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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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 January 26, 2011, 121,194,060 shares of the registrant’s Class A Common Stock, $.01 par value, and 76,232,041 shares of the registrant’s Class B Common Stock, $.01 par value, were outstanding.

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THE ESTÉE LAUDER COMPANIES INC.

INDEX

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PART I. FINANCIAL INFORMATION

item 1. financial statements

THE ESTÉE LAUDER COMPANIES INC.

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

See notes to consolidated financial statements.

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THE ESTÉE LAUDER COMPANIES INC.

CONSOLIDATED BALANCE SHEETS

See notes to consolidated financial statements.

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THE ESTÉE LAUDER COMPANIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See notes to consolidated financial statements.

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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”).  All significant intercompany balances and transactions have been eliminated.

The unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. 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 U.S. GAAP for complete financial statements.  In the opinion of management, all adjustments of a normal recurring nature 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 full 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, 2010.

Management Estimates

The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses reported in those financial statements.  Certain significant accounting policies that contain subjective management estimates and assumptions include those related to revenue recognition, inventory, pension and other post-retirement benefit costs, goodwill, other intangible assets and long-lived assets, income taxes and derivatives.  Descriptions of these policies are discussed in the Company’s Annual Report on Form 10-K for the year ended June 30, 2010.  Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, and makes adjustments when facts and circumstances dictate.  As future events and their effects cannot be determined with precision, actual results could differ significantly from those estimates and assumptions.  Significant changes, if any, in those estimates and assumptions resulting from continuing changes in the economic environment will be reflected in the consolidated financial statements in future periods.

Currency Translation and Transactions

All assets and liabilities of foreign subsidiaries and affiliates are translated at period-end rates of exchange, while revenue and expenses are translated at weighted average rates of exchange for the period.  Unrealized translation gains or losses are reported as cumulative translation adjustments through other comprehensive income (loss) (“OCI”).  Such adjustments, attributable to The Estée Lauder Companies Inc., amounted to $4.9 million and $0.1 million of unrealized translation gains, net of tax, during the three months ended December 31, 2010 and 2009, respectively, and $91.6 million and $33.7 million of unrealized translation gains, net of tax, during the six months ended December 31, 2010 and 2009, respectively.  For the Company’s Venezuelan subsidiary operating in a highly inflationary economy, the U.S. dollar is the functional currency.  Remeasurement adjustments in financial statements in a highly inflationary economy and other transactional gains and losses are reflected in earnings.

The accompanying consolidated statements of earnings include net exchange losses on foreign currency transactions of $3.6 million and $13.1 million during the three months ended December 31, 2010 and 2009, respectively, and $0.8 million and $13.5 million during the six months ended December 31, 2010 and 2009, respectively.

Accounts Receivable

Accounts receivable is stated net of the allowance for doubtful accounts and customer deductions totaling $36.0 million and $34.3 million as of December 31, 2010 and June 30, 2010, respectively.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Concentration of Credit Risk

The Company is a worldwide manufacturer, marketer and distributor of skin care, makeup, fragrance and hair care products.  Domestic and international sales are made primarily to department stores, perfumeries and specialty retailers.  The Company grants credit to all qualified customers and does not believe it is exposed significantly to any undue concentration of credit risk.

The Company’s largest customer sells products primarily within the United States and accounted for $246.3 million, or 10%, and $225.4 million, or 10%, of the Company’s consolidated net sales for the three months ended December 31, 2010 and 2009, respectively, and $528.3 million, or 12%, and $471.5 million, or 12%, of the Company’s consolidated net sales for the six months ended December 31, 2010 and 2009, respectively.  This customer accounted for $108.9 million, or 10%, and $84.3 million, or 11%, of the Company’s accounts receivable at December 31, 2010 and June 30, 2010, respectively.

Inventory and Promotional Merchandise

Property, Plant and Equipment

The cost of assets related to projects in progress of $181.4 million and $160.4 million as of December 31, 2010 and June 30, 2010, respectively, is included in their respective asset categories in the table above.  Depreciation and amortization of property, plant and equipment was $63.8 million and $59.2 million during the three months ended December 31, 2010 and 2009, respectively, and $129.2 million and $121.2 million during the six months ended December 31, 2010 and 2009, 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.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Income Taxes

The effective income tax rate was 31.0% and 31.1% for the three months ended December 31, 2010 and 2009, respectively.  The decrease in the effective income tax rate was attributable to favorable income tax reserve adjustments, including a tax and interest benefit of $11 million, net of tax, attributable to concluding the examination by the U.S. Internal Revenue Service (“IRS”) of fiscal 2006 through 2008.  The rate was also favorably impacted due to a reinstatement of the U.S. federal research and experimentation tax credit, the majority of such benefit recorded discretely in the quarter.  These favorable adjustments were partially offset by a higher income tax rate on the Company’s international operations, principally due to an increase in earnings from our travel retail business.

The effective income tax rate for income taxes was 31.7% and 31.2% for the six months ended December 31, 2010 and 2009, respectively.  The increase in the effective income tax rate was primarily due to an increase in earnings from our travel retail business, partially offset by favorable income tax reserve adjustments, including a tax and interest benefit of $11 million, net of tax, attributable to concluding the IRS examination of fiscal 2006 through 2008.

As of December 31, 2010 and June 30, 2010, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled $121.7 million and $157.3 million, respectively.  The change to the balance of gross unrecognized tax benefits in this period was primarily attributable to the completion of the IRS examination of fiscal 2006 through 2008.  The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $68.4 million.  During the three and six months ended December 31, 2010, the Company recognized a gross interest and penalty benefit in the consolidated statements of earnings of $1.1 million and $0.3 million, respectively.  The total gross accrued interest and penalties in the accompanying consolidated balance sheets at December 31, 2010 and June 30, 2010 was $40.0 million and $43.6 million, respectively.  On the basis of the information available as of December 31, 2010, it is reasonably possible that the total amount of unrecognized tax benefits could decrease in a range of $20 million to $30 million within 12 months as a result of projected resolutions of global tax examinations and controversies and a potential lapse of the applicable statutes of limitations.

During the six months ended December 31, 2010, the IRS commenced its examination of fiscal 2009.

Recently Issued Accounting Standards

In December 2010, the Financial Accounting Standards Board (“FASB”) amended its authoritative guidance related to Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more-likely-than-not that a goodwill impairment exists.  In determining whether it is more-likely-than-not that a goodwill impairment exists, consideration should be made as to whether there are any adverse qualitative factors indicating that an impairment may exist.  The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.

In December 2010, the FASB amended its authoritative guidance related to business combinations entered into by an entity that are material on an individual or aggregate basis.  These amendments clarify existing guidance that if an entity presents comparative financial statements that include a material business combination, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period.  The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings.  This guidance becomes effective prospectively for business combinations for which the acquisition date is on or after the first day of the Company’s fiscal 2012.  This disclosure-only guidance will not have a material impact on the Company’s results of operations, financial position or cash flows.

In January 2010, the FASB issued authoritative guidance that will require entities to make new disclosures about recurring or nonrecurring fair-value measurements of assets and liabilities.  The Company adopted the new guidance in its fiscal 2010 third quarter, except for certain detailed recurring Level 3 disclosures, which are effective for the Company’s fiscal 2012 first quarter.  The Company currently does not have any recurring Level 3 assets or liabilities.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In June 2009, the FASB issued authoritative guidance to eliminate the exception to consolidate a qualifying special-purpose entity, change the approach to determining the primary beneficiary of a variable interest entity and require companies to more frequently re-assess whether they must consolidate variable interest entities.  Under the new guidance, the primary beneficiary of a variable interest entity is identified qualitatively as the enterprise that has both (a) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity.  This guidance becomes effective for the Company’s fiscal 2011 year end and interim reporting periods thereafter.  The Company does not expect this guidance to have a material impact on its consolidated financial statements.

NOTE 2 — GOODWILL AND OTHER INTANGIBLE ASSETS

On July 1, 2010, the Company acquired Smashbox Beauty Cosmetics (“Smashbox”) which included the addition of goodwill of approximately $140 million, amortizable intangible assets of approximately $61 million (with a weighted average amortization period of 9 years) and non-amortizable intangible assets of approximately $77 million related to the Company’s makeup business.

The Company assigns goodwill of a reporting unit to the product category in which that reporting unit predominantly operates at the time of its acquisition.

The following table presents goodwill and the related change in the carrying amount:

Other intangible assets consists of the following:

The aggregate amortization expense related to amortizable intangible assets for the three months ended December 31, 2010 and 2009 was $3.9 million and $2.6 million, respectively, and for the six months ended December 31, 2010 and 2009 was $7.5 million and $5.1 million, respectively.  The estimated aggregate amortization expense for the remainder of fiscal 2011 and each of the fiscal years ending June 30, 2012 to 2015 is $7.0 million, $13.8 million, $13.8 million, $13.8 million and $13.8 million, respectively.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Fiscal 2010 Impairments

During the second quarter of fiscal 2010, the Darphin reporting unit identified issues related to the planned streamlining of its distribution process, resulting in revisions to its internal forecasts.  The Company determined that the reporting unit’s trademark was impaired, with fair value estimated based upon the application of a royalty rate to discounted projected future cash flows (“relief-from-royalty method”), and therefore recorded an impairment charge of $5.8 million, at the exchange rate in effect at that time, in the skin care product category and in the Europe, the Middle East & Africa region.

During the second quarter of fiscal 2010, the Ojon reporting unit altered and delayed certain components of its future expansion plans, resulting in revisions to its internal forecasts.  The Company concluded for the Ojon trademark and customer list, that the carrying values exceeded their estimated fair values, which were determined based on the application of the relief-from-royalty method for the trademark and discounted projected future cash flows for the customer list.  As a result, the Company recognized asset impairment charges of $6.0 million for the trademark and $17.2 million for the customer list, at the exchange rate in effect at that time.  After adjusting the carrying value of the trademark and customer list, the Company completed an interim impairment test for goodwill and recorded a goodwill impairment charge related to the Ojon reporting unit of $16.6 million at the exchange rate in effect at that time.  The fair value of the reporting unit was based upon weighting of the income and market approaches, utilizing estimated cash flows and a terminal value, discounted at a rate of return that reflects the relative risk of the cash flows, as well as valuation multiples derived from comparable publicly traded companies that are applied to operating performance of the reporting unit.  These impairment charges were reflected in the hair care and skin care product categories and in the Americas region.

NOTE 3 — ACQUISITION OF BUSINESS

On July 1, 2010, the Company acquired Smashbox.  The purchase price was funded by cash provided by operations.  The results of operations are included in the accompanying consolidated financial statements commencing with the date it was acquired.  Pro forma results of operations of the prior-year period have not been presented, as the impact on the Company’s consolidated financial results would not have been material.  The aggregate cost of this transaction, net of cash acquired, and continuing earn-out obligations related to the acquisition of the Bobbi Brown brand was approximately $256 million.

NOTE 4 — CHARGES ASSOCIATED WITH RESTRUCTURING ACTIVITIES

In an effort to drive down costs and achieve synergies within the organization, in February 2009, the Company announced the implementation of a multi-faceted cost savings program (the “Program”) to position itself to achieve long-term profitable growth.  The Company anticipates the Program will result in related restructuring and other special charges, inclusive of cumulative charges recorded to date and over the next few fiscal years, totaling between $350 million to $450 million, before taxes.  The total amount of charges (pre-tax) associated with the Program expected to be incurred (including those recorded plus other initiatives approved through January 24, 2011) is approximately $276 million to $281 million, of which approximately $184 million to $185 million relates to restructuring charges, approximately $42 million of other costs to implement the initiatives, approximately $35 million to $39 million in sales returns and approximately $15 million in inventory write-offs.  The restructuring charges are comprised of approximately $138 million to $139 million of employee-related costs, approximately $27 million of other exit costs and contract terminations (substantially all of which have resulted in or will result in cash expenditures), and approximately $19 million in non-cash asset write-offs.

The Program focuses on a redesign of the Company’s organizational structure in order to integrate it in a more cohesive way and operate more globally across brands and functions.  The principal aspect of the Program is the reduction of the workforce by approximately 2,000 employees.  Specific actions taken during the six months ended December 31, 2010 and 2009 included:

·                  Resize and Reorganize the Organization — The Company continued the realignment and optimization of its organization to better leverage scale, improve productivity and reduce complexity in each region and across various functions.  This included reduction of the workforce which occurred through the consolidation of certain functions through a combination of normal attrition and job eliminations.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

·                  Turnaround or Exit Unprofitable Operations — To improve the profitability in certain of the Company’s brands and regions, the Company has selectively exited certain channels of distribution, categories and markets, and has made changes to turnaround others.  This included the exit from the global wholesale distribution of the Company’s Prescriptives brand and the reformulation of Ojon brand products.  In connection with these activities, the Company incurred charges related to product returns, inventory write-offs, reduction of workforce and termination of contracts.

·                  Outsourcing — In order to balance the growing need for information technology support with the Company’s efforts to provide the most efficient and cost effective solutions, the Company continued the outsourcing of certain information technology processes.  The Company incurred costs to transition services to an outsource provider.

Restructuring Charges

The following table presents restructuring charges related to the Program as follows:

The following table presents aggregate restructuring charges related to the Program:

The following table presents accrued restructuring and the related activity as of and for the six months ended December 31, 2010 under the Program:

Accrued restructuring charges at December 31, 2010 are expected to result in cash expenditures funded from cash provided by operations of approximately $13 million, $11 million and $3 million in fiscal 2011, 2012 and 2013, respectively.

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THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Total Charges Associated with Restructuring Activities

The following table presents total charges (adjustments) associated with restructuring activities related to the Program:

During the three months ended December 31, 2010, we recorded $1.5 million reflecting sales returns (less a related cost of sales of $0.5 million) and a write-off of inventory of $4.3 million associated with turnaround operations, primarily related to the reformulation of Ojon brand products.  During the six months ended December 31, 2010, we recorded $1.5 million reflecting sales returns (less a related cost of sales of $0.5 million) and a write-off of inventory of $5.1 million associated with turnaround operations, primarily related to the reformulation of Ojon brand products.

During the three months ended December 31, 2009, the Company recorded an adjustment of $7.4 million to reduce then-anticipated sales returns (less a related cost of sales of $1.6 million) and a benefit of $3.2 million to reduce the estimated write-off of inventory associated with exiting unprofitable operations, primarily related to the exit from the global wholesale distribution of the Prescriptives brand.  During the six months ended December 31, 2009, the Company recorded $11.1 million reflecting sales returns (less a related cost of sales of $2.3 million) and a write-off of inventory of $6.3 million associated with exiting unprofitable operations, primarily related to the exit from the global wholesale distribution of the Prescriptives brand.

Other special charges in connection with the implementation of the Program relate to consulting, other professional services, and accelerated depreciation.

NOTE 5 — DERIVATIVE FINANCIAL INSTRUMENTS

The Company addresses certain financial exposures through a controlled program of risk management that includes the use of derivative financial instruments.  The Company enters into foreign currency forward and may enter into option contracts to reduce the effects of fluctuating foreign currency exchange rates and interest rate derivatives to manage the effects of interest rate movements on the Company’s aggregate liability portfolio.  The Company also enters into foreign currency forward and may use option contracts, not designated as hedging instruments, to mitigate the change in fair value of specific assets and liabilities on the balance sheet.  The Company does not utilize derivative financial instruments for trading or speculative purposes.  Costs associated with entering into these derivative financial instruments have not been material to the Company’s consolidated financial results.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For each derivative contract entered into where the Company looks to obtain special hedge accounting treatment, the Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking the hedge transaction, the nature of the risk being hedged, how the hedging instruments’ effectiveness in offsetting the hedged risk will be assessed prospectively and retrospectively, and a description of the method of measuring ineffectiveness.  This process includes linking all derivatives to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions.  The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.  If it is determined that a derivative is not highly effective, or that it has ceased to be a highly effective hedge, the Company will be required to discontinue hedge accounting with respect to that derivative prospectively.

The fair values of the Company’s derivative financial instruments included in the consolidated balance sheets are presented as follows:

(1) See Note 6 — Fair Value Measurements for further information about how the fair value of derivative assets and liabilities are determined.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The amounts of the gains and losses related to the Company’s derivative financial instruments designated as hedging instruments are presented as follows:

(1) The amount of gain (loss) recognized in earnings related to the amount excluded from effectiveness testing was $0.4 million and $0.1 million for the three and six months ended December 31, 2010, respectively.  There was a net $(0.5) million gain (loss) recognized in earnings related to the ineffective portion of the hedging relationships for the three and six months ended December 31, 2010.