Estee Lauder 2007 Annual Report Download - page 46

THE EST{E LAUDER COMPANIES INC. 45
decrease was primarily due to lower results in Spain,
Benelux (Belgium, the Netherlands and Luxembourg) and
Italy of approximately $20 million, collectively. These
decreases were partially offset by improvements of
approximately $12 million in France, our travel retail
business and Central Europe (Hungary, Poland and
Czech Republic).
In Asia/Pacifi c, operating income increased 27%, or
$14.8 million, to $70.1 million. This increase reflects
improved results of approximately $16 million in Korea,
Japan and China, partially offset by lower results in Taiwan
and Thailand of approximately $4 million, collectively. As
China is an emerging market for us, we have invested, and
plan to continue to invest, in new brand expansion
and business opportunities there.
INTEREST EXPENSE, NET
Net interest expense was $23.8 million as compared with
$13.9 million in fi scal 2005. The increase in net interest
expense was primarily due to higher average interest
rates and, to a lesser extent, higher average debt balances
due to outstanding commercial paper during the
year. 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, for-
eign, state and local income taxes. The effective rate for
income taxes for fi scal 2006 was 43.6% as compared with
41.2% in fi scal 2005. The effective rate differs from statu-
tory 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 year to year based on non-recurring and recurring
factors including, but not limited to, the geographic mix of
earnings, enacted tax legislation, state and local taxes, tax
audit fi ndings and settlements and the interaction of
various global tax strategies.
On July 13, 2006, we announced a settlement with the
Internal Revenue Service (“IRS”) regarding its examination
of our consolidated Federal income tax returns for the
fi scal years ended June 30, 1998 through June 30, 2001.
The settlement resolves previously disclosed issues raised
during the IRS’s examination, including transfer pricing
and foreign tax credit computations. The settlement of
these issues resulted in a tax charge of approximately $46
million in the fourth quarter of fi scal 2006 and represents
the aggregate earnings impact of the settlement through
fi scal 2006. In addition, during the fourth quarter of fi scal
2006, we completed the repatriation of foreign earnings
OPERATING RESULTS
Operating income decreased 15%, or $107.2 million, to
$619.6 million. Operating margin was 9.6% of net sales in
fi scal 2006 as compared with 11.6% in fi scal 2005. These
results were negatively impacted by the effects of special
charges related to our cost savings initiative of $92.1 mil-
lion, or 1.4% 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 refl ects the manner in
which we conduct and view our business.
Product Categories
Operating income declined 79%, or $28.1 million, to $7.7
million in the fragrance product category refl ecting lower
sales and, to a lesser extent, expenses incurred related to
development of new products and brands, partially offset
by a shift in spending in certain of our core brands to
other product categories. Skin care operating income
decreased 5%, or $19.4 million, to $346.4 million primar-
ily refl ecting lower than anticipated net sales in certain of
our core brands. Operating income increased 9%, or
$28.3 million, to $329.4 million in the makeup product
category primarily reflecting sales growth from our
makeup artist brands, partially offset by declines in certain
of our core brands. Hair care operating income increased
16%, or $3.7 million, to $26.5 million refl ecting worldwide
sales growth. In fi scal 2006, the merger of Federated
Department Stores, Inc. and The May Department Stores
Company had a negative impact on the operating results
of our skin care, makeup and fragrance product catego-
ries, while incremental operating expenses associated
with new accounting rules for stock-based compensation
negatively impacted all of our product categories.
Geographic Regions
Operating income in the Americas decreased 6%, or
$22.1 million, to $344.1 million, primarily refl ecting chal-
lenges experienced by certain of our core brands, due in
part to competitive pressures and retailer consolidations,
and incremental operating expenses of approximately
$33 million associated with new accounting rules for
stock-based compensation. The ongoing success of our
makeup artist and hair care brands and our internet distri-
bution partially offset these challenges.
In Europe, the Middle East & Africa, operating income
decreased 3%, or $7.8 million, to $297.5 million. This