UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
-
Exchange Act of 1934
For the quarterly period ended March 31, 2006
OR
- Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission file number: 1-14064
The Estee Lauder Companies Inc.
(Exact name of registrant as specified in its charter)
Delaware 11-2408943
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
767 Fifth Avenue, New York, New York 10153
(Address of principal executive offices) (Zip Code)
212-572-4200
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
- -
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one): Large accelerated filer X Accelerated filer Non-accelerated filer
- - -
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
- -
At May 1, 2006, 126,489,963 shares of the registrant's Class A Common Stock,
$.01 par value, and 85,700,901 shares of the registrant's Class B Common Stock,
$.01 par value, were outstanding.
THE ESTEE LAUDER COMPANIES INC.
Index
Page
----
Part I. Financial Information
Item 1. Financial Statements
Consolidated Statements of Earnings --
Three and Nine Months Ended March 31, 2006 and 2005 2
Consolidated Balance Sheets --
March 31, 2006 and June 30, 2005 3
Consolidated Statements of Cash Flows --
Nine Months Ended March 31, 2006 and 2005 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 37
Item 4. Controls and Procedures 37
Part II. Other Information
Item 1. Legal Proceedings 38
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 41
Item 6. Exhibits 41
Signatures 42
THE ESTEE LAUDER COMPANIES INC.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Nine Months Ended
March 31 March 31
----------------------- -----------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
(In millions, except per share data)
Net Sales $ 1,578.2 $ 1,525.3 $ 4,859.2 $ 4,751.9
Cost of Sales 411.5 383.7 1,289.5 1,235.3
---------- ---------- ---------- ----------
Gross Profit 1,166.7 1,141.6 3,569.7 3,516.6
---------- ---------- ---------- ----------
Operating expenses:
Selling, general and administrative 998.8 962.8 3,044.4 2,948.8
Special charges related to cost savings
initiative 51.6 -- 53.2 --
---------- ---------- ---------- ----------
1,050.4 962.8 3,097.6 2,948.8
---------- ---------- ---------- ----------
Operating Income 116.3 178.8 472.1 567.8
Interest expense, net 6.6 3.3 19.1 10.7
---------- ---------- ---------- ----------
Earnings before Income Taxes, Minority
Interest and Discontinued Operations 109.7 175.5 453.0 557.1
Provision for income taxes 43.4 65.7 169.4 208.3
Minority interest, net of tax (3.1) (2.2) (8.2) (5.8)
---------- ---------- ---------- ----------
Net Earnings from Continuing Operations 63.2 107.6 275.4 343.0
Discontinued operations, net of tax (3.7) (1.4) (75.7) (3.5)
---------- ---------- ---------- ----------
Net Earnings $ 59.5 $ 106.2 $ 199.7 $ 339.5
========== ========== ========== ==========
Basic net earnings per common share:
Net earnings from continuing operations $ .30 $ .48 $ 1.27 $ 1.52
Discontinued operations, net of tax (.02) (.01) (.35) (.02)
---------- ---------- ---------- ----------
Net earnings $ .28 $ .47 $ .92 $ 1.50
========== ========== ========== ==========
Diluted net earnings per common share:
Net earnings from continuing operations $ .29 $ .47 $ 1.26 $ 1.50
Discontinued operations, net of tax (.01) (.01) (.35) (.02)
---------- ---------- ---------- ----------
Net earnings $ .28 $ .46 $ .91 $ 1.48
========== ========== ========== ==========
Weighted average common shares outstanding:
Basic 212.4 225.5 215.9 226.1
Diluted 214.9 228.7 218.4 229.7
Cash dividends declared per share $ -- $ -- $ .40 $ .40
See notes to consolidated financial statements.
- 2 -
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED BALANCE SHEETS
March 31 June 30
2006 2005
----------------- ---------------
(Unaudited)
($ in millions)
ASSETS
Current Assets
Cash and cash equivalents $ 268.3 $ 553.3
Accounts receivable, net 900.1 776.6
Inventory and promotional merchandise, net 718.1 768.3
Prepaid expenses and other current assets 256.7 204.4
Assets held for sale 27.3 --
----------------- ---------------
Total current assets 2,170.5 2,302.6
----------------- ---------------
Property, Plant and Equipment, net 709.0 694.2
----------------- ---------------
Other Assets
Investments, at cost or market value 11.5 12.3
Goodwill 635.9 720.6
Other intangible assets, net 72.4 71.8
Other assets, net 97.7 84.3
----------------- ---------------
Total other assets 817.5 889.0
----------------- ---------------
Total assets $ 3,697.0 $ 3,885.8
================= ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Short-term debt $ 119.1 $ 263.6
Accounts payable 239.5 249.4
Accrued income taxes 133.1 109.9
Other accrued liabilities 956.5 874.8
Liabilities related to assets held for sale 12.2 --
----------------- ---------------
Total current liabilities 1,460.4 1,497.7
----------------- ---------------
Noncurrent Liabilities
Long-term debt 436.3 451.1
Other noncurrent liabilities 239.9 228.4
----------------- ---------------
Total noncurrent liabilities 676.2 679.5
----------------- ---------------
Minority Interest 22.0 15.8
----------------- ---------------
Stockholders' Equity
Common stock, $.01 par value; 650,000,000 shares Class A authorized; shares
issued: 163,688,623 at March 31, 2006 and 159,837,545 at June 30, 2005;
240,000,000 shares Class B authorized; shares issued and outstanding:
85,700,901 at March 31, 2006 and 87,640,901 at June 30, 2005 2.5 2.5
Paid-in capital 549.0 465.2
Retained earnings 2,317.4 2,203.2
Accumulated other comprehensive income 9.3 9.4
----------------- ---------------
2,878.2 2,680.3
Less: Treasury stock, at cost; 37,206,292 Class A shares at
March 31, 2006 and 27,174,160 Class A shares at June 30, 2005 (1,339.8) (987.5)
----------------- ---------------
Total stockholders' equity 1,538.4 1,692.8
----------------- ---------------
Total liabilities and stockholders' equity $ 3,697.0 $ 3,885.8
================= ===============
See notes to consolidated financial statements.
- 3 -
THE ESTEE LAUDER COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
March 31
-----------------------------------
2006 2005
------------ ------------
(In millions)
Revised
Cash Flows from Operating Activities -------
Net earnings $ 199.7 $ 339.5
Adjustments to reconcile net earnings to net cash flows provided by
operating activities:
Depreciation and amortization 147.0 144.0
Deferred income taxes (57.5) 36.1
Minority interest, net of tax 8.2 5.8
Non-cash stock compensation 29.5 (1.2)
Excess tax benefits from stock-based compensation arrangements (6.3) --
Loss on disposal of fixed assets 7.0 8.3
Discontinued operations, net of tax 75.7 --
Other non-cash items 0.6 0.9
Changes in operating assets and liabilities:
Increase in accounts receivable, net (136.7) (215.2)
Decrease (increase) in inventory and promotional merchandise, net 36.1 (41.2)
Decrease (increase) in other assets, net (28.2) 1.2
Decrease in accounts payable (7.6) (31.7)
Increase in accrued income taxes 59.4 37.1
Increase in other accrued liabilities 110.2 6.9
Increase in other noncurrent liabilities 39.2 5.2
------------ ------------
Net cash flows provided by operating activities of continuing operations 476.3 295.7
Net cash flows used for operating activities of discontinued operations (6.8) (0.9)
------------ ------------
Net cash flows provided by operating activities 469.5 294.8
------------ ------------
Cash Flows from Investing Activities
Capital expenditures (170.1) (162.5)
Capital expenditures of discontinued operations (0.2) --
Acquisition of businesses, net of cash acquired (49.2) (6.9)
Proceeds from disposition of long-term investments 0.5 --
Purchases of long-term investments (0.1) (0.3)
------------ ------------
Net cash flows used for investing activities (219.1) (169.7)
------------ ------------
Cash Flows from Financing Activities
Increase (decrease) in short-term debt, net (48.9) 8.3
Repayments and redemptions of long-term debt (96.4) (0.7)
Net proceeds from stock-based compensation transactions 43.8 74.4
Excess tax benefits from stock-based compensation arrangements 6.3 --
Payments to acquire treasury stock (352.5) (217.1)
Dividends paid to stockholders (85.4) (90.1)
Distributions made to minority holders of consolidated subsidiaries (2.0) (3.2)
------------ ------------
Net cash flows used for financing activities (535.1) (228.4)
------------ ------------
Effect of Exchange Rate Changes on Cash and Cash Equivalents (0.3) 9.7
------------ ------------
Net Decrease in Cash and Cash Equivalents (285.0) (93.6)
Cash and Cash Equivalents at Beginning of Period 553.3 611.6
------------ ------------
Cash and Cash Equivalents at End of Period $ 268.3 $ 518.0
============ ============
See notes to consolidated financial statements.
- 4 -
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements include the accounts of The
Estee Lauder Companies Inc. and its subsidiaries (collectively, the "Company")
as continuing operations, with the exception of the operating results of its
reporting unit that markets and sells Stila brand products, which have been
reflected as discontinued operations for the three and nine-month periods ended
March 31, 2006 and 2005. All significant intercompany balances and transactions
have been eliminated.
The consolidated financial statements have been prepared in accordance with U.S.
generally accepted accounting principles ("GAAP") for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by GAAP for complete financial statements. In the opinion of management
all adjustments (consisting of normal recurring accruals) considered necessary
for a fair presentation have been included. The results of operations of any
interim period are not necessarily indicative of the results of operations to be
expected for the fiscal year. For further information, refer to the consolidated
financial statements and accompanying footnotes included in the Company's Annual
Report on Form 10-K for the year ended June 30, 2005.
Certain amounts in the consolidated financial statements of prior periods have
been reclassified to conform to current period presentation for comparative
purposes.
Net Earnings Per Common Share
For the three and nine-month periods ended March 31, 2006 and 2005, 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 Nine Months Ended
March 31 March 31
--------------------- ---------------------
2006 2005 2006 2005
--------- --------- --------- ---------
(Unaudited)
(In millions, except per share data)
Numerator:
Net earnings from continuing operations $ 63.2 $ 107.6 $ 275.4 $ 343.0
Discontinued operations, net of tax (3.7) (1.4) (75.7) (3.5)
--------- --------- --------- ---------
Net earnings $ 59.5 $ 106.2 $ 199.7 $ 339.5
========= ========= ========= =========
Denominator:
Weighted average common shares outstanding - Basic 212.4 225.5 215.9 226.1
Effect of dilutive securities: Stock options and
restricted share units 2.5 3.2 2.5 3.6
--------- --------- --------- ---------
Weighted average common shares outstanding - Diluted 214.9 228.7 218.4 229.7
========= ========= ========= =========
Basic net earnings per common share:
Net earnings from continuing operations $ .30 $ .48 $ 1.27 $ 1.52
Discontinued operations, net of tax (.02) (.01) (.35) (.02)
--------- --------- --------- ---------
Net earnings $ .28 $ .47 $ .92 $ 1.50
========= ========= ========= =========
Diluted net earnings per common share:
Net earnings from continuing operations $ .29 $ .47 $ 1.26 $ 1.50
Discontinued operations, net of tax (.01) (.01) (.35) (.02)
--------- --------- --------- ---------
Net earnings $ .28 $ .46 $ .91 $ 1.48
========= ========= ========= =========
- 5 -
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of March 31, 2006 and 2005, outstanding options to purchase 15.2 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 March 31, 2006, the Company had established a number of share incentive
programs as discussed in more detail in Note 3 - Stock Programs. Prior to fiscal
2006, the Company applied the intrinsic value method as outlined in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB No. 25"), and related interpretations in accounting for stock options and
share units granted under these programs. Under the intrinsic value method, no
compensation expense was recognized if the exercise price of the Company's
employee stock options equaled the market price of the underlying stock on the
date of the grant. Accordingly, no compensation cost was recognized in the
accompanying consolidated statements of earnings prior to fiscal year 2006 on
stock options granted to employees, since all options granted under the
Company's share incentive programs had an exercise price equal to the market
value of the underlying common stock on the date of grant.
Effective July 1, 2005, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 123(R), "Share-Based Payment" ("SFAS No. 123(R)"). This
statement replaces SFAS No. 123, "Accounting for Stock-Based Compensation"
("SFAS No. 123") and supersedes APB No. 25. SFAS No. 123(R) requires that all
stock-based compensation be recognized as an expense in the financial statements
and that such cost be measured at the fair value of the award. This statement
was adopted using the modified prospective method of application, which requires
the Company to recognize compensation expense on a prospective basis. Therefore,
prior period financial statements have not been restated. Under this method, in
addition to reflecting compensation expense for new share-based awards, expense
is also recognized to reflect the remaining service period of awards that had
been included in pro-forma disclosures in prior periods. SFAS No. 123(R) also
requires that excess tax benefits related to stock option exercises be reflected
as financing cash inflows instead of operating cash inflows. For the nine months
ended March 31, 2006, this new treatment resulted in cash flows from financing
activities of $6.3 million, which reduced cash flows from operating activities
by the same amount.
Statement of Cash Flows
As of March 31, 2006, the Company has separately disclosed the operating and
investing portion of cash flows attributable to its discontinued operations,
which in prior periods were reported on a combined basis as a single amount. The
Company will also conform its full year statements of cash flows beginning with
its next Annual Report on Form 10-K. These revisions will reflect the
reclassification of cash flows used for discontinued operations from a single
line below the financing activities category into the appropriate operating
activity and investing activity categories. The amounts to be reclassified are
$1.1 million and $2.5 million for the fiscal years ended June 30, 2005 and 2004,
respectively. Certain other prior period cash flows have been revised to conform
to the current period presentation.
Supplemental cash flow information for the nine months ended March 31, 2006 and
2005 is as follows:
2006 2005
-------------- --------------
(Unaudited)
(In millions)
Cash paid during the period for interest $ 27.1 $ 16.1
============== ==============
Cash paid during the period for income taxes $ 152.2 $ 127.4
============== ==============
Incremental tax benefit from the exercise of stock options $ 4.5 $ 26.0
============== ==============
Liability associated with acquisition of business $ -- $ 5.6
============== ==============
Capital lease obligations incurred $ 0.3 $ 6.9
============== ==============
Accrued dividend equivalents $ 0.1 $ --
============== ==============
- 6 -
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Accounts Receivable
Accounts receivable is stated net of the allowance for doubtful accounts and
customer deductions of $31.3 million and $28.9 million as of March 31, 2006 and
June 30, 2005, respectively.
Inventory and Promotional Merchandise
Inventory and promotional merchandise only includes inventory considered
saleable or usable in future periods, and is stated at the lower of cost or
fair-market value, with cost being determined on the first-in, first-out method.
Cost components include raw materials, componentry, direct labor and overhead
(e.g., indirect labor, utilities, depreciation, purchasing, receiving,
inspection and warehousing) as well as inbound freight. Promotional merchandise
is charged to expense at the time the merchandise is shipped to the Company's
customers.
March 31 June 30
2006 2005
-------------- --------------
(Unaudited)
(In millions)
Inventory and promotional merchandise consists of:
Raw materials $ 129.6 $ 149.9
Work in process 30.4 43.2
Finished goods 407.8 403.4
Promotional merchandise 150.3 171.8
-------------- --------------
$ 718.1 $ 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.
March 31 June 30
2006 2005
-------------- --------------
(Unaudited)
(In millions)
Assets (Useful Life)
Land $ 13.6 $ 13.6
Buildings and improvements (10 to 40 years) 159.3 160.8
Machinery and equipment (3 to 10 years) 770.3 721.2
Furniture and fixtures (5 to 10 years) 111.2 109.1
Leasehold improvements 751.9 703.9
-------------- -------------
1,806.3 1,708.6
Less accumulated depreciation and amortization 1,097.3 1,014.4
-------------- -------------
$ 709.0 $ 694.2
============== =============
Depreciation and amortization of property, plant and equipment was $48.1 million
and $47.1 million during the three months ended March 31, 2006 and 2005,
respectively, and $140.8 million and $136.0 million during the nine months ended
March 31, 2006 and 2005, respectively. Depreciation and amortization related to
our manufacturing process is included in cost of sales and all other
depreciation and amortization is included in selling, general and administrative
expenses in the accompanying consolidated statements of earnings.
- 7 -
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Goodwill and Other Intangible Assets
In January 2006, the Company acquired a salon operations business in the United
Kingdom resulting in an increase to goodwill of $2.1 million.
In December 2005, the Company settled its obligation, recorded as goodwill at
June 30, 2005, related to an earn-out provision in the Company's fiscal 2000
acquisition of Jo Malone Limited.
In October 2005, the Company acquired a business engaged in the wholesale
distribution of Aveda products resulting in an increase to goodwill of $5.7
million.
In September 2005, as a result of the Company's commitment to sell the assets
and operations of its reporting unit that markets and sells Stila brand
products, $91.3 million of goodwill was reclassified to Assets Held For Sale on
the accompanying consolidated balance sheet. Refer to Note 4 - Discontinued
Operations and Assets Held For Sale for further discussion.
Debt
On March 24, 2006, the Company entered into a 3.0 billion yen revolving credit
facility that expires on March 24, 2009. The interest rate on borrowings under
the credit facility is based on TIBOR (Tokyo Interbank Offered Rate) and a 10
basis point facility fee is incurred on the undrawn balance. The Company
borrowed 3.0 billion yen under the new facility on March 28, 2006 to repay the
previously outstanding 3.0 billion yen term loan that was to mature on that
date. The outstanding balance ($25.6 million at the exchange rate at March 31,
2006) is classified as short-term debt on the accompanying consolidated balance
sheet.
In October 2005, the Company redeemed the remaining $68.4 million of the 2015
Preferred Stock.
Operating Leases
The Company recognizes rent expense from operating leases with periods of free
rent and scheduled rent increases on a straight-line basis over the applicable
lease term. The Company considers lease renewals in the useful life of its
leasehold improvements when such renewals are reasonably assured. From time to
time, the Company may receive capital improvement funding from its lessors.
These amounts are recorded as deferred liabilities and amortized over the
remaining lease term as a reduction of rent expense.
Pension and Postretirement Benefit Plans
The Company maintains pension plans covering substantially all of its full-time
employees for its U.S. operations and a majority of its international
operations. The Company also maintains a domestic postretirement benefit plan
which provides certain medical and dental benefits to eligible employees.
Descriptions of these plans are discussed in the Company's Annual Report on Form
10-K for the year ended June 30, 2005.
The components of net periodic benefit cost for the three months ended March 31,
2006 and 2005 consisted of the following:
Other than
Pension Plans Pension Plans
------------------------------------------------------- -------------------------
U.S. International Postretirement
------------------------- ------------------------- -------------------------
2006 2005 2006 2005 2006 2005
---------- ---------- ---------- ---------- ---------- -----------
(Unaudited)
(In millions)
Service cost, net $ 5.4 $ 4.8 $ 3.0 $ 2.8 $ 1.1 $ 0.8
Interest cost 5.3 5.3 2.4 2.5 1.3 1.0
Expected return on plan assets (6.2) (6.0) (2.8) (2.9) -- --
Amortization of:
Prior service cost 0.2 0.1 0.1 0.1 -- --
Actuarial loss 1.5 1.2 2.0 1.0 0.3 --
Settlements and curtailments -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- -----------
Net periodic benefit cost $ 6.2 $ 5.4 $ 4.7 $ 3.5 $ 2.7 $ 1.8
========== ========== ========== ========== ========== ===========
- 8 -
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of net periodic benefit cost for the nine months ended March 31,
2006 and 2005 consisted of the following:
Other than
Pension Plans Pension Plans
------------------------------------------------------ -------------------------
U.S. International Postretirement
------------------------- ------------------------- -------------------------
2006 2005 2006 2005 2006 2005
---------- ---------- ---------- ---------- ---------- ----------
(Unaudited)
(In millions)
Service cost, net $ 16.1 $ 14.5 $ 9.0 $ 8.5 $ 3.4 $ 2.4
Interest cost 15.9 15.9 7.3 7.4 3.8 3.0
Expected return on plan assets (18.7) (18.1) (8.6) (8.4) -- --
Amortization of:
Prior service cost 0.6 0.4 0.2 0.2 -- --
Actuarial loss 4.6 3.4 6.2 3.0 0.9 --
Settlements and curtailments -- -- 0.2 -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Net periodic benefit cost $ 18.5 $ 16.1 $ 14.3 $ 10.7 $ 8.1 $ 5.4
========== ========== ========== ========== ========== ==========
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 March 31, 2006, there have not been material changes to the expected
contributions for the U.S. pension plan. However, the expected contributions to
the international pension plans are anticipated to increase $1.9 million to a
total of $21.8 million for the fiscal year ending June 30, 2006.
Common Stock
During the nine months ended March 31, 2006, 1,940,000 shares of the Company's
Class B Common Stock were converted into Class A Common Stock. 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.
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.
Stock-Based Compensation
------------------------
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.
-9-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company uses an expected stock-price volatility assumption that is a
combination of both current and historical implied volatilities of the
underlying stock which are obtained from public data sources. This approach is
used as a predictor of future realized and implied volatilities and is directly
relevant for valuing stock options. For stock option grants issued during the
three and nine months ended March 31, 2006, the Company used a weighted-average
expected stock-price volatility of 25% and 23%, respectively, 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
and nine months ended March 31, 2006, the Company used a weighted-average
expected option life assumption of approximately 8 years.
Income Taxes
------------
The Company provides tax reserves for Federal, state, local and international
exposures relating to audit results, tax planning initiatives and compliance
responsibilities. The development of these reserves requires judgments about tax
issues, potential outcomes and timing, and is a subjective critical estimate.
Although the outcome of tax audits is uncertain, in management's opinion,
adequate provisions for income taxes have been made for known and determinable
liabilities emanating from these reviews. If actual outcomes differ materially
from these estimates, they could have a material impact on the Company's results
of operations.
The Internal Revenue Service ("IRS") has completed and closed its audits of the
Company's consolidated Federal income tax returns through fiscal 1997. The
Company is presently under examination by the IRS for fiscal years 1998 through
2001. During the current period, the Company entered into discussions with the
IRS regarding several issues that have been raised during their examination. The
effective tax rates include the Company's best estimates of the probable loss or
favorable resolution of certain of the issues currently under discussion with
the IRS. The final settlement of the remaining issues, which include transfer
pricing and foreign tax credit calculations, is subject to further discussions,
negotiations, review and computations. While it is probable that additional tax
liabilities will result from the conclusion of the IRS examination, due to the
complexity of the issues still under discussion, an estimate of the final
outcome cannot be made at this time. The Company expects to conclude these
discussions in conjunction with the finalization of the field examination
portion of the audit in the fourth quarter of fiscal 2006.
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 did not have an
additional impact on the Company's consolidated financial statements.
-10-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO 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 applied the
principles set forth in this FSP upon its adoption of SFAS No. 123(R).
In November 2005, the FASB issued FSP Nos. FAS 115-1 and FAS 124-1, "The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments,"
to give guidance on determining when investments in certain debt and equity
securities are considered impaired, whether that impairment is other than
temporary, and on measuring such impairment loss. This FSP also includes
accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. FSP Nos. FAS 115-1 and FAS 124-1 applies to reporting periods
beginning after December 15, 2005, although earlier application was permitted.
This FSP did not have a material impact on the Company's consolidated financial
statements.
In November 2005, the FASB published FSP No. FAS 123(R)-3, "Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards," to
provide an alternative transition method for accounting for the tax effects of
share-based payment awards to employees. The FASB learned, subsequent to
adoption of SFAS No. 123(R), that a number of constituents did not have the
information necessary to comply with the transition requirements of SFAS No.
123(R), and provided an elective alternative transition method in FSP No. FAS
123(R)-3. Entities can choose to follow either the transition guidance of SFAS
No. 123(R) or the alternative transition method described in FSP No. FAS
123(R)-3. The guidance in FSP No. FAS 123(R)-3 became effective upon
publication. The Company has applied the principles originally set forth in SFAS
No. 123(R). Therefore, the guidance set forth in this FSP is not applicable to
the Company.
In February 2006, the FASB issued FSP No. FAS 123(R)-4, "Classification of
Options and Similar Instruments Issued as Employee Compensation That Allow for
Cash Settlement upon the Occurrence of a Contingent Event," to amend guidance in
SFAS No. 123(R) on classifying options and similar instruments issued as part of
employee compensation arrangements. This FSP revises the requirement in SFAS No.
123(R) that share options with contingent cash settlement features be classified
as liabilities and re-measured to fair value each reporting period regardless of
the event's likelihood of occurrence. Under FSP No. FAS 123(R)-4, companies
shall classify these instruments as equity if the occurrence of such contingent
event is not probable. Any awards that require cash settlement or permit cash
settlement at the direction of the holder are classified as liabilities in the
Company's consolidated financial statements. For all other awards, the
discretion to allow cash settlement of the Company's stock-based compensation
awards lies with the Company and are thus classified as equity.
-11-
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 Nine Months Ended
March 31 March 31
---------------------- ----------------------
2006 2005 2006 2005
--------- --------- --------- ---------
(Unaudited)
(In millions)
Net earnings $ 59.5 $ 106.2 $ 199.7 $ 339.5
--------- --------- ---------- ---------
Other comprehensive income (loss):
Net unrealized investment gain 0.2 0.2 0.2 0.2
Net derivative instruments gain (loss) 0.7 3.3 0.8 (3.4)
Translation adjustments 12.0 (8.2) (1.1) 68.1
--------- --------- ---------- ---------
Other comprehensive income (loss) 12.9 (4.7) (0.1) 64.9
--------- --------- ---------- ---------
Comprehensive income $ 72.4 $ 101.5 $ 199.6 $ 404.4
========= ========= ========== =========
The accumulated net gain (loss) on derivative instruments consists of the
following:
Three Months Ended Nine Months Ended
March 31 March 31
---------------------- ----------------------
2006 2005 2006 2005
--------- --------- --------- ---------
(Unaudited)
(In millions)
OCI-derivative instruments, beginning of period $ 12.0 $ 3.5 $ 11.9 $ 10.2
--------- --------- --------- ---------
Gain (loss) on derivative instruments 2.3 0.2 7.3 (13.6)
Reclassification to earnings of net (gain) loss
during the period (1.2) 4.9 (6.7) 8.6
Deferred income tax benefit (expense) (0.4) (1.8) 0.2 1.6
--------- --------- --------- ---------
Net derivative instruments gain (loss) 0.7 3.3 0.8 (3.4)
--------- --------- --------- ---------
OCI-derivative instruments, end of period $ 12.7 $ 6.8 $ 12.7 $ 6.8
========= ========= ========= =========
Of the $12.7 million, net of tax, derivative instrument gain recorded in OCI at
the end of the current period, $9.2 million, net of tax, related to the October
2003 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 $3.5
million, net of tax, related to forward and option contracts which the Company
will reclassify to earnings during the next fifteen months.
At the end of the prior period, the $6.8 million, net of tax, derivative
instrument gain recorded in OCI included $8.9 million, net of tax, related to
the October 2003 gain on the settlement of treasury lock agreements upon
issuance of the Company's 5.75% Senior Notes due October 2033, which will be
reclassified to earnings as an offset to interest expense over the life of the
debt. This was offset by a $2.1 million loss, net of tax, related to forward and
option contracts, which the Company is reclassifying to earnings through the
fiscal year ending June 30, 2006.
-12-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Stock Programs
The Company has established the Amended and Restated Fiscal 2002 Share Incentive
Plan, the Fiscal 1999 Share Incentive Plan, the Fiscal 1996 Share Incentive Plan
and the Non-Employee Director Share Incentive Plan (collectively, the "Plans").
The Plans provide for the issuance of 40,750,000 shares to be granted in the
form of stock-based awards to key employees, consultants and non-employee
directors of the Company. As of March 31, 2006, 10,667,300 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 March 31, 2006. The
Company may satisfy the obligation of its stock based compensation awards with
either new or treasury shares. The Company's stock compensation awards
outstanding at March 31, 2006 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 March 31, 2006 was $5.8 million ($3.7 million after
tax, or $0.02 for both basic and diluted net earnings per common share).
Compensation expense attributable to net stock-based compensation in the nine
months ended March 31, 2006 was $29.4 million ($19.2 million after tax, or $0.09
for both basic and diluted net earnings per common share). As of March 31, 2006,
the total unrecognized compensation cost related to nonvested stock-based awards
was $33.0 million and the related weighted-average period over which it is
expected to be recognized is approximately 2.4 years.
Prior to the Company's adoption of SFAS No. 123(R), SFAS No. 123 required that
the Company provide pro forma information regarding net earnings and net
earnings per common share as if compensation cost for the Company's stock-based
awards had been determined in accordance with the fair value method prescribed
therein. The Company had previously adopted the disclosure portion of SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure,"
requiring quarterly SFAS No. 123 pro forma disclosure. The pro forma charge for
compensation cost related to stock-based awards granted was recognized over the
service period. For stock options, the service period represents the period of
time between the date of grant and the date each option becomes exercisable
without consideration of acceleration provisions (e.g., retirement, change of
control, etc.).
The following table illustrates the effect on net earnings per common share as
if the fair value method had been applied to all outstanding awards for the
three and nine months ended March 31, 2005:
Three Months Ended Nine Months Ended
March 31, 2005 March 31, 2005
------------------------ -----------------------
(Unaudited)
($ in millions)
Net earnings, as reported $ 106.2 $ 339.5
Deduct: Total stock-based compensation expense
determined under fair value method for all awards,
net of related tax effects (4.7) (18.2)
--------------- -------------
Pro forma net earnings $ 101.5 $ 321.3
=============== =============
Earnings per common share:
Net earnings per common share - Basic, as reported $ .47 $ 1.50
=============== =============
Net earnings per common share - Basic, pro forma $ .45 $ 1.42
=============== =============
Net earnings per common share - Diluted, as reported $ .46 $ 1.48
=============== =============
Net earnings per common share - Diluted, pro forma $ .44 $ 1.39
=============== =============
-13-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Options
A summary of the Company's stock option programs as of March 31, 2006 and
changes during the nine-month period then ended is presented below:
Weighted-
Weighted- Aggregate 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 1,880.6 35.54
Exercised (1,914.7) 22.90
Expired (163.8) 41.96
Forfeited (117.1) 37.98
-------------
Outstanding at March 31, 2006 27,029.7 39.30 $ 71.0 5.1
============= ================== ===================
Exercisable at March 31, 2006 22,833.7 39.47 $ 65.2 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 per-share weighted-average grant date fair value of stock options granted
during the three months ended March 31, 2006 and 2005 was $13.15 and $16.35,
respectively. The per-share weighted-average grant date fair value of stock
options granted during the nine months ended March 31, 2006 and 2005 was $11.87
and $16.45, respectively. The total intrinsic value of stock options exercised
during the three months ended March 31, 2006 and 2005 was $8.5 million and $20.7
million, respectively. The total intrinsic value of stock options exercised
during the nine months ended March 31, 2006 and 2005 was $30.9 million and $66.7
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
March 31
---------------------------------------------
(Unaudited) 2006 2005
------------------------------------------------------------ -------------------- --------------------
Weighted-average expected stock-price volatility 25% 31%
Weighted-average expected option life 8 years 7 years
Average risk-free interest rate 4.5% 4.1%
Average dividend yield 1.2% .9%
Nine Months Ended
March 31
---------------------------------------------
(Unaudited) 2006 2005
------------------------------------------------------------ -------------------- --------------------
Weighted-average expected stock-price volatility 23% 32%
Weighted-average expected option life 8 years 7 years
Average risk-free interest rate 4.3% 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 March 31, 2006 that will expire in October
2007.
-14-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Performance Share Units
During the nine months ended March 31, 2006, the Company issued 111,100 PSUs,
which will be settled in stock subject to the achievement of the Company's net
sales and net earnings per share goals for the three years ending June 30, 2008.
Settlement will be made pursuant to a range of opportunities relative to the net
sales and earnings per share targets of the Company. No settlement will occur
for results below the applicable minimum threshold and additional shares shall
be issued if performance exceeds the targeted performance goals. PSUs are
accompanied by dividend equivalent rights that will be payable in cash upon
settlement of the PSU. These awards are subject to the provisions of the
agreement under which the PSUs are granted. The PSUs were valued at $35.00 per
share representing the closing market value of the Company's Class A Common
Stock on the date of grant and generally vest at the end of the performance
period. The compensation cost of the PSUs is subject to adjustment based upon
the attainability of the target goals.
The following is a summary of the status of the Company's PSUs as of March 31,
2006 and activity during the nine 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 March 31, 2006 111.1 $ 35.00
==================== =======================
Restricted Stock Units
The Company issued 111,100 RSUs during the nine months ended March 31, 2006.
RSUs vest in one-third increments on or about October 31, 2006, 2007 and 2008,
subject to the continued employment of the grantee. RSUs are accompanied by
dividend equivalent rights that will be payable in cash upon settlement of the
RSU. These awards are subject to the provisions of the agreement under which the
RSUs are granted. The RSUs were valued at $35.00 per share 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 March 31,
2006 and activity during the nine 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 March 31, 2006 111.1 $ 35.00
==================== =======================
-15-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Share Units
Certain non-employee directors defer cash compensation in the form of share
units which are granted under the Non-Employee Director Share Incentive Plan and
will be converted into shares of Class A Common Stock as provided for in that
plan. Share units are accompanied by dividend equivalent rights that are
converted to additional share units when such dividends are declared. The
following is a summary of the status of the Company's share units as of March
31, 2006 and activity during the nine months then ended:
Weighted-Average
Grant Date
(Unaudited) (Shares in thousands) Shares Fair Value
------------------------------------------------------- -------------------- -----------------------
Outstanding at June 30, 2005 7.7 $ 39.13
Granted 5.2 33.45
Dividend equivalents 0.2 33.40
Converted -- --
-------------------- -----------------------
Outstanding at March 31, 2006 13.1 $ 36.79
==================== =======================
Cash Units
Certain non-employee directors defer cash compensation in the form of cash
payout share units, which are not subject to the Plans. These share units are
classified as liabilities and, as such, their fair value is adjusted to reflect
the current market value of the Company's Class A Common Stock. The Company
recorded $0.3 million and $0.1 million as compensation expense to reflect
additional deferrals and the change in the market value for the three months
ended March 31, 2006 and 2005, respectively. Compensation expense for the nine
months ended March 31, 2006 and 2005 was $0.3 million and $0.2 million,
respectively.
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. Subsequent to March 31, 2006, the
Company sold certain assets and operations of the Stila business, and pursuant
to such sale, has agreed to divest itself of continuing involvement in the Stila
business, except as discussed in Note 5 - Subsequent Event. As a result of the
operations of this business through March 31, 2006, and in consideration of the
then pending sale of certain assets and operations of this reporting unit, the
Company recorded charges of $3.7 million (net of $24.5 million tax benefit) and
$75.7 million (net of $40.7 million tax benefit) to discontinued operations for
the three and nine months ended March 31, 2006, respectively. The charges
reflect the anticipated loss on the disposition of the business of $0.8 million
and $66.3 million, net of tax, for the three and nine months ended March 31,
2006, respectively, which represent adjustments to the fair value of assets held
for sale, the costs to dispose of those assets not acquired by the purchaser and
other costs anticipated in connection with the sale. The charges also include
the operating losses of $2.9 million and $9.4 million, net of tax, for the three
and nine months ended March 31, 2006, respectively. Net sales associated with
the discontinued operations were $12.6 million and $38.3 million for the three
and nine months ended March 31, 2006, respectively. All statements of earnings
information for the prior periods has been restated for comparative purposes,
including the restatement of the makeup product category and each of the
geographic regions presented in Note 6 - Segment Data and Related Information.
-16-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The assets and liabilities of the Stila brand are presented in the consolidated
balance sheet under the 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:
March 31
2006
------------------
(Unaudited)
(In millions)
Assets
Accounts receivable, net $ 6.0
Inventory and promotional merchandise, net 14.3
Prepaid expenses and other current assets 0.1
Property, plant and equipment, net 3.3
Goodwill 3.6
------------------
Assets held for sale $ 27.3
==================
Liabilities
Accounts payable $ 2.0
Other accrued liabilities 10.2
------------------
Liabilities related to assets held for sale $ 12.2
==================
Note 5 - Subsequent Event
On April 10, 2006 (the "Effective Date"), the Company completed the sale of
certain assets and operations of the reporting unit that marketed and sold Stila
brand products to Stila Corp. (the "Purchaser"), an affiliate of Sun Capital
Partners, Inc., for consideration of $23.0 million. The sale price included cash
of $9.3 million, a promissory note with a notional value of $13.3 million and a
fair value of $11.0 million and convertible preferred stock with an aggregate
liquidation preference of $5.0 million and a fair value of $2.7 million. Stila
Corp. will immediately assume responsibility for all decisions regarding the
operations of the Stila business.
As additional consideration for the purchased assets, and subject to the terms
and conditions of the sale agreement, the Purchaser will pay the Company an
amount equal to two percent of the annual net sales of the acquired business
during the period commencing on the Effective Date and ending August 20, 2019.
The Company will use these proceeds to satisfy its commitment under the 1999
agreement pursuant to which it originally purchased the Stila business.
As discussed in Note 4, at March 31, 2006 the Company recorded a loss related to
the anticipated disposition of the Stila business. In connection with this
transaction, the Company anticipates additional future losses of approximately
$6 million, net of tax, substantially related to employee separation benefits,
beginning in the fourth quarter of fiscal 2006 and continuing into fiscal 2007.
In order to facilitate the transition of the Stila business to the Purchaser,
the Company will continue to provide certain information systems, accounting and
other back office services to the Purchaser. The Company will receive monthly
service fees, which are designed to recover the estimated costs of providing
these transition services. The Company has also agreed with the Purchaser to
provide certain distribution and online services. In both cases, the services
will continue for a period of up to four months from the Effective Date, subject
to an extension of two months at the request of the Purchaser. In addition, the
Company agreed to manufacture and sell to the Purchaser a limited range of
products for a period of up to four months following the Effective Date and, in
the case of one product, of up to two years.
-17-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 6 - Segment Data and Related Information
Reportable operating segments include components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker (the "Chief Executive") in deciding how to
allocate resources and in assessing performance. Although the Company 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 (loss). Operating income (loss) represents earnings
before income taxes, minority interest, net interest expense and discontinued
operations. The accounting policies for the Company's reportable segment are
substantially the same as those for the consolidated financial statements, as
described in the segment data and related information footnote included in the
Company's Annual Report on Form 10-K for the year ended June 30, 2005. The
assets and liabilities of the Company are managed centrally and are reported
internally in the same manner as the consolidated financial statements; thus, no
additional information is produced for the Chief Executive or included herein.
There has been no significant variance in the total or long-lived asset value
associated with the Company's segment data since June 30, 2005 other than the
reduction of assets associated with discontinued operations.
Three Months Ended Nine Months Ended
March 31 March 31
--------------------- ---------------------
2006 2005 2006 2005
--------- --------- --------- ---------
(Unaudited)
(In millions)
PRODUCT CATEGORY DATA
Net Sales:
Skin Care $ 611.1 $ 608.2 $ 1,778.6 $ 1,749.9
Makeup 634.9 615.3 1,882.1 1,779.4
Fragrance 246.3 228.7 947.4 999.0
Hair Care 80.3 67.3 229.9 202.0
Other 5.6 5.8 21.2 21.6
--------- --------- --------- ---------
$ 1,578.2 $ 1,525.3 $ 4,859.2 $ 4,751.9
========= ========= ========= =========
Operating Income (Loss):
Skin Care $ 80.3 $ 89.3 $ 252.4 $ 275.0
Makeup 92.5 92.5 245.5 232.9
Fragrance (11.7) (9.2) 5.2 40.3
Hair Care 6.8 5.6 19.7 17.7
Other -- 0.6 2.5 1.9
Special charges related to cost savings
initiative (51.6) -- (53.2) --
--------- --------- --------- ---------
116.3 178.8 472.1 567.8
Reconciliation:
Interest expense, net (6.6) (3.3) (19.1) (10.7)
--------- --------- --------- ---------
Earnings before income taxes, minority $ 109.7 $ 175.5 $ 453.0 $ 557.1
interest and discontinued operations ========= ========= ========= =========
GEOGRAPHIC DATA
Net Sales:
The Americas $ 870.1 $ 838.7 $ 2,629.9 $ 2,588.7
Europe, the Middle East & Africa 501.5 493.4 1,577.9 1,541.8
Asia/Pacific 206.6 193.2 651.4 621.4
--------- --------- --------- ---------
$ 1,578.2 $ 1,525.3 $ 4,859.2 $ 4,751.9
========= ========= ========= =========
Operating Income (Loss):
The Americas $ 99.2 $ 115.9 $ 259.2 $ 310.4
Europe, the Middle East & Africa 54.9 52.7 209.3 211.8
Asia/Pacific 13.8 10.2 56.8 45.6
Special charges related to cost savings
initiative (51.6) -- (53.2) --
--------- --------- --------- ---------
$ 116.3 $ 178.8 $ 472.1 $ 567.8
========= ========= ========= =========
-18-
THE ESTEE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 7 - Cost Savings Initiative
As part of an initiative to reduce expenses, the Company commenced streamlined
process and organizational changes. The principal component of the initiative is
a voluntary separation program offered to employees. During the three and nine
months ended March 31, 2006, the Company recorded charges of $51.6 million and
$53.2 million, respectively, related to employee separation costs in connection
with this cost savings initiative.
Note 8 - Legal Proceedings
On March 30, 2006, a purported securities class action complaint captioned
Thomas S. Shin, et al. v. The Estee Lauder Companies Inc., et al., was filed
against the Company and certain of its officers and directors (collectively the
"Defendants") in the United States District Court for the Southern District of
New York. The complaint alleges that Defendants made statements during the
period April 28, 2005 to October 25, 2005 in press releases, the Company's
public filings and during conference calls with analysts that were materially
false and misleading and which artificially inflated the price of the Company's
stock. The complaint alleges claims under Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. The complaint also asserts that during the
class period, certain executive officers and the trust for the benefit of a
director sold shares of the Company's Class A Common Stock at artificially
inflated prices. Three additional purported securities class action complaints
were subsequently filed in the United States District Court for the Southern
District of New York containing similar allegations. No motion to consolidate
the actions, appoint lead plaintiff or for approval of the selection of lead
counsel has yet been filed. The Defendants believe that the complaints are
without merit and intend to defend these actions vigorously. The Company has
received an informal request for information from the staff of the Securities
and Exchange Commission regarding matters raised in the above complaints and the
Company is cooperating.
On April 10, 2006, a shareholder derivative action complaint captioned Miriam
Loveman v. Leonard A. Lauder, et al., was filed against certain of the Company's
officers and all persons who were directors on that date (collectively the
"Derivative Action Defendants") in the United States District Court for the
Southern District of New York. The complaint alleges that Derivative Action
Defendants breached their fiduciary duties to the Company based on the same
alleged course of conduct identified in the securities actions described above.
Derivative Action Defendants are currently seeking to have the derivative action
transferred to the judge assigned to the securities class actions. Derivative
Action Defendants similarly believe that this complaint is without merit and
intend to defend the action vigorously.
-19-
THE ESTEE LAUDER COMPANIES INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Results Of Operations
---------------------
We manufacture, market and sell beauty products, including those in the skin
care, makeup, fragrance and hair care categories, which are distributed in over
130 countries and territories. The following is a comparative summary of
operating results from continuing operations for the three and nine months ended
March 31, 2006 and 2005, and reflects the basis of presentation described in
Note 1 of Notes to Consolidated Financial Statements - Summary of Significant
Accounting Policies for all periods presented. Sales of products and services
that do not meet our definition of skin care, makeup, fragrance or hair care
have been included in the "other" category.
Three Months Ended Nine Months Ended
March 31 March 31
------------------------- --------------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
(In millions)
NET SALES
By Region:
The Americas $ 870.1 $ 838.7 $ 2,629.9 $ 2,588.7
Europe, the Middle East & Africa 501.5 493.4 1,577.9 1,541.8
Asia/Pacific 206.6 193.2 651.4 621.4
---------- ---------- ---------- ----------
$ 1,578.2 $ 1,525.3 $ 4,859.2 $ 4,751.9
========== ========== ========== ==========
By Product Category:
Skin Care $ 611.1 $ 608.2 $ 1,778.6 $ 1,749.9
Makeup 634.9 615.3 1,882.1 1,779.4
Fragrance 246.3 228.7 947.4 999.0
Hair Care 80.3 67.3 229.9 202.0
Other 5.6 5.8 21.2 21.6
---------- ---------- ---------- ----------
$ 1,578.2 $ 1,525.3 $ 4,859.2 $ 4,751.9
========== ========== ========== ==========
OPERATING INCOME (LOSS)
By Region:
The Americas $ 99.2 $ 115.9 $ 259.2 $ 310.4
Europe, the Middle East & Africa 54.9 52.7 209.3 211.8
Asia/Pacific 13.8 10.2 56.8 45.6
Special charges related to cost
savings initiative (51.6) -- (53.2) --
---------- ---------- ---------- ----------
$ 116.3 $ 178.8 $ 472.1 $ 567.8
========== ========== ========== ==========
By Product Category:
Skin Care $ 80.3 $ 89.3 $ 252.4 $ 275.0
Makeup 92.5 92.5 245.5 232.9
Fragrance (11.7) (9.2) 5.2 40.3
Hair Care 6.8 5.6 19.7 17.7
Other -- 0.6 2.5 1.9
Special charges related to cost
savings initiative (51.6) -- (53.2) --
---------- ---------- ---------- ----------
$ 116.3 $ 178.8 $ 472.1 $ 567.8
========== ========== ========== ==========
-20-
THE ESTEE LAUDER COMPANIES INC.
The following table presents certain consolidated earnings data as a percentage
of net sales:
Three Months Ended Nine Months Ended
March 31 March 31
---------------------- ----------------------
2006 2005 2006 2005
-------- -------- --------- --------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 26.1 25.2 26.5 26.0
-------- -------- --------- --------
Gross profit 73.9 74.8 73.5 74.0
-------- -------- --------- --------
Operating expenses:
Selling, general and administrative 63.2 63.1 62.7 62.1
Special charges related to cost savings initiative 3.3 -- 1.1 --
-------- -------- --------- --------
66.5 63.1 63.8 62.1
-------- -------- --------- --------
Operating income 7.4 11.7 9.7 11.9
Interest expense, net 0.4 0.2 0.4 0.2
-------- -------- --------- --------
Earnings before income taxes, minority interest and
discontinued operations 7.0 11.5 9.3 11.7
Provision for income taxes 2.8 4.3 3.5 4.4
Minority interest, net of tax (0.2) (0.1) (0.2) (0.1)
-------- -------- --------- --------
Net earnings from continuing operations 4.0 7.1 5.6 7.2
Discontinued operations, net of tax (0.2) (0.1) (1.5) (0.1)
-------- -------- --------- --------
Net earnings 3.8% 7.0% 4.1% 7.1%
======== ======== ========= ========
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.
Third Quarter Fiscal 2006 as Compared with Third Quarter Fiscal 2005
Net Sales
Net sales increased 3% or $52.9 million to $1,578.2 million reflecting growth in
all product categories and geographic regions. Product category results were led
principally by makeup and fragrance, particularly in the Americas region, fueled
by new product launches. International growth, particularly in the Europe,
Middle East & Africa region, was tempered by the unfavorable effect of changes
in exchange rates. Excluding the impact of foreign currency translation, net
sales increased 6%.
Product Categories
Skin Care
Net sales of skin care products increased $2.9 million to $611.1 million. The
recent launches of Resilience Lift Extreme Ultra Firming Cremes by Estee Lauder,
and Turnaround Concentrate Visible Skin Renewer and Turnaround 15-Minute Facial
by Clinique generated incremental sales of approximately $49 million. Sales of
products in Clinique's 3-Step Skin Care System, bolstered by the introduction of
Liquid Facial Soap, also contributed approximately $6 million to the increase.
These contributions to net sales were partially offset by decreases in sales of
certain existing products in the Resilience Lift, Perfectionist and Re-Nutriv
lines by Estee Lauder, and Superdefense Triple Action Moisturizers SPF 25 by
Clinique of approximately $46 million, collectively. Excluding the impact of
foreign currency translation, skin care net sales increased 3%.
-21-
THE ESTEE LAUDER COMPANIES INC.
Makeup
Makeup net sales increased 3% or $19.6 million to $634.9 million primarily
reflecting growth from our makeup artist brands of approximately $45 million,
which offset challenges in certain of our core brands. Lower sales of
approximately $20 million of Pure Pops Brush-on Color, Ideal Matte Refinishing
Compact Makeup SPF 12 and So Ingenious by Estee Lauder, combined with declines
in our BeautyBank brands, which substantially completed their initial rollout in
the prior-year quarter, partially offset these positive results. Excluding the
impact of foreign currency translation, makeup net sales increased 5%.
Fragrance
Net sales of fragrance products increased 8% or $17.6 million to $246.3 million.
While fragrance continues to be a challenging product category for us, growth in
the current quarter reflects a strategic balance between new fragrance offerings
and some of our most successful franchises. Growth was fueled by the initial
sales of Unforgivable by Sean John and the recent launch of Youth Dew Amber Nude
by Estee Lauder of approximately $20 million, combined. Additional increases
from Estee Lauder pleasures and Beautiful contributed approximately $11 million
to the category. Partially offsetting these increases were lower sales of
approximately $13 million combined of DKNY Be Delicious Men, which was launched
in the third quarter of the prior fiscal year, and DKNY Be Delicious, which
launched internationally in the same period. Excluding the impact of foreign
currency translation, fragrance net sales increased 11%.
Hair Care
Hair care net sales increased 19% or $13.0 million to $80.3 million, primarily
due to sales growth from Bumble and bumble and Aveda products. Bumble and bumble
sales benefited from sales growth due to new points of distribution and the
launch of new hair shine and powder products. Aveda net sales increased as a
result of the recent acquisition of a distributor, sales of professional color
products and the recent launch of Damage Remedy hair care products. Excluding
the impact of foreign currency translation, hair care net sales increased 20%.
Geographic Regions
Net sales in the Americas increased 4% or $31.4 million to $870.1 million. The
increase was led by growth in the United States of approximately $56 million
from our makeup artist and hair care brands, and the introduction of the
Unforgivable fragrance by Sean John partially offset by approximately $36
million related to weaknesses in certain of our core brands as a result of
challenges from competitive pressures and business disruptions at certain key
retailers, and lower sales from our BeautyBank brands, which substantially
completed their initial rollout in the comparable prior-year quarter. We expect
business disruptions at certain key retailers in the United States to continue
throughout the remainder of the fiscal year and into fiscal 2007. Net sales
growth in Mexico, Canada and Latin America contributed an additional $8 million
to the increase.
In Europe, the Middle East & Africa, net sales increased 2% or $8.1 million to
$501.5 million, reflecting higher net sales of approximately $19 million from
Russia, our travel retail and distributor businesses, France and South Africa.
The travel retail and distributor businesses showed balanced growth from core
brands and makeup artist brands as well as the success of the DKNY Be Delicious
franchise. These increases were partially offset by lower sales in Spain and
Benelux (Belgium, the Netherlands and Luxembourg) of approximately $12 million,
collectively. In particular, Spain was negatively impacted by a difficult retail
environment and changes to our distribution policy. On a local currency basis,
net sales in Europe, the Middle East & Africa increased 8% which reflects the
strengthening of the U.S. dollar as compared with currencies in this region.
Net sales in Asia/Pacific increased 7% or $13.4 million to $206.6 million.
Strategic growth in China combined with positive results in Korea and Hong Kong,
driven by the success of our makeup artist brands, contributed approximately $17
million to sales growth in this region. These increases were partially offset by
decreases in Japan and Australia of approximately $5 million. Japan's results
were negatively impacted due to the strengthening of the U.S. dollar against the
Japanese yen. The decrease in Australia reflected slower sell-through in a
difficult retail environment, particularly in the fragrance category. On a local
currency basis, net sales in Asia/Pacific increased 10%.
We strategically stagger our new product launches by geographic market, which
may account for differences in regional sales growth.
-22-
THE ESTEE LAUDER COMPANIES INC.
Cost of Sales
Cost of sales as a percentage of total net sales increased to 26.1% as compared
with 25.2% in the prior period. This increase reflected the net unfavorable
change in the mix of our business within our geographic regions and product
categories of approximately 90 basis points, an increase in obsolescence charges
of approximately 40 basis points and a charge related to unutilized tooling of
approximately 30 basis points. Partially offsetting these increases were
favorable changes in promotional activities of approximately 70 basis points.
The higher price of oil has resulted in price increases in certain oil-based
chemicals, which has had 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
through our sourcing initiative in low-cost manufacturing locations worldwide.
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 66.5% of net sales as compared with 63.1% of net
sales in the prior period. During the quarter, we recorded a $51.6 million
charge to operating expenses related to the implementation of our cost savings
initiative that negatively impacted our operating expense margin by 330 basis
points. This charge primarily related to employee separation costs associated
with the cost savings initiative. This initiative is expected to generate cost
savings for the balance of this fiscal year and for future periods. Our
operating expense margin was also negatively impacted by the estimated effects
on net sales of retailer consolidations of approximately 80 basis points and the
effect of the recognition of stock-based compensation expense of approximately
40 basis points as a result of the adoption of Statement of Financial Accounting
Standards ("SFAS") No. 123(R), "Share-Based Payment" ("SFAS No. 123(R)").
Offsetting these incremental costs were operating expense margin improvements of
approximately 80 basis points resulting from net sales growth in brands with
lower advertising, merchandising and sampling cost structures as well as an
overall reduction in this type of spending, and approximately 30 basis points
related to sales growth from our travel retail business.
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
Operating income decreased 35%, or $62.5 million, to $116.3 million. Operating
margin was 7.4% of net sales in the current period as compared with 11.7% in the
prior period. These results were negatively impacted by the effects of a special
charge related to our cost savings initiative of $51.6 million, or 3.3% of net
sales. In addition to the special charge, net sales growth was more than offset
by the increases in our cost of sales and operating expense margins as
previously discussed.
The following discussions of Operating Results by Product Categories and
Geographic Regions exclude the impact of a special charge related to the
implementation of our cost savings initiative. We believe the following analysis
of operating results better reflects the manner in which we conduct and view our
business. See Note 6 of Notes to Consolidated Financial Statements - Segment
Data and Related Information.
Product Categories
Operating income declined 10% or $9.0 million in the skin care product category
reflecting weak sales growth in certain of our core brands as compared to the
launch activity in the prior-year quarter. Operating results in the fragrance
product category declined 27% or $2.5 million reflecting lower net sales from
certain of our designer fragrances and higher promotional costs related to new
launch activity. Overall, makeup results were flat as improvements in our makeup
artist brands were offset by lower sales volume at certain of our core brands
and our BeautyBank brands, which substantially completed their initial rollout
in the prior-year quarter. Partially offsetting these decreases, hair care
operating income increased 21% or $1.2 million, primarily reflecting net sales
growth from Bumble and bumble.
-23-
THE ESTEE LAUDER COMPANIES INC.
Geographic Regions
Operating income in the Americas decreased 14% or $16.7 million to $99.2
million. The ongoing success of our makeup artist brands contributed to higher
operating results, but was more than offset by challenges in certain of our core
brands, associated in part to competitive pressures and retailer consolidations,
and declines in our BeautyBank brands, which substantially completed their
initial rollout in the prior-year quarter. Results in this region also reflected
incremental operating expenses associated with new accounting rules for
stock-based compensation.
In Europe, the Middle East & Africa, operating income increased 4% or $2.2
million to $54.9 million primarily due to improved results of approximately $8
million from Russia, France, Germany and our distributor businesses, partially
offset by declines in Spain and Portugal of approximately $6 million,
collectively.
In Asia/Pacific, operating income increased 35% or $3.6 million to $13.8
million. This increase reflects improved results of approximately $7 million in
Japan, Australia and Hong Kong, partially offset by lower results in Taiwan and
Korea of approximately $3 million.
Interest Expense, Net
Net interest expense was $6.6 million as compared with $3.3 million in the prior
period. The increase in net interest expense was primarily due to a higher level
of borrowings compared with the prior period as a result of the issuance of
commercial paper. The increased expense was slightly offset by increased
interest income related to higher investment interest rates.
Provision for Income Taxes
The provision for income taxes represents Federal, foreign, state and local
income taxes. The effective rate differs from statutory rates due to the effect
of state and local taxes, tax rates in foreign jurisdictions and certain
nondeductible expenses. The Company's effective tax rate will change from
quarter to quarter based on non-recurring and recurring factors including, but
not limited to, the geographic mix of earnings, the timing and amount of foreign
dividends, enacted tax legislation, state and local taxes, tax audit settlements
and the interaction of various global tax strategies. The effective rate for
income taxes for the three months ended March 31, 2006 was 39.6% as compared
with 37.4% in the prior period. The increase in the effective income tax rate of
220 basis points was primarily attributable to an increase in state and local
income tax expense (130 basis points), an increase attributable to the
anticipated full-year mix of global earnings (130 basis points), offset by a
decrease from miscellaneous items (40 basis points).
The Internal Revenue Service ("IRS") has completed and closed its audits of our
consolidated Federal income tax returns through fiscal 1997. The Company is
presently under examination by the IRS for fiscal years 1998 through 2001.
During the current quarter, we entered into discussions with the IRS regarding
several issues that have been raised during their examination. The effective tax
rates include our best estimates of the probable loss or favorable resolution of
certain of the issues currently under discussion with the IRS. The final
settlement of the remaining issues, which include transfer pricing and foreign
tax credit calculations, is subject to further discussions, negotiations, review
and computations. While it is probable that additional tax liabilities will
result from the conclusion of the IRS examination, due to the complexity of the
issues still under discussion, an estimate of the final outcome cannot be made
at this time. We expect to conclude these discussions in conjunction with the
finalization of the field examination portion of the audit in the fourth quarter
of the current fiscal year.
-24-
THE ESTEE LAUDER COMPANIES INC.
Discontinued Operations
On September 30, 2005, we committed to a plan to sell the assets and operations
of our reporting unit that markets and sells Stila brand products and to
actively seek a buyer for the brand. Subsequent to March 31, 2006, we sold
certain assets and operations of the Stila business, and pursuant to such sale,
have agreed to divest ourself of continuing involvement in the Stila business,
except as discussed below. As a result of the operations of this business
through March 31, 2006 and in consideration of the then pending sale of certain
assets and operations of this reporting unit, we recorded a charge of $3.7
million (net of $24.5 million tax benefit) to discontinued operations for the
three months ended March 31, 2006. The charge reflects the additional
anticipated loss on the disposition of the business of $0.8 million, net of tax,
for the three months ended March 31, 2006, which represents adjustments to the
fair value of assets held for sale, the costs to dispose of those assets not
acquired by the purchaser and other costs anticipated in connection with the
sale. The charge also includes the operating loss of $2.9 million, net of tax,
for the three months ended March 31, 2006. All statements 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.
On April 10, 2006 (the "Effective Date"), we completed the sale of certain
assets and operations of the reporting unit that marketed and sold Stila brand
products to Stila Corp. (the "Purchaser"), an affiliate of Sun Capital Partners,
Inc. for consideration of $23.0 million. The sale price included cash of $9.3
million, a promissory note with a notional value of $13.3 million and a fair
value of $11.0 million and convertible preferred stock with an aggregate
liquidation preference of $5.0 million and a fair value of $2.7 million. Stila
Corp. will immediately assume responsibility for all decisions regarding the
operations of the Stila business.
As additional consideration for the purchased assets, and subject to the terms
and conditions of the sale agreement, the Purchaser will pay us an amount equal
to two percent of the annual net sales of the acquired business during the
period commencing on the Effective Date and ending August 20, 2019. We will use
these proceeds to satisfy our commitment under the 1999 agreement pursuant to
which we originally purchased the Stila business.
As discussed above, at March 31, 2006 we recorded a loss related to the
anticipated disposition of the Stila business. In connection with this
transaction, we anticipate additional future losses of approximately $6 million,
net of tax, substantially related to employee separation benefits, beginning in
the fourth quarter of fiscal 2006 and continuing into fiscal 2007.
In order to facilitate the transition of the Stila business to the Purchaser, we
will continue to provide certain information systems, accounting and other back
office services to the Purchaser. We will receive monthly service fees, which
are designed to recover the estimated costs of providing these transition
services. We have also agreed with the Purchaser to provide certain distribution
and online services. In both cases, these services will continue for a period of
up to four months from the Effective Date, subject to an extension of two months
at the request of the Purchaser. In addition, we agreed to manufacture and sell
to the Purchaser a limited range of products for a period of up to four months
following the Effective Date and, in the case of one product, of up to two
years.
Nine Months Fiscal 2006 as Compared with Nine Months Fiscal 2005
Net Sales
Net sales increased 2% or $107.3 million to $4,859.2 million due to growth in
our makeup, skin care and hair care product categories, which was partially
offset by lower sales in our fragrance product category. The net increase
reflects sales growth in all geographic regions. In particular, the Asia/Pacific
and Europe, Middle East & Africa regions posted solid gains, despite the
unfavorable effects of changes in exchange rates. Excluding the impact of
foreign currency translation, net sales increased 4%.
-25-
THE ESTEE LAUDER COMPANIES INC.
Product Categories
Skin Care
Net sales of skin care products increased 2% or $28.7 million to $1,778.6
million due primarily to new product launches. The recent launches of Resilience
Lift Extreme Ultra Firming Cremes by Estee Lauder, and Turnaround Concentrate
Visible Skin Renewer and Turnaround 15-Minute Facial by Clinique generated
incremental sales of approximately $71 million, combined. Perfectionist [CP+] by
Estee Lauder and products in Clinique's 3-Step Skin Care System, bolstered by
the introduction of Liquid Facial Soap, contributed approximately $64 million to
the increase. These improvements were offset by approximately $103 million of
decreases in certain existing products in certain of our core brands as well as
declines in our BeautyBank brands, which substantially completed their initial
rollout in the prior-year period. Excluding the impact of foreign currency
translation, skin care net sales increased 3%.
Makeup
Makeup net sales increased 6% or $102.7 million to $1,882.1 million reflecting
growth from our makeup artist brands of approximately $132 million. New product
launches helped offset challenges experienced by certain of our core brands.
Sales of Repairwear Anti-Aging Makeup SPF 15 and Colour Surge Butter Shine
Lipstick by Clinique, and Individualist Natural Finish Makeup by Estee Lauder
contributed approximately $56 million to the growth, collectively. Partially
offsetting these increases were lower sales of existing products, including
approximately $51 million of Superbalanced Compact Makeup SPF 20 by Clinique,
and So Ingenious and Lash XL Maximum Length Mascara by Estee Lauder as well as
declines in our BeautyBank brands, which substantially completed their initial
rollout in the prior-year period. Excluding the impact of foreign currency
translation, makeup net sales increased 7%.
Fragrance
Net sales of fragrance products decreased 5% or $51.6 million to $947.4 million
as we continue to be challenged in this product category. Lower sales of Estee
Lauder Beyond Paradise, Tommy Girl and Tommy by Tommy Hilfiger and various
fragrances from Clinique contributed approximately $85 million to the decrease.
Also contributing to the decrease were lower sales of approximately $41 million
of True Star by Tommy Hilfiger, Lauder Beyond Paradise Men and Donald Trump The
Fragrance as we anniversary the initial shipments of those products in the
prior-year period. Partially offsetting these decreases were higher sales of
DKNY Be Delicious, Estee Lauder pleasures and DKNY Be Delicious Men of
approximately $57 million, collectively. The recent launches of True Star Men by
Tommy Hilfiger and Unforgivable by Sean John contributed approximately $35
million to the category. Excluding the impact of foreign currency translation,
fragrance net sales decreased 3%.
Hair Care
Hair care net sales increased 14% or $27.9 million to $229.9 million, primarily
due to sales growth from Bumble and bumble and Aveda products. Bumble and bumble
sales benefited from sales growth due to new points of distribution, as well as
sales growth in both core and treatment products. Aveda net sales increases
benefited from the recent launch of Damage Remedy hair care products as well as
from the recent acquisition of a distributor. Foreign currency translation had a
de minimis impact on hair care net sales compared to the prior period.
Geographic Regions
Net sales in the Americas increased 2% or $41.2 million to $2,629.9 million. Net
sales in the United States grew approximately $127 million reflecting growth in
our makeup artist and hair care brands as well as from our internet
distribution, partially offset by approximately $106 million related to
weaknesses in certain of our core brands as a result of challenges from
competitive pressures and business disruptions at certain key retailers, and
lower sales from our BeautyBank brands, which substantially completed their
initial rollout in the comparable prior-year period. We expect business
disruptions at certain key retailers in the United States to continue throughout
the remainder of the fiscal year and into fiscal 2007. Net sales growth in
Mexico, Canada and Latin America contributed an additional $28 million to the
increase.
-26-
THE ESTEE LAUDER COMPANIES INC.
In Europe, the Middle East & Africa, net sales increased 2% or $36.1 million to
$1,577.9 million, reflecting higher net sales of approximately $41 million from
our travel retail and distributor businesses and Russia, with both benefiting
from a strong retail environment and the success of the DKNY Be Delicious
franchise. These increases were partially offset by decreases in Spain and Italy
of approximately $14 million, collectively. In particular, Spain was negatively
impacted by a difficult retail environment and changes to our distribution
policy. During the current period, we commenced operations at a new regional
inventory center in Europe. However, unforeseen logistical issues related to
start-up activities resulted in disruptions in shipments to certain European
markets serviced from this center. These issues have since been addressed and
while we believe lost sales will not be fully recovered, the inventory center is
now fully operational. On a local currency basis, net sales in Europe, the
Middle East & Africa increased 7%.
Net sales in Asia/Pacific increased 5% or $30.0 million to $651.4 million.
Strategic growth in China combined with positive results in Korea and Hong Kong,
contributed approximately $43 million to sales growth in this region. These
increases were partially offset by decreases in Japan and Australia of
approximately $17 million. Japan's results were negatively impacted due to the
strengthening of the U.S. dollar against the Japanese yen. The decrease in
Australia reflected slower sell-through in a difficult retail environment,
particularly in the fragrance category. On a local currency basis, net sales in
Asia/Pacific increased 6%.
We strategically stagger our new product launches by geographic market, which
may account for differences in regional sales growth.
Cost of Sales
Cost of sales as a percentage of total net sales increased to 26.5% as compared
with 26.0% in the prior period. This change reflected an increase in
obsolescence charges of approximately 40 basis points, unfavorable changes in
exchange rates and the net change in the mix of our business within our
geographic regions and product categories of approximately 20 basis points,
combined, and a charge related to unutilized tooling of approximately 10 basis
points. Partially offsetting these increases were favorable changes in
promotional activities of approximately 20 basis points.
The higher price of oil has resulted in price increases in certain oil-based
chemicals, which has had 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
through our sourcing initiative in low-cost manufacturing locations worldwide.
Since certain promotional activities are a component of sales or cost of sales
and the timing and level of promotions vary with our promotional calendar, we
have experienced, and expect to continue to experience, fluctuations in the cost
of sales percentage. In addition, future cost of sales mix may be impacted by
the inclusion of new brands which have margin and product cost structures
different from those of our existing brands.
Operating Expenses
Operating expenses increased to 63.8% of net sales as compared with 62.1% of net
sales in the prior period. The current period operating expense margin was
negatively impacted by charges related to the implementation of our cost savings
initiative of approximately $53.2 million or approximately 110 basis points,
costs related to stock-based compensation as a result of the adoption of SFAS
No. 123(R) of approximately 60 basis points, and the estimated impact of both
retailer consolidations resulting from the merger of Federated Department
Stores, Inc. and The May Department Stores Company and the hurricanes that
affected the southern United States of approximately 60 basis points. Partially
offsetting these incremental costs were operating expense margin improvements of
approximately 50 basis points resulting from net sales growth in brands with
lower advertising, merchandising and sampling cost structures as well as an
overall reduction in this type of spending, and approximately 40 basis points
related to sales growth from our travel retail business.
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.
-27-
THE ESTEE LAUDER COMPANIES INC.
Operating Results
Operating income decreased 17%, or $95.7 million, to $472.1 million. Operating
margin was 9.7% of net sales in the current period as compared with 11.9% in the
prior period. These results were negatively impacted by the effects of special
charges related to our cost savings initiative of $53.2 million, or 1.1% of net
sales. In addition to the special charges, net sales growth was more than offset
by the increases in our cost of sales and operating expense margins as
previously discussed.
The following discussions of Operating Results by Product Categories and
Geographic Regions exclude the impact of special charges related to the
implementation of our cost savings initiative. We believe the following analysis
of operating results better reflects the manner in which we conduct and view our
business.
Product Categories
Operating income declined 87% or $35.1 million to $5.2 million in the fragrance
product category reflecting lower sales and, to a lesser extent, expenses
incurred related to development of new products and brands. Skin care operating
income decreased 8% or $22.6 million to $252.4 million primarily reflecting
lower than anticipated net sales, coupled with spending to support new product
launches. Operating income increased 5% or $12.6 million to $245.5 million in
the makeup product category primarily reflecting sales growth from our makeup
artist brands. Hair care operating income increased 11% or $2.0 million to $19.7
million reflecting worldwide sales growth. Operating results from all of our
product categories were negatively impacted by the incremental operating
expenses associated with new accounting rules for stock-based compensation.
Geographic Regions
Operating income in the Americas decreased 16% or $51.2 million to $259.2
million, primarily reflecting incremental operating expenses associated with new
accounting rules for stock-based compensation of approximately $29 million. The
ongoing success of our makeup artist brands and our online business contributed
to higher operating results, but was more than offset by challenges in certain
of our core brands, associated in part to competitive pressures and retailer
consolidations. We expect business disruptions to continue throughout the
remainder of the fiscal year and into fiscal 2007 at certain key retailers in
the United States.
In Europe, the Middle East & Africa, operating income decreased 1% or $2.5
million to $209.3 million. This decrease was primarily due to lower results in
Spain, the United Kingdom and Austria of approximately $21 million,
collectively, partially offset by improvements of approximately $19 million from
France, Germany, Russia and our travel retail business.
In Asia/Pacific, operating income increased 25% or $11.2 million to $56.8
million. This increase reflects improved results of approximately $16 million in
Japan, China, Korea and Hong Kong, partially offset by lower results in Taiwan
and Malaysia of approximately $5 million.
Interest Expense, Net
Net interest expense was $19.1 million as compared with $10.7 million in the
prior period. The increase in net interest expense was primarily due to a higher
level of borrowings compared with the prior period as a result of the issuance
of commercial paper. The increased expense was partially offset by increased
interest income related to higher investment interest rates.
Provision for Income Taxes
The provision for income taxes represents Federal, foreign, state and local
income taxes. The effective rate differs from statutory rates due to the effect
of state and local taxes, tax rates in foreign jurisdictions and certain
nondeductible expenses. The Company's effective tax rate will change from
quarter to quarter based on non-recurring and recurring factors including, but
not limited to, the geographic mix of earnings, the timing and amount of foreign
dividends, enacted tax legislation, state and local taxes, tax audit settlements
and the interaction of various global tax strategies. The effective rate for
income taxes for the nine months ended March 31, 2006 and 2005 was 37.4%. While
there was no change in the overall effective rate between the two periods, the
effective rate for the nine months ended March 31, 2006 included an extra 10
basis points attributable to a decrease in tax credits and an increase of 40
basis points attributable to the anticipated full-year mix of global earnings,
which were offset by a decrease in state and local income tax expense of 20
basis points as well as a decrease of 30 basis points attributable to
miscellaneous items.
-28-
THE ESTEE LAUDER COMPANIES INC.
The IRS has completed and closed its audits of our consolidated Federal income
tax returns through fiscal 1997. The Company is presently under examination by
the IRS for fiscal years 1998 through 2001. During the current quarter, we
entered into discussions with the IRS regarding several issues that have been
raised during their examination. The effective tax rates include our best
estimates of the probable loss or favorable resolution of certain of the issues
currently under discussion with the IRS. The final settlement of the remaining
issues, which include transfer pricing and foreign tax credit calculations, is
subject to further discussions, negotiations, review and computations. While it
is probable that additional tax liabilities will result from the conclusion of
the IRS examination, due to the complexity of the issues still under discussion,
an estimate of the final outcome cannot be made at this time. We expect to
conclude these discussions in conjunction with the finalization of the field
examination portion of the audit in the fourth quarter of the current fiscal
year.
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. Subsequent to March 31, 2006, we sold
certain assets and operations of the Stila business, and pursuant to such sale,
have agreed to divest ourself of continuing involvement in the Stila business,
except as discussed below. As a result of the operations of this business
through March 31, 2006, and in consideration of the then pending sale of certain
assets and operations of this reporting unit, we recorded a charge of $75.7
million (net of $40.7 million tax benefit) to discontinued operations for the
nine months ended March 31, 2006. The charge reflects the anticipated loss on
the disposition of the business of $66.3 million, net of tax, for the nine
months ended March 31, 2006, which represents adjustments to the fair value of
assets held for sale, the costs to dispose of those assets not acquired by the
purchaser and other costs anticipated in connection with the sale. The charge
also includes the operating loss of $9.4 million, net of tax, for the nine
months ended March 31, 2006. All statements 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.
On April 10, 2005 (the "Effective Date"), we completed the sale of certain
assets and operations of the reporting unit that marketed and sold Stila brand
products to Stila Corp. (the "Purchaser"), an affiliate of Sun Capital Partners,
Inc. for consideration of $23.0 million. The sale price included cash of $9.3
million, a promissory note with a notional value of $13.3 million and a fair
value of $11.0 million and convertible preferred stock with an aggregate
liquidation preference of $5.0 million and a fair value of $2.7 million. Stila
Corp. will immediately assume responsibility for all decisions regarding the
operations of the Stila business.
As additional consideration for the purchased assets, and subject to the terms
and conditions of the sale agreement, the Purchaser will pay us an amount equal
to two percent of the annual net sales of the acquired business during the
period commencing on the Effective Date and ending August 20, 2019. We will use
these proceeds to satisfy our commitment under the 1999 agreement pursuant to
which we originally purchased the Stila business.
As discussed above, at March 31, 2006 we recorded a loss related to the
anticipated disposition of the Stila business. In connection with this
transaction, we anticipate additional future losses of approximately $6 million,
net of tax, substantially related to employee separation benefits, beginning in
the fourth quarter of fiscal 2006 and continuing into fiscal 2007.
In order to facilitate the transition of the Stila business to the Purchaser, we
will continue to provide certain information systems, accounting and other back
office services to the Purchaser. We will receive monthly service fees, which
are designed to recover the estimated costs of providing these transition
services. We have also agreed with the Purchaser to provide certain distribution
and online services. In both cases, these services will continue for a period of
up to four months from the Effective Date, subject to an extension of two months
at the request of the Purchaser. In addition, we agreed to manufacture and sell
to the Purchaser a limited range of products for a period of up to four months
following the Effective Date and, in the case of one product, of up to two
years.
-29-
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 March 31, 2006, we had cash and cash
equivalents of $268.3 million compared with $553.3 million at June 30, 2005.
At March 31, 2006, our outstanding borrowings of $555.4 million included: (i)
$233.3 million of 6% Senior Notes due January 2012 consisting of $250.0 million
principal, unamortized debt discount of $0.7 million and a $16.0 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) a 1.8
million Euro note (approximately $1.9 million at the exchange rate at March 31,
2006) payable semi-annually through February 2008 at a variable interest rate;
(iv) $7.0 million of capital lease obligations; (v) $65.0 million of outstanding
short-term commercial paper payable through April 2006 at a weighted-average
interest rate of 4.84%; (vi) a 3.0 billion yen short-term borrowing under a
revolving credit facility (approximately $25.6 million at the exchange rate at
March 31, 2006); and (vii) $25.2 million of other short-term borrowings.
We have a $750.0 million commercial paper program under which we may issue
commercial paper in the United States. Our commercial paper is currently rated
A-1 by Standard & Poor's and P-1 by Moody's. Our long-term credit ratings are A+
with a stable outlook by Standard & Poor's and A1 with a stable outlook by
Moody's. At March 31, 2006, we had $65.0 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 $167.1 million in additional uncommitted credit
facilities, of which $25.2 million was used as of March 31, 2006.
We have an unused $600.0 million senior revolving credit facility that expires
on May 27, 2010. The facility may be used for general corporate purposes,
including financing working capital, and also as credit support for our
commercial paper program. Up to the equivalent of $250.0 million of the facility
is available for multi-currency loans. The interest rate on borrowings under the
credit facility is based on LIBOR or on the higher of prime, which is the rate
of interest publicly announced by the administrative agent, or the Federal funds
rate plus 1/2%. The credit facility has an annual fee of $0.4 million, payable
quarterly, based on our current credit ratings. As of March 31, 2006, we were in
compliance with all related financial and other restrictive covenants, including
limitations on indebtedness and liens.
On March 24, 2006, we entered into a 3.0 billion yen revolving credit facility
that expires on March 24, 2009. The interest rate on borrowings under the credit
facility is based on TIBOR (Tokyo Interbank Offered Rate) and a 10 basis point
facility fee is incurred on the undrawn balance. We borrowed 3.0 billion yen
under the new facility on March 28, 2006 to repay the previously outstanding 3.0
billion yen term loan that was to mature on that date. The outstanding balance
at March 31, 2006 ($25.6 million at the exchange rate at March 31, 2006) is
classified as short-term debt on our consolidated balance sheet.
In October 2005, we redeemed the remaining $68.4 million of the 2015 Preferred
Stock that was outstanding at June 30, 2005 and paid the accrued dividends
thereon.
Our business is seasonal in nature and, accordingly, our working capital needs
vary. From time to time, we may enter into investing and financing transactions
that require additional funding. To the extent that these needs exceed cash from
operations, we could, subject to market conditions, issue commercial paper,
issue long-term debt securities or borrow under the revolving credit facility.
Total debt as a percent of total capitalization was 27% at March 31, 2006 and
30% at June 30, 2005.
-30-
THE ESTEE LAUDER COMPANIES INC.
The effects of inflation have not been significant to our overall operating
results in recent years. Generally, we have been able to introduce new products
at higher selling prices or increase selling prices sufficiently to offset cost
increases, which have been moderate.
We believe that cash on hand, cash generated from operations, available credit
lines and access to credit markets will be adequate to support currently planned
business operations and capital expenditures on both a near-term and long-term
basis.
Cash Flows
Net cash provided by operating activities from continuing operations was $476.3
million during the nine months ended March 31, 2006 as compared with net cash
provided of $295.7 million in the prior period. The improvement in cash flows
provided by operating activities primarily reflected significant deferred
compensation and supplemental pension payments made to retired executives in
fiscal 2005. Additional increases in other accrued liabilities and noncurrent
liabilities reflect employee separation benefits recorded in the current period
related to our cost savings initiative. Changes in accounts receivable reflect
improvements in our rate of collections as compared with the prior period and
the decrease in inventory levels had a favorable impact on cash flows from
operations reflecting our efforts to better manage our inventory.
Net cash used for investing activities was $219.1 million during the nine months
ended March 31, 2006 compared with $169.7 million in the prior period. For both
periods the use of cash primarily reflected capital expenditures, which were
slightly higher during the current period. Additional cash used for investing
activities in the current period reflects the earn-out payment related to the
fiscal 2000 acquisition of Jo Malone Limited.
Net cash used for financing activities was $535.1 million during the nine months
ended March 31, 2006 compared to net cash used for financing activities of
$228.4 million in the prior period. This change from the prior period primarily
reflected the acquisition of treasury stock, the net repayment of short-term
commercial paper and the redemption of the remaining shares of 2015 Preferred
Stock. The repayment of the 3.0 billion yen term loan in the current period was
offset by the borrowings under the new 3.0 billion yen revolving credit facility
we entered into in March 2006.
Dividends
On November 10, 2005, the Board of Directors declared an annual dividend of $.40
per share, or $85.5 million, on our Class A and Class B Common Stock, which was
paid on December 28, 2005 to stockholders of record at the close of business on
December 9, 2005. The annual common stock dividend declared during the prior
period was $.40 per share, or $90.1 million, which was paid on December 28, 2004
to stockholders of record at the close of business on December 10, 2004.
Dividends on the 2015 Preferred Stock were $0.5 million and $0.6 million for the
nine months ended March 31, 2006 and 2005, respectively. These dividends have
been characterized as interest expense in the accompanying consolidated
statements of earnings for the nine months ended March 31, 2006 and 2005.
-31-
THE ESTEE LAUDER COMPANIES INC.
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 March 31,
2006, the cumulative total of acquired shares pursuant to the authorization was
37.4 million, reducing the remaining authorized share repurchase balance to 10.6
million. During the first nine months of fiscal 2006, we purchased approximately
10.0 million shares for $352.5 million as outlined in the following table:
Total Number of Maximum Number of
Shares Purchased as Shares that May
Total Number of Average Price Part of Publicly Yet Be Purchased
Period Shares Purchased Paid Per Share Announced Program(1) Under the Program
-------------------- ------------------ ----------------- ----------------------- --------------------
July 2005 -- -- -- 20,607,900
August 2005 -- -- -- 20,607,900
September 2005 1,919,700 37.04 1,919,700 18,688,200
October 2005 3,726,700 35.02 3,726,700 14,961,500
November 2005 1,893,800 33.01 1,893,800 13,067,700
December 2005 1,237,800 33.71 1,237,800 11,829,900
January 2006 -- -- -- 11,829,900
February 2006 1,261,800 37.00 1,261,800 10,568,100
March 2006 -- -- -- 10,568,100
------------------ -----------------------
Year-to-date 10,039,800 35.11 10,039,800 10,568,100
================== =======================
(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.
Commitments and Contingencies
In October 2005, we redeemed the remaining $68.4 million of the 2015 Preferred
Stock that was outstanding at June 30, 2005 and paid the accrued dividends
thereon.
In December 2005, we made a cash payment of $36.4 million to satisfy our
obligation related to an earn-out provision, which was part of our fiscal 2000
acquisition of Jo Malone Limited.
Contractual Obligations
Since June 30, 2005, we made additional commitments pursuant to employment
agreements of approximately $30 million, which are expected to be paid through
fiscal 2011. Furthermore, we committed to spend approximately $26 million to
support the company-wide initiative to upgrade our information systems, which is
expected to be paid through November 2006.
During fiscal 2006, we implemented a cost savings initiative that was designed
to generate between $40 and $45 million in savings this fiscal year and
approximately $75 million annually. We anticipate this multi-faceted initiative
to result in one-time costs of up to $90 million during the fiscal year. As of
March 31, 2006, we incurred $53.2 million in special charges associated with
this initiative. These charges related primarily to employee separation costs,
which will be paid through fiscal 2008.
Derivative Financial Instruments and Hedging Activities
There have been no significant changes to our derivative financial instruments
and hedging activities as discussed in our Annual Report on Form 10-K for the
year ended June 30, 2005.
Foreign Exchange Risk Management
We enter into forward exchange contracts to hedge anticipated transactions as
well as receivables and payables denominated in foreign currencies for periods
consistent with our identified exposures. The purpose of the hedging activities
is to minimize the effect of foreign exchange rate movements on our costs and on
the cash flows that we receive from foreign subsidiaries. Almost all foreign
currency contracts are denominated in currencies of major industrial countries
and are with large financial institutions rated as strong investment grade by a
major rating agency. We also enter into foreign currency options to hedge
anticipated transactions where there is a high probability that anticipated
exposures will materialize. The forward exchange contracts and foreign currency
options entered into to hedge anticipated transactions have been designated as
cash-flow hedges. As of March 31, 2006, these cash-flow hedges were highly
effective, in all material respects.
-32-
THE ESTEE LAUDER COMPANIES INC.
As a matter of policy, we only enter into contracts with counterparties that
have at least an "A" (or equivalent) credit rating. The counterparties to these
contracts are major financial institutions. We do not have significant exposure
to any one counterparty. Our exposure to credit loss in the event of
nonperformance by any of the counterparties is limited to only the recognized,
but not realized, gains attributable to the contracts. Management believes risk
of loss under these hedging contracts is remote and in any event would not be
material to the consolidated financial results. The contracts have varying
maturities through the end of June 2007. Costs associated with entering into
such contracts have not been material to our consolidated financial results. We
do not utilize derivative financial instruments for trading or speculative
purposes. At March 31, 2006, we had foreign currency contracts in the form of
forward exchange contracts and option contracts in the amount of $864.3 million
and $130.2 million, respectively. The foreign currencies included in forward
exchange contracts (notional value stated in U.S. dollars) are principally the
Euro ($259.2 million), Swiss franc ($108.7 million), Canadian dollar ($97.2
million), British pound ($71.5 million) and Australian dollar ($54.3 million).
The foreign currencies included in the option contracts (notional value stated
in U.S. dollars) are principally the Japanese yen ($32.0 million), Euro ($27.7
million), Canadian dollar ($22.8 million), Swiss franc ($14.8 million) and South
Korean won ($13.4 million).
Interest Rate Risk Management
We enter into interest rate derivative contracts to manage the exposure to
fluctuations of interest rates on our funded indebtedness and anticipated
issuance of debt, as well as cash investments, for periods consistent with the
identified exposures. All interest rate derivative contracts are with large
financial institutions rated as strong investment grade by a major rating
agency.
We have an interest rate swap agreement with a notional amount of $250.0 million
to effectively convert fixed interest on the existing $250.0 million 6% Senior
Notes to variable interest rates based on LIBOR. We designated the swap as a
fair-value hedge. As of March 31, 2006, 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 $6.8 million related to our foreign
exchange contracts. As of March 31, 2006, our average value-at-risk related to
our interest rate contracts for the twelve month period for which these
contracts were outstanding was $8.3 million. There have been no significant
changes in market risk since June 30, 2005 that would have a material effect on
our calculated value-at-risk exposure, as disclosed in our Annual Report on Form
10-K for the fiscal year ended June 30, 2005.
Off-Balance Sheet Arrangements
We do not maintain any off-balance sheet arrangements, transactions, obligations
or other relationships with unconsolidated entities that would be expected to
have a material current or future effect upon our financial condition or results
of operations.
Critical Accounting Policies
----------------------------
As disclosed in our Annual Report on Form 10-K for the fiscal year ended June
30, 2005, the discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in conformity with U.S. generally accepted accounting principles. The
preparation of these financial statements requires us to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses reported in those financial statements. These judgments can be
subjective and complex, and consequently actual results could differ from those
estimates and assumptions. Our most critical accounting policies relate to
revenue recognition, concentration of credit risk, inventory, pension and other
postretirement benefit costs, goodwill and other intangible assets, income taxes
and derivatives. Since June 30, 2005, there have been no significant changes to
the assumptions and estimates related to those critical accounting policies.
-33-
THE ESTEE LAUDER COMPANIES INC.
Stock-Based Compensation
------------------------
With the adoption of SFAS No. 123(R) on July 1, 2005, we are 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, we apply the
Black-Scholes option-pricing model. Inherent in this model are assumptions
related to expected stock-price volatility, option life, risk-free interest rate
and dividend yield. While the risk-free interest rate and dividend yield are
less subjective assumptions, typically based on factual data derived from public
sources, the expected stock-price volatility and option life assumptions require
a greater level of judgment which makes them critical accounting estimates.
We use an expected stock-price volatility assumption that is a combination of
both current and historical implied volatilities of the underlying stock which
are obtained from public data sources. This approach is used as a predictor of
future realized and implied volatilities and is directly relevant for valuing
stock options. For stock option grants issued during the three and nine months
ended March 31, 2006, we used a weighted-average expected stock-price volatility
of 25% and 23%, respectively, based upon the implied volatility at the time of
issuance.
With regard to the weighted-average option life assumption, we consider the
exercise behavior of past grants and model the pattern of aggregate exercises.
Patterns are determined on specific criteria of the aggregate pool of optionees
including the reaction to vesting, realizable value, long-run exercise
propensity, pent-up demand, stock run-up effect and short-time-to-maturity
effect. For stock option grants issued during the three and nine months ended
March 31, 2006, we used a weighted-average expected option life assumption of
approximately 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 $0.4 million and $2.1 million in either direction for the
three and nine months ended March 31, 2006, respectively.
Income Taxes
------------
We provide tax reserves for Federal, state, local and international exposures
relating to audit results, tax planning initiatives and compliance
responsibilities. The development of these reserves requires judgments about tax
issues, potential outcomes and timing, and is a subjective critical estimate.
Although the outcome of tax audits is uncertain, in management's opinion,
adequate provisions for income taxes have been made for known and determinable
liabilities emanating from these reviews. If actual outcomes differ materially
from these estimates, they could have a material impact on our results of
operations.
The IRS has completed and closed its audits of our consolidated Federal income
tax returns through fiscal 1997. We are presently under examination by the IRS
for fiscal years 1998 through 2001. During the current period, we entered into
discussions with the IRS regarding several issues that have been raised during
their examination. The effective tax rates include our best estimates of the
probable loss or favorable resolution of certain of the issues currently under
discussion with the IRS. The final settlement of the remaining issues, which
include transfer pricing and foreign tax credit calculations, is subject to
further discussions, negotiations, review and computations. While it is probable
that additional tax liabilities will result from the conclusion of the IRS
examination, due to the complexity of the issues still under discussion, an
estimate of the final outcome cannot be made at this time. We expect to conclude
these discussions in conjunction with the finalization of the field examination
portion of the audit in the fourth quarter of fiscal 2006.
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).
-34-
THE ESTEE LAUDER COMPANIES INC.
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 did 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 applied the
principles set forth in this FSP upon our adoption of SFAS No. 123(R).
In November 2005, the FASB issued FSP Nos. FAS 115-1 and FAS 124-1, "The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments,"
to give guidance on determining when investments in certain debt and equity
securities are considered impaired, whether that impairment is other than
temporary, and on measuring such impairment loss. This FSP also includes
accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. FSP Nos. FAS 115-1 and FAS 124-1 applies to reporting periods
beginning after December 15, 2005, although earlier application was permitted.
This FSP did not have a material impact on our consolidated financial
statements.
In November 2005, the FASB published FSP No. FAS 123(R)-3, "Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards," to
provide an alternative transition method for accounting for the tax effects of
share-based payment awards to employees. The FASB learned, subsequent to
adoption of SFAS No. 123(R), that a number of constituents did not have the
information necessary to comply with the transition requirements of SFAS No.
123(R), and provided an elective alternative transition method in FSP No. FAS
123(R)-3. Entities can choose to follow either the transition guidance of SFAS
No. 123(R) or the alternative transition method described in FSP No. FAS
123(R)-3. The guidance in FSP No. FAS 123(R)-3 became effective upon
publication. We have applied the principles originally set forth in SFAS No.
123(R). Therefore the guidance set forth in this FSP is not applicable to us.
In February 2006, the FASB issued FSP No. FAS 123(R)-4, "Classification of
Options and Similar Instruments Issued as Employee Compensation That Allow for
Cash Settlement upon the Occurrence of a Contingent Event," to amend guidance in
SFAS No. 123(R) on classifying options and similar instruments issued as part of
employee compensation arrangements. This FSP revises the requirement in SFAS No.
123(R) that share options with contingent cash settlement features be classified
as liabilities and re-measured to fair value each reporting period regardless of
the event's likelihood of occurrence. Under FSP No. FAS 123(R)-4, companies
shall classify these instruments as equity if the occurrence of such contingent
event is not probable. Any awards that require cash settlement or permit cash
settlement at the direction of the holder are classified as liabilities in our
consolidated financial statements. For all other awards, the discretion to allow
cash settlement of our stock-based compensation awards lies with us and are thus
classified as equity.
-35-
THE ESTEE LAUDER COMPANIES INC.
Forward-Looking Information
---------------------------
We and our representatives from time to time make written or oral
forward-looking statements, including statements contained in this and other
filings with the Securities and Exchange Commission, in our press releases and
in our reports to stockholders. The words and phrases "will likely result,"
"expect," "believe," "planned," "may," "should," "could," "anticipate,"
"estimate," "project" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements include, without limitation, our
expectations regarding sales, earnings or other future financial performance and
liquidity, product introductions, entry into new geographic regions, information
systems initiatives, new methods of sale and future operations or operating
results. Although we believe that our expectations are based on reasonable
assumptions within the bounds of our knowledge of our business and operations,
actual results may differ materially from our expectations. Factors that could
cause actual results to differ from expectations include, without limitation:
(1) increased competitive activity from companies in the skin care,
makeup, fragrance and hair care businesses, some of which have greater
resources than we do;
(2) our ability to develop, produce and market new products on which
future operating results may depend;
(3) consolidations, restructurings, bankruptcies and reorganizations in
the retail industry causing a decrease in the number of stores that
sell our products, an increase in the ownership concentration within
the retail industry, ownership of retailers by our competitors and
ownership of competitors by our customers that are retailers;
(4) shifts in the preferences of consumers as to where and how they
shop for the types of products and services we sell;
(5) social, political and economic risks to our foreign or domestic
manufacturing, distribution and retail operations, including changes in
foreign investment and trade policies and regulations of the host
countries and of the United States;
(6) changes in the laws, regulations and policies that affect, or will
affect, our business, including those relating to our products, changes
in accounting standards, tax laws and regulations, trade rules and
customs regulations, and the outcome and expense of legal or regulatory
proceedings, and any action we may take as a result;
(7) foreign currency fluctuations affecting our results of operations
and the value of our foreign assets, the relative prices at which we
and our foreign competitors sell products in the same markets and our
operating and manufacturing costs outside of the United States;
(8) changes in global or local conditions, including those due to
natural or man-made disasters, real or perceived epidemics, or energy
costs, that could affect consumer purchasing, the willingness of
consumers to travel, the financial strength of our customers or
suppliers, our operations, the cost and availability of capital which
we may need for new equipment, facilities or acquisitions, the cost and
availability of raw materials and the assumptions underlying our
critical accounting estimates;
(9) shipment delays, depletion of inventory and increased production
costs resulting from disruptions of operations at any of the facilities
that manufacture nearly all of our supply of a particular type of
product (i.e., focus factories) or at our distribution or inventory
centers;
(10) real estate rates and availability, which may affect our ability
to increase the number of retail locations at which we sell our
products and the costs associated with our other facilities;
(11) changes in product mix to products which are less profitable;
(12) our ability to acquire, develop or implement new information and
distribution technologies, on a timely basis and within our cost
estimates;
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THE ESTEE LAUDER COMPANIES INC.
(13) our ability to capitalize on opportunities for improved
efficiency, such as publicly-announced cost savings initiatives and the
success of Stila under new ownership, and to integrate acquired
businesses and realize value therefrom;
(14) consequences attributable to the events that are currently taking
place in the Middle East, including terrorist attacks, retaliation and
the threat of further attacks or retaliation;
(15) the impact of repatriating certain of our foreign earnings to the
United States in connection with The American Jobs Creation Act of
2004; and
(16) additional factors as described in our filings with the Securities
and Exchange Commission, including our Annual Report on Form 10-K for
the fiscal year ended June 30, 2005.
We assume no responsibility to update forward-looking statements made herein or
otherwise.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The information required by this item is set forth in Item 2 of this Quarterly
Report on Form 10-Q under the caption "Liquidity and Capital Resources - Market
Risk" and is incorporated herein by reference.
Item 4. Controls and Procedures.
Our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) are designed to ensure that information required to be disclosed in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the rules and forms
of the Securities and Exchange Commission. The Chief Executive Officer and the
Chief Financial Officer, with assistance from other members of management, have
reviewed the effectiveness of our disclosure controls and procedures as of March
31, 2006 and, based on their evaluation, have concluded that the disclosure
controls and procedures were effective as of such date.
As part of our global distribution strategy to establish regional inventory
centers, we continue to migrate certain storage and distribution activities to a
third party in Europe as well as within our Belgian facilities.
We have implemented an information systems arrangement whereby the introduction
of certain program changes into our production computing environment at our data
centers in New York and Belgium has been outsourced to a third party.
In connection with these changes, we have updated our internal controls over
financial reporting. Except as noted in the previous sentences, 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 third
quarter of fiscal 2006 that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
-37-
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 March 31, 2006,
the remaining accrual balance was $16.6 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.
-38-
THE ESTEE LAUDER COMPANIES INC.
PART II. OTHER INFORMATION
In October 2005, we received a favorable decision from the Portuguese Tax
Administration on the opposition our subsidiary filed in March 2005 to the
notice of assessment it received in December 2004. We expect similar decisions
with respect to the assessments received by the subsidiary in May 2005. The
assessments related to income for the three calendar years ended December 31,
2002 of our subsidiary, which has been operating in the Madeira Free Trade Zone
since 1989 under license from the Madeira Development Corporation. On December
20, 2004, the subsidiary received a notice of assessment from the Portuguese Tax
Administration solely in respect of the calendar year ended December 31, 2000.
The assessment, which included interest, amounted to 26 million Euros. At the
end of March 2005, the subsidiary filed an opposition to the assessment, which
was accepted by the Tax Administration in October 2005. On May 17 and 18, 2005,
the subsidiary received notices of assessment from the Portuguese Tax
Administration with respect to the calendar years ended December 31, 2001 and
2002. The assessments are for 21.6 million Euros and 22.4 million Euros,
respectively, to which the subsidiary filed oppositions in July 2005. In
February 2004, the subsidiary filed an appeal of a report issued by the
Portuguese Tax Authorities in January 2004 related to the matter with the
Portuguese Secretary of State for Fiscal Matters. The appeal is still pending.
While no assurance can be given as to the ultimate outcome with respect to the
two remaining assessments or any additional assessments that may be issued for
subsequent periods, management believes that the likelihood that the assessment
or any future assessments ultimately will be upheld is remote.
In September 2005, the Superior Court of California for the County of San Diego
dismissed, with leave to replead, all of the plaintiff's claims in a matter
originally brought in December 2004 by the plaintiff purporting to represent a
nationwide class of individuals "who have purchased skin care products from
defendants that have been falsely advertised to have an 'anti-aging' or youth
inducing benefit or effect." Prior to the dismissal, the complaint, as amended,
named two of our subsidiaries and approximately 25 other defendants, including
manufacturers and retailers. The plaintiff sought injunctive relief,
restitution, and general, special and punitive damages for alleged violations of
the California Unfair Competition Law, the California False Advertising Law, and
for negligent and intentional misrepresentation. In October 2005, the plaintiff
filed a second amended complaint which states the same allegations and requests
for relief, but only names one of our subsidiaries and two retailers as
defendants. In November 2005, we filed a motion to dismiss the Second Amended
Complaint. In February 2006, plaintiff served a Third Amended Complaint, naming
the Company as the sole defendant, because the case against the two retailers
had been dismissed with prejudice. In March 2006, we filed a motion to dismiss
the Third Amended Complaint. Thereafter, plaintiff moved for leave a Fourth
Amended Complaint, again naming the Company as the only defendant. These motions
are scheduled to be argued in late May 2006. We intend to continue to defend
ourselves vigorously. While no assurance can be given as to the ultimate
outcome, management believes that the resolution of this lawsuit will not have a
material adverse effect on our consolidated financial condition.
In June 2005, an action was filed in the United States District Court for the
Southern District of Florida against one of our subsidiaries by a plaintiff
purporting to represent a nationwide class of individuals "who have purchased
skin care products from Defendant that have been falsely advertised to have an
'anti-aging' or youth-inducing benefit or effect." The plaintiff sought
injunctive relief as well as compensatory and punitive damages under a number of
theories. Two of our department store customers were added as defendants in an
amended complaint filed in August 2005. In September 2005, we moved to dismiss
that complaint. As a result, plaintiff dismissed all of her original claims and
filed an amended complaint under the Florida Deceptive Trade Practices Act. We
again filed a motion to dismiss, for which briefing was concluded in December
2005. In January 2006, the Court permitted the Plaintiff to file a Third Amended
Complaint. After a brief period of discovery, the parties stipulated to the
dismissal of the action with prejudice. In April 2006, upon the parties'
stipulation, the Court ordered the case dismissed with prejudice, with each
party bearing its own costs.
-39-
THE ESTEE LAUDER COMPANIES INC.
PART II. OTHER INFORMATION
On March 30, 2006, a purported securities class action complaint captioned
Thomas S. Shin, et al. v. The Estee Lauder Companies Inc., et al., was filed
against the Company and certain of our officers and directors (collectively the
"Defendants") in the United States District Court for the Southern District of
New York. The complaint alleges that Defendants made statements during the
period April 28, 2005 to October 25, 2005 in press releases, the Company's
public filings and during conference calls with analysts that were materially
false and misleading and which artificially inflated the price of the Company's
stock. The complaint alleges claims under Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. The complaint also asserts that during the
class period, certain executive officers and the trust for the benefit of a
director sold shares of our Class A Common Stock at artificially inflated
prices. Three additional purported securities class action complaints were
subsequently filed in the United States District Court for the Southern District
of New York containing similar allegations. No motion to consolidate the
actions, appoint lead plaintiff or for approval of the selection of lead counsel
has yet been filed. The Defendants believe that the complaints are without merit
and intend to defend these actions vigorously. The Company has received an
informal request for information from the staff of the Securities and Exchange
Commission regarding matters raised in the above complaints and the Company is
cooperating.
On April 10, 2006, a shareholder derivative action complaint captioned Miriam
Loveman v. Leonard A. Lauder, et al., was filed against certain of our officers
and all persons who were directors on that date (collectively the "Derivative
Action Defendants") in the United States District Court for the Southern
District of New York. The complaint alleges that Derivative Action Defendants
breached their fiduciary duties to the Company based on the same alleged course
of conduct identified in the securities actions described above. Derivative
Action Defendants are currently seeking to have the derivative action
transferred to the judge assigned to the securities class actions. Derivative
Action Defendants similarly believe that this complaint is without merit and
intend to defend the action vigorously.
-40-
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 March 31, 2006, 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 3/16/2006 100,000
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 Stock Option Agreement for grants to be made under Amended
and Restated Fiscal 2002 Share Incentive Plan.+
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)
-----------------
+ Exhibit is a management contract or compensatory plan or arrangement.
-41-
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: May 4, 2006 By: /s/Richard W. Kunes
----------------------------
Richard W. Kunes
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
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THE ESTEE LAUDER COMPANIES INC.
INDEX TO EXHIBITS
Exhibit
Number Description
------ -----------
10.1 Form of Stock Option Agreement for grants to be made under Amended
and Restated Fiscal 2002 Share Incentive Plan.+
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)
-----------------
+ Exhibit is a management contract or compensatory plan or arrangement.