DERIVATIVES AND HEDGING TRANSACTIONS

12 Months Ended

Dec. 31, 2016

DERIVATIVES AND HEDGING TRANSACTIONS

DERIVATIVES AND HEDGING TRANSACTIONS

8. DERIVATIVES AND HEDGING TRANSACTIONS

The Company uses foreign currency forward contracts, interest rate swap agreements and foreign currency debt to manage risks associated with foreign currency exchange rates, interest rates and net investments in foreign operations. The Company does not hold derivative financial instruments of a speculative nature or for trading purposes. The Company records 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. Cash flows from derivatives are classified in the statement of cash flows in the same category as the cash flows from the items subject to designated hedge or undesignated (economic) hedge relationships. 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 is exposed to credit risk 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, and therefore, recording a valuation allowance against the Company’s derivative balance is not considered necessary.

Derivative Positions Summary

Certain of the Company’s derivative transactions are subject to master netting arrangements that allow the Company to net settle contracts with the same counterparties. These arrangements generally do not call for collateral and as of the applicable dates presented below, no cash collateral had been received or pledged related to the underlying derivatives.

The respective net amounts are included in other current assets, other non-current assets and other current liabilities on the Consolidated Balance Sheet.

The following table summarizes the gross fair value of the Company’s outstanding derivatives.

	Asset Derivatives				Liability Derivatives
(millions)	2016		2015		2016		2015
Derivatives designated as hedging instruments
Foreign currency forward contracts		$ 73.4		$ 70.2		$ 19.8		$ 3.2
Interest rate swap agreements		-		-		3.5		5.4
Derivatives not designated as hedging instruments
Foreign currency forward contracts		20.0		41.0		26.9		32.7
Gross value of derivatives		93.4		111.2		50.2		41.3
Gross amounts offset in the Consolidated Balance Sheet		(25.7)		(9.8)		(25.7)		(9.8)
Net value of derivatives		$ 67.7		$ 101.4		$ 24.5		$ 31.5

The following table summarized the notional values of the Company’s outstanding derivatives.

	Notional Values
(millions)	2016		2015
Foreign currency forward contracts		$ 4,317		$ 4,029
Interest rate agreements		$ 1,450		$ 1,675
Net investment hedge contracts (a)		€ 0		€ 25

(a) The net investment hedge contracts exclude the Company’s euro denominated debt.

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 inventory purchases and intercompany royalty, management fee and other 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 accumulated other comprehensive income (“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 cash flow hedged transactions are forecasted to occur within the next two years.

The Company occasionally enters into forward starting interest rate swap or treasury lock agreements to manage interest rate exposure.

During 2016 and 2015, the Company entered into and subsequently closed a series of treasury lock and forward starting interest rate swap agreements, in conjunction with both its U.S. public debt issuances in January and October 2016, as discussed in Note 6.

During 2014, the Company entered into and subsequently closed a series of forward starting interest rate swap agreements in connection with both its U.S. public debt issuance completed in January 2015 and its euro public debt issuance completed in July 2015. During 2011, the Company entered into and subsequently closed a series of forward starting interest rate swap agreements in connection with the issuance of its private placement debt. During 2006, the Company entered into and subsequently closed two forward starting interest rate swap agreements related to the issuance of its senior euro notes.

The agreements noted above were designated and effective as a cash flow hedge of the expected interest payments related to the anticipated future debt issuance. Amounts recorded in AOCI for the respective transactions above are recognized as part of interest expense over the remaining life of the notes as the forecasted interest transactions occur.  

The effective portion of gains and losses recognized into AOCI and earnings from derivative contracts that qualified as cash flow hedges was as follows:

(millions)			2016		2015		2014
Unrealized gain (loss) recognized into AOCI
Foreign currency forward contracts	AOCI (equity)	AOCI (equity)		$ 7.0		$ 68.4		$ 26.7
Interest rate swap agreements	AOCI (equity)	AOCI (equity)		(9.3)		3.6		(22.1)
	Total	Total		(2.3)		72.0		4.6
(millions)
Gain (loss) recognized in income
Foreign currency forward contracts	Cost of sales	Cost of sales		23.0		30.9		6.1
	SG&A	SG&A		(0.1)		24.7		1.5
	Interest expense, net	Interest expense, net		5.8		2.9		-
	Subtotal	Total		28.7		58.5		7.6
Interest rate swap agreements	Interest expense, net	Interest expense, net		(6.6)		(5.5)		(4.1)
	Total	Total		$ 22.1		$ 53.0		$ 3.5

Gains and losses recognized in income related to the ineffective portion of the Company’s cash flow hedges were insignificant during 2016, 2015 and 2014.

Fair Value Hedges

The Company manages interest expense using a mix of fixed and floating rate debt. To help manage exposure to interest rate movements and to reduce borrowing costs, the Company may enter into interest rate swaps under which the Company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed upon notional principal amount. The mark-to-market of these fair value hedges is recorded as gains or losses in interest expense and is offset by the gain or loss of the underlying debt instrument, which also is recorded in interest expense. These fair value hedges are highly effective and thus, there is no impact on earnings due to hedge ineffectiveness.

In January 2016, the Company entered into an interest rate swap agreement that converted its $400 million 2.00% debt from a fixed rate to a floating rate. In January 2015, the Company entered into interest rate swap agreements that converted its $300 million 1.55% debt, its $250 million 3.69% debt and a portion of its $1.25 billion 3.00% debt from fixed rates to floating interest rates. In May 2014, the Company entered into an interest rate swap agreement that converted its $500 million 1.45% debt from a fixed rate to a floating interest rate. The interest rate swap agreement tied to a portion of the Company’s $1.25 billion 3.00% debt expired in December 2016 upon repayment of the underlying debt.

The interest rate swaps referenced above were designated as fair value hedges.

The impact on earnings from derivative contracts that qualified as fair value hedges was as follows:

(millions)		2016		2015		2014
Gain (loss) on derivative recognized income
Interest rate swap	Interestexpense, net		$ (1.4)		$ 0.0		$ (2.1)
Gain (loss) on hedged item recognized income
Interest rate swap	Interest expense, net		$ 1.4		$ (0.0)		$ 2.1

Net Investment Hedges

The Company designates its outstanding €1,150 million (total of $1,214 million as of year-end 2016) senior notes and related accrued interest as a hedge of existing foreign currency exposures related to net investments the Company has in certain euro denominated functional currency subsidiaries. The series B euro denominated private placement notes that were also designated as a hedge of existing foreign currency exposures matured in December 2016.

The revaluation gains and losses on the euro notes and of the forward contracts, 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, and were as follows:

(millions)	2016		2015		2014
Revaluation gains (losses), net of tax		$ (2.5)		$ 101.3		$ 34.7

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 held at foreign subsidiaries, primarily receivables and payables, which are remeasured at the end of each period. 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 impact on earnings from derivative contracts that are not designated as hedging instruments was as follows:

(millions)		2016		2015		2014
Gain (loss) recognized in income
Foreign currency forward contracts	SG&A		$ (6.0)		$ 15.9		$ 8.6
	Interestexpense, net		(8.4)		(8.6)		(9.0)
	Total		$ (14.4)		$ 7.3		$ (0.4)

The amounts recognized in SG&A above offset the earnings impact of the related foreign currency denominated assets and liabilities. The amounts recognized in interest expense above represent the component of the hedging gains (losses) attributable to the difference between the spot and forward rates of the hedges as a result of interest rate differentials.