estee lauder _ar03

T H E E S T { E L A U D E R C O M PA N I E S I N C . 2 0 0 3 A N N U A L R E P O R T

02 Portfolio of Brands

06 Chairman’s Message

10 Chief Executive’s Review

34 Board of Directors

35 Officers

36 Financial Highlights

37 Selected Financial Data

38 Consolidated Statements of Earnings

39 Management’s Discussion and Analysis of

Financial Condition and Results of Operations

56 Consolidated Balance Sheets

57 Consolidated Statements of Stockholders’ Equity

and Comprehensive Income

58 Consolidated Statements of Cash Flows

59 Notes to Consolidated Financial Statements

82 Independent Auditors’ Report

84 Stockholder Information

THE EST{E LAUDER COMPANIES INC.

The Estée Lauder Companies Inc. is one of the world’s leading manufacturers and marketers of

quality skin care, makeup, fragrance and hair care products. The Company’s products are sold in over

130 countries and territories under well recognized brand names, including Estée Lauder, Aramis,

Clinique, Prescriptives, Origins, M.A.C, La Mer, Bobbi Brown, Tommy Hilfiger, jane, Donna Karan, Aveda,

Stila, Jo Malone, Bumble and bumble, kate spade beauty, Michael Kors and Darphin.

THE AMERICAS — The Company was founded by Estée Lauder in 1946 in New York City.

In fiscal 2003, the Americas region represented 58% of net sales and 48% of operating

income, before special charges.

EUROPE, THE MIDDLE EAST & AFRICA — Our first international door opened in 1960 in

London. In fiscal 2003, Europe, the Middle East & Africa represented 29% of net sales

and 44% of operating income, before special charges. This region includes results from

our travel retail business.

ASIA/PACIFIC — We established a presence in Hong Kong in 1961. In fiscal 2003, the

Asia/Pacific region represented 13% of net sales and 8% of operating income, before

special charges.

CONTENTS

02

EST{E LAUDERIntroduced in 1946 . Sold in more than 120 countries and territories . Select products:Perfectionist Correcting Serum for Lines/Wrinkles, Idealist Skin Refinisher, Re-NutrivUltimate Lifting Creme, So Ingenious Multi-Dimension Liquid Makeup SPF 8,MagnaScopic Maximum Volume Mascara, Estée Lauder pleasures intense, Pure ColorLong Lasting Lipstick, Pure Color EyeShadow and Beautiful . Technologically advancedand high-performance products with a reputation for innovation, sophistication andsuperior quality.

ARAMISIntroduced in 1964 . Sold in more than 120 countries and territories . Select products:Aramis Classic, Age Rescue by Lab Series for Men, Eye Rescue by Lab Series for Menand Mega Foam Shave Formula by Lab Series for Men . A pioneer in the marketing ofprestige men’s fragrance, grooming and skin care products.

CLINIQUEIntroduced in 1968 . Sold in more than 130 countries and territories . Select products:3-Step Skin Care System, Total Turnaround Visible Skin Renewer, Repairwear IntensiveNight Cream and Lotion, Advanced Stop Signs, Lash Curling Mascara, City Block Sheer Shimmer Oil-Free Daily Face Protector SPF 15, Superbalm Tinted Lip Treatment,Aromatics Elixir, Clinique Happy and Clinique Happy Heart, Colour Surge Lipstick andSkin Supplies for Men . A leading skin care authority, Clinique develops allergy-tested,fragrance-free products based on the research of leading dermatologists.

PORTFOLIO OF BRANDS

03

PRESCRIPTIVESIntroduced in 1979 . Sold in ten countries and territories . Select products: Traceless SkinResponsive Tint, False Eyelashes Plush Mascara, Super Line Preventor+, Dermapolish,

�magic by Prescriptives and Virtual Youth Lifting Moisture Makeup . A foundationauthority that celebrates women of all skins and all ages with its Colorprinting system,Prescriptives is known for its Custom Beauty approach and technologically innovativeskin care and makeup lines.

ORIGINSIntroduced in 1990 . Sold in more than 25 countries and territories . Select products: A Perfect World White tea skin guardian, Have a Nice Day Super-charged moisturecream and lotion SPF 15, Ginger Souffle Whipped body cream and A Perfect WorldIntensely hydrating body cream with White Tea . A feel-good alternative to traditionalhealth and beauty, featuring multi-sensory skin care, color, bath and body, fragrance,hair care products and lifestyle accessories.

M.A.CMajority interest acquired in 1994; acquisition completed in 1998 . Sold in more than 45 countries and territories . Select products: Studio Fix Powder Plus Foundation, M.A.CPaints, M.A.C Lipstick in seven formulas and Lipglass . A broad line of color-orientedcosmetics, makeup tools, skin care, foundations, fragrances and accessories targetingprofessional makeup artists and fashion-conscious consumers. M.A.C: All races,All ages, All sexes.

LA MERAcquired in 1995 . Sold in more than 30 countries and territories . Select products:Crème de la Mer, The Face Serum, The Eye Balm, The Concentrate and La MerSkinColor . An exclusive and highly sought-after treatment line combining the finestingredients with a unique scientific process. In 1999, La Mer expanded from the original,best-selling Crème de la Mer into a complete range of facial skin care and body products.

BOBBI BROWNAcquired in 1995 . Sold in more than 30 countries and territories . Select products:Foundation Stick, Creamy Concealer Kit, Lip Color, Lip Gloss, Shimmer Brick Compact,Bobbi Brown Extra, Long-Wear Gel Eyeliner and Bobbi Brown Beach . A professionalbeauty line developed by celebrated makeup artist Bobbi Brown, encompassing colorcosmetics, skin care, professional makeup brushes, accessories and fragrance.

04

TOMMY HILFIGERExclusive global license agreement signed in 1993 . Sold in more than 120 countriesand territories . Select products: “tommy,” “tommy girl,” T for Him, T Girl, “tommy”and “tommy girl” Summer Colognes . Fragrances and body products that reflect the all-American lifestyle themes of designer Tommy Hilfiger.

janeAcquired in 1997 . Sold in the U.S. in mass merchandisers and chain drug outlets .

Select products: Iced Shadow, MegaBites Glossy Gloss, Fabulizer for Lips, Double TalkLongwear Lip Color, Hi-Fiber Mascara and Lucky Star Pure Sparkling Lip Color . A colorcosmetics brand targeted to young women, offering a complete line of face, lip, eye and nail products.

DONNA KARANExclusive global license agreement signed in 1997 . Sold in more than 120 countries andterritories . Select products: Donna Karan Black Cashmere, Donna Karan CashmereMist, Donna Karan Formula Cleanser, Donna Karan Tinted Moisturizer, DKNY TheFragrance for Women and DKNY The Fragrance for Men . Luxury fragrance, bath and body collections that reflect the quality, style and innovation identified with designer Donna Karan.

AVEDAAcquired in 1997 . Sold in 25 countries and territories . Select products: Sap MossStyling Spray, Color Conserve Foaming Leave-In Conditioner, Hand Relief, ShampureShampoo and Conditioner, Rosemary Mint Body Care, Aveda Love Pure-Fume, LightElements and Curessence Damage Relief Shampoo . Premium professional and con-sumer hair care, styling, professional hair color, skin, body and spa, aroma, makeup andlifestyle products based on the art and science of pure flower and plant essences thatfulfill the brand’s mission of environmental responsibility.

STILAAcquired in 1999 . Sold in more than 20 countries and territories . Select Products: Lip Glaze, Illuminating Liquid Foundation, All Over Shimmer, Convertible Color,Convertible Lip Color and Bouquet de Jour . Stila is Style. Los Angeles-based, created andled by Hollywood makeup artist Jeanine Lobell; stylish and pretty color cosmetics and body products known for their sense of shimmer, eco-friendly packaging andwhimsical illustrations.

JO MALONEAcquired in 1999 . Sold in five countries . Select products: Lime Basil & MandarinCologne, Vitamin E Gel, Orange Blossom Cologne and Grapefruit Scented HomeCandle . Sophisticated yet simple lifestyle collection of everyday luxuries created byBritish fragrance and skin care authority Jo Malone.

BUMBLE AND BUMBLEMajority interest acquired in 2000 . Sold in more than 15 countries and territories .

Select products: Surf Spray, Does It All Styling Spray, Hair Powder and Gentle Shampoo . A New York-based hair care company and salon that markets and sellsquality hair care products distributed through top-tier salons and prestige retailers.

kate spade beautyExclusive global license agreement signed in 1999 . Introduced in spring 2002 . Sold inspecialty and select department stores in the United States, Canada and the UnitedKingdom . Select products: parfum, eau de parfum, soap trio, buttercream, bodymoisturizer and travel vanity . kate spade beauty is a collection of fragrance, bath andbody products created by American handbag designer Kate Spade. The distinctivefragrance is feminine, timeless and unexpected — a bouquet of Kate’s favorite whiteflowers — complex, yet beautifully tuned.

MICHAEL KORSExclusive global license agreement signed and certain assets acquired in 2003 .

Sold in five countries . Select products: MICHAEL Eau de Parfum Spray and Leg Shine;Michael Kors SHEER Eau de Parfum Spray and Body Lotion; MICHAEL for Men Eau deToilette Spray and After Shave Splash; KORS Michael Kors Eau de Parfum Sprayand Opalescent Body Creme . Award-winning designer fragrances and bath and body products created by Michael Kors, one of the leading American designers of luxury sportswear.

DARPHINAcquired in 2003 . Sold in more than 50 countries and territories . Select products: BlackMascara, Stimulskin Plus Firming and Smoothing Cream, Stimulskin Plus Eye ContourCream, Camomile Aromatic Care, Predermine Cream and Denblan . A well-establishedParis-based brand considered la haute couture of beauty, offering prestige skin careproducts formulated with a high concentration of active natural ingredients and a carefullychosen blend of pure essential oils, applying the benefits of aromatherapy to skin care.

06

Dear Fellow Stockholders:

In preparing this year’s annual report, I reviewed the seven reports that have been issued since The Estée

Lauder Companies went public in 1995. Each annual report is a chapter in the story of this thriving Company.

This year, we’ve turned a significant page in the history of the Company as we’ve

reached our highest level of sales ever.

What is the glue that binds each chapter to the next and keeps us on a successful

course? I believe the secret to our success as a 57-year old Company is staying true to

the clear vision that launched this Company in 1946 — to offer the finest quality

products in the best stores in the world.

Mrs. Estée Lauder’s original vision — of who we are and what we stand for — has proven

to be resilient and timeless. Over the years, our Company has grown because

we’ve remained true to those early core philosophies. We come into work each day with a passion to

keep that vision vibrant.

DEFINING WHO WE ARE

From the beginning, we have understood what prestige means. A prestige business defines itself as much by

what it doesn’t do, as by what it does. Similarly, we are defined by where we don’t advertise, as much as

by where we do advertise, and by where we don’t sell, as much as by where we do sell. Throughout our

history, we have refined the delicate role of being a prestige player.

CHAIRMAN’S MESSAGE

LEONARD A. LAUDER

07

A prestige company relies on consistent imagery worldwide. When we started expanding internationally in

the 1960s, we observed the industry landscape and saw that our competitors looked different in every

country. We made a decision then — one that we still adhere to

today — to keep a consistent image around the world. Wherever you

travel — be it to the highly competitive French market or the wonder-

fully unique Asian countries — you will recognize The Estée Lauder

Companies’ brands for their consistent imagery. Each product in

every package reinforces our commitment to the highest quality

around the world.

We are a company where style matters. Style is the intersection of fashion, design, elegance and taste. At The

Estée Lauder Companies, we have a sense of style that extends to every corner of our business. You can see

our distinctive sense of style in our exceptional packaging; the way our beauty advisors, consultants and

makeup artists are groomed and dressed at the counter, and the fashion leadership of our newest spokes-

people, international model Liya Kebede and tennis star Andre Agassi.

Another defining trait of our Company is that we are passionate. When I meet a candidate for a new position,

I often ask, “Does this individual burn?” Does she burn with passion to develop the best product? Do I see

passion to provide the most outstanding service? Will this person care deeply about building strong

relationships and leading the best people?

Our people are passionate about being the best and leave no stone unturned in that pursuit. I am grateful that

our more than 20,000 colleagues at this Company share and embrace our founder’s vision.

KNOWING WHAT WE STAND FOR

Over our 57-year history, we have developed a strong sense of what we stand for as a Company. We do not

waver from our core principles or choose a “flavor-of-the-month” set of management priorities. Our loyal

customers, suppliers, consumers and employees know that we stand for the highest quality, leading-edge

innovation and uncompromising integrity.

Quality ingredients run through all of our products. Quality packaging surrounds the products. Quality

service delivers those products to our customers and consumers. Quality is our mantra. I remember a time

when an employee came to Mrs. Estée Lauder and said that we could save money by using a lesser ingredient.

She responded by saying, “A woman always remembers quality.” It is the quality in our fragrance, skin care,

makeup and hair care products that keeps the consumer coming back.

OVER THE L AST YEAR,

O U R C O M PA N Y H A S

GROWN BECAUSE WE’VE

R E M A I N E D T R U E T O

T H O S E E A R LY C O R E

P H I L O S O P H I E S.

08

Over the years, we’ve insisted on being the best innovators and coming to the marketplace first with new

ideas. Hundreds of scientists in our laboratories collaborate with researchers at universities and medical

institutions around the world to find breakthroughs in dermatology, biophysics, molecular biology, immunology

and chemistry.

Our research insights led to this year’s major launch of Clinique’s revolutionary and patent-pending

Repairwear, which optimizes the skin’s natural repair processes while you sleep. We call the line’s three

products (Repairwear Intensive Night Cream, Repairwear Intensive Night Lotion and Repairwear Extra Help

Serum) the “Dream Team” — and they’ve been a dream come true for consumers and retailers alike.

At the Estée Lauder brand, our scientists triumphed by creating the brand’s most technically advanced

volumizing mascara: MagnaScopic Maximum Volume Mascara. Its newly patented formula builds up the

lashes, magnifying them up to four times their original thickness, with-

out weight or clumping, through a unique lofting complex called

Expandex and its dedicated Speed-Meter Brush. Color is intensified

by 30 percent. Mascara has become enormously competitive this

year with one major magazine referring to “The Mascara Wars.” With

our innovation, we are emerging as a leader in the mascara business.

Our legacy in innovation — with our drive to be first to market — has given rise to a funny saying that I often

hear around the industry: “Follow the Lauder.”

Integrity and a high standard of ethics have always been cornerstones of our Company. Sadly, we’ve seen

many major companies falter over the last couple of years because of lapses in integrity. At The Estée Lauder

Companies, we strive to keep the precious faith of our stockholders, customers, suppliers, consumers and

employees by always being fair, transparent and ethical.

KEEPING OUR “FOUNDING VISION” ALIVE TODAY

Our mission is to keep that founding vision alive and vibrant today. Our traditions are reinvigorated by attract-

ing and retaining the best people, taking inspiration from ideas generated all over the world and holding

a leadership position in this dynamic industry.

People want to come to work for The Estée Lauder Companies, and they want to stay. I believe our

retention rates far exceed the industry average. At our Company, most employees find more than a job —

they find a home.

WE DO NOT WAVER FROM

OUR CORE PRINCIPLES OR

CHOOSE A “FLAVOR-OF-

T H E - M O N T H ” S E T O F

MANAGEMENT PRIORITIES.

09

I know we have hired the best people when I apply my simple elevator test. Whenever I ride in the elevator

at any of our office locations around the world, I pick out those people who will step off the elevator at

our floor. I distinguish them by all of the qualities we’ve mentioned

here — that burning passion, that style, that desire to be the best.

In addition to our people, it is ideas that keep our vision alive.

We exchange new concepts between headquarters and the more

than 130 countries and territories where our products are sold

around the world. Both our packaging concepts and our technology

in makeup and skin care reflect the influence of global teams. In the

last year alone, I have traveled more than 200 days to make the point that we must learn from people

around the world.

Finally, we define leadership in our industry. Leadership doesn’t just mean sales leadership, but

thought leadership.

We have an outstanding Board of Directors to whom we look for unbiased guidance and leadership. We are

particularly delighted that Rose Marie Bravo, Chief Executive of Burberry, joined us this year. Ms. Bravo

herself is a leader, currently in charge of one of the world’s most prestigious brands, and is an expert at

retailing, having led Saks Fifth Avenue and I. Magnin.

As we now face the future of the Company, we are certain to grow and expand globally as the world presents

more opportunity. But one thing is certain — that we will evolve and grow by holding on to the original vision

of Mrs. Estée Lauder to “Keep Your Own Image Straight in Your Mind,” and to “Hire the Best People.”

It is to all of these people that I now extend my thanks for persisting in their pursuit of excellence. My thanks,

as well, to our stockholders, customers and consumers for continuing to believe in our vision. May our vision

burn as brightly over the next 50 years as it has over the last 57 years.

Sincerely,

Leonard A. Lauder

Chairman of the Board

M R S . E S T { E L A U D E R ’ S

ORIGINAL VIS ION — OF

W H O W E A R E A N D

WHAT WE STAND FOR—

H A S P R O V E N TO B E

RESILIENT AND TIMELESS.

10

Dear Fellow Stockholders:

Our Company performed very well in fiscal 2003 by continuing our 57-year tradition of uninterrupted sales

growth and achieving our first $5 billion sales year in our history. We extended this remarkable streak by

continuing to do what we do best: building brands, exciting customers with product innovation, evolving our

distribution around consumer shopping patterns, forging more deeply into markets

around the globe, strengthening our position in our four product categories and

focusing on our most important relationships.

While staying true to our core principles and strategies, we grew in many important

ways over the last 12 months. Our portfolio of brands grew from 16 to 18 with

the acquisitions of Darphin and the Michael Kors fragrance license. Darphin is

a Paris-based skin care line that deepens our penetration in skin care, builds our

position in Europe and places us in the very important independent pharmacy

channel. Similarly, we have great expectations for the Michael Kors fragrances,

which are inspired by a wonderfully dynamic designer. We believe the brand’s

prospects for further growth, inside and outside the United States, are strong.

As for our financial results in fiscal year 2003, we generated net sales of $5.12 billion, an 8% increase over last

year. Our net earnings were $319.8 million compared with $191.9 million in fiscal 2002 and diluted earnings

per common share were $1.26, compared with $.70 in the prior year. Earnings in fiscal 2002 were impacted

by a restructuring charge of $76.9 million after-tax, or $.32 per share, and a one-time charge of $20.6 million,

or $.08 per share, related to the cumulative effect of a change in accounting principle. Earnings in fiscal year

2003 were impacted by a $13.5 million or $.06 per share after-tax charge relating to the pending settlement

of an industry-wide lawsuit involving us and 20 other cosmetic companies and retailers. We determined

that a settlement was in our best interest. While we did not do anything wrong, we decided to settle to allow

ourselves to focus on our business and not become mired in protracted litigation.

CHIEF EXECUTIVE ’S REVIEW

FRED H. LANGHAMMER

11

We continued to improve in all regions and, for the first time in years, we benefited from the effect of

a weaker U.S. dollar.

• In Europe, the Middle East & Africa, annual net sales increased 19% to $1.51 billion. In local currencies, sales

in the region rose 8%.

• In Asia/Pacific, annual net sales rose 8% to $657.8 million, while sales in local currency grew 3%.

• In the Americas, annual net sales increased 3% to $2.95 billion.

RESULTS BY PRODUCT CATEGORY

Our motto, “Bringing the Best to Everyone We Touch,” is imbedded in each of our more than 9,000

products. As a result, these products draw new consumers to our brands while building loyalty with our

long-standing consumers.

• In fiscal year 2003, skin care benefited from a heightened interest in treatment products. Thanks in part to

the strong launches of Estée Lauder’s Perfectionist Correcting Serum for Lines/Wrinkles and Clinique’s

Repairwear Intensive Night Cream and Repairwear Intensive Night Lotion, our skin care sales were $1.89 billion,

up 11% on a reported basis and 7% on a constant currency basis.

• Makeup sales continued to be a growth engine for the Company.

Net sales of makeup products for the year were $1.91 billion, rising

7% on a reported basis and 4% on a constant currency basis.

Both M.A.C and Bobbi Brown performed extraordinarily well

during the fiscal year.

• The fragrance industry as a whole was challenged as consumers

made fewer impulse purchases given the economic environment

and the challenging market climate. Nevertheless, in fiscal 2003,

our fragrance business grew to $1.06 billion, up 4% on a reported basis, but was relatively unchanged on

a constant currency basis. We continue to believe in our ability to pick the winners in this category and

have four of the top ten prestige fragrances for women sold in department stores in the United States.

• Hair care continued to show growth. For fiscal year 2003, our reported hair care sales were up 6% to $228.9

million. We continue to see a vast opportunity in the estimated $4.6 billion worldwide prestige hair care and

scalp treatment business. We are building our two hair care brands — Aveda and Bumble and bumble — to

capitalize on this opportunity.

COMMUNICATING WITH CONSUMERS

We are incredibly fortunate to have intensely loyal consumers who are passionate about our brands. Over the

last year, we reached more consumers through more diverse and interconnected communications channels

than ever before. For example, the Internet has proven to be an effective and efficient way to build rapport

with customers. While our e-commerce business grew 44% last year, the real Internet revolution is communi-

cation via on-line media. We are reaching consumers interested in our products on-line, telling them about

new launches, servicing them more extensively and inviting them to the counter.

W E A R E A B L E T O

IN V EST AG G R ES S I V E LY

IN N E W V E N T U R E S ,

A S W E L L A S G L O B A L

E X PA N S I O N , B E C A U S E

W E H AV E M A N A G E D

OUR RESOURCES WISELY.

12

BUILDING BRANDS

Our dialogue with consumers reminds us that our most important assets are our brands and their credibility.

We continuously find that consumers want to do more than buy a brand; they want to associate with a

brand’s values.

Each of our 18 brands has built a compelling brand proposition through which it creates and maintains mean-

ingful relationships with our consumers. For example, in our biggest brands this year, we’ve seen the Estée

Lauder brand redefine the notion of contemporary beauty with

outstanding products, appealing packaging and a trio of glamorous

spokesmodels. Meanwhile, our colleagues at Clinique reinforced

their leadership position in skin care, remaining true to their

dermatological heritage. As consumers fight the aging effects of

sun, stress and pollution, Clinique rightfully captures the market for

high-performance skin care.

Communicating these propositions is critical, and it is a point of pride

that we did not retreat from our advertising and promotion commit-

ments during this period of slower growth. In fact, we saw this as an opportunity to build brand equity and

capture greater market share. Accordingly, we have been aggressive in our advertising and promotion

spending, raising it to $1.43 billion from $1.33 billion in the previous year.

Beyond our current brands, we will continue to be opportunistic in our acquisitions. We will look for brands

that strategically enhance our portfolio and meet our high standards. We endeavor to be the best company,

not the biggest.

STRENGTHENING DISTRIBUTION

Integral to being the best company is utilizing a distribution system that is modern, efficient and appealing

to customers. We have always been committed to being in the finest stores in the world. Our relationships

with retailers have never been stronger.

Additionally, we conduct a tremendous amount of business through retailers at airports and other travel

venues around the world. Even during a year when many people were deferring their travel, our travel retail

division delivered strong sales growth.

INTERNATIONAL EXPANSION

We still have a significant opportunity to grow in countries outside the United States. There is a long list

of countries that have welcomed our brands — both the established and newer lines — over the last year.

In fiscal year 2003, we launched Stila in Greece, Spain and Singapore, and M.A.C products are now

sold in Brazil.

In emerging markets, Russia and China present an enormous opportunity for us to reach new consumers who

are eager to enjoy the benefits of prestige cosmetics. To take full advantage of the opportunity in China,

we will be moving our Asia regional headquarters to Shanghai in the coming year. In Moscow, we are

establishing our own affiliate for Russia to serve this fast-growing market.

W E A R E I N C R E D I B LY

FORTUNATE TO HAVE

I N T E N S E L Y L O Y A L

CONSUMERS WHO ARE

P A S S I O N A T E A B O U T

O U R B R A N D S .

13

With ten more countries from Central Europe joining the European Union, we see big opportunities for

growth and efficiencies as Pan-European synergies unfold.

PRODUCT INNOVATION

New products are still the lifeblood of this business. Our Research and Development team provides an

important competitive asset. This year we launched more than 315 new products, many with groundbreaking

results. In particular, we reinforced our strength in skin care, positioned ourselves as innovators in the highly

competitive mascara arena and made great strides in hair and scalp care.

PERFORMANCE IMPROVEMENTS

We are able to invest aggressively in new ventures, as well as global expansion, because we have managed

our resources wisely. Last year, cost savings from our Global Operations Group helped achieve goals and

fuel profitability. Additional savings were gained through ongoing globalization efforts. Cost of goods as

a percentage of net sales improved 70 basis points over last year and speed-to-market improved dramatically.

FOCUSING ON EMPLOYEES

Once again, the creativity, passion and drive of our employees was a source of inspiration. From the

challenges of geo-political unrest to the threat of SARS, our employees remained shining examples of

composure, commitment and good humor.

I am especially delighted that in January, William P. Lauder became our Chief Operating Officer. William

and I agree that the development and growth of our people is a top priority. He will lead the effort to improve

our training programs and evaluation methods to ensure we attract and retain the very best people.

In addition to leading the Human Resources function, William’s responsibilities as COO include the Inter-

national Division, Operations and our Specialty Brands.

THE FUTURE

Throughout this letter, I have expressed themes you’ve heard before. However, we firmly believe good

strategies never go out of fashion. Our core competencies reinforce a sound strategy, build strong relation-

ships over time and inspire our more than 20,000 colleagues globally.

Though we are steadfast in our strategy and core values, we are open to new ideas, new people and new ways

of looking at the world. One of the great strengths of The Estée Lauder Companies is our ability to combine

trends with traditions.

I want to thank our Chairman, Leonard Lauder, and the entire Board of Directors for guiding us through

another successful, productive and profitable year.

Sincerely,

Fred H. Langhammer

President and Chief Executive Officer

HIGHLIGHTS

EVENTS

Generating excitement for our brands as we continue to reinforce their authority

remains an important strategy. This year, two books, Bobbi Brown Beauty Evolution

and Michael Gordon’s Hair Heroes, from the founder of Bumble and bumble,

shared the wisdom and experience of two of the beauty business’ most respected

leaders. More than 100 medical professionals attended the Clinique-sponsored

First Annual Dermatology Update to gain new insights into skin aging. And the

Company once again supported Breast Cancer Awareness by sponsoring the

lighting of hundreds of global landmarks in pink, including Harrods department

store in London.

AWARDS

Leading beauty associations and media worldwide honored The Estée Lauder

Companies’ products and people with over 150 prestigious awards. The Company

received Cosmetic Executive Women Best in Beauty awards for Estée Lauder,

Clinique and Origins; a FiFi award for kate spade beauty, and the Prix Santé award

for Clinique. Evelyn H. Lauder, Senior Corporate Vice President and Founder and

Chairman of The Breast Cancer Research Foundation, received France’s Legion

of Honor in recognition of her campaign to raise awareness and funds to fight

breast cancer. She also celebrated the publication of An Eye for Beauty, which

benefits the Foundation.

PEOPLE

Dynamic people are one of our Company’s most important assets. This year, we

added several exciting new faces to our team. Liya Kebede became the first

spokesmodel of African descent to represent the Estée Lauder brand, underscoring

its commitment to global beauty. Aramis signed a multi-year contract with tennis

superstar Andre Agassi to endorse its new fragrance, Aramis Life, which launches

this fall. William P. Lauder became Chief Operating Officer, and Leonard A. Lauder

continued his role as the Company’s ambassador, with appearances at the U.S.

Naval Academy and many other important sites.

BRANDS

The Estée Lauder Companies made two strategic investments in the prestige arena.

We acquired Darphin, the Paris-based maker of products incorporating natural

ingredients and essential oils. The Company entered into a license agreement

with Michael Kors L.L.C. for their award-winning fragrance, bath and body line.

Among our existing brands, M.A.C opened its first freestanding store in Berlin,

bringing the total number of M.A.C doors in Germany to 13, and Aveda sponsored

its bi-annual Congress for 6,000 customers.

15

Clockwise from top left: Harrods department store; by Evelyn H. Lauder; Clinique’s

brochure for the First Annual Dermatology Update; Chief Operating Officer William P. Lauder; Liya Kebede, Estée Lauder’s new

spokesmodel; Andre Agassi, spokesman for Aramis Life; Products from Darphin; M.A.C’s Berlin store; Michael Kors’ fragrance line;

Participants at Aveda’s Congress; FiFi Bath & Body Star award for CEW Best in Beauty Awards for Estée Lauder,

Clinique and Origins products; by Michael Gordon; Leonard A. Lauder at the U.S. Naval AcademyHair Heroes

kate spade beauty;

Bobbi Brown Beauty Evolution;An Eye for Beauty

17

UNFORGETTABLE SCENTS POSITIONED IN INSPIRED WAYS

Unforgettable scents positioned in inspired ways have been a hallmark of The Estée Lauder

Companies since our first fragrance, Youth Dew, was launched in 1953. In a challenging year

complicated by war, SARS and economic issues, our fragrance sales rose 4% on a reported

basis and were relatively unchanged when measured in constant currency. One of approxi-

mately every four bottles of fragrance sold in United States prestige department stores in which

we sell carried an Estée Lauder Companies brand name. We also continued to develop our

business in Europe despite a challenging category worldwide.

Customizing business strategies for each of our fragrances enables us to achieve our objectives

and maximize our connection with consumers. Often, that means updating traditional

approaches with innovative new ones that remain true to each fragrance’s heritage. In 2003,

FRAGRANCE

18

“sibling” scents, including Estée Lauder pleasures intense — one of the best-selling

offerings of this kind in the industry — Beautiful Sheer and Clinique Happy Heart,

refreshed well-established positioning and attracted new consumers. At the

same time, Beautiful, Clinique Happy and Estée Lauder pleasures remained the

top three prestige fragrances in department stores in the United States.

Fragrances that are relevant, approachable and modern continue to drive our

business. Donna Karan Cashmere Mist celebrated its tenth anniversary as one of

the fastest-growing fragrances in United States department stores. Donna Karan

also introduced Black Cashmere, inspired by two of the designer’s foundation

concepts: the fashion-consciousness of the color black and the sensual luxury

of cashmere.

In May, we allied ourselves with Michael Kors, the high-profile fashion designer

known for his young, luxury-minded customers, when we entered into a license

agreement to offer his three fragrance, bath and body lines. MICHAEL, the

19

FiFi award-winning women’s fragrance, MICHAEL for Men and KORS Michael

Kors have a strong specialty store following. This new brand also complements

existing licenses like Tommy Hilfiger, which successfully launched T Girl in fiscal

2003. Meanwhile, kate spade beauty has built a solid business in the United States,

winning the United States FiFi for Bath and Body Star of the Year. And Aramis

announced that tennis superstar Andre Agassi will endorse Aramis Life, a new

men’s fragrance that launches this fall.

Fragrances that deliver rich, multi-sensory experiences are another key focus for

the Company. The vanilla flavor of M.A.C’s lipsticks has become the foundation

for its new MV1, MV2 and MV3 scents. Stila also explores sensory positioning

with Crème Bouquet, which incorporates vanilla, pink lilac and lily of the valley,

and Jade Blossom, a blend including green tea, cucumber and lemon verbena.

Each scent can be customized with one of three companion body lotions, each

scented with a key fragrance note.

Flowers also figured importantly for Jo Malone in the launch of Orange Blossom,

a blend of clementine, orange blossom and water lily. The ancient spring festival of

Floralia inspired Origins Frolic Floral Fantasy Mist, composed of linden blossom,

rose, muguet de Mai and honeysuckle. And Bobbi Brown Beach’s success as a

limited-edition fragrance last year has earned the blend of sand jasmine, sea spray,

dianthus and neroli an ongoing place in the makeup artist’s line.

21

THE WATCHWORD IN MAKEUP IS “HIGH-PERFORMANCE”

Whether the focus is lips, eyes or face, the watchword in makeup for 2003 is “high-performance.”

Longer, flirtier lashes, more lustrous lips, high-impact pigments in eye shadows and founda-

tions that do more than cover and correct were among the year’s key concepts. Our makeup

sales increased 7% on a reported basis and 4% in constant currency.

The Estée Lauder Companies gained momentum in mascara with breakthrough formulas driven

by our unwavering commitment to technology. Estée Lauder made its mark with the introduc-

tion of MagnaScopic Maximum Volume Mascara, which is designed to increase the volume

of lashes by increasing their original thickness up to four times. Clinique launched Lash

Curling Mascara with a formula that provides significant lift to straight lashes, while Prescriptives

continued with False Eyelashes Plush Mascara and added new EyeLash Curler Mascara.

MAKEUP

22

M.A.C’s Pro LongLash delivered results as well as loyal users, helping the

brand more than double the number of consumers that purchased its mascara

products in fiscal 2002. Younger consumers weren’t left out either, as jane offered

Hi-Fiber Mascara.

In eye shadow, many brands turned up the volume with newer, more artistic

pigments that provide color and shading ranging from dramatic to subtle. M.A.C

launched Sheer Lustre for eyes as a limited edition but made it an ongoing part

of the collection after consumer enthusiasm established it as a best-seller. Pure

Color by Estée Lauder continued to gain momentum around the world with its

distinctive, stylish cube and eye-opening colors, earning it the award for Best New

Cosmetic Product (Luxury Brands) at the New Woman Beauty Awards 2003 in

the United Kingdom.

Weightless lipstick that bursts with color was one of the season’s most successful

trends. Colour Surge from Clinique delivered with an alluring palette of deep reds,

pinks and browns that use rich pigments to give delicious depth. M.A.C extended

its fashion focus with the introduction of Lustre Lipstick in 26 shades, addressing

the current trend for sheer formulas. Stila flashed its style with Convertible Lip

Color, a double lipstick that features matte and sheer versions of the same shade.

Origins brought treatment to lips with Service with a Smile Anti-chap lip color,

which incorporates softening ingredients like mango butter, Vitamin E and

jojoba oil.

Beauty expert Bobbi Brown has won a strong following among women every-

where with her collection of clean, modern shades and philosophy that “makeup

is a way for a woman to look and feel like herself, only prettier and more confident.”

Bobbi Brown Beauty Evolution, her third book, offers women of all ages insights and

advice on finding inner and outer beauty. Shimmer Gloss Stick, the brand’s most

recent introduction in the lip category, is an innovative formula that delivers the

shimmer and high-shine look of a gloss with the ease and feel of a lipstick.

Foundation continued to grow for several of our brands. Clinique, which

introduced Dewy Smooth Anti-Aging Makeup SPF 15 in fiscal 2003, maintains its

global leadership in foundation. Estée Lauder drove innovation with So Ingenious

and Amber Bronze. Two new entries from M.A.C for face include M.A.C Select

SPF 15 Foundation and Sheertone Blush, which contributed significantly to the

brand’s overall growth in the face category, while Prescriptives launched Virtual

Youth Lifting Moisture Makeup.

25

QUALITY PRODUCTS THAT DELIVER VISIBLE RESULTS

Skin care sales continued to grow at The Estée Lauder Companies. Net sales increased 11% on

a reported basis and rose 7% before foreign currency translation. Holding true to our heritage

of developing highly innovative, quality products that deliver visible results helps drive our

success in this area.

As the art of cosmetic science becomes more advanced, research and development plays a

larger role in creating products that deliver more clinically proven benefits to the skin. More

than 400 Estée Lauder Companies scientists work in seven labs around the world to stay

on the cutting edge of skin science. From this research, we introduced several dazzling

SK IN CARE

26

new products in fiscal 2003. Clinique successfully launched Repairwear Intensive

Night Cream, Intensive Night Lotion and Extra Help Serum globally as a new repair

and anti-aging line.

Estée Lauder Perfectionist Correcting Serum for Lines/Wrinkles won international

acclaim and is enjoying brisk sales, joining the highly successful Idealist Skin

Refinisher as a leader in prestige department store sales in the United States.

A Perfect World White tea skin guardian from Origins continues to build momen-

tum with its extremely loyal following.

Prescriptives is experiencing double-digit growth in skin care by delving deeper

into the world of dermatologist-inspired products, such as the Dermapolish

System, which promises to deliver results similar to a professional salon micro-

dermabrasion at home.

La Mer bolstered its success as one of the world’s most sought-after skin care lines

with the launch of its luxurious hand cream and its introduction of The Concentrate.

Lab Series for Men targeted younger men with the launch of its Ab Rescue,

designed to tighten and firm the appearance of abdominal muscles. Skin Supplies

for Men from Clinique is gaining momentum around the world as the product line

continues to draw attention to the skin care needs of men.

Jo Malone expanded on her skin care line by adding custom blends that cater to

women who seek a personal touch.

Strong sales for existing products also helped sustain The Estée Lauder Companies’

position as a global leader in skin care. Resilience Lift Overnight Face and Throat

Creme, DayWear Protective Anti-Oxident Creme and Lotion SPF 15, Advanced

Night Repair Eye Recovery Complex and Re-Nutriv Ultimate Lifting Creme helped

the Estée Lauder brand maintain its strong foothold in skin care. A bottle of

Dramatically Different Moisturizing Lotion from Clinique is sold every 3.5

seconds around the world. If Clinique’s 3-Step Skin Care System, including

Cleansing Soap, Clarifying Lotion and Dramatically Different Moisturizing Lotion,

were a separate skin care brand, that brand would be the fourth largest skin care

brand in United States department stores.

Finally, we added the Darphin brand to our portfolio and anticipate that this

aromatherapy-based line from France will expand our expertise in skin care.

29

PRESTIGE HAIR CARE IS AN IMPORTANT PRIORITY

Defining prestige hair care is an important priority for The Estée Lauder Companies, which

enjoyed another year of growth in sales in this category. Our hair care business grew 6%.

Domestic performance was particularly robust, thanks to new product offerings and our focus

on increasing business with our existing salons.

In the United States, Aveda’s sales to salon customers grew. Internationally, the brand sustained

its momentum in established markets like the United Kingdom while bolstering its developing

businesses in Italy and Germany and laying the groundwork for its launch in Japan this fall.

Product innovation also contributed to Aveda’s success. It launched Light Elements, four

styling products that refresh and define hair, including Defining Whip, Smoothing Fluid,

HAIR CARE

30

Finishing Solution and Reviving Mist. Color Current Energized Gel Color, a

conditioning, ammonia- and peroxide-free hair color, enhanced the brand’s salon-

professional-only hair color portfolio. Aveda also added to its hair care offerings

with Curessence Damage Relief Shampoo, a deep treatment shampoo that

fortifies and improves the condition of damaged hair, and Sap Moss Styling Spray,

a moisturizing spray gel that delivers flexible firm hold, replenishment and shine.

Meanwhile, Color Conserve Foaming Leave-In Conditioner made its debut,

incorporating conditioners and sun filters to protect hair color from fading.

At Bumble and bumble, Thickening Conditioner, a light moisturizer and detangler

for fine and limp hair, joined Thickening Shampoo and Thickening Spray, and Extra

Strength Holding Spray enhanced the brand’s hairspray portfolio. Educational

programs for salon owners and staff were also expanded in 2003. By the end of the

fiscal year, more than a third of Bumble and bumble’s United States salon cus-

tomers had taken advantage of “Bumble and bumble University,” which focuses

on building hairdressers’ and stylists’ technical expertise and product knowledge

with an eye toward growing business skills and overall productivity. This fall,

Bumble and bumble will open a new training facility and corporate headquarters

in New York City that will enable it to expand and enrich its offerings.

Multi-sensory positioning and formulas enhanced with real essential oils sustained

Origins’ position in hair care. The brand added Rich Rewards Intensive Moisture

Treatment for Scalp and Hair, a five-minute, deep conditioning therapy containing

wheat protein, Vitamins E and A, and William’s Pear, to its already strong hair

care line.

Clinique’s Simple Hair Care System maintained its ranking as the top department

store hair care brand in the United States on the strength of products like Daily

Shampoo, a lightweight formula that cleanses without stripping, and Healthy Shine

Serum, which promotes shine while controlling frizz.

Communicating with consumers is crucial to the growth of our Company. Our

brands continually refresh themselves, developing advertising and promotional

strategies that create new excitement for customers. A number of these brand-

building initiatives generated enthusiastic responses from consumers this year.

They included the famous icon Clinique advertising campaign by photographer

Irving Penn; personal appearances by Carolyn Murphy and Elizabeth Hurley

for the Estée Lauder brand; Hollywood tie-ins such as Stila’s exclusive makeup

partnership with the film Legally Blonde 2: Red, White and Blonde, starring Reese

Witherspoon; dynamic makeup collections like M.A.C’s Aquadisiac, and in-store

promotions like Bobbi Brown’s “10 Minute Face Event”.

ADVERTIS ING & PROMOTION32

33

Our philanthropic activities also deepen our relationships with consumers. Our

Breast Cancer Awareness Campaign celebrated its 10th year by distributing

millions of pink ribbons and informational bookmarks worldwide and spear-

heading the Global Landmarks Illumination Initiative, which bathes hundreds of

monuments in pink light to build awareness of the importance of early detection

and the fight for the cure. The M.A.C AIDS Fund, which has raised nearly $30 million,

supported the creation and distribution of an HIV/AIDS educational packet for

high school students; donated $250,000 to the United Nations HIV/AIDS pro-

grams, and developed a widely-aired public service announcement aimed at

teenagers. Aveda’s Earth Month efforts raised more than $720,000 for grass-roots

environmental organizations. The brand also embarked on a partnership with the

RARE Center for Tropical Conservation, which helps rural people living near at-risk

sites in more than 30 countries benefit from protecting biodiversity. These sites

include Ecuador’s Galapagos Islands and Australia’s Great Barrier Reef.

34 BOARD OF DIRECTORS

1 Member of Audit Committee2 Member of Compensation Committee3 Member of Nominating and Board Affairs Committee4 Member of Stock Plan Subcommittee

CHARLENE BARSHEFSKY 1

Senior International Partner

Wilmer, Cutler & Pickering

ROSE MARIE BRAVO

Chief Executive

Burberry Group Plc.

LEONARD A. LAUDER 3

Chairman

The Estée Lauder Companies Inc.

RONALD S. LAUDER

Chairman

Clinique Laboratories, Inc.

Private Investor

IRVINE O. HOCKADAY, JR.1

Retired President and

Chief Executive Officer

Hallmark Cards, Inc.

FRED H. LANGHAMMER

President



WILLIAM P. LAUDER

Chief Operating Officer


RICHARD D. PARSONS 2,3

Chairman


AOL Time Warner Inc.

MARSHALL ROSE 2,4

Managing Partner

The Georgetown Group

LYNN FORESTER DE ROTHSCHILD 1,2,3,4


ELR Holdings, Ltd.

35

PATRICK BOUSQUET-CHAVANNE

Group President

DANIEL J. BRESTLE

Group President

ANDREW J. CAVANAUGH

Senior Vice President

Global Human Resources

RICHARD W. KUNES


Chief Financial Officer

FRED H. LANGHAMMER

President


EVELYN H. LAUDER

Senior Corporate Vice President

LEONARD A. LAUDER

Chairman

RONALD S. LAUDER

Chairman

Clinique Laboratories, Inc.

WILLIAM P. LAUDER

Chief Operating Officer

SARA E. MOSS


General Counsel and Secretary

CEDRIC PROUVÉ

Group President

International

PHILIP SHEARER

Group President

EDWARD M. STRAW

Group President

Global Operations

SALLY SUSMAN


Global Communications

OFFICERS

THE ES T{E L AUDER COMPANIES INC. 36

F INANCIAL HIGHLIGHTS

* Fiscal 2003 information includes the effect of a special charge of $22.0 million ($13.5 million after-tax), or $.06 per diluted common share, related tothe proposed settlement of a legal action. Fiscal 2002 information includes the effect of restructuring charges of $117.4 million ($76.9 million after-tax),or $.32 per common share, and is after the cumulative effect of adopting a new accounting principle in the amount of $20.6 million, or $.08 percommon share. Fiscal 2001 information is reported after considering the effect of restructuring and special charges of $63.0 million ($40.3 million after-tax), or $.17 per common share, and after the cumulative effect of adopting a new accounting principle in the amount of $2.2 million after-tax,or $.01 per common share. For a more detailed description of our operating results, including the impact of these items refer to “Management’sDiscussion and Analysis of Financial Condition — Results of Operations.”

† Before preferred dividends.

A HERITAGE OF UNINTERRUPTED SALES GROWTH

1953 1972 1985 1991 2003$100 million $1 billion $2 billion $5.1 billion

NET SALES*(Dollars in billions)

4.04 4.44 4.67 4.74 5.12

1999 2000 2001 2002 2003

OPERATING INCOME*(Dollars in millions)

456.9 515.8 495.6 341.4 495.1

1999 2000 2001 2002 2003

NET EARNINGS* †

(Dollars in millions)

272.9 314.1 305.2 191.9 319.8

1999 2000 2001 2002 2003

PercentYEAR ENDED JUNE 30 2003 2002 Change(Dollars in millions, except per share data)

Net Sales* $5,117.6 $4,743.7 8%

Operating Income* 495.1 341.4 45%

Net Earnings (before preferred dividends)* 319.8 191.9 67%

Net Earnings Per Share — Diluted* 1.26 0.70 80%

AT JUNE 30

Total Assets $3,349.9 $3,416.5 (2%)

Stockholder’s Equity 1,423.6 1,461.9 (3%)

THE ES T{E L AUDER COMPANIES INC.

SELEC T ED F INANCIAL DATA

The table below summarizes selected financial information. For further information, refer to the audited consolidatedfinancial statements and the notes thereto beginning on page 56 of this report.

YEAR ENDED OR AT JUNE 30 2003 2002 2001 2000 1999(In millions, except per share data)

STATEMENT OF EARNINGS DATA:Net sales(a) $5,117.6 $4,743.7 $4,667.7 $4,440.3 $4,040.3Gross profit(a) 3,781.9 3,470.3 3,441.3 3,202.3 2,877.5Operating income 495.1 341.4 495.6 515.8 456.9Earnings before income taxes, minority interest and

accounting change 487.0 331.6 483.3 498.7 440.2Net earnings 319.8(b) 191.9(c) 305.2(d) 314.1 272.9Preferred stock dividends 23.4 23.4 23.4 23.4 23.4Net earnings attributable to common stock 296.4(b) 168.5(c) 281.8(d) 290.7 249.5

CASH FLOW DATA:Net cash flows provided by operating activities $ 548.5 $ 518.0 $ 305.4 $ 442.5 $ 352.3Net cash flows used for investing activities (192.5) (217.0) (206.3) (374.3) (200.3)Net cash flows used for financing activities (550.4) (121.8) (63.5) (87.9) (73.2)

PER SHARE DATA:Net earnings per common share:

Basic $ 1.27(b) $ .71(c) $ 1.18(d) $ 1.22 $ 1.05Diluted $ 1.26(b) $ .70(c) $ 1.16(d) $ 1.20 $ 1.03

Weighted average common shares outstanding:Basic 232.6 238.2 238.4 237.7 237.0Diluted 234.7 241.1 242.2 242.5 241.2

Cash dividends declared per common share $ .20 $ .20 $ .20 $ .20 $ .1775

BALANCE SHEET DATA:Working capital $ 791.3 $ 968.0 $ 882.2 $ 716.7 $ 708.0Total assets 3,349.9 3,416.5 3,218.8 3,043.3 2,746.7Total debt 291.4 410.5 416.7 425.4 429.1Redeemable preferred stock 360.0 360.0 360.0 360.0 360.0Stockholders’ equity 1,423.6 1,461.9 1,352.1 1,160.3 924.5

(a) Effective January 1, 2002, we adopted Emerging Issues Task Force (“EITF”) Issue No. 01-9, “Accounting for Consideration Given by a Vendor to aCustomer.” Upon adoption of this Issue, we reclassified revenues generated from our purchase with purchase activities as sales and the costs of ourpurchase with purchase and gift with purchase activities as cost of sales, which were previously reported net as operating expenses. Operatingincome has remained unchanged by this adoption. For purposes of comparability, these reclassifications have been reflected retroactively for allperiods presented.

(b) Net earnings, net earnings attributable to common stock and net earnings per common share for the year ended June 30, 2003 included a specialcharge related to the proposed settlement of a legal action of $13.5 million, after-tax, or $.06 per diluted common share.

(c) Net earnings, net earnings attributable to common stock and net earnings per common share for the year ended June 30, 2002 included arestructuring charge of $76.9 million, after-tax, or $.32 per diluted common share, and a one-time charge of $20.6 million, or $.08 per diluted commonshare, attributable to the cumulative effect of adopting Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.”

(d) Net earnings, net earnings attributable to common stock and net earnings per common share for the year ended June 30, 2001 includedrestructuring and other non-recurring charges of $40.3 million, after-tax, or $.17 per diluted common share, and a one-time charge of $2.2 million,after-tax, or $.01 per diluted common share, attributable to the cumulative effect of adopting SFAS No. 133, “Accounting for Derivative Instrumentsand Hedging Activities.”

37


CONSOLIDAT ED S TAT EMEN TS OF EAR NINGS

YEAR ENDED JUNE 30 2003 2002 2001(In millions, except per share data)

Net Sales $5,117.6 $4,743.7 $4,667.7Cost of sales 1,335.7 1,273.4 1,226.4

Gross Profit 3,781.9 3,470.3 3,441.3

Operating expenses:Selling, general and administrative 3,244.5 3,002.0 2,869.2Restructuring — 110.4 37.6Special charges 22.0 — 16.3Related party royalties 20.3 16.5 22.6

3,286.8 3,128.9 2,945.7

Operating Income 495.1 341.4 495.6Interest expense, net 8.1 9.8 12.3

Earnings before Income Taxes, Minority Interest and Accounting Change 487.0 331.6 483.3Provision for income taxes 160.5 114.4 174.0Minority interest, net of tax (6.7) (4.7) (1.9)

Net Earnings before Accounting Change 319.8 212.5 307.4Cumulative effect of a change in accounting principle, net of tax — (20.6) (2.2)

Net Earnings 319.8 191.9 305.2Preferred stock dividends 23.4 23.4 23.4

Net Earnings Attributable to Common Stock $ 296.4 $ 168.5 $ 281.8

Basic net earnings per common share:Net earnings attributable to common stock before accounting change $ 1.27 $ .79 $ 1.19Cumulative effect of a change in accounting principle, net of tax — (.08) (.01)

Net earnings attributable to common stock $ 1.27 $ .71 $ 1.18

Diluted net earnings per common share:Net earnings attributable to common stock before accounting change $ 1.26 $ .78 $ 1.17Cumulative effect of a change in accounting principle, net of tax — (.08) (.01)

Net earnings attributable to common stock $ 1.26 $ .70 $ 1.16

Weighted average common shares outstanding:Basic 232.6 238.2 238.4Diluted 234.7 241.1 242.2

See notes to consolidated financial statements.

38


MANAGEMEN T’S DISCUSSION AND ANALYSIS OF F INANCIAL CONDIT ION AND R ESULTS OF OPERAT IONS

39

CRITICAL ACCOUNTING POLICIES AND ESTIMATESThe discussion and analysis of our financial condition andresults of operations are based upon our consolidatedfinancial statements, which have been prepared in con-formity with accounting principles generally accepted inthe United States. The preparation of these financial state-ments requires us to make estimates and assumptions thataffect the reported amounts of assets, liabilities, revenuesand expenses reported in those financial statements.These judgments can be subjective and complex, andconsequently actual results could differ from those esti-mates. Our most critical accounting policies relate to reve-nue recognition; concentration of credit risk; inventory;pension and other postretirement benefit costs; goodwilland other intangible assets; income taxes; and derivatives.

REVENUE RECOGNITIONGenerally, revenues from merchandise sales are recordedat the time the product is shipped to the customer. Wereport our sales levels on a net sales basis, which is com-puted by deducting from gross sales the amount of actualreturns received and an amount established for antici-pated returns.

As is customary in the cosmetics industry, our practiceis to accept returns of our products from retailers if prop-erly requested, authorized and approved. In acceptingreturns, we typically provide a credit to the retailer againstsales and accounts receivable from that retailer on adollar-for-dollar basis.

Our sales return accrual is a subjective critical estimatethat has a direct impact on reported net sales. This accrualis calculated based on a history of gross sales and actualreturns by region and product category. In addition, asnecessary, specific accruals may be established for futureknown or anticipated events. As a percentage of grosssales, sales returns were 5.2%, 4.9% and 4.9% in fiscal2003, 2002 and 2001, respectively.

CONCENTRATION OF CREDIT RISKAn entity is more vulnerable to concentrations of creditrisk if it is exposed to risk of loss greater than it wouldhave had it mitigated its risk through diversification of cus-tomers. Such risks of loss manifest themselves differently,depending on the nature of the concentration, and vary insignificance.

We have three major customers that owned and oper-ated retail stores that in the aggregate accounted forapproximately $1.24 billion, or 24%, of our consolidatednet sales in fiscal 2003 and $179.8 million, or 28%, of ouraccounts receivable at June 30, 2003. These customers

sell products primarily within North America. Althoughmanagement believes that these customers are soundand creditworthy, a severe adverse impact on their busi-ness operations could have a corresponding materialadverse effect on our net sales, cash flows, and/or finan-cial condition.

In the ordinary course of business, we have establishedan allowance for doubtful accounts and customer deduc-tions in the amount of $31.8 million and $30.6 million asof June 30, 2003 and 2002, respectively. Our allowancefor doubtful accounts is a subjective critical estimate thathas a direct impact on reported net earnings. This reserveis based upon the evaluation of accounts receivableaging, specific exposures and historical trends.

INVENTORYWe state our inventory at the lower of cost or fair marketvalue, with cost being determined on the first-in, first-out(FIFO) method. We believe FIFO most closely matchesthe flow of our products from manufacture through sale.The reported net value of our inventory includes saleableproducts, promotional products, raw materials andcomponentry that will be sold or used in future periods.Inventory cost includes raw materials, direct labor and overhead.

We also record an inventory obsolescence reserve,which represents the difference between the cost of theinventory and its estimated market value, based on vari-ous product sales projections. This reserve is calculatedusing an estimated obsolescence percentage applied tothe inventory based on age, historical trends and require-ments to support forecasted sales. In addition, and asnecessary, we may establish specific reserves for futureknown or anticipated events.

PENSION AND OTHER POSTRETIREMENTBENEFIT COSTSWe offer the following benefits to some or all of ouremployees: a domestic trust-based noncontributorydefined benefit pension plan (“U.S. Plan”); an unfunded,nonqualified domestic noncontributory pension plan toprovide benefits in excess of statutory limitations; a con-tributory defined contribution plan; international pensionplans, which vary by country, consisting of both definedbenefit and defined contribution pension plans; deferredcompensation; and certain other postretirement benefits.

The amounts necessary to fund future payouts underthese plans are subject to numerous assumptions andvariables. Certain significant variables require us to make assumptions that are within our control such as ananticipated discount rate, expected rate of return on plan


assets and future compensation levels. We evaluate theseassumptions with our actuarial advisors and we believethey are within accepted industry ranges, although anincrease or decrease in the assumptions or economicevents outside our control could have a direct impact onreported net earnings.

The pre-retirement discount rate for each plan used fordetermining future pension obligations is based on areview of highly rated long-term bonds. At June 30, 2003,we used a pre-retirement discount rate for our U.S. Planof 5.75% and varying rates on our international plans ofbetween 2.75% and 7.0%. For fiscal 2003, we used anexpected return on plan assets of 8.5% for our U.S. Planand varying rates of between 4.5% and 8.25% for ourinternational plans. In determining the long-term rate ofreturn for a plan, we consider the historical rates of return,the nature of the plan’s investments and an expectationfor the plan’s investment strategies. The U.S. Plan assetallocation as of June 30, 2003 was approximately58% equity investments, 23% fixed income investments,13% cash and 6% other investments.

For fiscal 2004, we will use a pre-retirement discountrate for the U.S. Plan of 5.75% and anticipate using anexpected return on plan assets of 8.00%. The change in this assumption from that used in fiscal 2003 will causean increase in pension expense in fiscal 2004. We willcontinue to monitor the market conditions relative tothese assumptions and adjust them accordingly.

GOODWILL AND OTHER INTANGIBLE ASSETSGoodwill is calculated as the excess of the cost of pur-chased businesses over the value of their underlying netassets. Other intangible assets principally consist ofpurchased royalty rights and trademarks. Goodwill andother intangible assets that have an indefinite life are not amortized.

On an annual basis, we test goodwill and other intan-gible assets for impairment. To determine the fair value ofthese intangible assets, there are many assumptions andestimates used that directly impact the results of thetesting. We have the ability to influence the outcome andultimate results based on the assumptions and estimateswe choose. To mitigate undue influence, we use industryaccepted valuation models and set criteria that arereviewed and approved by various levels of management.Additionally, we evaluate our recorded goodwill with theassistance of a third-party valuation firm.

INCOME TAXESWe have accounted for, and currently account for, incometaxes in accordance with SFAS No. 109, “Accounting forIncome Taxes.” This Statement establishes financialaccounting and reporting standards for the effects ofincome taxes that result from an enterprise’s activities dur-ing the current and preceding years. It requires an assetand liability approach for financial accounting and report-ing of income taxes.

As of June 30, 2003, we have current net deferred taxassets of $116.0 million and non-current net deferred tax assets of $38.7 million. These net deferred tax assetsassume sufficient future earnings for their realization,as well as the continued application of current tax rates. Included in net deferred tax assets is a valuationallowance of approximately $2.9 million for deferred taxassets, which relates to foreign tax loss carryforwards notutilized to date, where management believes it is morelikely than not that the deferred tax assets will not be real-ized in the relevant jurisdiction. Based on our assess-ments, no additional valuation allowance is required. If wedetermine that a deferred tax asset will not be realizable,an adjustment to the deferred tax asset will result in areduction of earnings at that time.

Furthermore, we provide tax reserves for Federal, stateand international exposures relating to audit results, plan-ning initiatives and compliance responsibilities. The devel-opment of these reserves requires judgments about taxissues, potential outcomes and timing, and is a subjectivecritical estimate.

DERIVATIVES We currently account for derivative financial instrumentsin accordance with SFAS No. 133, “Accounting for Deriva-tive Instruments and Hedging Activities,” as amended,which establishes accounting and reporting standards forderivative instruments, including certain derivative instru-ments embedded in other contracts, and for hedgingactivities. This Statement also requires the recognition ofall derivative instruments as either assets or liabilities onthe balance sheet and that they be measured at fair value.

We currently use derivative financial instruments tohedge certain anticipated transactions and interest rates,as well as receivables and payables denominated in for-eign currencies. We do not utilize derivatives for tradingor speculative purposes. Hedge effectiveness is docu-mented, assessed and monitored by our employees whoare qualified to make such assessments and monitor theinstruments. Variables that are external to us such associal, political and economic risks may have an impacton our hedging program and the results thereof.

40

THE ES T{E L AUDER COMPANIES INC.41

RESULTS OF OPERATIONSWe manufacture, market and sell skin care, makeup, fragrance and hair care products which are distributed in over 130countries and territories. The following is a comparative summary of operating results for fiscal 2003, 2002 and 2001 andreflects the basis of presentation described in Note 2 and Note 18 to the Notes to Consolidated Financial Statements forall periods presented. Products and services that do not meet our definition of skin care, makeup, fragrance and haircare have been included in the “other” category.

YEAR ENDED JUNE 30 2003 2002 2001(In millions)

NET SALESBy Region:

The Americas $2,953.4 $2,878.2 $2,857.8Europe, the Middle East & Africa 1,506.4 1,261.1 1,221.8Asia/Pacific 657.8 610.6 596.1

5,117.6 4,749.9 4,675.7Restructuring* — (6.2) (8.0)

$5,117.6 $4,743.7 $4,667.7

By Product Category:Skin Care $1,893.7 $1,703.3 $1,660.7Makeup 1,909.4 1,790.5 1,721.6Fragrance 1,059.6 1,017.3 1,085.1Hair Care 228.9 215.8 180.7Other 26.0 23.0 27.6

5,117.6 4,749.9 4,675.7Restructuring* — (6.2) (8.0)

$5,117.6 $4,743.7 $4,667.7

OPERATING INCOME By Region:

The Americas $ 246.7 $ 222.9 $ 299.9Europe, the Middle East & Africa 227.7 179.9 201.8Asia/Pacific 42.7 56.0 56.9

517.1 458.8 558.6Restructuring and Special Charges* (22.0) (117.4) (63.0)

$ 495.1 $ 341.4 $ 495.6

By Product Category:Skin Care $ 273.2 $ 248.4 $ 266.9Makeup 198.0 183.2 212.5Fragrance 32.1 13.4 63.6Hair Care 14.8 13.7 13.1Other (1.0) 0.1 2.5

517.1 458.8 558.6Restructuring and Special Charges* (22.0) (117.4) (63.0)

$ 495.1 $ 341.4 $ 495.6

*Refer to the following tables and discussion for further information regarding these charges.


The following table presents certain consolidated earnings data as a percentage of net sales:

YEAR ENDED JUNE 30 2003 2002 2001

Net sales 100.0% 100.0% 100.0%Cost of sales 26.1 26.8 26.3

Gross profit 73.9 73.2 73.7

Operating expenses:Selling, general and administrative 63.4 63.3 61.5Restructuring — 2.3 0.8Special charges 0.4 — 0.3 Related party royalties 0.4 0.4 0.5

64.2 66.0 63.1

Operating income 9.7 7.2 10.6Interest expense, net 0.2 0.2 0.2

Earnings before income taxes, minority interest and accounting change 9.5 7.0 10.4Provision for income taxes 3.1 2.4 3.7Minority interest, net of tax (0.1) (0.1) (0.1)

Net earnings before accounting change 6.3 4.5 6.6Cumulative effect of a change in accounting principle, net of tax — (0.4) (0.1)

Net earnings 6.3% 4.1% 6.5%

The following tables present reconciliations of our financial results for the fiscal years ended June 30, 2003, 2002 and2001 as reported in conformity with generally accepted accounting principles in the United States (“GAAP”) and thoseresults adjusted to exclude certain charges described above each table. We have presented these reconciliations becauseof the special nature of the charges or the fact that they are not necessarily comparable from period to period.We believe that such measures provide investors with a view of our ongoing business trends and results of operations.This is consistent with the approach used by management in its evaluation and monitoring of such trends and resultsand provides investors with a base for evaluating future periods.

While we consider the non-GAAP financial measures useful in analyzing our results, it is not intended to replace, or actas a substitute for, any presentation included in the consolidated financial statements prepared in conformity with GAAP.

The table below reconciles the fiscal 2003 results as reported and results prior to adjustment for a special pre-taxcharge of $22.0 million, or $13.5 million after-tax, equal to $.06 per diluted common share, in connection with theproposed settlement of a class action lawsuit brought against us and a number of other defendants (see “Item 3. LegalProceedings.”). The amount of the charge in this case is significantly larger than similar charges we have incurredindividually or in the aggregate for legal proceedings in any prior year and we do not expect to take a charge of a similarmagnitude for a single matter like it in the near future.

YEAR ENDED JUNE 30, 2003 Results as Reported Reconciling Items Non-GAAP Results(In millions, except per share data)Net sales $5,117.6 $ — $5,117.6Cost of sales 1,335.7 — 1,335.7

Gross profit 3,781.9 — 3,781.9

Gross margin 73.9% 73.9%Operating expenses 3,286.8 22.0 3,264.8

Operating expense margin 64.2% 63.8%Operating income 495.1 22.0 517.1

Operating income margin 9.7% 10.1%Provision (benefit) for income taxes 160.5 (8.5) 169.0

Net earnings $ 319.8 $13.5 $ 333.3

Diluted net earnings per common share $ 1.26 $ .06 $ 1.32

The table below reconciles the fiscal 2002 results as reported and results prior to adjustment for (i) pre-tax restructuringcharges of $117.4 million, or $76.9 million after-tax, equal to $.32 per diluted common share (see “Results of Operations —


Fiscal 2002 as Compared with Fiscal 2001”); and (ii) a $20.6 million charge, equal to $.08 per diluted common share, inconnection with the cumulative effect of a change in accounting principle upon adoption of SFAS No. 142, “Goodwill andOther Intangible Assets” (see Note 2 “Summary of Significant Accounting Policies” in the accompanying ConsolidatedFinancial Statements). The restructuring charges were related to repositioning certain businesses as part of a globalizationand reorganization initiative and are described in greater detail in Note 5 to Notes to Consolidated Financial Statements.The restructuring and the adoption of the new accounting pronouncement were not considered part of our core businessoperations in fiscal 2002. Management also excludes the related charges in evaluating its performance when comparingfiscal 2002 to future periods.

YEAR ENDED JUNE 30, 2002 Results as Reported Reconciling Items Non-GAAP Results(In millions, except per share data)Net sales $4,743.7 $ 6.2 $4,749.9Cost of sales 1,273.4 0.8 1,272.6

Gross profit 3,470.3 7.0 3,477.3




Net earnings before accounting change 212.5 76.9 289.4Cumulative effect of a change in accounting principle (20.6) 20.6 —

Net earnings $ 191.9 $ 97.5 $ 289.4

Diluted net earnings per common share $ .70 $ .40 $ 1.10

The table below reconciles the fiscal 2001 results as reported and results prior to adjustment for (i) pre-tax restructuringand special charges of $63.0 million, or $40.3 million after-tax, equal to $.17 per diluted common share (see “Results ofOperations — Fiscal 2002 as Compared with Fiscal 2001”); (ii) $13.4 million after-tax adjustment, equal to $.06 per dilutedcommon share, to reflect the retroactive impact of the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets”(see Note 2 “Summary of Significant Accounting Policies” in the accompanying Consolidated Financial Statements); and (iii) a one-time charge of $2.2 million after-tax, or $.01 per diluted common share, attributable to the cumulative effect ofadopting SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” We adopted a restructuring plan inthe fourth quarter of fiscal 2001, our first since the initial public offering in 1995. The particular restructuring and specialcharges relating to the plan are described in Note 5 to Notes to Consolidated Financial Statements. These costs, as well asthose resulting from the adoption of new accounting standards, were not considered part of our core business in fiscal 2001.Management also excludes the related charges in evaluating its performance when comparing fiscal 2001 to future periods.

YEAR ENDED JUNE 30, 2001 Results as Reported Reconciling Items Non-GAAP Results(In millions, except per share data)Net sales $4,667.7 $ 8.0 $4,675.7Cost of sales 1,226.4 1.1 1,225.3

Gross profit 3,441.3 9.1 3,450.4




Net earnings before accounting change 307.4 40.3 347.72001 amortization of goodwill, net of tax — 13.4 13.4Cumulative effect of a change in accounting principle, net of tax (2.2) 2.2 —

Net earnings $ 305.2 $ 55.9 $ 361.1

Diluted net earnings per common share $ 1.16 $ .23 $ 1.39

43


FISCAL 2003 AS COMPARED WITH FISCAL 2002

NET SALESNet sales increased 8% or $373.9 million to $5,117.6 mil-lion, reflecting growth in all product categories and eachof our geographic regions. Product category results wereled by skin care, and our regions were led by Europe, theMiddle East & Africa, where results benefited fromfavorable foreign exchange rates to the U.S. dollar andimprovements in the travel retail business. Travel retailimproved during the middle of fiscal 2003 compared with lower results during the middle of fiscal 2002 but was adversely affected during the last quarter of fiscal2003 by certain world events, including the lingeringeffects of the war in Iraq and concerns relating to SARS.Such events may affect our future sales and earnings.Excluding the impact of foreign currency translation, netsales increased 4%.

Product CategoriesSkin Care Net sales of skin care products increased 11%or $190.4 million to $1,893.7 million, which was primarilyattributable to the recent launches of PerfectionistCorrecting Serum for Lines/Wrinkles and Resilience LiftOverNight Face and Throat Crème by Estée Lauder, andthe Repairwear line of products and Advanced Stop Signsfrom Clinique. Additionally, the increase was supportedby strong sales of Comforting Cream Cleanser, MoistureSurge Extra Thirsty Skin Relief and Moisture Surge EyeGel, and products in the 3-Step Skin Care System byClinique, as well as by Re-Nutriv Ultimate Lifting Cremefrom Estée Lauder, and A Perfect World line of productsby Origins. Partially offsetting this increase were lower netsales of certain existing products such as Stop Signs, TotalTurnaround Cream and Turnaround Cream by Cliniqueand Idealist Skin Refinisher by Estée Lauder. Excluding theimpact of foreign currency translation, skin care net salesincreased 7%.

Makeup Makeup net sales increased 7% or $118.9 mil-lion to $1,909.4 million due to strong sales of our makeupartist lines and current year launches of Dewy SmoothAnti-Aging Makeup and Colour Surge Lipstick byClinique, and MagnaScopic Maximum Volume Mascaraand Artist’s Lip and Eye Pencils from Estée Lauder. Alsocontributing to growth were strong sales from EstéeLauder brand products including So Ingenious Multi-Dimension Liquid Makeup and Loose Powder, as well asfrom new and existing products in the Pure Color line.Offsetting this increase were lower net sales of certainexisting products such as Sumptuous Lipstick from Estée Lauder, and Gentle Light Makeup and Powder and

High Impact Eye Shadow Duos by Clinique. Excluding theimpact of foreign currency translation, makeup net salesincreased 4%.

Fragrance Net sales of fragrance products increased 4%or $42.3 million to $1,059.6 million, primarily reflectingthe effects of favorable foreign currency exchange ratesto the U.S. dollar. The fragrance industry continues toexperience a difficult environment. The travel retail busi-ness, which depends substantially on fragrance products,began to improve in the middle of the fiscal year relativeto the prior year, however the latter part of fiscal 2003was adversely affected by international uncertaintiesstemming from events in Iraq and concerns relating toSARS. In fiscal 2003, we successfully launched EstéeLauder pleasures intense, T girl by Tommy Hilfiger, CliniqueHappy Heart, Lauder Intuition for Men and Donna KaranBlack Cashmere. Net sales also benefited from strongsales of Beautiful by Estée Lauder and Aromatics Elixirfrom Clinique. Offsetting these increases and sales fromnew product launches were lower net sales of certainTommy Hilfiger products, Intuition by Estée Lauder andEstée Lauder pleasures. Excluding the impact of foreigncurrency translation, fragrance net sales were relativelyunchanged from the prior year.

Hair Care Hair care net sales increased 6% or $13.1 mil-lion to $228.9 million. This increase was primarily theresult of sales growth from Aveda and Bumble andbumble products. We also increased the number ofCompany-owned Aveda Experience Centers and strate-gically decreased the number of salons that offer Avedaproducts. Partially offsetting the increase were lower netsales of Clinique’s Simple Hair Care System.

The introduction of new products may have somecannibalizing effect on sales of existing products, whichwe take into account in our business planning.

Geographic RegionsNet sales in the Americas increased 3% or $75.2 millionto $2,953.4 million primarily reflecting growth from ournewer brands as well as the success of new and recentlylaunched products. Despite the increase, we continue toexperience a soft retail environment in the United States.

In Europe, the Middle East & Africa, net sales increased19% or $245.3 million to $1,506.4 million. Net sales inthe United Kingdom, Spain, Italy, France, Switzerland andGreece experienced double-digit growth. Also contribut-ing to the increase with double-digit growth was ourworldwide travel retail business, as sales recovered fromthe levels experienced after September 11, 2001. How-ever, our travel retail business was adversely affected at

44


the end of fiscal 2003 by certain world events includingthe lingering effects of the war in Iraq and concerns asso-ciated with SARS. Excluding the impact of foreign cur-rency translation, Europe, the Middle East & Africa netsales increased 8%.

Net sales in Asia/Pacific increased 8% or $47.2 millionto $657.8 million primarily due to higher net sales inKorea, Japan, Australia and Thailand. Despite increasednet sales in Japan, the country remains a difficult marketdue to local economic conditions and competition.Excluding the impact of foreign currency translation,Asia/Pacific net sales increased 3%.

We strategically stagger our new product launches bygeographic market, which may account for differences inregional sales growth.

COST OF SALESCost of sales as a percentage of total net sales improved to26.1% from 26.8%, reflecting production and supply chainefficiencies and lower costs from promotional activities.

We continued to emphasize sourcing initiatives andoverall supply chain management which resulted in lowermanufacturing costs, whereas in the prior year we experi-enced under-absorption of overhead as a result of theimpact of the events of September 11, 2001.

The inclusion of promotional merchandise as a com-ponent of cost of sales results in lower margins. A strategicshift to reduce these activities has contributed to theimprovement in our gross profit margin for the year. Theinclusion of the cost of purchase with purchase and giftwith purchase merchandise as a component of cost ofsales resulted from our adoption of EITF Issue No. 01-9.Since the cost of these promotional activities is a compo-nent of cost of sales and the timing and level of promo-tions vary with our promotional calendar, we haveexperienced, and expect to continue to experience, fluc-tuations in the cost of sales percentage.

OPERATING EXPENSESOperating expenses decreased to 64.2% of net sales ascompared with 66.0% of net sales in the prior-yearperiod. The current year results were impacted by acharge related to the pending settlement of a legal pro-ceeding of $22.0 million or 0.4% of net sales. Prior-yearoperating expenses included a restructuring charge of$110.4 million or 2.3% of net sales. Before consideringthe effect of these two charges, operating expensesincreased slightly to 63.8% of net sales compared with63.5% of net sales in the prior year. The increase in spend-ing primarily related to advertising, sampling and

merchandising activities particularly during the early por-tion of fiscal 2003 (excluding purchase with purchase andgift with purchase activities, discussed as a component ofcost of sales) which supported our sales growth and builtmomentum going into the second half of fiscal 2003.Changes in advertising, sampling and merchandisingspending result from the type, timing and level of activi-ties related to product launches and rollouts, as well asthe markets being emphasized.

OPERATING RESULTSOperating income increased 45% or $153.7 million to$495.1 million as compared with the prior-year period.Operating margins were 9.7% of net sales in the currentperiod as compared with 7.2% in the prior-year period.These results include a charge related to the pending set-tlement of a legal proceeding of $22.0 million in the cur-rent year and a prior year restructuring charge of $117.4million. Absent these items, operating income increased13% or $58.3 million to $517.1 million and operatingmargins increased to 10.1% as compared with 9.7% infiscal 2002. These increases in operating income andoperating margin reflect sales growth, including the ben-efits from favorable foreign currency exchange rates tothe U.S. dollar and gross margin improvement, as well asbenefits from our prior restructurings and our continuedcost containment efforts.

Net earnings and net earnings per diluted shareincreased approximately 67% and 80%, respectively. Netearnings improved $127.9 million to $319.8 million andnet earnings per diluted share increased by $.56 from$.70 to $1.26. Absent the cumulative effect of a change inaccounting principle in fiscal 2002, net earnings increasedby $107.3 million or 50% and diluted earnings per com-mon share increased 62% to $1.26 from $.78 in the prioryear. Before the fiscal 2003 charge related to the pend-ing settlement of a legal proceeding and the fiscal 2002restructuring and the cumulative effect of adopting a newaccounting principle, net earnings increased 15% to$333.3 million and diluted earnings per common shareincreased 20% to $1.32 from $1.10 in the prior year.

The following discussions of Operating Results byProduct Categories and Geographic Regions exclude theimpact of the fiscal 2003 charge related to the pendingsettlement of a legal proceeding and the fiscal 2002restructuring. We believe the following analysis of oper-ating income better reflects the manner in which weconduct and view our business. The tables on pages 42and 43 reconcile these results to operating income asreported in the consolidated statement of earnings.

45


Product CategoriesOperating income more than doubled to $32.1 million infragrance due primarily to improved results from ourtravel retail business. Operating income increased 10% to $273.2 million in skin care and 8% to $198.0 million in makeup reflecting higher net sales, partially offset by strategic spending on advertising, sampling andmerchandising, particularly in the earlier portion of thecurrent year. Operating income increased $1.1 million or8% to $14.8 million in hair care, reflecting improvementsin Aveda and Bumble and bumble, as well as higher profits in the latter portion of the year outside the United States.

Geographic RegionsOperating income in the Americas increased 11% or$23.8 million to $246.7 million due to sales growth, thebenefits of our prior restructurings and continued costcontainment efforts. Operating income also benefitedfrom the results of strategic efforts related to product sup-port spending in the earlier part of the year that led toincreased net sales during the year. In Europe, the MiddleEast & Africa, operating income increased 27% or $47.8million to $227.7 million primarily due to the improvedoperating results in the United Kingdom as well asincreased results generated from our travel retail business.As described elsewhere, profitability in the region hasbeen and will continue to be affected by current interna-tional uncertainties. In Asia/Pacific, operating incomedecreased 24% or $13.3 million to $42.7 million. Thisdecrease reflects improved results in Korea and Thailand,which were more than offset by a decrease in Australia,which derived a benefit in the prior-year period from achange in our retailer arrangements.

INTEREST EXPENSE, NETNet interest expense was $8.1 million as compared with$9.8 million in the prior year. The decrease in net interestexpense was primarily due to lower outstanding net bor-rowings and higher interest income generated by higherinvested cash balances. This improvement was partiallyoffset by a higher effective interest rate, which resultedfrom the increased proportion of fixed rate debt as com-pared with variable rate debt in the same period last year.In May 2003, we executed a fixed-to floating interest rateswap on our $250.0 million 6% Senior Notes due 2012.See “Liquidity and Capital Resources” for further details.

PROVISION FOR INCOME TAXESThe provision for income taxes represents Federal, for-eign, state and local income taxes. The effective rate for

income taxes for the fiscal year was 33.0% as comparedwith 34.5% in the prior-year period. These rates differfrom statutory rates, reflecting the effect of state and localtaxes, tax rates in foreign jurisdictions and certain non-deductible expenses. The decrease in the effective taxrate was principally attributable to ongoing tax planninginitiatives, including the favorable settlement of certain taxnegotiations and the reduction of the overall tax rate relat-ing to the Company’s foreign operations. In addition, thetax effect of the charge related to the pending settlementof a legal proceeding in late fiscal 2003 contributed to aneffective tax rate slightly lower than previously expected.

FISCAL 2002 AS COMPARED WITH FISCAL 2001

NET SALESNet sales increased 2% or $76.0 million to $4.74 billionreflecting growth in the makeup, skin care and hair carecategories, partially offset by a decline in fragrance netsales. Excluding the impact of foreign currency translation,net sales increased 3%. The unusual events that occurredduring fiscal 2002 and their effect on the economy,particularly in the United States, adversely impacted ourbusiness. In addition, the decline in worldwide travelduring most of fiscal 2002 led to a 13% reduction in ourtravel retail sales. Sales growth from certain newer brands and recently launched products partially offsetthese decreases.

The following discussions of Net Sales by ProductCategories and Geographic Regions exclude the impactof the restructurings in fiscal 2002 and fiscal 2001.Neither restructuring was material to our net sales, and webelieve the following analysis of net sales better reflectsthe manner in which we conduct and view our business.For a discussion of the restructurings, see “OperatingExpenses — Restructuring and Special Charges” in thissection. The tables on page 43 reconcile these results tooperating income as reported in the consolidated state-ment of earnings.

Product CategoriesSkin Care Net sales of skin care products increased 3%or $42.6 million to $1.70 billion. The net sales increase isprimarily attributable to recently launched products suchas Total Turnaround Visible Skin Renewer, AdvancedNight Repair Eye Recovery Complex, Moisture SurgeExtra Thirsty Skin Relief and Moisture Surge Eye Gel,A Perfect World line of products, LightSource Trans-forming Moisture Lotion and Cream, and Re-NutrivUltimate Lifting Creme. Partially offsetting these increaseswere lower net sales of certain existing products such as

46


Turnaround Cream and Resilience Lift, as well as productsin Clinique’s 3-Step Skin Care System.

Makeup Makeup net sales increased 4% or $68.9 millionto $1.79 billion. Newer brands such as M.A.C, BobbiBrown and Stila, which are primarily makeup products,contributed through growth at existing doors andincreased distribution. In addition, strong sales of the PureColor Line of products, the worldwide launch of GentleLight Makeup and Illusionist Mascara contributed posi-tively to net sales growth. Partially offsetting the increasein net sales were lower sales of Two-in-One Eye Shadow,Lucidity Makeup, and Long Last Soft Shine Lipstick.

Fragrance Net sales of fragrance products decreased 6%or $67.8 million to $1.02 billion. This category wasimpacted by the softness of the fragrance business in theUnited States and the decline in our travel retail business,which depends substantially on fragrance products. Lowernet sales of Beautiful, Estée Lauder pleasures, DKNY forWomen and certain existing Tommy Hilfiger productswere partially offset by the launch of T, a fragrance in theTommy Hilfiger line, and Intuition for Men, as well asstrong sales of Donna Karan Cashmere Mist.

Hair Care Hair care net sales increased 19% or $35.1 mil-lion to $215.8 million. This increase was primarily theresult of growth from Aveda, which benefited from thelaunch of texture lotion products and Color ConserveShampoo and an increase in the number of Company-owned Aveda Experience Centers. Sales of Bumble andbumble products increased due to an expanded productline and an increase in the number of points of sale. Theresults were partially offset by lower sales from Clinique’sSimple Hair Care System when compared with the prior-year launch.

The introduction of new products may have some can-nibalizing effect on sales of existing products, which wetake into account in our business planning.

Geographic RegionsNet sales in the Americas increased 1% or $20.4 millionto $2.88 billion. The increase was primarily due to the suc-cess of most newer brands, partially offset by economicweakness and uncertainty in the United States duringmost of the fiscal year. In Europe, the Middle East & Africa,net sales increased 3% or $39.3 million to $1.26 billion.This increase was primarily the result of higher net sales inthe United Kingdom, Spain and Greece, where in fiscal2002 we formed a joint venture, in which we own a con-trolling majority interest, with our former distributor. Theincrease was partially offset by lower net sales in our travelretail business, which has been adversely affected by a

decrease in worldwide travel. Excluding the impact of ourtravel retail business, net sales in Europe, the Middle East& Africa increased 8% or $77.8 million. Net sales inAsia/Pacific increased 2% or $14.5 million to $610.6 mil-lion primarily due to higher net sales in Korea and Thai-land, as well as in Australia where we benefited from achange in retailer arrangements. The increased sales werepartially offset by lower net sales in Japan. Japan contin-ued to be a difficult market due to local economic condi-tions and increasing competition. The challenges weremade more difficult by the weakness of the Japanese yenduring fiscal 2002 as compared with the U.S. dollar.Excluding the impact of foreign currency translation,Asia/Pacific net sales increased 9%.

We strategically stagger our new product launches bygeographic market, which may account for differences inregional sales growth.

COST OF SALESCost of sales as a percentage of total net sales was 26.8%as compared with 26.3% in the prior year. The lower mar-gin can be attributed in part to production volumedecreases resulting in under-absorption of overhead, aswell as lower than planned raw material purchases thatreduced anticipated savings from sourcing initiatives.Partially offsetting these negative factors were lower salesvolumes of products with a higher cost of goods, particu-larly in travel retail and fragrance.

OPERATING EXPENSESOperating ExpensesOperating expenses increased to 66.0% of net sales ascompared with 63.1% of net sales in the prior year. Theincrease in operating expenses primarily related torestructuring expenses, continued advertising and pro-motional spending and the cost to expand and operateour retail stores. The increase in operating expenses as apercentage of net sales reflects a slower growth rate insales than operating expenses, primarily due to economicconditions in the United States as discussed above.As part of our long-term strategies, we continued toemphasize the building of “brand equities” throughadvertising and promotional spending and retail storeexpansion despite difficult economic times. Changes inadvertising and promotional spending result from thetype, timing and level of advertising and promotionalactivities related to product launches and rollouts, as wellas the markets being emphasized. Excluding the impact ofrestructuring and special charges, operating expenseswere 63.5% and 61.9% of net sales for the fiscal yearsended 2002 and 2001, respectively.

47


Restructuring and Special ChargesDuring the fourth quarter of fiscal 2002, we recordedcharges for a restructuring related to repositioning cer-tain businesses as part of our ongoing efforts to drivelong-term growth and increase profitability. The restruc-turing focused on cost reduction opportunities related tothe Internet, our supply chain, globalization of the organ-ization and distribution channel refinements. We commit-ted to a defined plan of action, which resulted in anaggregate pre-tax charge of $117.4 million, of which$59.4 million is cash related. On an after-tax basis, theaggregate charge was $76.9 million, equal to $.32 perdiluted share.

Specifically, the charge included the following:

• Internet. In an effort to achieve strategic objectives,reduce costs and improve profitability, we outsourcedGloss.com platform development and maintenanceefforts to a third-party provider. Additionally, Gloss.comclosed its San Francisco facility and consolidated itsoperations in New York. As a result, included in thecharge was a $23.9 million provision for restructuringthe Gloss.com operations, including benefits and sever-ance packages for 36 employees as well as asset write-offs. We also took a $20.1 million charge to write off therelated Gloss.com acquisition goodwill.

• Supply Chain. Building on previously announced supplychain initiatives, we restructured certain manufacturing,distribution, research and development, information sys-tems and quality assurance operations in the UnitedStates, Canada and Europe, which included benefits andseverance for 110 employees. A charge of $23.7 millionwas recorded related to this effort.

• Globalization of Organization. We continued to imple-ment our transition, announced in fiscal 2001, to aglobal brand structure designed to streamline thedecision-making process and increase innovation andspeed-to-market. The next phase of this transitionentailed eliminating duplicate functions and responsi-bilities, which resulted in charges for benefits and sever-ance for 122 employees. We recorded a charge of$27.1 million associated with these efforts.

• Distribution. We evaluated areas of distribution relative toour financial targets and decided to focus our resourceson the most productive sales channels and markets. As aresult, we closed our operations in Argentina and theremaining customers are being serviced by our Chileanaffiliate. We began to close all remaining in-store“tommy’s shops” and we identified for closing otherselect points of distribution. We recorded a $22.6 mil-lion provision related to these actions, which includedbenefits and severance for 85 employees.

48

Following is a summary of the charges as recorded in the consolidated statement of earnings for fiscal 2002:

Net Sales Cost of Sales Operating Expenses Total(In millions)

Internet $ — $ — $ 44.0 $ 44.0Supply Chain — — 23.7 23.7Globalization of Organization — — 27.1 27.1Distribution 6.2 0.8 15.6 22.6

Total charge $6.2 $0.8 $110.4 117.4

Tax effect (40.5)

Net charge $ 76.9

Restructuring

The restructuring charge was recorded in other accruedliabilities or, where applicable, as a reduction of therelated asset. During fiscal 2002, $9.3 million related tothis restructuring was paid. We expected to, and did, settlea majority of the remaining obligations by the end of fiscal2003 with certain additional payments to be made ratablythrough fiscal 2006.

During the fourth quarter of fiscal 2001, we recordedcharges for restructuring and special charges related torepositioning certain businesses as part of our ongoingefforts to drive long-term growth and increase profit-

ability. The restructuring and special charges focused onfour areas: product fixtures for the jane brand; in-store“tommy’s shops”; information systems and other assets;and global brand reorganization. We committed to adefined plan of action, which resulted in an aggregatepre-tax charge of $63.0 million, of which $35.9 million iscash related. On an after-tax basis, the aggregate chargewas $40.3 million, equal to $.17 per diluted share. As ofJune 30, 2003, the remaining obligation was $2.6 millionwith payments expected to be made ratably through fiscal 2004.


OPERATING RESULTSOperating income decreased 31% or $154.2 million to$341.4 million as compared with the prior year. Operatingmargins were 7.2% of net sales in fiscal 2002 as com-pared with 10.6% in the prior year. The decrease in oper-ating margin was primarily due to restructuring expenses,lower than expected sales levels, increased supportspending and new distribution channel costs. This was par-tially offset by the exclusion of amortization expense dueto the adoption of SFAS No. 142, “Goodwill and OtherIntangible Assets,” in fiscal 2002 and the November 2000expiration of amortization related to purchased royaltyrights. Operating income reflected the inclusion ofrestructuring and special charges of $117.4 million and$63.0 million in fiscal 2002 and 2001, respectively. Beforeconsideration of the restructuring and special charges,operating income decreased 18% to $458.8 million andoperating margins were 9.7% in fiscal 2002 as comparedwith 11.9% in fiscal 2001.

Net earnings and net earnings per diluted sharedecreased approximately 37% and 39%, respectively. Netearnings declined $113.3 million to $191.9 million andnet earnings per diluted share was lower by $.46 perdiluted share from $1.16 to $.70. On a comparable basis,before restructuring and special charges, before thecumulative effect of adopting a new accounting princi-ple, and excluding goodwill amortization in fiscal 2001,net earnings were $289.4 million, representing a decreaseof 20% over the prior year, and diluted earnings per com-mon share decreased 21% to $1.10 from $1.39 in theprior year.

The following discussions of Operating Results byProduct Categories and Geographic Regions exclude the impact of restructuring and special charges. Webelieve the following analysis of operating income betterreflects the manner in which we conduct and view ourbusiness. The tables on page 43 reconcile these results tooperating income as reported in the consolidated state-ment of earnings.

Product CategoriesOperating income decreased 79% to $13.4 million infragrance, 14% to $183.2 million in makeup and 7% to$248.4 million in skin care, primarily due to lower thananticipated sales levels, coupled with continued advertis-ing and promotional spending to promote new andrecently launched products. Hair care operating incomeincreased 5%, from a smaller base, to $13.7 million,primarily due to sales growth from Aveda and Bumble and bumble.

Geographic RegionsOperating income in the Americas decreased 26% or$77.0 million to $222.9 million, primarily due to lowersales attributable to weakness in the U.S. economy andcontinued advertising and promotional spending. InEurope, the Middle East & Africa, operating incomedecreased 11% or $21.9 million to $179.9 million, prima-rily due to the significant decrease in our travel retail busi-ness. Partially offsetting the decrease were improvedoperating results in Italy, the United Kingdom, Spain andGermany. We also benefited from the inclusion of oper-ating results from our majority-owned joint venture inGreece. In Asia/Pacific, operating income decreasedslightly to $56.0 million due to lower income in China andHong Kong offset by higher results in Korea, in Australia,where we benefited from a change in retailer arrange-ments, and in Japan, where we were able to reduceoperating expenses.

INTEREST EXPENSE, NETNet interest expense was $9.8 million as compared with$12.3 million in the prior year. The decrease in net interestexpense resulted from a lower effective interest rate com-pared with the prior year. This was primarily due to ourinterest rate risk management strategy that relied on com-mercial paper and variable-rate term loans. In January2002, we took advantage of prevailing market rates andissued fixed rate long-term notes to replace our variable-rate debt.

PROVISION FOR INCOME TAXESThe Company’s effective tax rate will change from year toyear based on non-recurring and recurring factors includ-ing, but not limited to, the geographical mix of earnings,the timing and amount of foreign dividends, state andlocal taxes, tax audit settlements and the interaction ofvarious global tax strategies.

The provision for income taxes represents Federal, for-eign, state and local income taxes. The effective rate forincome taxes for fiscal 2002 was 34.5% compared with36% in the prior year. These rates reflect the effect of stateand local taxes, changes in tax rates in foreign jurisdic-tions, tax credits and certain non-deductible expenses.The decrease in the effective income tax rate was attrib-utable to ongoing tax planning initiatives, as well as adecrease in non-deductible domestic royalty expense andthe elimination of certain non-deductible goodwill amor-tization resulting from the implementation of SFAS No. 142, “Goodwill and Other Intangible Assets.”

49


FINANCIAL CONDITION

LIQUIDITY AND CAPITAL RESOURCESOur principal sources of funds historically have been cashflows from operations and borrowings under commercialpaper, borrowings from the issuance of long-term debtand committed and uncommitted credit lines providedby banks in the United States and abroad. At June 30,2003, we had cash and cash equivalents of $364.1 mil-lion compared with $546.9 million at June 30, 2002.

At June 30, 2003, our outstanding borrowings of$291.4 million included: (i) $257.1 million of 6% SeniorNotes due January 2012 consisting of $250.0 million prin-cipal, an unamortized debt discount of $1.0 million, andan $8.1 million adjustment to reflect the fair value of anoutstanding interest rate swap; (ii) a 3.0 billion yen termloan (approximately $25.2 million at current exchangerates), which is due in March 2006; (iii) $7.8 million ofother short-term borrowings; and (iv) $1.3 million of otherlong-term borrowings.

In May 2003, we entered into an interest rate swapagreement with a notional amount of $250.0 million toeffectively convert the fixed rate interest on our outstand-ing $250.0 million 6% Senior Notes to variable interestrates based on LIBOR. In the short-term, this will provideus with a lower level of interest expense related to the 6%Senior Notes based on current variable interest rates,however, over the life of the notes, interest expense maybe greater than 6% based upon the fluctuations of LIBOR.

We have a $750.0 million commercial paper programunder which we may issue commercial paper in theUnited States. Our commercial paper is currently ratedA-1 by Standard & Poor’s and P-1 by Moody’s. Our long-term credit ratings are A+ by Standard & Poor’s and A1by Moody’s. At June 30, 2003, we had no commercialpaper outstanding. We also have an effective shelf regis-tration statement covering the potential issuance of up to$500.0 million in debt securities. As of June 30, 2003, wehad an unused $400.0 million revolving credit facility,expiring on June 28, 2006, and $156.6 million in addi-tional uncommitted credit facilities.

Our business is seasonal in nature and, accordingly, ourworking capital needs vary. From time to time, we mayenter into investing and financing transactions that requireadditional funding. To the extent that these needs exceedcash from operations, we could, subject to market condi-tions, issue commercial paper, issue long-term debt secu-rities or borrow under the revolving credit facility.

The effects of inflation have not been significant to ouroverall operating results in recent years. Generally, wehave been able to introduce new products at higher

selling prices or increase selling prices sufficiently tooffset cost increases, which have been moderate.

We believe that cash on hand, cash generated fromoperations, available credit lines and access to creditmarkets will be adequate to support currently plannedbusiness operations and capital expenditures on both a near-term and long-term basis.

Cash FlowsNet cash provided by operating activities was $548.5million in fiscal 2003 as compared with $518.0 million in fiscal 2002 and $305.4 million in fiscal 2001. Theimproved operating cash flow primarily reflects increasedearnings and seasonal levels of operating assets andliabilities. Operating assets and liabilities reflect animprovement in accounts receivable collections, and ahigher level of accounts payable, partially offset byincreased inventories in anticipation of product launchesin the first half of fiscal 2004 and the impact of acquisi-tions on required inventory levels. The improvement innet cash flows for fiscal 2002 compared to fiscal 2001was generated primarily by a reduction of inventory.Inventory levels were unseasonably high at the end of fis-cal 2001 and were lowered during fiscal 2002 as part ofour effort to keep inventory levels in line with forecastedsales. Operating cash flows were generally not impactedby the fiscal 2002 restructuring as lower net earningswere offset by the non-cash portion of the charge and theincrease in other accrued liabilities.

Net cash used for investing activities was $192.5 mil-lion in fiscal 2003, compared with $217.0 million in fiscal2002 and $206.3 million in fiscal 2001. Net cash used ininvesting activities in fiscal 2003 primarily relates to capitalexpenditures and the acquisition of Darphin and certainAveda distributors. Net cash used in investing activitiesduring fiscal 2002 and fiscal 2001 relates primarily tocapital expenditures.

Capital expenditures amounted to $163.1 million,$203.2 million and $192.2 million in fiscal 2003, 2002 and2001, respectively. Spending in all three years primarilyreflected the continued upgrade of manufacturingequipment, dies and molds, new store openings, storeimprovements, counter construction and informationtechnology enhancements. The reduced level of capitalexpenditures in fiscal 2003 reflects tight control on ourspending in light of economic conditions, fewer retailstore openings and reduced spending related to lease-hold improvements.

Cash used for financing activities was $550.4 million,$121.8 million and $63.5 million in fiscal 2003, 2002 and 2001, respectively. The net cash used for financing

50


activities in 2003 primarily relates to common stock repur-chases, the repayment of long-term debt and dividendpayments. Net cash used for financing during fiscal 2002primarily relates to dividend payments and common stockrepurchases. The net cash used in fiscal 2001 was prima-rily related to dividend payments.

DividendsThe Board of Directors declared, and we paid on ourClass A Common Stock and Class B Common Stock, anannual dividend of $.20 per share in fiscal 2003 andquarterly dividends at the rate of $.05 per share in eachquarter of fiscal 2002 and 2001. The last quarterly divi-dend of $.05 per share was paid in the first quarter offiscal 2003. As previously disclosed, the Board of Direc-tors determined that, at its discretion, it would declare andthe Company would pay dividends on its common stockannually rather than quarterly commencing in fiscal 2003.In fiscal 2003, 2002 and 2001, dividends declared on ourcommon stock totaled $46.5 million, $47.5 million and$47.7 million, respectively. Total dividends declared,including dividends on the $6.50 Cumulative RedeemablePreferred Stock, were $69.9 million, $70.9 million and$71.1 million in fiscal 2003, 2002 and 2001, respectively.

Share Repurchase ProgramIn September 1998, our Board of Directors authorized ashare repurchase program to repurchase a total of up to8.0 million shares of Class A Common Stock in the openmarket or in privately negotiated transactions, dependingon market conditions and other factors. In October 2002,the Board of Directors authorized the repurchase of upto 10.0 million additional shares of Class A CommonStock, increasing the total authorization under the sharerepurchase program to 18.0 million shares. During fiscal2003, we purchased 11.2 million shares for $352.4million. As of June 30, 2003, we have purchased approxi-mately 13.8 million shares under this program. Subse-quent to year-end, we purchased an additional 0.4 millionshares for $12.3 million bringing the cumulative total ofacquired shares to 14.2 million.

Pension Plan Funding and ExpenseWe maintain pension plans covering substantially all ofour full-time employees for our U.S. operations and amajority of our international operations. Several plans pro-vide pension benefits based primarily on years of serviceand employees’ earnings. In the United States, we main-tain a trust-based, noncontributory defined benefit pen-sion plan (“U.S. Plan”). Additionally, we have an unfunded,nonqualified domestic benefit plan to provide benefits inexcess of Internal Revenue Code limitations. Our interna-

tional pension plans are comprised of defined benefit anddefined contribution plans.

Several factors influence our annual funding require-ments. For the U.S. Plan, our funding policy consists of anannual contribution at a rate that provides for future planbenefits and maintains appropriate funded percentages.Such contribution is not less than the minimum requiredby the Employee Retirement Income Security Act of1974, as amended (“ERISA”), and subsequent pension leg-islation and is not more than the maximum amountdeductible for income tax purposes. For each internationalplan, our funding policies are determined by local lawsand regulations. In addition, amounts necessary to fundfuture obligations under these plans could vary dependingon estimated assumptions (as detailed in “CriticalAccounting Polices and Estimates”). The effect on operat-ing results in the future of pension plan funding willdepend on economic conditions, employee demograph-ics, mortality rates, the number of participants electing totake lump-sum distributions, investment performance andfunding decisions.

During fiscal 2003, we changed certain of the underly-ing assumptions associated with our pension plans basedupon the recent past performance and outlook of thesecurities markets, resulting in a larger funding require-ment. In addition, the assets associated with the pensionplans experienced negative investment returns, whichalso affected our funding requirements. Even afterconsidering the impact of these factors, there was nominimum contribution to the U.S. Plan required by ERISAfor fiscal 2003 and 2002. However, at management’sdiscretion, we made cash contributions to the U.S. Plan of$76.0 million and $43.0 million during fiscal 2003 and2002, respectively.

In addition, at June 30, 2003, we recognized a liabilityon our balance sheet for each pension plan if the fair mar-ket value of the assets of that plan was less than the accu-mulated benefit obligation and, accordingly, a charge isrecorded in accumulated other comprehensive income(loss) in shareholders’ equity. During fiscal 2003 and 2002,we recorded a charge to accumulated other comprehen-sive income (loss) of $20.3 million and $7.9 million,respectively. This charge had no impact on our consoli-dated net earnings or liquidity.

Commitments and ContingenciesWe will be required to redeem the outstanding $6.50Cumulative Redeemable Preferred Stock on June 30,2005. However, in the event that Mrs. Estée Lauder wereto pass away before such date, then we would have theright to redeem the shares from the current holders, and

51


the holders of such shares would have the right to put theshares to us, at $100 per share (for an aggregate cost of$360.0 million). If shares of $6.50 Cumulative RedeemablePreferred Stock are put to us, we would have up to 120days after notice to purchase such shares.

Certain of our business acquisition agreements include“earn-out” provisions. These provisions generally requirethat we pay to the seller or sellers of the business addi-tional amounts based on the performance of the acquiredbusiness. The payments typically are made after a certainperiod of time and our next “earn-out” payment isexpected to be made after the end of fiscal 2005. Since

the size of each payment depends upon performance ofthe acquired business, we do not expect that such pay-ments will have a material adverse impact on our futureresults of operations or financial condition.

Under agreements covering our purchase of trade-marks for a percentage of related sales, royalty paymentstotaling $20.3 million, $16.5 million and $16.0 million in fiscal 2003, 2002 and 2001, respectively, have beencharged to expense. Such payments were made to Mrs. Estée Lauder. This obligation is not necessarily fixedand determinable, and therefore has been excluded fromthe following contractual obligation table.

52

Contractual ObligationsThe following table summarizes scheduled maturities of our contractual obligations for which cash flows are fixed anddeterminable as of June 30, 2003.

Total 2004 2005 2006 2007 2008 Thereafter(In millions)

Long-term debt including current portion(1) $ 291.4 $ 7.8 $ 1.3 $ 25.2 $ — $ — $257.1Redeemable preferred stock(2) 360.0 — 360.0 — — — —Lease commitments(3) 605.6 120.1 104.6 74.4 61.9 54.8 189.8Unconditional purchase obligations(4) 698.7 346.9 37.8 42.6 27.3 25.5 218.6

Total contractual obligations $1,955.7 $474.8 $503.7 $142.2 $89.2 $80.3 $665.5

(1) Refer to Note 8 of Notes to Consolidated Financial Statements.

(2) Refer to Note 12 of Notes to Consolidated Financial Statements.

(3) Includes operating lease commitments, and to a lesser extent, minimal capital lease commitments. Refer to Note 15 of Notes to Consolidated Financial Statements.

(4) Unconditional purchase obligations primarily include inventory commitments, estimated future earn-out payments, estimated royalty payments pursuantto license agreements, advertising commitments and capital improvement commitments.

Payments Due in Fiscal

In July 2003, we signed a new lease for our principaloffices at the same location. Our rental obligations under the new lease will commence in fiscal 2005 andexpire in fiscal 2020. Obligations pursuant to the lease in fiscal 2005, 2006, 2007, 2008 and thereafter are $5.9million, $23.6 million, $23.6 million, $24.1 million and$324.2 million, respectively.

Business Acquisitions and License AgreementsIn April 2003, we acquired the Paris-based Darphin groupof companies that develops, manufactures and marketsthe “Darphin” brand of skin care products. The initial pur-chase price, paid at closing, was funded by cash providedby operations, and did not have a material effect on ourresults of operations or financial condition. An additionalpayment is expected to be made in fiscal 2009, theamount of which will depend on future net sales and earn-ings of the Darphin business.

In May 2003, we entered into a license agreement tomanufacture and sell fragrances and beauty productsunder the “Michael Kors” trademarks with Michael KorsL.L.C. At the same time, we purchased certain relatedrights and inventory from American Designer Fragrances,a division of LVMH.

Derivative Financial Instruments and Hedging ActivitiesWe address certain financial exposures through a con-trolled program of risk management that includes the useof derivative financial instruments. We primarily enter intoforeign currency forward exchange contracts and foreigncurrency options to reduce the effects of fluctuating for-eign currency exchange rates. We also enter into interestrate derivative contracts to manage the effects of fluctu-ating interest rates. We categorize these instruments asentered into for purposes other than trading.


For each derivative contract entered into where welook to obtain special hedge accounting treatment, we for-mally document the relationship between the hedginginstrument and hedged item, as well as its risk-manage-ment objective and strategy for undertaking the hedge.This process includes linking all derivatives that are desig-nated as fair-value, cash-flow, or foreign-currency hedgesto specific assets and liabilities on the balance sheet or tospecific firm commitments or forecasted transactions. Wealso formally assess, both at the hedge’s inception and onan ongoing basis, whether the derivatives that are used inhedging transactions are highly effective in offsettingchanges in fair values or cash flows of hedged items. If it isdetermined that a derivative is not highly effective, thenwe will be required to discontinue hedge accounting withrespect to that derivative prospectively.

Foreign Exchange Risk ManagementWe enter into forward exchange contracts to hedge antic-ipated transactions as well as receivables and payablesdenominated in foreign currencies for periods consistentwith our identified exposures. The purpose of the hedgingactivities is to minimize the effect of foreign exchangerate movements on our costs and on the cash flows thatwe receive from foreign subsidiaries. Almost all foreigncurrency contracts are denominated in currencies ofmajor industrial countries and are with large financial insti-tutions rated as strong investment grade by a major rat-ing agency. We also enter into foreign currency optionsto hedge anticipated transactions where there is a highprobability that anticipated exposures will materialize. Theforward exchange contracts and foreign currency optionsentered into to hedge anticipated transactions have beendesignated as cash-flow hedges. As of June 30, 2003,these cash-flow hedges were highly effective, in all mate-rial respects.

As a matter of policy, we only enter into contracts withcounterparties that have at least an “A” (or equivalent)credit rating. The counterparties to these contracts aremajor financial institutions. We do not have significantexposure to any one counterparty. Our exposure to creditloss in the event of nonperformance by any of the coun-terparties is limited to only the recognized, but not real-ized, gains attributable to the contracts. Managementbelieves risk of loss under these hedging contracts isremote and in any event would not be material to the con-solidated financial results. The contracts have varyingmaturities through the end of June 2004. Costs associ-ated with entering into such contracts have not beenmaterial to our consolidated financial results. We do notutilize derivative financial instruments for trading or

speculative purposes. At June 30, 2003, we had foreigncurrency contracts in the form of forward exchange con-tracts and option contracts in the amount of $476.7million and $57.7 million, respectively. The foreign cur-rencies included in forward exchange contracts (notionalvalue stated in U.S. dollars) are principally the Euro($114.0 million), Swiss franc ($61.9 million), Japanese yen($56.0 million), British pound ($49.8 million), Canadiandollar ($37.7 million), South Korean won ($37.6 million)and Australian dollar ($30.6 million). The foreign cur-rencies included in the option contracts (notional valuestated in U.S. dollars) are principally the Swiss franc ($21.9 million), Canadian dollar ($21.0 million) and Euro($11.7 million).

Interest Rate Risk ManagementWe enter into interest rate derivative contracts to managethe exposure to fluctuations of interest rates on ourfunded and unfunded indebtedness, as well as cash invest-ments, for periods consistent with the identified expo-sures. All interest rate derivative contracts are with largefinancial institutions rated as strong investment grade by amajor rating agency.

In May 2003, we entered into an interest rate swapagreement with a notional amount of $250.0 million toeffectively convert fixed interest on the existing $250.0million 6% Senior Notes to variable interest rates basedon LIBOR. We designated the swap as a fair value hedge.As of June 30, 2003, the fair value hedge was highly effec-tive, in all material respects.

Additionally, in May 2003, we entered into a series oftreasury lock agreements on a notional amount totaling$195.0 million at a weighted average all-in rate of 4.53%.These treasury lock agreements expire in September2003 and are used to hedge the exposure to a possiblerise in interest rates prior to the anticipated issuance ofdebt. The agreements will be settled upon the issuanceof the new debt, if completed, and any realized gain orloss to be received or paid by us will be amortized ininterest expense over the life of the new debt. We desig-nated the treasury lock agreements as cash flow hedges.As of June 30, 2003, the cash flow hedges were highlyeffective, in all material respects.

Market RiskWe use a value-at-risk model to assess the market risk ofour derivative financial instruments. Value-at-risk repre-sents the potential losses for an instrument or portfoliofrom adverse changes in market factors for a specifiedtime period and confidence level. We estimate value-at-risk across all of our derivative financial instrumentsusing a model with historical volatilities and correlations

53


calculated over the past 250-day period. The measuredvalue-at-risk, calculated as an average, for the twelvemonths ended June 30, 2003 related to our foreignexchange contracts was $7.6 million. As of June 30, 2003,the measured value-at-risk related to our interest ratecontracts was $10.3 million. The model estimates weremade assuming normal market conditions and a 95 percentconfidence level. We used a statistical simulation modelthat valued our derivative financial instruments againstone thousand randomly generated market price paths.

Our calculated value-at-risk exposure represents anestimate of reasonably possible net losses that would berecognized on our portfolio of derivative financial instru-ments assuming hypothetical movements in future mar-ket rates and is not necessarily indicative of actual results,which may or may not occur. It does not represent themaximum possible loss or any expected loss that mayoccur, since actual future gains and losses will differ fromthose estimated, based upon actual fluctuations in mar-ket rates, operating exposures, and the timing thereof, andchanges in our portfolio of derivative financial instrumentsduring the year.

We believe, however, that any loss incurred would beoffset by the effects of market rate movements on therespective underlying transactions for which the hedge is intended.

OFF-BALANCE SHEET ARRANGEMENTSWe do not maintain any off-balance sheet arrangements,transactions, obligations or other relationships with uncon-solidated entities that would be expected to have a mate-rial current or future effect upon our financial condition orresults of operations.

RECENTLY ISSUED ACCOUNTING STANDARDSIn May 2003, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Lia-bilities and Equity” (“SFAS No. 150”). SFAS No. 150 estab-lished standards for classifying and measuring certainfinancial instruments with characteristics of both liabilitiesand equity. It specifically requires that mandatorilyredeemable instruments, instruments with repurchaseobligations which embody, are indexed to, or obligate therepurchase of, the issuer’s own equity shares, and instru-ments with obligations to issue a variable number of theissuer’s own equity shares, be classified as a liability. Initialand subsequent measurements of the instruments differbased on the characteristics of each instrument and asprovided for in the statement. SFAS No. 150 is effective

for all freestanding financial instruments entered into ormodified after May 31, 2003 and otherwise becameeffective at the beginning of the first interim period begin-ning after June 15, 2003. We have adopted this statementeffective for all instruments entered into or modified afterMay 31, 2003 and will adopt the statement for any exist-ing financial instruments in the first quarter of fiscal 2004.Based on the provisions of this statement, beginning infiscal 2004, we will be classifying the $6.50 CumulativeRedeemable Preferred Stock as a liability and the relateddividends thereon will be characterized as interestexpense. Restatement of financial statements for earlieryears presented is not permitted. The adoption of thisstatement will result in the inclusion of the dividends onthe preferred stock (equal to $23.4 million per year) asinterest expense. While the inclusion will impact net earn-ings, net earnings attributable to common stock andearnings per common share will be unaffected. Given thatthe dividends are not deductible for income tax purposes,the inclusion of the preferred stock dividends as an inter-est expense will cause an increase in our effective taxrate. The adoption of SFAS No. 150 will have no impacton our financial condition.

In December 2002, the FASB issued SFAS No. 148,“Accounting for Stock-Based Compensation — Transitionand Disclosure” (“SFAS No. 148”). SFAS No. 148 providesalternative methods of transition for a voluntary changeto the fair value method of accounting for stock-basedemployee compensation as originally defined by SFASNo. 123, “Accounting for Stock-Based Compensation.”Additionally, SFAS No. 148 amends the disclosure require-ments of SFAS No. 123 to require prominent disclosure inboth the annual and interim financial statements aboutthe method of accounting for stock-based compensationand the effect of the method used on reported results.The transitional requirements of SFAS No. 148 are effec-tive for all financial statements for fiscal years ending afterDecember 15, 2002. We adopted the disclosure portionof this statement for the fiscal quarter ended March 31,2003. The application of the disclosure portion of thisstandard has no impact on our consolidated financialposition or results of operations. The FASB recently indi-cated that it will require stock-based employee compen-sation to be recorded as a charge to earnings pursuant toa standard on which it is currently deliberating. The FASBanticipates issuing an Exposure Draft in the fourth quarterof 2003 and a final statement in the second quarter of2004. We will continue to monitor the FASB’s progress onthe issuance of this standard as well as evaluate our posi-tion with respect to current guidance.

54


FORWARD-LOOKING INFORMATIONWe and our representatives from time to time make writ-ten or oral forward-looking statements, including state-ments contained in this and other filings with theSecurities and Exchange Commission, in our pressreleases and in our reports to stockholders. The words andphrases “will likely result,” “expect,” “believe,” “planned,”“will,” “will continue,” “may,” “could,” “anticipated,”“estimate,” “project” or similar expressions are intendedto identify “forward-looking statements” within the mean-ing of the Private Securities Litigation Reform Act of 1995.These statements include, without limitation, our expec-tations regarding sales, earnings or other future financialperformance and liquidity, product introductions, entryinto new geographic regions, information systems initia-tives, new methods of sale and future operations or oper-ating results. Although we believe that our expectationsare based on reasonable assumptions within the boundsof our knowledge of our business and operations, actualresults may differ materially from our expectations. Factorsthat could cause actual results to differ from expectationsinclude, without limitation:

(1) increased competitive activity from companies in theskin care, makeup, fragrance and hair care businesses,some of which have greater resources than we do;

(2) our ability to develop, produce and market newproducts on which future operating results may depend;

(3) consolidations, restructurings, bankruptcies and reor-ganizations in the retail industry causing a decrease in thenumber of stores that sell our products, an increase in the ownership concentration within the retail industry,ownership of retailers by our competitors and ownershipof competitors by our customers that are retailers;

(4) shifts in the preferences of consumers as to where and how they shop for the types of products and serviceswe sell;

(5) social, political and economic risks to our foreign ordomestic manufacturing, distribution and retail opera-tions, including changes in foreign investment and tradepolicies and regulations of the host countries and of theUnited States;

(6) changes in the laws, regulations and policies thataffect, or will affect, our business, including changes inaccounting standards, tax laws and regulations, trade rulesand customs regulations, and the outcome and expenseof legal or regulatory proceedings;

(7) foreign currency fluctuations affecting our results ofoperations and the value of our foreign assets, the rela-tive prices at which we and our foreign competitors sellproducts in the same markets and our operating andmanufacturing costs outside of the United States;

(8) changes in global or local economic conditions thatcould affect consumer purchasing, the willingness of con-sumers to travel, the financial strength of our customers,the cost and availability of capital, which we may need fornew equipment, facilities or acquisitions, and the assump-tions underlying our critical accounting estimates;

(9) shipment delays, depletion of inventory and increasedproduction costs resulting from disruptions of operationsat any of the facilities which, due to consolidations in our manufacturing operations, now manufacture nearlyall of our supply of a particular type of product (i.e.focus factories);

(10) real estate rates and availability, which may affect ourability to increase the number of retail locations at whichwe sell our products and the costs associated with ourother facilities;

(11) changes in product mix to products which are lessprofitable;

(12) our ability to acquire or develop e-commerce capa-bilities, and other new information and distribution tech-nologies, on a timely basis and within our cost estimates;

(13) our ability to capitalize on opportunities for improvedefficiency, such as globalization, and to integrate acquiredbusinesses and realize value therefrom; and

(14) consequences attributable to the events that arecurrently taking place in Iraq and that took place in New York City and Washington, D.C. on September 11,2001, including further attacks, retaliation and the threatof further attacks or retaliation.

We assume no responsibility to update forward-lookingstatements made herein or otherwise.

55


CONSOLIDAT ED BAL ANCE SHEE TS

JUNE 30 2003 2002(In millions, except share data)

ASSETSCurrent AssetsCash and cash equivalents $ 364.1 $ 546.9Accounts receivable, net 634.2 624.8Inventory and promotional merchandise, net 599.0 544.5Prepaid expenses and other current assets 247.6 211.4

Total current assets 1,844.9 1,927.6

Property, Plant and Equipment, net 607.7 580.7

Other AssetsInvestments, at cost or market value 14.0 30.3Deferred income taxes 38.7 72.7Goodwill, net 695.3 675.6Other intangible assets, net 65.4 18.4Other assets, net 83.9 111.2

Total other assets 897.3 908.2

Total assets $3,349.9 $3,416.5

LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent LiabilitiesShort-term debt $ 7.8 $ 6.6Accounts payable 229.9 216.4Accrued income taxes 111.9 110.0Other accrued liabilities 704.0 626.6

Total current liabilities 1,053.6 959.6

Noncurrent LiabilitiesLong-term debt 283.6 403.9Other noncurrent liabilities 216.8 220.9

Total noncurrent liabilities 500.4 624.8

Commitments and Contingencies (see Note 15)

$6.50 Cumulative Redeemable Preferred Stock, at redemption value 360.0 360.0

Minority interest 12.3 10.2

Stockholders’ EquityCommon stock, $.01 par value; 650,000,000 shares Class A authorized; shares issued:

133,616,710 in 2003 and 131,567,986 in 2002; 240,000,000 shares Class B authorized; shares issued and outstanding: 107,462,533 in 2003 and 108,412,533 in 2002 2.4 2.4

Paid-in capital 293.7 268.8Retained earnings 1,613.6 1,363.7Accumulated other comprehensive income (loss) (53.1) (92.5)

1,856.6 1,542.4Less: Treasury stock, at cost; 13,623,060 Class A shares at June 30, 2003 and

2,377,860 Class A shares at June 30, 2002 (433.0) (80.5)

Total stockholders’ equity 1,423.6 1,461.9

Total liabilities and stockholders’ equity $3,349.9 $3,416.5


56


CONSOLIDAT ED S TAT EMEN TS OF S TOCKHOLDER S’ EQUIT YAND COMPR EHENSIVE INCOME


STOCKHOLDERS’ EQUITYCommon stock, beginning of year $ 2.4 $ 2.4 $ 2.4

Common stock, end of year 2.4 2.4 2.4

Paid-in capital, beginning of year 268.8 258.3 237.1Stock compensation programs 24.9 10.5 21.2

Paid-in capital, end of year 293.7 268.8 258.3

Retained earnings, beginning of year 1,363.7 1,242.7 1,008.6Preferred stock dividends (23.4) (23.4) (23.4)Common stock dividends (46.5) (47.5) (47.7)Net earnings for the year 319.8 191.9 305.2

Retained earnings, end of year 1,613.6 1,363.7 1,242.7

Accumulated other comprehensive loss, beginning of year (92.5) (120.5) (57.1)Other comprehensive income (loss) 39.4 28.0 (63.4)

Accumulated other comprehensive loss, end of year (53.1) (92.5) (120.5)

Treasury stock, beginning of year (80.5) (30.8) (30.7)Acquisition of treasury stock (352.5) (49.7) (0.1)

Treasury stock, end of year (433.0) (80.5) (30.8)

Total stockholders’ equity $1,423.6 $1,461.9 $1,352.1

COMPREHENSIVE INCOMENet earnings $ 319.8 $ 191.9 $ 305.2

Other comprehensive income (loss):Net unrealized investment gains (losses) 0.8 (3.0) (11.0)Net derivative instrument gains (losses) 7.6 (7.1) (2.0)Net minimum pension liability adjustments (20.3) (7.9) (12.4)Translation adjustments 51.3 46.0 (38.0)

Other comprehensive income (loss) 39.4 28.0 (63.4)

Total comprehensive income $ 359.2 $ 219.9 $ 241.8


57


CONSOLIDAT ED S TAT EMEN TS OF CA SH F LOWS


Cash Flows from Operating ActivitiesNet earnings $ 319.8 $ 191.9 $ 305.2Adjustments to reconcile net earnings to net cash flows provided by

operating activities:Depreciation and amortization 174.8 162.0 156.3Amortization of purchased royalty rights — — 6.6Deferred income taxes 36.5 (22.6) 4.7Minority interest 6.7 4.7 1.9Non-cash stock compensation 1.5 (0.1) 0.7Cumulative effect of a change in accounting principle — 20.6 2.2Non-cash portion of restructuring and other non-recurring expenses — 58.0 27.1Other non-cash items 0.9 0.9 —

Changes in operating assets and liabilities:Decrease (increase) in accounts receivable, net 38.6 (15.4) (57.3)Decrease (increase) in inventory and promotional merchandise, net (15.7) 102.2 (102.1)Increase in other assets (15.3) (11.7) (53.6)Increase (decrease) in accounts payable (8.4) (32.6) 14.2Increase in accrued income taxes 5.4 28.8 5.9Increase (decrease) in other accrued liabilities 52.7 59.6 (23.4)Increase (decrease) in other noncurrent liabilities (49.0) (28.3) 17.0

Net cash flows provided by operating activities 548.5 518.0 305.4

Cash Flows from Investing ActivitiesCapital expenditures (163.1) (203.2) (192.2)Acquisition of businesses, net of acquired cash (50.4) (18.5) (16.0)Proceeds from disposition of long-term investments 21.0 4.7 1.9

Net cash flows used for investing activities (192.5) (217.0) (206.3)

Cash Flows from Financing ActivitiesIncrease (decrease) in short-term debt, net 2.9 0.6 (0.1)Proceeds from issuance of long-term debt, net — 247.2 24.5Repayments of long-term debt (135.8) (256.6) (30.1)Net proceeds from employee stock transactions 16.7 7.7 13.3Payments to acquire treasury stock (352.5) (49.7) (0.1)Dividends paid (81.7) (71.0) (71.0)

Net cash flows used for financing activities (550.4) (121.8) (63.5)

Effect of Exchange Rate Changes on Cash and Cash Equivalents 11.6 21.0 (9.2)

Net Increase (Decrease) in Cash and Cash Equivalents (182.8) 200.2 26.4Cash and Cash Equivalents at Beginning of Year 546.9 346.7 320.3

Cash and Cash Equivalents at End of Year $ 364.1 $ 546.9 $ 346.7

Supplemental disclosures of cash flow information (see Note 17)Cash paid during the year for:

Interest $ 17.7 $ 17.6 $ 26.7

Income Taxes $ 134.7 $ 120.5 $ 176.6


58

NOTE 1 – DESCRIPTION OF BUSINESSThe Estée Lauder Companies Inc. manufactures, marketsand sells skin care, makeup, fragrance and hair care prod-ucts around the world. Products are marketed under thefollowing brand names: Estée Lauder, Clinique, Aramis,Prescriptives, Origins, M.A.C, Bobbi Brown, La Mer, jane,Aveda, Stila, Jo Malone, Bumble and bumble and Darphin.The Estée Lauder Companies Inc. is also the globallicensee of the Tommy Hilfiger, Donna Karan, kate spadeand Michael Kors brands for fragrances and cosmetics.

NOTE 2 – SUMMARY OF SIGNIFICANTACCOUNTING POLICIESPrinciples of ConsolidationThe accompanying consolidated financial statementsinclude the accounts of The Estée Lauder Companies Inc.and its subsidiaries (collectively, the “Company”). All

significant intercompany balances and transactions havebeen eliminated.

Certain amounts in the consolidated financial state-ments of prior years have been reclassified to conform tocurrent year presentation for comparative purposes.

Net Earnings Per Common ShareNet earnings per common share (“basic EPS”) is com-puted by dividing net earnings, after deducting preferredstock dividends on the Company’s $6.50 CumulativeRedeemable Preferred Stock, by the weighted averagenumber of common shares outstanding and contingentlyissuable shares (which satisfy certain conditions). Netearnings per common share assuming dilution (“dilutedEPS”) is computed by reflecting potential dilution from theexercise of stock options.

A reconciliation between the numerators and denomi-nators of the basic and diluted EPS computations is as follows:

YEAR ENDED JUNE 30 2003 2002 2001(In millions, except per share data)Numerator:Net earnings before accounting change $319.8 $212.5 $307.4Preferred stock dividends (23.4) (23.4) (23.4)

Net earnings attributable to common stock before accounting change 296.4 189.1 284.0Cumulative effect of a change in accounting principle, net of tax — (20.6) (2.2)

Net earnings attributable to common stock $296.4 $168.5 $281.8

Denominator:Weighted average common shares outstanding — Basic 232.6 238.2 238.4Effect of dilutive securities: Stock options 2.1 2.9 3.8

Weighted average common shares outstanding — Diluted 234.7 241.1 242.2

Basic net earnings per common share: Net earnings before accounting change $ 1.27 $ .79 $ 1.19Cumulative effect of a change in accounting principle, net of tax — (.08) (.01)

Net earnings $ 1.27 $ .71 $ 1.18

Diluted net earnings per common share:Net earnings before accounting change $ 1.26 $ .78 $ 1.17Cumulative effect of a change in accounting principle, net of tax — (.08) (.01)

Net earnings $ 1.26 $ .70 $ 1.16

As of June 30, 2003, 2002 and 2001, options to purchase13.6 million, 12.1 million and 10.5 million shares, respec-tively, of Class A Common Stock were not included in thecomputation of diluted EPS because the exercise pricesof those options were greater than the average marketprice of the common stock and their inclusion would beanti-dilutive. The options were still outstanding at the endof the applicable periods.

Cash and Cash EquivalentsCash and cash equivalents include $76.2 million and$104.6 million of short-term time deposits at June 30,2003 and 2002, respectively. The Company considers allhighly liquid investments with original maturities of threemonths or less to be cash equivalents.

Accounts ReceivableAccounts receivable is stated net of the allowance for doubtful accounts and customer deductions of$31.8 million and $30.6 million as of June 30, 2003 and2002, respectively.


NOT ES TO CONSOLIDAT ED F INANCIAL S TAT EMEN TS


Currency Translation and TransactionsAll assets and liabilities of foreign subsidiaries and affili-ates are translated at year-end rates of exchange, whilerevenue and expenses are translated at weighted averagerates of exchange for the year. Unrealized translation gainsor losses are reported as cumulative translation adjustmentsthrough other comprehensive income. Such adjustmentsamounted to $51.3 million, $46.0 million and $(38.0)million of unrealized translation gains (losses) in fiscal2003, 2002 and 2001, respectively.

The Company enters into forward foreign exchangecontracts and foreign currency options to hedge foreigncurrency transactions for periods consistent with its iden-tified exposures. Accordingly, the Company categorizesthese instruments as entered into for purposes other than trading.

The accompanying consolidated statements of earn-ings include net exchange losses of $15.0 million and $6.8million in fiscal 2003 and 2002, respectively, and netexchange gains of $9.2 million in fiscal 2001.

Inventory and Promotional MerchandiseInventory and promotional merchandise only includesinventory considered saleable or usable in future periods, and is stated at the lower of cost or fair-marketvalue, with cost being determined on the first-in, first-out method. Promotional merchandise is charged toexpense at the time the merchandise is shipped to theCompany’s customers.

JUNE 30 2003 2002(In millions)

Inventory and promotional merchandise consists of:

Raw materials $137.7 $117.5Work in process 34.1 27.0Finished goods 296.6 272.2Promotional merchandise 130.6 127.8

$599.0 $544.5

Property, Plant and EquipmentProperty, plant and equipment is carried at cost lessaccumulated depreciation and amortization. For financialstatement purposes, depreciation is provided principallyon the straight-line method over the estimated useful livesof the assets ranging from 3 to 40 years. Leaseholdimprovements are amortized on a straight-line basis overthe shorter of the lives of the respective leases or theexpected useful lives of those improvements.


Land $ 13.5 $ 13.0Buildings and improvements 152.7 144.0Machinery and equipment 676.7 611.7Furniture and fixtures 95.3 86.1Leasehold improvements 538.6 447.2

1,476.8 1,302.0Less accumulated depreciation and amortization 869.1 721.3

$ 607.7 $ 580.7

Depreciation and amortization of property, plant andequipment was $157.0 million, $140.5 million and $112.1million in fiscal 2003, 2002 and 2001, respectively.

Goodwill and Other Intangible AssetsEffective July 1, 2001, the Company adopted Statementof Financial Accounting Standards (“SFAS”) No. 141,“Business Combinations” and SFAS No. 142, “Goodwilland Other Intangible Assets.” These statements estab-lished financial accounting and reporting standards foracquired goodwill and other intangible assets. Specifically,the standards address how acquired intangible assetsshould be accounted for both at the time of acquisitionand after they have been recognized in the financial state-ments. The provisions of SFAS No. 141 apply to allbusiness combinations initiated after June 30, 2001. Inaccordance with SFAS No. 142, intangible assets, includ-ing purchased goodwill, must be evaluated for impair-ment. Those intangible assets that will continue to beclassified as goodwill or as other intangibles with indefi-nite lives are no longer amortized.

In accordance with SFAS No. 142, the Company com-pleted its transitional impairment testing of intangibleassets during the first quarter of fiscal 2002. That effort,and preliminary assessments of the Company’s identifi-able intangible assets, indicated that little or no adjustmentwould be required upon adoption of this pronouncement.The impairment testing is performed in two steps: (i) theCompany determines impairment by comparing the fairvalue of a reporting unit with its carrying value, and (ii) ifthere is an impairment, the Company measures theamount of impairment loss by comparing the implied fairvalue of goodwill with the carrying amount of that good-will. Subsequent to the first quarter of fiscal 2002, withthe assistance of a third-party valuation firm, the Companyfinalized the testing of goodwill. Using conservative, butrealistic, assumptions to model the Company’s jane busi-ness, the Company determined that the carrying value ofthis unit was slightly greater than the derived fair value,indicating an impairment in the recorded goodwill. To

60


determine fair value, the Company relied on three valua-tion models: guideline public companies, acquisitionanalysis and discounted cash flow. For goodwill valuationpurposes only, the revised fair value of this unit was allo-cated to the assets and liabilities of the business unit toarrive at an implied fair value of goodwill, based uponknown facts and circumstances, as if the acquisitionoccurred currently. This allocation resulted in a write-down of recorded goodwill in the amount of $20.6

million, which has been reported as the cumulative effectof a change in accounting principle, as of July 1, 2001, in the accompanying consolidated statements of earnings.On a product category basis, this write-down would haveprimarily impacted the Company’s makeup category.

During fiscal 2002, the Company recorded a goodwillimpairment charge related to its Gloss.com business as a component of its restructuring expense (see Note 5).

61

The following table presents adjusted net earnings and earnings per share data restated to include the retroactive impactof the adoption of SFAS No. 142.

YEAR ENDED JUNE 30 2003 2002 2001(In millions, except per share data)

Reported Net Earnings before Accounting Change $319.8 $212.5 $307.4Cumulative effect of a change in accounting principle, net of tax — (20.6) (2.2)

Net Earnings 319.8 191.9 305.2Preferred stock dividends 23.4 23.4 23.4

Reported Net Earnings Attributable to Common Stock 296.4 168.5 281.8Add back:Goodwill amortization, net of tax — — 13.4

Adjusted Net Earnings $296.4 $168.5 $295.2

Basic net earnings per common share:Reported net earnings attributable to common stock before accounting change $ 1.27 $ .79 $ 1.19Cumulative effect of a change in accounting principle, net of tax — (.08) (.01)

Net earnings attributable to common stock 1.27 .71 1.18Goodwill amortization, net of tax — — .06

Adjusted net earnings attributable to common stock $ 1.27 $ .71 $ 1.24

Diluted net earnings per common share:Reported net earnings attributable to common stock before accounting change $ 1.26 $ .78 $ 1.17Cumulative effect of a change in accounting principle, net of tax — (.08) (.01)

Net earnings attributable to common stock 1.26 .70 1.16Goodwill amortization, net of tax — — .06

Adjusted net earnings attributable to common stock $ 1.26 $ .70 $ 1.22

Weighted average common shares outstanding:Basic 232.6 238.2 238.4Diluted 234.7 241.1 242.2

GoodwillThe change in the carrying amount of goodwill is as follows:

YEAR ENDED JUNE 30 2003 2002(In millions)

Net beginning balance $675.6 $699.7Goodwill impairment loss upon adoption of new accounting principle — (20.6)Restructuring write-off of Gloss.com acquisition goodwill — (20.1)Goodwill acquired during the period 19.7 16.6

Net ending balance $695.3 $675.6


Other Intangible AssetsOther intangible assets consist of the following:

Gross TotalCarrying Accumulated Net Book

JUNE 30, 2003 Value Amortization Value(In millions)

License agreements $32.4 $ 7.9 $24.5Trademarks and other 46.7 6.7 39.9Patents 1.6 0.6 1.0

Total $80.7 $15.3 $65.4

Gross TotalCarrying Accumulated Net Book

JUNE 30, 2002 Value Amortization Value(In millions)

License agreements $15.0 $ 6.2 $ 8.8Trademarks and other 15.2 6.7 8.5Patents 1.6 0.5 1.1

Total $31.8 $13.4 $18.4

Pursuant to the adoption of SFAS No. 142 and effectiveJuly 1, 2001, trademarks have been classified as indefinitelived assets and are no longer amortized, and are evalu-ated periodically for impairment. The cost of other intan-gible assets is amortized on a straight-line basis over their estimated useful lives. The aggregate amortizationexpenses related to amortizable intangible assets for theyears ended June 30, 2003, 2002 and 2001 were $1.9million, $1.5 million and $9.6 million, respectively.

Long-Lived AssetsIn accordance with SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” long-livedassets are reviewed for impairment whenever events orchanges in circumstances indicate that the carryingamount of the assets in question may not be recoverable.An impairment would be recorded in circumstanceswhere undiscounted cash flows expected to be generatedby an asset are less than the carrying value of that asset.

62

Accumulated Other Comprehensive Income The components of accumulated other comprehensive income (loss) (“OCI”) included in the accompanying consoli-dated balance sheets consist of the following:


Net unrealized investment gains (losses), beginning of year $ (0.1) $ 2.9 $ 13.9Unrealized investment gains (losses) 1.4 (5.0) (18.3)Provision for deferred income taxes (0.6) 2.0 7.3

Net unrealized investment gains (losses), end of year 0.7 (0.1) 2.9

Net derivative instruments, beginning of year (9.1) (2.0) —Gain (loss) on derivative instruments (1.6) (16.1) 8.8Provision for deferred income taxes 0.5 5.5 (3.1)Reclassification to earnings during the year 13.3 5.3 (12.0)Provision for deferred income taxes on reclassification (4.6) (1.8) 4.3

Net derivative instruments, end of year (1.5) (9.1) (2.0)

Net minimum pension liability adjustments, beginning of year (20.3) (12.4) —Minimum pension liability adjustments (30.8) (11.6) (19.4)Provision for deferred income taxes 10.5 3.7 7.0

Net minimum pension liability adjustments, end of year (40.6) (20.3) (12.4)

Cumulative translation adjustments, beginning of year (63.0) (109.0) (71.0)Translation adjustments 51.3 46.0 (38.0)

Cumulative translation adjustments, end of year (11.7) (63.0) (109.0)

Accumulated other comprehensive income (loss) $(53.1) $ (92.5) $(120.5)

2003. Offsetting the aforementioned was a $1.7 million,net of tax, gain relating to treasury lock agreements thatexpire in September 2003 which will be settled upon theissuance of new debt, if completed. Any realized gain or loss to be received or paid by the Company will beamortized in interest expense over the life of the new debt.

Of the $1.5 million, net of tax, derivative instruments lossrecorded in OCI at June 30, 2003, $3.2 million, net of tax,related to foreign currency derivatives that the Companyestimates will be classified to earnings as losses during thenext twelve months assuming exchange rates at the timeof settlement are equal to the forward rates as of June 30,


Revenue RecognitionGenerally, revenues from merchandise sales are recordedat the time the product is shipped to the customer. TheCompany reports its sales levels on a net sales basis,which is computed by deducting from gross sales theamount of actual returns received and an amount estab-lished for anticipated returns. As a percent of gross sales,returns were 5.2% in fiscal 2003 and 4.9% in each of fiscal2002 and 2001.

Advertising and PromotionCosts associated with advertising are expensed during theyear as incurred. Global advertising expenses, whichprimarily include television, radio and print media, andpromotional expenses, such as products used as salesincentives, were $1,425.6 million, $1,326.2 million and$1,255.3 million in fiscal 2003, 2002 and 2001, respec-tively. These amounts include expenses relating to pur-chase with purchase and gift with purchase promotionsthat are reflected in net sales and cost of sales. Advertisingand promotional expenses included in operating expenseswere $1,227.3 million, $1,122.0 million and $1,060.8million in fiscal 2003, 2002 and 2001, respectively.

Research and DevelopmentResearch and development costs, which amounted to$60.8 million, $61.3 million and $57.3 million in fiscal 2003,2002 and 2001, respectively, are expensed as incurred.

Related Party Royalties and Trademarks Under agreements covering the Company’s purchase oftrademarks for a percentage of related sales, royaltypayments totaling $20.3 million, $16.5 million and $16.0million in fiscal 2003, 2002 and 2001, respectively, have

been charged to expense. Such payments were made toMrs. Estée Lauder. During fiscal 1996, the Companypurchased a stockholder’s rights to receive certain U.S.royalty payments for $88.5 million, which was fully amor-tized by November 2000. In fiscal 2001, $6.6 million wasamortized as a charge to expense.

Stock CompensationThe Company observes the provisions of SFAS No. 123,“Accounting for Stock-Based Compensation,” (“SFASNo. 123”) by continuing to apply the provisions ofAccounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees” (“APB No. 25”).

The Company applies the intrinsic value method asoutlined in APB No. 25 and related interpretations inaccounting for stock options and share units grantedunder these programs. Under the intrinsic value method,no compensation expense is recognized if the exerciseprice of the Company’s employee stock options equalsthe market price of the underlying stock on the date ofthe grant. Accordingly, no compensation cost has beenrecognized on options granted to employees. SFASNo. 123 requires that the Company provide pro formainformation regarding net earnings and net earnings percommon share as if compensation cost for the Company’sstock option programs had been determined in accor-dance with the fair value method prescribed therein. TheCompany adopted the disclosure portion of SFASNo. 148, “Accounting for Stock-Based Compensation —Transition and Disclosure” requiring quarterly SFASNo. 123 pro forma disclosure. The following table illus-trates the effect on net earnings and earnings per com-mon share as if the fair value method had been applied toall outstanding awards in each period presented.

63

YEAR ENDED JUNE 30 2003 2002(i) 2001(ii)

(In millions, except per share data)

Net earnings attributed to common stock, as reported $296.4 $168.5 $281.8Deduct: Total stock-based employee compensation expense determined

under fair value method for all awards, net of related tax effects 22.9 2.7 24.4

Pro forma net earnings, attributable to common stock $273.5 $165.8 $257.4

Earnings per common share:Net earnings per common share — Basic, as reported $ 1.27 $ .71 $ 1.18

Net earnings per common share — Basic, pro forma $ 1.18 $ .70 $ 1.08

Net earnings per common share — Diluted, as reported $ 1.26 $ .70 $ 1.16

Net earnings per common share — Diluted, pro forma $ 1.16 $ .68 $ 1.06

(i) Beginning in fiscal 2002, the pro forma charge for compensation cost related to stock options granted will be recognized over the service period.The service period represents the period of time between the date of grant and the date each option becomes exercisable without consideration ofacceleration provisions (e.g. retirement, change of control, etc.).

(ii) In fiscal 2001, the Company determined the pro forma charge for compensation cost assuming all options were immediately vested upon the date of grant.


Concentration of Credit RiskThe Company is a worldwide manufacturer, marketer anddistributor of skin care, makeup, fragrance and hair careproducts. Domestic and international sales are madeprimarily to department stores, specialty retailers, per-fumeries and pharmacies. The Company grants credit toall qualified customers and does not believe it is exposedsignificantly to any undue concentration of credit risk.

For the fiscal years ended June 30, 2003, 2002 and2001, the Company’s three largest customers accountedfor an aggregate of 24%, 25% and 28%, respectively, ofnet sales. No single customer accounted for more than10% of the Company’s net sales during fiscal 2003 or2002. One department store group accounted for 11% ofthe Company’s net sales in the fiscal year ended June 30,2001. In the same year, another department store groupaccounted for 10% of the Company’s net sales.

Additionally, as of June 30, 2003 and 2002, theCompany’s three largest customers accounted for anaggregate of 28% of its outstanding accounts receivable.

Management EstimatesThe preparation of financial statements in conformity withgenerally accepted accounting principles requires man-agement to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues andexpenses reported in those financial statements. Actualresults could differ from those estimates and assumptions.

Derivative Financial InstrumentsEffective July 1, 2000, the Company adopted SFAS No. 133,“Accounting for Derivative Instruments and HedgingActivities,” as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain HedgingActivities.” These statements established accounting and reporting standards for derivative instruments, includ-ing certain derivative instruments embedded in othercontracts, and for hedging activities. SFAS No. 133, asamended, requires the recognition of all derivative

instruments as either assets or liabilities in the statement of financial position measured at fair value.

In accordance with the provisions of SFAS No. 133, asamended, the Company recorded a non-cash charge toearnings of $2.2 million, after tax, to reflect the change intime-value from the dates of the derivative instruments’inception through the date of transition (July 1, 2000). Thischarge is reflected as the cumulative effect of a change inaccounting principle in fiscal 2001 in the accompanyingconsolidated statements of earnings.

Recently Issued Accounting StandardsIn May 2003, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabili-ties and Equity” (“SFAS No. 150”). SFAS No. 150 estab-lished standards for classifying and measuring certainfinancial instruments with characteristics of both liabilitiesand equity. It specifically requires that mandatorilyredeemable instruments, instruments with repurchaseobligations which embody, are indexed to, or obligate therepurchase of, the issuer’s own equity shares, and instru-ments with obligations to issue a variable number of theissuer’s own equity shares, be classified as a liability. Initialand subsequent measurements of the instruments differbased on the characteristics of each instrument and asprovided for in the statement. SFAS No. 150 is effectivefor all freestanding financial instruments entered into ormodified after May 31, 2003 and otherwise becameeffective at the beginning of the first interim period begin-ning after June 15, 2003. The Company has adopted thisstatement effective for all instruments entered into ormodified after May 31, 2003 and will adopt the statementfor any existing financial instruments in the first quarter offiscal 2004. Based on the provisions of this statement,beginning in fiscal 2004, the Company will be classifyingthe $6.50 Cumulative Redeemable Preferred Stock as aliability and the related dividends will be characterized as

64

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

YEAR ENDED JUNE 30 2003 2002 2001

Average expected volatility 31% 31% 31%Average expected option life 7 years 7 years 7 yearsAverage risk-free interest rate 4.2% 4.9% 5.9%Average dividend yield .6% .5% .5%


interest expense. Restatement of financial statements forearlier years presented is not permitted. The adoption ofthis statement will result in the inclusion of the dividendson the preferred stock (equal to $23.4 million per year)as interest expense. While the inclusion will impact netearnings, net earnings attributable to common stock andearnings per common share will be unaffected. Given thatthe dividends are not deductible for income tax purposes,the inclusion of the preferred stock dividends as interestexpense will cause an increase in the Company’s effec-tive tax rate. The adoption of SFAS No. 150 will have noimpact on the Company’s financial condition.

In December 2002, the FASB issued SFAS No. 148,“Accounting for Stock-Based Compensation — Transitionand Disclosure” (“SFAS No. 148”). SFAS No. 148 providesalternative methods of transition for a voluntary changeto the fair value method of accounting for stock-basedemployee compensation as originally defined by SFASNo. 123. Additionally, SFAS No. 148 amends the disclo-sure requirements of SFAS No. 123 to require prominentdisclosure in both the annual and interim financial state-ments about the method of accounting for stock-basedcompensation and the effect of the method used onreported results. The transitional requirements of SFASNo. 148 are effective for all financial statements for fiscalyears ending after December 15, 2002. The Companyadopted the disclosure portion of this statement for thefiscal quarter ended March 31, 2003. The application ofthe disclosure portion of this standard has no impact onthe Company’s consolidated financial position or resultsof operations. The FASB recently indicated that it willrequire stock-based employee compensation to berecorded as a charge to earnings pursuant to a standardon which it is currently deliberating. The FASB anticipatesissuing an Exposure Draft in the fourth quarter of 2003and a final statement in the second quarter of 2004. TheCompany will continue to monitor the FASB’s progress onthe issuance of this standard as well as evaluate its posi-tion with respect to current guidance.

NOTE 3 – PUBLIC OFFERINGSDuring October 2001, a member of the Lauder familysold 5,000,000 shares of Class A Common Stock in a reg-istered public offering. The Company did not receive anyproceeds from the sale of these shares.

NOTE 4 – ACQUISITION OF BUSINESSES ANDLICENSE ARRANGEMENTSOn April 30, 2003, the Company completed the acquisi-tion of the Paris-based Darphin group of companies thatdevelops, manufactures and markets the “Darphin” brandof skin care and makeup products. The initial purchaseprice, paid at closing, was funded by cash provided byoperations, the payment of which did not have a materialeffect on the Company’s results of operations or financialcondition. An additional payment is expected to be madein fiscal 2009, the amount of which will depend on futurenet sales and earnings of the Darphin business.

At various times during fiscal 2003, 2002 and 2001, theCompany acquired businesses engaged in the wholesaledistribution and retail sale of Aveda products, as well asother products, in the United States and other countries.In fiscal 2002, the Company purchased an Avedawholesale distributor business in Korea and acquired the minority interest of its Aveda joint venture in the United Kingdom.

In fiscal 2001, the Company purchased a wholesaledistributor business in Israel, a majority interest of thewholesale distributor business in Chile and created a jointventure in Greece in which the Company owns a con-trolling majority interest. In fiscal 2002, the Companyacquired the remaining minority interest of its jointventure in Chile.

The aggregate purchase price for these transactions,which includes acquisition costs, was $50.4 million, $18.5million, and $16.0 million in fiscal 2003, 2002 and 2001,respectively, and each transaction was accounted forusing the purchase method of accounting. Accordingly,the results of operations for each of the acquired busi-nesses are included in the accompanying consolidatedfinancial statements commencing with its date of originalacquisition. Pro forma results of operations, as if each ofsuch businesses had been acquired as of the beginningof the year of acquisition, have not been presented, as theimpact on the Company’s consolidated financial resultswould not have been material.

Subsequent to year-end, the Company acquired theRodan & Fields skin care line (see Note 20).

In May 2003, the Company entered into a licenseagreement for fragrances and beauty products under the“Michael Kors” trademarks with Michael Kors L.L.C.and purchased certain related rights and inventory fromAmerican Designer Fragrances, a division of LVMH.



Net Sales Cost of Sales Operating Expenses Total(In millions)

Internet $ — $ — $ 44.0 $ 44.0Supply Chain — — 23.7 23.7Globalization of Organization — — 27.1 27.1Distribution 6.2 0.8 15.6 22.6

Total charge $6.2 $0.8 $110.4 117.4

Tax effect (40.5)

Net charge $ 76.9

Restructuring

NOTE 5 – RESTRUCTURING AND SPECIAL CHARGESDuring the fourth quarter of fiscal 2003, the Companyrecorded a special pre-tax charge of $22.0 million, or$13.5 million after-tax, equal to $.06 per diluted commonshare, in connection with the proposed settlement of alegal proceeding brought against a number of defendantsincluding the Company (see Note 15). The amount of thecharge in this case is significantly larger than similarcharges the Company has incurred individually or in theaggregate for legal proceedings in any prior year.

During the fourth quarter of fiscal 2002, the Companyrecorded a restructuring charge related to repositioningcertain businesses as part of its ongoing efforts to drivelong-term growth and increase profitability. The restruc-turing focused on cost reduction opportunities related tothe Internet, supply chain, globalization of the organiza-tion and distribution channel refinements. The Companycommitted to a defined plan of action, which resulted inan aggregate pre-tax charge of $117.4 million, of which$59.4 million is cash related. On an after-tax basis, theaggregate charge was $76.9 million, equal to $.32 perdiluted share.

Specifically, the charge includes the following:

• Internet. In an effort to achieve strategic objectives,reduce costs and improve profitability, the Companyoutsourced Gloss.com platform development and main-tenance efforts to a third-party provider. Additionally,Gloss.com closed its San Francisco facility and consoli-dated its operations in New York. As a result, included inthe charge is a $23.9 million provision for restructuringthe Gloss.com operations, including benefits and sever-ance packages for 36 employees as well as asset write-offs. The Company also took a $20.1 million charge towrite off the related Gloss.com acquisition goodwill.

• Supply Chain. Building on previously announced sup-ply chain initiatives, the Company restructured certainmanufacturing, distribution, research and development,information systems and quality assurance operations inthe United States, Canada and Europe, which includedbenefits and severance packages for 110 employees.A charge of $23.7 million was recorded related to this effort.

• Globalization of Organization. The Company con-tinued to implement its transition, announced in fiscal2001, to a global brand structure designed to stream-line the decision making process and increase inno-vation and speed-to-market. The next phase of thistransition entailed eliminating duplicate functions andresponsibilities, which resulted in charges for benefitsand severance for 122 employees. The Companyrecorded a charge of $27.1 million associated withthese efforts.

• Distribution. The Company evaluated areas of distribu-tion relative to its financial targets and decided to focusits resources on the most productive sales channels andmarkets. As a result, the Company closed its operationsin Argentina and the remaining customers are beingserviced by the Company’s Chilean affiliate. The Com-pany began closing all remaining in-store “tommy’sshops” and other select points of distribution. TheCompany recorded a $22.6 million provision related tothese actions, which included benefits and severance for85 employees.


The restructuring charge was recorded in other accruedliabilities or, where applicable, as a reduction of therelated asset. During fiscal 2003 and 2002, $32.2 millionand $9.3 million, respectively, related to this restructuringwas paid. As of June 30, 2003 and 2002, the restructuringaccrual balance was $21.9 million and $54.1 million,respectively, and the Company expects to settle a major-ity of the remaining obligations by the end of fiscal 2004with certain additional payments made ratably throughfiscal 2006.

During the fourth quarter of fiscal 2001, the Companyrecorded one-time charges for restructuring and specialcharges related to repositioning certain businesses as partof the Company’s ongoing efforts to drive long-termgrowth and increase profitability. The restructuring andspecial charges focused on four areas: product fixturesfor the jane brand; in-store “tommy’s shops”; informationsystems and other assets; and global brand reorganiza-tion. The Company committed to a defined plan of action,which resulted in an aggregate pre-tax charge of $63.0million, of which $35.9 million is cash related. On an after-tax basis, the aggregate charge was $40.3 million, equal to$.17 per diluted share.

Specifically, the charge included the following:

• jane. jane switched from its traditional wall displays to acarded program. The charge included a $16.1 millionwrite-down of existing jane product fixtures and thereturn of uncarded product from virtually all of thedistribution outlets in the United States.

• “tommy’s shops.” The Company restructured thein-store “tommy’s shops” to focus on the most pro-ductive locations and decided to close certain shopsthat underperformed relative to expectations. As aresult, the Company recorded a $6.3 million provisionfor the closing of 86 under-performing in-store“tommy’s shops,” located in the United States, and forrelated product returns.

• Information systems and other assets. In response tochanging technology and the Company’s new strategicdirection, the charge included a $16.2 million provisionfor costs associated with the reevaluation of supplychain systems that the Company no longer utilized andwith the elimination of unproductive assets related tothe change to standard financial systems.

• Global brand reorganization. The Company recorded$20.8 million related to benefits and severance pack-ages for 75 management employees who were affectedby the reconfiguration to a global brand structure andanother $3.6 million related to infrastructure costs.


Net Sales Cost of Sales Operating Expenses Special Charges Total(In millions)

jane $5.7 $ 1.5 $ 4.8 $ 4.1 $16.1“tommy’s shops” 2.3 (0.4) 4.4 — 6.3Information systems and

other assets — — 4.6 11.6 16.2Global brand reorganization — — 23.8 0.6 24.4

Total charge $8.0 $ 1.1 $37.6 $16.3 63.0

Tax effect (22.7)

Net charge $40.3

Restructuring

The restructuring charge was recorded in other accruedliabilities or as a reduction of fixed assets. During fiscal2003, 2002 and 2001, $4.7 million, $26.7 million and $0.7 million, respectively, was paid. As of June 30, 2003

and 2002, the remaining obligation was $2.6 million and$7.1 million, respectively, with remaining paymentsexpected to be made ratably through fiscal 2004.


NOTE 6 – INCOME TAXESThe provision for income taxes is comprised of the following:


Current:Federal $ 34.8 $ 38.3 $ 72.3Foreign 84.0 92.2 89.3State and local 5.2 6.5 7.7

124.0 137.0 169.3

Deferred:Federal 33.5 (13.2) 3.7Foreign 1.9 (8.9) 0.5State and local 1.1 (0.5) 0.5

36.5 (22.6) 4.7

$160.5 $114.4 $174.0

A reconciliation between the provision for income taxescomputed by applying the statutory Federal income taxrate to earnings before income taxes and minority interestand the actual provision for income taxes is as follows:

YEAR ENDED JUNE 30 2003 2002 2001(In millions)Provision for income taxes at statutory rate $170.4 $116.1 $169.2

Increase (decrease) due to:State and local income taxes,net of Federal tax benefit 4.1 3.9 5.3

Effect of foreign operations (1.0) (0.9) (2.9)Domestic royalty expense not deductible for U.S. tax purposes — — 1.6

Other nondeductible expenses 1.7 3.2 3.8Tax credits (12.5) (2.1) —Other, net (2.2) (5.8) (3.0)

Provision for income taxes $160.5 $114.4 $174.0

Effective tax rate 33.0% 34.5% 36.0%

Significant components of the Company’s deferred income tax assets and liabilities as of June 30, 2003 and 2002 were as follows:

2003 2002(In millions)Deferred tax assets:

Deferred compensation and other payroll related expenses $ 55.4 $ 53.3Inventory obsolescence and other inventory related reserves 55.9 58.5Pension plan reserves 7.1 26.2Postretirement benefit obligations 22.9 25.9Various accruals not currently deductible 76.4 72.0Net operating loss and credit carryforwards 16.3 1.5Other differences between tax and financial statement values 8.0 9.4

242.0 246.8Valuation allowance for deferred tax assets (2.9) (1.5)

Total deferred tax assets 239.1 245.3

Deferred tax liabilities:Depreciation and amortization (84.0) (60.2)Other differences between tax and financial statement values (0.4) —

Total deferred tax liabilities (84.4) (60.2)

Total net deferred tax assets $154.7 $185.1

As of June 30, 2003 and 2002, the Company had currentnet deferred tax assets of $116.0 million and $112.4 mil-lion, respectively, which are included in prepaid expensesand other current assets in the accompanying consoli-dated balance sheets, and noncurrent net deferred taxassets of $38.7 million and $72.7 million, respectively.

Federal income and foreign withholding taxes have notbeen provided on $476.6 million, $473.5 million and$476.4 million of undistributed earnings of internationalsubsidiaries at June 30, 2003, 2002 and 2001, respectively.The Company intends to permanently reinvest these

earnings in its foreign operations, except where it is ableto repatriate these earnings to the United States withoutany material incremental tax provision.

As of June 30, 2003 and 2002, certain international sub-sidiaries had tax loss carryforwards for local tax purposes ofapproximately $14.7 million and $10.2 million, respectively.With the exception of $3.9 million of losses with an indef-inite carryforward period as of June 30, 2003, these lossesexpire at various dates through fiscal 2008. Deferred taxassets in the amount of $2.9 million and $1.5 million asof June 30, 2003 and 2002, respectively, have been


recorded to reflect the tax benefits of the losses not uti-lized to date. A full valuation allowance has been providedsince, in the opinion of management, it is more likely thannot that the deferred tax assets will not be realized.

Earnings before income taxes and minority interestinclude amounts contributed by the Company’s inter-national operations of $393.1 million, $283.4 million and$307.2 million for fiscal 2003, 2002 and 2001, respectively.Some of these earnings are taxed in the United States.

NOTE 7 – OTHER ACCRUED LIABILITIESOther accrued liabilities consist of the following:


Advertising and promotional accruals $266.2 $213.5Employee compensation 195.9 169.9Restructuring and special charges 46.5 61.2Other 195.4 182.0

$704.0 $626.6

NOTE 8 – DEBTThe Company’s short-term and long-term debt and available financing consist of the following:

Debt at June 30

Available financing at June 30

2003 2002 2003 2002 2003 2002

(In millions)

Commercial paper with an average interest rate of 1.81% in fiscal 2002 $ — $130.0 $ — $ — $ 750.0 $620.0

6% Senior Notes, due January 15, 2012 257.1 248.9 — — — —2% Japan loan payable, due in installments through April 2003 — 5.8 — — — —

1.45% Japan loan payable, due on March 28, 2006 25.2 25.0 — — — —Other long-term borrowings 1.3 — — — — —Other short-term borrowings 7.8 0.8 — — 156.6 22.9Revolving credit facility — — 400.0 400.0 — —Shelf registration for debt securities — — — — 500.0 150.0

291.4 410.5 $400.0 $400.0 $1,406.6 $792.9

Less current maturities (7.8) (6.6)

$283.6 $403.9

UncommittedCommitted

Historically, outstanding commercial paper had been clas-sified as long-term debt based upon the Company’s intentand ability to refinance maturing commercial paper on along-term basis. It is the Company’s policy to maintainbackup facilities to support the commercial paper pro-gram and its classification as long-term debt. During fiscal 2003, the Company repaid all of its outstandingcommercial paper obligations.

As of June 30 2003, the Company had outstanding$257.1 million of 6% Senior Notes due January 2012(“6% Senior Notes”) consisting of $250.0 million princi-pal, an unamortized debt discount of $1.0 million, and an$8.1 million adjustment to reflect the fair value of an out-standing interest rate swap. The 6% Senior Notes, whenissued in January 2002, were priced at 99.538% with ayield of 6.062%. Interest payments are required to bemade semi-annually on January 15 and July 15 of eachyear. In May 2003, the Company entered into an interestrate swap agreement with a notional amount of $250.0

million to effectively convert the fixed rate interest on ouroutstanding 6% Senior Notes to variable interest ratesbased on LIBOR.

During fiscal 1998, the Company entered into a 2%loan payable in Japan. Principal repayments of 350.0 mil-lion yen, approximately $2.9 million at current rates, weremade semi-annually through 2003. As of June 30, 2003,this loan had been repaid.

As of June 30, 2003, other long-term borrowings con-sisted primarily of several term loans held by the Darphingroup of companies, which was acquired by the Com-pany in April 2003 (see Note 4). These loans have variousmaturities through July 2007 with variable and fixed inter-est rates ranging from 2.5% to 5.8%.

The Company maintains uncommitted credit facilitiesin various regions throughout the world. Interest rateterms for these facilities vary by region and reflectprevailing market rates for companies with strong creditratings. During fiscal 2003 and 2002, the monthly average


amount outstanding was approximately $1.4 million and$12.9 million, respectively, and the annualized monthlyweighted average interest rate incurred was approxi-mately 5.4% and 4.1%, respectively.

Effective June 28, 2001, the Company entered into afive-year $400.0 million revolving credit facility, expiringon June 28, 2006, which includes an annual fee of .07%on the total commitment. At June 30, 2003 and 2002, theCompany was in compliance with all related financial andother restrictive covenants, including limitations onindebtedness and liens.

The Company also had an effective shelf registrationstatement covering the potential issuance of up to $500.0million and $150.0 million in debt securities at June 30,2003 and 2002, respectively.

NOTE 9 – FINANCIAL INSTRUMENTSDerivative Financial InstrumentsThe Company addresses certain financial exposuresthrough a controlled program of risk management thatincludes the use of derivative financial instruments. TheCompany primarily enters into foreign currency forwardexchange contracts and foreign currency options toreduce the effects of fluctuating foreign currencyexchange rates. The Company, if necessary, enters intointerest rate derivatives to manage the effects of interestrate movements on the Company’s aggregate liabilityportfolio. The Company categorizes these instruments asentered into for purposes other than trading.

All derivatives are recognized on the balance sheet attheir fair value. On the date the derivative contract isentered into, the Company designates the derivative as(i) a hedge of the fair value of a recognized asset or liabil-ity or of an unrecognized firm commitment (“fair value”hedge), (ii) a hedge of a forecasted transaction or of thevariability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge),(iii) a foreign-currency fair-value or cash-flow hedge(“foreign currency” hedge), (iv) a hedge of a net invest-ment in a foreign operation, or (v) other. Changes in thefair value of a derivative that is highly effective as (and thatis designated and qualifies as) a fair-value hedge, alongwith the loss or gain on the hedged asset or liability that isattributable to the hedged risk (including losses or gainson firm commitments), are recorded in current-periodearnings. Changes in the fair value of a derivative that ishighly effective as (and that is designated and qualifies as)a cash-flow hedge are recorded in other comprehensiveincome, until earnings are affected by the variability ofcash flows (e.g., when periodic settlements on a variable-rate asset or liability are recorded in earnings). Changes in

the fair value of derivatives that are highly effective as (andthat are designated and qualify as) foreign-currencyhedges are recorded in either current-period earnings orother comprehensive income, depending on whether the hedge transaction is a fair-value hedge (e.g., a hedgeof a firm commitment that is to be settled in a foreigncurrency) or a cash-flow hedge (e.g., a foreign-currency-denominated forecasted transaction). If, however, a deriv-ative is used as a hedge of a net investment in a foreignoperation, its changes in fair value, to the extent effectiveas a hedge, are recorded in accumulated other compre-hensive income within equity. Furthermore, changes in thefair value of other derivative instruments are reported incurrent-period earnings.

For each derivative contract entered into where theCompany looks to obtain special hedge accountingtreatment, the Company formally documents all relation-ships between hedging instruments and hedged items, aswell as its risk-management objective and strategy forundertaking the hedge transaction. This process includeslinking all derivatives that are designated as fair-value,cash-flow, or foreign-currency hedges to specific assetsand liabilities on the balance sheet or to specific firmcommitments or forecasted transactions. The Companyalso formally assesses, both at the hedge’s inception andon an ongoing basis, whether the derivatives that are usedin hedging transactions are highly effective in offsettingchanges in fair values or cash flows of hedged items. If it isdetermined that a derivative is not highly effective, or thatit has ceased to be a highly effective hedge, the Companywill be required to discontinue hedge accounting withrespect to that derivative prospectively.

Foreign Exchange Risk ManagementThe Company enters into forward exchange contracts tohedge anticipated transactions as well as receivables andpayables denominated in foreign currencies for periodsconsistent with the Company’s identified exposures. Thepurpose of the hedging activities is to minimize the effectof foreign exchange rate movements on costs and on thecash flows that the Company receives from foreign sub-sidiaries. Almost all foreign currency contracts are denom-inated in currencies of major industrial countries and arewith large financial institutions rated as strong investmentgrade by a major rating agency. The Company also entersinto foreign currency options to hedge anticipated trans-actions where there is a high probability that anticipatedexposures will materialize. The forward exchangecontracts and foreign currency options entered into tohedge anticipated transactions have been designated as


cash-flow hedges. As of June 30, 2003, these cash-flowhedges were highly effective, in all material respects.

As a matter of policy, the Company only enters intocontracts with counterparties that have at least an “A” (orequivalent) credit rating. The counterparties to these con-tracts are major financial institutions. The Company doesnot have significant exposure to any one counterparty.Exposure to credit loss in the event of nonperformanceby any of the counterparties is limited to only the recog-nized, but not realized, gains attributable to the contracts.Management believes risk of loss under these hedgingcontracts is remote and in any event would not be mate-rial to the Company’s consolidated financial results. Thecontracts have varying maturities through the end of June2004. Costs associated with entering into such contractshave not been material to the Company’s consolidatedfinancial results. The Company does not utilize derivativefinancial instruments for trading or speculative purposes.At June 30, 2003, the Company had foreign currency con-tracts in the form of forward exchange contracts andoption contracts in the amount of $476.7 million and $57.7 million, respectively. The foreign currenciesincluded in forward exchange contracts (notional valuestated in U.S. dollars) are principally the Euro ($114.0million), Swiss franc ($61.9 million), Japanese yen ($56.0 million), British pound ($49.8 million), Canadiandollar ($37.7 million), South Korean won ($37.6 million)and Australian dollar ($30.6 million). The foreign curren-cies included in the option contracts (notional value statedin U.S. dollars) are principally the Swiss franc ($21.9million), Canadian dollar ($21.0 million) and Euro ($11.7 million). At June 30, 2002, the Company had for-eign currency contracts in the form of forward exchangecontracts in the amount of $227.2 million. The foreigncurrencies included in these contracts (notional valuestated in U.S. dollars) are principally the Japanese yen ($70.7 million), Euro ($31.7 million), British pound($26.2 million), Australian dollar ($16.0 million), Swissfranc ($11.8 million), Danish krone ($11.6 million) andCanadian dollar ($10.5 million).

Interest Rate Risk ManagementThe Company enters into interest rate derivative contractsto manage the exposure to fluctuations of interest rateson its funded and unfunded indebtedness, as well as cashinvestments, for periods consistent with the identifiedexposures. All interest rate derivative contracts are withlarge financial institutions rated as strong investmentgrade by a major rating agency.

In May 2003, the Company entered into an interestrate swap agreement with a notional amount of $250.0

million to effectively convert fixed interest on the existing6% Senior Notes to a variable interest rate based onLIBOR. The interest rate swap was designated as a fairvalue hedge. As of June 30, 2003, the fair value hedge washighly effective, in all material respects.

Information regarding the interest rate swap is pre-sented in the following table:

YEAR ENDED OR NotionalAT JUNE 30, 2003 Amount Pay Rate Receive Rate(In millions)

Interest rate swap $250.0 3.21% 6.00%

Additionally, in May 2003, the Company entered into aseries of treasury lock agreements on a notional amounttotaling $195.0 million at a weighted average all-in rate of4.53%. These treasury lock agreements expire in Septem-ber 2003 and are used to hedge the exposure to a possi-ble rise in interest rates prior to the anticipated issuance ofnew debt, if completed. The agreements will be settledupon the issuance of the new debt and any realized gainor loss to be received or paid by the Company will beamortized in interest expense over the life of new debt.The treasury lock agreements were designated as cashflow hedges. As of June 30, 2003, the cash flow hedgeswere highly effective, in all material respects.

Fair Value of Financial InstrumentsThe following methods and assumptions were used toestimate the fair value of each class of financial instru-ments for which it is practicable to estimate that value:

Cash and cash equivalents:The carrying amount approximates fair value, primarilybecause of the short maturity of cash equivalentinstruments.

Long-term debt:The fair value of the Company’s long-term debt was esti-mated based on the current rates offered to the Companyfor debt with the same remaining maturities. Included insuch amount, where applicable, is the fair value of theCompany’s commercial paper.

Cumulative redeemable preferred stock:The fair value of the cumulative redeemable preferredstock is estimated utilizing a cash flow analysis at adiscount rate equal to rates available for debt with termssimilar to the preferred stock.

Foreign exchange and interest rate contracts:The fair value of forwards, swaps, options and treasury ratelocks is the estimated amount the Company wouldreceive or pay to terminate the agreements.

Weighted Average


NOTE 10 – PENSION, DEFERRED COMPENSATIONAND POSTRETIREMENT BENEFIT PLANSThe Company maintains pension plans covering substan-tially all of its full-time employees for its U.S. operationsand a majority of its international operations. Several plansprovide pension benefits based primarily on years ofservice and employees’ earnings. In certain instances, theCompany adjusts benefits in connection with internationalemployee transfers.

Retirement Growth Account Plan (U.S.)The Retirement Growth Account Plan is a trust-based,noncontributory defined benefit pension plan. The Com-pany’s funding policy consists of an annual contributionat a rate that provides for future plan benefits and main-tains appropriate funded percentages. Such contributionis not less than the minimum required by the EmployeeRetirement Income Security Act of 1974, as amended,(“ERISA”) and subsequent pension legislation and is notmore than the maximum amount deductible for incometax purposes.

Restoration Plan (U.S.)The Company also has an unfunded, nonqualified domes-tic benefit Restoration Plan to provide benefits in excessof Internal Revenue Code limitations.

International Pension PlansThe Company maintains International Pension Plans, themost significant of which are defined benefit pensionplans. The Company’s funding policies for these plans aredetermined by local laws and regulations.

Postretirement BenefitsThe Company maintains a domestic contributory post-retirement benefit plan which provides certain medicaland dental benefits to eligible employees. Employeeshired after January 1, 2002 will not be eligible for retiree medical benefits when they retire. Certain retiredemployees who are receiving monthly pension benefitsare eligible for participation in the plan. Contributionsrequired and benefits received by retirees and eligiblefamily members are dependent on the age of the retiree.It is the Company’s practice to fund these benefits asincurred. The cost of the Company-sponsored programsis not significant.

Certain of the Company’s international subsidiaries and affiliates have postretirement plans, although mostparticipants are covered by government-sponsored oradministered programs.

The estimated fair values of the Company’s financial instruments are as follows:

JUNE 30, 2003 JUNE 30, 2002

Carrying Amount Fair Value Carrying Amount Fair Value(In millions)

NonderivativesCash and cash equivalents $364.1 $364.1 $546.9 $546.9Long-term debt, including current portion 291.4 320.9 410.5 415.6Cumulative redeemable preferred stock 360.0 389.8 360.0 374.9DerivativesForward exchange contracts (6.5) (6.5) (14.8) (14.8)Foreign currency option contracts 3.6 3.6 — —Interest rate swap contract 8.1 8.1 — —Treasury rate lock contracts 2.6 2.6 — —


The significant components of the above mentioned plans as of and for the year ended June 30 are summarized as follows:

Other thanPension Plans Pension Plans

2003 2002 2003 2002 2003 2002

(In millions)

Change in benefit obligation:Benefit obligation at beginning of year $310.3 $ 280.4 $154.7 $131.5 $ 43.7 $ 43.2

Service cost 15.1 13.5 8.5 7.9 2.2 1.8Interest cost 21.2 20.6 8.1 7.2 3.2 2.9Plan participant contributions — — 1.1 0.9 0.1 0.1Actuarial loss (gain) 19.8 10.8 18.9 3.6 14.5 (1.9)Foreign currency exchange rate impact — — 15.0 13.8 — —Benefits paid (11.5) (14.9) (6.0) (10.2) (1.9) (1.9)Plan amendments 3.8 (0.1) — — — (0.5)Settlements and curtailments — — (9.3) — — —

Benefit obligation at end of year 358.7 310.3 191.0 154.7 61.8 43.7

Change in plan assets:Fair value of plan assets at beginning of year 201.8 179.7 116.3 104.6 — —

Actual return on plan assets 9.3 (9.5) (13.2) (0.9) — —Foreign currency exchange rate impact — — 9.9 10.5 — —Employer contributions 77.8 46.5 16.4 11.4 1.8 1.8Plan participant contributions — — 1.1 0.9 0.1 0.1Settlements and curtailments — — (3.6) — — —Benefits paid from plan assets (11.5) (14.9) (6.0) (10.2) (1.9) (1.9)

Fair value of plan assets at end of year 277.4 201.8 120.9 116.3 — —

Funded status (81.3) (108.5) (70.1) (38.4) (61.8) (43.7)Unrecognized net actuarial loss (gain) 128.1 104.4 73.4 37.2 6.4 (8.1)Unrecognized prior service cost 7.6 4.0 2.4 2.5 (0.2) (0.2)Unrecognized net transition (asset) obligation — (1.5) 0.3 0.6 — —

Prepaid (accrued) benefit cost $ 54.4 $ (1.6) $ 6.0 $ 1.9 $(55.6) $(52.0)

Amounts recognized in the Balance Sheets consist of:Prepaid benefit cost $101.5 $ 39.5 $ 12.9 $ 10.1 $ — $ —Accrued benefit liability (56.4) (47.3) (60.6) (40.1) (55.6) (52.0)Intangible asset 0.7 0.2 0.5 1.0 — —Minimum pension liability 8.6 6.0 53.2 30.9 — —

Net amount recognized $ 54.4 $ (1.6) $ 6.0 $ 1.9 $(55.6) $(52.0)

PostretirementInternationalU.S.


Other than Pension Plans Pension Plans

2003 2002 2001 2003 2002 2001 2003 2002 2001

Weighted-average assumptionsPre-retirement discount rate 5.75% 7.00% 7.50% 2.75– 2.75– 3.00– 5.75% 7.00% 7.50%

7.00% 7.00% 7.25%

Postretirement discount rate 4.75% 5.75% 6.00% — — — — — —

Expected return on assets 8.50% 9.00% 9.00% 4.50– 4.50– 5.00– N/A N/A N/A8.25% 8.25% 8.50%

Rate of compensation increase 3.00– 4.50– 5.00– 1.75– 1.75– 2.00– N/A N/A N/A9.50% 11.00% 11.50% 4.00% 4.00% 5.50%

Components of net periodic benefit cost (In millions)

Service cost, net $ 15.1 $ 13.5 $ 12.3 $ 8.5 $ 8.0 $ 8.0 $ 2.2 $ 1.8 $ 1.9Interest cost 21.2 20.6 19.7 8.1 7.2 6.7 3.2 2.9 3.0Expected return on assets (18.3) (17.3) (16.2) (9.2) (8.3) (7.4) — — —Amortization of:

Transition (asset) obligation (1.5) (1.5) (1.4) 0.3 0.2 0.2 — — —Prior service cost 0.2 0.4 0.4 0.2 0.2 0.2 — — —Actuarial loss (gain) 5.1 2.6 1.1 1.5 1.0 0.9 (0.1) (0.4) (0.2)Settlements and curtailments — — — 2.3 — — — — —

Net periodic benefit cost $ 21.8 $ 18.3 $ 15.9 $11.7 $ 8.3 $ 8.6 $ 5.3 $ 4.3 $ 4.7

Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates for fiscal 2003 would have had the following effects:

One-Percentage-Point Increase One-Percentage-Point Decrease(In millions)

Effect on total service and interest costs $0.7 $(0.6)

Effect on postretirement benefit obligations $6.8 $(6.1)

The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the Company’s pensionplans at June 30 are as follows:

Pension Plans

2003 2002 2003 2002 2003 2002(In millions)

Projected Benefit Obligation $286.6 $244.7 $72.1 $65.6 $191.0 $154.7 Accumulated Benefit Obligation 238.7 191.5 56.4 47.3 160.7 127.9Fair Value of Plan Assets 277.4 201.8 — — 120.9 116.3

InternationalRestorationRetirement

Growth Account

PostretirementInternationalU.S.


International pension plans with accumulated benefitobligations in excess of the plans’ assets had aggregateprojected benefit obligations of $137.8 million and$113.3 million, aggregate accumulated benefit obligationsof $119.1 million and $97.2 million and aggregate fairvalue of plan assets of $68.9 million and $66.3 million atJune 30, 2003 and 2002, respectively.

401(k) Savings Plan (U.S.)The Company’s 401(k) Savings Plan (“Savings Plan”) is acontributory defined contribution plan covering substan-tially all regular U.S. employees who have completed thehours and service requirements, as defined by the plandocument. Effective January 1, 2002, regular full-timeemployees are eligible to participate in the Plan on thefirst day of the second month following their date of hire.The Savings Plan is subject to the applicable provisions of ERISA. The Company matches a portion of the par-ticipant’s contributions after one year of service under a predetermined formula based on the participant’s con-tribution level and years of service. The Company’scontributions were approximately $9.1 million in fiscal2003 and $6.7 million for the fiscal years ended June 30,2002 and 2001. Shares of the Company’s Class A Com-mon Stock are not an investment option in the SavingsPlan and the Company does not use such shares to matchparticipants’ contributions.

Deferred CompensationThe Company accrues for deferred compensation andinterest thereon and for the increase in the value of shareunits pursuant to agreements with certain key executivesand outside directors. The amounts included in theaccompanying consolidated balance sheets under theseplans were $109.2 million and $95.7 million as of June30, 2003 and 2002, respectively. The expense for fiscal2003 was $17.4 million and for fiscal 2002 and 2001 was$11.6 million in each year.

NOTE 11 – POSTEMPLOYMENT BENEFITS OTHER THAN TO RETIREESThe Company provides certain postemployment benefitsto eligible former or inactive employees and theirdependents during the period subsequent to employ-ment but prior to retirement. These benefits includehealth care coverage and severance benefits. Generally,the cost of providing these benefits is accrued and anyincremental benefits were not material to the Company’sconsolidated financial results.

NOTE 12 – $6.50 CUMULATIVE REDEEMABLEPREFERRED STOCK, AT REDEMPTION VALUEAs of June 30, 2003, the Company’s authorized capitalstock included 23.6 million shares of preferred stock,par value $.01 per share, of which 3.6 million shares areoutstanding and designated as $6.50 CumulativeRedeemable Preferred Stock. The outstanding preferredstock was issued in June 1995 in exchange for nonvotingcommon stock of the Company owned by The EstéeLauder 1994 Trust.

Holders of the $6.50 Cumulative Redeemable Pre-ferred Stock are entitled to receive cumulative cash divi-dends at a rate of $6.50 per annum per share payable inquarterly installments. Such dividends have preferenceover all other dividends of stock issued by the Company.Shares are subject to mandatory redemption on June 30,2005 at a redemption price of $100 per share. Followingsuch date and so long as such mandatory redemptionobligations have not been discharged in full, no dividendsmay be paid or declared upon the Class A or Class BCommon Stock, or on any other capital stock rankingjunior to or in parity with such $6.50 CumulativeRedeemable Preferred Stock and no shares of Class A orClass B Common Stock or such junior or parity stock maybe redeemed or acquired for any consideration by theCompany. Under certain circumstances, the Companymay redeem the stock, in whole or in part, prior to themandatory redemption date. Holders of such stock mayput such shares to the Company at a price of $100 pershare upon the occurrence of certain events.

The Company recorded the $6.50 CumulativeRedeemable Preferred Stock at its redemption value of$360.0 million and charged this amount, net of the parvalue of the shares of nonvoting common stockexchanged, to stockholders’ equity in fiscal 1995.


NOTE 13 – COMMON STOCKAs of June 30, 2003, the Company’s authorized commonstock consists of 650 million shares of Class A CommonStock, par value $.01 per share, and 240 million shares ofClass B Common Stock, par value $.01 per share. Class BCommon Stock is convertible into Class A CommonStock, in whole or in part, at any time and from time totime at the option of the holder, on the basis of one shareof Class A Common Stock for each share of Class B Com-mon Stock converted. Holders of the Company’s Class ACommon Stock are entitled to one vote per share andholders of the Company’s Class B Common Stock areentitled to ten votes per share.

Information about the Company’s common stock out-standing is as follows:

Class A Class B(Shares in thousands)

Balance at June 30, 2000 124,181.7 113,679.3Acquisition of treasury stock (0.9) —Conversion of Class B to Class A 189.0 (189.0)Stock option programs 806.2 —

Balance at June 30, 2001 125,176.0 113,490.3Acquisition of treasury stock (1,500.0) —Conversion of Class B to Class A 5,077.8 (5,077.8)Stock option programs 436.3 —

Balance at June 30, 2002 129,190.1 108,412.5Acquisition of treasury stock (11,245.2) —Conversion of Class B to Class A 950.0 (950.0)Share grants 4.0 —Share units converted 0.8 —Stock option programs 1,094.0 —

Balance at June 30, 2003 119,993.7 107,462.5

On September 18, 1998, the Company’s Board of Direc-tors authorized a share repurchase program to repurchasea total of up to 8.0 million shares of Class A CommonStock in the open market or in privately negotiated trans-actions, depending on market conditions and other fac-tors. In October 2002, the Board of Directors authorizedthe repurchase of up to 10.0 million additional shares ofClass A Common Stock increasing the total authorizationunder the share repurchase program to 18.0 millionshares. As of June 30, 2003, approximately 13.8 millionshares have been purchased under this program.

NOTE 14 – STOCK PROGRAMSThe Company has established the Fiscal 2002 ShareIncentive Plan, the Fiscal 1999 Share Incentive Plan, theFiscal 1996 Share Incentive Plan and the Non-EmployeeDirector Share Incentive Plan (collectively, the “Plans”)and, additionally, has made available stock options andshare units that were, or will be, granted pursuant to thesePlans and certain employment agreements. These stock-based compensation programs are described below.

Total net compensation expense attributable to thegranting of share units and the increase in value of exist-ing share units was $1.4 million and $0.7 million in fiscal2003 and 2001, respectively. Total net compensationincome attributable to the granting of share units and therelated decrease in value of existing share units was $0.2million in fiscal 2002.

Share Incentive PlansThe Plans provide for the issuance of 30,750,000 sharesto be awarded in the form of stock options, stock appre-ciation rights and other stock awards to key employeesand stock options, stock awards and stock units to non-employee directors of the Company. As of June 30, 2003,6,457,000 shares of Class A Common Stock werereserved and were available to be granted pursuant to thePlans. The exercise period for all stock options generallymay not exceed ten years from the date of grant. Pursuantto the Plans, stock option awards in respect of 6,651,200,2,175,300 and 2,709,500 shares were granted in fiscal2003, 2002 and 2001, respectively, and share units inrespect of 57,800, 50,000 and 43,100 shares weregranted in fiscal 2003, 2002 and 2001, respectively.During fiscal 2003, approximately 800 share units wereconverted into shares of Class A Common Stock. Duringfiscal 2002, 40,700 share units were cancelled without theissuance of any shares, but the value of such units wastransferred to a deferred compensation account. Gener-ally, the stock option awards become exercisable atvarious times through January 2007, while the share unitswill be paid out in shares of Class A Common Stock at atime to be determined by the Company.

In addition to awards made by the Company, certainoutstanding stock options were assumed as part of theOctober 1997 acquisition of Sassaby. Of the 221,200originally issued options to acquire shares of the Com-pany’s Class A Common Stock, 14,100 were outstandingas of June 30, 2003, all of which were exercisable and willexpire through May 2007.


A summary of the Company’s stock option programs as of June 30, 2003, 2002 and 2001, and changes during the yearsthen ended, is presented below:

2003 2002 2001

Weighted- Weighted- Weighted-Average Average AverageExercise Exercise Exercise

Shares Price Shares Price Shares Price(Shares in thousands)

Outstanding at beginning of year 24,843.5 $35.10 23,393.2 $34.55 21,914.1 $33.14Granted at fair value 6,651.2 32.02 2,175.3 39.07 2,709.5 42.80Exercised (1,094.0) 15.16 (435.4) 17.85 (806.0) 16.50Cancelled or Expired (858.5) 43.10 (289.6) 46.38 (424.4) 48.19

Outstanding at end of year 29,542.2 34.93 24,843.5 35.10 23,393.2 34.55

Options exercisable at year-end 16,425.6 32.31 13,149.5 27.59 8,497.6 21.69

Weighted-average fair value ofoptions granted during the year $12.35 $16.02 $17.01

Summarized information about the Company’s stock options outstanding and exercisable at June 30, 2003 is as follows:

Exercise Price Range Options(a) Average Life(b) Average Price(c) Options(a) Average Price(c)

$ 3.10 14.1 4.3 $ 3.10 14.1 $ 3.10$13.00 to $20.813 2,668.8 2.4 13.08 2,668.8 13.08$21.313 to $30.52 5,960.1 4.1 23.88 5,478.9 23.37$31.875 to $47.625 14,541.2 7.6 36.14 4,371.3 37.30$49.75 to $53.50 6,358.0 6.1 51.77 3,892.5 52.14

$ 3.10 to $53.50 29,542.2 34.93 16,425.6 32.31

(a) Shares in thousands.

(b) Weighted average contractual life remaining in years.

(c) Weighted average exercise price.

Subsequent to June 30, 2003, the Company granted options under the terms of the Plans described above to purchase anadditional 2,211,200 of the Company’s Class A Common Stock with an exercise price equal to fair market value on thedate of grant. In addition, subsequent to June 30, 2003, the Company granted approximately 58,500 share units to a keyexecutive pursuant to the terms of the Fiscal 2002 Share Incentive Plan.

ExercisableOutstanding

Executive Employment AgreementsThe executive employment agreements provide for theissuance of 11,400,000 shares to be awarded in the formof stock options and other stock awards to certain keyexecutives. The Company has reserved 661,600 shares ofits Class A Common Stock pursuant to such agreementsas of June 30, 2003. In accordance with such employmentagreements approximately 1,400 share units were grantedin fiscal 2003 and 900 share units were granted in fiscal

2002 and 2001. The reserve is solely for dividend equiva-lents on units granted pursuant to one of the agreements.Most of the stock options granted pursuant to the agree-ments are exercisable and expire at various times fromNovember 2005 through July 2009. The share units willbe paid out in shares of Class A Common Stock at a timeto be determined by the Company, but no later than 90 days subsequent to the termination of employment ofthe executive.


NOTE 15 – COMMITMENTS AND CONTINGENCIESTotal rental expense included in the accompanying con-solidated statements of earnings was $147.8 million infiscal 2003, $142.8 million in fiscal 2002 and $120.9 mil-lion in fiscal 2001. At June 30, 2003, the future minimumrental commitments under long-term operating leases areas follows:

YEAR ENDING JUNE 30 (In millions)

2004 $118.52005 103.72006 74.12007 61.82008 54.7Thereafter 189.8

$602.6

In July 2003, the Company signed a new lease for itsprincipal offices at the same location. Rental obligationsunder the new lease will commence in fiscal 2005 andexpire in fiscal 2020. Obligations pursuant to the lease in fiscal 2005, 2006, 2007, 2008 and thereafter are $5.9million, $23.6 million, $23.6 million, $24.1 million and$324.2 million, respectively.

In July 2003, the U.S. Magistrate Judge appointed bythe U.S. District Judge, Southern District of New York,issued his report and recommendation finding in favor ofthe Company and its subsidiaries with respect to, amongother things, their motion for summary judgment of non-infringement in the case brought against them in August2000 by an affiliate of Revlon, Inc. Revlon claimed, amongother things, that five Estée Lauder products, two Originsfoundations, a La Mer concealer and a jane foundationinfringed its patent. Revlon sought, among other things,treble damages, punitive damages, equitable relief andattorneys’ fees. Revlon has objected to this opinion. TheCompany has responded to the objection. Revlon alsomay appeal the decision to the Court of Appeals for theFederal Circuit.

In July 2003, the Company entered into a settlementagreement with the plaintiffs, the other manufacturerdefendants and the department store defendants in a con-solidated class action lawsuit that had been pending inthe Superior Court of the State of California in MarinCounty since 1998. In connection with the settlement, thecase has been refiled in the United States District Courtfor the Northern District of California on behalf of anationwide class of consumers of prestige cosmetics inthe United States. The settlement requires Court approvaland, if approved by the Court, will result in the plaintiffs’claims being dismissed, with prejudice, in their entirety.There has been no finding or admission of any wrong-

doing by the Company in this lawsuit. The Companyentered into the settlement agreement solely to avoidprotracted and costly litigation. In connection with thesettlement agreement, the defendants, including the Com-pany, will provide consumers with certain free productsand pay the plaintiffs’ attorneys’ fees. To meet its obliga-tions under the settlement, the Company took a specialpre-tax charge of $22.0 million, or $13.5 million after-tax,equal to $.06 per diluted common share in the fourthquarter of fiscal 2003.

In 1998, the Office of the Attorney General of the Stateof New York (the “State”) notified the Company and tenother entities that they are potentially responsible parties(“PRPs”) with respect to the Blydenburgh landfill in Islip,New York. Each PRP may be jointly and severally liable forthe costs of investigation and cleanup, which the Stateestimates to be $16 million. While the State has suedother PRPs in connection with the site, the State has notsued the Company. The Company and certain other PRPsare in discussions with the State regarding possible settle-ment of the matter. While no assurance can be given as to the ultimate outcome, management believes that the matter will not have a material adverse effect on theCompany’s consolidated financial condition.

In 1998, the State notified the Company and fifteenother entities that they are PRPs with respect to theHuntington/East Northport landfill. The cleanup costs areestimated at $20 million. No litigation has commenced.The Company and other PRPs are in discussions with theState regarding possible settlement of the matter. Whileno assurance can be given as to the ultimate outcome,management believes that the matter will not have amaterial adverse effect on the Company’s consolidatedfinancial condition.

In June 2003, a lawsuit was filed in the U.S. DistrictCourt, Eastern District of New York, on behalf of twoformer employees and one former temporary employeealleging race and disability discrimination, harassment andretaliation. The complaint seeks $10 million in damagesfor each of seven causes of action. The Company intendsto defend the action vigorously. While no assurances can be given as to the ultimate outcome, managementbelieves that this matter will not have a material adverseeffect on the Company’s consolidated financial condition.

The Company is involved in various routine legal pro-ceedings incident to the ordinary course of its business. Inmanagement’s opinion, the outcome of pending legal pro-ceedings, separately and in the aggregate, will not have amaterial adverse effect on the Company’s business orconsolidated financial results.

78


NOTE 16 – NET UNREALIZED INVESTMENT GAINSUnder SFAS No. 115, “Accounting for Certain Investmentsin Debt and Equity Securities,” available-for-sale securitiesare recorded at market value. Unrealized holding gainsand losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and arereported as a component of stockholders’ equity untilrealized. The Company’s investments subject to the pro-visions of SFAS No. 115 are treated as available-for-saleand, accordingly, the applicable investments have beenadjusted to market value with a corresponding adjust-ment, net of tax, to net unrealized investment gains inaccumulated other comprehensive income. Included in accumulated other comprehensive income was anunrealized investment gain (net of deferred taxes) of $0.7million at June 30, 2003 and an unrealized investment loss(net of deferred taxes) of $0.1 million at June 30, 2002.

NOTE 17 – STATEMENT OF CASH FLOWSSupplemental disclosure of significant non-cash transactionsAs a result of stock option exercises, the Companyrecorded tax benefits of $7.9 million, $2.9 million and$7.2 million during fiscal 2003, 2002 and 2001, respec-tively, which are included in additional paid-in capital inthe accompanying consolidated financial statements.

As of June 30, 2003, the Company had a current assetand an equal and offsetting increase in long-term debt of$8.1 million reflecting the fair market value of an interestrate swap which was classified as a fair value hedge of the6% Senior Notes (see Note 8).

NOTE 18 – SEGMENT DATA AND RELATEDINFORMATION Reportable operating segments, as defined by SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information,” include components of anenterprise about which separate financial information isavailable that is evaluated regularly by the chief operatingdecision maker (the “Chief Executive”) in deciding howto allocate resources and in assessing performance. As aresult of the similarities in the manufacturing, marketingand distribution processes for all of the Company’sproducts, much of the information provided in theconsolidated financial statements is similar to, or the sameas, that reviewed on a regular basis by the Chief Execu-tive. Although the Company operates in one business seg-ment, beauty products, management also evaluatesperformance on a product category basis.

While the Company’s results of operations are alsoreviewed on a consolidated basis, the Chief Executivereviews data segmented on a basis that facilitates com-parison to industry statistics. Accordingly, net sales, depre-ciation and amortization, and operating income areavailable with respect to the manufacture and distributionof skin care, makeup, fragrance, hair care and otherproducts. These product categories meet the FinancialAccounting Standards Board’s definition of operatingsegments and therefore, additional financial data areprovided below. The “other” segment includes the salesand related results of ancillary products and services thatdo not fit the definition of skin care, makeup, fragranceand hair care.

The Company evaluates segment performance basedupon operating income, which represents earnings beforeincome taxes, minority interest and net interest income or expense. The accounting policies for each of thereportable segments are the same as those described inthe summary of significant accounting policies, except fordepreciation and amortization charges, which areallocated, primarily, based upon net sales. The assets andliabilities of the Company are managed centrally and arereported internally in the same manner as the consoli-dated financial statements, thus no additional informationis produced for the Chief Executive or included herein.

79


YEAR ENDED OR AT JUNE 30 2003 2002 2001(In millions)

SEGMENT DATANet Sales:

Skin Care $1,893.7 $1,703.3 $1,660.7Makeup 1,909.4 1,790.5 1,721.6Fragrance 1,059.6 1,017.3 1,085.1Hair Care 228.9 215.8 180.7Other 26.0 23.0 27.6

5,117.6 4,749.9 4,675.7Restructuring — (6.2) (8.0)

$5,117.6 $4,743.7 $4,667.7

Depreciation and Amortization:Skin Care $ 62.2 $ 58.3 $ 48.6Makeup 69.2 60.0 64.1Fragrance 35.5 36.0 32.6Hair Care 7.1 6.5 9.6Other 0.8 1.2 1.4

$ 174.8 $ 162.0 $ 156.3

Operating Income:Skin Care $ 273.2 $ 248.4 $ 266.9Makeup 198.0 183.2 212.5Fragrance 32.1 13.4 63.6Hair Care 14.8 13.7 13.1Other (1.0) 0.1 2.5

517.1 458.8 558.6Reconciliation:Restructuring and special charges (22.0) (117.4) (63.0)Interest expense, net (8.1) (9.8) (12.3)

Earnings before Income Taxes, Minority Interest and Accounting Change $ 487.0 $ 331.6 $ 483.3

GEOGRAPHIC DATANet Sales:

The Americas $2,953.4 $2,878.2 $2,857.8Europe, the Middle East & Africa 1,506.4 1,261.1 1,221.8Asia/Pacific 657.8 610.6 596.1

5,117.6 4,749.9 4,675.7Restructuring — (6.2) (8.0)

$5,117.6 $4,743.7 $4,667.7

Operating Income:The Americas $ 246.7 $ 222.9 $ 299.9Europe, the Middle East & Africa 227.7 179.9 201.8Asia/Pacific 42.7 56.0 56.9

517.1 458.8 558.6Restructuring and special charges (22.0) (117.4) (63.0)

$ 495.1 $ 341.4 $ 495.6

Total Assets:The Americas $2,272.7 $2,467.1 $2,379.9Europe, the Middle East & Africa 831.1 703.3 610.3Asia/Pacific 246.1 246.1 228.6

$3,349.9 $3,416.5 $3,218.8

Long-Lived Assets (property, plant and equipment):The Americas $ 446.2 $ 458.4 $ 445.2Europe, the Middle East & Africa 132.2 99.6 70.5Asia/Pacific 29.3 22.7 13.0

$ 607.7 $ 580.7 $ 528.7

80


NOTE 19 – UNAUDITED QUARTERLY FINANCIAL DATAThe following summarizes the unaudited quarterly operating results of the Company for the years ended June 30, 2003and 2002:

September 30 December 31 March 31 June 30 Total Year(In millions, except per share data)

Fiscal 2003Net sales $1,242.5 $1,412.7 $1,239.4 $1,223.0 $5,117.6Gross profit 885.4 1,041.3 922.8 932.4 3,781.9Operating income 114.4 170.0 127.8 82.9 495.1Net earnings 73.4 109.6 83.8 53.0 319.8Basic EPS .29 .45 .34 .21 1.27Diluted EPS .28 .44 .33 .20 1.26

Fiscal 2002Net sales $1,194.8 $1,298.2 $1,121.7 $1,129.0 $4,743.7Gross profit 849.5 954.9 803.4 862.5 3,470.3Operating income (loss) 152.9 143.5 81.1 (36.1) 341.4Net earnings (loss) 97.1(a) 90.1 50.7 (25.4) 212.5(a)

Basic EPS .30(a) .35 .19 (.13) .71(a)

Diluted EPS .30(a) .35 .19 (.13) .70(a)

(a) Net earnings for the Quarter ended September 30, 2001 includes a one-time charge of $20.6 million or $.08 per common share, attributable to thecumulative effect of adopting SFAS No. 142, “Goodwill and Other Intangible Assets.”

NOTE 20 – UNAUDITED SUBSEQUENT EVENTPursuant to the Company’s authorized share repurchase program, subsequent to June 30, 2003, the Company purchasedan additional 0.4 million shares of Class A Common Stock for $12.3 million bringing the cumulative total of acquiredshares to 14.2 million under this program.

Subsequent to June 30, 2003, the Company acquired the Rodan & Fields skin care line. The initial purchase price,paid at closing, was funded by cash provided by operations, the payment of which did not have a material effect on theCompany’s results of operations or financial condition. The Company expects to make additional payments betweenfiscal 2007 and 2011 based on certain conditions.

Quarter Ended


INDEPENDEN T AUDITOR S’ R EPORT

The Board of Directors and StockholdersThe Estée Lauder Companies Inc.:

We have audited the accompanying consolidated balance sheets of The Estée Lauder Companies Inc. and subsidiaries asof June 30, 2003 and 2002, and the related consolidated statements of earnings, stockholders’ equity and comprehensiveincome and cash flows for the years then ended. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. The 2001 financial statements of The Estée Lauder Companies Inc. and subsidiaries were audited by otherauditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements,before the revision described in Note 2 to the financial statements, in their report dated August 10, 2001.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America.Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles usedand significant estimates made by management, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financialposition of The Estée Lauder Companies Inc. and subsidiaries as of June 30, 2003 and 2002, and the results of theiroperations and their cash flows for the years then ended in conformity with accounting principles generally accepted inthe United States of America.

As discussed above, the 2001 consolidated financial statements of The Estée Lauder Companies Inc. and subsidiarieswere audited by other auditors who have ceased operations. As described in Note 2, these financial statements havebeen revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142,“Goodwill and Other Intangible Assets,” which was adopted by the Company as of July 1, 2001. In our opinion,the disclosures for 2001 in Note 2 are appropriate. However, we were not engaged to audit, review, or apply anyprocedures to the 2001 consolidated financial statements of The Estée Lauder Companies Inc. and subsidiaries otherthan with respect to such disclosures and, accordingly, we do not express an opinion or any other form of assurance onthe 2001 consolidated financial statements taken as a whole.

New York, New YorkAugust 8, 2003

82


R EPORT OF INDEPENDEN T PUBLIC ACCOUN TAN TS

To The Estée Lauder Companies Inc.:

We have audited the accompanying consolidated balance sheets of The Estée Lauder Companies Inc. (a Delawarecorporation) and subsidiaries as of June 30, 2001 and 2000, and the related consolidated statements of earnings,stockholders’ equity and comprehensive income and cash flows for each of the three years in the period ended June 30,2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles usedand significant estimates made by management, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position ofThe Estée Lauder Companies Inc. and subsidiaries as of June 30, 2001 and 2000, and the results of their operations andtheir cash flows for each of the three years in the period ended June 30, 2001 in conformity with accounting principlesgenerally accepted in the United States.

New York, New YorkAugust 10, 2001

This is a copy of the audit report previously issued by Arthur Andersen LLP in connection with our filing on Form 10-K for the fiscal year ended June 30, 2001. This audit report has not been reissued by Arthur Andersen LLP in connection with this filing on Form 10-K. See Exhibit 23.2 for further discussion.

83


S TOCKHOLDER INFOR MAT ION

Company HeadquartersThe Estée Lauder Companies Inc.767 Fifth Avenue, New York, New York 10153212-572-4200

Stockholder InformationStockholders may access Company information, includinga summary of the latest financial results, 24 hours a day, bydialing our toll-free information line, 800-308-2334. Newsreleases issued in the last 12 months are available on theWorld Wide Web at www.elcompanies.com.

Investor InquiriesWe welcome inquiries from investors, securities analystsand other members of the professional financial community.Please contact the Investor Relations Department in writ-ing at the Company’s headquarters or by telephone at212-572-4384.

Form 10-K Annual ReportIf you would like a copy of the Company’s Annual Reporton Form 10-K, as filed with the Securities and ExchangeCommission, please call the toll-free information line,800-308-2334, or write to the Investor Relations Depart-ment at the Company’s headquarters.

Common Stock InformationThe Class A Common Stock of The Estée Lauder CompaniesInc. is listed on the New York Stock Exchange with thesymbol EL.

Quarterly Per Share Market Prices

Fiscal 2003 Market Price of Common StockQuarter Ended High Low Close

September 30 $35.99 $25.80 $28.74

December 31 30.10 25.20 26.40

March 31 31.04 25.73 30.36

June 30 35.99 28.91 33.53

DividendsDividends on the common stock are expected to be paidannually in January, following declaration by the Board ofDirectors. The last annual dividend was $.20 per share andwas paid in January 2003.

Annual MeetingThe Company’s Annual Meeting of Stockholders will beheld on Wednesday, November 5, 2003, at 10:00 a.m. at:The Essex House160 Central Park SouthNew York, New York 10019

Attendance at the Annual Meeting will require an admis-sion ticket.

Stockholder ServicesMellon Investor Services is the Company’s transfer agentand registrar. Please contact Mellon directly with allinquiries and requests to:

• Change the name, address or ownership of stock;

• Replace lost certificates or dividend checks;

• Obtain information about dividend reinvestment, directstock purchase or direct deposit of dividends.

Mellon Investor Services LLCP.O. Box 3315South Hackensack, New Jersey 07606888-860-6295www.melloninvestor.com

TrademarksThe Estée Lauder Companies Inc. and its subsidiaries ownnumerous trademarks. Those appearing in the text of thisreport include: 3-Step Skin Care System, Ab Rescue,Advanced Night Repair Eye Recovery Complex, AdvancedStop Signs, All Over Shimmer, Age Rescue, A Perfect WorldWhite tea skin guardian, Aramis, Aramis Life, Aromatics Elixir, Aveda, Aveda Love, Beautiful, Bobbi Brown, BobbiBrown Beach, Shimmer Brick Compact, Bobbi Brown Extra,Bumble and bumble, Calyx, City Block, Clinique, CliniqueHappy, Clinique Happy Heart, Color Conserve, Color Cur-rent, Colour Surge, Convertible Lip Color, Crème Bouquet,Crème de la Mer, Curessence, Darphin, Daywear, DewySmooth, Dramatically Different Moisturizing Lotion, Does It All, Double Talk, Estée Lauder, Estée Lauder pleasures intense, Eye Rescue, Fabulizer, False Eyelashes, Frolic, GingerSoufflé, Have a Nice Day, Hi-Fiber, Iced Shadow, Idealist,jane, Jo Malone, La Mer, Light Elements, Lucky Star, LustreLipstick, Lab Series for Men, M.A.C, �Magic by Prescriptives,MagnaScopic, MegaBites, Origins, Perfectionist, Pro LongLash, Prescriptives, Re-Nutriv, Repairwear, Resilence Lift,Rich Rewards, Rosemary Mint Body Care, Sap Moss, Service with a Smile, Shampure, So Ingenious, Stila, Studio Fix, SuperLine Preventor+, Surf Spray, Total Turnaround, Traceless,Virtual Youth.

Tommy Hilfiger, Tommy Hilfiger T for Him, T Girl “tommy,”“tommy girl,” “tommy” and “tommy girl” Summer Colognesare licensed trademarks from Tommy Hilfiger Licensing Inc.Donna Karan, Donna Karan Black Cashmere, Donna KaranCashmere Mist, Donna Karan Formula Cleanser, DonnaKaran Tinted Moisturizer, DKNY the Fragrance for Men andDKNY The Fragrance for Women are licensed trademarksfrom Donna Karan Studio. kate spade beauty, body moistur-izer, buttercream, eau de parfum, parfum, soap trio and travelvanity are licensed trademarks from kate spade LLP. Kors,Michael Kors and Michael are licensed trademarks fromMichael Kors L.L.C.

84

BRINGING

THE BEST TO

EVERYONE

WE TOUCH

T H E E S T { E L A U D E R C O M PA N I E S I N C . 7 6 7 F I F T H AV E N U E N E W Y O R K , N E W Y O R K 1 0 15 3

estee lauder _ar03

Economy & Finance