DERIVATIVES AND HEDGING TRANSACTIONS

9 Months Ended

Sep. 30, 2017

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 global 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 in the following table 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, other current liabilities and other liabilities on the Consolidated Balance Sheet.

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

	Asset Derivatives				Liability Derivatives
	September 30		December 31		September 30		December 31
(millions)	2017		2016		2017		2016
Derivatives designated as hedging instruments
Foreign currency forward contracts		$30.2		$73.4		$156.7		$19.8
Interest rate swap agreements		-		-		3.6		3.5
Derivatives not designated as hedging instruments
Foreign currency forward contracts		21.9		20.0		52.5		26.9
Gross value of derivatives		52.1		93.4		212.8		50.2
Gross amounts offset in the Consolidated Balance Sheet		(23.1)		(25.7)		(23.1)		(25.7)
Net value of derivatives		$29.0		$67.7		$189.7		$24.5

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

	Notional Values
	September 30		December 31
(millions)	2017		2016
Foreign currency forward contracts (a)		$ 5,617		$ 4,317
Interest rate agreements		$ 1,450		$ 1,450

(a) Includes net investment hedge forward contracts of €40 million and €0 million as of September 30, 2017 and December 31, 2016, respectively.

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. Cash flow hedged transactions impacting AOCI are forecasted to occur within the next five years.

The Company occasionally enters into treasury lock and forward starting interest rate swap agreements to manage interest rate exposure. During 2016, 2015, and 2014 the Company entered into and subsequently closed a series of treasury lock and forward starting interest rate swap agreements, in conjunction with its public debt issuances. The agreements were designated and effective as cash flow hedges of the expected interest payments related to the anticipated future debt issuances. Amounts recorded in AOCI 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:

		Third Quarter Ended				Nine Months Ended
		September 30				September 30
(millions)		2017		2016		2017		2016
Unrealized gain (loss) recognized into AOCI
Foreign currency forward contracts	AOCI (equity)		$(118.8)		$(12.9)		$(192.4)		$(40.4)
Interest rate swap agreements	AOCI (equity)		-		1.4		-		(11.5)
	Total		(118.8)		(11.5)		(192.4)		(51.9)
Gain (loss) recognized in income
Foreign currency forward contracts	Cost of sales		(0.9)		5.0		(11.7)		26.6
	SG&A		(99.5)		(0.7)		(157.3)		(20.3)
	Interest expense, net		7.4		-		16.1		2.9
	Subtotal		(93.0)		4.3		(152.9)		9.2
Interest rate swap agreements	Interest expense, net		(1.8)		(1.6)		(5.4)		(4.8)
	Total		$(94.8)		$2.7		$(158.3)		$4.4

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 2017 and 2016.

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 interest 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 and its $250 million 3.69% debt from fixed interest 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 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:

		Third Quarter Ended				Nine Months Ended
		September 30				September 30
(millions)		2017		2016		2017		2016
Gain (loss) on derivative recognized income
Interest rate swap	Interestexpense, net		$0.3		$(7.6)		$(0.1)		$6.1
Gain (loss) on hedged item recognized income
Interest rate swap	Interest expense, net		$(0.3)		$7.6		$0.1		$(6.1)

Net Investment Hedges

The Company designates its outstanding €1,150 million ($1,356 million at the end of the third quarter of 2017) senior notes (“euronotes”) and €200 million ($238 million at the end of the third quarter of 2017) Euro commercial paper and related accrued interest as hedges of existing foreign currency exposures related to investments the Company has in certain euro denominated functional currency subsidiaries.

The revaluation gains and losses on the euronotes and Euro commercial paper, 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:

	Third Quarter Ended				Nine Months Ended
	September 30				September 30
(millions)	2017		2016		2017		2016
Revaluation gains (losses), net of tax		$(50.9)		$(1.2)		$(103.7)		$(29.1)

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)		2017		2016		2017		2016
Gain (loss) recognized in income
Foreign currency forward contracts	SG&A		$(29.4)		$(12.0)		$(38.1)		$(27.3)
	Interestexpense, net		(0.2)		1.0		(3.5)		(2.1)
	Total		$(29.6)		$(11.0)		$(41.6)		$(29.4)

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. The losses recognized in 2017 primarily relate to movements in the Euro rates.