Annual report pursuant to Section 13 and 15(d)

DERIVATIVES

v2.4.0.8
DERIVATIVES
 12 Months Ended
Dec. 31, 2013
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVES
NOTE 21. DERIVATIVES
We are exposed to financial risk resulting from volatility in foreign exchange rates, commodity prices and interest rates.  This risk is closely monitored and managed through the use of financial derivative instruments including foreign currency forward contracts, commodity swap contracts, commodity zero-cost collars and interest rate swaps.  As stated in our policies and procedures, financial derivatives are used expressly for hedging purposes and under no circumstances are they used for speculative purposes.  When material, we adjust the value of our derivative contracts for counter-party or our credit risk.  None of our derivative instruments are subject to collateral requirements.  Substantially all of our derivative contracts are subject to master netting arrangements which provide us with the option to settle certain contracts on a net basis when they settle on the same day with the same currency.  In addition, these arrangements provide for a net settlement of all contracts with a given counterparty in the event that the arrangement is terminated due to the occurrence of default or a termination event.
Foreign Exchange Rates
As a result of our international business presence, we are exposed to foreign currency exchange risks.  We transact business in foreign currencies and, as a result, our income experiences some volatility related to movements in foreign currency exchange rates.  To help manage our exposure to exchange rate volatility, we use foreign currency forward contracts on a regular basis to hedge forecasted intercompany and third-party sales and purchases denominated in non-functional currencies.  Our internal policy allows for managing anticipated foreign currency cash flows for up to one year.  These foreign currency forward contracts are designated and qualify as foreign currency cash flow hedges under GAAP.  The effective portion of the unrealized gain or loss on the forward contract is deferred and reported as a component of “Accumulated other comprehensive loss” (AOCL).  When the hedged forecasted transaction (sale or purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income.  The ineffective portion of the hedge, if any, is recognized in current income during the period of change. As of December 31, 2013, the amount we expect to reclassify from AOCL to income over the next year is an unrealized net gain of $4 million. For the years ended December 31, 2013 and 2012, there were no circumstances that would have resulted in the discontinuance of a foreign currency cash flow hedge.
To minimize the income volatility resulting from the remeasurement of net monetary assets and payables denominated in a currency other than the functional currency, we enter into foreign currency forward contracts, which are considered economic hedges.  The objective is to offset the gain or loss from remeasurement with the gain or loss from the fair market valuation of the forward contract.  These derivative instruments are not designated as hedges under GAAP.
The table below summarizes our outstanding foreign currency forward contracts. Only the U.S. dollar forward contracts are designated and qualify for hedge accounting as of each period presented below. The currencies in this table represent 94 percent and 95 percent of the notional amounts of contracts outstanding as of December 31, 2013 and 2012.
 
 
Notional amount in millions
Currency denomination
 
December 31,
2013
 
December 31,
2012
United States Dollar (USD)
 
98

 
110

British Pound Sterling (GBP)
 
170

 
227

Euro (EUR)
 
32

 
28

Singapore Dollar (SGD)
 
—

 
3

Indian Rupee (INR)
 
3,118

 
1,943

Japanese Yen (JPY)
 
1,357

 
384

Canadian Dollar (CAD)
 
14

 
59

South Korea Won (KRW)
 
21,855

 
35,266

Chinese Renmimbi (CNY)
 
331

 
45

Brazilian Real (BRL)
 
79

 
—


Commodity Price Risk
We are exposed to fluctuations in commodity prices due to contractual agreements with component suppliers.  In order to protect ourselves against future price volatility and, consequently, fluctuations in gross margins, we periodically enter into commodity swap contracts with designated banks to fix the cost of certain raw material purchases with the objective of minimizing changes in inventory cost due to market price fluctuations.  Certain commodity swap contracts are derivative contracts that are designated as cash flow hedges under GAAP.  We also have commodity swap contracts that represent an economic hedge, but are not designated for hedge accounting and are marked to market through earnings.  For those contracts that qualify for hedge accounting, the effective portion of the unrealized gain or loss is deferred and reported as a component of AOCL.  When the hedged forecasted transaction (purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income.  The ineffective portion of the hedge, if any, is recognized in current income in the period in which the ineffectiveness occurs.  As of December 31, 2013, we expect to reclassify an unrealized net loss of $4 million from AOCL to income over the next year.  Our internal policy allows for managing these cash flow hedges for up to three years.
The following table summarizes our outstanding commodity swap contracts that were entered into to hedge the cost of certain raw material purchases:
Dollars in millions
 
December 31, 2013
 
 
December 31, 2012
 
Commodity
 
Notional Amount
 
Quantity
 
 
Notional Amount
 
Quantity
 
Copper
 
$
—

 
—
(1) 
 
$
24

 
3,025 metric tons
(1) 
Platinum
 
61

 
41,403 troy ounces
(2) 
 
71

 
45,126 troy ounces
(2) 
Palladium
 
16

 
21,790 troy ounces
(2) 
 
10

 
14,855 troy ounces
(2) 
___________________________________________________
(1)A metric ton is a measurement of mass equal to 1,000 kilograms.
(2)A troy ounce is a measurement of mass equal to approximately 31 grams.
In 2012, we began to use a combination of call and put option contracts for copper in net-zero-cost collar arrangements (zero-cost collars) that establish ceiling and floor prices for copper. These contracts are used strictly for hedging and not for speculative purposes. For these zero-cost collars, if the average price of the copper during the calculation period is within the call and put price, the zero-cost collar contracts expire at no cost to us. If the price falls below the floor, the counter-party to the collar receives the difference from us and if the price rises above the ceiling, the counter-party pays the difference to us. We believe that these zero-cost collars will act as economic hedges; however we have chosen not to designate them as hedges for accounting purposes.
The following table summarizes our outstanding commodity zero-cost collar contracts that were entered into to hedge the cost of copper purchases:
 
 
December 31,
 
 
2013
 
2012
Average cap
 
$
7,639

 
$
8,196

Average floor
 
6,978

 
7,005

Quantity in metric tons(1)
 
5,421

 
4,100

___________________________________________________
(1) 
A metric ton is a measurement of mass equal to 1,000 kilograms.
Interest Rate Risk
We are exposed to market risk from fluctuations in interest rates.  We manage our exposure to interest rate fluctuations through the use of interest rate swaps.  The objective of the swaps is to more effectively balance our borrowing costs and interest rate risk.
In November 2005, we entered into an interest rate swap to effectively convert our $250 million debt issue, due in 2028, from a fixed rate of 7.125 percent to a floating rate based on a LIBOR spread. The terms of the swap mirror those of the debt, with interest paid semi-annually. This swap qualifies as a fair value hedge under GAAP. The gain or loss on this derivative instrument as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in current income as “Interest expense.” The following table summarizes these gains and losses for the years presented below:
 
 
For the years ended December 31,
In millions
 
2013
 
2012
Income Statement Classification
 
Gain/(Loss) on
Swaps
 
Gain/(Loss) on
Borrowings
 
Gain/(Loss) on
Swaps
 
Gain/(Loss) on
Borrowings
Interest expense
 
$
(39
)
 
$
39

 
$
6

 
$
(6
)

Cash Flow Hedging
The following table summarizes the effect on our Consolidated Statements of Income for derivative instruments classified as cash flow hedges for the years ended December 31, 2013 and 2012 presented below.  The table does not include amounts related to ineffectiveness as it was not material for the periods presented.
 
 
 
 
For the years ended December 31,
 
 
 
 
Amount of
Gain/(Loss)
Recognized in
AOCL on
Derivative
(Effective Portion)
 
Amount of
Gain/(Loss)
Reclassified from
AOCL into Income
(Effective Portion)
In millions
 
Location of Gain/(Loss)
Reclassified into Income
(Effective Portion)
 
Derivatives in Cash Flow Hedging Relationships
 
2013
 
2012
 
2013
 
2012
Foreign currency forward contracts
 
Net sales
 
$
1

 
$
8

 
$
(2
)
 
$
(2
)
Commodity swap contracts
 
Cost of sales
 
(7
)
 
8

 
(1
)
 
(9
)
Total
 
 
 
$
(6
)
 
$
16

 
$
(3
)
 
$
(11
)

Derivatives Not Designated as Hedging Instruments
The following table summarizes the effect on our Consolidated Statements of Income for derivative instruments that are not classified as hedges for the years ended December 31, 2013 and 2012.
 
 
Location of Gain/(Loss)
Recognized in
Income on Derivatives
 
Amount of Gain/(Loss) Recognized in Income on Derivatives
In millions
For the years ended December 31,
Derivatives Not Designated as Hedging Instruments
2013
 
2012
Foreign currency forward contracts
 
Cost of sales
 
$
(1
)
 
$
(4
)
Foreign currency forward contracts
 
Other income (expense), net
 
3

 
11

Commodity zero-cost collars
 
Cost of sales
 
(2
)
 
1


Fair Value Amount and Location of Derivative Instruments
The following tables summarize the location and fair value of derivative instruments on our Consolidated Balance Sheets:
 
 
Derivative Assets
 
 
Fair Value
 
 
In millions
 
December 31,
2013
 
December 31,
2012
 
Balance Sheet Location
Derivatives designated as hedging instruments
 
 
 
 
 
 
Interest rate contract
 
$
49

 
$
88

 
Other assets
Foreign currency forward contracts
 
5

 
2

 
Prepaid expenses and other current assets
Commodity swap contracts
 
—

 
1

 
Prepaid expenses and other current assets
Total derivatives designated as hedging instruments
 
54

 
91

 
 
Derivatives not designated as hedging instruments
 
 
 
 
 
 
Foreign currency forward contracts
 
6

 
1

 
Prepaid expenses and other current assets
Commodity zero-cost collars
 
—

 
1

 
Other assets
Total derivatives not designated as hedging instruments
 
6

 
2

 
 
Total derivative assets
 
$
60

 
$
93

 
 

 
 
Derivative Liabilities
 
 
Fair Value
 
 
In millions
 
December 31,
2013
 
December 31,
2012
 
Balance Sheet Location
Derivatives designated as hedging instruments
 
 
 
 
 
 
Commodity swap contracts
 
$
5

 
$
2

 
Other accrued expenses
Total derivatives designated as hedging instruments
 
5

 
2

 
 
Derivatives not designated as hedging instruments
 
 
 
 
 
 
Commodity zero-cost collars
 
—

 
1

 
Other accrued expenses
Foreign currency forward contracts
 
5

 
—

 
Other accrued expenses
Total derivatives not designated as hedging instruments
 
5

 
1

 
 
Total derivative liabilities
 
$
10

 
$
3

 
 


We have elected to present our derivative contracts on a gross basis in our Consolidated Balance Sheets.  Had we chosen to present on a net basis, we would have derivatives in a net asset position of $53 million and derivatives in a net liability position of $3 million.