Financial Instruments
We utilize derivative financial instruments to manage exposure to certain risks related to our ongoing operations. The primary risks managed through the use of derivative instruments include interest rate risk, currency exchange risk and commodity price risk. We do not use derivative instruments for trading or speculative purposes. While the majority of our derivative instruments are designated as hedging instruments, we also enter into derivative instruments that are designed to hedge a risk, but are not designated as hedging instruments. These derivative instruments are adjusted to current fair value through earnings at the end of each period.
We are exposed to counterparty credit risk on all of our derivative instruments. Accordingly, we have established and maintain strict counterparty credit guidelines and enter into derivative instruments only with major financial institutions that are investment grade or better. We do not have significant exposure to any one counterparty and we believe the risk of loss is remote. Additionally, we do not require collateral under these agreements.
Interest Rate Risk Management
We are exposed to the impact of interest rate changes. Our objective is to manage the impact of interest rate changes on cash flows and the market value of our borrowings. We utilize a mix of debt maturities along with both fixed-rate and variable-rate debt to manage changes in interest rates. In addition, we enter into interest rate swaps to further manage our exposure to interest rate variations related to our borrowings and to lower our overall borrowing costs.
Currency Exchange Risk Management
We conduct business in several major international currencies and are subject to risks associated with changing foreign exchange rates. Our objective is to reduce earnings and cash flow volatility associated with foreign exchange rate changes to allow management to focus its attention on business operations. Accordingly, we enter into various contracts that change in value as foreign exchange rates change to protect the value of existing foreign currency assets and liabilities, commitments and anticipated foreign currency revenue and expenses.
Commodity Price Risk Management
We are exposed to changes in the price of certain commodities. Our objective is to reduce earnings and cash flow volatility associated with forecasted purchases of these commodities to allow management to focus its attention on business operations. Accordingly, we enter into derivative contracts to manage the price risk associated with these forecasted purchases.
The following table summarizes the fair value of our assets and liabilities related to derivatives designated as hedging instruments and the respective line items in which they were recorded in the consolidated balance sheets at June 30:
|
| | | | | | | |
(in millions) | 2013 | | 2012 |
Assets: | | | |
Foreign currency contracts (1) | $ | 4 |
| | $ | 2 |
|
Forward interest rate swaps (2) | 20 |
| | — |
|
Pay-floating interest rate swaps (2) | — |
| | 49 |
|
Total assets | $ | 24 |
| | $ | 51 |
|
| | | |
Liabilities: | | | |
Foreign currency contracts (3) | $ | 1 |
| | $ | 1 |
|
Commodity contracts (3) | — |
| | 1 |
|
Pay-floating interest rate swaps (4) | 11 |
| | — |
|
Total liabilities | $ | 12 |
| | $ | 2 |
|
| |
(1) | Included in prepaid expenses and other in the consolidated balance sheets. |
| |
(2) | Included in other assets in the consolidated balance sheets. |
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(3) | Included in other accrued liabilities in the consolidated balance sheets. |
| |
(4) | Included in deferred income taxes and other liabilities in the consolidated balance sheets. |
Fair Value Hedges
We enter into pay-floating interest rate swaps to hedge the changes in the fair value of fixed-rate debt resulting from fluctuations in interest rates. These contracts are designated and qualify as fair value hedges. Accordingly, the gain or loss recorded on the pay-floating interest rate swaps is directly offset by the change in fair value of the underlying debt. Both the derivative instrument and the underlying debt are adjusted to market value at the end of each period with any resulting gain or loss recorded in interest expense, net in the consolidated statements of earnings.
During fiscal 2013 and 2012, we entered into pay-floating interest rate swaps with total notional amounts of $775 million and $363 million. These swaps have been designated as fair value hedges of our fixed rate debt.
In September 2012 and August 2011, we terminated notional amounts of $350 million and $640 million of pay-floating interest rate swaps, respectively, and received net settlement proceeds of $43 million and $34 million, respectively. These swaps were previously designated as fair value hedges. There was no immediate impact to earnings; however, the fair value adjustment to debt is being amortized over the life of the underlying debt as a reduction to interest expense, net in the consolidated statements of earnings.
The following tables summarize the outstanding interest rate swaps designated as fair value hedges at June 30:
|
| | | | | | | |
| 2013 |
(in millions) | Notional Amount | | Maturity Date |
Pay-floating interest rate swaps | $ | 1,138 |
| | Jun 2015 | - | Jun 2022 |
|
| | | | | | | |
| 2012 |
(in millions) | Notional Amount | | Maturity Date |
Pay-floating interest rate swaps | $ | 773 |
| | Jun 2013 | - | Jun 2022 |
The following table summarizes the gain/(loss) recognized in earnings for interest rate swaps designated as fair value hedges:
|
| | | | | | | | | | | |
(in millions) | 2013 | | 2012 | | 2011 |
Pay-floating interest rate swaps (1) | $ | 28 |
| | $ | 38 |
| | $ | 36 |
|
Fixed-rate debt (1) | (28 | ) | | (38 | ) | | (36 | ) |
| |
(1) | Included in interest expense, net in the consolidated statements of earnings. |
There was no ineffectiveness associated with these derivative instruments.
Cash Flow Hedges
We enter into derivative instruments to hedge our exposure to changes in cash flows attributable to interest rate, foreign currency and commodity price fluctuations associated with certain forecasted transactions. These derivative instruments are designated and qualify as cash flow hedges. Accordingly, the effective portion of the gain or loss on the derivative instrument is reported as a component of OCI and reclassified into earnings in the same line item associated with the forecasted transaction and in the same period during which the hedged transaction affects earnings. The ineffective portion of the gain or loss on the derivative instrument is recognized in earnings immediately.
We enter into forward interest rate swaps to manage variability of expected future cash flows from changing interest rates. During fiscal 2013, we entered into forward interest rate swaps with total notional amount of $250 million to hedge probable, but not firmly committed, future transactions associated with our debt.
We enter into foreign currency contracts to protect the value of anticipated foreign currency revenues and expenses. At June 30, 2013 and 2012, we held contracts to hedge probable, but not firmly committed, revenue and expenses. The principal currencies hedged are the Canadian dollar, Japanese yen, Mexican peso, European euro and Thai baht.
We enter into commodity contracts to manage the price risk associated with forecasted purchases of certain commodities used in our Medical segment.
The following tables summarize the outstanding cash flow hedges at June 30:
|
| | | | | | | |
| 2013 |
(in millions) | Notional Amount | | Maturity Date |
Forward interest rate swaps | $ | 250 |
| | Jun 2025 |
Foreign currency contracts | 164 |
| | Jul 2013 | - | Jun 2014 |
Commodity contracts | 24 |
| | Jul 2013 | - | Mar 2016 |
|
| | | | | | | |
| 2012 |
(in millions) | Notional Amount | | Maturity Date |
Foreign currency contracts | $ | 158 |
| | Jul 2012 | - | Jun 2013 |
Commodity contracts | 23 |
| | Jul 2012 | - | Mar 2015 |
The following table summarizes the gain/(loss) included in AOCI for derivative instruments designated as cash flow hedges at June 30:
|
| | | | | | | |
(in millions) | 2013 | | 2012 |
Forward interest rate swaps | $ | 20 |
| | $ | — |
|
Foreign currency contracts | 3 |
| | — |
|
Commodity contracts | — |
| | (1 | ) |
The following table summarizes the gain/(loss) reclassified from AOCI into earnings for derivative instruments designated as cash flow hedges:
|
| | | | | | | | | | | |
(in millions) | 2013 | | 2012 | | 2011 |
Foreign currency contracts (1) | $ | 1 |
| | $ | 1 |
| | $ | — |
|
Foreign currency contracts (2) | 1 |
| | (1 | ) | | (3 | ) |
Foreign currency contracts (3) | 1 |
| | (1 | ) | | 3 |
|
Commodity contracts (3) | 1 |
| | 2 |
| | 2 |
|
Forward interest rate swaps (4) | 1 |
| | — |
| | — |
|
| |
(1) | Included in revenue in the consolidated statements of earnings. |
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(2) | Included in cost of products sold in the consolidated statements of earnings. |
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(3) | Included in SG&A expenses in the consolidated statements of earnings. |
| |
(4) | Included in interest expense, net in the consolidated statements of earnings. |
The amount of ineffectiveness associated with these derivative instruments was not material for all periods presented.
Economic (Non-Designated) Hedges
We enter into foreign currency contracts to manage our foreign exchange exposure related to intercompany financing transactions and other balance sheet items subject to revaluation that do not meet the requirements for hedge accounting treatment. Accordingly, these derivative instruments are adjusted to current market value at the end of each period through earnings. The gain or loss recorded on these instruments is substantially offset by the remeasurement adjustment on the foreign currency denominated asset or liability. The settlement of the derivative instrument and the remeasurement adjustment on the foreign currency denominated asset or liability are both recorded in other (income)/expense, net at the end of each period.
The following tables summarize the outstanding economic (non-designated) derivative instruments at June 30:
|
| | | | | | | |
| 2013 |
(in millions) | Notional Amount | | Maturity Date |
Foreign currency contracts | $ | 479 |
| | Jul 2013 | - | Sep 2013 |
|
| | | | | | | |
| 2012 |
(in millions) | Notional Amount | | Maturity Date |
Foreign currency contracts | $ | 500 |
| | Jul 2012 | - | Sep 2012 |
During fiscal 2011, we entered into swap contracts of certain commodities to mitigate price volatility for materials we purchased or used in our manufacturing and distribution businesses. These instruments did not qualify for hedge accounting and as such fair value changes as well as periodic settlements of these contracts were recorded in other income, net in the consolidated statements of earnings. These instruments matured in the same fiscal year.
The following table summarizes the gain/(loss) recognized in earnings for economic (non-designated) derivative instruments:
|
| | | | | | | | | | | |
(in millions) | 2013 | | 2012 | | 2011 |
Foreign currency contracts (1) | $ | 6 |
| | $ | (39 | ) | | $ | 36 |
|
Commodity contracts (1) | — |
| | (1 | ) | | (1 | ) |
| |
(1) | Included in other income, net in the consolidated statements of earnings. |
Fair Value of Financial Instruments
The carrying amounts of cash and equivalents, trade receivables, net, accounts payable and other accrued liabilities at June 30, 2013 and 2012 approximate fair value due to their short-term maturities.
Cash balances are invested in accordance with our investment policy. These investments are exposed to market risk from interest rate fluctuations and credit risk from the underlying issuers, although this is mitigated through diversification.
We held investments in fixed income corporate debt securities at June 30, 2012, which were classified as held-to-maturity as we had the intent and ability to hold these investments until maturity. These investments were held at amortized cost, which approximated fair value. The fair value was estimated based on either the quoted market prices for the same or similar issues or other inputs derived from available market information, which represented a Level 2 measurement. We held $72 million of these investments at June 30, 2012, which were included within prepaid expenses and other in the consolidated balance sheets and matured during fiscal 2013.
The following table summarizes the estimated fair value of our long-term obligations and other short-term borrowings compared to the respective carrying amounts at June 30:
|
| | | | | | | |
(in millions) | 2013 | | 2012 |
Estimated fair value | $ | 3,899 |
| | $ | 3,075 |
|
Carrying amount | 3,854 |
| | 2,894 |
|
The fair value of our long-term obligations and other short-term borrowings is estimated based on either the quoted market prices for the same or similar issues or other inputs derived from available market information, which represents a Level 2 measurement.
The following table is a summary of the fair value gain/(loss) of our derivative instruments, based upon the estimated amount that we would receive (or pay) to terminate the contracts at June 30:
|
| | | | | | | | | | | | | | | |
| 2013 | | 2012 |
(in millions) | Notional Amount | | Fair Value
Gain/(Loss) | | Notional Amount | | Fair Value
Gain/(Loss) |
Pay-floating interest rate swaps | $ | 1,138 |
| | $ | (11 | ) | | $ | 773 |
| | $ | 49 |
|
Foreign currency contracts | 643 |
| | 3 |
| | 658 |
| | 1 |
|
Forward interest rate swaps | 250 |
| | 20 |
| | — |
| | — |
|
Commodity contracts | 24 |
| | — |
| | 23 |
| | (1 | ) |
The fair values are based on quoted market prices for the same or similar instruments, which represents a Level 2 measurement. See Note 10 for further information regarding fair value measurements.
