Derivative Instruments and Hedging Activities

3 Months Ended

Mar. 28, 2020

General Discussion of Derivative Instruments and Hedging Activities [Abstract]

Derivative Instruments and Hedging Activities

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 investment hedge.

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, net. The forward points on fair value hedges resulted in pretax income of $5.0 million and $3.7 million in the first quarters of 2020 and 2019, 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 the beginning of 2019 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 the first quarters of 2020 and 2019. The Company recognized $0.8 million and $1.0 million of 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 the first quarters of 2020 and 2019, respectively.

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 investment 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 gain of $56.2 million and a net loss of $13.1 million associated with these hedges in the first quarters of 2020 and 2019, 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 the beginning of 2019 to include forward points in the assessment of effectiveness for net investment 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 investment hedges as of December 30, 2018, the Company recorded an adjustment of $3.8 million, net of taxes, to accumulated comprehensive income to reflect this accounting policy change. The impact related to forward points on hedges of net equity investment recorded as a component of other comprehensive income in the first quarters of 2020 and 2019 was a loss of $6.3 million and a gain of $4.3 million, respectively.

The net cash flow impact from hedging activity for the first quarters of 2020 and 2019 was an outflow of $1.9 million and an inflow of $0.8 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 March 28, 2020 and December 28, 2019, the notional amounts of outstanding forward contracts to purchase currencies were $90.8 million and $137.7 million, respectively, and the notional amounts of outstanding forward contracts to sell currencies were $82.5 million and $143.5 million, respectively. As of March 28, 2020, the notional values of the largest positions outstanding were to purchase $69.8 million of U.S. dollars and $12.2 million of euros, and to sell $19.6 million of Swiss francs and $16.3 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 March 28, 2020 and December 28, 2019. Fair values were determined based on third party quotations (Level 2 fair value measurement):

Asset derivatives

Liability derivatives

Fair value

Derivatives designated as hedging
instruments (in millions)

Balance sheet
location

Mar 28,
2020

Dec 28,
2019

Balance sheet
location

Mar 28,
2020

Dec 28,
2019

Foreign exchange contracts

Non-trade amounts receivable

95.5

16.0

Accrued liabilities

86.5

19.8

The following table summarizes the impact on the results of operations for the first quarters of 2020 and 2019 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 (loss) gain recognized in income on derivatives	Amount of (loss) gain recognized in income on derivatives					Location of gain (loss) recognized in income on related hedged items	Amount of gain (loss) recognized in income on related hedged items
		2020			2019			2020		2019
Foreign exchange contracts	Other expense	$	(75.3	)	$	17.3	Other expense	$	75.3	$	(17.3	)

The following table summarizes the impact of the Company's hedging activities on comprehensive income for the first quarters of 2020 and 2019:



Derivatives designated as cash flow and net equity hedges (in millions)	Amount of gain (loss) recognized in OCI on derivatives (effective portion)				Location of gain (loss) reclassified from accumulated OCI into income (effective portion)	Amount of gain (loss) reclassified from accumulated OCI into income (effective portion)
Cash flow hedging relationships	2020		2019			2020		2019
Foreign exchange contracts	$	10.6	(2.8	)	Cost of products sold	$	0.5	$	(0.5	)
Net investment hedging relationships
Foreign exchange contracts	70.7		(17.7	)
Euro denominated debt	1.8		0.8