Derivative Instruments and Hedging Activities

9 Months Ended

Sep. 30, 2012

Derivative Instruments and Hedging Activities

8. Derivative Instruments and Hedging Activities

We are exposed to certain market risks relating to our ongoing business operations, including foreign currency exchange rate risk, commodity price risk, interest rate risk and credit risk. We manage our exposure to these and other market risks through regular operating and financing activities. Currently, the only risks that we manage through the use of derivative instruments are interest rate risk and foreign currency exchange rate risk.

Interest Rate Risk

Derivatives Designated as Fair Value Hedges

We use interest rate derivative instruments to manage our exposure to interest rate movements by converting fixed-rate debt into variable-rate debt. Under these agreements, we agree to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to an agreed-upon notional principal amount. The objective of the instruments is to more closely align interest expense with interest income received on cash and cash equivalents. These derivative instruments are designated as fair value hedges under GAAP. Changes in the fair value of the derivative instrument are recorded in current earnings and are offset by gains or losses on the underlying debt instrument.

We have multiple nine-year fixed-to-variable interest rate swap agreements with a total notional amount of $250 million. These interest rate swap agreements were designated as fair value hedges of the fixed interest rate obligation of our 2019 Notes. We receive a fixed interest rate of 4.625 percent and pay variable interest equal to the three-month LIBOR plus an average of 133 basis points on these interest rate swap agreements.

Foreign Currency Exchange Rate Risk

We operate on a global basis and are exposed to the risk that our financial condition, results of operations and cash flows could be adversely affected by changes in foreign currency exchange rates. To reduce the potential effects of foreign currency exchange rate movements on net earnings, we enter into derivative financial instruments in the form of foreign currency exchange forward contracts and options with major financial institutions. We are primarily exposed to foreign currency exchange rate risk with respect to transactions and net assets denominated in Euros, Swiss Francs, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles and Indian Rupees. We do not use derivative financial instruments for trading or speculative purposes.

Derivatives Designated as Cash Flow Hedges

Our revenues are generated in various currencies throughout the world. However, a significant amount of our inventory is produced in U.S. Dollars. Therefore, movements in foreign currency exchange rates may have different proportional effects on our revenues compared to our cost of products sold. To minimize the effects of foreign currency exchange rate movements on cash flows, we hedge intercompany sales of inventory expected to occur within the next 30 months with foreign currency exchange forward contracts and options. We designate these derivative instruments as cash flow hedges.

We perform quarterly assessments of hedge effectiveness by verifying and documenting the critical terms of the hedge instrument and that forecasted transactions have not changed significantly. We also assess on a quarterly basis whether there have been adverse developments regarding the risk of a counterparty default. For derivatives which qualify as hedges of future cash flows, the effective portion of changes in fair value is temporarily recorded in other comprehensive income and then recognized in cost of products sold when the hedged item affects net earnings. The ineffective portion of a derivative’s change in fair value, if any, is immediately reported in cost of products sold.

For forward contracts and options outstanding at September 30, 2012, we have obligations to purchase U.S. Dollars and sell Euros, Japanese Yen, British Pounds, Canadian Dollars, Australian Dollars, Korean Won, Swedish Krona, Czech Koruna, Thai Baht, Taiwan Dollars, South African Rand, Russian Rubles and Indian Rupees and purchase Swiss Francs and sell U.S. Dollars at set maturity dates ranging from October 2012 through March 2014. As of September 30, 2012, the notional amounts of outstanding forward contracts and options entered into with third parties to purchase U.S. Dollars were $1,488.3 million. As of September 30, 2012, the notional amounts of outstanding forward contracts and options entered into with third parties to purchase Swiss Francs were $278.5 million.

Derivatives Not Designated as Hedging Instruments

We enter into foreign currency forward exchange contracts with terms of one month to manage currency exposures for monetary assets and liabilities denominated in a currency other than an entity’s functional currency. As a result, any foreign currency remeasurement gains/losses recognized in earnings are generally offset with gains/losses on the foreign currency forward exchange contracts in the same reporting period. These offsetting gains/losses are recorded in cost of products sold as the underlying assets and liabilities exposed to remeasurement include inventory-related transactions. These contracts are settled on the last day of each reporting period. Therefore, there is no outstanding balance related to these contracts recorded on the balance sheet as of the end of the reporting period. The notional amounts of these contracts are typically in a range of $1.2 billion to $1.7 billion per quarter.

Foreign Currency Exchange and Interest Rate Risk

Derivatives Designated as Cash Flow Hedges

In 2011, our subsidiary in Japan, with a functional currency of Japanese Yen, borrowed variable-rate debt of $143.0 million denominated in U.S. Dollars under our previous credit facility. To manage the foreign currency exchange risk associated with remeasuring the debt to Japanese Yen and the interest rate risk associated with the variable-rate debt, we entered into multiple cross-currency interest rate swap agreements with a total notional amount of 11,798 million Japanese Yen. We designated these swaps as cash flow hedges of the foreign currency exchange and interest rate risks. The effective portion of changes in fair value of the cross-currency interest rate swaps was temporarily recorded in other comprehensive income and then recognized in interest expense when the hedged item affected net earnings. The cross-currency interest rate swap agreements matured in the first quarter of 2012 and we paid off the subsidiary’s U.S. Dollar debt with Japanese Yen debt borrowed under our previous credit facility.

Income Statement Presentation

Derivatives Designated as Fair Value Hedges

Derivative instruments designated as fair value hedges had the following effects on our condensed consolidated statements of earnings (in millions):

			Gain on Instrument								Loss on Hedged Item
	Location  on Statement of Earnings		Three Months Ended September 30,				Nine Months Ended September 30,				Three Months Ended September 30,						Nine Months Ended September 30,
Derivative Instrument			2012		2011		2012		2011		2012			2011			2012			2011
Interest rate swaps		Interest expense	$	2.7	$	21.2	$	7.8	$	25.2	$	(2.7	)	$	(21.2	)	$	(7.8	)	$	(25.2	)

We had no ineffective fair value hedging instruments during the three or nine month periods ended September 30, 2012 and 2011.

Derivatives Designated as Cash Flow Hedges

Derivative instruments designated as cash flow hedges had the following effects, before taxes, on other comprehensive income (OCI) and net earnings on our condensed consolidated statements of earnings, condensed consolidated statements of comprehensive income and condensed consolidated balance sheets (in millions):

	Amount of Gain / (Loss) Recognized in OCI												Location on Statement of  Earnings	Amount of Gain / (Loss) Reclassified from OCI
	Three  Months Ended September 30,						Nine Months Ended September  30,							Three  Months Ended September 30,						Nine Months Ended September  30,
Derivative Instrument	2012			2011			2012			2011				2012			2011			2012			2011
Foreign exchange forward contracts	$	(46.1	)	$	31.8		$	(14.3	)	$	(42.3	)	Cost of products sold	$	(1.6	)	$	(7.0	)	$	(9.4	)	$	(24.4	)
Foreign exchange options		(0.3	)		(2.2	)		(1.4	)		1.5		Cost of products sold		(0.3	)		—			(0.4	)		—
Cross-currency interest rate swaps		—			—			—			0.2		Interest expense		—			(7.9	)		—			(11.4	)
	$	(46.4	)	$	29.6		$	(15.7	)	$	(40.6	)		$	(1.9	)	$	(14.9	)	$	(9.8	)	$	(35.8	)

The net amount recognized in earnings during the three and nine month periods ended September 30, 2012 and 2011 due to ineffectiveness and amounts excluded from the assessment of hedge effectiveness was not significant.

The fair value of outstanding derivative instruments designated as cash flow hedges and recorded on the balance sheet at September 30, 2012, together with settled derivatives where the hedged item has not yet affected earnings, was a net unrealized loss of $25.7 million, or $19.6 million after taxes, which is deferred in accumulated other comprehensive income. Of the net unrealized loss, $14.1 million, or $8.3 million after taxes, is expected to be reclassified to earnings over the next twelve months.

Derivatives Not Designated as Hedging Instruments

The following gains/(losses) from these derivative instruments were recognized on our condensed consolidated statements of earnings (in millions):

	Location  on Statement of Earnings		Three Months Ended September 30,					Nine Months Ended September 30,
Derivative Instrument			2012			2011		2012			2011
Foreign exchange forward contracts		Cost of products sold	$	(9.8	)	$	9.7	$	(1.2	)	$	(4.0	)

This impact does not include any offsetting gains/losses recognized in earnings as a result of foreign currency remeasurement of monetary assets and liabilities denominated in a currency other than an entity’s functional currency.

Balance Sheet Presentation

As of September 30, 2012 and December 31, 2011, all derivative instruments designated as fair value hedges and cash flow hedges are recorded at fair value on the balance sheet. On our condensed consolidated balance sheets, we recognize individual forward contracts and options with the same counterparty on a net asset/liability basis if we have a master netting agreement with the counterparty. The fair value of derivative instruments on a gross basis is as follows (in millions):

	September 30, 2012			December 31, 2011
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Asset Derivatives
Foreign exchange forward contracts	Other current assets	$	20.6	Other current assets	$	24.9
Foreign exchange options	Other current assets		0.6	Other current assets		1.4
Foreign exchange forward contracts	Other assets		8.1	Other assets		14.5
Foreign exchange options	Other assets		—	Other assets		1.0
Interest rate swaps	Other assets		35.6	Other assets		27.8
Total asset derivatives		$	64.9		$	69.6
Liability Derivatives
Foreign exchange forward contracts	Other current liabilities	$	31.1	Other current liabilities	$	35.6
Cross -currency interest rate swaps	Other current liabilities		—	Other current liabilities		8.2
Foreign exchange forward contracts	Other long-term liabilities		13.0	Other long-term liabilities		13.1
Total liability derivatives		$	44.1		$	56.9