Estee Lauder 2005 Annual Report Download - page 54

THE EST{E LAUDER COMPANIES INC.
respectively. The foreign currencies included in forward
exchange contracts (notional value stated in U.S. dollars) are
principally the Swiss franc ($128.6 million), British pound
($127.6 million), Euro ($123.3 million), Canadian dollar
($78.1 million), Australian dollar ($43.3 million), Japanese
yen ($31.6 million) and South Korean won ($27.6 million).
The foreign currencies included in the option contracts
(notional value stated in U.S. dollars) are principally the
Japanese yen ($33.6 million), South Korean won ($26.3
million), Euro ($21.5 million) and Swiss franc ($20.3 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 for periods consistent with the
identified exposures. All interest rate derivative contracts
are with large financial institutions rated as strong invest-
ment grade by a major rating agency.
We have 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 six-month LIBOR.
We designated the swap as a fair-value hedge. As of
June 30, 2005, the fair-value hedge was 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 represents
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 calculated
over the past 250-day period. The measured value-at-risk,
calculated as an average, for the twelve months ended
June 30, 2005 related to our foreign exchange contracts
and our interest rate contracts was $6.8 million and $11.2
million, respectively. The model estimates were made
assuming normal market conditions and a 95 percent con-
fidence level. We used a statistical simulation model that
valued our derivative financial instruments against one
thousand randomly generated market price paths.
Our calculated value-at-risk exposure represents an
estimate of reasonably possible net losses that would be
recognized on our portfolio of derivative financial instru-
ments assuming hypothetical movements in future market
rates and is not necessarily indicative of actual results,
which may or may not occur. It does not represent the
maximum possible loss or any expected loss that may
occur, since actual future gains and losses will differ from
those estimated, based upon actual fluctuations in market
rates, operating exposures, and the timing thereof, and
changes in our portfolio of derivative financial instruments
during the year.
We believe, however, that any such loss incurred would
be offset by the effects of market rate movements on the
respective underlying transactions for which the derivative
financial instrument was intended.
OFF-BALANCE SHEET ARRANGEMENTS
We do not maintain any off-balance sheet arrangements,
transactions, obligations or other relationships with uncon-
solidated entities that would be expected to have a mate-
rial current or future effect upon our financial condition or
results of operations.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2005, the Emerging Issues Task Force (“EITF”)
reached a consensus on Issue No. 05-6, “Determining the
Amortization Period for Leasehold Improvements.” This
Issue addresses the amortization period for leasehold
improvements in operating leases that are either (a) placed
in service significantly after and not contemplated at or
near the beginning of the initial lease term or (b) acquired
in a business combination. Leasehold improvements that
are placed in service significantly after and not contem-
plated at or near the beginning of the lease term should
be amortized over the shorter of the useful life of the
assets or a term that includes required lease periods and
renewals that are deemed to be reasonably assured at the
date the leasehold improvements are purchased. Leasehold
improvements acquired in a business combination should
be amortized over the shorter of the useful life of the
assets or a term that includes required lease periods and
renewals that are deemed to be reasonably assured at the
date of acquisition. This Issue shall be applied to leasehold
improvements that are purchased or acquired in reporting
periods after June 29, 2005 and we do not expect this
Issue to have a material impact on our consolidated finan-
cial statements.
In June 2005, the Financial Accounting Standards Board
(“FASB”) issued FASB Staff Position (“FSP”) FAS 143-1,
“Accounting for Electronic Equipment Waste Obligations,”
to address the accounting for electronic equipment waste
obligations associated with Directive 2002/96/EC on
Waste Electrical and Electronic Equipment (the “Directive”)
adopted by the European Union (“EU”). The Directive
effectively obligates a commercial user to incur costs asso-
ciated with the retirement of a specified asset that qualifies
as historical waste equipment, as defined in the Directive.
Commercial users of electronic equipment should apply
the provisions of SFAS No. 143, “Accounting for Asset
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