Note 11. Hedging Activities and Fair Value Measurements

Hedging Activities

The Company is exposed to certain market risks during the normal course of its business arising from adverse changes in commodity prices, interest rates, and foreign currency exchange rates. The Company’s exposure to these risks is managed through a combination of operating and financing activities. The Company selectively uses derivative financial instruments (“derivatives”), including foreign currency forward contracts and interest rate swaps, to manage the risks from fluctuations in foreign currency exchange rates and interest rates, respectively. The Company does not purchase or hold derivatives for trading or speculative purposes. Fluctuations in commodity prices, interest rates, and foreign currency exchange rates can be volatile, and the Company’s risk management activities do not totally eliminate these risks. Consequently, these fluctuations could have a significant effect on the Company’s financial results.

The Company’s exposure to interest rate risk results primarily from its borrowings of $440.0 million at September 30, 2012. The Company manages its debt centrally, considering tax consequences and its overall financing strategies. The Company manages its exposure to interest rate risk by maintaining a mixture of fixed and variable rate debt and, from time to time, uses pay-fixed interest rate swaps as cash flow hedges of variable rate debt in order to adjust the relative proportions.

A substantial portion of the Company’s operations is conducted by its subsidiaries outside of the U.S. in currencies other than the U.S. Dollar (“USD”). Almost all of the Company’s non-U.S. subsidiaries conduct their business primarily in their local currencies, which are also their functional currencies. The USD, Euro (“EUR”), British pound sterling (“GBP”), and Chinese Yuan (“CNY”) are the principal currencies in which the Company and its subsidiaries enter into transactions. The Company is exposed to the impacts of changes in foreign currency exchange rates on the translation of its non-U.S. subsidiaries’ assets, liabilities, and earnings into USD. The Company partially offsets these exposures by having certain of its non-U.S. subsidiaries act as the obligor on a portion of its borrowings and by denominating such borrowings, as well as a portion of the borrowings for which the Company is the obligor, in currencies other than the USD.

The Company and its subsidiaries are also subject to the risk that arises when they, from time to time, enter into transactions in currencies other than their functional currency. To mitigate this risk, the Company and its subsidiaries typically settle intercompany trading balances monthly. The Company also selectively uses forward currency contracts to manage this risk. These contracts for the sale or purchase of European and other currencies generally mature within one year.

The Company records its derivatives as assets or liabilities on the balance sheet at fair value. Changes in the fair value of derivatives are recognized either in net income or in other comprehensive income, depending on the designated purpose of the derivative. All cash flows associated with derivatives are classified as operating cash flows in the Condensed Consolidated Statements of Cash Flows.

Fluctuations due to changes in foreign currency exchange rates in the value of non-USD borrowings that have been designated as hedges of the Company’s net investment in foreign operations are included in other comprehensive income.

The following tables summarize the notional amounts, fair values and classification of the Company’s outstanding derivatives by risk category and instrument type within the Condensed Consolidated Balance Sheets:


	September 30, 2012
	Balance Sheet Location	Notional Amount ⁽¹⁾		Asset Derivatives Fair Value ⁽¹⁾		Liability Derivatives Fair Value ⁽¹⁾
Derivatives designated as hedging instruments

Interest rate swap contracts	Other liabilities	$	200,000	$	—	$	728

Derivatives not designated as hedging instruments

Foreign currency forwards	Other current assets	$	35,221	$	652	$	—
Foreign currency forwards	Accrued liabilities	$	14,035	$	8	$	238


	December 31, 2011
	Balance Sheet Location	Notional Amount ⁽¹⁾		Asset Derivatives Fair Value ⁽¹⁾		Liability Derivatives Fair Value ⁽¹⁾
Derivatives designated as hedging instruments

Interest rate swap contracts	Other liabilities	$	75,920	$	—	$	855

Derivatives not designated as hedging instruments

Foreign currency forwards	Other current assets	$	14,138	$	43	$	—
Foreign currency forwards	Accrued liabilities	$	228,338	$	150	$	2,029

(1)

Notional amounts represent the gross contract amounts of the outstanding derivatives excluding the total notional amount of positions that have been effectively closed through offsetting positions. The net gains and net losses associated with positions that have been effectively closed through offsetting positions but not yet settled are included in the asset and liability derivatives fair value columns, respectively.

Gains and losses on derivatives designated as cash flow hedges included in the Condensed Consolidated Statements of Operations for the three and nine-month periods ended September 30, 2012 and 2011, respectively, are as presented in the table below:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Interest rate swap contracts ⁽¹⁾

Gain or (loss) recognized in AOCI on derivatives (effective portion)	$	(356	)	$	(174	)	$	(600	)	$	(344	)
Gain or (loss) reclassified from AOCI into income (effective portion)		(170	)		(257	)		(702	)		(808	)
Gain or (loss) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)		(1	)		(2	)		—			(3	)

(1)	Losses on derivatives reclassified from accumulated other comprehensive income (“AOCI”) into income (effective portion) were included in “Interest expense” in the Condensed Consolidated Statements of Operations.

At September 30, 2012, the Company is the fixed rate payor on seven interest rate swap contracts that effectively fix the LIBOR-based index used to determine the interest rates charged on a total of $200.0 million of the Company’s LIBOR-based variable rate borrowings. These contracts carry fixed rates ranging from 0.3% to 2.2% and will expire during 2013 and 2014. These swap agreements qualify as hedging instruments and have been designated as cash flow hedges of forecasted LIBOR-based interest payments. Based on LIBOR-based swap yield curves as of September 30, 2012, the Company expects to reclassify losses of $0.6 million out of AOCI into earnings during the next 12 months. The Company’s LIBOR-based variable rate borrowings outstanding at September 30, 2012 were $388.2 million and €30.0 million.

There were 21 foreign currency forward contracts outstanding as of September 30, 2012 with notional amounts ranging from $0.1 million to $16.8 million. The Company has not designated any forward contracts as hedging instruments. The majority of these contracts are used to hedge the change in fair value of recognized foreign currency denominated assets or liabilities caused by changes in foreign currency exchange rates. The changes in the fair value of these contracts generally offset the changes in the fair value of a corresponding amount of the hedged items, both of which are included in the “Other operating expense, net,” line on the face of the Condensed Consolidated Statements of Operations. The Company’s gains and (losses) on forward currency contracts outstanding and total net foreign currency gains and (losses) for the three and nine-month periods ended September 30, 2012 and 2011 were as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Foreign currency forward contracts gains	$	738		$	2,747		$	684		$	742
Total net foreign currency gains⁽¹⁾		(94	)		(25	)		(1,245	)		(2,614	)

(1)	See Note 13 “Supplemental Information”

As of September 30, 2012 and December 31, 2011, the Company had designated a portion of its Euro Term Loan of approximately €30.0 million and €37.6 million, respectively, as a hedge of the Company’s net investment in European subsidiaries with EUR functional currencies. Accordingly, changes in the fair value of this debt due to changes in the USD to EUR exchange rate have been recorded through other comprehensive income. The Company’s gains and (losses), net of income tax, associated with changes in the fair value of this debt for the three and nine-month periods ended September 30, 2012 and 2011, and the net balance of such gains and (losses) included in accumulated other comprehensive income at September 30, 2012 and 2011 were as follows:


	Three Months Ended September 30,					Nine Months Ended September 30,
	2012			2011		2012			2011
Gain (loss), net of income tax, recorded through other comprehensive income	$	(403	)	$	1,955	$	183		$	1,638
Balance included in accumulated other comprehensive income at September 30, 2012							(2,167	)		(3,495	)

Fair Value Measurements

The Company’s financial instruments consist primarily of cash equivalents, trade receivables, trade payables, deferred compensation assets and obligations, derivatives and debt instruments. The book values of these instruments are a reasonable estimate of their respective fair values.

The following table summarizes the Company’s financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2012:


	Level 1		Level 2		Level 3		Total
Financial Assets
Foreign currency forwards ⁽¹⁾	$	—	$	660	$	—	$	660
Trading securities held in deferred compensation plan ⁽²⁾		8,755		—		—		8,755

Total	$	8,755	$	660	$	—	$	9,415

Financial Liabilities
Foreign currency forwards ⁽¹⁾	$	—	$	238	$	—	$	238
Interest rate swaps ⁽³⁾		—		728		—		728
Phantom stock plan ⁽⁴⁾		—		4,569		—		4,569
Deferred compensation plan ⁽⁵⁾		8,755		—		—		8,755

Total	$	8,755	$	5,535	$	—	$	14,290

(1)	Based on internally-developed models that use as their basis readily observable market parameters such as current spot and forward rates, and the LIBOR index.

(2)	Based on the observable price of publicly traded mutual funds which are classified as trading securities and accounted for using the mark-to-market method.

(3)	Measured as the present value of all expected future cash flows based on the LIBOR-based swap yield curve as of September 30, 2012. The present value calculation uses discount rates that have been adjusted to reflect the credit quality of the Company and its counterparties.

(4)	Based on the price of the Company’s common stock.

(5)	Based on the fair value of the investments in the deferred compensation plan.