Derivative Instruments

9 Months Ended

Sep. 27, 2014

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments

Note 9 – Derivative Instruments

Portions of our operations are subject to fluctuations in foreign exchange rates. We manage these risks using derivative financial instruments. We conduct business on a multinational basis in a wide variety of foreign currencies. Our exposure to market risk for changes in foreign currency exchange rates arises from international financing activities between subsidiaries, foreign currency denominated monetary assets and liabilities and transactions arising from international trade. Our objective is to preserve the economic value of non-functional currency denominated cash flows. We attempt to hedge transaction exposures with natural offsets to the fullest extent possible and, once these opportunities have been exhausted, through foreign exchange forward and option contracts with third parties.

In addition, we have exposure to market risk for changes in interest rates resulting from the announced acquisition of the Enterprise business of Motorola Solutions, Inc. In June 2014, we entered into a commitment letter for a new variable rate credit facility to fund the announced acquisition and we also entered into two tranches of floating-to-fixed forward interest rate swaps to hedge the interest rate risk. In July 2014, we designated these forward interest rate swaps as cash flow hedges of interest rate exposure associated with variability in future cash flows on our variable rate commitment. Changes in fair value of the forward interest rate swaps that are effective at offsetting variability in the future cash flows are recognized in other comprehensive income (loss). Ineffectiveness is immediately recognized in earnings.

The fair value of the forward interest rate swap contracts is estimated using market quoted forward interest rates for the London Interbank Offered Rate “LIBOR” at the balance sheet date and the application of such rates subject to the interest rate swap terms. In accordance with ASC 815 we recognize derivative instruments and hedging activities as either assets or liabilities on the balance sheet and measure them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated as and qualifies for hedge accounting.

Credit and Market Risk

Financial instruments, including derivatives, expose us to counterparty credit risk for nonperformance and to market risk related to interest and currency exchange rates. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties, and procedures to monitor concentrations of credit risk. Our counterparties in derivative transactions are commercial banks with significant experience using derivative instruments. We monitor the impact of market risk on the fair value and cash flows of our derivative and other financial instruments considering reasonably possible changes in interest rates and currency exchange rates and restrict the use of derivative financial instruments to hedging activities. We continually monitor the creditworthiness of our customers to which we grant credit terms in the normal course of business.

Fair Value of Derivative Instruments

Zebra has determined derivative instruments for hedges that have traded but have not settled are considered Level 1 in the fair value hierarchy, and hedges that have not traded are considered Level 2 in the fair value hierarchy. Derivative instruments are used to manage risk and are not used for trading or other speculative purposes, nor do we use leveraged derivative financial instruments. Our foreign currency exchange and forward interest-rate swap contracts are valued using broker quotations or market transactions in either the listed or over-the-counter markets.

Hedging of Net Assets

We use forward contracts to manage exposure related to our pound and euro denominated net assets. Forward contracts typically mature within three months after execution of the contracts. We record gains and losses on these contracts in income each quarter along with the transaction gains and losses related to our net asset positions, which would ordinarily offset each other.

Summary financial information related to these activities included in our consolidated statement of earnings as other income (expense) is as follows (in thousands):

	Three Months Ended						Nine Months Ended
	September 27,			September 28,			September 27,			September 28,
	2014			2013			2014			2013
Change in gains (losses) from foreign exchange derivatives	$	3,211		$	(1,611	)	$	3,752		$	(892	)
Gain (loss) on net foreign currency assets		(3,294	)		1,438			(4,084	)		159
Foreign exchange loss	$	(83	)	$	(173	)	$	(332	)	$	(733	)

	As of
	September 27, 2014			December 31, 2013
Notional balance of outstanding contracts:
Pound/US dollar	£	2,942		£	0
Euro/US dollar	€	36,786		€	41,021
Net fair value of outstanding contracts	$	(135	)	$	33

Hedging of Anticipated Sales

We manage the exchange rate risk of anticipated euro-denominated sales using purchased options, forward contracts, and participating forwards. We designate these contracts as cash flow hedges which mature within twelve months after the execution of the contracts. Gains and losses on these contracts are deferred in other comprehensive income until the contracts are settled and the hedged sales are realized. The deferred gains or losses will then be reported as an increase or decrease to sales.

Summary financial information related to the cash flow hedges is as follows (in thousands):

	As of
	September 27, 2014		September 28, 2013
Unrealized gains on anticipated sales hedging:
Gross	$	8,196	$	448
Income tax expense		1,674		103
Net	$	6,522	$	345

Summary financial information related to the cash flow hedges of future revenues is as follows (in thousands, except percentages):

	As of
	September 27, 2014			December 31, 2013
Notional balance of outstanding contracts versus the dollar	€	91,860		€	85,627
Hedge effectiveness		100	%		100	%

	Three Months Ended					Nine Months Ended
	September 27, 2014		September 28, 2013			September 27, 2014			September 28, 2013
Net gains (losses) included in net sales	$	421	$	(1,135	)	$	(1,507	)	$	(3,082	)

Forward Contracts

We record our forward contracts at fair value on our consolidated balance sheet as a current asset or current liability, depending upon the fair value calculation as detailed in Note 2 of Zebra’s financial statements. The amounts recorded on our consolidated balance sheet are as follows (in thousands):

	As of
	September 27, 2014		December 31, 2013
Assets:
Prepaid expenses and other current assets	$	9,622	$	0
Total	$	9,622	$	0
Liabilities:
Accrued liabilities	$	0	$	2,743
Total	$	0	$	2,743

Forward Interest Rate Swaps

The forward interest rate swaps hedge the interest rate risk associated with the variable rate commitment entered into for the announced acquisition of the Enterprise business of Motorola Solutions, Inc.

These forward interest rate swaps were used to economically hedge interest rate risk associated with the variable rate commitment until July 30, 2014, and as such, changes in their fair value were recognized in earnings in other income (expense). Effective July 30, 2014, these forward interest rate swaps were designated as cash flow hedges of interest rate exposure associated with variability in future cash flows on the variable rate commitment. Subsequent to the hedge designation, the effective portion of changes in their fair value is recognized in other comprehensive income (loss) and the ineffective portion is recognized in earnings in other income (expense). The effective portion recognized in other comprehensive income (loss) will be reclassified to earnings as interest expense in other income (expense) as the interest payments under the committed variable rate credit facility affect earnings.

The location of the forward interest rate swaps designated in a hedge relationship is as follows (in thousands):

	As of
	September 27, 2014		December 31, 2013
Liabilities:
Other long-term liabilities	$	3,472	$	0
Total	$	3,472	$	0

The volume of the forward interest rate swaps designated in a hedge relationship is as follows (in thousands):

	As of
	September 27, 2014		December 31, 2013
Notional balance of outstanding contracts	$	3,339,000	$	0

Zebra entered into a series of forward starting swaps, each with a term of one year, with the following notional amounts per year (in thousands):

Year 2015	$	1,010,000
Year 2016	$	697,000
Year 2017	$	544,000
Year 2018	$	544,000
Year 2019	$	272,000
Year 2020	$	272,000
Notional balance of outstanding contracts	$	3,339,000

The gain (loss) recognized on the forward interest rate swaps not designated in a hedge relationship is as follows (in thousands):

	Three Months Ended				Nine Months Ended
	September 27, 2014		September 28, 2013		September 27, 2014			September 28, 2013
Gain (loss) on forward interest-rate swaps	$	185	$	0	$	(2,248	)	$	0

The gain (loss) recognized in other comprehensive income (loss) on the forward interest rate swaps designated in a hedging relationship is as follows (in thousands):

	As of
	September 27, 2014			September 28, 2013
Unrealized loss on forward interest rate swap hedging:
Gross	$	(1,224	)	$	0
Income tax benefit		(443	)		0
Net	$	(781	)	$	0

No gain (loss) was reclassified from accumulated other comprehensive income (loss) into earnings on the forward interest rate swaps designated in a hedging relationship during the three months and nine months ended September 27, 2014.

At September 27, 2014, we expect that approximately $1,077,980 in losses on the forward interest rate swaps designated in a hedging relationship will be reclassified from accumulated other comprehensive loss into earnings during the next 12 months.