8.Derivatives and Hedging Transactions

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 does not hold derivative financial instruments of a speculative nature or for trading purposes. 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. 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.

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 three years.

The company occasionally enters into forward starting interest rate swap agreements to manage interest rate exposure.

During the third quarter of 2015, the company entered into a series of forward starting interest rate swap agreements to hedge against changes in interest rates that could impact future debt issuances. The agreements were designated and effective as cash flow hedges of the expected interest payments related to the anticipated future debt issuances. The underlying loss recognized during the third quarter of 2015 was recorded within AOCI.

During 2014, the company entered into 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. The agreements closed in January 2015 and July 2015, in conjunction with the respective U.S. and euro debt issuances discussed in Note 5. 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 2014, 2011 and 2006 forward starting interest rate swap agreements were designated and effective as cash flow hedges of the expected interest payments related to the debt issuances. The amounts recorded in AOCI for the respective transactions are recognized as part of interest expense over the remaining life of the notes as the forecasted interest transactions occur.

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	2015			2014			2015			2014

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

Foreign currency forward contracts	AOCI (equity)	$	19.0		$	5.5		$	38.9		$	2.8

Interest rate swap contracts	AOCI (equity)	7.7			0.5			1.2			0.5

		$	26.7		$	6.0		$	40.1		$	3.3


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

Foreign currency forward contracts	Cost of sales	$	13.3		$	0.9		$	23.2		$	3.4
	SG&A	0.2			—			1.1			1.0
	Interest expense, net	1.4			—			1.4			—

		$	14.9		$	0.9		$	25.7		$	4.4

Interest rate swap contracts	Interest expense, net	(1.4		)	(1.0		)	(4.0		)	(3.0		)

		$	13.5		$	(0.1	)	$	21.7		$	1.4

Gains and losses recognized in income related to the ineffective portion of the company’s cash flow hedges were insignificant during the first nine months of 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 is also recorded in interest expense. These fair value hedges are highly effective and thus, there is no impact on earnings due to hedge ineffectiveness.

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

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

		Third Quarter Ended						Nine Months Ended
		September 30						September 30
(millions)	Location	2015			2014			2015			2014
Gain (loss) on derivative recognized in income

Interest rate swaps	Interest expense, net	$	7.6		$	(3.4	)	$	9.5		$	(4.4	)

Gain (loss) on hedged item recognized in income

Interest rate swaps	Interest expense, net	$	(7.6	)	$	3.4		$	(9.5	)	$	4.4

Net Investment Hedges

The company designates its outstanding €175 million and €575 million ($196 million and $639 million as of September 30, 2015, respectively) senior notes (“euronotes”) 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 company also enters into euro denominated forward contracts to hedge additional portions of its net investments in euro denominated functional currency subsidiaries.

During the second half of 2014, the company entered into forward contracts with notional values of €495 million, which were closed in July 2015.

During the first quarter of 2015, the company entered into forward contracts with notional values of €360 million and €80 million. During the second quarter of 2015, the company de-designated the €360 million net investment hedges and initiated undesignated hedges for €360 million to offset the impact of the original €360 million forward contract.

The revaluation gains and losses on the euronotes 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.

Total revaluation gains and losses related to the euronotes and forward contract recorded as part of shareholders’ equity were as follows:

	Third Quarter Ended					Nine Months Ended
	September 30					September 30
(millions)	2015			2014		2015		2014

Revaluation gain (loss), net of tax	$	(12.0	)	$	7.4	$	66.8	$	5.6

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:

		Third Quarter Ended							Nine Months Ended
		September 30							September 30
(millions)	Location		2015			2014			2015			2014

Gain (loss) recognized in income

Foreign currency forward contracts	SG&A		$	7.1		$	(0.6	)	$	6.4		$	6.2
	Interest expense, net		(0.3		)	(2.7		)	(10.9		)	(8.1		)

			$	6.8		$	(3.3	)	$	(4.5	)	$	(1.9	)

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.

Derivative 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.

During 2015, the company made an accounting policy election regarding the presentation of derivatives subject to master netting arrangements with the same counterparties within its Consolidated Balance Sheet. The company previously presented all derivative positions on a gross basis and began presenting derivatives subject to master netting arrangements with the same counterparties on a net basis during the first quarter of 2015. The company reclassified the presentation of derivatives subject to master netting arrangements with the same counterparty as of December 31, 2014 to conform to the new accounting policy which resulted in a reduction in other current assets and other current liabilities of $18.1 million. The immaterial reclassification had no impact on previously reported earnings or cash flows.

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

	Asset Derivatives						Liability Derivatives
	September 30			December 31			September 30			December 31
(millions)	2015			2014			2015			2014


Gross value of derivatives	$	97.8		$	75.5		$	42.6		$	52.1

Gross amounts offset in the Consolidated Balance Sheet	(13.7		)	(18.1		)	(13.7		)	(18.1		)


Net value of derivatives presented in the Consolidated Balance Sheet	$	84.1		$	57.4		$	28.9		$	34.0

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

	Asset Derivatives				Liability Derivatives
	September 30		December 31		September 30		December 31
(millions)	2015		2014		2015		2014

Derivatives designated as hedging instruments

Foreign currency forward contracts	$	53.5	$	17.9	$	6.7	$	0.6

Interest rate swap contracts	7.4		—		5.7		24.2

Derivatives not designated as hedging instruments

Foreign currency forward contracts	36.9		57.6		30.2		27.3


Total	$	97.8	$	75.5	$	42.6	$	52.1

The following table summarizes the notional values of the company’s outstanding derivatives.

	Notional Values
	September 30		December 31
(millions)	2015		2014

Foreign currency forward contracts	$	3,800	$	2,800

Interest rate swap agreements	$	1,675	$	725
	€	—	€	400

Net investment hedge contracts(a)	€	80	€	495

(a)

The net investment hedge contracts exclude the company’s euro denominated debt.