Estee Lauder 2007 Annual Report Download - page 74

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 identifi ed exposures. The
purpose of the hedging activities is to minimize the effect
of foreign exchange rate movements on costs and on the
cash fl ows 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 fi nancial 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-
fl ow hedges. Hedge effectiveness of forward exchange
contracts is based on a hypothetical derivative methodol-
ogy and excludes the portion of fair value attributable to
the spot-forward difference which is recorded in current-
period earnings. Hedge effectiveness of foreign currency
option contracts is based on a dollar offset methodology.
The ineffective portion of both forward exchange and
foreign currency option contracts is recorded in current-
period earnings. For hedge contracts that are no longer
deemed highly effective, hedge accounting is discontin-
ued and gains and losses accumulated in other compre-
hensive income are reclassifi ed to earnings when the
underlying forecasted transaction occurs. If it is probable
that the forecasted transaction will no longer occur, then
any gains or losses accumulated in other comprehensive
income are reclassifi ed to current-period earnings. As of
June 30, 2007, these cash-fl ow hedges were highly effec-
tive, 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 fi nancial institutions. The Company does
not have signifi cant exposure to any one counterparty.
Exposure to credit loss in the event of nonperformance by
any of the counterparties is limited to only the recognized,
but not realized, gains attributable to the contracts. Man-
agement believes risk of loss under these hedging con-
tracts is remote and in any event would not be material to
the Company’s consolidated financial results. The
contracts have varying maturities through the end of
June 2008. Costs associated with entering into such
contracts have not been material to the Company’s
consolidated fi nancial results. The Company does not
utilize derivative financial instruments for trading or
speculative purposes.
At June 30, 2007, the Company had foreign currency
contracts in the form of forward exchange contracts in the
amount of $862.0 million. The foreign currencies included
in forward exchange contracts (notional value stated
in U.S. dollars) are principally the British pound
($148.1 million), Canadian dollar ($140.3 million), Euro
($124.1 million), Swiss franc ($113.1 million), Australian
dollar ($79.3 million), Japanese yen ($42.6 million) and
South Korean won ($33.6 million). As of June 30, 2007, all
of the Company’s previously outstanding option contracts
have matured.
At June 30, 2006, the Company had foreign currency
contracts in the form of forward exchange contracts and
option contracts in the amount of $782.6 million
and $130.2 million, respectively. The foreign currencies
included in forward exchange contracts (notional value
stated in U.S. dollars) are principally the Euro ($238.5
million), Swiss franc ($98.5 million), British pound
($92.4 million), Canadian dollar ($71.7 million), Japanese
yen ($50.6 million), Australian dollar ($50.5 million) and
South Korean won ($33.1 million). The foreign currencies
included in the option contracts (notional value stated in
U.S. dollars) are principally the Japanese yen ($32.0
million), Euro ($27.7 million), Canadian dollar ($22.8
million), Swiss franc ($14.8 million) and South Korean won
($13.4 million).
Interest Rate Risk Management
The Company enters into interest rate derivative contracts
to manage the exposure to fl uctuations of interest rates
on its funded and unfunded indebtedness for periods con-
sistent with the identifi ed exposures. All interest rate deriv-
ative contracts are with large fi nancial institutions rated as
strong investment grade by a major rating agency.
In April 2007, the Company entered into interest rate
swap agreements with a notional amount totaling $250.0
million to effectively convert the fi xed rate interest on its
2017 Senior Notes to variable interest rates based on six-
month LIBOR. The interest rate swaps were designated as
fair-value hedges. As of June 30, 2007, these fair-value
hedges were highly effective in all material respects.
In April 2007, the Company terminated an interest-rate
swap agreement with a notional amount of $250.0 million
to effectively convert fi xed rate interest on its 2012 Senior
Notes to variable interest rates based on six-month LIBOR.
This instrument was classifi ed as a liability and had a ter-
mination fair value of $11.1 million at cash settlement,
which included $0.9 million of accrued interest payable to
the counterparty. Hedge accounting treatment was dis-
continued prospectively and the offsetting adjustment to
the carrying amount of the related debt will be amortized
to interest expense over the remaining life of the debt.
THE EST{E LAUDER COMPANIES INC. 73