Derivative Instruments and Hedging Activities

3 Months Ended

Mar. 31, 2013

General Discussion of Derivative Instruments and Hedging Activities [Abstract]

Derivative Instruments and Hedging Activities

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

We operate globally, with manufacturing and distribution facilities in various locations around the world. We may reduce our exposure to fluctuations in the fair value and cash flows associated with changes in interest rates and foreign exchange rates by creating offsetting positions through the use of derivative financial instruments. Since we use foreign currency-rate sensitive and interest-rate sensitive instruments to hedge a certain portion of our existing and forecasted transactions, we expect that any gain or loss in value of the hedge instruments generally would be offset by decreases or increases in the value of the underlying forecasted transactions.

We do not enter into derivative financial instruments for trading or speculative purposes, nor are we a party to leveraged derivatives. The master agreements governing our derivative contracts generally contain standard provisions that could trigger early termination of the contracts in certain circumstances, including if we were to merge with another entity and the creditworthiness of the surviving entity were to be "materially weaker" than that of Avon prior to the merger.

Derivatives are recognized on the balance sheet at their fair values. The following table presents the fair value of derivative instruments outstanding at March 31, 2013:

	Asset			Liability
	Balance Sheet Classification	Fair Value		Balance Sheet Classification	Fair Value
Derivatives designated as hedges:
Interest-rate swap agreements	Prepaid expenses and other	$	.4	Other liabilities	$	—
Total derivatives designated as hedges		$	.4		$	—
Derivatives not designated as hedges:
Interest-rate swap agreements	Prepaid expenses and other	$	.6	Accounts payable	$	.6
Foreign exchange forward contracts	Prepaid expenses and other	4.7		Accounts payable	4.0
Total derivatives not designated as hedges		$	5.3		$	4.6
Total derivatives		$	5.7		$	4.6

The following table presents the fair value of derivative instruments outstanding at December 31, 2012:

	Asset			Liability
	Balance Sheet Classification	Fair Value		Balance Sheet Classification	Fair Value
Derivatives designated as hedges:
Interest-rate swap agreements	Other assets/ Prepaid expenses and other	$	93.1	Other liabilities	$	—
Total derivatives designated as hedges		$	93.1		$	—
Derivatives not designated as hedges:
Interest-rate swap agreements	Prepaid expenses and other	$	1.7	Accounts payable	$	1.7
Foreign exchange forward contracts	Prepaid expenses and other	4.9		Accounts payable	1.5
Total derivatives not designated as hedges		$	6.6		$	3.2
Total derivatives		$	99.7		$	3.2

Accounting Policies

Derivatives are recognized on the balance sheet at their fair values. When we become a party to a derivative instrument and intend to apply hedge accounting, we designate the instrument, for financial reporting purposes, as a fair value hedge, a cash flow hedge, or a net investment hedge. The accounting for changes in fair value (gains or losses) of a derivative instrument depends on whether we had designated it and it qualified as part of a hedging relationship and further, on the type of hedging relationship. We apply the following accounting policies:

• Changes in the fair value of a derivative that is designated as a fair value hedge, along with the loss or gain on the hedged asset or liability that is attributable to the hedged risk are recorded in earnings.

• Changes in the fair value of a derivative that is designated as a cash flow hedge are recorded in AOCI to the extent effective and reclassified into earnings in the same period or periods during which the transaction hedged by that derivative also affects earnings.

• Changes in the fair value of a derivative that is designated as a hedge of a net investment in a foreign operation are recorded in foreign currency translation adjustments within AOCI to the extent effective as a hedge.

• Changes in the fair value of a derivative not designated as a hedging instrument are recognized in earnings in other expense, net on the Consolidated Statements of Income.

Realized gains and losses on a derivative are reported on the Consolidated Statements of Cash Flows consistent with the underlying hedged item.

For derivatives designated as hedges, we assess, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. Highly effective means that cumulative changes in the fair value of the derivative are between 85% - 125% of the cumulative changes in the fair value of the hedged item. The ineffective portion of a derivative’s gain or loss, if any, is recorded in earnings in other expense, net on the Consolidated Statements of Income. In addition, when we determine that a derivative is not highly effective as a hedge, hedge accounting is discontinued. When it is probable that a hedged forecasted transaction will not occur, we discontinue hedge accounting for the affected portion of the forecasted transaction, and reclassify gains or losses that were accumulated in AOCI to earnings in other expense, net on the Consolidated Statements of Income.

Interest Rate Risk

A portion of our borrowings is subject to interest rate risk. We use interest-rate swap agreements, which effectively convert the fixed rate on long-term debt to a floating interest rate, to manage our interest rate exposure. The agreements are designated as fair value hedges. We held interest-rate swap agreements that effectively converted approximately 7% at March 31, 2013, and 62% at December 31, 2012, of our outstanding long-term, fixed-rate borrowings to a variable interest rate based on LIBOR. Our total exposure to floating interest rates was approximately 31% at March 31, 2013, and 69% at December 31, 2012.

In January 2013, we terminated eight of our interest-rate swap agreements designated as fair value hedges, with notional amounts totaling $1,000. As of the interest-rate swap agreements’ termination date, the aggregate favorable adjustment to the carrying value (deferred gain) of our debt was $90.4, which is being amortized as a reduction to interest expense over the remaining term of the underlying debt obligations. We incurred termination fees of $2.3 which were recorded in other expense, net. For the three months ended March 31, 2013, the net impact of the gain amortization was $5.2. The interest-rate swap agreements were terminated in order to improve our capital structure, including increasing our ratio of fixed-rate debt. At March 31, 2013, the unamortized deferred gain associated with the January 2013 interest-rate swap termination was $85.2, of which $10.3 was included within debt maturing within one year and $74.9 was included within long-term debt.

In March 2012, we terminated two of our interest-rate swap agreements designated as fair value hedges, with notional amounts totaling $350. As of the interest-rate swap agreements’ termination date, the aggregate favorable adjustment to the carrying value (deferred gain) of our debt was $46.1, which is being amortized as a reduction to interest expense over the remaining term of the underlying debt obligations through March 2019. We incurred termination fees of $2.5 which were recorded in other expense, net. For the three months ended March 31, 2013 and 2012, the net impact of the gain amortization was $1.5 and immaterial, respectively. The interest-rate swap agreements were terminated in order to increase our ratio of fixed-rate debt. At March 31, 2013, the unamortized deferred gain associated with the March 2012 interest-rate swap termination was $40.2, and was included within long-term debt.

At March 31, 2013, we had interest-rate swap agreements designated as fair value hedges of fixed-rate debt, with notional amounts totaling $125. During the three months ended March 31, 2013 and 2012, we recorded net losses of $.7 and $4.5, respectively, in interest expense for these interest-rate swap agreements designated as fair value hedges. The impact on interest expense of these interest-rate swap agreements was offset by an equal and offsetting impact in interest expense on our fixed-rate debt.

At times, we may de-designate the hedging relationship of a receive-fixed/pay-variable interest-rate swap agreement. In these cases, we enter into receive-variable/pay-fixed interest-rate swap agreements that are designated to offset the gain or loss on the de-designated contract. At March 31, 2013, we had interest-rate swap agreements that are not designated as hedges with notional amounts totaling $250. During the three months ended March 31, 2013 and 2012, we recorded an immaterial net loss and an immaterial net gain, respectively, in other expense, net associated with these undesignated interest-rate swap agreements.

There was no hedge ineffectiveness for the three months ended March 31, 2013 and 2012, related to these interest-rate swaps.

Foreign Currency Risk

At March 31, 2013, the primary currencies for which we had net underlying foreign currency exchange rate exposures were the Argentine peso, Australian dollar, Brazilian real, British pound, Canadian dollar, Chinese renminbi, Colombian peso, the Czech Republic koruna, the euro, Mexican peso, New Zealand dollar, Peruvian new sol, Philippine peso, Polish zloty, Russian ruble, South Africa rand, Turkish lira, Ukrainian hryvnia, and Venezuelan bolívar. We use foreign exchange forward contracts to manage a portion of our foreign currency exchange rate exposures. At March 31, 2013, we had outstanding foreign exchange forward contracts with notional amounts totaling approximately $238 for the Mexican peso, British pound, euro, Peruvian new sol, Romanian leu, Polish zloty, the Czech Republic koruna, and New Zealand dollar.

We use foreign exchange forward contracts to manage foreign currency exposure of intercompany loans. These contracts are not designated as hedges. The change in fair value of these contracts is immediately recognized in earnings and substantially offsets the foreign currency impact recognized in earnings relating to the intercompany loans. During the three months ended March 31, 2013 and 2012, we recorded a loss of $3.0 and a gain of $3.4, respectively, in other expense, net related to these undesignated foreign exchange forward contracts. During the three months ended March 31, 2013 and 2012, we recorded a gain of $3.1and a loss of $2.9, respectively, related to the intercompany loans, caused by changes in foreign currency exchange rates.

We also used a foreign exchange forward contract to hedge the foreign currency exposure related to the net assets of a foreign subsidiary, which was effective as a hedge. A loss of $.3 on the foreign exchange forward contract was recorded in foreign currency translation adjustments within AOCI for the three months ended March 31, 2012. The foreign exchange forward contract terminated in January 2012, and therefore no gain or loss was recorded for the three months ended March 31, 2013.