Estee Lauder 2003 Annual Report Download - page 54

THEEST{E LAUDER COMPANIES INC.
For each derivative contract entered into where we
look to obtain special hedge accounting treatment, we for-
mally document the relationship between the hedging
instrument 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 hedges
to specific assets and liabilities on the balance sheet or to
specific firm commitments or forecasted transactions. We
also formally assess, 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
determined that a derivative is not highly effective, then
we will be required to discontinue hedge accounting with
respect to that derivative prospectively.
Foreign Exchange Risk Management
We enter into forward exchange contracts to hedge antic-
ipated transactions as well as receivables and payables
denominated in foreign currencies for periods consistent
with our identified exposures. The purpose of the hedging
activities is to minimize the effect of foreign exchange
rate movements on our costs and on the cash flows that
we receive from foreign subsidiaries. Almost all foreign
currency contracts are denominated in currencies of
major 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 options
to hedge anticipated transactions where there is a high
probability that anticipated exposures will materialize. The
forward exchange contracts and foreign currency options
entered into to hedge anticipated transactions have been
designated as cash-flowhedges.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 with
counterparties that have at least an “A” (or equivalent)
credit rating.The counterparties to these contracts are
major financial institutions. We do not have significant
exposure to any one counterparty. Our exposure to credit
loss 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. Management
believes risk of loss under these hedging contracts is
remote and in any event would not be material to the con-
solidated financial results. The contracts have varying
maturities through the end of June 2004. Costs associ-
ated with entering into such contracts have not been
material to our consolidated financial results. We do not
utilize derivative financial instruments for trading or
speculative purposes. At June 30, 2003, we had foreign
currency contracts in the form of forward exchange con-
tracts and option contracts in the amount of $476.7
million and $57.7 million, respectively. The foreign cur-
rencies included in forward exchange contracts (notional
value 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), Canadian
dollar ($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 value
stated 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 Management
We enter into interest rate derivative contracts to manage
the exposure to fluctuations of interest rates on our
funded and unfunded indebtedness, as well as cash invest-
ments, for periods consistent with the identified expo-
sures. All interest rate derivative contracts are with large
financial institutions rated as strong investment grade by a
major rating agency.
In May 2003, we entered into an interest rate swap
agreement with a notional amount of $250.0 million to
effectively convert fixed interest on the existing $250.0
million 6% Senior Notes to variable interest rates based
on 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 of
treasury 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 September
2003 and are used to hedge the exposure to a possible
rise in interest rates prior to the anticipated issuance of
debt. The agreements will be settled upon the issuance
of the new debt, if completed, and any realized gain or
loss to be received or paid by us will be amortized in
interest 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 highly
effective, in all material respects.
Market Risk
We use a value-at-risk model to assess the market risk of
our derivative financial instruments. Value-at-risk repre-
sents the potential losses for an instrument or portfolio
from adverse changes in market factors for a specified
time period and confidence level. We estimate value-
at-risk across all of our derivative financial instruments
using a model with historical volatilities and correlations
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