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: YEAR ENDED JUNE 30 2003 2002 2001 Average expected volatility 31% 31% 31% Average expected option life 7 years 7 years 7 years Average risk-free interest rate 4.2% 4.9% 5.9% Average dividend yield .6% .5% .5% Concentration of Credit Risk 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, as amended, the Company recorded a non-cash charge to earnings of $2.2 million, after tax, to reflect the change in time-value from the dates of the derivative instruments’ inception through the date of transition (July 1, 2000). This charge is reflected as the cumulative effect of a change in accounting principle in fiscal 2001 in the accompanying consolidated statements of earnings. The Company is a worldwide manufacturer, marketer and distributor of skin care, makeup, fragrance and hair care products. Domestic and international sales are made primarily to department stores, specialty retailers, per- fumeries and pharmacies. The Company grants credit to all qualified customers and does not believe it is exposed significantly to any undue concentration of credit risk. For the fiscal years ended June 30, 2003, 2002 and 2001, the Company’s three largest customers accounted for an aggregate of 24%, 25% and 28%, respectively, of net sales. No single customer accounted for more than 10% of the Company’s net sales during fiscal 2003 or 2002. One department store group accounted for 11% of the Company’s net sales in the fiscal year ended June 30, 2001. In the same year, another department store group accounted for 10% of the Company’s net sales. Additionally, as of June 30, 2003 and 2002, the Company’s three largest customers accounted for an aggregate of 28% of its outstanding accounts receivable. The preparation of financial statements in conformity with generally accepted accounting principles requires man- agement to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses reported in those financial statements. Actual results could differ from those estimates and assumptions. Effective July 1, 2000, the Company adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 138, “Accounting  for Certain Derivative Instruments and Certain Hedging Activities.” These statements established accounting  and reporting standards for derivative instruments, includ- ing certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133, as amended, requires the recognition of all derivative In May 2003, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabili- ties and Equity” (“SFAS No. 150”). SFAS No. 150 estab- lished standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. It specifically requires that mandatorily redeemable instruments, instruments with repurchase obligations which embody, are indexed to, or obligate the repurchase of, the issuer’s own equity shares, and instru- ments with obligations to issue a variable number of the issuer’s own equity shares, be classified as a liability. Initial and subsequent measurements of the instruments differ based on the characteristics of each instrument and as provided for in the statement. SFAS No. 150 is effective for all freestanding financial instruments entered into or modified after May 31, 2003 and otherwise became effective at the beginning of the first interim period begin- ning after June 15, 2003. The Company has adopted this statement effective for all instruments entered into or modified after May 31, 2003 and will adopt the statement for any existing financial instruments in the first quarter of fiscal 2004. Based on the provisions of this statement, beginning in fiscal 2004, the Company will be classifying the $6.50 Cumulative Redeemable Preferred Stock as a liability and the related dividends will be characterized as Recently Issued Accounting Standards Management Estimates Derivative Financial Instruments THEEST{E LAUDER COMPANIES INC. 64