MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)

In July 2007, we acquired Ojon Corporation, a privately held hair care and skin care company based in Canada that sells its products primarily through direct response television ("DRTV") and specialty stores. We also recently announced that we purchased a minority interest in a privately held company that manufactures, markets and sells beauty products in India under the Forest Essentials brand.

This past year we continued to build on our strength in research and development. For example, we further improved the Estée Lauder Re-Nutriv product line with the introduction of Re-Nutriv Ultimate Youth Crème. Clinique launched a "dermatologist-certified" line called Redness Solutions to reduce the appearance of skin redness. Origins recently launched Origins Organics, the first full line of skin, body and hair care products to be certified under the USDA National Organic Program.

Again in fiscal 2008, the majority of our net sales came from outside the United States. We generated growth in sales and profits in our travel retail business, including accelerated growth from downtown locations in Asian cities, border stores in Latin America and shops on cruise ships. We continued to increase our presence in China and Russia and recently established affiliates in the Middle East and India. In an effort to improve the return on our media investment abroad, we consolidated the work of several media agencies into one by selecting M2M, a media company of Omnicom Media Group, to be our media agency in eight European and four Asian/Pacific countries. By doing so, we anticipate integrating traditional media and expanding the use of Internet and digital advertising in these areas.

In alternative distribution channels, we continued to grow our online business in the United States, where we sell products from 15 of our brands on Company-owned websites. With the recent expansion of our online business into Korea, we now sell products on our own e-commerce sites in five foreign countries. In fiscal 2008, we also expanded our presence in the DRTV distribution channel, most significantly with the acquisition of Ojon in July 2007. In the United States, Clinique debuted on QVC, where Bobbi Brown, Origins and Ojon currently have regular shows. BeautyBank created Eyes by Design, a brand which is currently being sold exclusively on HSN. Internationally, Ojon debuted on QVC in Germany while Bobbi Brown and Prescriptives aired on QVC in the United Kingdom. Origins and Good Skin™ have also had shows on DRTV in Korea.

As part of our international pharmacy channel business initiative, several distributor markets for Darphin products will now be serviced by our own affiliates and Origins opened more than 20 new pharmacies in France. Tri-Aktiline by Good Skin™ launched in over 500 Sephora doors throughout Europe and exclusively in Cosmed's 250 pharmacies in Taiwan, our first entry in Taiwan's pharmacy channel. In January 2008, we formed a strategic collaboration with Allergan, Inc., a global medical aesthetics company, to develop a Clinique-branded skin care line, Clinique Medical, to be sold exclusively through physicians' offices in the United States.

We continued to make progress on our Strategic Modernization Initiative ("SMI"). During fiscal 2008, Demand Planning for select business units began using SAP software, a critical part of SMI. We anticipate SMI implementation will continue at additional primary locations in fiscal 2009, with the majority of our business to be implemented through fiscal 2012.

Despite the rise in energy and raw material prices in the current year, we were able to maintain our overall cost of sales margin through other efficiencies achieved from our ongoing savings initiatives. We also opened a new distribution center in Singapore to improve service levels in the fast-growing Asia/Pacific region. In December 2007, we entered into agreements to ensure that the equivalent of all electricity utilized by our Global Operations division is generated from green sources. We now rank 22nd on the EPA's list of leading Fortune 500 companies in alternative power usage.

During fiscal 2008, we also faced challenges, many of which we expect to be ongoing in fiscal 2009. We believe that economic uncertainty in the United States has affected our business, particularly in the department store channel. We continue to see softness in the United States, including the impact of the consolidation and changes taking place among retailers. In addition, the fragrance category continues to be highly competitive. These challenges have been mitigated through sales in alternative channels, such as freestanding retail stores, internet distribution, self-select distribution and DRTV. Efforts to expand geographically are complicated by increasing regulatory issues and cultural barriers.

As we continue to implement our strategic imperatives, we expect to make selective investments, embark on new business endeavors, and pursue initiatives that we believe will have long-term benefits. The timing, impact and magnitude of any particular actions, such as an acquisition to strengthen our product categories and/or diversify our distribution channels, are subject to numerous factors and one-time charges that cannot be predicted.