NOTE 7 — DERIVATIVE FINANCIAL INSTRUMENTS

The Company addresses certain financial exposures through a controlled program of risk management that includes the use of derivative financial instruments. The Company enters into foreign currency forward contracts and may enter into option contracts to reduce the effects of fluctuating foreign currency exchange rates. In addition, the Company enters into interest rate derivatives to manage the effects of interest rate movements on the Company’s aggregate liability portfolio, including potential future debt issuances. The Company also enters into foreign currency forward contracts and may use option contracts, not designated as hedging instruments, to mitigate the change in fair value of specific assets and liabilities on the balance sheet. The Company does not utilize derivative financial instruments for trading or speculative purposes. Costs associated with entering into derivative financial instruments have not been material to the Company’s consolidated financial results.

For each derivative contract entered into where the Company looks to obtain hedge accounting treatment, the Company formally and contemporaneously documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking the hedge transaction, the nature of the risk being hedged, how the hedging instruments’ effectiveness in offsetting the hedged risk will be assessed prospectively and retrospectively, and a description of the method of measuring ineffectiveness. This process includes linking all derivatives to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the inception of the hedges 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, or that it has ceased to be a highly effective hedge, the Company will be required to discontinue hedge accounting with respect to that derivative prospectively.

The fair values of the Company’s derivative financial instruments included in the consolidated balance sheets are presented as follows:

	Asset Derivatives					Liability Derivatives
		Fair Value (1)					Fair Value (1)
(In millions)	Balance Sheet Location	December 31 2016		June 30 2016		Balance Sheet Location	December 31 2016		June 30 2016
Derivatives Designated as Hedging Instruments
Foreign currency forward contracts	Prepaid expenses and other current assets	$	47	$	37	Other accrued liabilities	$	7	$	18
Interest rate-related derivatives	Prepaid expenses and other current assets	11		—		Not applicable
Interest rate swap contracts	Prepaid expenses and other current assets	1		18		Other accrued liabilities	5		—


Total Derivatives Designated as Hedging Instruments		59		55			12		18

Derivatives Not Designated as Hedging Instruments
Foreign currency forward contracts	Prepaid expenses and other current assets	9		11		Other accrued liabilities	4		8


Total Derivatives		$	68	$	66		$	16	$	26

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See Note 8 — Fair Value Measurements for further information about how the fair value of derivative assets and liabilities are determined.

The amounts of the gains and losses related to the Company’s derivative financial instruments designated as hedging instruments are presented as follows:

	Amount of Gain or (Loss) Recognized in OCI on Derivatives (Effective Portion)				Location of Gain or (Loss) Reclassified	Amount of Gain or (Loss) Reclassified from AOCI into Earnings (Effective Portion) (1)
	Three Months Ended December 31				from AOCI into Earnings	Three Months Ended December 31
(In millions)	2016		2015		(Effective Portion)	2016		2015
Derivatives in Cash Flow Hedging Relationships
Foreign currency forward contracts	$	45	$	11	Cost of sales	$	4	$	4
					Selling, general and administrative	12		14
Interest rate-related derivatives	11		—		Not applicable

Total Derivatives	$	56	$	11		$	16	$	18

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The amount of gain (loss) recognized in earnings related to the amount excluded from effectiveness testing was de minimis and $1 million for the three months ended December 31, 2016 and 2015, respectively. The amount of gain recognized in earnings related to the ineffective portion of the hedging relationships was de minimis for the three months ended December 31, 2016. There was no gain (loss) recognized in earnings related to the ineffective portion of the hedging relationships for the three months ended December 31, 2015.

	Amount of Gain or (Loss) Recognized in OCI on Derivatives (Effective Portion)				Location of Gain or (Loss) Reclassified	Amount of Gain or (Loss) Reclassified from AOCI into Earnings (Effective Portion) (1)
	Six Months Ended December 31				from AOCI into Earnings	Six Months Ended December 31
(In millions)	2016		2015		(Effective Portion)	2016		2015
Derivatives in Cash Flow Hedging Relationships
Foreign currency forward contracts	$	48	$	36	Cost of sales	$	6	$	7
					Selling, general and administrative	19		24
Interest rate-related derivatives	11		—		Not applicable

Total Derivatives	$	59	$	36		$	25	$	31

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The amount of gain (loss) recognized in earnings related to the amount excluded from effectiveness testing was $(1) million and $2 million for the six months ended December 31, 2016 and 2015, respectively. The amount of gain recognized in earnings related to the ineffective portion of the hedging relationships was de minimis for the six months ended December 31, 2016 and 2015.

		Amount of Gain or (Loss) Recognized in Earnings on Derivatives (1)
	Location of Gain or (Loss) Recognized in Earnings on	Three Months Ended December 31						Six Months Ended December 31
(In millions)	Derivatives	2016			2015			2016			2015
Derivatives in Fair Value Hedging Relationships
Interest rate swap contracts	Interest expense	$	(17	)	$	(2	)	$	(22	)	$	6

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Changes in the fair value of the interest rate swap agreements are exactly offset by the change in the fair value of the underlying long-term debt.

The amounts of the gains and losses related to the Company’s derivative financial instruments not designated as hedging instruments are presented as follows:

		Amount of Gain or (Loss) Recognized in Earnings on Derivatives
	Location of Gain or (Loss) Recognized in Earnings on	Three Months Ended December 31					Six Months Ended December 31
(In millions)	Derivatives	2016		2015			2016		2015
Derivatives Not Designated as Hedging Instruments
Foreign currency forward contracts	Selling, general and administrative	$	4	$	(6	)	$	1	$	1

Cash-Flow Hedges

The Company enters into foreign currency forward contracts to hedge anticipated transactions, as well as receivables and payables denominated in foreign currencies, for periods consistent with the Company’s identified exposures. The purpose of the hedging activities is to minimize the effect of foreign exchange rate movements on costs and on the cash flows that the Company receives from foreign subsidiaries. The majority of foreign currency forward contracts are denominated in currencies of major industrial countries. The Company may also enter into foreign currency option contracts to hedge anticipated transactions where there is a high probability that anticipated exposures will materialize. The foreign currency forward contracts entered into to hedge anticipated transactions have been designated as cash-flow hedges and have varying maturities through the end of December 2018. Hedge effectiveness of foreign currency forward contracts is based on a hypothetical derivative methodology and excludes the portion of fair value attributable to the spot-forward difference which is recorded in current-period earnings. Hedge effectiveness of foreign currency option contracts is based on a dollar offset methodology.

The Company may enter into interest rate forward contracts to hedge anticipated issuance of debt for periods consistent with the Company’s identified exposures. The purpose of the hedging activities is to minimize the effect of interest rate movements on the cost of debt issuance.

The ineffective portion of both foreign currency forward and interest rate derivatives is recorded in current-period earnings. For hedge contracts that are no longer deemed highly effective, hedge accounting is discontinued and gains and losses in AOCI are reclassified to earnings when the underlying forecasted transaction occurs. If it is probable that the forecasted transaction will no longer occur, then any gains or losses in AOCI are reclassified to current-period earnings. As of December 31, 2016, the Company’s foreign currency cash-flow hedges were highly effective.

At December 31, 2016, the Company had foreign currency forward contracts in the amount of $3,016 million. The foreign currencies included in foreign currency forward contracts (notional value stated in U.S. dollars) are principally the British pound ($477 million), Chinese yuan ($358 million), Hong Kong dollar ($351 million), Euro ($343 million), Swiss franc ($324 million), Australian dollar ($172 million) and Japanese yen ($130 million).

The estimated net gain on the Company’s derivative instruments designated as cash-flow hedges as of December 31, 2016 that is expected to be reclassified from AOCI into earnings, net of tax, within the next twelve months is $25 million. The accumulated gain on derivative instruments in AOCI was $84 million and $50 million as of December 31, 2016 and June 30, 2016, respectively.

Fair-Value Hedges

The Company enters into interest rate derivative contracts to manage the exposure to interest rate fluctuations on its funded indebtedness. The Company has interest rate swap agreements, with a notional amount totaling $450 million and $250 million to effectively convert the fixed rate interest on its 2021 and 2022 Senior Notes, respectively, to variable interest rates based on three-month LIBOR plus a margin. These interest rate swap agreements are designated as fair-value hedges of the related long-term debt, and the changes in the fair value of the interest rate swap agreements are exactly offset by the change in the fair value of the underlying long-term debt.

Credit Risk

As a matter of policy, the Company enters into derivative contracts only with counterparties that have a long-term credit rating of at least A- or higher by at least two nationally recognized rating agencies. The counterparties to these contracts are major financial institutions. Exposure to credit risk in the event of nonperformance by any of the counterparties is limited to the gross fair value of contracts in asset positions, which totaled $68 million at December 31, 2016. To manage this risk, the Company has strict counterparty credit guidelines that are continually monitored. Accordingly, management believes risk of loss under these hedging contracts is remote.