Sally Beauty Supply 2007 Annual Report Download - page 71

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a multinational corporation, we are subject to certain market risks including foreign currency fluctuations, interest rates and government actions. We
consider a variety of practices to manage these market risks, including, when deemed appropriate, the occasional use of derivative financial instruments.
Foreign currency exchange rate risk
We are exposed to potential gains or losses from foreign currency fluctuations affecting net investments and earnings denominated in foreign currencies. Our
primary exposures are to changes in exchange rates for the U.S. dollar versus the British pound sterling, Canadian dollar, Euro and Mexican peso. Our various
currency exposures at times offset each other providing a natural hedge against currency risk. For fiscal year 2007, approximately 16% of our sales were made in
currencies other than the U.S. dollar. Fluctuations in U.S. dollar exchange rates within the range of the rates for fiscal years 2007, 2006 and 2005 did not have a
material effect on our financial condition and results of operations. We do not use derivative financial instruments to manage foreign currency exchange rate risk.
Interest rate risk
As a result of the debt financing incurred in connection with the Separation Transactions, we are subject to interest rate market risk in connection with our
long-term debt. The principal interest rate exposure relates to amounts borrowed under the Term Loans and the ABL facility. Based on the approximately
$1.1 billion of borrowings under the Term Loans and the ABL facility as of September 30, 2007, a change in the estimated interest rate up or down by 1/8% will
increase or decrease earnings before provision for income taxes by approximately $1.3 million on an annual basis, without considering the effect of any interest
rate swap agreements we may have from time to time.
We and certain of our subsidiaries are sensitive to interest rate fluctuations. In order to enhance our ability to manage risk relating to cash flow and interest rate
exposure, we and/or our other subsidiaries who are borrowers under the ABL facility may from time to time enter into and maintain derivative instruments, such
as interest rate swap agreements, for periods consistent with the related underlying exposures. In addition, the agreement underlying our Term Loans require that
we and/or certain of our other subsidiaries hedge a portion of our floating interest rate exposure for a specified period.
On November 24, 2006, we entered into two interest rate swap agreements with a notional amount of $150.0 million and $350.0 million, respectively. These
agreements expire on November 24, 2008 and 2009, respectively. The agreements allow us to convert a portion of our variable rate interest to a fixed rate of
4.9975% plus (2.00% to 2.50%) and 4.94% plus (2.00% to 2.50%), respectively. As discussed in "Risk Factors" herein, changes in the fair value of these interest
rate swap agreements driven by interest rate changes will increase or decrease our net interest expense and may therefore affect our earnings.
Credit risk
We are exposed to credit risk on certain assets, primarily cash equivalents, short-term investments and accounts receivable. The credit risk associated with cash
equivalents and short-term investments is mitigated by our policy of investing in a diversified portfolio of securities with high credit ratings.
We provide credit to customers in the ordinary course of business and perform ongoing credit evaluations. Our exposure to concentrations of credit risk with
respect to trade receivables is mitigated by our broad customer base. We believe our allowance for doubtful accounts is sufficient to cover customer credit risks.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Index to Financial Statements" which is located on page 74 of this report.
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Source: Sally Beauty Holding, 10-K, November 29, 2007