Derivatives and Fair Value | 9 Months Ended |
Sep. 30, 2014 |
Derivatives And Fair Value Disclosure [Abstract] | ' |
Derivatives and Fair Value | ' |
Note 5. Derivatives and Fair Value |
Foreign exchange risk management |
The Company transacts business in more than 100 countries and is subject to risks associated with changing foreign exchange rates. The Company’s objective is to reduce earnings and cash flow volatility associated with foreign exchange rate changes. Accordingly, the Company enters into foreign currency forward contracts to minimize the impact of foreign exchange movements on non–functional currency assets and liabilities and to hedge non-U.S. Dollar anticipated royalties (“Royalty Hedging”). Additionally, through March 2014, the Company utilized foreign currency forward contracts to minimize the impact of foreign exchange movements on EBITDA. These contracts will unwind through the end of 2014. It is the Company’s policy to enter into foreign currency transactions only to the extent necessary to meet its objectives as stated above. The Company does not enter into foreign currency transactions for investment or speculative purposes. The principal currencies hedged are the Euro, the Japanese Yen, the Swiss Franc and the Canadian Dollar. |
The forward contracts entered into for balance sheet risk management purposes are not designated as hedges and are carried at fair value, with changes in the fair value recorded to Other income (loss), net in the Condensed Consolidated Statements of Comprehensive (Loss) Income. These contracts do not subject the Company to material balance sheet risk because gains and losses on these derivatives are intended to offset gains and losses on the assets and liabilities being hedged. |
Unrealized and realized gains and losses on the contracts entered into for managing foreign exchange movement on EBITDA did not qualify for hedge accounting, and therefore were not deferred and were included in the Condensed Consolidated Statements of Comprehensive (Loss) Income in Other income (loss), net. |
The forward contracts entered into for Royalty Hedging purposes are designated as hedges and are carried at fair value, with changes in the fair value recorded to Accumulated Other Comprehensive Income (Loss) (“AOCI”). The change in fair value is reclassified from AOCI to earnings in the quarter in which the hedged royalty is paid. |
For derivatives designated as hedges, the Company assesses, both at the inception of the hedge and on an ongoing basis, whether the derivatives are highly effective in offsetting changes in fair values or cash flows of hedged items. If it is determined that a derivative ceases to be highly effective as a hedge, the Company will discontinue hedge accounting with respect to that derivative prospectively. When it is probable that a hedged forecasted transaction will not occur, the Company discontinues hedge accounting for the affected portion of the forecasted transaction, and reclassifies gains or losses that were accumulated in AOCI to earnings in Other income (loss), net on the Condensed Consolidated Statements of Comprehensive (Loss) Income. Cash flows are classified consistent with the underlying hedged item. |
In April 2014, the Company designated Euro currency borrowings as hedges of its foreign currency exposures of the net investment in certain foreign affiliates. As of September 30, 2014, these borrowings (net of original issue discount) were €869 million ($1,093 million). The effective portion of foreign exchange gains or losses on the remeasurement of the debt is recognized in the cumulative translation adjustment component of AOCI with the related offset in long-term debt. Those amounts would be reclassified from AOCI to earnings upon the sale or substantial liquidation of these net investments. The amount of foreign exchange gains related to the net investment hedges included in cumulative translation adjustment for the three and nine months ended September 30, 2014 was $94 million and $105 million, respectively. |
The following table details the components of foreign exchange gain (loss) included in Other income (loss), net on the Condensed Consolidated Statements of Comprehensive (Loss) Income: |
|
| | Three Months Ended | | | Nine Months Ended | | | | | | | | | | | | | |
September 30, | September 30, | | | | | | | | | | | | |
(in millions) | | 2014 | | | 2013 | | | 2014 | | | 2013 | | | | | | | | | | | | | |
Translation of non-functional currency debt | | $ | — | | | $ | (34 | ) | | $ | — | | | $ | (22 | ) | | | | | | | | | | | | |
Revaluation of other non-functional currency assets and liabilities(1) | | | 8 | | | | (17 | ) | | | (48 | ) | | | (14 | ) | | | | | | | | | | | | |
Effect of derivatives | | | (4 | ) | | | — | | | | (4 | ) | | | 7 | | | | | | | | | | | | | |
Total foreign exchange gain (loss) | | $ | 4 | | | $ | (51 | ) | | $ | (52 | ) | | $ | (29 | ) | | | | | | | | | | | | |
|
-1 | The nine months ended September 30, 2014 included a $49 million charge related to a change in the exchange rate used to remeasure the Company’s Venezuelan Bolívar account balances. Additionally, the nine months ended September 30, 2013 included a $14 million charge resulting from devaluation of Venezuelan Bolívars. Both the 2014 and 2013 charges are further described below in this Note. | | | | | | | | | | | | | | | | | | | | | | | | | | | |
The foreign exchange forward contracts outstanding designated as hedges have various expiration dates through September 2015. The foreign exchange forward contracts outstanding not designated as hedges have various expiration dates through December 2014. Foreign exchange forward contracts are recorded at estimated fair value. The estimated fair values of the forward contracts are based on quoted market prices. |
Interest rate risk management |
The Company purchases interest rate caps and entered into interest rate swap agreements for purposes of managing its risk in interest rate fluctuations. |
In April 2014, the Company purchased U.S. Dollar denominated interest rate caps (“2014 Caps”) for a total notional value of $1 billion at strike rates ranging between 2% and 3%. These caps are effective at various times between April 2014 and April 2016, and expire at various times between April 2017 and April 2019. The total premiums paid were $21 million. The 2014 Caps are designated as cash flow hedges. The 2014 Caps are in addition to the U.S. Dollar and Euro denominated interest rate caps that the Company purchased in May 2010 (“2010 Caps”). The 2010 Caps have strike rates of 4% and expire at various times through January 2015. The 2010 Caps are not designated as cash flow hedges. |
The Company also entered into U.S. Dollar and Euro denominated interest rate swap agreements in April 2014 (“2014 Swaps”) to hedge interest rate exposure on notional amounts of approximately $600 million of its borrowings. The 2014 swaps were effective between April and June 2014, and expire at various times from March 2017 through March 2021. On these agreements, the Company pays a fixed rate ranging from 1.4% to 2.1% and receives a variable rate of interest equal to the greater of three-month U.S. Dollar London Interbank Offered Rate (“LIBOR”) or three-month Euro Interbank Offered Rate (“EURIBOR”), and 1%. The 2014 Swaps are designated as cash flow hedges. The Company also entered into interest rate swap agreements in May 2010 (“2010 Swaps”) to hedge interest rate exposure on notional amounts of $375 million of its borrowings. The 2010 Swaps were effective January 2012, and expire at various times through January 2016. On these agreements, the Company pays a fixed rate ranging from 3% to 3.3% and receives a variable rate of interest equal to the three-month LIBOR. The 2010 Swaps are not designated as cash flow hedges. |
The fair values of derivative instruments in the Condensed Consolidated Statements of Financial Position are as follows: |
|
| | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | 30-Sep-14 | | | 31-Dec-13 | |
| | | | Fair Value of Derivative | | | U.S. Dollar | | | Fair Value of Derivative | | | U.S. Dollar | |
(in millions) | | Balance Sheet Caption | | Asset | | | Liability | | | Notional | | | Asset | | | Liability | | | Notional | |
Derivatives designated as hedging instruments | | | | | | | | | | | | | | | | | | | | | | | | |
Foreign exchange contracts | | Accounts receivable/Accounts payable | | $ | 13 | | | $ | — | | | $ | 215 | | | $ | 6 | | | $ | 4 | | | $ | 202 | |
Interest rate caps | | Non-Current Assets | | | 16 | | | | — | | | | 1,000 | | | | — | | | | — | | | | — | |
Interest rate swaps | | See below(1) | | | — | | | | 10 | | | | 565 | | | | — | | | | — | | | | — | |
Derivatives not designated as hedging instruments | | | | | | | | | | | | | | | | | | | | | | | | |
Foreign exchange contracts | | Accounts receivable/Accounts payable | | | 4 | | | | 7 | | | | 228 | | | | 3 | | | | 11 | | | | 219 | |
Interest rate caps | | — | | | — | | | | — | | | | 110 | | | | — | | | | — | | | | 365 | |
Interest rate swaps | | See below(1) | | | — | | | | 6 | | | | 225 | | | | — | | | | 12 | | | | 375 | |
Total derivatives | | | | $ | 33 | | | $ | 23 | | | | | | | $ | 9 | | | $ | 27 | | | | | |
|
-1 | $2 million included in Accrued and other current liabilities and $14 million included in Other liabilities at September 30, 2014 and $12 million included in Other liabilities at December 31, 2013 in the Condensed Consolidated Statements of Financial Position. | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
The effects of derivative instruments on the Condensed Consolidated Statements of Comprehensive (Loss) Income are as follows: |
|
(in millions) | | Effect of Derivatives on Financial Performance | | | | | | | | | | | |
Derivatives in Cash Flow Hedging Relationships | | Amount of Income/(Loss) | | | Location of Income/(Loss) | | Amount of | | | | | | | | | | | |
Recognized in AOCI | Reclassified from AOCI into | Income/(Loss) | | | | | | | | | | |
| Earnings | Reclassified from | | | | | | | | | | |
| | AOCI | | | | | | | | | | |
| | into Earnings | | | | | | | | | | |
Three Months Ended September 30, | | 2014 | | | 2013 | | | | | 2014 | | | 2013 | | | | | | | | | | | |
Foreign exchange contracts | | $ | 15 | | | $ | (5 | ) | | Other income (loss), net | | $ | 1 | | | $ | 4 | | | | | | | | | | | |
Interest rate derivatives | | | (3 | ) | | | — | | | Interest expense | | | (2 | ) | | | — | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Nine Months Ended September 30, | | | 2014 | | | | 2013 | | | | | | 2014 | | | | 2013 | | | | | | | | | | | |
Foreign exchange contracts | | $ | 12 | | | $ | 9 | | | Other income (loss), net | | $ | 1 | | | $ | 11 | | | | | | | | | | | |
Interest rate derivatives | | | (16 | ) | | | — | | | Interest expense | | | (2 | ) | | | — | | | | | | | | | | | |
|
The pre-tax gain (loss) recognized in earnings on derivatives not designated as hedging instruments was as follows: |
|
| | Three Months Ended | | | Nine Months Ended | | | | | | | | | | | | | |
September 30, | September 30, | | | | | | | | | | | | |
(in millions) | | 2014 | | | 2013 | | | 2014 | | | 2013 | | | | | | | | | | | | | |
Foreign exchange contracts(1) | | $ | (5 | ) | | $ | (4 | ) | | $ | (5 | ) | | $ | (4 | ) | | | | | | | | | | | | |
Interest rate derivatives(2) | | | — | | | | 2 | | | | — | | | | 7 | | | | | | | | | | | | | |
Total derivatives not designated as hedging instruments | | $ | (5 | ) | | $ | (2 | ) | | $ | (5 | ) | | $ | 3 | | | | | | | | | | | | | |
-1 | Included in Other income (loss), net | | | | | | | | | | | | | | | | | | | | | | | | | | | |
-2 | Included in interest expense | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Changes in the fair value of derivatives that are designated as cash flow hedges 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. The Company expects $17 million of pre-tax unrealized losses related to its foreign exchange contracts and interest rate derivatives included in AOCI at September 30, 2014 to be reclassified into earnings within the next twelve months. |
Fair value disclosures |
The Company is subject to authoritative guidance which requires a three-level hierarchy for disclosure of fair value measurements as follows: |
|
Level 1 — | Quoted prices in active markets for identical assets or liabilities. | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Level 2 — | Quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets; and model-derived valuations in which all significant inputs are observable in active markets. | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Level 3 — | Unobservable inputs reflecting management’s own assumptions about the inputs used in pricing the asset or liability. | | | | | | | | | | | | | | | | | | | | | | | | | | | |
The carrying values of cash, cash equivalents, restricted cash, accounts receivable and accounts payable approximated their fair values at September 30, 2014 and December 31, 2013 due to the short-term nature of these instruments. At September 30, 2014 and December 31, 2013, the fair value of total debt approximated $3,910 million and $5,280 million, respectively, as determined under Level 2 measurements based on quoted prices for these financial instruments. |
Recurring measurements |
The following tables summarize assets and liabilities measured at fair value on a recurring basis at the dates indicated: |
|
| | Basis of Fair Value Measurements | | | | | | | | | | | | | |
| | 30-Sep-14 | | | | | | | | | | | | | |
(in millions) | | Level 1 | | | Level 2 | | | Level 3 | | | Total | | | | | | | | | | | | | |
Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Short-term investments | | $ | — | | | $ | 1 | | | $ | — | | | $ | 1 | | | | | | | | | | | | | |
Derivatives | | | — | | | | 33 | | | | — | | | | 33 | | | | | | | | | | | | | |
Total | | $ | — | | | $ | 34 | | | $ | — | | | $ | 34 | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Contingent consideration | | $ | — | | | $ | — | | | $ | 25 | | | $ | 25 | | | | | | | | | | | | | |
Derivatives | | | — | | | | 23 | | | | — | | | | 23 | | | | | | | | | | | | | |
Total | | $ | — | | | $ | 23 | | | $ | 25 | | | $ | 48 | | | | | | | | | | | | | |
|
| | December 31, 2013 | | | | | | | | | | | | | |
(in millions) | | Level 1 | | | Level 2 | | | Level 3 | | | Total | | | | | | | | | | | | | |
Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Short-term investments | | $ | — | | | $ | 4 | | | $ | — | | | $ | 4 | | | | | | | | | | | | | |
Derivatives | | | — | | | | 9 | | | | — | | | | 9 | | | | | | | | | | | | | |
Total | | $ | — | | | $ | 13 | | | $ | — | | | $ | 13 | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Contingent consideration | | $ | — | | | $ | — | | | $ | 65 | | | $ | 65 | | | | | | | | | | | | | |
Derivatives | | | — | | | | 27 | | | | — | | | | 27 | | | | | | | | | | | | | |
Total | | $ | — | | | $ | 27 | | | $ | 65 | | | $ | 92 | | | | | | | | | | | | | |
|
Short-term investments consist of government bond funds. Derivatives consist of foreign exchange contracts and interest rate caps and swaps. The fair value of foreign exchange contracts is based on observable market inputs of spot and forward rates. The fair value of the interest rate caps and swaps is the estimated amount that the Company would receive or pay to terminate such agreements, taking into account market interest rates and the remaining time to maturities. |
The following table summarizes Level 3 acquisition-related contingent consideration liabilities (see Note 2) carried at fair value on a recurring basis with the use of unobservable inputs for the period indicated. |
|
(in millions) | | Contingent | | | | | | | | | | | | | | | | | | | | | | | | | |
Consideration | | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2013 | | $ | 65 | | | | | | | | | | | | | | | | | | | | | | | | | |
New acquisitions | | | 3 | | | | | | | | | | | | | | | | | | | | | | | | | |
Cash payments | | | (28 | ) | | | | | | | | | | | | | | | | | | | | | | | | |
Changes in fair value estimates included in Selling and administrative expenses | | | (15 | ) | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at September 30, 2014 | | $ | 25 | | | | | | | | | | | | | | | | | | | | | | | | | |
During the third quarter of 2014, the Company paid $25 million as a final settlement for an earn-out related to a 2013 acquisition. The settlement resulted in a $9 million change in the fair value of the contingent consideration liability. |
Non-recurring measurements |
During the second quarter of 2014, the Company recorded a $7 million impairment charge for a leased facility, resulting in a fair value measurement of $9 million at June 30, 2014. The fair value was based on a third party market assessment, a Level 2 measurement. Additionally during the second quarter of 2014, the Company wrote off the value of computer software that was no longer in use to zero and recorded an impairment charge of $2 million. The fair value reflects an internal review of the net realizable value of the software and thus is a Level 3 measurement. |
Devaluation of Venezuelan Bolívars |
In February 2013, the Venezuelan government announced the devaluation of its currency. The official exchange rate was adjusted from 4.30 Bolívars to each U.S. Dollar to 6.30. The Company’s Swiss operating subsidiary, IMS AG, maintains certain account balances in Bolívars (mainly cash and cash equivalents). As these balances are held in a non-functional currency of IMS AG, the Company is required to mark-to-market these balances at each reporting date and reflect these movements as gains or losses in income. Additionally, since January 2010, Venezuela has been designated as hyper-inflationary, and as such, all foreign currency fluctuations are recorded in income for certain account balances at the Company’s local Venezuelan operating subsidiary. The Company recorded a pre-tax charge of approximately $14 million to Other income (loss), net, in the first quarter of 2013 related to the remeasurement of the IMS AG Venezuelan Bolívar account balances and the remeasurement of certain local Bolívar account balances. |
In 2014, the Venezuelan government significantly expanded the use of the Supplementary Foreign Currency Administration System (“SICAD”) I exchange market and created a third exchange market called SICAD II. These markets have exchange rates significantly less favorable than the official exchange rate. As a result, the Company assessed its legal eligibility to access the available foreign exchange mechanisms, the transactions that would be eligible, and the Company’s past and expected future ability to transact through those mechanisms. Based on the Company’s analysis, the Company believes SICAD II represents the rate which best reflects the economics of the Company’s Venezuelan business activity, and as such, the Company concluded that it should utilize the SICAD II exchange rate to remeasure its Venezuelan Bolívar account balances as of June 30, 2014. The SICAD II rate at June 30, 2014 was approximately 50 Bolívars to one U.S. Dollar. As a result of the change to the SICAD II rate, the Company recorded a pre-tax charge of $49 million to foreign exchange loss within Other income (loss), net in the second quarter of 2014. The Company continued to remeasure its Venezuela account balances at the SICAD II rate of approximately 50 Bolívars to one U.S. Dollar as of September 30, 2014. The net assets held and revenue generated by our Venezuelan subsidiaries were not material to our consolidated results as of September 30, 2014. |
|