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EL > SEC Filings for EL > Form 10-Q on 5-Feb-2009All Recent SEC Filings

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Form 10-Q for ESTEE LAUDER COMPANIES INC


5-Feb-2009

Quarterly Report


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 140 countries and territories. The following is a comparative summary of operating results for the three and six months ended December 31, 2008 and 2007, and reflects the basis of presentation described in Note 1 of Notes to Consolidated Financial Statements - Summary of Significant Accounting Policiesfor all periods presented. Sales of products and services that do not meet our definition of skin care, makeup, fragrance or hair care have been included in the "other" category.

                                     Three Months Ended       Six Months Ended
                                        December 31              December 31
                                      2008        2007        2008        2007
                                                   (In millions)
NET SALES
By Region:
The Americas                       $    903.8   $ 1,028.2   $ 1,842.8   $ 1,927.1
Europe, the Middle East & Africa        762.3       933.2     1,403.8     1,484.4
Asia/Pacific                            374.9       347.4       697.9       607.4
                                   $  2,041.0   $ 2,308.8   $ 3,944.5   $ 4,018.9

By Product Category:
Skin Care                          $    772.4   $   831.2   $ 1,489.2   $ 1,450.7
Makeup                                  728.3       827.3     1,471.2     1,490.4
Fragrance                               415.0       520.5       742.8       833.5
Hair Care                               108.5       110.4       207.3       213.0
Other                                    16.8        19.4        34.0        31.3
                                   $  2,041.0   $ 2,308.8   $ 3,944.5   $ 4,018.9

OPERATING INCOME (LOSS)
By Region:
The Americas                       $     54.4   $    91.0   $   110.9   $   143.4
Europe, the Middle East & Africa        129.6       207.0       137.2       216.0
Asia/Pacific                             86.6        72.4       115.1        89.2
Special charges                          (0.3 )       0.1        (0.4 )      (0.2 )
                                   $    270.3   $   370.5   $   362.8   $   448.4

By Product Category:
Skin Care                          $    136.9   $   166.5   $   180.4   $   202.3
Makeup                                  108.2       149.4       162.6       190.5
Fragrance                                13.5        48.1         8.0        43.1
Hair Care                                14.4         6.4        13.4        13.8
Other                                    (2.4 )         -        (1.2 )      (1.1 )
Special charges                          (0.3 )       0.1        (0.4 )      (0.2 )
                                   $    270.3   $   370.5   $   362.8   $   448.4


Table of Contents

                        THE ESTÉE LAUDER COMPANIES INC.



The following table presents certain consolidated earnings data as a percentage
of net sales:



                                          Three Months Ended        Six Months Ended
                                             December 31              December 31
                                          2008         2007         2008        2007

Net sales                                   100.0 %      100.0 %     100.0 %     100.0 %
Cost of sales                                24.9         25.1        25.6        25.7
Gross profit                                 75.1         74.9        74.4        74.3
Operating expenses:
Selling, general and administrative          61.9         58.9        65.2        63.1
Special charges                               0.0         (0.0 )       0.0         0.0
                                             61.9         58.9        65.2        63.1

Operating income                             13.2         16.0         9.2        11.2
Interest expense, net                         0.9          0.8         0.9         0.9

Earnings before income taxes and
minority interest                            12.3         15.2         8.3        10.3
Provision for income taxes                    4.4          5.3         3.0         3.6
Minority interest, net of tax                (0.2 )       (0.2 )      (0.0 )      (0.1 )

Net earnings                                  7.7 %        9.7 %       5.3 %       6.6 %

In order to meet the demands of consumers, we continually introduce new products, support new and established products through advertising, merchandising and sampling and phase out existing products that no longer meet the needs of our consumers. The economics of developing, producing, launching and supporting 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.

Overview

The recent economic challenges and uncertainties in a number of countries where we do business, including the United States, have had a significant impact on our business during our fiscal second quarter. This financial crisis is global in scale and has negatively affected consumer demand, which is having an adverse impact on our customers that are retailers as well as on our own retail stores. These events have led to significant retailer destocking as well as changes in their ordering patterns for the products that we sell. As a result, the 2008 holiday period was challenging for us on multiple levels.

In the Americas region, the U.S. department store channel experienced a very soft retail environment, which deteriorated beyond our expectations. While our business suffered from lower store traffic and destocking, we were also faced with competitive pressures as retailers offered significant markdowns on other fashion and luxury items. Despite these challenges, we believe that we gained share in the beauty business at U.S. department stores with the help of positive consumer response to new product offerings and gift sets, particularly in the skin care category. Net sales results in alternative channels were generally mixed. Trends at our freestanding retail stores followed those in department stores while sales of our products online continued to grow.

Global economic uncertainty has also impacted our business in Europe, the Middle East & Africa. Net sales in many of our key markets declined during the quarter. Our business was also impacted by retailer destocking and tighter working capital management. Sales and profits in our travel retail business fell sharply due to a slowdown in passenger traffic, retailer destocking and the impact of weaker currencies.


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THE ESTÉE LAUDER COMPANIES INC.

At this time, our business in the Asia/Pacific region has been least affected by the global financial crisis, with net sales rising double digits in several countries, although growth in the region has slowed overall, including Japan, our largest market there. The success in this region has resulted in net sales growth in our skin care category for the six months ended December 31, 2008. In addition, net sales in China grew as we continue our expansion in this emerging market. There are, however, some areas of concern. In Korea, the weakness of the Korean won has put pressure on our reported sales in that country. The global financial crisis had a greater impact on our businesses in Australia and New Zealand than the rest of the region.

In addition to the ongoing global financial crisis, our business has been negatively impacted by changes in foreign currency exchange rates caused by the dramatic strengthening of the U.S. dollar during our fiscal second quarter. If the current exchange rates persist or the U.S. dollar continues to strengthen, there will be a continuing adverse impact on our results for the full fiscal year.

We are reviewing our plans and taking actions to mitigate the impact of these conditions. Our cost-containment plans that we implemented throughout the Company during the first fiscal quarter will continue for the remainder of the fiscal year. In addition, we announced that we will implement cost savings programs, including a number of initiatives to resize and reorganize the Company to achieve long-term profitable growth. We anticipate this multi-faceted initiative to result in related one-time restructuring and other special charges between $350 million and $450 million as it is rolled out over the next few fiscal years. As part of our strategy, we plan to continue to make investments behind fast-growing markets and channels to grow market share. Skin care, which is our most profitable category, will be a priority for our strategic, innovative and support spending. While our business strategies are designed to strengthen the Company over the long-term, we believe the uncertainty about future market conditions, consumer spending patterns and the financial strength of some of our retail customers, coupled with retailer destocking, will continue to negatively affect our net sales and operating results.

Second Quarter Fiscal 2009 as Compared with Second Quarter Fiscal 2008

NET SALES

Net sales decreased 12%, or $267.8 million, to $2,041.0 million, reflecting declines in each of our product categories. Geographically, net sales decreases in Europe, the Middle East & Africa and the Americas were partially offset by modest growth in Asia/Pacific. Excluding the impact of foreign currency translation, net sales decreased 6%.

Product Categories

Skin Care

Net sales of skin care products decreased 7%, or $58.8 million, to $772.4 million, primarily reflecting declines in net sales from our core brands. Despite the difficult economic environment, we continued to enhance select product lines to address the needs of our consumers. Our efforts have resonated well, as the recent launches of Perfectionist [CP+] Wrinkle Lifting Serum and the new Time Zone line of moisturizing products from Estée Lauder and Superdefense SPF 25 Age Defense Moisturizer and Moisture Surge Extended Thirst Relief from Clinique contributed incremental sales of approximately $56 million, combined. While these new product launches contributed favorably to the category, they were partially offset by lower sales from other existing products in the Perfectionist line from Estée Lauder and the Moisture Surge and Superdefense lines from Clinique. Net sales of most other product lines in this category also experienced declines, particularly in Europe, the Middle East & Africa and the Americas, partially offset by modest growth in Asia/Pacific. Excluding the impact of foreign currency translation, skin care net sales were flat as compared with the prior-year period.

Makeup

Makeup net sales decreased 12%, or $99.0 million, to $728.3 million, primarily reflecting lower net sales from our core brands of approximately $84 million. We also experienced lower net sales from our makeup artist brands, particularly driven by declines in the Americas. These declines were mitigated in part by recent product launches and incremental net sales from new international points of distribution. Excluding the impact of foreign currency translation, makeup net sales decreased 6%.


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THE ESTÉE LAUDER COMPANIES INC.

Fragrance

Net sales of fragrance products decreased 20%, or $105.5 million, to $415.0 million. This decline was largely due to lower sales of designer fragrances, of which approximately $59 million was attributable to DKNY Be Delicious, Sean John Unforgivable, DKNY Red Delicious Women, Sean John Unforgivable Woman and certain Tommy Hilfiger fragrances. Also contributing to the decrease were lower sales of certain Estée Lauder fragrances, as well as various Clinique fragrances, of approximately $52 million, combined. The recent launches of Estée Lauder Sensuous and Hilfiger Men partially offset these declines by collectively contributing sales of approximately $30 million to the category. Excluding the impact of foreign currency translation, fragrance net sales decreased 14%.

Hair Care

Hair care net sales decreased 2%, or $1.9 million, to $108.5 million. Net sales declined primarily as a result of the conclusion of a hotel amenities program in the third quarter of fiscal 2008 and, to a lesser extent, a softer salon retail environment in the United States. These declines were partially offset by incremental sales from new products, such as Dry Remedy Shampoo and Conditioner from Aveda, an increase in points of distribution and the acquisition of an independent distributor in Australia. Excluding the impact of foreign currency translation, hair care net sales increased 2%.

Geographic Regions

Net sales in the Americas decreased 12%, or $124.4 million, to $903.8 million. Lower net sales in the United States from our core brands and our makeup artist brands contributed approximately $109 million to the decrease. Net sales declines in Canada and Latin America of approximately $13 million added to the decrease and were adversely impacted by the strengthening of the U.S. dollar. Economic conditions in this region, particularly in the department store channel, as well as competitive pressures, have negatively impacted our businesses. Ongoing challenges faced by certain of our department store customers in the United States may continue to affect our net sales for the short and long term. Excluding the impact of foreign currency translation, net sales in the Americas decreased 10%.

In Europe, the Middle East & Africa, net sales decreased 18%, or $170.9 million, to $762.3 million. Net sales decreases of approximately $134 million were driven by the United Kingdom, our travel retail business, France, Spain and Italy. These performances reflected retailer destocking and tighter working capital management by certain key retailers. Net sales in our travel retail business also declined due to a significant slowdown in passenger traffic and the impact of weaker currencies in certain key markets. Excluding the impact of foreign currency translation, net sales in Europe, the Middle East & Africa decreased 7%.

Net sales in Asia/Pacific increased 8%, or $27.5 million, to $374.9 million, reflecting growth from most countries in the region. This increase reflected higher net sales of approximately $40 million in Japan, China and Hong Kong. Partially offsetting these increases were lower net sales of approximately $18 million combined in Australia and Korea. Australia was the only affiliate in this region to experience a local currency sales decline and Korea's decline reflected the stronger U.S. dollar against the Korean won. Despite the overall net sales increase in this region, growth has been tempered by a softening retail environment, which we believe will continue and may worsen. Excluding the impact of foreign currency translation, Asia/Pacific net sales increased 13%.

We believe the economic conditions that are currently having a negative impact on the global economy will likely have an adverse impact on our future financial performance. We cannot predict with certainty the magnitude or duration of the impact or how it will vary across each of our geographic regions.

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 improved to 24.9% as compared with 25.1% in the prior-year period. Cost of sales as a percentage of net sales reflected a favorable change in manufacturing variances of approximately 50 basis points as well as a positive effect of exchange rates of approximately 10 basis points. Partially offsetting these improvements was an increase in obsolescence charges of approximately 40 basis points.


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THE ESTÉE LAUDER COMPANIES INC.

Since certain promotional activities are a component of sales or cost of sales and the timing and level of promotions vary with our promotional calendar, we have experienced, and expect to continue to experience, fluctuations in the cost of sales percentage. In addition, future cost of sales mix may be impacted by the inclusion of new brands which have margin and product cost structures different from those of our existing brands.

OPERATING EXPENSES

Operating expenses increased to 61.9% of net sales as compared with 58.9% of net sales in the prior-year period. In line with our contingency plans and in light of the current economic conditions, we continued to apply various cost-containment measures to maintain expenses in line with our business needs. While the implementation of these initiatives helped reduce total operating expenses as compared with the prior-year period, the dramatic and greater-than-expected decline in net sales during the current-year quarter ultimately had a negative impact on operating expense margin. Exacerbating the net sales impact on operating expense margin were net losses from foreign exchange transactions.

Changes in advertising, merchandising and sampling 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 27%, or $100.2 million, to $270.3 million as compared with the prior-year period. Operating margin decreased to 13.2% of net sales as compared with 16.0% in the prior-year period, reflecting the increase in our operating expense margin, partially offset by the improvement in our gross margin as previously discussed. The ongoing economic challenges and uncertainties will likely adversely impact our operating results.

Product Categories

Fragrance operating income declined 72%, or $34.6 million, to $13.5 million, primarily reflecting lower net sales of designer fragrance products and certain fragrances from our core brands, partially offset by a reduction in selling, advertising, merchandising and sampling spending. Makeup operating income decreased 28%, or $41.2 million, to $108.2 million, primarily reflecting lower results from certain of our core brands and from our makeup artist brands. Skin care operating income decreased 18%, or $29.6 million, to $136.9 million, primarily reflecting lower results from certain of our core brands. Hair care operating income increased over 100%, or $8.0 million, to $14.4 million, primarily reflecting a favorable comparison to the prior-year period when we made investments in new points of distribution and recorded higher intangible asset amortization resulting from the acquisition of the Ojon brand, partially offset by the current-year period decline in net sales as previously discussed.

Geographic Regions

Operating income in the Americas decreased 40%, or $36.6 million, to $54.4 million. This decline primarily reflected lower sales experienced by the majority of our businesses in the region due to current economic conditions and competitive pressures, partially offset by cost containment and contingency plan efforts.

In Europe, the Middle East & Africa, operating income decreased 37%, or $77.4 million, to $129.6 million. This decrease reflected lower results of approximately $66 million in the United Kingdom, our travel retail business, France, Russia, the Balkans and Italy.

In Asia/Pacific, operating income increased 20%, or $14.2 million, to $86.6 million, primarily reflecting improved results in Japan, China, Hong Kong and Taiwan of approximately $16 million, collectively. Partially offsetting these improvements were lower results in Australia of approximately $5 million.

INTEREST EXPENSE, NET

Net interest expense was $19.6 million as compared with $18.3 million in the prior-year period. This increase primarily resulted from higher average debt balances which include an additional $300.0 million of senior notes issued during the current-year period, partially offset by lower average interest rates on borrowings.


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THE ESTÉE LAUDER COMPANIES INC.

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 income taxes, tax rates in foreign jurisdictions and certain nondeductible expenses. Our effective tax rate will change from quarter to quarter based on recurring and non-recurring factors including, but not limited to, the geographical mix of earnings, enacted tax legislation, state and local income taxes, tax audit settlements and the interaction of various global tax strategies. In addition, changes in judgment from the evaluation of new information resulting in the recognition, derecognition or remeasurement of a tax position taken in a prior annual period are recognized separately in the quarter of the change.

The effective rate for income taxes for the three months ended December 31, 2008 was 35.7% as compared with 34.9% in the prior-year period. The increase in the effective income tax rate of 80 basis points was primarily attributable to the tax impact of our foreign operations.

Six Months Fiscal 2009 as Compared with Six Months Fiscal 2008

NET SALES

Net sales decreased 2%, or $74.4 million, to $3,944.5 million. This decrease reflected lower net sales in the fragrance, hair care and makeup product categories, partially offset by higher net sales in skin care. Geographically, net sales declines in Europe, the Middle East & Africa and the Americas were partially offset by double-digit growth in Asia/Pacific, particularly in the skin care category. Current economic conditions have caused a slowdown in net sales growth in the Asia/Pacific region and decreases in net sales in the other two regions. Such conditions are expected to continue for the remainder of the fiscal year. Excluding the impact of foreign currency translation, net sales increased 1%.

Product Categories

Skin Care

Net sales of skin care products increased 3%, or $38.5 million, to $1,489.2 million. The recent launches of Perfectionist [CP+] Wrinkle Lifting Serum and Cyber White EX from Estée Lauder and Superdefense SPF 25 Age Defense Moisturizer and Moisture Surge Extended Thirst Relief from Clinique contributed incremental sales of approximately $112 million, combined. These sales were partially offset by approximately $77 million of lower sales from other existing products in the Perfectionist line from Estée Lauder and the Moisture Surge, Superdefense and Repairwear lines from Clinique. Excluding the impact of foreign currency translation, skin care net sales increased 6%.

Makeup

Makeup net sales decreased 1%, or $19.2 million, to $1,471.2 million, primarily reflecting lower net sales from our core brands. These declines were mitigated by the recent launches of High Impact Lip Colour SPF 15 and reformulated Superfit Makeup from Clinique, as well as Estée Lauder Signature Blush, which contributed incremental sales of approximately $54 million, combined. In addition, international net sales increases from our makeup artist brands offset net sales decreases in the United States, resulting in slight growth during the current-year period. Excluding the impact of foreign currency translation, makeup net sales increased 1%.

Fragrance

Net sales of fragrance products decreased 11%, or $90.7 million, to $742.8 million. This decline was largely due to lower sales of designer fragrances, of which approximately $91 million was attributable to Sean John Unforgivable, DKNY Be Delicious, DKNY Red Delicious Women, Donna Karan Cashmere Mist, Sean John Unforgivable Woman and certain Tommy Hilfiger fragrances. Also contributing to the decrease were lower sales of certain Estée Lauder fragrances and various Clinique fragrances of approximately $64 million, combined. The recent launches of Estée Lauder Sensuous and Hilfiger Men, as well as increased sales of DKNY Delicious Night, partially offset these declines by collectively contributing approximately $72 million to the category. Excluding the impact of foreign currency translation, fragrance net sales decreased 8%.


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THE ESTÉE LAUDER COMPANIES INC.

Hair Care

Hair care net sales decreased 3%, or $5.7 million, to $207.3 million. Net sales declined primarily as a result of the conclusion of a hotel amenities program in the third quarter of fiscal 2008 and, to a lesser extent, a softer salon retail environment in the United States. These declines were partially offset by incremental sales from new products, such as Dry Remedy Shampoo and Conditioner from Aveda, an increase in points of distribution and the acquisition of an independent distributor in Australia. Excluding the impact of foreign currency translation, hair care net sales decreased 1%.

Geographic Regions

Net sales in the Americas decreased 4%, or $84.3 million, to $1,842.8 million. Lower net sales from our core brands, as well as our makeup artist brands, in the United States contributed approximately $91 million to the decrease. Net sales declines in Canada of approximately $6 million were offset by growth in Latin America. Economic conditions in this region, particularly in the department store channel, as well as competitive pressures, have negatively impacted our businesses. Ongoing challenges faced by certain of our department store customers in the United States may continue to affect our net sales for the short and long term. The impact of foreign currency translation on net sales in the Americas was de minimis.

In Europe, the Middle East & Africa, net sales decreased 5%, or $80.6 million, to $1,403.8 million. This decrease reflected lower net sales in the United Kingdom, Spain, France and South Africa of approximately $88 million, combined. Partially offsetting these declines were net sales increases of approximately $15 million in the Middle East and Russia, which benefited from our continuing expansion in these markets. Excluding the impact of foreign currency translation, net sales in Europe, the Middle East & Africa were flat as compared with the prior-year period.

Net sales in Asia/Pacific increased 15%, or $90.5 million, to $697.9 million. This increase reflected higher net sales of approximately $77 million in China, Japan and Hong Kong. Partially offsetting these increases were lower net sales of approximately $4 million in Australia and New Zealand. Australia was the only affiliate in this region to have a local currency sales decline. Excluding the impact of foreign currency translation, Asia/Pacific net sales increased 17%.

We believe the economic conditions that are currently having a negative impact on the global economy will likely have an adverse impact on our future financial performance. We cannot predict with certainty the magnitude or duration of the impact or how it will vary across each of our geographic regions.

We strategically stagger our new product launches by geographic market, which may account for differences in regional sales growth. . . .

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