Derivatives and Fair Value | 3 Months Ended |
Mar. 31, 2015 |
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”). 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 Income (Loss). 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. |
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. These contracts have various expiration dates through February 2016. |
The following table details the components of foreign exchange gain (loss) included in Other income (loss), net on the Condensed Consolidated Statements of Comprehensive Income (Loss): |
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| | Three Months Ended | | | | | | | | | | | | | | | | | | | | | |
| | March 31, | | | | | | | | | | | | | | | | | | | | | |
(in millions) | | 2015 | | | 2014 | | | | | | | | | | | | | | | | | | | | | |
Revaluation of other non-functional currency assets and liabilities(1) | | $ | — | | | $ | (4 | ) | | | | | | | | | | | | | | | | | | | | |
Effect of derivatives | | | 4 | | | | — | | | | | | | | | | | | | | | | | | | | | |
Total foreign exchange gain (loss) | | $ | 4 | | | $ | (4 | ) | | | | | | | | | | | | | | | | | | | | |
-1 | The three months ended March 31, 2015 included a $7 million charge related to a change in the exchange rate used to remeasure the Company’s Venezuelan Bolívar account balances, offset by $7 million in revaluation of other non-functional assets and liabilities. The charge for the remeasurement of the Bolívar account balances is further described below in this Note. | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net Investment Risk Management |
Beginning in April 2014, the Company designated its foreign currency denominated debt as a hedge of net investment in foreign subsidiaries to reduce the volatility in shareholders’ equity caused by changes in the Euro exchange rate with respect to the U.S. Dollar. As of March 31, 2015, these borrowings (net of original issue discount) were €1,137 million ($1,223 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 months ended March 31, 2015 was $122 million. |
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 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 expired 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: |
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| | | | 31-Mar-15 | | | 31-Dec-14 | |
| | | | 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/ | | $ | 19 | | | $ | — | | | $ | 197 | | | $ | 18 | | | $ | — | | | $ | 189 | |
Accounts payable |
Interest rate caps | | Non-Current Assets | | | 8 | | | | — | | | | 1,000 | | | | 12 | | | | — | | | | 1,000 | |
Interest rate swaps | | See below(1) | | | — | | | | 12 | | | | 512 | | | | — | | | | 12 | | | | 553 | |
Derivatives not Designated as Hedging Instruments: | | | | | | | | | | | | | | | | | | | | | | | | |
Foreign exchange contracts | | Accounts receivable/ | | | 1 | | | | 2 | | | | 131 | | | | — | | | | 2 | | | | 93 | |
Accounts payable |
Interest rate swaps | | See below(1) | | | — | | | | 3 | | | | 100 | | | | — | | | | 4 | | | | 225 | |
Total Derivatives | | | | $ | 28 | | | $ | 17 | | | | | | | $ | 30 | | | $ | 18 | | | | | |
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-1 | $3 million included in Accrued and other current liabilities and $12 million included in Other liabilities at March 31, 2015 and $1 million included in Accrued and other current liabilities and $15 million included in Other liabilities at December 31, 2014 in the Condensed Consolidated Statements of Financial Position. | | | | | | | | | | | | | | | | | | | | | | | | | | | |
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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 Income (Loss). Cash flows are classified consistent with the underlying hedged item. |
The effects of derivative instruments in cash flow hedging relationships on the Condensed Consolidated Statements of Comprehensive Income (Loss) are as follows: |
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| | Effect of Derivatives on Financial Performance | | | | | | | | | | | |
(in millions) | | Amount of Income/(Loss) | | | Location of Income/(Loss) | | Amount of | | | | | | | | | | | |
Recognized in AOCI | Reclassified from AOCI | Income/(Loss) | | | | | | | | | | |
| into Earnings | Reclassified from | | | | | | | | | | |
| | AOCI into Earnings | | | | | | | | | | |
Three Months Ended March 31, | | 2015 | | | 2014 | | | | | 2015 | | | 2014 | | | | | | | | | | | |
Foreign exchange contracts | | $ | 7 | | | $ | (1 | ) | | Other income (loss), net | | $ | 6 | | | $ | 1 | | | | | | | | | | | |
Interest rate derivatives | | | (4 | ) | | | — | | | Interest expense | | | — | | | | — | | | | | | | | | | | |
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The pre-tax gain (loss) recognized in earnings on derivatives not designated as hedging instruments was as follows: |
| | Three Months Ended | | | | | | | | | | | | | | | | | | | | | |
| | March 31, | | | | | | | | | | | | | | | | | | | | | |
(in millions) | | 2015 | | | 2014 | | | | | | | | | | | | | | | | | | | | | |
Foreign exchange contracts(1) | | $ | (2 | ) | | $ | — | | | | | | | | | | | | | | | | | | | | | |
Interest rate derivatives(2) | | | — | | | | — | | | | | | | | | | | | | | | | | | | | | |
Total derivatives not designated as hedging instruments | | $ | (2 | ) | | $ | — | | | | | | | | | | | | | | | | | | | | | |
-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 $15 million of pre-tax unrealized gains related to its foreign exchange contracts and interest rate derivatives included in AOCI at March 31, 2015 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: |
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Level 1 — | Quoted prices in active markets for identical assets or liabilities. | | | | | | | | | | | | | | | | | | | | | | | | | | | |
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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. | | | | | | | | | | | | | | | | | | | | | | | | | | | |
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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 March 31, 2015 and December 31, 2014 due to the short-term nature of these instruments. At March 31, 2015 and December 31, 2014, the fair value of total debt approximated $3,992 million and $3,799 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: |
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| | Basis of Fair Value Measurements | | | | | | | | | | | | | |
| | 31-Mar-15 | | | | | | | | | | | | | |
(in millions) | | Level 1 | | | Level 2 | | | Level 3 | | | Total | | | | | | | | | | | | | |
Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Derivatives | | | — | | | | 28 | | | | — | | | | 28 | | | | | | | | | | | | | |
Total | | $ | — | | | $ | 28 | | | $ | — | | | $ | 28 | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Contingent consideration | | $ | — | | | $ | — | | | $ | 21 | | | $ | 21 | | | | | | | | | | | | | |
Derivatives | | | — | | | | 17 | | | | — | | | | 17 | | | | | | | | | | | | | |
Total | | $ | — | | | $ | 17 | | | $ | 21 | | | $ | 38 | | | | | | | | | | | | | |
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| | 31-Dec-14 | | | | | | | | | | | | | |
(in millions) | | Level 1 | | | Level 2 | | | Level 3 | | | Total | | | | | | | | | | | | | |
Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Derivatives | | | — | | | | 30 | | | | — | | | | 30 | | | | | | | | | | | | | |
Total | | $ | — | | | $ | 30 | | | $ | — | | | $ | 30 | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Contingent consideration | | $ | — | | | $ | — | | | $ | 24 | | | $ | 24 | | | | | | | | | | | | | |
Derivatives | | | — | | | | 18 | | | | — | | | | 18 | | | | | | | | | | | | | |
Total | | $ | — | | | $ | 18 | | | $ | 24 | | | $ | 42 | | | | | | | | | | | | | |
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. |
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(in millions) | | Contingent | | | | | | | | | | | | | | | | | | | | | | | | | |
Consideration | | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2014 | | $ | 24 | | | | | | | | | | | | | | | | | | | | | | | | | |
Cash payments | | | (1 | ) | | | | | | | | | | | | | | | | | | | | | | | | |
Changes in fair value estimates and foreign currency translation adjustments | | | (2 | ) | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at March 31, 2015 | | $ | 21 | | | | | | | | | | | | | | | | | | | | | | | | | |
Venezuelan Bolívars |
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. |
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, which the Company utilized to remeasure its Venezuelan Bolívar account balances beginning on June 30, 2014. In February 2015, the Venezuelan government announced that the SICAD II market would no longer be available, and a new foreign exchange market system ("SIMADI") was created. SIMADI has exchange rates significantly less favorable than SICAD II and at March 31, 2015, was approximately 193 Bolívars to one U.S. Dollar. As a result of the change to the SIMADI rate, the Company recorded a pre-tax charge of $7 million to foreign exchange loss within Other income (loss), net in the first quarter of 2015. The net assets held and revenue generated by the Company’s Venezuelan subsidiaries were not material to the Company’s consolidated results as of March 31, 2015. |