FISCAL 2007 AS COMPARED WITH FISCAL 2006

NET SALES
Net sales increased 9%, or $573.7 million, to $7,037.5 million, reflecting net sales growth in all product categories and geographic regions. The increases in our skin care, makeup and fragrance product categories were led by Europe, the Middle East & Africa while the increase in hair care net sales was predominantly in the Americas. Excluding the impact of foreign currency translation, net sales increased 7%.

Product Categories
Skin Care Net sales of skin care products increased 8%, or $200.2 million, to $2,601.0 million. Most of this growth was fueled by new product launches which made their most significant impact in our Europe, the Middle East & Africa and Asia/Pacific regions. The recent launches of Advanced Night Repair Concentrate Recovery Boosting Treatment and Idealist Refinisher from Estée Lauder, and Repairwear Lift Firming Night Cream, Continuous Rescue Antioxidant Moisturizer, All About Eyes Rich and Repairwear Contour Firming Formula from Clinique contributed incremental sales of approximately $95 million, combined. Net sales increases from our fast-growing La Mer brand, Resilience Lift Extreme Ultra Firming products and other existing Advanced Night Repair products from Estée Lauder, along with products in the Clinique 3-Step Skin Care System and Superdefense from Clinique, totaled approximately $97 million. These improvements were partially offset by approximately $35 million of lower sales from certain other Resilience Lift products and Perfectionist [CP+] from Estée Lauder. Excluding the impact of foreign currency translation, skin care net sales increased 6%.

Makeup Makeup net sales increased 8%, or $208.5 million, to $2,712.7 million, reflecting growth from our makeup artist brands of approximately $191 million. This increase was supported by new points of distribution and new product launches as well as M·A·C Viva Glam lip products, the proceeds of which are donated to AIDS-related charities. Higher sales of Double Wear Foundation and the recent launch of Resilience Lift Extreme Ultra Firming Makeup SPF 15 by Estée Lauder contributed approximately $56 million to the growth in this product category. Lower sales of approximately $35 million of Pure Color Gloss and Individualist Natural Finish Makeup by Estée Lauder, and Repairwear Anti-Aging Makeup SPF 15 by Clinique partially offset this growth. Excluding the impact of foreign currency translation, makeup net sales increased 6%.

Fragrance Net sales of fragrance products increased 8%, or $95.3 million, to $1,308.6 million, primarily driven by incremental international sales from newer fragrance offerings. DKNY Red Delicious, Pure White Linen from Estée Lauder, Sean John Unforgivable, DKNY Red Delicious Men and Donna Karan Gold collectively contributed approximately $128 million to the category. Lower sales of approximately $67 million of True Star and True Star Men by Tommy Hilfiger, and Estée Lauder pleasures partially offset the growth in this product category. While current year sales levels compared favorably to the prior year, we anticipate continued challenges in this product category due in part to competitive dynamics, particularly in the United States. Excluding the impact of foreign currency translation, fragrance net sales increased 5%.

Hair Care Hair care net sales increased 18%, or $58.4 million, to $377.1 million, primarily due to sales growth from Aveda and Bumble and bumble products. Aveda net sales increases were primarily due to sales of professional color products, the recent launch of Be Curly shampoo and conditioner and the acquisition of an independent distributor. Bumble and bumble sales benefited from a new hotel amenities program, sales growth in its existing salon distribution and new points of distribution. Excluding the impact of foreign currency translation, hair care net sales increased 17%.

Geographic Regions
Net sales in the Americas increased 3%, or $114.5 million, to $3,560.9 million. The increase was led by growth in the United States of approximately $152 million from our makeup artist brands, our hair care business, our internet distribution, and the recent launch of the Unforgivable fragrance by Sean John. Partially offsetting this growth was approximately $90 million related to weaknesses in our core brands as a result of competitive pressures and retailer consolidations. Net sales growth in Canada, Latin America and Mexico contributed an additional $31 million to the increase. The prior year results reflected an incremental provision of approximately $16 million for returns that were anticipated at that time as a result of then-announced store closings from retailer consolidations.

In Europe, the Middle East & Africa, net sales increased 16%, or $345.7 million, to $2,493.4 million, including an exchange rate benefit due to the weakening of the U.S. dollar of approximately $122 million. The growth in the region reflected higher net sales of approximately $260 million in the United Kingdom, our travel retail business, Russia, Germany and Spain, with all benefiting from an improving retail environment, and in Turkey, where we acquired a distributor. On a local currency basis, net sales in Europe, the Middle East & Africa increased 10%.

Net sales in Asia/Pacific increased 13%, or $113.5 million, to $983.2 million. The growth in this region reflected higher net sales of approximately $86 million in Korea, China, Hong Kong and Australia. These markets benefited from an improved economy across the region while China's growth in net sales primarily reflected our continuing strategic expansion in this country. We also experienced modest sales growth in Japan, our largest market in this region. Excluding the impact of foreign currency translation, Asia/Pacific net sales increased 11%.

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 decreased to 25.2% as compared with 26.1% in the prior year. Cost of sales as a percentage of net sales reflected a favorable change in the mix of our business of approximately 40 basis points, a decrease in the level and timing of promotional activities of approximately 20 basis points, the effect of exchange rate translation of approximately 20 basis points and a decrease in obsolescence charges of approximately 10 basis points. Certain of these items reflect savings achieved during the current period from our cost savings initiative, which commenced during fiscal 2006.

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 improved to 64.1% of net sales as compared with 64.3% of net sales in the prior year. During the prior year, we recorded a $92.1 million charge to operating expenses related to the implementation of our cost savings initiative that negatively impacted our operating expense margin by approximately 140 basis points. Partially offsetting this improvement was an increase of approximately 50 basis points in selling, general and administrative expenses reflecting higher demonstration, field selling and training costs in support of our business. In fiscal 2007, our operating expense margin was negatively impacted by approximately 40 basis points resulting from expenses related to our pharmacy channel for organizational costs, costs to streamline the distribution of goods, and the impairment of goodwill and other intangible assets. An increase in costs incurred related to the implementation of our Strategic Modernization Initiative and higher stock-based compensation expenses lowered our operating expense margin by approximately 20 additional basis points, combined. Overall operating expenses reflected savings achieved during the current period from our cost savings initiative, which commenced during fiscal 2006.

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
Due to the growth in net sales and the decreases in our cost of sales and operating expense margins as previously discussed, operating income increased 21%, or $130.3 million, to $749.9 million as compared with the prior year. Operating margins were 10.7% of net sales as compared with 9.6% in the prior year, which was negatively impacted by 1.4% of net sales as a result of the special charge related to our cost savings initiative.

The following discussions of Operating Results by Product Categories and Geographic Regions exclude the impact of special charges related to our cost savings initiative of $1.1 million and $92.1 million for the fiscal years ended June 30, 2007 and 2006, respectively. We believe the following analysis of operating results better reflects the manner in which we conduct and view our business. See Note 17 of Notes to Consolidated Financial Statements-Segment Data and Related Information.

Product Categories
Fragrance operating results increased over 100%, or $20.4 million, to $28.1 million, as profits from higher international net sales and lower spending at certain of our core brands in the United States more than offset spending behind new and developing brands. Hair care operating results grew 60%, or $16.0 million, to $42.5 million as the increase in net sales outpaced increased spending in support of new distribution points and product launches. Operating results increased 3%, or $9.9 million, to $339.3 million in makeup, primarily as a result of higher net sales and profits from our makeup artist brands, which more than offset challenges among certain core brands. Skin care operating results decreased 1%, or $4.9 million, to $341.5 million. The results in this product category were negatively impacted in fiscal 2007 by charges related to our pharmacy channel. We recorded approximately $30 million for organizational costs, costs to streamline the distribution of goods, and the impairment of goodwill and other intangible assets. In addition, improvements in international skin care results were partially offset by challenges in certain core brands in the United States.

Geographic Regions
Operating income in the Americas decreased 2%, or $7.7 million, to $336.4 million, reflecting spending behind strategic initiatives at our core brands, retailer consolidation and costs to develop new brands in the United States. Operating income growth from our makeup artist brands, hair care business and our internet distribution partially offset these results.

In Europe, the Middle East & Africa, operating income increased 8%, or $23.9 million, to $321.4 million primarily due to higher results of approximately $49 million from our travel retail business, the United Kingdom, Russia and Germany. Lower results from France partially offset these improvements by approximately $10 million. The current year operating results in France reflected the rebalancing of inventory levels at certain retailers as well as strategic investment spending behind the field sales force. During the current year, the region was negatively impacted by the charges discussed above related to our pharmacy channel, partially offset by modest combined operating income growth from the remaining affiliates in this region.

In Asia/Pacific, operating income increased 33%, or $23.1 million, to $93.2 million. This increase reflected improved results of approximately $23 million in Hong Kong, China, Australia and Korea.

INTEREST EXPENSE, NET
Net interest expense was $38.9 million as compared with $23.8 million in the prior year. This change primarily resulted from higher average debt balances, primarily associated with the funding of our accelerated share repurchase program, and higher average interest rates. Also contributing to the increase was reduced interest income generated from lower average investment balances internationally, partially offset by higher average investment rates. These increases were partially offset by the capitalization of interest expense on internally developed software in connection with the upgrade of our information systems.

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 quarter to quarter 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, 2007 was 35.9% as compared with 43.6% in the prior year. The decrease in the effective income tax rate was primarily attributable to the prior year effect of the IRS tax settlement of approximately 770 basis points.

DISCONTINUED OPERATIONS
On September 30, 2005, we committed to a plan to sell and on April 10, 2006, we completed the sale of certain assets and operations of our reporting unit that marketed and sold Stila brand products. For the fiscal year ended June 30, 2007, $0.5 million, net of tax, of operating income was reflected as discontinued operations, reflecting the conclusion of transitional distribution services provided to the purchaser. The prior year charge of $80.3 million, net of tax, reflected the then-anticipated loss on the sale of the business of $69.9 million, net of tax, and the operating loss of $10.4 million, net of tax.

NET EARNINGS
Net earnings as compared with the prior fiscal year increased $205.0 million to $449.2 million and diluted net earnings per common share improved 93% from $1.12 to $2.16. Net earnings from continuing operations as compared with the prior fiscal year increased by $124.2 million, or 38%, to $448.7 million and diluted net earnings per common share from continuing operations increased 45% from $1.49 to $2.16.

top of page	< back | next >