Derivative Instruments and Hedging Activities

6 Months Ended

Jul. 01, 2012

Derivative Instruments and Hedging Activities

10. Derivative Instruments and Hedging Activities

The Company is exposed to certain risks such as foreign currency exchange rate risk, interest rate risk and commodity price risk. To reduce its exposure to such risks, the Company selectively uses derivative financial instruments. All derivative transactions are authorized and executed pursuant to regularly reviewed policies and procedures, which prohibit the use of financial instruments for speculative trading purposes.

All derivative instruments are recognized on the balance sheet at fair value (see Note 9). In accordance with ASC Topic 815, “Derivatives and Hedging,” the accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, further, on the type of hedging relationship. Changes in the fair value of derivatives that are designated as fair value hedges, along with the gain or loss on the hedged item, are recorded in current period earnings. For derivative instruments that are designated as cash flow hedges, the effective portion of gains and losses that result from changes in the fair value of derivative instruments is initially recorded in other comprehensive income (OCI) and subsequently reclassified into earnings when the hedged item affects income. The Company assesses, both at the inception of each hedge and on an on-going basis, whether the derivatives that are used in its hedging transactions are highly effective in offsetting changes in cash flows of the hedged items. Any ineffective portion is immediately recognized in earnings. No component of a hedging derivative instrument’s gain or loss is excluded from the assessment of hedge effectiveness. Derivative instruments that do not qualify for hedge accounting are recorded at fair value and any changes in fair value are recorded in current period earnings.

The Company sells its products internationally and in most markets those sales are made in the foreign country’s local currency. As a result, the Company’s earnings can be affected by fluctuations in the value of the U.S. dollar relative to foreign currency. The Company’s most significant foreign currency risk relates to the Euro, the Australian dollar and the Japanese yen. The Company utilizes foreign currency contracts to mitigate the effects of these currencies’ fluctuations on earnings. The foreign currency contracts are entered into with banks and allow the Company to exchange a specified amount of foreign currency for U.S. dollars at a future date, based on a fixed exchange rate.

The Company utilizes natural gas contracts and diesel fuel contracts to hedge portions of the cost of those commodities consumed in the Company’s motorcycle production and distribution operations.

The Company’s foreign currency contracts and commodity contracts generally have maturities of less than one year.

The Company’s earnings are affected by changes in interest rates. HDFS utilizes interest rate swaps to reduce the impact of fluctuations in interest rates on its unsecured commercial paper by converting a portion from a floating rate basis to a fixed rate basis. HDFS also entered into derivative contracts to facilitate its first quarter 2008 term asset-backed securitization transaction. These derivatives, which hedged assets held by a VIE, did not qualify for hedge accounting treatment and expired during 2011. The fair value of HDFS’s interest rate swaps is determined using pricing models that incorporate quoted prices for similar assets and observable inputs such as interest rates and yield curves.

The following table summarizes the fair value of the Company’s derivative financial instruments (in thousands):

	July 1, 2012						December 31, 2011						June 26, 2011
Derivatives Designated As Hedging Instruments Under ASC Topic 815	Notional Value		Asset Fair  Value(a)		Liability Fair  Value(b)		Notional Value		Asset Fair Value(a)		Liability Fair  Value(b)		Notional Value		Asset Fair  Value(a)		Liability Fair  Value(b)
Foreign currency contracts(c)	$	244,221	$	8,879	$	1,027	$	306,450	$	16,443	$	1,852	$	272,637	$	—	$	9,691
Natural gas contracts(c)		1,066		—		33		3,915		—		265		2,915		—		86
Interest rate swaps—unsecured commercial paper(c)		41,600		—		982		102,100		—		3,020		117,500		—		5,156
Total	$	286,887	$	8,879	$	2,042	$	412,465	$	16,443	$	5,137	$	393,052	$	—	$	14,933
	July 1, 2012						December 31, 2011						June 26, 2011
Derivatives Not Designated As Hedging Instruments Under ASC Topic 815	Notional Value		Asset Fair  Value(a)		Liability Fair  Value(b)		Notional Value		Asset Fair  Value(a)		Liability Fair  Value(b)		Notional Value		Asset Fair  Value(a)		Liability Fair  Value(b)
Disel fuel contracts	$	4,346	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
	$	4,346	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

(a) Included in other current assets

(b) Included in accrued liabilities

(c) Derivative designated as a cash flow hedge

The following tables summarize the amount of gains and losses related to derivative financial instruments designated as cash flow hedges (in thousands):

	Amount of Gain/(Loss) Recognized in OCI
	Three months ended						Six months ended
Cash Flow Hedges	July 1, 2012			June 26, 2011			July 1, 2012			June 26, 2011
Foreign currency contracts	$	10,309		$	(6,760	)	$	4,095		$	(16,921	)
Natural gas contracts		(109	)		(227	)		(424	)		(264	)
Interest rate swaps—unsecured commercial paper		(9	)		(397	)		(24	)		(405	)
Total	$	10,191		$	(7,384	)	$	3,647		$	(17,590	)

	Amount of Gain/(Loss) Reclassified from AOCI into Income
	Three months ended						Six months ended						Expected to be Reclassified
Cash Flow Hedges	July 1, 2012			June 26, 2011			July 1, 2012			June 26, 2011			Over the Next Twelve Months
Foreign currency contracts(a)	$	9,683		$	(14,781	)	$	12,104		$	(20,788	)	$	(5,162	)
Natural gas contracts(a)		(337	)		(166	)		(656	)		(424	)		33
Interest rate swaps—unsecured commercial paper(b)		(968	)		(1,336	)		(1,935	)		(2,686	)		(986	)
Total	$	8,378		$	(16,283	)	$	9,513		$	(23,898	)	$	(6,115	)

(a) Gain/(loss) reclassified from accumulated other comprehensive income (AOCI) to income is included in cost of goods sold.

(b) Gain/(loss) reclassified from AOCI to income is included in financial services interest expense.

For the three and six months ended July 1, 2012 and June 26, 2011, the cash flow hedges were highly effective and, as a result, the amount of hedge ineffectiveness was not material. No amounts were excluded from effectiveness testing.

For the three and six months ended July 1, 2012 and June 26, 2011, there were no gains or losses recognized in income related to derivative financial instruments designated as fair value hedges.

For the three and six months ended July 1, 2012 and June 26, 2011, there were no gains or losses recognized in income related to derivative financial instruments not designated as hedging instruments.

The Company is exposed to credit loss risk in the event of non-performance by counterparties to these derivative financial instruments. Although no assurances can be given, the Company does not expect any of the counterparties to these derivative financial instruments to fail to meet its obligations. To manage credit loss risk, the Company selects counterparties based on credit ratings and, on a quarterly basis, evaluates each hedge’s net position relative to the counterparty’s ability to cover its position.