Derivative Financial Instruments

12 Months Ended

Dec. 28, 2019

General Discussion of Derivative Instruments and Hedging Activities [Abstract]

The Company is exposed to fluctuations in foreign currency exchange rates on the earnings, cash flows and financial position of its international operations. Although this currency risk is partially mitigated by the natural hedge arising from the Company's local manufacturing in many markets, a strengthening U.S. dollar generally has a negative impact on the Company. In response, the Company uses financial instruments to hedge certain of its exposures and to manage the foreign exchange impact to its financial statements. At its inception, a derivative financial instrument is designated as a fair value, cash flow or net equity hedge as described in Note 1 to the Consolidated Financial Statements.

Fair value hedges are entered into with financial instruments such as forward contracts, with the objective of limiting exposure to certain foreign exchange risks primarily associated with accounts payable and non-permanent intercompany transactions. For derivative instruments that are designated and qualify as fair value hedges, the gain or loss on the derivative, as well as the offsetting gain or loss on the hedged item attributable to the hedged risk, are recognized in current earnings. In assessing hedge effectiveness, as of the beginning of 2019, the Company made the accounting policy election in accordance with ASU 2017-12 to exclude forward points and record their impact in the same income statement line item that is used to present the earnings effect of the hedged item for 2019, Other (income) expense. Prior to 2019, the forward points had been included as a component of interest expense. The forward points on fair value hedges resulted in pretax income of $17.5 million, $19.8 million and $22.6 million for 2019, 2018 and 2017, respectively.

The Company also uses derivative financial instruments to hedge foreign currency exposures resulting from certain forecasted purchases and classifies these as cash flow hedges. The majority of cash flow hedge contracts that the Company enters into relate to inventory purchases. At initiation, the Company's cash flow hedge contracts are generally for periods ranging from one month to fifteen months. The effective portion of the gain or loss on the open hedging instrument is recorded in other comprehensive income and is reclassified into earnings when settled through the same line item as the transaction being hedged. As such, the balance at the end of the current reporting period in other comprehensive income, related to cash flow hedges, will generally be reclassified within the next twelve months. The associated asset or liability on the open hedges is recorded in other current assets or accrued liabilities, as applicable. In assessing hedge effectiveness, the Company made an accounting policy change as of December 30, 2018 to include forward points in the assessment of effectiveness for cash flow hedges causing the impact from forward points to be recorded as part of other comprehensive income compared to interest expense as it previously had been recorded. Based on the interest expense incurred for open cash flow hedges as of December 30, 2018, the Company recorded an adjustment of $1.2 million, net of taxes, to accumulated comprehensive income and retained earnings to reflect this accounting policy change. There was an immaterial impact from forward points recorded in other comprehensive income for activity related to 2019. The Company recognized $4.1 million of negative manufacturing variances that will be capitalized and amortized over actual months of inventory turns related to the forward point impact from the settlement of cash flow hedges in 2019. The balance in accumulated other comprehensive (loss), net of tax, resulting from open foreign currency hedges designated as cash flow hedges was a deferred loss of $2.4 million, and a deferred gain of $1.7 million and $1.6 million as of December 28, 2019, December 29, 2018 and December 30, 2017, respectively. In 2019, 2018 and 2017, the Company recorded in other comprehensive (loss), net of tax, a net loss of $2.9 million, a net gain of $0.1 million and a net loss of $3.3 million, respectively, which represents the net change to accumulated other comprehensive income on the Company's balance sheet related to this type of hedges.

The Company also uses financial instruments, such as forward contracts and certain euro denominated borrowings under its Credit Agreement, to hedge a portion of its net equity investment in international operations and classifies these as net equity hedges. Changes in the value of these financial instruments, excluding any ineffective portion of the hedges, are included in foreign currency translation adjustments within accumulated other comprehensive loss. The Company recorded, net of tax, in other comprehensive income a net loss of $22.5 million, gain of $23.7 million and loss of $21.2 million associated with these hedges in 2019, 2018 and 2017, respectively. Due to the permanent nature of the investments, the Company does not anticipate reclassifying any portion of these amounts to the income statement in the next twelve months. In assessing hedge effectiveness, the Company made an accounting policy change as of December 30, 2018 to include forward points in the assessment of effectiveness for net equity hedges causing the impact from forward points to be recorded as part of other comprehensive income compared to interest expense as it previously had been recorded. The impact of forward points is being recorded in other comprehensive income, and will remain there indefinitely since that is where the gains and losses on hedges of net equity are recorded. Based on the interest expense associated with forward points incurred for open net equity hedges as of December 30, 2018, the Company recorded an adjustment of $3.8 million, net of taxes, to accumulated comprehensive income and retained earnings to reflect this accounting policy change. The impact related to forward points on hedges of net equity recorded as a component of other comprehensive income in 2019 were losses of $18.3 million.

The net cash flow impact from hedging activity for 2019, 2018 and 2017 was outflow of $2.3 million and inflows of $2.9 million and $0.1 million, respectively.

The Company considers the total notional value of its forward contracts as the best measure of the volume of derivative transactions. As of December 28, 2019 and December 29, 2018, the notional amounts of outstanding forward contracts to purchase currencies were $137.7 million and $186.8 million, respectively, and the notional amounts of outstanding forward contracts to sell currencies were $143.5 million and $184.6 million, respectively. As of December 28, 2019, the notional values of the largest positions outstanding were to purchase $72.5 million of U.S. dollars and $56.6 million of euros and to sell $50.3 million of Swiss francs and $31.9 million of Mexican pesos.

The following table summarizes the Company's derivative positions, which are the only assets and liabilities recorded at fair value on a recurring basis, and the impact they had on the Company's financial position as of December 28, 2019 and December 29, 2018. Fair values were determined based on third party quotations (Level 2 fair value measurement):



	Asset derivatives					Liability derivatives
		Fair value					Fair value
Derivatives designated as hedging instruments (in millions)	Balance sheet location	2019		2018		Balance sheet location	2019		2018
Foreign exchange contracts	Non-trade amounts receivable	$	16.0	$	26.7	Accrued liabilities	$	19.8	$	22.6

The following table summarizes the impact on the results of operations for the years ended December 28, 2019, December 29, 2018 and December 30, 2017 for the components included in the hedge effectiveness assessment of the Company's fair value hedging positions:



Derivatives designated as fair value hedges (in millions)	Location of gain or (loss) recognized in income on derivatives	Amount of gain or (loss) recognized in income on derivatives							Location of (loss) or gain recognized in income on related hedged items	Amount of (loss) or gain recognized in income on related hedged items
		2019		2018			2017			2019			2018		2017
Foreign exchange contracts	Other expense	$	9.6	$	(21.9	)	$	17.2	Other expense		($9.6	)		$21.6		($17.1	)

The following table summarizes the impact of Company's hedging activities on comprehensive income for the years ended December 28, 2019, December 29, 2018 and December 30, 2017:



Derivatives designated as cash flow and net equity hedges (in millions)	Amount of (loss) or gain recognized in OCI on derivatives (effective portion)								Location of (loss) or gain reclassified from accumulated OCI into income (effective portion)	Amount of (loss) or gain reclassified from accumulated OCI into income (effective portion)							Location of loss recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)	Amount of loss recognized in income on derivatives (ineffective portion and amounts excluded from effectiveness testing)
Cash flow hedging relationships	2019			2018		2017				2019			2018		2017			2019		2018			2017
Foreign exchange contracts	$	(6.3	)	$	6.9	$	(2.7	)	Cost of products sold	$	(3.1	)	$	6.9	$	1.4	Interest expense	$	—	$	(4.1	)	$	(4.8	)
Net equity hedging relationships
Foreign exchange contracts	(30.9		)	26.5		(21.6		)									Interest expense	—		(21.2		)	(26.0		)
Euro denominated debt	2.6			3.8		(11.5		)

The Company's theoretical credit risk for each foreign exchange contract is its replacement cost, but management believes that the risk of incurring credit losses is remote and such losses, if any, would not be material. The Company is also exposed to market risk on its derivative instruments due to potential changes in foreign exchange rates; however, such market risk would be fully offset by changes in the valuation of the underlying items being hedged. For all outstanding derivative instruments, the net accrued loss was $3.8 million and gain was $4.1 million and $2.6 million at December 28, 2019, December 29, 2018 and December 30, 2017, respectively, and was recorded either in non-trade amounts receivable or accrued liabilities, depending upon the net position of the individual contracts. The notional amounts shown above change based upon the Company's outstanding exposure to fair value fluctuations.