Estee Lauder 2005 Annual Report Download - page 41

THE EST{E LAUDER COMPANIES INC.
future periods. Inventory cost includes raw materials, direct
labor and overhead.
We also record an inventory obsolescence reserve,
which represents the difference between the cost of the
inventory and its estimated market 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,
we may establish specific reserves for future known or
anticipated events.
PENSION AND OTHER POSTRETIREMENT
BENEFIT COSTS
We offer the following benefits to some or all of our
employees: a domestic trust-based noncontributory quali-
fied defined benefit pension plan (“U.S. Qualified Plan”)
and an unfunded, nonqualified domestic noncontributory
pension plan to provide benefits in excess of statutory
limitations (collectively with the U.S. Qualified Plan, the
“Domestic Plans”); a contributory defined contribution
plan; international pension plans, which vary by country,
consisting of both defined benefit and defined contribu-
tion pension plans; deferred compensation; and certain
other postretirement benefits.
The amounts necessary to fund future payouts under
these plans are subject to numerous assumptions and vari-
ables. Certain significant variables require us to make
assumptions that are within our control such as an antici-
pated discount rate, expected rate of return on plan assets
and future compensation levels. We evaluate these
assumptions with our actuarial advisors and we believe
they are within accepted industry ranges, although an
increase or decrease in the assumptions or economic
events outside our control could have a direct impact on
reported net earnings.
The pre-retirement discount rate for each plan used for
determining future net periodic benefit cost is based on a
review of highly rated long-term bonds. For fiscal 2005, we
used a pre-retirement discount rate for our Domestic Plans
of 6.00% and varying rates on our international plans of
between 2.25% and 6.00%. The pre-retirement rate for our
Domestic Plans is based on a bond portfolio that includes
only long-term bonds with an Aa rating, or equivalent, from
a major rating agency. We believe the timing and amount
of cash flows related to the bonds included in this portfolio
is expected to match the estimated defined benefit pay-
ment streams of our Domestic Plans. For fiscal 2005, we
used an expected return on plan assets of 7.75% for our
U.S. Qualified Plan and varying rates of between 3.25%
and 7.50% for our international plans. In determining the
long-term rate of return for a plan, we consider the histori-
cal rates of return, the nature of the plan’s investments and
an expectation for the plan’s investment strategies. The U.S.
Qualified Plan asset allocation as of June 30, 2005 was
approximately 67% equity investments, 26% fixed income
investments and 7% other investments. The asset alloca-
tion of our combined international plans as of June 30,
2005 was approximately 62% equity investments, 32%
fixed income investments and 6% other investments. The
difference between actual and expected returns on plan
assets is accumulated and amortized over future periods
and, therefore, affects our recorded obligations and rec-
ognized expenses in such future periods. For fiscal 2005,
our pension plans had actual returns on assets of $43.2
million as compared with expected returns on assets of
$35.3 million, which resulted in a net deferred gain of
$7.9 million.
A 25 basis-point change in the discount rate or the
expected rate of return on plan assets would have had
the following effect on fiscal 2005 pension expense:
25 Basis-Point 25 Basis-Point
Increase Decrease
(In millions)
Discount rate $(2.3) $2.3
Expected return on assets $(1.3) $1.3
Our postretirement plans are comprised of health care
plans that could be impacted by health care cost trend
rates, which may have a significant effect on the amounts
reported. A one-percentage-point change in assumed
health care cost trend rates for fiscal 2005 would have had
the following effects:
One- One-
Percentage-Point Percentage-Point
Increase Decrease
(In millions)
Effect on total service
and interest costs $ 1.1 $(1.0)
Effect on postretirement
benefit obligations $10.1 $(9.1)
For fiscal 2006, we will use a pre-retirement discount rate
for the Domestic Plans of 5.25% and varying rates for our
international plans of between 1.75% and 5.25%. We
anticipate using an expected return on plan assets of
7.75% for the U.S. Qualified Plan and varying rates for our
international pension plans of between 2.75% and 7.50%.
The net change in these assumptions from those used in
fiscal 2005 will cause approximately a $6.5 million increase
in pension expense in fiscal 2006. We will continue to
monitor the market conditions relative to these assump-
tions and adjust them accordingly.
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