Quarterly report pursuant to Section 13 or 15(d)

DERIVATIVES

v2.4.0.8
DERIVATIVES
 9 Months Ended
Sep. 29, 2013
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVES
NOTE 13. 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 September 29, 2013, the amount we expect to reclassify from AOCL to income over the next year is an unrealized net gain of $2 million.  For the nine month periods ended September 29, 2013 and September 30, 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 93 percent and 95 percent of the notional amounts of contracts outstanding as of September 29, 2013 and December 31, 2012, respectively.
 
 
 
Notional amount in millions
Currency denomination
 
September 29,
2013
 
December 31,
2012
United States Dollar (USD)
 
105

 
110

British Pound Sterling (GBP)
 
193

 
227

Euro (EUR)
 
30

 
28

Singapore Dollar (SGD)
 
—

 
3

Indian Rupee (INR)
 
3,025

 
1,943

Japanese Yen (JPY)
 
1,987

 
384

Canadian Dollar (CAD)
 
65

 
59

South Korea Won (KRW)
 
32,822

 
35,266

Chinese Renmimbi (CNY)
 
74

 
45

Brazilian Real (BRL)
 
92

 
—


 
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 September 29, 2013, we expect to reclassify an unrealized net loss of $3 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
 
September 29, 2013
 
December 31, 2012
Commodity
 
Notional Amount
 
Quantity
 
Notional Amount
 
Quantity
Copper
 
$
—

 
—
(1) 
 
$
24

 
3,025 metric tons
(1) 
Platinum
 
62

 
41,076 troy ounces
(2) 
 
71

 
45,126 troy ounces
(2) 
Palladium
 
18

 
24,251 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 call and put 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, therefore we present the calls and puts on a gross basis on our Condensed Consolidated Balance Sheets. 
 
The following table summarizes our outstanding commodity zero-cost collar contracts that were entered into to hedge the cost of copper purchases:
 
 
 
September 29, 2013
 
December 31, 2012
Commodity
 
Average Floor
or Cap
 
Quantity in
metric tons (1)
 
Average Floor
or Cap
 
Quantity in
metric tons (1)
Copper call options
 
$
7,852

 
5,062

 
$
8,196

 
4,100

Copper put options
 
7,052

 
5,062

 
7,005

 
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 three and nine month periods presented below:
 
 
 
Three months ended
 
Nine months ended
In millions
 
September 29, 2013
 
September 30, 2012
 
September 29, 2013
 
September 30, 2012
Income Statement
Classification
 
Gain/(Loss) on
Swaps
 
Gain/(Loss) on
Borrowings
 
Gain/(Loss) on
Swaps
 
Gain/(Loss) on
Borrowings
 
Gain/(Loss) on
Swaps
 
Gain/(Loss) on
Borrowings
 
Gain/(Loss) on
Swaps
 
Gain/(Loss) on
Borrowings
Interest expense
 
$
(6
)
 
$
6

 
$
1

 
$
(1
)
 
$
(34
)
 
$
34

 
$
6

 
$
(6
)

 
Cash Flow Hedging
 
The following table summarizes the effect on our Condensed Consolidated Statements of Income for derivative instruments classified as cash flow hedges for the three and nine month periods presented below:  The table does not include amounts related to ineffectiveness as it was not material for the periods presented.
 
 
 
 
 
Three months ended
 
Nine months ended
 
 
Location of
Gain/(Loss)
 
Amount of Gain/(Loss)
Recognized in
AOCL on Derivative
 
Amount of Gain/(Loss)
Reclassified from
AOCL into Income
 
Amount of Gain/(Loss)
Recognized in
AOCL on Derivative
 
Amount of Gain/(Loss)
Reclassified from
AOCL into Income
In millions
 
Reclassified
 
(Effective Portion)
 
(Effective Portion)
 
(Effective Portion)
 
(Effective Portion)
Derivatives in Cash Flow Hedging Relationships
 
into Income(Effective Portion)
 
September 29,
2013
 
September 30,
2012
 
September 29,
2013
 
September 30,
2012
 
September 29,
2013
 
September 30,
2012
 
September 29,
2013
 
September 30,
2012
Foreign currency forward contracts
 
Net sales
 
$
5

 
$
5

 
$
(2
)
 
$
(1
)
 
$
(3
)
 
$
8

 
$
(4
)
 
$
(3
)
Commodity swap contracts
 
Cost of sales
 
5

 
10

 
(2
)
 
(3
)
 
(4
)
 
13

 
1

 
(8
)
Total
 
 
 
$
10

 
$
15

 
$
(4
)
 
$
(4
)
 
$
(7
)
 
$
21

 
$
(3
)
 
$
(11
)

 
Derivatives Not Designated as Hedging Instruments
 
The following table summarizes the effect on our Condensed Consolidated Statements of Income for derivative instruments not classified as cash flow hedges for the three and nine month periods presented below:
 
 
 
 
Three months ended
 
Nine months ended
In millions
 
 
 
Amount of Gain/(Loss) Recognized in Income on Derivatives
 
Amount of Gain/(Loss) Recognized in Income on Derivatives
Derivatives Not Designated as
Hedging Instruments
 
Location of Gain/(Loss)
Recognized in Income
on Derivatives
 
September 29,
2013
 
September 30, 2012
 
September 29, 2013
 
September 30, 2012
Foreign currency forward contracts
 
Cost of sales
 
$
(3
)
 
$
(1
)
 
$
—

 
$
(4
)
Foreign currency forward contracts
 
Other income (expense), net
 
19

 
13

 
(3
)
 
18

Commodity swap contracts
 
Cost of sales
 
—

 
2

 
—

 
1

Commodity zero-cost collars
 
Cost of sales
 
2

 
1

 
(2
)
 
1


 
Fair Value Amount and Location of Derivative Instruments
 
The following tables summarize the location and fair value of derivative instruments on our Condensed Consolidated Balance Sheets:

 
 
Derivative Assets
 
 
Fair Value
 
 
In millions
 
September 29, 2013
 
December 31, 2012
 
Balance Sheet Location
Derivatives designated as hedging instruments
 
 

 
 

 
 
Interest rate contract
 
$
54

 
$
88

 
Other assets
Foreign currency forward contracts
 
4

 
2

 
Prepaid expenses and other current assets
Commodity swap contracts
 
—

 
1

 
Prepaid expenses and other current assets
Total derivatives designated as hedging instruments
 
58

 
91

 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments
 
 

 
 

 
 
Foreign currency forward contracts
 
1

 
1

 
Prepaid expenses and other current assets
Commodity call option contracts
 
1

 
1

 
Other assets
Total derivatives not designated as hedging instruments
 
2

 
2

 
 
Total derivative assets
 
$
60

 
$
93

 
 
 
 
 
Derivative Liabilities
 
 
Fair Value
 
 
In millions
 
September 29,
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
 
 

 
 

 
 
Foreign currency forward contracts
 
2

 
—

 
Other accrued expenses
Commodity put option contracts
 
1

 
1

 
Other accrued expenses
Total derivatives not designated as hedging instruments
 
3

 
1

 
 
Total derivative liabilities
 
$
8

 
$
3

 
 

 
We have elected to present our derivative contracts on a gross basis in our Condensed Consolidated Balance Sheets.  Had we chosen to present on a net basis, we would have derivatives in a net asset position of $55 million and derivatives in a net liability position of $3 million.