Derivative Financial Instruments and Hedging Activities

12 Months Ended

Dec. 31, 2016

Derivative Financial Instruments and Hedging Activities [Abstract]

Derivative Financial Instruments and Hedging Activities

Note 11. Derivative Financial Instruments and Hedging Activities

As a multinational corporation with operations throughout the world, the Company is exposed to certain market risks.  The Company uses a variety of practices to manage these market risks, including, when considered appropriate, derivative financial instruments.  The Company's objective is to offset gains and losses resulting from interest rates and foreign currency exposures with gains and losses on the derivative contracts used to hedge them.  The Company uses derivative financial instruments only for risk management and not for trading or speculative purposes.

By using derivative financial instruments to hedge exposures to changes in interest rates and foreign currencies, the Company exposes itself to credit risk and market risk.  Credit risk is the risk that the counterparty will fail to perform under the terms of the derivative contract.  When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates credit risk for the Company.  When the fair value of a derivative contract is negative, the Company owes the counterparty, and therefore, it does not face any credit risk.  The Company minimizes the credit risk in derivative instruments by entering into transactions with major financial institutions.

Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates, currency exchange rates, or commodity prices.  The market risk associated with interest rate and forward exchange contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.

Cash flow hedges:

For derivative instruments that are designated and qualify as cash flow hedges, the Company records the effective portion of the gain or loss in accumulated other comprehensive income (loss) as a separate component of shareholders' equity.  The Company subsequently reclassifies the effective portion of gain or loss into earnings in the period during which the hedged transaction is recognized in earnings.

The Company utilizes interest rate swaps to limit exposure to market fluctuations on floating-rate debt.  During the second quarter of 2016, the Company entered into a floating to fixed interest rate swap for an initial aggregate notional amount of $300 million.  The notional amount at December 31, 2016 was $257 million.  This interest rate swap is designated as a cash flow hedge.  The gains and losses associated with this interest rate swap are recorded in accumulated other comprehensive income (loss).  The fair value of this swap was an asset of $2.5 million at December 31, 2016 and is recorded in other assets and deferred charges on the Consolidated Balance Sheet.

In addition, the Company uses foreign exchange forward contracts to protect against foreign currency exchange rate risks inherent in its forecasted inventory purchases.  The Company had 2open foreign exchange contracts as of December 31, 2016, designated as cash flow hedges.  The gains and losses associated with these forward exchange contracts are recognized into cost of sales.  Gains and losses and hedge ineffectiveness associated with these derivatives were not significant.  The fair value of these contracts at December 31, 2016 and 2015 was not significant.

Other:

The Company is exposed to potential gains or losses from foreign currency fluctuations affecting net investments and earning denominated in foreign currencies.  The Company is particularly sensitive to currency exchange rate fluctuations for the following currencies:  British pound sterling (GBP), Chinese renminbi (CYN), Euro, Malaysian ringgit (MYR), Polish zloty (PLN), South African Rand (ZAR), Thai baht (THB) and Turkish lira (TRY).  When considered appropriate, the Company enters into foreign exchange derivative contracts to mitigate the risk of fluctuations on these exposures.  The Company does not designate these contracts for hedge accounting treatment and the changes in fair value of these contracts are recorded in earnings.  The Company recorded losses of $0.6 million and $0.3 million in other non-operating income (deductions), net within the Consolidated Statements of Income for the years ended 2016 and 2015, respectively.  There were 2 open contracts at December 31, 2016.  The fair value of these contracts at December 31, 2016 was not significant.  There were no open foreign exchange rate contracts at December 31, 2015.

Refer to Note 12 for further discussion of the determination of the fair value of derivatives.