Estee Lauder 2005 Annual Report Download - page 46

THE EST{E LAUDER COMPANIES INC.
Changes in advertising, sampling and merchandising
spending result from the type, timing and level of activities
related to product launches and rollouts, as well as the mar-
kets being emphasized.
OPERATING RESULTS
Based on the growth of net sales, our constant cost of sales
margin and the improvement in our operating expense
margin as previously discussed, operating income
increased 12% or $76.6 million to $720.6 million as com-
pared with the prior fiscal year. Operating margins were
11.4% of net sales in the current period as compared with
11.1% in the prior fiscal year.
Product Categories
Operating income increased 14% or $37.2 million in
makeup and 9% or $29.5 million in skin care reflecting
overall sales growth and sales of recently launched prod-
ucts. Operating results also increased 44% or $11.0 mil-
lion in fragrance reflecting sales growth from new and
recently launched products. While we experienced
improved results in fiscal 2005 due to these new launches,
the fragrance business continues to be challenging. Hair
care operating results decreased 3% or $0.8 million reflect-
ing an increase in operating expenses related to the
growth of our business in the United States as well as the
opening of new points of distribution in Korea and Japan,
partially offset by increases in net sales as previously
discussed. Hair care results were also adversely impacted
in fiscal 2005 by the need to make alternative arrange-
ments due to the bankruptcy of a third-party supplier. The
situation was rectified during fiscal 2005.
Geographic Regions
Operating income in the Americas increased 12% or $38.0
million to $357.2 million, primarily due to higher net sales
resulting from an overall improvement in the retail envi-
ronment, strong product launches and growth from our
newer brands. As noted above, we expect results in the
Americas region to be adversely impacted by the August
2005 merger of Federated Department Stores, Inc. and
The May Department Stores Company.
In Europe, the Middle East & Africa, operating income
increased 12% or $31.7 million to $306.1 million primarily
due to improved results from our travel retail business,
Spain, the United Kingdom and Switzerland of approxi-
mately $34 million, collectively. Partially offsetting this
improvement were lower results in France, which was
negatively impacted by the consolidation of major retail-
ers, and in Russia, where we converted our business from
a distributor to a direct subsidiary, of approximately $5 mil-
lion on a combined basis.
In Asia/Pacific, operating income increased 14% or $6.9
million to $57.3 million. This increase reflected improved
results in Hong Kong, Taiwan, Thailand and Japan of
approximately $11 million, collectively, partially offset by
a decrease in operating income in Korea and China of
approximately $6 million, combined. As China is an emerg-
ing market for us, we have invested, and plan to continue to
invest, in new brand expansion and business opportunities.
In addition, the Asia/Pacific region did not realize the
benefits of spending behind new whitening products,
which experienced a delay in launching during fiscal 2005.
INTEREST EXPENSE, NET
Net interest expense was $13.9 million as compared with
$27.1 million in the prior year. The decrease in net interest
expense was due primarily to a $16.5 million decrease in
preferred stock dividends as a result of the redemption of
$291.6 million aggregate principal amount of the 2015
Preferred Stock on June 10, 2004 and the reduction in the
dividend rate on the remaining $68.4 million of the 2015
Preferred Stock. This improvement was partially offset by
an increase in interest expense as a result of higher debt
balances and, to a lesser extent, higher interest rates.
PROVISION FOR INCOME TAXES
The provision for income taxes represents Federal, foreign,
state and local income taxes. The effective rate for income
taxes for fiscal 2005 was 41.2% as compared with 37.7% in
the prior year. The effective rate differs from statutory rates
due to the effect of state and local taxes, tax rates in
foreign jurisdictions, the effect of repatriating foreign
earnings and certain nondeductible expenses.
During the fourth quarter of fiscal 2005, we formulated
a plan to repatriate approximately $690 million of foreign
earnings in fiscal 2006, which includes $500 million of
extraordinary intercompany dividends under the provisions
of the American Jobs Creation Act of 2004 (the “AJCA”).
This action resulted in an aggregate tax charge of approxi-
mately $35 million in fiscal 2005, which included an
incremental tax charge of approximately $28 million.
The increase in the effective income tax rate was attrib-
utable to the incremental tax charge resulting from the
repatriation plan of approximately 390 basis points and an
increase of approximately 120 basis points resulting from
our foreign operations. These increases were partially
offset by a reduction in the amount of nondeductible pre-
ferred stock dividends of approximately 100 basis points, a
decrease in state and local income taxes of approximately
40 basis points and an increase in tax credits of approxi-
mately 20 basis points.
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