UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549-1004

FORM 10-Q

(Mark One)
x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

	For the quarterly period ended December 31, 2007

	OR

o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

	For the transition period from to

	Commission file number: 1-14064

The Estée Lauder Companies Inc.

(Exact name of registrant as specified in its charter)

Delaware

(State or other jurisdiction of
incorporation or organization)

11-2408943

(IRS Employer Identification No.)

767 Fifth Avenue, New York, New York

(Address of principal executive offices)

10153

(Zip Code)

212-572-4200

(Registrant’s telephone number, including area code)

Not Applicable

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

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

Large accelerated filer x Accelerated filer o Non-accelerated filer o

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

At January 28, 2008, 114,215,083 shares of the registrant’s Class A Common Stock, $.01 par value, and 79,217,261 shares of the registrant’s Class B Common Stock, $.01 par value, were outstanding.

THE ESTÉE LAUDER COMPANIES INC.

INDEX

	Page
Part I. Financial Information

Item 1. Financial Statements

Consolidated Statements of Earnings --
Three and Six Months Ended December 31, 2007 and 2006	2

Consolidated Balance Sheets --
December 31, 2007 and June 30, 2007	3

Consolidated Statements of Cash Flows --
Six Months Ended December 31, 2007 and 2006	4

Notes to Consolidated Financial Statements	5

Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations	17

Item 3. Quantitative and Qualitative Disclosures About Market Risk	31

Item 4. Controls and Procedures	31

Part II. Other Information

Item 1. Legal Proceedings	32

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	33

Item 4. Submission of Matters to a Vote of Security Holders	33

Item 6. Exhibits	34

Signatures	35

THE ESTÉE LAUDER COMPANIES INC.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

	Three Months Ended December 31						Six Months Ended December 31
	2007			2006			2007			2006
	(In millions, except per share data)

Net Sales	$	2,308.8		$	1,991.1		$	4,018.9		$	3,584.6
Cost of Sales	578.5			499.0			1,034.3			927.1

Gross Profit	1,730.3			1,492.1			2,984.6			2,657.5

Operating expenses:
Selling, general and administrative	1,359.9			1,159.7			2,536.0			2,224.7
Special charges related to cost savings initiative	(0.1		)	—			0.2			0.5
	1,359.8			1,159.7			2,536.2			2,225.2

Operating Income	370.5			332.4			448.4			432.3

Interest expense, net	18.3			7.7			36.7			14.4
Earnings before Income Taxes, Minority Interest and Discontinued Operations	352.2			324.7			411.7			417.9

Provision for income taxes	122.9			113.3			144.0			146.7
Minority interest, net of tax	(4.9		)	(2.9		)	(4.2		)	(4.7		)
Net Earnings from Continuing Operations	224.4			208.5			263.5			266.5

Discontinued operations, net of tax	—			(0.1		)	—			0.2
Net Earnings	$	224.4		$	208.4		$	263.5		$	266.7

Basic net earnings per common share:
Net earnings from continuing operations	$	1.16		$	1.00		$	1.36		$	1.27
Discontinued operations, net of tax	—			(.00		)	—			.00
Net earnings	$	1.16		$	1.00		$	1.36		$	1.27

Diluted net earnings per common share:
Net earnings from continuing operations	$	1.14		$	.99		$	1.34		$	1.25
Discontinued operations, net of tax	—			(.00		)	—			.00
Net earnings	$	1.14		$	.99		$	1.34		$	1.25

Weighted average common shares outstanding:
Basic	193.3			208.3			193.7			209.7
Diluted	196.5			211.4			196.8			212.5

Cash dividends declared per share	$	.55		$	.50		$	.55		$	.50

See notes to consolidated financial statements.

THE ESTÉE LAUDER COMPANIES INC.

CONSOLIDATED BALANCE SHEETS

	December 31			June 30
	2007			2007
	(Unaudited)
	($ in millions)
ASSETS
Current Assets
Cash and cash equivalents	$	319.5		$	253.7
Accounts receivable, net	1,099.4			860.5
Inventory and promotional merchandise, net	899.0			855.8
Prepaid expenses and other current assets	296.1			269.4
Total current assets	2,614.0			2,239.4

Property, Plant and Equipment, net	943.7			880.8

Other Assets
Investments, at cost or market value	22.3			22.2
Goodwill and other intangible assets, net	901.0			764.7
Other assets, net	256.2			218.6
Total other assets	1,179.5			1,005.5
Total assets	$	4,737.2		$	4,125.7

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Short-term debt	$	198.9		$	60.4
Accounts payable	341.4			314.7
Accrued income taxes	68.9			161.7
Other accrued liabilities	1,105.5			963.9
Total current liabilities	1,714.7			1,500.7

Noncurrent Liabilities
Long-term debt	1,073.3			1,028.1
Other noncurrent liabilities	548.3			376.6
Total noncurrent liabilities	1,621.6			1,404.7

Minority Interest	26.9			21.3

Stockholders’ Equity
Common stock, $.01 par value; 650,000,000 shares Class A authorized; shares issued: 177,031,882 at December 31, 2007 and 173,365,104 at June 30, 2007; 240,000,000 shares Class B authorized; shares issued and outstanding: 79,217,261 at December 31, 2007 and 81,804,761 at June 30, 2007	2.6			2.6
Paid-in capital	866.7			801.7
Retained earnings	2,875.0			2,731.5
Accumulated other comprehensive income	104.6			54.7
	3,848.9			3,590.5
Less: Treasury stock, at cost; 62,819,999 Class A shares at December 31, 2007 and 60,841,674 Class A shares at June 30, 2007	(2,474.9		)	(2,391.5		)
Total stockholders’ equity	1,374.0			1,199.0
Total liabilities and stockholders’ equity	$	4,737.2		$	4,125.7

See notes to consolidated financial statements.

THE ESTÉE LAUDER COMPANIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six Months Ended December 31
	2007			2006
	(In millions)

Cash Flows from Operating Activities
Net earnings	$	263.5		$	266.7
Adjustments to reconcile net earnings to net cash flows from operating activities:
Depreciation and amortization	121.9			103.8
Deferred income taxes	(8.3		)	(12.4		)
Minority interest, net of tax	4.2			4.7
Non-cash stock-based compensation	33.2			26.6
Excess tax benefits from stock-based compensation arrangements	(0.4		)	(1.7		)
Loss on disposal of fixed assets	3.8			2.7
Discontinued operations, net of tax	—			(0.2		)
Other non-cash items	0.3			0.4
Changes in operating assets and liabilities
Increase in accounts receivable, net	(201.5		)	(212.5		)
Increase in inventory and promotional merchandise, net	(8.0		)	(6.5		)
Increase in other assets, net	(24.7		)	(26.1		)
Increase in accounts payable	12.3			22.4
Increase in accrued income taxes	50.4			47.9
Increase in other accrued liabilities	109.6			101.3
Increase (decrease) in other noncurrent liabilities	5.6			(4.4		)
Net cash flows provided by operating activities of continuing operations	361.9			312.7
Net cash flows used for operating activities of discontinued operations	—			(5.7		)
Net cash flows provided by operating activities	361.9			307.0

Cash Flows from Investing Activities
Capital expenditures	(160.4		)	(140.5		)
Acquisition of businesses, net of cash acquired	(116.0		)	(56.7		)
Purchases of long-term investments	(0.4		)	(0.4		)
Net cash flows used for investing activities	(276.8		)	(197.6		)

Cash Flows from Financing Activities
Increase in short-term debt, net	138.1			99.6
Repayments and redemptions of long-term debt	(2.4		)	(1.2		)
Net proceeds from stock-based compensation transactions	26.1			37.1
Excess tax benefits from stock-based compensation arrangements	0.4			1.7
Payments to acquire treasury stock	(80.1		)	(254.3		)
Dividends paid to stockholders	(106.6		)	(103.6		)
Distributions made to minority holders of consolidated subsidiaries	—			(9.5		)
Net cash flows used for financing activities	(24.5		)	(230.2		)

Effect of Exchange Rate Changes on Cash and Cash Equivalents	5.2			4.0

Net Increase (Decrease) in Cash and Cash Equivalents	65.8			(116.8		)
Cash and Cash Equivalents at Beginning of Period	253.7			368.6
Cash and Cash Equivalents at End of Period	$	319.5		$	251.8

See notes to consolidated financial statements.

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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

The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the fiscal year. For further information, refer to the consolidated financial statements and accompanying footnotes included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2007.

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

Net Earnings Per Common Share

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

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

	Three Months Ended December 31					Six Months Ended December 31
	2007		2006			2007		2006
			(Unaudited)
	(In millions, except per share data)
Numerator:
Net earnings from continuing operations	$	224.4	$	208.5		$	263.5	$	266.5
Discontinued operations, net of tax	—		(0.1		)	—		0.2
Net earnings	$	224.4	$	208.4		$	263.5	$	266.7

Denominator:
Weighted average common shares outstanding — Basic	193.3		208.3			193.7		209.7
Effect of dilutive stock options	2.7		2.9			2.6		2.7
Effect of restricted stock units	0.5		0.2			0.5		0.1
Weighted average common shares outstanding — Diluted	196.5		211.4			196.8		212.5

Basic net earnings per common share:
Net earnings from continuing operations	$	1.16	$	1.00		$	1.36	$	1.27
Discontinued operations, net of tax	—		(.00		)	—		.00
Net earnings	$	1.16	$	1.00		$	1.36	$	1.27

Diluted net earnings per common share:
Net earnings from continuing operations	$	1.14	$	.99		$	1.34	$	1.25
Discontinued operations, net of tax	—		(.00		)	—		.00
Net earnings	$	1.14	$	.99		$	1.34	$	1.25

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 2007 and 2006, outstanding options to purchase 10.1 million and 13.3 million shares, respectively, of Class A Common Stock were not included in the computation of diluted EPS because their inclusion would be anti-dilutive. As of December 31, 2007 and 2006, 0.3 million and 0.2 million, respectively, of performance share units have been excluded from the calculation of diluted EPS because the number of shares ultimately issued is contingent on the achievement of certain performance targets of the Company, as discussed in Note 4 — Stock Programs.

Supplemental Disclosures of Cash Flow Information

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

	2007		2006
	(Unaudited)
	(In millions)
Cash
Cash paid during the period for interest	$	39.8	$	18.2
Cash paid during the period for income taxes	$	104.9	$	106.7

Non-cash investing and financing activities
Long-term debt issued upon acquisition of business	$	23.9	$	—
Change in liability associated with acquisitions	$	5.3	$	(2.1	)
Incremental tax benefit from the exercise of stock options	$	2.3	$	3.6
Capital lease obligations incurred	$	0.4	$	1.4
Accrued dividend equivalents	$	0.3	$	0.2
Interest rate swap derivative mark to market	$	19.6	$	7.3

Accounts Receivable

Accounts receivable is stated net of the allowance for doubtful accounts and customer deductions of $20.0 million and $23.3 million as of December 31, 2007 and June 30, 2007, respectively.

Inventory and Promotional Merchandise

Inventory and promotional merchandise only includes inventory considered saleable or usable in future periods, and is stated at the lower of cost or fair-market value, with cost being determined on the first-in, first-out method. Cost components include raw materials, componentry, direct labor and overhead (e.g., indirect labor, utilities, depreciation, purchasing, receiving, inspection and warehousing) as well as inbound freight. Promotional merchandise is charged to expense at the time the merchandise is shipped to the Company’s customers. Included in inventory and promotional merchandise is an inventory obsolescence reserve, which represents the difference between the cost of the inventory and its estimated realizable value, based on various product sales projections. This reserve is calculated using an estimated obsolescence percentage applied to the inventory based on age, historical trends and requirements to support forecasted sales. In addition, and as necessary, specific reserves for future known or anticipated events may be established.

	December 31		June 30
	2007		2007
	(Unaudited)
	(In millions)
Inventory and promotional merchandise, net consists of:
Raw materials	$	134.9	$	179.5
Work in process	55.2		49.2
Finished goods	510.4		431.3
Promotional merchandise	198.5		195.8
	$	899.0	$	855.8

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Property, Plant and Equipment

Property, plant and equipment, including leasehold and other improvements that extend an asset’s useful life or productive capabilities, are carried at cost less accumulated depreciation and amortization. The cost of assets related to projects in progress of $91.0 million and $72.1 million as of December 31, 2007 and June 30, 2007, respectively, is included in their respective asset categories in the table below. For financial statement purposes, depreciation is provided principally on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on a straight-line basis over the shorter of the lives of the respective leases or the expected useful life of those improvements.

	December 31		June 30
	2007		2007
	(Unaudited)
	(In millions)
Asset Category (Useful Life)
Land	$	14.5	$	14.4
Buildings and improvements (10 to 40 years)	173.0		167.5
Machinery and equipment (3 to 10 years)	944.6		905.0
Furniture and fixtures (5 to 10 years)	93.1		108.2
Leasehold improvements	999.1		917.2
	2,224.3		2,112.3
Less accumulated depreciation and amortization	1,280.6		1,231.5
	$	943.7	$	880.8

Depreciation and amortization of property, plant and equipment was $57.4 million and $50.4 million during the three months ended December 31, 2007 and 2006, respectively, and $111.4 million and $99.1 million during the six months ended December 31, 2007 and 2006, respectively. Depreciation and amortization related to the Company’s manufacturing process is included in cost of sales and all other depreciation and amortization is included in selling, general and administrative expenses in the accompanying consolidated statements of earnings.

Goodwill and Other Intangible Assets

In July 2007, the Company acquired Ojon Corporation, which markets and sells Ojon hair care and skin care products primarily through direct response television and specialty stores (see Note 3 — Acquisition of Businesses). Concurrent with this acquisition and under a separate agreement, the Company purchased, from an unrelated party, the exclusive rights to sell and distribute Ojon products worldwide. During the six months ended December 31, 2007, the Company also acquired a business engaged in the wholesale distribution and retail sale of Aveda products. These activities resulted in an increase to goodwill and other intangible assets of $131.6 million as of December 31, 2007.

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Pension and Post-retirement Benefit Plans

The Company maintains pension plans covering substantially all of its full-time employees for its U.S. operations and a majority of its international operations. Certain of the Company’s employees are eligible to participate in a post-retirement benefit plan which provides certain medical and dental benefits. Descriptions of these plans are discussed in the Company’s Annual Report on Form 10-K for the year ended June 30, 2007.

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

													Other than
	Pension Plans												Pension Plans
	U.S.						International						Post-retirement

	2007			2006			2007			2006			2007		2006
(Unaudited)
(In millions)
Service cost, net	$	4.9		$	4.6		$	4.1		$	4.0		$	1.1	$	1.2
Interest cost	6.6			6.2			3.7			3.2			1.6		1.6
Expected return on plan assets	(7.9		)	(7.2		)	(3.8		)	(3.4		)	—		—
Amortization of:
Prior service cost	0.2			0.2			0.1			0.1			—		—
Actuarial loss	0.4			0.5			1.5			1.9			0.1		0.2
Net periodic benefit cost	$	4.2		$	4.3		$	5.6		$	5.8		$	2.8	$	3.0

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

													Other than
	Pension Plans												Pension Plans
	U.S.						International						Post-retirement

	2007			2006			2007			2006			2007		2006
(Unaudited)
(In millions)
Service cost, net	$	9.9		$	9.2		$	8.0		$	7.9		$	2.1	$	2.4
Interest cost	13.1			12.5			7.2			6.4			3.2		3.3
Expected return on plan assets	(15.9		)	(14.4		)	(7.4		)	(6.8		)	—		—
Amortization of:
Prior service cost	0.3			0.3			0.1			0.1			—		—
Actuarial loss	0.9			0.9			3.0			3.9			0.2		0.4
Net periodic benefit cost	$	8.3		$	8.5		$	10.9		$	11.5		$	5.5	$	6.1

The Company previously disclosed in its consolidated financial statements for the fiscal year ended June 30, 2007 that it expected to make cash contributions totaling $20.0 million to its trust based, noncontributory qualified defined benefit pension plan (“U.S. Qualified Plan”) and $21.0 million to its international defined benefit pension plans during the fiscal year ending June 30, 2008. As of December 31, 2007, there have not been material changes to the expected contributions to the U.S. Qualified Plan. However, the expected contributions to the international defined benefit pension plans are anticipated to increase $3.4 million to a total of $24.4 million for the fiscal year ending June 30, 2008.

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Common Stock

During the six months ended December 31, 2007, 2,587,500 shares of the Company’s Class B Common Stock were converted into Class A Common Stock.

In August 2007, pursuant to the Company’s accelerated share repurchase program, the financial counterparty informed the Company that it had completed its obligations under the agreement. The per-share price paid by the Company at inception of the program exceeded the final volume weighted average price per share, as defined by the contract. Accordingly, the Company received 97,417 shares of its Class A Common Stock from the financial counterparty as a price adjustment and final settlement, which was recorded as treasury stock and additional paid-in capital in the consolidated balance sheet.

Pursuant to the Company’s share repurchase program, during the six months ended December 31, 2007, it purchased approximately 1.9 million shares for $80.1 million.

Management Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses reported in those financial statements. These judgments can be subjective and complex, and consequently actual results could differ from those estimates and assumptions. The Company’s most critical accounting policies relate to revenue recognition, concentration of credit risk, inventory, pension and other post-retirement benefit costs, goodwill and other intangible assets, income taxes, derivatives and stock-based compensation. Descriptions of these policies are discussed in the Company’s Annual Report on Form 10-K for the year ended June 30, 2007.

Recently Adopted Accounting Standards

In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a two-step evaluation process for tax positions taken, or expected to be taken, in a tax return. The first step is recognition and the second is measurement. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, disclosures, transition and accounting for interim periods. The Company adopted the provisions of FIN 48 effective July 1, 2007. As a result, the Company recognized an increase in the liability for unrecognized tax benefits and interest of approximately $13.1 million (net of tax effect), which, as required, was accounted for as a reduction to the July 1, 2007 balance of retained earnings.

As of July 1, 2007, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled approximately $142.7 million. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was approximately $106.5 million. The Company has elected to continue its historical practice of classifying applicable interest and penalties as a component of the provision for income taxes. The Company’s gross accrual for interest and penalties related to unrecognized tax benefits was approximately $42.0 million upon adoption of FIN 48. Interest is computed on the difference between the Company’s uncertain tax benefit positions under FIN 48 and the amount reflected or expected to be reflected in the Company’s tax returns. Adoption of FIN 48 also resulted in a reclassification of approximately $140.2 million of tax and related interest liabilities (net of tax effect) from accrued income taxes to other noncurrent liabilities because payment of cash is not anticipated within one year of the balance sheet date.

As of December 31, 2007, the gross amount of unrecognized tax benefits, exclusive of interest and penalties, totaled approximately $150.7 million. If recognized, approximately $114.2 million would affect the effective tax rate. The Company’s gross accrual for interest and penalties related to unrecognized tax benefits as of December 31, 2007 was approximately $49.3 million.

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Earnings from the Company’s global operations are subject to tax in various jurisdictions both within and outside the United States. The Company provides tax reserves for U.S. federal, state, local and international unrecognized tax benefits for periods subject to audit. The Company believes that the tax reserves are adequate for all years subject to examination. The Company is currently subject to a U.S. federal tax audit as well as examinations in several state, local, and international jurisdictions. These audits and examinations are in various stages of completion and involve complex multi-jurisdictional issues, including transfer pricing, that may require an extended period of time for resolution. It is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease during the next twelve months. However, because these multi-jurisdictional issues, including transfer pricing, are complex and the level and disposition of such issues are subject to change, the range of reasonably possible change cannot be estimated at this time.

The tax years subject to examination vary depending on the tax jurisdiction. As of December 31, 2007, the following tax years remain subject to examination by the major tax jurisdictions indicated:

Major Jurisdiction		Open Fiscal Years

Belgium		2004—2007
Canada		2000—2007
France		2005—2007
Germany		1999—2007
Japan		2006—2007
Korea		2002—2007
Spain		1999—2007
Switzerland		2004—2007
United Kingdom		2005—2007
United States		2002—2007
State of California		2002—2007
State of Minnesota		2001—2007
State of New York		2004—2007

The Company is also subject to income tax examinations in numerous other state, local and foreign jurisdictions. The Company believes that its tax reserves are adequate for all years subject to examination.

Recently Issued Accounting Standards

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

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

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) replaces SFAS No. 141, “Business Combinations,” however, it retains the fundamental requirements of the former Statement that the acquisition method of accounting (previously referred to as the purchase method) be used for all business combinations and for an acquirer to be identified for each business. SFAS No. 141(R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control. Among other requirements, SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree at their acquisition-date fair values, with limited exceptions; acquisition-related costs generally will be expensed as incurred. SFAS No. 141(R) requires certain financial statement disclosures to enable users to evaluate and understand the nature and financial effects of the business combination. SFAS No. 141(R) must be applied prospectively to business combinations that are consummated beginning in the Company’s fiscal 2010.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51” (“SFAS No. 160”) to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Among other requirements, SFAS No. 160 clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as minority interest, is to be reported as a separate component of equity in the consolidated financial statements. SFAS No. 160 also requires consolidated net income to include the amounts attributable to both the parent and the noncontrolling interest and to disclose those amounts on the face of the consolidated statement of income. SFAS No. 160 must be applied prospectively for fiscal years, and interim periods within those fiscal years, beginning in the Company’s fiscal 2010, except for the presentation and disclosure requirements, which will be applied retrospectively for all periods presented.

NOTE 2 — COMPREHENSIVE INCOME

The components of accumulated other comprehensive income (“OCI”) included in the accompanying consolidated balance sheets consist of net unrealized investment gain (loss), net gain (loss) on derivative instruments designated and qualifying as cash-flow hedging instruments, net actuarial gain (loss) and prior service costs or credits associated with pension and other post-retirement benefits, and cumulative translation adjustments as of the end of each period.

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

	Three Months Ended December 31						Six Months Ended December 31
	2007			2006			2007			2006
				(Unaudited) (In millions)

Net earnings	$	224.4		$	208.4		$	263.5		$	266.7
Other comprehensive income (loss):
Net unrealized investment gain (loss)	(0.1		)	0.1			(0.3		)	0.1
Net derivative instruments gain (loss)	—			(2.0		)	(0.9		)	(3.2		)
Amortization of amounts included in net periodic benefit cost, net	1.7			—			3.3			—
Translation adjustments	17.4			18.9			47.8			19.0

Other comprehensive income (loss)	19.0			17.0			49.9			15.9

Comprehensive income	$	243.4		$	225.4		$	313.4		$	282.6

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

	Three Months Ended December 31						Six Months Ended December 31
	2007			2006			2007			2006
	(Unaudited)
	(In millions)

OCI-derivative instruments, beginning of period	$	7.3		$	9.1		$	8.2		$	10.3
Gain (loss) on derivative instruments	(0.6		)	(4.9		)	(2.0		)	(6.2		)
Reclassification to earnings of net (gain) loss during the period	0.6			1.9			0.6			1.4
Benefit for deferred income taxes	—			1.0			0.5			1.6

Net derivative instruments gain (loss)	—			(2.0		)	(0.9		)	(3.2		)

OCI-derivative instruments, end of period	$	7.3		$	7.1		$	7.3		$	7.1

Of the $7.3 million, net of tax, derivative instrument gain recorded in OCI at December 31, 2007, $9.0 million, net of tax, related to the October 2003 gain from the settlement of the treasury lock agreements upon the issuance of the Company’s 5.75% Senior Notes due October 2033, which will be reclassified to earnings as an offset to interest expense over the life of the debt. Partially offsetting this gain was $0.6 million, net of tax, related to a loss from the settlement of a series of forward-starting interest rate swap agreements upon the issuance of the Company’s 6.00% Senior Notes due May 2037, which will be reclassified to earnings as an addition to interest expense over the life of the debt. Also partially offsetting the net derivative instrument gain recorded in OCI was $1.1 million in losses, net of tax, related to forward contracts which the Company will reclassify to earnings during the next six months.

At the end of the prior period, the $7.1 million, net of tax, derivative instrument gain recorded in OCI included $9.1 million, net of tax, related to the gain on the settlement of treasury lock agreements upon issuance of the Company’s 5.75% Senior Notes due October 2033, which will be reclassified to earnings as an offset to interest expense over the life of the debt, partially offset by $2.0 million of losses, net of tax, related to forward and option contracts which were reclassified to earnings.

NOTE 3 – ACQUISITION OF BUSINESSES

In July 2007, the Company acquired Ojon Corporation. Concurrent with this acquisition and under a separate agreement, the Company purchased, from an unrelated party, the exclusive rights to sell and distribute Ojon products worldwide. The initial purchase price, paid at closing, was funded by cash provided by operations and the issuance of commercial paper as well as the issuance of two promissory notes. The Company issued (i) a promissory note due July 31, 2009 with a notional value of $7.0 million (present value of $7.6 million at December 31, 2007), bearing interest at 10.00% due at maturity and (ii) a promissory note due August 31, 2012 with a notional amount of $13.5 million (present value of $15.9 million), bearing interest at 10.00% payable annually on July 31. The notes were recorded in the accompanying consolidated balance sheet at present value using effective rates of 5.11% and 5.42%, respectively. The purchase agreement also provides for an additional payment, which is expected to be made in fiscal 2013, contingent upon the attainment of certain net sales targets of Ojon products. In addition, the Company also acquired a business engaged in the wholesale distribution and retail sale of Aveda products.

The aggregate purchase price for these transactions, which includes acquisition costs, was $144.9 million at December 31, 2007. The results of operations for each of the acquired businesses are included in the accompanying consolidated financial statements commencing with its date of original acquisition. Pro forma results of operations have not been presented, as the impact on the Company’s consolidated financial results would not have been material.

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4 – STOCK PROGRAMS

As of December 31, 2007, the Company has three active equity compensation plans which include the Amended and Restated Fiscal 2002 Share Incentive Plan, the Fiscal 1999 Share Incentive Plan and the Non-Employee Director Share Incentive Plan (collectively, the “Plans”). These Plans currently provide for the issuance of 33,194,400 shares, which consist of shares originally provided for and shares transferred to the Plans from a previous plan and employment agreement, to be granted in the form of stock-based awards to key employees, consultants and non-employee directors of the Company. As of December 31, 2007, approximately 6,536,800 shares of Class A Common Stock were reserved and available to be granted pursuant to these Plans. The Company may satisfy the obligation of its stock-based compensation awards with either new or treasury shares. The Company’s stock compensation awards outstanding at December 31, 2007 include stock options, performance share units (“PSU”), restricted stock units (“RSU”) and share units.

Total net stock-based compensation expense is attributable to the granting of, and the remaining requisite service periods of, stock options, PSUs, RSUs and share units. Compensation expense attributable to net stock-based compensation during the three months ended December 31, 2007 and 2006 was $14.3 million and $11.7 million, respectively. Compensation expense attributable to net stock-based compensation during the six months ended December 31, 2007 and 2006 was $33.2 million and $26.5 million, respectively. As of December 31, 2007 and 2006, the total unrecognized compensation cost related to nonvested stock-based awards was $48.8 and $47.7 million, respectively, and the related weighted-average period over which it is expected to be recognized is approximately 2.0 and 2.2 years, respectively.

Stock Options

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

(Unaudited) (Shares in thousands)	Shares		Weighted- Average Exercise Price		Aggregate Intrinsic Value(1) (in millions)		Weighted-Average Contractual Life Remaining in Years

Outstanding at June 30, 2007	22,572.0		$	41.42
Granted at fair value	1,675.2		42.62
Exercised	(763.9	)	34.27
Expired	(93.9	)	44.46
Forfeited	(38.8	)	40.30
Outstanding at December 31, 2007	23,350.6		41.73		$	93.7	4.4

Exercisable at December 31, 2007	19,893.7		41.95		$	82.9	3.6

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

The exercise period for all stock options generally may not exceed ten years from the date of grant. Stock option grants to individuals generally become exercisable in three substantively equal tranches over a service period of up to four years. The Company attributes the value of option awards on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards.

The per-share weighted-average grant date fair value of stock options granted during the three months ended December 31, 2007 and 2006 was $15.54 and $14.71, respectively. The per-share weighted-average grant date fair value of stock options granted during the six months ended December 31, 2007 and 2006 was $14.37 and $13.67, respectively. The total intrinsic value of stock options exercised during the three months ended December 31, 2007 and 2006 was $6.4 million and $14.0 million, respectively. The total intrinsic value of stock options exercised during the six months ended December 31, 2007 and 2006 was $7.1 million and $15.9 million, respectively.

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

	Three Months Ended December 31
(Unaudited)	2007	2006
Weighted-average expected stock-price volatility	24%	24%
Weighted-average expected option life	9 years	9 years
Average risk-free interest rate	4.6%	4.7%
Average dividend yield	1.2%	1.2%


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

Performance Share Units

During the six months ended December 31, 2007, the Company issued 119,200 PSUs, which will be settled in stock subject to the achievement of the Company’s net sales and net earnings per share goals for the three years ending June 30, 2010. Settlement will be made pursuant to a range of opportunities relative to the net sales and net earnings per share targets of the Company and, as such, the compensation cost of the PSU is subject to adjustment based upon the attainability of these target goals. No settlement will occur for results below the applicable minimum threshold and additional shares shall be issued if performance exceeds the targeted performance goals. PSUs are accompanied by dividend equivalent rights that will be payable in cash upon settlement of the PSU. These awards are subject to the provisions of the agreement under which the PSUs are granted. The PSUs were valued at the closing market value of the Company’s Class A Common Stock on the date of grant and generally vest at the end of the performance period.

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

		Weighted-Average
		Grant Date
(Unaudited) (Shares in thousands)	Shares	Fair Value
Nonvested at June 30, 2007	230.1	$	37.36
Granted	119.2	42.58
Vested	—	—
Forfeited	—	—
Nonvested at December 31, 2007	349.3	$	39.14

Restricted Stock Units

The Company granted approximately 578,400 RSUs during the six months ended December 31, 2007, of which 321,500 are scheduled to vest on October 31, 2008, 167,200 on November 2, 2009 and 89,700 on November 1, 2010, all subject to the continued employment or retirement of the grantees. Certain RSUs granted in fiscal 2008 are accompanied by dividend equivalent rights that will be payable in cash upon settlement of the RSU and, as such, were valued at the closing market value of the Company’s Class A Common Stock on the date of grant. Other RSUs granted in fiscal 2008 are not accompanied by dividend equivalent rights and, as such, were valued at the closing market value of the Company’s Class A Common Stock on the date of grant less the discounted present value of the dividends expected to be paid on the shares during the vesting period.

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following is a summary of the status of the Company’s RSUs as of December 31, 2007 and activity during the six months then ended:

			Weighted-Average
			Grant Date
(Unaudited) (Shares in thousands)	Shares		Fair Value
Nonvested at June 30, 2007	659.4		$	38.74
Granted	578.4		42.00
Vested	(346.7	)	38.90
Forfeited	(16.5	)	39.98
Nonvested at December 31, 2007	874.6		$	40.81

Share Units

The Company grants share units to certain non-employee directors under the Non-Employee Director Share Incentive Plan. The share units are convertible into shares of Class A Common Stock as provided for in that plan. Share units are accompanied by dividend equivalent rights that are converted to additional share units when such dividends are declared. The following is a summary of the status of the Company’s share units as of December 31, 2007 and activity during the six months then ended:

		Weighted-Average
		Grant Date
(Unaudited) (Shares in thousands)	Shares	Fair Value
Outstanding at June 30, 2007	13.8	$	37.65
Granted	4.1	44.25
Dividend equivalents	0.2	43.79
Converted	—	—
Outstanding at December 31, 2007	18.1	$	39.21

Cash Units

Certain non-employee directors defer cash compensation in the form of cash payout share units, which are not subject to the Plans. These share units are classified as liabilities and, as such, their fair value is adjusted to reflect the current market value of the Company’s Class A Common Stock. The Company recorded expense of $0.2 million as compensation to reflect additional deferrals and the change in the market value for the three months ended December 31, 2007 and 2006. The Company recorded expense of $0.2 million and $0.4 million as compensation to reflect additional deferrals and the change in the market value for the six months ended December 31, 2007 and 2006, respectively.

THE ESTÉE LAUDER COMPANIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5 – SEGMENT DATA AND RELATED INFORMATION

Reportable operating segments include components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker (the “Chief Executive”) in deciding how to allocate resources and in assessing performance. Although the Company does business in one operating segment, beauty products, management also evaluates performance on a product category basis. Performance is measured based upon net sales and operating income. Operating income represents earnings before income taxes, minority interest, net interest expense and discontinued operations. The accounting policies for the Company’s reportable segment are substantially the same as those for the consolidated financial statements, as described in the segment data and related information footnote included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2007. The assets and liabilities of the Company are managed centrally and are reported internally in the same manner as the consolidated financial statements; thus, no additional information is produced for the Chief Executive or included herein. There has been no significant variance in the total or long-lived asset value associated with the Company’s segment data since June 30, 2007.

	Three Months Ended December 31				Six Months Ended December 31
	2007		2006		2007			2006
	(Unaudited)
	(In millions)
PRODUCT CATEGORY DATA
Net Sales:
Skin Care	$	831.2	$	701.1	$	1,450.7		$	1,268.1
Makeup	827.3		716.8		1,490.4			1,363.6
Fragrance	520.5		465.1		833.5			754.4
Hair Care	110.4		93.9		213.0			176.3
Other	19.4		14.2		31.3			22.2
	$	2,308.8	$	1,991.1	$	4,018.9		$	3,584.6
Operating Income (Loss):
Skin Care	$	166.5	$	148.8	$	202.3		$	191.7
Makeup	149.4		128.6		190.5			178.5
Fragrance	48.1		37.4		43.1			42.5
Hair Care	6.4		15.6		13.8			19.5
Other	—		2.0		(1.1		)	0.6
Special charges related to cost savings initiative	0.1		—		(0.2		)	(0.5		)
	370.5		332.4		448.4			432.3
Reconciliation:
Interest expense, net	18.3		7.7		36.7			14.4
Earnings before income taxes, minority interest and discontinued operations	$	352.2	$	324.7	$	411.7		$	417.9

GEOGRAPHIC DATA
Net Sales:
The Americas	$	1,028.2	$	944.0	$	1,927.1		$	1,844.5
Europe, the Middle East & Africa	933.2		761.7		1,484.4			1,233.6
Asia/Pacific	347.4		285.4		607.4			506.5
	$	2,308.8	$	1,991.1	$	4,018.9		$	3,584.6
Operating Income (Loss):
The Americas	$	91.0	$	109.9	$	143.4		$	183.0
Europe, the Middle East & Africa	207.0		170.8		216.0			189.1
Asia/Pacific	72.4		51.7		89.2			60.7
Special charges related to cost savings initiative	0.1		—		(0.2		)	(0.5		)
	$	370.5	$	332.4	$	448.4		$	432.3

THE ESTÉE LAUDER COMPANIES INC.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

RESULTS OF OPERATIONS

We manufacture, market and sell beauty products including those in the skin care, makeup, fragrance and hair care categories which are distributed in over 135 countries and territories. The following is a comparative summary of operating results from continuing operations for the three and six months ended December 31, 2007 and 2006, and reflects the basis of presentation described in Note 1 of Notes to Consolidated Financial Statements — Summary of Significant Accounting Policies for all periods presented. Sales of products and services that do not meet our definition of skin care, makeup, fragrance or hair care have been included in the “other” category.

	Three Months Ended December 31				Six Months Ended December 31
	2007		2006		2007			2006
	(In millions)
NET SALES
By Region:
The Americas	$	1,028.2	$	944.0	$	1,927.1		$	1,844.5
Europe, the Middle East & Africa	933.2		761.7		1,484.4			1,233.6
Asia/Pacific	347.4		285.4		607.4			506.5
	$	2,308.8	$	1,991.1	$	4,018.9		$	3,584.6

By Product Category:
Skin Care	$	831.2	$	701.1	$	1,450.7		$	1,268.1
Makeup	827.3		716.8		1,490.4			1,363.6
Fragrance	520.5		465.1		833.5			754.4
Hair Care	110.4		93.9		213.0			176.3
Other	19.4		14.2		31.3			22.2
	$	2,308.8	$	1,991.1	$	4,018.9		$	3,584.6
OPERATING INCOME (LOSS)
By Region:
The Americas	$	91.0	$	109.9	$	143.4		$	183.0
Europe, the Middle East & Africa	207.0		170.8		216.0			189.1
Asia/Pacific	72.4		51.7		89.2			60.7
Special charges related to cost savings initiative	0.1		—		(0.2		)	(0.5		)
	$	370.5	$	332.4	$	448.4		$	432.3

By Product Category:
Skin Care	$	166.5	$	148.8	$	202.3		$	191.7
Makeup	149.4		128.6		190.5			178.5
Fragrance	48.1		37.4		43.1			42.5
Hair Care	6.4		15.6		13.8			19.5
Other	—		2.0		(1.1		)	0.6
Special charges related to cost savings initiative	0.1		—		(0.2		)	(0.5		)
	$	370.5	$	332.4	$	448.4		$	432.3

THE ESTÉE LAUDER COMPANIES INC.

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

	Three Months Ended December 31				Six Months Ended December 31
	2007		2006		2007		2006

Net sales	100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales	25.1		25.1		25.7		25.9
Gross profit	74.9		74.9		74.3		74.1
Operating expenses:
Selling, general and administrative	58.9		58.2		63.1		62.0
Special charges related to cost savings initiative	(0.0	)	—		0.0		0.0
	58.9		58.2		63.1		62.0

Operating income	16.0		16.7		11.2		12.1
Interest expense, net	0.8		0.4		0.9		0.4
Earnings before income taxes, minority interest and discontinued operations	15.2		16.3		10.3		11.7
Provision for income taxes	5.3		5.7		3.6		4.1
Minority interest, net of tax	(0.2	)	(0.1	)	(0.1	)	(0.1	)

Net earnings from continuing operations	9.7		10.5		6.6		7.5
Discontinued operations, net of tax	—		(0.0	)	—		0.0
Net earnings	9.7	%	10.5	%	6.6	%	7.5	%

In order to meet the demands of consumers, we continually introduce new products, support new and established products through advertising, sampling and merchandising and phase out existing products that no longer meet the needs of our consumers or our strategic and financial objectives. The economics of developing, producing and launching these new products influence our sales and operating performance each period. The introduction of new products may have some cannibalizing effect on sales of existing products, which we take into account in our business planning.

The recent challenges and uncertainties in the economies of certain key countries, including the United States, may have an adverse impact on consumer demand, which could affect our net sales and operating results in the short and long term.

Second Quarter Fiscal 2008 as Compared with Second Quarter Fiscal 2007

NET SALES

Net sales increased 16%, or $317.7 million, to $2,308.8 million, reflecting net sales growth in all of our product categories within each of our regions. Geographically, a substantial portion of this growth was attained internationally, reflecting our efforts to capitalize on growth opportunities, as well as the soft retail environment in the United States. Excluding the impact of foreign currency translation, net sales increased 11%.

Product Categories

In the current quarter, net sales in the skin care, makeup and fragrance product categories were favorably impacted in the United States by the ordering patterns of department store customers as a result of a one week shift in the retail calendar from our first fiscal quarter.

Skin Care

Net sales of skin care products increased 19%, or $130.1 million, to $831.2 million. The recent launches of Idealist Pore Minimizing Skin Refinisher and Hydra Bright Skin Tone Perfecting Moisturizers from Estée Lauder and products in the Acne Solutions Clear Skin System, Continuous Rescue Antioxidant Moisturizers and Zero Gravity Repairwear Lift Firming Cream from Clinique contributed incremental sales of approximately $52 million, combined. Net sales increases from La Mer, Origins and Good Skin ^TM products, as well as products in the Re-Nutriv line from Estée Lauder and in the Clinique 3-Step System totaled approximately $41 million. These improvements were partially offset by approximately $19 million of lower sales from other existing Idealist and Perfectionist products from Estée Lauder. Net sales of other new and existing products also significantly contributed to the growth. Excluding the impact of foreign currency translation, skin care net sales increased 13%.

THE ESTÉE LAUDER COMPANIES INC.

Makeup

Makeup net sales increased 15%, or $110.5 million, to $827.3 million, reflecting increases from our makeup artist brands of approximately $73 million. Also contributing to the growth were the recent launches of Estée Lauder Signature Hydra Lustre Lipstick and Supermoisture Makeup from Clinique, as well as higher sales of Resilience Lift Extreme Ultra Firming products from Estée Lauder of approximately $26 million, combined. This growth was partially offset by approximately $12 million of lower sales of Pure Color Eyeshadow and High Gloss Lip Gloss from Estée Lauder. Excluding the impact of foreign currency translation, makeup net sales increased 11%.

Fragrance

Net sales of fragrance products increased 12%, or $55.4 million, to $520.5 million. The recent launches of Sean John Unforgivable Woman, Estée Lauder pleasures delight, Dreaming Tommy Hilfiger and Tom Ford for Men collectively contributed approximately $34 million to the growth in the category. Net sales growth of approximately $29 million from DKNY Be Delicious, Jo Malone fragrances, Clinique Aromatics Elixir, Clinique Happy, and Estée Lauder Beautiful also contributed to the increase. Partially offsetting these increases, by approximately $16 million, were lower sales of DKNY Be Delicious Men and DKNY Red Delicious Women. While current year sales levels compared favorably to the prior year, we anticipate continued challenges in this product category primarily in the United States. Excluding the impact of foreign currency translation, fragrance net sales increased 7%.

Hair Care

Hair care net sales increased 18%, or $16.5 million, to $110.4 million, primarily due to the inclusion of the Ojon brand and growth from Aveda and Bumble and bumble. Aveda net sales increases benefited from the recent launches of Aveda Men Pure-Formance and Smooth Infusion products, as well as the recent acquisition of an independent distributor. Bumble and bumble net sales benefited from increases from its hotel amenities program and sales from new points of distribution. Excluding the impact of foreign currency translation, hair care net sales increased 15%.

Geographic Regions

Net sales in the Americas increased 9%, or $84.2 million, to $1,028.2 million. The results in the United States benefited from the shift in the retail calendar, which affected the ordering patterns of department store customers in our first fiscal quarter, partially offset by ongoing challenges within this channel and their impact on certain of our brands. Outside of the U.S. department store channel, net sales grew through our internet distribution, offerings from our BeautyBank brands, and in our hair care brands, which included the addition of the Ojon brand, by approximately $29 million combined. In addition, we experienced net sales growth in Latin America and Canada of approximately $21 million. Excluding the impact of foreign currency translation, net sales in the Americas increased 8%.

In Europe, the Middle East & Africa, net sales increased 23%, or $171.5 million, to $933.2 million, including an exchange rate benefit due to the weakening of the U.S. dollar of approximately $71 million. The growth in the region reflected contributions from all countries in the region, led by the United Kingdom, our travel retail business and Russia, which benefited from our continuing expansion in this emerging market. Excluding the impact of foreign currency translation, net sales in Europe, the Middle East & Africa increased 13%.

Net sales in Asia/Pacific increased 22%, or $62.0 million, to $347.4 million, including an exchange rate benefit due to the weakening of the U.S. dollar of approximately $19 million. This increase reflected higher net sales of approximately $51 million in China, Australia, Hong Kong, Korea and Japan. Excluding the impact of foreign currency translation, Asia/Pacific net sales increased 15%.

We strategically stagger our new product launches by geographic market, which may account for differences in regional sales growth.

COST OF SALES

Cost of sales as a percentage of total net sales was 25.1%, which remained unchanged as compared with the prior period. Cost of sales as a percentage of net sales reflected a positive effect of exchange rates of 20 basis points and favorable changes in manufacturing variances of 10 basis points. Offsetting these improvements was an increase in obsolescence charges of 20 basis points and an increase in the level and timing of promotions of 10 basis points.

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Since certain promotional activities are a component of sales or cost of sales and the timing and level of promotions vary with our promotional calendar, we have experienced, and expect to continue to experience, fluctuations in the cost of sales percentage. In addition, future cost of sales mix may be impacted by the inclusion of new brands which have margin and product cost structures different from those of our existing brands.

OPERATING EXPENSES

Operating expenses increased to 58.9% of net sales as compared with 58.2% of net sales in the prior period. The increase in operating expenses and operating expense margin reflected higher costs of global information technology systems and infrastructure of approximately 50 basis points as well as new business development initiatives and activities of approximately 40 basis points. The comparatively lower operating expenses generated by our higher growth brands, as well as our ongoing cost containment initiatives, primarily offset these increases.

Changes in advertising, sampling and merchandising spending result from the type, timing and level of activities related to product launches and rollouts, as well as the markets being emphasized.

OPERATING RESULTS

Based on the growth of net sales, our constant cost of sales margin and the increase in our operating expense margin as previously discussed, operating income increased 11%, or $38.1 million, to $370.5 million as compared with the prior-year period. Operating margins were 16.0% of net sales in the current period as compared with 16.7% in the prior-year period.

Product Categories

Fragrance operating results grew 29%, or $10.7 million, to $48.1 million, reflecting growth outside of the United States in certain of our core fragrances, partially offset by lower results from designer fragrances resulting from sales of lower-margin products and continued spending in support of new product launches. Makeup operating results increased 16%, or $20.8 million, to $149.4 million, reflecting strong growth overseas, partially offset by softness in certain of our core brands in the United States. Skin care operating results increased 12%, or $17.7 million, to $166.5 million, reflecting worldwide growth from certain of our core brands, as well as contributions from our La Mer brand. Our makeup and skin care categories were the primary beneficiaries of the shift in the retail calendar. Hair care results declined 59%, or $9.2 million, to $6.4 million. This decrease in profitability reflects investments designed to support our short and long-term growth in this category through new points of distribution and an increase in intangible asset amortization resulting from recent strategic acquisitions.

Geographic Regions

Operating income in the Americas decreased 17%, or $18.9 million, to $91.0 million reflecting increased spending on global information technology systems and infrastructure, as well as on new business development initiatives and activities. In the United States, operating income improvements as a result of the shift in the retail calendar were offset by the ongoing challenges experienced in the department store channel.

In Europe, the Middle East & Africa, operating income increased 21%, or $36.2 million, to $207.0 million primarily due to improved results in the United Kingdom, our travel retail business, the Balkans and Germany of approximately $27 million, collectively. Partially offsetting these increases were lower results in Russia of approximately $2 million, reflecting spending to support our continuing expansion in this emerging market.

In Asia/Pacific, operating income increased 40%, or $20.7 million, to $72.4 million. All of our affiliates in this region experienced an increase in operating income, primarily resulting from net sales growth led by Australia, Japan, China, Korea, and Hong Kong, which contributed approximately $17 million, collectively.

INTEREST EXPENSE, NET

Net interest expense was $18.3 million as compared with $7.7 million in the prior period. This change primarily resulted from higher average debt balances, including an additional $600.0 million of senior notes issued in the fourth quarter of fiscal 2007.

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PROVISION FOR INCOME TAXES

The provision for income taxes represents Federal, foreign, state and local income taxes. The effective rate differs from statutory rates due to the effect of state and local taxes, tax rates in foreign jurisdictions and certain nondeductible expenses. Our effective tax rate will change from quarter to quarter based on non-recurring and recurring factors including, but not limited to, the geographical mix of earnings, enacted tax legislation, state and local taxes, tax audit settlements and the interaction of various global tax strategies. In addition, changes in judgment from the evaluation of new information resulting in recognition, derecognition or remeasurement of a tax position taken in a prior annual period are recognized separately in the quarter of change.

The effective rate for income taxes for the three months ended December 31, 2007 and December 31, 2006 was 34.9%. While there was no change in the overall effective income tax rate between the two periods (including the remeasurement of tax positions requiring recognition in the current quarter), the rate for the current quarter included an extra 210 basis for nondeductible expenses and other miscellaneous items offset by a decrease in 210 basis points relating to the tax effect of our foreign operations (90 basis points), lower state and local tax expense (100 basis points) and an increase in tax credits (20 basis points).

Six Months Fiscal 2008 as Compared with Six Months Fiscal 2007

NET SALES

Net sales increased 12%, or $434.3 million, to $4,018.9 million, reflecting net sales growth in all of our product categories, with hair care showing the largest proportionate growth. Skin care, makeup and fragrance net sales increases were led by Europe, the Middle East and Africa while most of the net sales growth in hair care was achieved in the Americas. Overall, the increase in net sales reflected our efforts to capitalize on growth opportunities internationally. Excluding the impact of foreign currency translation, net sales increased 8%.

Product Categories

Skin Care

Net sales of skin care products increased 14%, or $182.6 million, to $1,450.7 million. The recent launches of Idealist Pore Minimizing Skin Refinisher and Hydra Bright Skin Tone Perfecting Moisturizers from Estée Lauder and products in the Acne Solutions Clear Skin System, Zero Gravity Repairwear Lift Firming Cream and Continuous Rescue Antioxidant Moisturizers from Clinique contributed incremental sales of approximately $92 million, combined. Net sales increases from La Mer, Origins and Good Skin TM products, as well as Re-Nutriv and Resilience Lift Extreme Ultra Firming products from Estée Lauder, totaled approximately $72 million. These improvements were partially offset by approximately $39 million of lower sales from certain other existing Idealist products and Perfectionist products from Estée Lauder. Net sales of other new and existing products also significantly contributed to the growth. Excluding the impact of foreign currency translation, skin care net sales increased 10%.

Makeup

Makeup net sales increased 9%, or $126.8 million, to $1,490.4 million reflecting growth from our makeup artist brands of approximately $89 million. Also contributing to the growth were the recent launches of Estée Lauder Signature Hydra Lustre Lipstick and Supermoisture Makeup from Clinique, as well as higher sales of Resilience Lift Extreme Ultra Firming products from Estée Lauder of approximately $46 million, combined. Partially offsetting these increases were lower sales of approximately $22 million of Pure Color Eyeshadow by Estée Lauder and High Definition Lashes Brush Then Comb Mascara and Perfectly Real Makeup by Clinique. Excluding the impact of foreign currency translation, makeup net sales increased 6%.

Fragrance

Net sales of fragrance products increased 10%, or $79.1 million, to $833.5 million. The recent launches of Sean John Unforgivable Woman, Estée Lauder pleasures delight, Tom Ford for Men and Dreaming Tommy Hilfiger collectively contributed approximately $47 million to the growth in the category. Higher sales of approximately $48 million of DKNY Be Delicious, Jo Malone fragrances, Sean John Unforgivable and Clinique Happy also contributed to the increase. Lower sales of approximately $23 million of DKNY Be Delicious Men and Youth Dew Amber Nude by Tom Ford for Estée Lauder partially offset the growth in this product category. Excluding the impact of foreign currency translation, fragrance net sales increased 6%.

THE ESTÉE LAUDER COMPANIES INC.

Hair Care

Hair care net sales increased 21%, or $36.7 million, to $213.0 million, pri