Estee Lauder 2008 Annual Report Download - page 65

THE EST{E LAUDER COMPANIES INC. 63
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 effi ciencies achieved from
ongoing savings initiatives. While sustained energy and
raw material price increases could result in higher costs,
we believe that this will not have a material adverse effect
on our cost of sales margin in the near future.
Since certain promotional activities are a component
of sales or cost of sales and the timing and level of promo-
tions vary with our promotional calendar, we have experi-
enced, and expect to continue to experience, fl uctuations
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 prior year. The
increase in operating expenses and operating expense
margin refl ected higher costs of global information tech-
nology systems and infrastructure of approximately 30
basis points. An additional 20 basis points resulted from
an increase in valuation reserves refl ecting the diminish-
ing 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 the prior year 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 activi-
ties 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 the prior year. Operat-
ing margin declined to 10.3% of net sales as compared
with 10.7% in the prior year, refl ecting 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 mil-
lion, to $36.2 million, refl ecting profi table international
growth, partially offset by increased spending in support
of designer fragrance products initiatives. Skin care
Additional net sales increases of approximately $65 million
were attributable to our designer fragrances business and
our makeup artist and hair care brands in the United
States. Partially offsetting this growth was approximately
$37 million related to weaknesses in certain of our core
brands in the United States as a result of competitive pres-
sures and challenges in the department store channel. We
believe that economic uncertainty in the United States
has affected our business, particularly in the department
store channel. These challenges have been mitigated
through sales in alternative channels, such as freestanding
retail stores, internet distribution, self-select distribution
and direct-response television. Excluding the impact of
foreign currency translation, net sales in the Americas
increased 3%.
All countries in Europe, the Middle East & Africa expe-
rienced net sales growth, which contributed to the
increase in net sales of 21%, or $513.3 million, to $3,006.7
million, although net sales growth rates slowed in certain
key countries. This growth was led by our travel retail busi-
ness and the United Kingdom, as well as in Russia, which
benefi ted from our expansion in this emerging market.
The results in this region were inclusive of an exchange
rate benefi t due to the weakening of the U.S. dollar of
approximately $206 million. Excluding the impact of for-
eign currency translation, net sales in Europe, the Middle
East & Africa increased 12%.
Net sales in Asia/Pacifi c increased 21%, or $209.4
million, to $1,192.6 million, refl ecting growth from all
countries in the region. This increase refl ected higher net
sales of approximately $172 million in China, Japan, Hong
Kong, Australia and Korea. The results in this region were
inclusive of an exchange rate benefi t due to the weaken-
ing of the U.S. dollar of approximately $66 million. Exclud-
ing the impact of foreign currency translation, Asia/Pacifi c
net sales increased 15%.
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 was 25.2%,
which is the same as the prior year. Cost of sales as a per-
centage of net sales refl ected a decrease in the level and
timing of promotional activities of approximately 20 basis
points and a positive effect of exchange rates of approxi-
mately 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.