11. Derivative Instruments and Hedging Activities

Interest Rate Risk Management

The Company engages in an interest rate hedging strategy for which the hedged transactions are forecasted interest payments on the Company’s Credit Facility. The hedged risk is the variability of forecasted interest rate cash flows, where the hedging strategy involves the purchase of interest rate swaps. For the outstanding cash flow hedges on interest rate exposures at December 31, 2012, the maximum length of time over which the Company is hedging certain of these exposures is approximately seven months.

During August 2009, the Company entered into four interest rate swap agreements with an effective date of December 31, 2009. The agreements collectively provide for the Company to pay interest for less than a four-year period at a weighted average fixed rate of 2.78% on notional amounts aggregating to $140.0 million while receiving interest for the same period at the one month LIBOR rate on the same notional amounts. These agreements will expire in July 2013. These swaps at inception were designated as cash flow hedges against the variability in the LIBOR interest rate on the Company’s term loan under the Prior Credit Facility or against the variability in the LIBOR interest rate on the replacement debt. The Company’s term loan under the Prior Credit Facility was terminated in March 2011 and refinanced with the Credit Facility as discussed further in Note 4, Long-Term Debt. The Company’s swaps remain effective and continue to be designated as cash flow hedges against the variability in certain LIBOR interest rate borrowings under the Credit Facility at LIBOR plus 1.50% to 2.50%, fixing the Company’s weighted average effective rate on the notional amounts at 4.28% to 5.28%. There was no hedge ineffectiveness recorded as result of this refinancing event.

The Company assesses hedge effectiveness and measures hedge ineffectiveness at least quarterly. During the years ended December 31, 2012 and 2011, the ineffective portion relating to these hedges was immaterial and the hedges remained effective as of December 31, 2012 and December 31, 2011. Consequently, all changes in the fair value of the derivatives are deferred and recorded in other comprehensive income (loss) until the related forecasted transactions are recognized in the consolidated statements of income. The fair value of the interest rate swap agreements are based on third-party quotes. At December 31, 2012 and 2011, the Company recorded the interest rate swaps as liabilities at their fair value of $2.0 million and $5.1 million, respectively.

The table below describes the interest rate swaps in aggregate, and the fair value of the liabilities that were outstanding as of December 31, 2012 and 2011:

 

Interest Rate		Aggregate Notional Amounts				Average Swap Rate				Aggregate Fair Value				Maturity Dates
		(In millions)								(In millions)
At December 31, 2012
Interest Rate Swaps		$	140.0				2.78	%		$	(2.0	)			July 2013
At December 31, 2011
Interest Rate Swaps		$	140.0				2.78	%		$	(5.1	)			July 2013

Foreign Currency Instruments

The Company also designates certain foreign currency derivatives, such as certain foreign currency forward and option contracts, as freestanding derivatives for which hedge accounting does not apply. The changes in the fair market value of these freestanding derivatives are included in selling, general and administrative expenses in the Company’s consolidated statements of income. The Company uses foreign currency forward contracts to hedge foreign-currency-denominated intercompany transactions and to partially mitigate the impact of foreign currency fluctuations. The Company also uses foreign currency option contracts to partially mitigate the impact of foreign currency fluctuations. The fair value of the forward and option contracts are based on third-party bank quotes. The Company’s foreign currency derivative contracts are generally executed on a monthly basis.

The Company designates as cash-flow hedges those foreign currency forward contracts it entered into to hedge forecasted inventory purchases and intercompany management fees that are subject to foreign currency exposures. Forward contracts are used to hedge forecasted inventory purchases over specific months. Changes in the fair value of these forward contracts, excluding forward points, designated as cash-flow hedges are recorded as a component of accumulated other comprehensive income (loss) within shareholders’ equity, and are recognized in cost of sales in the consolidated statement of income during the period which approximates the time the hedged inventory is sold. The Company also hedges forecasted intercompany management fees over specific months. These contracts allow the Company to sell Euros in exchange for U.S. dollars at specified contract rates. Changes in the fair value of these forward contracts designated as cash flow hedges are recorded as a component of accumulated other comprehensive income (loss) within shareholders’ equity, and are recognized in selling, general and administrative expenses in the consolidated statement of income during the period when the hedged item and underlying transaction affect earnings.

 

As of December 31, 2012 and 2011, the aggregate notional amounts of all foreign currency contracts outstanding designated as cash flow hedges were approximately $256.9 million and $64.4 million, respectively. At December 31, 2012, these outstanding contracts were expected to mature over the next twelve months. The Company’s derivative financial instruments are recorded on the consolidated balance sheet at fair value based on third-party quotes. As of December 31, 2012, the Company recorded assets at fair value of $0.5 million and liabilities at fair value of $3.3 million relating to all outstanding foreign currency contracts designated as cash-flow hedges. As of December 31, 2011, the Company recorded assets at fair value of $4.4 million relating to all outstanding foreign currency contracts designated as cash-flow hedges. The Company assesses hedge effectiveness and measures hedge ineffectiveness at least quarterly. During the years ended December 31, 2012 and 2011, the ineffective portion relating to these hedges was immaterial and the hedges remained effective as of December 31, 2012 and December 31, 2011.

As of December 31, 2012 and 2011, the majority of the Company’s outstanding foreign currency forward contracts had maturity dates of less than twelve months and fifteen months, respectively, with the majority of freestanding derivatives expiring within one month as of December 31, 2012 and 2011. There were no foreign currency option contracts outstanding as of December 31, 2012 and 2011.

The table below describes all foreign currency forward contracts that were outstanding as of December 31, 2012 and 2011:

 

Foreign Currency		Average Contract Rate				Original Notional Amount				Fair Value Gain (Loss)
						(In millions)				(In millions)
At December 31, 2012
Buy Brazilian real sell U.S. dollar			2.08			$	12.5			$	0.2
Buy Chinese yuan sell U.S. dollar			6.29				1.3				—
Buy Euro sell Argentine peso			6.66				3.0				—
Buy Euro sell Australian dollar			1.27				1.4				—
Buy Euro sell Chilean peso			633.00				1.5				—
Buy Euro sell Indonesian rupiah			12,935.00				9.7				—
Buy Euro sell Mexican peso			17.18				143.7				0.3
Buy Euro sell Malaysian ringgit			4.06				15.2				(0.1	)
Buy Euro sell Peruvian nuevo sol			3.41				2.0				—
Buy Euro sell U.S. dollar			1.33				82.1				(0.4	)
Buy British pound sell Euro			0.82				2.4				—
Buy Japanese yen sell U.S. dollar			85.88				9.3				(0.1	)
Buy South Korean won sell U.S. dollar			1,077.18				52.5				0.2
Buy Malaysian ringgit sell Euro			4.07				0.8				—
Buy Malaysian ringgit sell U.S. dollar			3.08				21.7				0.1
Buy U.S. dollar sell Brazilian real			2.05				12.6				—
Buy U.S. dollar sell Colombian peso			1,800.10				11.7				(0.2	)
Buy U.S. dollar sell Euro			1.30				174.4				(2.9	)
Buy U.S. dollar sell British pound			1.62				16.2				(0.1	)
Buy U.S. dollar sell South Korean won			1,089.08				6.3				(0.1	)
Buy U.S. dollar sell Mexican peso			13.12				25.4				(0.3	)
Buy U.S. dollar sell Philippine peso			40.99				2.9				—
Buy U.S. dollar sell New Taiwan dollar			28.98				0.8				—
Buy U.S. dollar sell South African rand			8.54				0.7				—
Total forward contracts						$	610.1			$	(3.4	)

 

Foreign Currency		Average Contract Rate				Original Notional Amount				Fair Value Gain (Loss)
						(In millions)				(In millions)
At December 31, 2011
Buy Chinese yuan sell U.S. dollar			6.34			$	2.5			$	—
Buy Euro sell Argentine peso			5.70				3.0				—
Buy Euro sell Australian dollar			1.30				0.8				—
Buy Euro sell British pound			0.83				0.8				—
Buy Euro sell Hong Kong dollar			10.15				0.9				—
Buy Euro sell Indonesian rupiah			11,985.00				2.2				—
Buy Euro sell Indian rupee			69.21				2.3				—
Buy Euro sell Mexican peso			18.14				14.9				—
Buy Euro sell Malaysian ringgit			4.17				6.0				(0.1	)
Buy Euro sell Russian ruble			41.74				9.2				—
Buy Euro sell U.S. dollar			1.30				44.8				(0.1	)
Buy Euro sell South African rand			10.89				0.6				—
Buy British pound sell Euro			0.84				0.8				—
Buy Japanese yen sell U.S. dollar			77.85				7.0				0.1
Buy South Korean won sell U.S. dollar			1,161.81				32.2				(0.2	)
Buy Malaysian ringgit sell Euro			4.12				0.8				—
Buy Malaysian ringgit sell U.S. dollar			3.18				19.0				—
Buy Peruvian nuevo sol sell U.S. dollar			2.70				6.7				—
Buy Swedish kronor sell Euro			8.98				1.0				—
Buy U.S. dollar sell Argentine peso			4.37				0.8				—
Buy U.S. dollar sell Colombian peso			1,943.00				5.1				—
Buy U.S. dollar sell Euro			1.37				81.4				4.4
Buy U.S. dollar sell British pound			1.55				24.1				—
Buy U.S. dollar sell Indian rupee			53.30				1.0				—
Buy U.S. dollar sell South Korean won			1,156.38				7.5				—
Buy U.S. dollar sell Mexican peso			13.89				37.3				0.4
Buy U.S. dollar sell Philippine peso			43.79				3.2				—
Buy U.S. dollar sell Russian ruble			31.86				1.3				—
Buy U.S. dollar sell Singapore dollar			1.28				0.3				—
Buy U.S. dollar sell Thai baht			31.43				0.2				—
Buy U.S. dollar sell South African rand			8.33				1.1				—
Total forward contracts						$	318.8			$	4.5

The following tables summarize the derivative activity during the year ended December 31, 2012, 2011, and 2010 relating to all the Company’s derivatives.

Gains and Losses on Derivative Instruments

The following table summarizes gains (losses) relating to derivative instruments recorded in other comprehensive income (loss) during the years ended December 31, 2012, 2011, and 2010:

 

		Amount of Gain (Loss) Recognized in Other Comprehensive Income (Loss) For the Year Ended
		December 31, 2012				December 31, 2011				December 31, 2010
		(In millions)
Derivatives designated as cash flow hedging instruments:
Foreign exchange currency contracts relating to inventory and intercompany management fee hedges		$	(3.3	)		$	4.1			$	5.6
Interest rate swaps		$	(0.6	)		$	(2.1	)		$	(7.5	)

As of December 31, 2012, the estimated amount of existing net losses related to cash flow hedges recorded in accumulated other comprehensive income (loss) that are expected to be reclassified into earnings over the next twelve months was $5.3 million.

 

The following table summarizes gains (losses) relating to derivative instruments recorded to income during the years ended December 31, 2012, 2011, and 2010:

 

		Amount of Gain (Loss) Recognized in Income For the Year Ended												Location of Gain (Loss) Recognized in Income
		December 31, 2012				December 31, 2011				December 31, 2010
		(In millions)
Derivatives designated as cash flow hedging instruments:
Foreign exchange currency contracts relating to inventory hedges and intercompany management fee hedges(1)		$	(1.8	)		$	—			$	—			Selling, general and administrative expenses
Derivatives not designated as hedging instruments:
Foreign exchange currency contracts		$	(10.0	)		$	2.7			$	(9.4	)		Selling, general and administrative expenses

 

(1)	For foreign exchange contracts designated as hedging instruments, the amounts recognized in income (loss) represent the amounts excluded from the assessment of hedge effectiveness. There were no ineffective amounts reported for derivatives designated as hedging instruments.

The following table summarizes gains (losses) relating to derivative instruments reclassified from accumulated other comprehensive loss into income during the years ended December 31, 2012, 2011, and 2010:

 

		Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income												Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income  (effective portion)
		For the Year Ended
		December 31, 2012				December 31, 2011				December 31, 2010
		(In millions)
Derivatives designated as cash flow hedging instruments:
Foreign exchange currency contracts relating to inventory hedges		$	0.1			$	(0.3	)		$	1.8			Cost of sales
Foreign exchange currency contracts relating to intercompany management fee hedges		$	4.5			$	(1.8	)		$	6.6			Selling, general and administrative expenses
Interest rate contracts		$	(3.6	)		$	(3.6	)		$	(3.6	)		Interest expense, net

The Company reports its derivatives at fair value as either assets or liabilities within its consolidated balance sheet. See Note 13, Fair Value Measurements, for information on derivative fair values and their consolidated balance sheet location as of December 31, 2012, and December 31, 2011.