Financial Instruments and Fair Value

3 Months Ended

Mar. 31, 2020

Note 11. Financial Instruments and Fair Value

Financial instruments that are potentially subject to credit risk consist principally of trade receivables. Collateral is generally not required. The risk associated with this concentration is mitigated by our ongoing credit-review procedures.

A large portion of our cash is held in a few major financial institutions. We monitor the exposure with these institutions and do not expect any of these institutions to fail to meet their obligations. All highly liquid investments with a maturity of three months or less from the date of purchase are considered to be cash equivalents. The cost of these investments approximates fair value. We also consider the carrying value of restricted cash balances to be representative of its fair value.

As of March 31, 2020 and December 31, 2019, we had $20.0 million and $18.8 million, respectively, primarily related to equity method investments included in other noncurrent assets on our condensed consolidated balance sheet.

The following table summarizes the fair value information at March 31, 2020 and December 31, 2019 for foreign exchange contract assets (liabilities), contingent consideration liabilities, net investment hedge assets (liabilities) and cash flow hedge assets (liabilities) measured at fair value on a recurring basis in the respective balance sheet line items, as well as long-term debt (including TEU amortizing notes) for which fair value is disclosed on a recurring basis:


			Fair Value Measurements Using
Financial statement line item	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Fair Value
March 31, 2020
Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments	$	28.0	$	—	$	28.0	$	—	$	28.0
Other current liabilities - foreign exchange contracts not designated as hedging instruments	(8.2)		—		(8.2)		—		(8.2)
Other noncurrent liabilities - contingent consideration	(4.7)		—		—		(4.7)		(4.7)
Other noncurrent assets - cross currency interest rate contracts designated as net investment hedges	6.6		—		6.6		—		6.6
Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges	(50.6)		—		(50.6)		—		(50.6)
Long-term debt - senior notes	(2,000.0)		—		(2,067.3)		—		(2,067.3)

TEU amortizing note ⁽¹⁾	(79.2)		—		(79.2)		—		(79.2)
December 31, 2019
Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments	$	0.8	$	—	$	0.8	$	—	$	0.8
Other current liabilities - foreign exchange contracts not designated as hedging instruments	(1.1)		—		(1.1)		—		(1.1)
Other noncurrent liabilities - contingent consideration	(4.7)		—		—		(4.7)		(4.7)
Other noncurrent assets - cross currency interest rate contracts designated as net investment hedges	2.3		—		2.3		—		2.3

Long-term debt - senior notes	(2,000.0)		—		(2,120.6)		—		(2,120.6)
Long-term debt - term credit facility ⁽¹⁾	(371.4)		—		(371.4)		—		(371.4)

⁽¹⁾We consider the carrying value to be representative of its fair value.

We determine our Level 2 fair value measurements based on a market approach using quoted market values or significant other observable inputs for identical or comparable assets or liabilities.

Contingent consideration liabilities as of March 31, 2020 and December 31, 2019 related to contingent consideration associated with the acquisitions of Aratana and Prevtec during 2019. For Aratana, we will pay up to

$12 million in contingent value rights that are dependent on the achievement of a specified milestone as outlined in the merger agreement. For Prevtec, based on the terms of the purchase agreement, we will pay up to $16.3 million contingent upon the achievement of specific Coliprotec sales milestones by December 31, 2021. The fair value of both contingent consideration liabilities was estimated using the Monte Carlo simulation model and Level 3 inputs including historical revenue, discount rate, asset volatility, and revenue volatility. See Note 6: Acquisitions and Divestitures for further discussion.

Derivative Instruments and Hedging Activities

We are exposed to market risks, such as changes in foreign currency exchange rates and interest rates. To manage the volatility related to these exposures, we have entered into various derivative transactions. We formally assess, designate and document, as a hedge of an underlying exposure, each qualifying derivative instrument that will be accounted for as an accounting hedge at inception. Additionally, we assess, both at inception and at least quarterly thereafter, whether the financial instruments used in the hedging transaction are effective at offsetting changes in either the fair values or cash flows of the underlying exposures.

Derivatives Not Designated as Hedges

We may enter into foreign exchange forward or option contracts to reduce the effect of fluctuating currency exchange rates. These derivative financial instruments primarily offset exposures in the British pound, Canadian dollar, Euro, Japanese yen and Swiss franc (CHF). Foreign currency derivatives used for hedging are put in place using the same or like currencies and duration as the underlying exposures and are recorded at fair value with the gain or loss recognized in other – net, (income) expense. Forward contracts generally have maturities not exceeding 12 months. At March 31, 2020 and December 31, 2019, we had outstanding foreign exchange contracts with aggregate notional amounts of $898.4 million and $861.2 million, respectively. During the three months ended March 31, 2020 and 2019, the amount of net gains and losses on derivative instruments not designated as hedging instruments, recorded in other – net, (income) expense were $(28.0) million and $8.0 million, respectively. These amounts were substantially offset in other – net, (income) expense by the effect of changing exchange rates on the underlying foreign currency exposures.

Derivatives Designated as Hedges

In October 2018, as a means of mitigating the impact of currency fluctuations on our operations in Switzerland, we entered into a five-year cross-currency fixed interest rate swap with a 750 million CHF notional amount, which is designated as a net investment hedge (NIH) against CHF denominated assets (the fair value of which was estimated based on quoted market values of similar hedges and is classified as Level 2). During the three months ended March 31, 2020 and 2019 our interest expense was offset by $6.0 million and $6.1 million, respectively, as a result of the NIH. Over the life of the derivative, gains or losses due to spot rate fluctuations are recorded in cumulative translation adjustment in other comprehensive income. During the three months ended March 31, 2020 and 2019, we recorded a gain, net of tax, of $23.3 million and $12.2 million, respectively, on the NIH. In March 2020, approximately 75% of our cross-currency swaps were liquidated for a cash benefit of $26.7 million (including $1.5 million in interest). We had an approximately 190 million CHF notional remaining on our NIH as of March 31, 2020. In April 2020, we liquidated our remaining position for a cash benefit of $8.3 million. Notwithstanding settlement, gains and losses within accumulated other comprehensive income loss will remain in accumulated other comprehensive loss until either the sale or substantial liquidation of the hedged subsidiary.

Separately, in March 2020, as a means of mitigating variability in cash flows associated with the anticipated term loan B issuance, we executed forward-starting interest rate swaps with a $4.05 billion notional amount, which are designated as cash flow hedges and have settlement dates ranging between 2022 and 2025. These instruments effectively convert floating-rate debt to fixed-rate debt. The cash flow hedges are recorded at fair value on our condensed consolidated balance sheet, while changes in the fair value of the hedge are recognized in other comprehensive income. Fair value is estimated based on quoted market values of similar hedges and is classified as Level 2. Amounts recorded in accumulated other comprehensive loss will be recognized in earnings in interest expense when the hedged transaction affects earnings (i.e., when interest payments are accrued on the term loan B). During the three months ended March 31, 2020, we recorded a loss of $39.2 million, net of tax benefit of $11.4 million, on the cash flow hedges in other comprehensive loss.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial 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 entity 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 risks 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.

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