. As of September 30, 2005, our average value-at-risk related
to our interest rate contracts for the twelve month period for which these
contracts were outstanding was $9.8 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.
-24-
THE ESTEE LAUDER COMPANIES INC.
CRITICAL ACCOUNTING POLICIES
As disclosed in our Annual Report on Form 10-K for the fiscal year ended June
30, 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
is 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 months ended
September 30, 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 months ended September
30, 2005, we used a weighted-average expected option life assumption of 8 years.
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 $1.0 million in either direction for the three months
ended September 30, 2005.
- 25-
THE ESTEE LAUDER COMPANIES INC.
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).
- 26-
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 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 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;
(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;
-27-
THE ESTEE LAUDER COMPANIES INC.
(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
September 30, 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 have migrated certain storage and distribution activities to a third
party in Europe and implemented new warehousing systems in our Belgium facility.
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 first
quarter of fiscal 2006 that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
-28-
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
September 30, 2005, the remaining accrual balance was $17.2 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.
-29-
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
in respect of 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 27.7 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 in respect of 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 April
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 in respect of 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. 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. The purported class includes
individuals "who have purchased skin care products from defendants that have
been falsely advertised to have an 'anti-aging' or youth inducing benefit or
effect." 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. 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. Two of our
department store customers were added as defendants in an amended complaint
filed in August 2005. The 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," seeks injunctive relief as well as compensatory and punitive damages
for alleged breach of express and implied warranties, negligent
misrepresentation, and false advertising and unfair business practices. In
September 2005, we moved to dismiss the complaint. 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.
-30-
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 September 30, 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 Number of Shares Converted/
Common Stock to Class A Common Stock Date of Conversion Received
--------------------------------------- --------------------------------- --------------------------------
Ronald S. Lauder 08/02/2005 315,000
Lauder & Sons L.P. 08/18/2005 750,000
The RSL Article VII 2002 Trust 09/07/2005 475,000
Ronald S. Lauder 09/13/2005 50,000
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 6. Exhibits.
Exhibit
Number Description
------ -----------
10.1 Form of Performance Share Unit Award Agreement Under The Estee
Lauder Companies Inc. Fiscal 2002 Share Incentive Plan (including
Form of Notice of Grant) (attached as Exhibit 10.3 to the
Company's Current Report on Form 8-K filed on September 28,
2005). *+
10.2 Form of Restricted Stock Unit Agreement Under The Estee Lauder
Companies Inc. Fiscal 2002 Share Incentive Plan (including Form of
Notice of Grant) (attached as Exhibit 10.4 to the Company's
Current Report on Form 8-K filed on September 28, 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.
-31-
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: October 26, 2005 By: /s/Richard W. Kunes
---------------------------
Richard W. Kunes
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
-32-
THE ESTEE LAUDER COMPANIES INC.
INDEX TO EXHIBITS
Exhibit
Number Description
------ -----------
10.1 Form of Performance Share Unit Award Agreement Under The Estee
Lauder Companies Inc. Fiscal 2002 Share Incentive Plan (including
Form of Notice of Grant) (attached as Exhibit 10.3 to the
Company's Current Report on Form 8-K filed on September 28,
2005). *+
10.2 Form of Restricted Stock Unit Agreement Under The Estee Lauder
Companies Inc. Fiscal 2002 Share Incentive Plan (including Form of
Notice of Grant) (attached as Exhibit 10.4 to the Company's
Current Report on Form 8-K filed on September 28, 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.