Estee Lauder 2005 Annual Report Download - page 49

THE EST{E LAUDER COMPANIES INC.
requirements (such as those arising under the Sarbanes-
Oxley Act of 2002). Partially offsetting the net favorability
in fiscal 2004 were higher levels of advertising, mer-
chandising and sampling expenses incurred to support
new and recently launched products of approximately
70 basis points.
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.
Under agreements covering our purchase of trademarks
for a percentage of related sales, royalty payments totaling
$18.8 million and $20.3 million in fiscal 2004 and 2003,
respectively, have been charged to expense. Such pay-
ments were made to Mrs. Estée Lauder until her death on
April 24, 2004, after which time the final payments ceased
to accrue and were made to a trust. This event resulted in a
reduction of operating expenses in fiscal 2004 of $3.7 mil-
lion, or $2.2 million after tax. We realized a benefit from
the elimination of these royalty payments in fiscal 2005.
OPERATING RESULTS
Operating income increased 28% or $140.3 million to
$644.0 million. Operating margins were 11.1% of net sales
in fiscal 2004 as compared with 9.9% in fiscal 2003.
Absent the special charge, operating income increased
23% or $118.3 million and operating margins increased
80 basis points from fiscal 2003. These increases in oper-
ating income and operating margin reflect sales growth,
improvements in the components of cost of sales and
a reduction in operating expenses as a percentage of
net sales.
Net earnings and diluted net earnings per common
share increased approximately 7% and 17%, respectively.
Net earnings improved $22.3 million to $342.1 million and
diluted net earnings per common share increased by 17%
from $1.26 to $1.48. Net earnings from continuing opera-
tions increased by $49.8 million or 15% and diluted net
earnings per common share from continuing operations
increased 26% to $1.62 from $1.29 in the prior year.
Absent the special charge, net earnings from continuing
operations increased by $36.3 million or 11% and diluted
net earnings per common share from continuing opera-
tions increased 21% from $1.35.
The following discussions of Operating Results by
Product Categories and Geographic Regions exclude
the impact of the fiscal 2003 special charge. We believe the
following analysis of operating income better reflects
the manner in which we conduct and view our business.
Product Categories
Operating income increased 23% to $336.3 million in skin
care, 25% to $257.7 million in makeup and 59% to $23.6
million in hair care reflecting overall sales growth and new
product launches. Operating income decreased 23% to
$24.8 million in fragrance reflecting the softness in that
product category in the United States as well as increased
support spending related to new product launch activities.
Geographic Regions
Operating income in the Americas increased 25% or $63.9
million to $319.2 million due to sales growth resulting from
an improved retail environment, strong product launches
and growth from newer brands. In Europe, the Middle East
& Africa, operating income increased 21% or $46.7 mil-
lion to $274.4 million primarily due to significantly
improved results from our travel retail business, improved
operating results in the United Kingdom and Spain as well
as the addition of a full year of results of the Darphin line of
products, all of which contributed approximately $71 mil-
lion to the increase. Partially offsetting these increases
were approximately $26 million of lower gains on foreign
exchange transactions and lower results in Switzerland
and Italy due to difficult market conditions, collectively.
In Asia/Pacific, operating income increased 18% or
$7.7 million to $50.4 million. This increase reflected
improved results in Taiwan, Hong Kong and Thailand,
partially offset by lower results in Korea, of approximately
$7 million, combined.
INTEREST EXPENSE, NET
Net interest expense was $27.1 million as compared with
$8.1 million in fiscal 2003. The increase in net interest
expense was due to the inclusion of the dividends on
redeemable preferred stock of $17.4 million as interest
expense in fiscal 2004. This change in reporting resulted
from a change in accounting standards which prohibited
us from restating fiscal 2003 results. To a lesser extent,
interest expense was also affected by higher average net
borrowings and a marginally higher effective interest rate
on our debt portfolio.
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 2004 was 37.7% as compared with 32.9% in
fiscal 2003. These rates differ from statutory rates, reflecting
the effect of state and local taxes, tax rates in foreign juris-
dictions and certain nondeductible expenses. The increase
in the effective income tax rate was attributable to the
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