MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
COST OF SALES
Cost of sales as a percentage of total net sales was 25.2%,
which is the same as in fiscal 2007. Cost of sales as a
percentage of net sales reflected a decrease in the level
and timing of promotional activities of approximately 20
basis points and a positive effect of exchange rates of
approximately 10 basis points. Offsetting these improvements
was an unfavorable change in the mix of our
business, an increase in obsolescence charges, and
employee-related charges designed to streamline certain
business activities and achieve future cost savings of
approximately 10 basis points, each.
Despite the rise in energy and raw material prices in
the current year, we were able to maintain our overall cost
of goods margin through other efficiencies achieved from
ongoing savings initiatives.
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 64.5% of net sales as
compared with 64.1% of net sales in the fiscal 2007. The
increase in operating expenses and operating expense
margin reflected higher costs of global information technology
systems and infrastructure of approximately 30
basis points. An additional 20 basis points resulted from
an increase in valuation reserves reflecting the diminishing
likelihood of realizing value from a promissory note
and convertible preferred stock received in connection
with the divestiture of Stila in fiscal 2006. We also
recorded an increase in intangible asset amortization
resulting from recent strategic acquisitions, as well as
employee-related charges designed to streamline certain
business activities and achieve future cost savings, of
approximately 10 basis points each. Operating expense
margin in fiscal 2007 was adversely impacted by charges
related to our pharmacy channel of approximately 40
basis points.
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 increased 8%, or $60.8 million, to
$810.7 million as compared with fiscal 2007. Operating
margin declined to 10.3% of net sales as compared with
10.7% in fiscal 2007, reflecting our constant cost of sales
margin and the increase in our operating expense margin,
as previously discussed.
Product Categories
Fragrance operating income increased 29%, or $8.1 million,
to $36.2 million, reflecting profitable international
growth, partially offset by increased spending in support
of designer fragrance products initiatives. Skin care operating
income increased 19%, or $64.1 million, to $405.6
million, primarily reflecting improved international results
from certain of our heritage brands and net sales growth
from La Mer products and Tri-Aktiline™ Instant Deep
Wrinkle Filler from Good Skin™. In addition, the fiscal
2007 results in this category reflected organizational costs
of approximately $30 million, primarily related to our
pharmacy channel in Europe. Makeup operating income
increased 6%, or $20.1 million, to $359.4 million, primarily
reflecting improved results internationally. These
improvements were partially offset by lower results in the
United States from certain of our heritage brands, the
charge on the impairment of Stila-related financial instruments,
and costs related to the establishment of new
points of distribution for M·A·C Hair care operating
income declined 73%, or $31.0 million, to $11.5 million,
primarily reflecting costs related to the acquisition and
integration of Ojon to position the brand for future
growth. The results in this category also reflected an
increase in intangible asset amortization resulting from fiscal
2008 strategic acquisitions as well as costs related to
the establishment of new points of distribution.
Geographic Regions
Operating income in the Americas declined 32%, or
$108.1 million, to $228.3 million, primarily reflecting a difficult retail environment in which our heritage brands
faced challenges in the department store channel. We
also experienced significant pressure on the profitability
of our hair care business as discussed above. At the same
time, we continued to invest in our global information
technology systems and infrastructure. In addition, we
established new points of distribution for existing brands,
incurred costs to streamline certain business activities to
generate future efficiencies and incurred a charge on the
impairment of Stila-related financial instruments, as discussed
above.
In Europe, the Middle East & Africa, operating income
increased 35%, or $111.7 million, to $433.1 million primarily
due to higher results of approximately $71 million
in our travel retail business, the United Kingdom, Italy, the
Balkans and Spain. Partially offsetting these increases
were lower results in Russia and India of approximately $6
million, reflecting spending to support our expansion in
these markets. The overall operating results in this region
were adversely impacted in fiscal 2007 by the pharmacy
channel charges discussed above.
In Asia/Pacific, operating income increased 61%, or
$56.5 million, to $149.7 million. All of our affiliates in this
region experienced an increase in operating income, primarily
resulting from net sales growth led by Japan, Hong
Kong, China, Australia and Korea, which contributed
approximately $43 million, collectively.
INTEREST EXPENSE, NET
Net interest expense was $66.8 million as compared with
$38.9 million in fiscal 2007. This change primarily resulted
from higher average debt balances, including an additional
$600.0 million of senior notes issued in the fourth
quarter of fiscal 2007, partially offset by lower average
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. Our effective tax rate will change from
year to year based on non-recurring and recurring factors
including, but not limited to, the geographical mix of
earnings, 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
year ended June 30, 2008 was 34.9% as compared with
35.9% in fiscal 2007. The decrease in the effective income
tax rate of 100 basis points resulted primarily from a
decrease in state and local income tax expense (240 basis
points) partially offset by an increase in the tax effect of
our foreign operations (140 basis points).
NET EARNINGS
Net earnings as compared with fiscal 2007 increased 5%,
or $24.6 million, to $473.8 million and diluted net earnings
per common share improved 11% from $2.16 to $2.40.
