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Financial Instruments and Hedging Transactions

9 Months Ended

Sep. 30, 2011

Financial Instruments and Hedging Transactions

Financial Instruments and Hedging Transactions

5. Financial Instruments and Hedging Transactions

Fair Value of Financial Instruments

The company’s financial instruments include cash and cash equivalents, accounts receivable, accounts payable, commercial paper, notes payable, foreign currency forward contracts, interest rate swap contracts and long-term debt. The carrying values of cash and cash equivalents, accounts receivable, accounts payable, commercial paper and notes payable approximate fair value because of their short maturities. The carrying values of foreign currency forward contracts and interest rate swap contracts are at fair value, which is determined based on foreign currency exchange rates and current interest rates, respectively, as of the balance sheet date (level 2 - significant other observable inputs).

The carrying amount and the estimated fair value of long-term debt, including current maturities, held by the company were:

		September 30, 2011						December 31, 2010
		Carrying			Fair			Carrying			Fair
(millions)		Amount			Value			Amount			Value

Long-term debt (including current maturities)		$	707.4		$	772.6		$	813.2		$	850.6

The fair value of long-term debt is based on quoted market prices for the same or similar debt instruments. The company has concluded that it does not have any significant level 3 financial instruments (unobservable inputs) measured using the company’s own assumptions of fair market value.

Derivative Instruments and Hedging

The company uses foreign currency forward contracts, interest rate swaps and foreign currency debt to manage risks associated with foreign currency exchange rates, interest rates and net investments in foreign operations. The company records all derivatives as assets and liabilities on the balance sheet at fair value. Changes in fair value are recognized immediately in earnings unless the derivative qualifies and is designated as a hedge. The effective portion of changes in fair value of hedges are initially recognized in accumulated other comprehensive income (“AOCI”) on the Consolidated Balance Sheet. Amounts recorded in AOCI are reclassified into earnings in the same period or periods during which the hedged transactions affect earnings. The company evaluates hedge effectiveness at inception and on an ongoing basis. If a derivative is no longer expected to be effective, hedge accounting is discontinued. Hedge ineffectiveness, if any, is recorded in earnings.

The company does not hold derivative financial instruments of a speculative nature. The company is exposed to credit loss in the event of nonperformance of counterparties for foreign currency forward exchange contracts and interest rate swap agreements. The company monitors its exposure to credit risk by using credit approvals and credit limits and by selecting major international banks and financial institutions as counterparties. The company does not anticipate nonperformance by any of these counterparties.

Derivatives Designated as Cash Flow Hedges

The company utilizes foreign currency forward contracts to hedge the effect of foreign currency exchange rate fluctuations on forecasted foreign currency transactions, including: sales, inventory purchases, and intercompany royalty and management fee payments. These forward contracts are designated as cash flow hedges. The effective portions of the changes in fair value of these contracts are recorded in AOCI until the hedged items affect earnings, at which time the gain or loss is reclassified into the same line item in the Consolidated Statement of Income as the underlying exposure being hedged. All hedged transactions are forecasted to occur within the next twelve months.

The company occasionally enters into interest rate swap contracts to manage interest rate exposures. During the first nine months of 2011, the company entered into six forward starting swap agreements in anticipation of a long-term debt issuance. On October 27, 2011 the company entered into a Note Purchase Agreement, which is expected to be funded in November 2011. The interest rate swap agreements were designated and effective as cash flow hedges of the expected interest payments related to the anticipated debt issuance. In 2006, the company entered into and subsequently closed two forward starting swap contracts related to the issuance of its senior euro notes. The settlement payment was recorded in AOCI and is recognized in earnings as part of interest expense over the remaining life of the notes as the forecasted interest transactions occur.

Derivatives Not Designated as Hedging Instruments

The company also uses foreign currency forward contracts to offset its exposure to the change in value of certain foreign currency denominated assets and liabilities, primarily receivables and payables. Although the contracts are effective economic hedges, they are not designated as accounting hedges. Therefore, changes in the value of these derivatives are recognized immediately in earnings, thereby offsetting the current earnings effect of the related foreign currency denominated assets and liabilities.

The following table summarizes the fair value of the company’s outstanding derivatives. The amounts are included in other current assets and other current liabilities on the balance sheet.

		Asset Derivatives						Liability Derivatives
		September 30			December 31			September 30			December 31
(millions)		2011			2010			2011			2010

Derivatives designated as hedging instruments

Foreign currency forward contracts		$	1.1		$	0.5		$	3.4		$	3.2

Interest rate swap contracts		—			—			15.1			—

Derivatives not designated as hedging instruments

Foreign currency forward contracts		9.5			1.3			3.3			1.9

Total		$	10.6		$	1.8		$	21.8		$	5.1

The company had foreign currency forward exchange contracts with notional values that totaled approximately $501 million at September 30, 2011, and $433 million at December 31, 2010.

The company had interest rate swap contracts with notional values that totaled $250 million at September 30, 2011.

The impact on AOCI and earnings from derivative contracts that qualified as cash flow hedges was as follows:

				Third Quarter Ended						Nine Months Ended
				September 30						September 30
(millions)		Location		2011			2010			2011			2010

Unrealized gain (loss) recognized into AOCI (effective portion)

Foreign currency forward contracts		AOCI (equity)		$	0.6		$	(1.5	)	$	(5.0	)	$	0.8

Interest rate swap contracts		AOCI (equity)		(8.9		)	—			(16.7		)	—

Gain (loss) reclassified from AOCI into income (effective portion)

Foreign currency forward contracts		Sales		$	(0.1	)	$	—		$	(0.3	)	$	0.1
		Cost of sales		(1.6		)	(0.8		)	(4.0		)	(3.8		)
		SG&A		(0.5		)	0.3			(1.4		)	0.8
				(2.2		)	(0.5		)	(5.7		)	(2.9		)

Interest rate swap		Interest expense, net		(0.1		)	(0.1		)	(0.3		)	(0.3		)
				$	(2.3	)	$	(0.6	)	$	(6.0	)	$	(3.2	)

Gain (loss) recognized in income on derivative (ineffective portion)

Foreign currency forward contracts		Interest expense, net		$	(0.6	)	$	(0.3	)	$	(1.4	)	$	(0.8	)

The impact on earnings from derivative contracts that are not designated as hedging instruments was as follows:

				Third Quarter Ended						Nine Months Ended
				September 30						September 30
(millions)		Location		2011			2010			2011			2010

Gain (loss) recognized in income

Foreign currency forward contracts		SG&A		$	0.2		$	(1.4	)	$	5.7		$	(5.4	)
		Interest expense, net		(1.2		)	(1.3		)	(4.0		)	(4.1		)
				$	(1.0	)	$	(2.7	)	$	1.7		$	(9.5	)

The amounts recognized in earnings above offset the earnings impact of the related foreign currency denominated assets and liabilities.

Net Investment Hedge

The company designates its euro 300 million ($431 million as of September 30, 2011) senior notes and related accrued interest as a hedge of existing foreign currency exposures related to net investments the company has in certain Euro functional subsidiaries. Accordingly, the transaction gains and losses on the euronotes which are designated and effective as hedges of the company’s net investments have been included as a component of the cumulative translation adjustment account. Total transaction gains and losses related to the euronotes charged to shareholders’ equity were as follows:

		Third Quarter Ended						Nine Months Ended
		September 30						September 30
(millions)		2011			2010			2011			2010

Transaction gains (losses), net of tax		$	0.5		$	(6.9	)	$	(27.4	)	$	43.3

This element reflects the entity's entire fair value of financial instruments and derivative instruments and hedging activities disclosure as a single block of text. Describes an entity's risk management strategies, derivatives in hedging activities and non-hedging derivative instruments, the assets, obligations, liabilities, revenues and expenses arising there from, and the amounts of and methodologies and assumptions used in determining the amounts of such items. Provides disclosure regarding the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments, assets, and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the Company is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risk is are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.