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DERIVATIVES AND RISK MANAGEMENT | 6 Months Ended
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Jul. 04, 2015
DERIVATIVES AND RISK MANAGEMENT |
DERIVATIVES AND RISK MANAGEMENT | 10. DERIVATIVES AND RISK MANAGEMENT Cash Flow Hedges. The primary risks managed by using derivative instruments are the fluctuations in global currencies that will ultimately be used by non-U.S. dollar functional currency subsidiaries to settle future payments of intercompany inventory transactions denominated in U.S. dollars. Specifically, the Company projects future intercompany purchases by its non-U.S. dollar functional currency subsidiaries generally over a period of up to 24 months. The Company enters into foreign currency forward contracts (“forward contracts”) generally for up to 85% of the forecasted purchases to manage fluctuations in global currencies that will ultimately be used to settle such U.S. dollar denominated inventory purchases. Forward contracts represent agreements to exchange the currency of one country for the currency of another country at an agreed-upon settlement date and exchange rate. These forward contracts are designated as single cash flow hedges. Fluctuations in exchange rates will either increase or decrease the Company’s U.S. dollar equivalent cash flows from these intercompany inventory transactions, which will affect the Company’s U.S. dollar earnings. Gains or losses on the forward contracts are expected to offset these fluctuations to the extent the cash flows are hedged by the forward contracts. These forward contracts meet the criteria for hedge accounting, which requires that they represent foreign-currency-denominated forecasted inter-entity transactions in which (i) the operating unit that has the foreign currency exposure is a party to the hedging instrument and (ii) the hedged transaction is denominated in a currency other than the hedging unit’s functional currency. At the inception of each forward contract designated as a cash flow hedge, the hedging relationship is expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk. The Company assesses hedge effectiveness under the critical terms matched method at inception and at least quarterly throughout the life of the hedging relationship. If the critical terms (i.e., amounts, currencies and settlement dates) of the forward contract match the terms of the forecasted transaction, the Company concludes that the hedge is effective. For a derivative instrument that is designated and qualifies as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income (loss), net of taxes and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, the Company’s hedges resulted in no ineffectiveness in the condensed consolidated statements of income and comprehensive income, and there were no components excluded from the assessment of hedge effectiveness for the Second Quarter, Prior Year Quarter, Year To Date Period or Prior Year YTD Period. All derivative instruments are recognized as either assets or liabilities at fair value in the condensed consolidated balance sheets. Derivatives designated as cash flow hedges are recorded at fair value at each balance sheet date and the change in fair value is recorded to accumulated other comprehensive income (loss) within the equity section of the Company’s condensed consolidated balance sheet until such derivative’s gains or losses become realized or the cash flow hedge relationship is terminated. If the cash flow hedge relationship is terminated, the derivative’s gains or losses that are recorded in accumulated other comprehensive income (loss) will be recognized in earnings when the hedged cash flows occur. However, for cash flow hedges that are terminated because the forecasted transaction is not expected to occur in the original specified time period, the derivative’s gains or losses are immediately recognized in earnings. There were no gains or losses reclassified into earnings as a result of the discontinuance of cash flow hedges in the Second Quarter, Prior Year Quarter, Year To Date Period or Prior Year YTD Period. Hedge accounting is discontinued if it is determined that the derivative is not highly effective. The Company records all forward contract hedge assets and liabilities on a gross basis as they do not meet the balance sheet netting criteria because the Company does not have master netting agreements established with the derivative counterparties that would allow for net settlement. As of July 4, 2015, the Company had the following outstanding forward contracts designated as cash flow hedges that were entered into to hedge the future payments of intercompany inventory transactions (in millions):
Functional Currency |  | Contract Currency |
Type |  | Amount |  | Type |  | Amount |
Euro |  | 209.3 |  | U.S. dollar |  | 250.2 |
British pound |  | 41.9 |  | U.S. dollar |  | 65.9 |
Canadian dollar |  | 51.5 |  | U.S. dollar |  | 42.9 |
Japanese yen |  | 3,788.1 |  | U.S. dollar |  | 32.7 |
Mexican peso |  | 306.6 |  | U.S. dollar |  | 19.9 |
Australian dollar |  | 19.0 |  | U.S. dollar |  | 14.7 |
The Company is also exposed to interest rate risk related to its outstanding debt. To manage the interest rate risk related to its $231.3 million U.S.-based term loan, as amended and restated on March 9, 2015 (“Term Loan”), the Company entered into an interest rate swap agreement on July 26, 2013 with a term of approximately five years. The objective of this hedge is to offset the variability of future payments associated with interest rates on the Term Loan. The interest rate swap agreement hedges the 1-month London Interbank Offer Rate (“LIBOR”) based variable rate debt obligations under the Term Loan. Under the terms of the swap, the Company pays a fixed interest rate of 1.288% per annum to the swap counterparty plus the LIBOR rate applicable margin (which varies based upon the Company’s consolidated leverage ratio (the “Ratio”) from 1.25% if the Ratio is less than 1.00 to 1.00, to 2.00% if the Ratio is greater than or equal to 2.00 to 1.00). The notional amount will amortize over the remaining life of the Term Loan to coincide with the amortization of the underlying loan. The Company will receive interest from the swap counterparty at a variable rate based on 1-month LIBOR. This hedge is designated as a cash flow hedge. Additionally, to manage interest rate risk related to forecasted debt issuances, the Company entered into a forward starting interest rate swap agreement on March 20, 2015 with a term of approximately 10 years. The objective of this hedge was to offset the variability of future interest payments associated with forecasted debt issuances. The forecasted debt issuances did not occur, and in May 2015, the Company entered into an agreement to offset and unwind the forward starting interest rate swap. As a result of this transaction, a gain of $3.3 million net of taxes was reclassed out of accumulated other comprehensive income (loss) to other income (expense). Net Investment Hedge. The Company is also exposed to risk that adverse changes in foreign currency exchange rates could impact its net investment in foreign operations. To manage this risk, during the first quarter of fiscal year 2014, the Company entered into a forward contract designated as a net investment hedge to reduce exposure to changes in currency exchange rates on €25.0 million of its total investment in a wholly-owned euro-denominated foreign subsidiary. The hedge was settled in the Prior Year Quarter. The effective portion of derivatives designated as net investment hedges are recorded at fair value at each balance sheet date and the change in fair value is recorded as a component of other comprehensive income (loss) in the Company’s condensed consolidated statements of income and comprehensive income. The Company uses the hypothetical derivative method to assess the ineffectiveness of net investment hedges. Should any portion of a net investment hedge become ineffective, the ineffective portion will be reclassified to other income-net on the Company’s condensed consolidated statements of income and comprehensive income. Gains and losses reported in accumulated other comprehensive income (loss) will not be reclassified into earnings until the Company’s underlying investment is liquidated or dissolved. Non-designated Hedges. The Company also periodically enters into forward contracts to manage exchange rate risks associated with certain non-inventory intercompany transactions and to which the Company does not elect hedge treatment. As of July 4, 2015, the Company had approximately $0.1 million in assets of outstanding forward exchange contracts acquired as part of the SKWG Acquisition, for which the Company did not elect hedge treatment. As of January 3, 2015, all of the Company’s outstanding forward contracts were designated as hedging instruments. Changes in the fair value of derivatives not designated as hedging instruments are recognized in earnings when they occur. The effective portion of gains and losses on derivative instruments that were recognized in other comprehensive income (loss), net of taxes during the Second Quarter, Prior Year Quarter, Year To Date Period and Prior Year YTD Period are set forth below (in thousands):
|  | For the 13 |  | For the 13 |
|  | Weeks Ended |  | Weeks Ended |
|  | July 4, 2015 |  | July 5, 2014 |
Cash flow hedges: |  |  |  |  |
Forward contracts |  | $ | 2,954 |  | $ | (1,639 | )
Interest rate swaps |  | 6,648 |  | (579 | )
Net investment hedge: |  |  |  |  |
Forward contract |  | 0 |  | 95 |
Total gain (loss) recognized in other comprehensive income (loss), net of taxes |  | $ | 9,602 |  | $ | (2,123 | )
|  | For the 26 |  | For the 27 |
|  | Weeks Ended |  | Weeks Ended |
|  | July 4, 2015 |  | July 5, 2014 |
Cash flow hedges: |  |  |  |  |
Forward contracts |  | $ | 15,497 |  | $ | (1,987 | )
Interest rate swaps |  | 1,941 |  | (1,117 | )
Net investment hedge: |  |  |  |  |
Forward contract |  | 0 |  | 257 |
Total gain (loss) recognized in other comprehensive income (loss), net of taxes |  | $ | 17,438 |  | $ | (2,847 | )
The following table illustrates the effective portion of gains and losses on derivative instruments recorded in other comprehensive income (loss), net of taxes during the term of the hedging relationship and reclassified into earnings, and gains and losses on derivatives not designated as hedging instruments recorded directly to earnings during the Second Quarter, Prior Year Quarter, Year To Date Period and Prior Year YTD Period (in thousands):
|  | Condensed Consolidated |  |  |  |  |  |  |
|  | Statements of Income |  |  |  | For the 13 |  | For the 13 |
|  | and Comprehensive |  | Effect of Derivative |  | Weeks Ended |  | Weeks Ended |
Derivative Instruments |  | Income Location |  | Instruments |  | July 4, 2015 |  | July 5, 2014 |
Forward contracts designated as cash flow hedging instruments |  | Other income (expense)-net |  | Total gain (loss) reclassified from other comprehensive income (loss) |  | $ | 6,921 |  | $ | (1,033 | )
Forward contracts not designated as hedging instruments |  | Other income (expense)-net |  | Total gain (loss) recognized in income |  | $ | (9 | ) | 0 |
Interest rate swap designated as a cash flow hedging instrument |  | Interest expense |  | Total gain (loss) reclassified from other comprehensive income (loss) |  | $ | (404 | ) | $ | (439 | )
Interest rate swap designated as a cash flow hedging instrument |  | Other income (expense)-net |  | Total gain (loss) reclassified from other comprehensive income (loss) |  | $ | 3,331 |  | 0 |
|  | Condensed Consolidated |  |  |  |  |  |  |
|  | Statements of Income |  |  |  | For the 26 |  | For the 27 |
|  | and Comprehensive |  | Effect of Derivative |  | Weeks Ended |  | Weeks Ended |
Derivative Instruments |  | Income Location |  | Instruments |  | July 4, 2015 |  | July 5, 2014 |
Forward contracts designated as cash flow hedging instruments |  | Other income (expense)-net |  | Total gain (loss) reclassified from other comprehensive income (loss) |  | $ | 15,129 |  | $ | (1,531 | )
Forward contracts not designated as hedging instruments |  | Other income (expense)-net |  | Total gain (loss) recognized in income |  | $ | 80 |  | $ | (148 | )
Interest rate swap designated as a cash flow hedging instrument |  | Interest expense |  | Total gain (loss) reclassified from other comprehensive income (loss) |  | $ | (837 | ) | $ | (904 | )
Interest rate swap designated as a cash flow hedging instrument |  | Other income (expense)-net |  | Total gain (loss) reclassified from other comprehensive income (loss) |  | $ | 3,331 |  | 0 |
The following table discloses the fair value amounts for the Company’s derivative instruments as separate asset and liability values, presents the fair value of derivative instruments on a gross basis, and identifies the line items in the condensed consolidated balance sheets in which the fair value amounts for these categories of derivative instruments are included (in thousands):
|  | Asset Derivatives |  | Liability Derivatives |
|  | July 4, 2015 |  | January 3, 2015 |  | July 4, 2015 |  | January 3, 2015 |
|  | Condensed |  |  |  | Condensed |  |  |  | Condensed |  |  |  | Condensed |  |  |
|  | Consolidated |  |  |  | Consolidated |  |  |  | Consolidated |  |  |  | Consolidated |  |  |
|  | Balance Sheets |  | Fair |  | Balance Sheets |  | Fair |  | Balance Sheets |  | Fair |  | Balance Sheets |  | Fair |
Derivative Instruments |  | Location |  | Value |  | Location |  | Value |  | Location |  | Value |  | Location |  | Value |
Forward contracts designated as cash flow hedging instruments |  | Prepaid expenses and other current assets |  | $ | 22,887 |  | Prepaid expenses and other current assets |  | $ | 25,867 |  | Accrued expenses- other |  | $ | 1,021 |  | Accrued expenses- other |  | $ | 0 |
Forward contracts not designated as cash flow hedging instruments |  | Prepaid expenses and other current assets |  | 123 |  | Prepaid expenses and other current assets |  | 0 |  | Accrued expenses- other |  | 0 |  | Accrued expenses- other |  | 0 |
Interest rate swap designated as a cash flow hedging instrument |  | Prepaid expenses and other current assets |  | 0 |  | Prepaid expenses and other current assets |  | 0 |  | Accrued expenses- other |  | 1,991 |  | Accrued expenses- other |  | 2,157 |
Forward contracts designated as cash flow hedging instruments |  | Intangible and other assets-net |  | 664 |  | Intangible and other assets-net |  | 1,802 |  | Other long-term liabilities |  | 246 |  | Other long-term liabilities |  | 0 |
Interest rate swap designated as a cash flow hedging instrument |  | Intangible and other assets-net |  | 743 |  | Intangible and other assets-net |  | 1,724 |  | Other long-term liabilities |  | 412 |  | Other long-term liabilities |  | 357 |
Total |  |  |  | $ | 24,417 |  |  |  | $ | 29,393 |  |  |  | $ | 3,670 |  |  |  | $ | 2,514 |
At the end of the Second Quarter, the Company had forward contracts with maturities extending through June 2017. As of July 4, 2015, an estimated net gain of $14.3 million is expected to be reclassified into earnings within the next twelve months at prevailing foreign currency exchange rates. See “Note 1—Financial Statement Policies” for additional disclosures on foreign currency hedging instruments.

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