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DERIVATIVE INSTRUMENTS AND FAIR VALUE MEASUREMENTS
6 Months Ended
Jul. 03, 2016
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Instruments and Fair Value Measurements
DERIVATIVE INSTRUMENTS AND FAIR VALUE MEASUREMENTS
We are exposed to market risks arising principally from changes in foreign currency exchange rates, interest rates and commodity prices. We use certain derivative instruments to manage these risks. These include interest rate swaps to manage interest rate risk, foreign currency forward exchange contracts and options to manage foreign currency exchange rate risk, and commodities futures and options contracts to manage commodity market price risk exposures.
In entering into these contracts, we have assumed the risk that might arise from the possible inability of counterparties to meet the terms of their contracts. We mitigate this risk by entering into exchanged-traded contracts with collateral posting requirements and/or by performing financial assessments prior to contract execution, conducting periodic evaluations of counterparty performance and maintaining a diverse portfolio of qualified counterparties. We do not expect any significant losses from counterparty defaults.
Commodity Price Risk
We enter into commodities futures and options contracts and other commodity derivative instruments to reduce the effect of future price fluctuations associated with the purchase of raw materials, energy requirements and transportation services. We generally hedge commodity price risks for 3- to 24-month periods. Through 2015, we designated the majority of our commodity derivative instruments as cash flow hedges under the hedge accounting requirements. Under hedge accounting, we account for the effective portion of mark-to-market gains and losses on commodity derivative instruments in other comprehensive income, to be recognized in cost of sales in the same period that we record the hedged raw material requirements in cost of sales. The ineffective portion of gains and losses is recorded currently in cost of sales.
Effective July 6, 2015 for cocoa commodity derivatives and January 1, 2016 for other commodity derivatives, we discontinued the designation of any of our existing or new cocoa or other commodity derivatives for hedge accounting treatment.  Since such dates, changes in the fair value of these derivatives have been recorded as incurred within cost of sales. Effective as of such dates, we also revised our definition of segment income to exclude gains and losses on commodity derivatives until the related inventory is sold.  This change to our definition of segment income enables us to continue to align the derivative gains and losses with the underlying economic exposure being hedged and thereby eliminate the mark-to-market volatility within our reported segment income.
Foreign Exchange Price Risk
We are exposed to foreign currency exchange rate risk related to our international operations, including non-functional currency intercompany debt and other non-functional currency transactions of certain subsidiaries. Principal currencies hedged include the euro, Canadian dollar, Japanese yen, and Brazilian real. We typically utilize foreign currency forward exchange contracts and options to hedge these exposures for 3- to 24-month periods. The contracts are either designated as cash flow hedges or are undesignated. The net notional amount of foreign exchange contracts accounted for as cash flow hedges was $49,852 at July 3, 2016 and $10,752 at December 31, 2015. The effective portion of the changes in fair value on these contracts is recorded in other comprehensive income and reclassified into earnings in the same period in which the hedged transactions affect earnings. The net notional amount of foreign exchange contracts that are not designated as accounting hedges was $2,791 at July 3, 2016 and December 31, 2015, respectively. The change in fair value on these instruments is recorded directly in cost of sales or selling, marketing and administrative expense, depending on the nature of the underlying exposure.
Interest Rate Risk
In order to manage interest rate exposure, we enter into interest rate swap agreements to protect against unfavorable interest rate changes relating to forecasted debt transactions. These swaps are designated as cash flow hedges, with gains and losses deferred in other comprehensive income to be recognized as an adjustment to interest expense in the same period that the hedged interest payments affect earnings. The notional amount of interest rate derivative instruments in cash flow hedging relationships was $500,000 at July 3, 2016 and December 31, 2015, respectively.
We also manage our targeted mix of fixed and floating rate debt with debt issuances and by entering into fixed-to-floating interest rate swaps in order to mitigate fluctuations in earnings and cash flows that may result from interest rate volatility. These swaps are designated as fair value hedges, for which the gain or loss on the derivative and the offsetting loss or gain on the hedged item are recognized in current earnings as interest expense (income), net. The notional amount, interest payment and maturity date of these swaps generally match the principal, interest payment and maturity date of the related debt, and the swaps are valued using observable benchmark rates (Level 2 valuation). The notional amount of interest rate derivative instruments in fair value hedge relationships was $350,000 at July 3, 2016 and December 31, 2015, respectively.
Equity Price Risk
We are exposed to market price changes in certain broad market indices related to our deferred compensation obligations to our employees. We use equity swap contracts to hedge the portion of the exposure that is linked to market-level equity returns. These contracts are not designated as hedges for accounting purposes and are entered into for 3- to 12-month periods. The change in fair value of these derivatives is recorded in selling, marketing and administrative expense, together with the change in the related liabilities. The notional amount of the contracts outstanding was $19,048 at July 3, 2016 and $22,230 at December 31, 2015.
Fair Value
Accounting guidance on fair value measurements requires that financial assets and liabilities be classified and disclosed in one of the following categories of the fair value hierarchy:
Level 1 – Based on unadjusted quoted prices for identical assets or liabilities in an active market.
Level 2 – Based on observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3 – Based on unobservable inputs that reflect the entity's own assumptions about the assumptions that a market participant would use in pricing the asset or liability.
We did not have any level 3 financial assets or liabilities, nor were there any transfers between levels during the periods presented.
The following table presents assets and liabilities that were measured at fair value in the Consolidated Balance Sheet on a recurring basis as of July 3, 2016 and December 31, 2015:
 
 
July 3, 2016
 
December 31, 2015
 
 
Assets (1)
 
Liabilities (1)
 
Assets (1)
 
Liabilities (1)
Derivatives designated as cash flow hedging instruments:
 
 
 
 
 
 
 
 
Commodities futures and options (2)
 
$

 
$

 
$

 
$
479

Foreign exchange contracts (3)
 
26

 
5,630

 
367

 
475

Interest rate swap agreements (4)
 

 
87,248

 

 
40,299

 
 
26

 
92,878

 
367

 
41,253

Derivatives designated as fair value hedging instruments:
 
 
 
 
 
 
 
 
Interest rate swap agreements (4)
 
15,374

 

 
4,313

 

 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Commodities futures and options (2)
 
5,067

 

 

 
1,574

Deferred compensation derivatives (5)
 
418

 

 
1,198

 

Foreign exchange contracts (3)
 

 
425

 
69

 

 
 
5,485

 
425

 
1,267

 
1,574

Total
 
$
20,885

 
$
93,303

 
$
5,947

 
$
42,827



(1)
Derivatives assets are classified on our balance sheet within prepaid expenses and other as well as other assets. Derivative liabilities are classified on our balance sheet within accrued liabilities and other long-term liabilities.
(2)
The fair value of commodities futures and options contracts is based on quoted market prices and is, therefore, categorized as Level 1 within the fair value hierarchy. As of July 3, 2016, assets included the net of assets of $63,644 and liabilities of $58,663 associated with cash transfers receivable or payable on commodities futures contracts reflecting the change in quoted market prices on the last trading day for the period. The comparable amounts reflected on a net basis in liabilities at December 31, 2015 were assets of $54,090 and liabilities of $54,860. At July 3, 2016 and December 31, 2015, the remaining amount in assets and liabilities, respectively, related to the fair value of other non-exchange traded derivative instruments.
(3)
The fair value of foreign currency forward exchange contracts is the difference between the contract and current market foreign currency exchange rates at the end of the period. We estimate the fair value of foreign currency forward exchange contracts on a quarterly basis by obtaining market quotes of spot and forward rates for contracts with similar terms, adjusted where necessary for maturity differences. These contracts are classified as Level 2 within the fair value hierarchy.
(4)
The fair value of interest rate swap agreements represents the difference in the present value of cash flows calculated at the contracted interest rates and at current market interest rates at the end of the period. We calculate the fair value of interest rate swap agreements quarterly based on the quoted market price for the same or similar financial instruments. Such contracts are categorized as Level 2 within the fair value hierarchy.
(5)
The fair value of deferred compensation derivatives is based on quoted prices for market interest rates and a broad market equity index and is, therefore, categorized as Level 2 within the fair value hierarchy.
Other Financial Instruments
The carrying amounts of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and short-term debt approximated fair value as of July 3, 2016 and December 31, 2015 because of the relatively short maturity of these instruments.
The estimated fair value of our long-term debt is based on quoted market prices for similar debt issues and is, therefore, classified as Level 2 within the valuation hierarchy. The fair values and carrying values of long-term debt, including the current portion, was as follows:
 
 
Fair Value
 
Carrying Value
 
 
July 3, 2016
 
December 31, 2015
 
July 3, 2016
 
December 31, 2015
Current portion of long-term debt
 
$
501,969

 
$
509,580

 
$
500,078

 
$
499,923

Long-term debt
 
1,756,515

 
1,668,379

 
1,571,179

 
1,557,091

Total
 
$
2,258,484

 
$
2,177,959

 
$
2,071,257

 
$
2,057,014


Income Statement Impact of Derivative Instruments
The effect of derivative instruments on the Consolidated Statements of Income for the three months ended July 3, 2016 and July 5, 2015 was as follows:
 
 
Non-designated Hedges
 
Cash Flow Hedges
 
 
 
 
 
Gains (losses) recognized in income (a)
 
Gains (losses) recognized in other comprehensive income (“OCI”) (effective portion)
 
Gains (losses) reclassified from accumulated OCI into income (effective portion) (b)
 
Gains recognized in income (ineffective portion) (c)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Commodities futures and options
 
$
39,011

 
$

 
$

 
$
112,288

 
$
6,139

 
$
19,100

 
$

 
$
1,141

Foreign exchange contracts
 
(253
)
 
(209
)
 
(3,916
)
 
(1,744
)
 
(761
)
 
(253
)
 

 

Interest rate swap agreements
 

 

 
(17,156
)
 
36,357

 
(1,511
)
 
(1,124
)
 

 

Deferred compensation derivatives
 
418

 
207

 

 

 

 

 

 

Total
 
$
39,176

 
$
(2
)
 
$
(21,072
)
 
$
146,901

 
$
3,867

 
$
17,723

 
$

 
$
1,141


(a)
Gains (losses) recognized in income for non-designated commodities futures and options contracts were included in cost of sales. Gains (losses) recognized in income for non-designated foreign currency forward exchange contracts and deferred compensation derivatives were included in selling, marketing and administrative expenses.
(b)
Gains (losses) reclassified from accumulated OCI ("AOCI") into income were included in cost of sales for commodities futures and options contracts and for foreign currency forward exchange contracts designated as hedges of purchases of inventory or other productive assets. Other gains (losses) for foreign currency forward exchange contracts were included in selling, marketing and administrative expenses. Losses reclassified from AOCI into income for interest rate swap agreements were included in interest expense.
(c)
Gains representing hedge ineffectiveness were included in cost of sales for commodities futures and options contracts.
The effect of derivative instruments on the Consolidated Statements of Income for the six months ended July 3, 2016 and July 5, 2015 was as follows:
 
 
Non-designated Hedges
 
Cash Flow Hedges
 
 
 
 
 
Gains (losses) recognized in income (a)
 
Gains (losses) recognized in OCI (effective portion)
 
Gains (losses) reclassified from AOCI into income (effective portion) (b)
 
Gains recognized in income (ineffective portion) (c)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Commodities futures and options
 
$
70

 
$
(2,777
)
 
$

 
$
97,190

 
$
15,869

 
$
20,300

 
$

 
$
854

Foreign exchange contracts
 
(457
)
 
(276
)
 
(8,032
)
 
(504
)
 
(1,022
)
 
88

 

 

Interest rate swap agreements
 

 

 
(46,949
)
 
8,003

 
(3,071
)
 
(2,313
)
 

 

Deferred compensation derivatives
 
821

 
379

 

 

 

 

 

 

Total
 
$
434

 
$
(2,674
)
 
$
(54,981
)
 
$
104,689

 
$
11,776

 
$
18,075

 
$

 
$
854


(a)
Gains (losses) recognized in income for non-designated commodities futures and options contracts were included in cost of sales. Gains (losses) recognized in income for non-designated foreign currency forward exchange contracts and deferred compensation derivatives were included in selling, marketing and administrative expenses.
(b)
Gains (losses) reclassified from AOCI into income were included in cost of sales for commodities futures and options contracts and for foreign currency forward exchange contracts designated as hedges of purchases of inventory or other productive assets. Other gains (losses) for foreign currency forward exchange contracts were included in selling, marketing and administrative expenses. Losses reclassified from AOCI into income for interest rate swap agreements were included in interest expense.
(c)
Gains representing hedge ineffectiveness were included in cost of sales for commodities futures and options contracts.
The amount of net losses on derivative instruments, including interest rate swap agreements, foreign currency forward exchange contracts and options, commodities futures and options contracts, and other commodity derivative instruments expected to be reclassified from AOCI into earnings in the next 12 months was approximately $1,624 after tax as of July 3, 2016. This amount was primarily associated with losses on interest rate swap agreements and foreign currency forward exchange contracts which more than offset gains on commodities futures contracts.
Fair Value Hedges
For the three months ended July 3, 2016 and July 5, 2015, we recognized a pretax benefit to interest expense of $1,137 and $1,954, respectively, relating to our fixed-to-floating interest swap agreements. For the six months ended July 3, 2016 and July 5, 2015, we recognized a pretax benefit to interest expense of $2,454 and $4,049, respectively, relating to our fixed-to-floating interest swap arrangements.