Estee Lauder 2005 Annual Report Download - page 53

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THE EST{E LAUDER COMPANIES INC.
Derivative Financial Instruments and Hedging Activities
We address certain financial exposures through a con-
trolled program of risk management that includes the use
of derivative financial instruments. We primarily enter into
foreign currency forward exchange contracts and foreign
currency options to reduce the effects of fluctuating for-
eign currency exchange rates. We also enter into interest
rate derivative contracts to manage the effects of fluctuat-
ing interest rates. We categorize these instruments as
entered into for purposes other than trading.
For each derivative contract entered into where we look
to obtain special hedge accounting treatment, we formally
document the relationship between the hedging instru-
ment and hedged item, as well as its risk-management
objective and strategy for undertaking the hedge. This
process includes linking all derivatives that are designated
as fair-value, cash-flow, or foreign-currency hedges to spe-
cific assets and liabilities on the balance sheet or to spe-
cific 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 institutions
rated as strong investment grade by a major rating 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-flow hedges. As of June 30, 2005,
these cash-flow hedges were highly effective, in all
material 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 default under these hedging contracts is
remote and in any event would not be material to the con-
solidated financial results. The contracts have varying matu-
rities through the end of June 2006. Costs associated 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, 2005, we had foreign currency contracts in the
form of forward exchange contracts and option contracts
in the amount of $667.5 million and $120.9 million,
52
Contractual Obligations
The following table summarizes scheduled maturities of our contractual obligations for which cash flows are fixed and
determinable as of June 30, 2005:
Total 2006 2007 2008 2009 2010 Thereafter
(In millions)
Debt service
(1)
$1,132.1 $ 291.6 $ 28.9 $ 27.5 $ 27.0 $ 26.1 $ 731.0
Operating lease commitments
(2)
1,137.4 149.3 134.2 117.5 102.5 90.7 543.2
Unconditional purchase obligations
(3)
1,661.4 849.0 234.0 201.0 104.4 62.0 211.0
Total contractual obligations $3,930.9 $1,289.9 $397.1 $346.0 $233.9 $178.8 $1,485.2
(1) Includes long-term and short-term debt and the related projected interest costs, and to a lesser extent, capital lease commitments. Refer to Note 8 of
Notes to Consolidated Financial Statements.
(2) Refer to Note 14 of Notes to Consolidated Financial Statements.
(3) Unconditional purchase obligations primarily include inventory commitments, estimated future earn-out payments, estimated royalty payments pursuant
to license agreements, advertising commitments, capital improvement commitments, planned funding of pension and other postretirement benefit
obligations and commitments pursuant to executive compensation arrangements. Future earn-out payments and future royalty and advertising commitments
were estimated based on planned future sales for the term that was in effect at June 30, 2005, without consideration for potential renewal periods.
Payments Due in Fiscal