UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549-1004

FORM 10-Q

(Mark One)
x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2007
OR
o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the transition period from                 to
	Commission file number: 1-14064

 

The Estée Lauder Companies Inc.

 (Exact name of registrant as specified in its charter)

 

212-572-4200

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

At April 30, 2007, 111,608,027 shares of the registrant’s Class A Common Stock, $.01 par value, and 81,804,761 shares of the registrant’s Class B Common Stock, $.01 par value, were outstanding.

THE ESTÉE LAUDER COMPANIES INC.

INDEX

	Page
Part I. Financial Information
Item 1. Financial Statements
Consolidated Statements of Earnings —
Three and Nine Months Ended March 31, 2007 and 2006	2
Consolidated Balance Sheets —
March 31, 2007 and June 30, 2006	3
Consolidated Statements of Cash Flows —
Nine Months Ended March 31, 2007 and 2006	4
Notes to Consolidated Financial Statements	5
Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations	17
Item 3. Quantitative and Qualitative Disclosures About Market Risk	31
Item 4. Controls and Procedures	31
Part II. Other Information
Item 1. Legal Proceedings	32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	33
Item 6. Exhibits	34
Signatures	35

 

THE ESTÉE LAUDER COMPANIES INC.

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements.

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

		Three Months Ended March 31						Nine Months Ended March 31
		2007			2006			2007			2006
		(In millions, except per share data)
Net Sales		$	1,690.5		$	1,578.2		$	5,275.1		$	4,859.2
Cost of Sales		426.0			411.5			1,353.1			1,289.5
Gross Profit		1,264.5			1,166.7			3,922.0			3,569.7
Operating expenses:
Selling, general and administrative		1,107.9			998.8			3,332.6			3,044.4
Special charges related to cost savings initiative		(0.1		)	51.6			0.4			53.2
		1,107.8			1,050.4			3,333.0			3,097.6
Operating Income		156.7			116.3			589.0			472.1
Interest expense, net		8.8			6.6			23.2			19.1
Earnings before Income Taxes, Minority Interest and Discontinued Operations		147.9			109.7			565.8			453.0
Provision for income taxes		52.4			43.4			199.1			169.4
Minority interest, net of tax		(1.7		)	(3.1		)	(6.4		)	(8.2		)
Net Earnings from Continuing Operations		93.8			63.2			360.3			275.4
Discontinued operations, net of tax		0.1			(3.7		)	0.3			(75.7		)
Net Earnings		$	93.9		$	59.5		$	360.6		$	199.7
Basic net earnings per common share:
Net earnings from continuing operations		$	.46		$	.30		$	1.74		$	1.27
Discontinued operations, net of tax		.00			(.02		)	.00			(.35		)
Net earnings		$	.46		$	.28		$	1.74		$	.92
Diluted net earnings per common share:
Net earnings from continuing operations		$	.45		$	.29		$	1.71		$	1.26
Discontinued operations, net of tax		.00			(.01		)	.00			(.35		)
Net earnings		$	.45		$	.28		$	1.71		$	.91
Weighted average common shares outstanding:
Basic		203.8			212.4			207.7			215.9
Diluted		208.0			214.9			211.0			218.4
Cash dividends declared per share		$	—		$	—		$	.50		$	.40

 

See notes to consolidated financial statements.

2

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THE ESTÉE LAUDER COMPANIES INC.

CONSOLIDATED BALANCE SHEETS

		March 31			June 30
		2007			2006
		(Unaudited)
		($ in millions)
ASSETS
Current Assets
Cash and cash equivalents		$	202.0		$	368.6
Accounts receivable, net		964.9			771.2
Inventory and promotional merchandise, net		806.3			766.3
Prepaid expenses and other current assets		292.7			270.8
Total current assets		2,265.9			2,176.9
Property, Plant and Equipment, net		830.5			758.0
Other Assets
Investments, at cost or market value		22.2			13.4
Goodwill, net		684.1			635.8
Other intangible assets, net		78.0			77.0
Other assets, net		133.5			123.0
Total other assets		917.8			849.2
Total assets		$	4,014.2		$	3,784.1
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Short-term debt		$	141.2		$	89.7
Accounts payable		273.0			264.5
Accrued income taxes		191.0			135.5
Other accrued liabilities		1,042.6			948.5
Total current liabilities		1,647.8			1,438.2
Noncurrent Liabilities
Long-term debt		1,033.0			431.8
Other noncurrent liabilities		248.1			266.4
Total noncurrent liabilities		1,281.1			698.2
Minority Interest		20.4			25.4
Stockholders’ Equity
Common stock, $.01 par value; 650,000,000 shares Class A authorized; shares issued: 172,249,172 at March 31, 2007 and 164,837,563 at June 30, 2006; 240,000,000 shares Class B authorized; shares issued and outstanding: 81,804,761 at March 31, 2007 and 85,305,915 at June 30, 2006		2.5			2.5
Paid-in capital		753.8			581.0
Retained earnings		2,618.7			2,361.9
Accumulated other comprehensive income		81.5			64.7
		3,456.5			3,010.1
Less: Treasury stock, at cost; 60,843,574 Class A shares at March 31, 2007 and 38,382,458 Class A shares at June 30, 2006		(2,391.6		)	(1,387.8		)
Total stockholders’ equity		1,064.9			1,622.3
Total liabilities and stockholders’ equity		$	4,014.2		$	3,784.1

 

See notes to consolidated financial statements.

3

THE ESTÉE LAUDER COMPANIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

		Nine Months Ended March 31
		2007			2006
		(In millions)
Cash Flows from Operating Activities
Net earnings		$	360.6		$	199.7
Adjustments to reconcile net earnings to net cash flows from operating activities:
Depreciation and amortization		152.8			147.0
Deferred income taxes		(16.3		)	(57.5		)
Minority interest, net of tax		6.4			8.2
Non-cash stock compensation		35.6			29.5
Excess tax benefits from stock-based compensation arrangements		(5.5		)	(6.3		)
Loss on disposal of fixed assets		7.6			7.0
Discontinued operations, net of tax		(0.3		)	75.7
Other non-cash items		0.5			0.6
Changes in operating assets and liabilities:
Increase in accounts receivable, net		(174.7		)	(136.7		)
Decrease (increase) in inventory and promotional merchandise, net		(29.3		)	36.1
Increase in other assets, net		(41.1		)	(28.2		)
Increase (decrease) in accounts payable		8.0			(7.6		)
Increase in accrued income taxes		70.7			59.4
Increase in other accrued liabilities		87.7			110.2
Increase (decrease) in other noncurrent liabilities		(6.4		)	39.2
Net cash flows provided by operating activities of continuing operations		456.3			476.3
Net cash flows used for operating activities of discontinued operations		(5.7		)	(6.8		)
Net cash flows provided by operating activities		450.6			469.5
Cash Flows from Investing Activities
Capital expenditures		(212.0		)	(170.1		)
Capital expenditures of discontinued operations		—			(0.2		)
Acquisition of businesses, net of cash acquired		(56.7		)	(49.2		)
Proceeds from disposition of long-term investments		—			0.5
Purchases of long-term investments		(0.5		)	(0.1		)
Net cash flows used for investing activities		(269.2		)	(219.1		)
Cash Flows from Financing Activities
Increase (decrease) in short-term debt, net		49.9			(48.9		)
Proceeds from issuance of commercial paper expected to be refinanced		591.1			—
Repayments and redemptions of long-term debt		(2.5		)	(96.4		)
Net proceeds from stock-based compensation transactions		121.6			43.8
Excess tax benefits from stock-based compensation arrangements		5.5			6.3
Payments to acquire treasury stock		(1,004.3		)	(352.5		)
Dividends paid to stockholders		(103.6		)	(85.4		)
Distributions made to minority holders of consolidated subsidiaries		(9.5		)	(2.0		)
Net cash flows used for financing activities		(351.8		)	(535.1		)
Effect of Exchange Rate Changes on Cash and Cash Equivalents		3.8			(0.3		)
Net Decrease in Cash and Cash Equivalents		(166.6		)	(285.0		)
Cash and Cash Equivalents at Beginning of Period		368.6			553.3
Cash and Cash Equivalents at End of Period		$	202.0		$	268.3

 

See notes to consolidated financial statements.

4

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THE ESTÉE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements include the accounts of The Estée Lauder Companies Inc. and its subsidiaries (collectively, the “Company”) as continuing operations, with the exception of the operating results of its reporting unit that marketed and sold Stila brand products, which have been reflected as discontinued operations for the three and nine-month periods ended March 31, 2007 and 2006.  All significant intercompany balances and transactions have been eliminated.

The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  In the opinion of management all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the fiscal year.  For further information, refer to the consolidated financial statements and accompanying footnotes included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2006.

Certain amounts in the consolidated financial statements of prior periods have been reclassified to conform to current period presentation for comparative purposes.

Net Earnings Per Common Share

For the three and nine-month periods ended March 31, 2007 and 2006, net earnings per common share (“basic EPS”) is computed by dividing net earnings by the weighted-average number of common shares outstanding and contingently issuable shares (which satisfy certain conditions).  Net earnings per common share assuming dilution (“diluted EPS”) is computed by reflecting potential dilution from stock-based awards and contingently issuable shares.

A reconciliation between the numerators and denominators of the basic and diluted EPS computations is as follows:

		Three Months Ended March 31						Nine Months Ended March 31
		2007			2006			2007			2006
		(Unaudited)
		(In millions, except per share data)
Numerator:
Net earnings from continuing operations		$	93.8		$	63.2		$	360.3		$	275.4
Discontinued operations, net of tax		0.1			(3.7		)	0.3			(75.7		)
Net earnings		$	93.9		$	59.5		$	360.6		$	199.7
Denominator:
Weighted average common shares outstanding — Basic		203.8			212.4			207.7			215.9
Effect of dilutive stock options		3.7			2.4			3.0			2.4
Effect of dilutive restricted share units		0.4			0.1			0.2			0.1
Effect of contingently issuable shares pursuant to accelerated share repurchase program		0.1			—			0.1			—
Weighted average common shares outstanding — Diluted		208.0			214.9			211.0			218.4
Basic net earnings per common share:
Net earnings from continuing operations		$	.46		$	.30		$	1.74		$	1.27
Discontinued operations, net of tax		.00			(.02		)	.00			(.35		)
Net earnings		$	.46		$	.28		$	1.74		$	.92
Diluted net earnings per common share:
Net earnings from continuing operations		$	.45		$	.29		$	1.71		$	1.26
Discontinued operations, net of tax		.00			(.01		)	.00			(.35		)
Net earnings		$	.45		$	.28		$	1.71		$	.91

 

5

 

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

As of March 31, 2007 and 2006, outstanding options to purchase 6.5 million and 15.2 million shares, respectively, of Class A Common Stock were not included in the computation of diluted EPS because their inclusion would be anti-dilutive.  As of March 31, 2007 and 2006, 0.2 million and 0.1 million, respectively, of performance share units have been excluded from the calculation of diluted EPS because the number of shares ultimately issued is contingent on the achievement of certain performance targets of the Company, as discussed in Note 3 — Stock Programs.

Supplemental Disclosures of Cash Flow Information

Supplemental cash flow information for the nine months ended March 31, 2007 and 2006 were as follows:

		2007			2006
		(Unaudited)
		(In millions)
Cash
Cash paid during the period for interest		$	31.8		$	27.1
Cash paid during the period for income taxes		$	148.2		$	152.2
Non-cash
Incremental tax benefit from the exercise of stock options		$	12.3		$	4.5
Capital lease obligations incurred		$	3.9		$	0.3
Accrued dividend equivalents		$	0.2		$	0.1
Interest rate swap derivative mark to market		$	(9.0	)	$	13.1

 

Accounts Receivable

Accounts receivable is stated net of the allowance for doubtful accounts and customer deductions of $29.1 million and $27.1 million as of March 31, 2007 and June 30, 2006, respectively.

Inventory and Promotional Merchandise

Inventory and promotional merchandise includes inventory considered saleable or usable in future periods, and is stated at the lower of cost or fair-market value, with cost being determined on the first-in, first-out method.  Cost components include raw materials, componentry, direct labor and overhead (e.g., indirect labor, utilities, depreciation, purchasing, receiving, inspection and warehousing) as well as inbound freight.  Promotional merchandise is charged to expense at the time the merchandise is shipped to the Company’s customers.

		March 31			June 30
		2007			2006
		(Unaudited)
		(In millions)
Inventory and promotional merchandise consists of:
Raw materials		$	161.8		$	151.0
Work in process		40.7			44.2
Finished goods		443.9			407.1
Promotional merchandise		159.9			164.0
		$	806.3		$	766.3

 

6

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Property, Plant and Equipment

Property, plant and equipment, including leasehold and other improvements that extend an asset’s useful life or productive capabilities, are carried at cost less accumulated depreciation and amortization.  The cost of assets related to projects in progress of $129.3 million and $91.9 million as of March 31, 2007 and June 30, 2006, respectively, is included in their respective asset categories in the table below.  For financial statement purposes, depreciation is provided principally on the straight-line method over the estimated useful lives of the assets.  Leasehold improvements are amortized on a straight-line basis over the shorter of the lives of the respective leases or the expected useful life of those improvements.

		March 31			June 30
		2007			2006
		(Unaudited)
		(In millions)
Assets (Useful Life)
Land		$	13.8		$	13.7
Buildings and improvements (10 to 40 years)		164.8			161.7
Machinery and equipment (3 to 10 years)		902.7			803.0
Furniture and fixtures (5 to 10 years)		106.6			108.2
Leasehold improvements		878.8			790.8
		2,066.7			1,877.4
Less accumulated depreciation and amortization		1,236.2			1,119.4
		$	830.5		$	758.0

 

Depreciation and amortization of property, plant and equipment was $46.8 million and $48.1 million during the three months ended March 31, 2007 and 2006, respectively, and $145.9 million and $140.8 million during the nine months ended March 31, 2007 and 2006, respectively.  Depreciation and amortization related to the Company’s manufacturing process is included in cost of sales and all other depreciation and amortization is included in selling, general and administrative expenses in the accompanying consolidated statements of earnings.

Goodwill and Other Intangible Assets

During the nine months ended March 31, 2007, the Company purchased the remaining minority equity interest in Bumble and Bumble Products, LLC and Bumble and Bumble, LLC, acquired a business engaged in the wholesale distribution and retail sale of Aveda products and acquired an international distributor, all of which resulted in an increase to goodwill of $46.5 million and other intangible assets of $4.6 million.

Debt

In March 2007, the Company entered into a $400 million senior unsecured 364-day revolving credit facility primarily to provide credit support for the Company’s commercial paper program.  This facility may also be used for general corporate purposes and to repurchase shares of the Company’s common stock.  The interest rate on borrowings under the credit facility is based on LIBOR or on the higher of prime, which is the rate of interest publicly announced by the administrative agent, or ½% plus the Federal funds rate.  The credit facility has an annual fee of $0.2 million, payable quarterly, based on the Company’s current credit ratings.  As of March 31, 2007, this facility was undrawn and the Company was in compliance with all related financial and other restrictive covenants, including limitations on indebtedness and liens.

During March 2007, the Company issued commercial paper to finance the repurchase of treasury stock as part of an accelerated share repurchase program and for general corporate purposes (see Note 6 — Accelerated Share Repurchase Program).  At March 31, 2007, $591.1 million of this amount was classified as long-term debt in the accompanying consolidated balance sheet based on the Company’s intent and ability to refinance the debt on a long-term basis.  The Company has refinanced a majority of this amount, and intends to refinance the remainder upon maturity, with the net proceeds from the issuance of long-term notes (see Note 7 — Subsequent Events).

Operating Leases

The Company recognizes rent expense from operating leases with periods of free and scheduled rent increases on a straight-line basis over the applicable lease term.  The Company considers lease renewals in the useful life of its leasehold improvements when such renewals are reasonably assured.  From time to time, the Company may receive capital improvement funding from its lessors.  These amounts are recorded as deferred liabilities and amortized over the remaining lease term as a reduction of rent expense.

7

THE ESTÉE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Pension and Post-retirement Benefit Plans

The Company maintains pension plans covering substantially all of its full-time employees for its U.S. operations and a majority of its international operations.  Certain of the Company’s employees are eligible to participate in a post-retirement benefit plan which provides certain medical and dental benefits.  Descriptions of these plans are discussed in the Company’s Annual Report on Form 10-K for the year ended June 30, 2006.

The components of net periodic benefit cost for the three months ended March 31, 2007 and 2006 consisted of the following:

														Other than
		Pension Plans												Pension Plans
		U.S.						International						Post-retirement
		2007			2006			2007			2006			2007			2006
(Unaudited)
(In millions)
Service cost, net		$	4.6		$	5.4		$	4.0		$	3.0		$	1.1		$	1.1
Interest cost		6.2			5.3			3.2			2.4			1.7			1.3
Expected return on plan assets		(7.2		)	(6.2		)	(3.5		)	(2.8		)	—			—
Amortization of:
Prior service cost		0.2			0.2			0.1			0.1			—			—
Actuarial loss		0.5			1.5			2.0			2.0			0.2			0.3
Net periodic benefit cost		$	4.3		$	6.2		$	5.8		$	4.7		$	3.0		$	2.7

 

The components of net periodic benefit cost for the nine months ended March 31, 2007 and 2006 consisted of the following:

														Other than
		Pension Plans												Pension Plans
		U.S.						International						Post-retirement
		2007			2006			2007			2006			2007			2006
(Unaudited)
(In millions)
Service cost, net		$	13.8		$	16.1		$	11.9		$	9.0		$	3.5		$	3.4
Interest cost		18.7			15.9			9.6			7.3			5.0			3.8
Expected return on plan assets		(21.5		)	(18.7		)	(10.3		)	(8.6		)	—			—
Amortization of:
Prior service cost		0.5			0.6			0.2			0.2			—			—
Actuarial loss		1.3			4.6			5.8			6.2			0.6			0.9
Settlements and curtailments		—			—			—			0.2			—			—
Net periodic benefit cost		$	12.8		$	18.5		$	17.2		$	14.3		$	9.1		$	8.1

 

During the first quarter of fiscal 2007, the Pension Protection Act of 2006 was adopted into law in the United States.  Certain provisions of this law changed the calculation related to the maximum contribution amount deductible for income tax purposes.  As a result of these provisions, the Company made discretionary contributions totaling $15.0 million to its trust-based, noncontributory qualified defined benefit pension plan during the current year and expects to contribute an additional $5.0 million during the remainder of fiscal 2007.  The Company expects to make benefit payments under its non-qualified domestic noncontributory pension plan totaling $10.3 million during the fiscal year ending June 30, 2007.  In addition, the Company expects to contribute $20.8 million to its international pension plans during the fiscal year ending June 30, 2007.

8

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THE ESTÉE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Common Stock

During the nine months ended March 31, 2007, 3,501,154 shares of the Company’s Class B Common Stock were converted into Class A Common Stock.  There is no cash or other consideration paid by the holders converting the shares and, accordingly, there is no cash or other consideration received by the Company.

Management Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses reported in those financial statements.  These judgments can be subjective and complex, and consequently actual results could differ from those estimates and assumptions.  The Company’s most critical accounting policies relate to revenue recognition, concentration of credit risk, inventory, pension and other post-retirement benefit costs, goodwill and other intangible assets, income taxes, derivatives and stock-based compensation.  Descriptions of these policies are set forth in the Company’s Annual Report on Form 10-K for the year ended June 30, 2006.

Recently Issued Accounting Standards

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”) to clarify the definition of fair value, establish a framework for measuring fair value and expand the disclosures on fair value measurements.  SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price).  SFAS No. 157 also stipulates that, as a market-based measurement, fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability, and establishes a fair value hierarchy that distinguishes between (a) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (b) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).  SFAS No. 157 becomes effective for the Company in its fiscal year ending June 30, 2009.  The Company is currently evaluating the impact of the provisions of SFAS No. 157 on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 106, and 132(R)” (“SFAS No. 158”).  SFAS No. 158 requires employers to recognize a net liability or asset and an offsetting adjustment to accumulated other comprehensive income to report the funded status of defined benefit pension and other postretirement benefit plans.  Previous standards required employers to disclose the complete funded status of its plans only in the notes to the financial statements.  Additionally, SFAS No. 158 requires employers to measure plan assets and obligations at their year-end balance sheet date.  The Company will adopt SFAS No. 158 prospectively, as of the end of the current fiscal year, as required.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB No. 108”), which sets forth the SEC Staff’s views on the proper methods for quantifying errors when there were uncorrected errors in a prior year.  Under SAB No. 108, companies should evaluate a misstatement that existed in prior years based on its impact on the current year income statement, as well as the cumulative effect of correcting such misstatements in the current year’s ending balance sheet.  SAB No. 108 will become effective for the Company at June 30, 2007.  The Company is currently evaluating the impact of the provisions of SAB No. 108 on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (“SFAS No. 159”) to permit all entities to choose to elect, at specified election dates, to measure eligible financial instruments at fair value.  An entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date, and recognize upfront costs and fees related to those items in earnings as incurred and not deferred.  SFAS No. 159 applies to fiscal years beginning after November 15, 2007, with early adoption permitted for an entity that has also elected to apply the provisions of SFAS No. 157.  An entity is prohibited from retrospectively applying SFAS No. 159, unless it chooses early adoption.  The Company is currently evaluating the impact of the provisions of SFAS No. 159 on its consolidated financial statements, if any, when it becomes effective for the fiscal year ending June 30, 2009.

9

THE ESTÉE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 — COMPREHENSIVE INCOME

The components of accumulated other comprehensive income (“OCI”) included in the accompanying consolidated balance sheets consist of net unrealized investment gain (loss), net gain (loss) on derivative instruments designated and qualifying as cash-flow hedging instruments, net minimum pension liability adjustments and cumulative translation adjustments as of the end of each period.

Comprehensive income and its components, net of tax, are as follows:

		Three Months Ended March 31						Nine Months Ended March 31
		2007			2006			2007			2006
		(Unaudited) (In millions)
Net earnings		$	93.9		$	59.5		$	360.6		$	199.7
Other comprehensive income (loss):
Net unrealized investment gain		0.1			0.2			0.2			0.2
Net derivative instruments gain (loss)		(0.2		)	0.7			(3.4		)	0.8
Translation adjustments		1.0			12.0			20.0			(1.1		)
Other comprehensive income (loss)		0.9			12.9			16.8			(0.1		)
Comprehensive income		$	94.8		$	72.4		$	377.4		$	199.6

 

The accumulated net gain (loss) on derivative instruments consists of the following:

		Three Months Ended March 31						Nine Months Ended March 31
		2007			2006			2007			2006
		(Unaudited) (In millions)
OCI-derivative instruments, beginning of period		$	7.1		$	12.0		$	10.3		$	11.9
Gain (loss) on derivative instruments		(0.9		)	2.3			(7.1		)	7.3
Reclassification to earnings of net (gain) loss during the period		0.6			(1.2		)	2.0			(6.7		)
Benefit (provision) for deferred income taxes		0.1			(0.4		)	1.7			0.2
Net derivative instruments gain (loss)		(0.2		)	0.7			(3.4		)	0.8
OCI-derivative instruments, end of period		$	6.9		$	12.7		$	6.9		$	12.7

 

The $6.9 million, net of tax, derivative instrument gain recorded in OCI at the end of the current period included $9.1 million, net of tax, related to the gain on the settlement of treasury lock agreements upon issuance of the Company’s 5.75% Senior Notes due October 2033, which will be reclassified to earnings as an offset to interest expense over the life of the debt.  Offsetting this gain was $2.2 million, net of tax, related to the loss on forward and option contracts, which the Company will reclassify to earnings during the next fifteen months.

At the end of the prior period, the $12.7 million, net of tax, derivative instrument gain recorded in OCI included $9.2 million, net of tax, related to the gain on the settlement of treasury lock agreements upon issuance of the Company’s 5.75% Senior Notes due October 2033, which will be reclassified to earnings as an offset to interest expense over the life of the debt, and $3.5 million, net of tax, related to forward and option contracts which the Company is reclassifying to earnings through the fiscal year ending June 30, 2007.

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THE ESTÉE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 — STOCK PROGRAMS

As of March 31, 2007, the Company has three active equity compensation plans which include the Amended and Restated Fiscal 2002 Share Incentive Plan, the Fiscal 1999 Share Incentive Plan and the Non-Employee Director Share Incentive Plan (collectively, the “Plans”).  These Plans currently provide for the issuance of 32,894,400 shares, which consist of shares originally provided for and shares transferred to the Plans from a previous plan and employment agreement, to be granted in the form of stock-based awards to key employees, consultants and non-employee directors of the Company.  As of March 31, 2007, approximately 6,480,000 shares of Class A Common Stock were reserved and available to be granted pursuant to these Plans.  The Company may satisfy the obligation of its stock-based compensation awards with either new or treasury shares.  The Company’s stock compensation awards outstanding at March 31, 2007 include stock options, performance share units (“PSU”), restricted stock units (“RSU”) and share units.

Stock-based compensation expense is attributable to the granting of, and the remaining requisite service periods of, stock options, PSUs, RSUs and share units, net of estimated forfeitures.  Compensation expense attributable to net stock-based compensation during the three months ended March 31, 2007 and 2006 was $9.0 million and $5.8 million, respectively.  Compensation expense attributable to net stock-based compensation during the nine months ended March 31, 2007 and 2006 was $35.5 million and $29.4 million, respectively.  As of March 31, 2007 and 2006, the total unrecognized compensation cost related to nonvested stock-based awards was $39.5 million and $33.0 million, respectively and the related weighted-average period over which it is expected to be recognized is approximately 1.9 and 2.4 years, respectively.

Stock Options

A summary of the Company’s stock option programs as of March 31, 2007 and changes during the nine-month period then ended, is presented below:

(Unaudited) (Shares in thousands)		Shares		Weighted- Average Exercise Price			Aggregate  Intrinsic  Value(1) (in millions)			Weighted-  Average  Contractual Life  Remaining in  Years
Outstanding at June 30, 2006		26,215.7		$	39.53
Granted at fair value		1,684.3		39.68
Exercised		(3,884.1	)	31.35
Expired		(164.0	)	42.46
Forfeited		(104.2	)	39.20
Outstanding at March 31, 2007		23,747.7		40.86			$	206.8		4.5
Exercisable at March 31, 2007		19,899.7		41.19			$	169.4		3.7

 

(1) The intrinsic value of a stock option is the amount by which the current market value of the underlying stock exceeds the exercise price of the option.

The exercise period for all stock options generally may not exceed ten years from the date of grant.  Stock option grants to individuals generally become exercisable in three substantively equal tranches over a service period of up to four years.

The weighted-average grant date fair value of stock options granted for the three months ended March 31, 2007 and 2006 was $15.30 and $13.15, respectively.  The weighted-average grant date fair value of stock options granted for the nine months ended March 31, 2007 and 2006 was $13.69 and $11.87, respectively.  The total intrinsic value of stock options exercised during the three months ended March 31, 2007 and 2006 was $35.9 million and $8.5 million, respectively.  The total intrinsic value of stock options exercised during the nine months ended March 31, 2007 and 2006 was $51.8 million and $30.9 million, respectively.

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THE ESTÉE LAUDER COMPANIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

		Three Months Ended March 31
(Unaudited)		2007		2006
Weighted-average expected stock-price volatility		24	%	25	%
Weighted-average expected option life		7 years		8 years
Average risk-free interest rate		4.7	%	4.5	%
Average dividend yield		1.2	%	1.2	%

 

		Nine Months Ended March 31
(Unaudited)		2007		2006
Weighted-average expected stock-price volatility		24	%	23	%
Weighted-average expected option life		8 years		8 years
Average risk-free interest rate		4.7	%	4.3	%
Average dividend yield		1.2	%	.9	%

 

Performance Share Units

During the nine months ended March 31, 2007, the Company issued approximately 119,000 PSUs, which will be settled in stock subject to the achievement of the Company’s net sales and net earnings per share goals for the three years ending June 30, 2009.  Settlement will be made pursuant to a range of opportunities relative to the net sales and earnings per share targets of the Company and, as such, the compensation cost of the PSUs is subject to adjustment based upon the attainability of these target goals.  No settlement will occur for results below the minimum threshold and additional shares shall be issued if performance exceeds the targeted performance goals.  PSUs are accompanied by dividend equivalent rights that will be payable in cash upon settlement of the PSU.  These awards are subject to the provisions of the agreement under which the PSUs are granted.  The PSUs were valued at the closing market value of the Company’s Class A Common Stock on the date of grant and generally vest at the end of the performance period.

The following is a summary of the status of the Company’s PSUs as of March 31, 2007 and activity during the nine months then ended:

				Weighted-Average
				Grant Date
(Unaudited) (Shares in thousands)		Shares		Fair Value
Nonvested at June 30, 2006		111.1		$	35.00
Granted		119.0		39.56
Vested		—		—
Forfeited		—		—
Nonvested at March 31, 2007		230.1		37.36

 

Restricted Stock Units

The Company granted approximately 603,100 RSUs during the nine months ended March 31, 2007, of which 332,800 are scheduled to vest on October 31, 2007, 173,500 on October 31, 2008 and 96,800 on November 2, 2009, all subject to the continued employment or retirement of the grantees.  Certain RSUs granted in fiscal 2007 are accompanied by dividend equivalent rights that will be payable in cash upon settlement of the RSU and, as such, were valued at the closing market value of the Company’s Class A Common Stock on the date of grant.  Other RSUs granted in fiscal 2007 are not accompanied by dividend equivalent rights and, as such, were valued at the closing market value of the Company’s Class A Common Stock on the date of grant less the discounted present value of the dividends expected to be paid on the shares during the vesting period.

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