Sally Beauty Supply 2011 Annual Report Download - page 59

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business to manage these market risks, including, when deemed appropriate, the use of derivative
instruments such as interest rate swaps and foreign currency options, collars and forwards.
Interest Rate Swap Agreements
The Company is exposed to a wide variety of economic risks, including risks arising from changing market
interest rates. The Company manages its exposure to certain economic risks (including liquidity, credit risk
and changes in interest rates) primarily (a) by closely managing its cash flows from operating and investing
activities and the amounts and sources of its debt obligations; (b) by assessing periodically the
creditworthiness of its business partners; and (c) through the use of interest rate swaps by Sally Holdings.
The Company uses interest rate swaps, as part of its overall economic risk management strategy, to add
stability to the interest payments due in connection with its senior term loan obligations. Interest payments
related to our senior term loans are impacted by changes in LIBOR. The Company’s interest rate swap
agreements involve the periodic receipt by Sally Holdings of amounts based on a variable rate in exchange
for Sally Holdings making payments based on a fixed rate over the term of the interest rate swap
agreements, without exchange of the underlying notional amount.
In November 2006, Sally Holdings entered into certain interest rate swap agreements with an aggregate
notional amount of $500 million. These interest rate swap agreements expired on or before November
2009 and were not designated as effective hedges. Accordingly, the changes in fair value of these interest
rate swap agreements (which were adjusted quarterly) were recorded in interest expense in our
consolidated statements of earnings.
Additionally, in May 2008, Sally Holdings entered into certain interest rate swap agreements with an
aggregate notional amount of $300 million. These agreements expire in May 2012 and are designated and
qualify as effective cash flow hedges. Accordingly, changes in the fair value of these derivative instruments
(which are adjusted quarterly) are recorded, net of income tax, in accumulated other comprehensive (loss)
income until the hedged obligation is settled or the swap agreements expire, whichever is earlier. Any
hedge ineffectiveness is recognized in interest expense in the Company’s consolidated statements of
earnings. Please see ‘‘Item 7A—Quantitative and Qualitative Disclosures about Market Risk—Interest
rate risk’’ and Note 16 of the ‘‘Notes to Consolidated Financial Statements’’ in Item 8—‘‘Financial
Statements and Supplementary Data’’ contained elsewhere in this Annual Report.
Foreign Currency Option, Collar and Forward Contracts
The Company is exposed to potential gains or losses from foreign currency fluctuations affecting its net
investments in subsidiaries (including intercompany notes not permanently invested) and earnings
denominated in foreign currencies. The Company’s primary exposures are to changes in the exchange rates
for the U.S. dollar versus the Euro, the British pound sterling, the Canadian dollar, the Chilean peso, and
the Mexican peso. The Company’s foreign currency exposures at times offset each other, providing a
natural hedge against its foreign currency risk. In connection with the remaining foreign currency risk, the
Company from time to time uses foreign currency options, collars and forwards to effectively fix the
foreign currency exchange rate applicable to specific anticipated foreign currency-denominated cash flows,
thus limiting the potential fluctuations in such cash flows resulting from foreign currency market
movements.
The Company uses foreign currency options and collars, including, at September 30, 2011, collars with an
aggregate notional amount of $12.5 million to manage the exposure to the U.S. dollar resulting from our
Sinelco Group subsidiaries’ purchases of merchandise from third-party suppliers. Sinelco’s functional
currency is the Euro. The foreign currency collar agreements held by the Company at September 30, 2011
have contractual Euro to U.S. dollar exchange rates between 1.4000 and 1.4612 and expire in varying
amounts monthly through September 2012. In addition, the Company uses foreign currency forwards to
mitigate its exposure to changes in foreign currency exchange rates in connection with certain
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