Estee Lauder 2004 Annual Report Download - page 72

THE EST{E LAUDER COMPANIES INC.
hedge), (ii) a hedge of a forecasted transaction or of the
variability 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 the
fair value of a derivative that is highly effective as (and that
is designated and qualifies as) a fair-value hedge, along
with the loss or gain on the hedged asset or liability that is
attributable to the hedged risk (including losses or gains
on firm commitments), are recorded in current-period
earnings. Changes in the fair value of a derivative that is
highly effective as (and that is designated and qualifies as)
a cash-flow hedge are recorded in other comprehensive
income, until earnings are affected by the variability of
cash 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 (and
that are designated and qualify as) foreign-currency
hedges are recorded in either current-period earnings or
other comprehensive income, depending on whether the
hedge transaction is a fair-value hedge (e.g., a hedge of
a firm commitment that is to be settled in a foreign
currency) 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 foreign
operation, its changes in fair value, to the extent effective
as a hedge, are recorded in accumulated other compre-
hensive income within equity. Furthermore, changes in the
fair value of other derivative instruments are reported in
current-period earnings.
For each derivative contract entered into where the
Company looks to obtain special hedge accounting treat-
ment, the Company formally documents all relationships
between hedging instruments and hedged items, as well
as its risk-management objective and strategy for under-
taking the hedge transaction. This process includes linking
all derivatives that are designated as fair-value, cash-flow,
or foreign-currency hedges to specific assets and liabili-
ties on the balance sheet or to specific firm commitments
or forecasted transactions. The Company also formally
assesses, both at the hedge’s inception and on an ongoing
basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in
fair values or cash flows of hedged items. If it is deter-
mined that a derivative is not highly effective, or that it has
ceased to be a highly effective hedge, the Company will
be required to discontinue hedge accounting with
respect to that derivative prospectively.
Foreign Exchange Risk Management
The Company enters into forward exchange contracts to
hedge anticipated transactions as well as receivables and
payables denominated in foreign currencies for periods
consistent with the Company’s identified exposures. The
purpose of the hedging activities is to minimize the effect
of foreign exchange rate movements on costs and on the
cash flows that the Company receives from foreign sub-
sidiaries. Almost all foreign currency contracts are denom-
inated in currencies of major industrial countries and are
with large financial institutions rated as strong investment
grade by a major rating agency. The Company also enters
into foreign currency options to hedge anticipated trans-
actions where there is a high probability that anticipated
exposures will materialize. The forward exchange con-
tracts and foreign currency options entered into to hedge
anticipated transactions have been designated as cash-
flow hedges. As of June 30, 2004, these cash-flow hedges
were highly effective, in all material respects.
As a matter of policy, the Company only enters into
contracts with counterparties that have at least an “A” (or
equivalent) credit rating. The counterparties to these con-
tracts are major financial institutions. The Company does
not have significant exposure to any one counterparty.
Exposure to credit loss in the event of nonperformance
by 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 hedging
contracts is remote and in any event would not be mate-
rial to the Company’s consolidated financial results. The
contracts have varying maturities through the end of June
2005. Costs associated with entering into such contracts
have not been material to the Company’s consolidated
financial results. The Company does not utilize derivative
financial instruments for trading or speculative purposes.
At June 30, 2004, we had foreign currency contracts in
the form of forward exchange contracts and option con-
tracts in the amount of $593.6 million and $82.0 million,
respectively. The foreign currencies included in forward
exchange contracts (notional value stated in U.S. dollars)
are principally the Euro ($122.6 million), Swiss franc
($117.1 million), British pound ($72.8 million), Japanese
yen ($66.7 million), South Korean won ($42.0 million),
Canadian dollar ($41.7 million), and Australian dollar
($33.7 million). The foreign currencies included in the
option contracts (notional value stated in U.S. dollars) are
principally the Euro ($34.1 million), British pound ($25.4
million), and Swiss franc ($12.7 million). At June 30, 2003,
the Company had foreign currency contracts in the form
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