Derivative Financial Instruments and Hedging Activities

9 Months Ended

Sep. 28, 2014

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Financial Instruments and Hedging Activities

The Company operates internationally, with manufacturing and sales facilities in various locations around the world, and utilizes certain derivative financial instruments to manage its foreign currency, debt and interest rate exposures. At September 28, 2014, the Company had outstanding currency exchange, interest rate, and cross-currency swap derivative contracts with notional amounts of $2.7 billion, $9.0 billion and $8.3 billion respectively. At December 29, 2013, the Company had outstanding currency exchange, interest rate, and cross-currency swap derivative contracts with notional amounts of $2.5 billion, $9.0 billion and $8.3 billion, respectively.

The following table presents the fair values and corresponding balance sheet captions of the Company’s derivative instruments as of September 28, 2014 and December 29, 2013:



	September 28, 2014						December 29, 2013
	Foreign Exchange Contracts		Interest Rate Contracts		Cross-Currency Swap Contracts		Foreign Exchange Contracts		Interest Rate Contracts		Cross-Currency Swap Contracts
	(In thousands)
Assets:
Derivatives designated as hedging instruments:
Other receivables, net	$	24,828	$	—	$	—	$	37,072	$	—	$	—
Other non-current assets	2,905		87,508		79,563		4,129		265,390		31,303
	27,733		87,508		79,563		41,201		265,390		31,303
Derivatives not designated as hedging instruments:
Other receivables, net	89,217		—		—		8,771		—		—
Other non-current assets	—		—		—		—		—		—
	89,217		—		—		8,771		—		—
Total assets⁽¹⁾	$	116,950	$	87,508	$	79,563	$	49,972	$	265,390	$	31,303
Liabilities:
Derivatives designated as hedging instruments:
Other payables	$	25,331	$	—	$	—	$	5,251	$	—	$	—
Other non-current liabilities	3,553		—		94,384		—		—		221,899
	28,884		—		94,384		5,251		—		221,899
Derivatives not designated as hedging instruments:
Other payables	2,169		—		—		10,286		—		—
Other non-current liabilities	—		—		—		—		—		—
Total liabilities⁽¹⁾	$	31,053	$	—	$	94,384	$	15,537	$	—	$	221,899

_______________________________________

(1)

The Company’s derivative financial instruments are subject to master netting arrangements that allow for the offset of asset and liabilities in the event of default or early termination of the contract. The Company elects to record the gross assets and liabilities of its derivative financial instruments in the condensed consolidated balance sheets. If the derivative financial instruments had been netted in the condensed consolidated balance sheets, the asset and liability positions each would have been reduced by $125.4 million and $237.4 million at September 28, 2014 and December 29, 2013, respectively. No material amounts of collateral were received or posted on the Company’s derivative assets and liabilities as of September 28, 2014.

Refer to Note 15 for further information on how fair value is determined for the Company’s derivatives.

The following table presents the pre-tax effect of derivative instruments on the condensed consolidated statements of operations for the periods presented:



	Successor
	June 30 - September 28, 2014							June 24 - September 22, 2013
	Foreign Exchange Contracts			Interest Rate Contracts		Cross-Currency Swap Contracts		Foreign Exchange Contracts			Interest Rate Contracts			Cross-Currency Swap Contracts
	(In thousands)
Cash flow hedges:
Gains/(losses) recognized in other comprehensive income (effective portion)	$	7,836		$	29,925	$	—	$	10,315		$	(13,201	)	$	—

Net investment hedges:
Gains/(losses) recognized in other comprehensive income (effective portion)	—			—		434,616		—			—			—
Total gains/(losses) recognized in other comprehensive income (effective portion)	$	7,836		$	29,925	$	434,616	$	10,315		$	(13,201	)	$	—

Cash flow hedges:
Sales	$	(624	)	$	—	$	—	$	125		$	—		$	—
Cost of products sold	(1,558		)	—		—		650			—			—
Selling, general and administrative expenses	—			—		—		(19		)	—			—
Other expense, net	148			—		—		672			—			—
Interest expense	—			—		—		—			40			—
	(2,034		)	—		—		1,428			40			—

Fair value hedges:
Gains/(losses) recognized in other expense, net	—			—		—		—			—			—

Derivatives not designated as hedging instruments:
Unrealized gains/(losses) on derivative instruments	—			—		—		—			—			—
Gains/(losses) recognized in other expense, net	99,411			—		—		36,353			—			—
Gains/(losses) recognized in interest income	—			—		—		—			—			—
	99,411			—		—		36,353			—			—
Total gains/(losses) recognized in statement of operations	$	97,377		$	—	$	—	$	37,781		$	40		$	—



	Successor																Predecessor
	December 30, 2013 - September 28, 2014								February 8 - September 22, 2013								December 24, 2012 - June 7, 2013
	Foreign Exchange Contracts			Interest Rate Contracts			Cross-Currency Swap Contracts		Foreign Exchange Contracts			Interest Rate Contracts			Cross-Currency Swap Contracts		Foreign Exchange Contracts			Interest Rate Contracts			Cross-Currency Interest Rate Swap Contracts
	(In thousands)
Cash flow hedges:
Gains/(losses) recognized in other comprehensive income (effective portion)	$	(22,017	)	$	(177,882	)	$	—	$	17,881		$	141,547		$	—	$	39,351		$	—		$	(57,558	)

Net investment hedges:
Gains/(losses) recognized in other comprehensive income (effective portion)	—			—			175,776		—			—			—		—			—			—
Total gains/(losses) recognized in other comprehensive income (effective portion)	$	(22,017	)	$	(177,882	)	$	175,776	$	17,881		$	141,547		$	—	$	39,351		$	—		$	(57,558	)

Cash flow hedges:
Sales	$	(967	)	$	—		$	—	$	125		$	—		$	—	$	4,836		$	—		$	—
Cost of products sold	7,207			—			—		650			—			—		4,695			—			—
Selling, general and administrative expenses	(125		)	—			—		(19		)	—			—		—			—			—
Other expense, net	966			—			—		672			—			—		9,761			—			(52,447		)
Interest expense	6			—			—		—			40			—		230			(98		)	(11,765		)
	7,087			—			—		1,428			40			—		19,522			(98		)	(64,212		)

Fair value hedges:
Gains/(losses) recognized in other expense, net	—			—			—		—			(180		)	—		—			(8,065		)	—

Derivatives not designated as hedging instruments:
Unrealized gains/(losses) on derivative instruments	—			—			—		—			117,934			—		—			—			—
Gains/(losses) recognized in other expense, net	98,815			—			—		36,434			—			—		(2,922		)	—			—
Gains/(losses) recognized in interest income	—			—			—		—			—			—		—			(10,512		)	—
	98,815			—			—		36,434			117,934			—		(2,922		)	(10,512		)	—
Total gains/(losses) recognized in statement of operations	$	105,902		$	—		$	—	$	37,862		$	117,794		$	—	$	16,600		$	(18,675	)	$	(64,212	)

Foreign Currency Hedging:

The Company uses forward contracts and, to a lesser extent, option contracts to mitigate its foreign currency exchange rate exposure due to forecasted purchases of raw materials and sales of finished goods, and future settlement of foreign currency denominated assets and liabilities. The Company’s principal foreign currency exposures that are hedged include the Australian dollar, British pound sterling, Canadian dollar, euro, and the New Zealand dollar. Derivatives used to hedge forecasted transactions and specific cash flows associated with foreign currency denominated financial assets and liabilities that meet the criteria for hedge accounting are designated as cash flow hedges. Consequently, the effective portion of gains and losses is deferred as a component of accumulated other comprehensive loss and is recognized in earnings at the time the hedged item affects earnings, in the same line item as the underlying hedged item.

Interest Rate Hedging:

The Company uses interest rate swaps to manage debt and interest rate exposures. The Company is exposed to interest rate volatility with regard to existing and future issuances of fixed and floating rate debt. Primary exposures include U.S. Treasury rates and London Interbank Offered Rates (LIBOR). Derivatives used to hedge risk associated with changes in the fair value of certain fixed-rate debt obligations are primarily designated as fair value hedges. Consequently, changes in the fair value of these derivatives, along with changes in the fair value of the hedged debt obligations that are attributable to the hedged risk, are recognized in current period earnings.

The Company also entered into cross-currency interest rate swaps which were designated as cash flow hedges of the future payments of loan principal and interest associated with certain foreign denominated variable rate debt obligations. As a result of the merger, these contracts were terminated in May 2013.

Prior to the Merger date, Merger Subsidiary entered into interest rate swaps to mitigate exposure to variable rate debt that was raised to finance the acquisition. These agreements were not designated as hedging instruments prior to the acquisition date, and as such, we recognized the fair value of these instruments as an asset with gains recognized in income. As a result of the Merger and the transactions entered into in connection therewith, we have assumed the liabilities and obligations of Merger Subsidiary. Upon consummation of the acquisition, these interest rate swaps with an aggregate notional amount of $9.0 billion met the criteria for hedge accounting and were designated as hedges of future interest payments.

Deferred Hedging Gains and Losses:

As of September 28, 2014, the Company is hedging forecasted transactions for periods not exceeding 2 years. During the next 12 months, the Company expects $8.4 million of net deferred losses reported in accumulated other comprehensive loss to be reclassified to earnings, assuming market rates remain constant through contract maturities. Hedge ineffectiveness related to cash flow hedges, as well as reclassifications to earnings due to hedged transactions no longer expected to occur, which is reported in current period earnings as other income/(expense), net, was not significant for the third quarters of 2014 and 2013, respectively.

Hedges of Net Investments in Foreign Operations:

We have numerous investments in our foreign subsidiaries, the net assets of which are exposed to volatility in foreign currency exchange rates. Beginning in October 2013, we have used cross currency swaps to hedge a portion of our net investment in such foreign operations against adverse movements in exchange rates. We designated cross currency swap contracts between the pound sterling and USD, the euro and USD, the Australian dollar and USD, and the Japanese yen and USD, as net investment hedges of a portion of our equity in foreign operations in those currencies. The component of the gains and losses on our net investment in these designated foreign operations, driven by changes in foreign exchange rates, are economically offset by movements in the fair values of our cross currency swap contracts. The fair value of the swaps is calculated each period with changes in fair value reported in foreign currency translation adjustments within accumulated other comprehensive income (loss), net of tax. Such amounts will remain in other comprehensive income (loss) until the complete or substantially complete liquidation of our investment in the underlying foreign operations.

In relation to the cross currency swaps:

•We pay 6.462% per annum on the pound sterling notional amount of £2.795 billion and receive 6.15% per annum on the USD notional amount of $4.50 billion on each January 8, April 8, July 8 and October 8, through the maturity date of the swap, which was also expected to be on October 8, 2019.

•We pay 5.696% per annum on the Euro notional amount of €2.21 billion and receive 6.15% per annum on the USD notional amount of $3 billion on each January 9, April 9, July 9 and October 9, through the maturity date of the swap, which was also expected to be on October 9, 2019.

•We pay 9.164% per annum on the Australian dollar notional amount of A$793.8 million and receive 6.15% per annum on the USD notional amount of $750 million on each January 10, April 10, July 10 and October 10, through the maturity date of the swap, which was also expected to be on October 10, 2019.

•We pay 4.104% per annum on the Japanese yen notional amount of ¥4,854.5 billion and receive 6.15% per annum on the USD notional amount of $50 million on each January 11, April 11, July 11 and October 11, through the maturity date of the swap, which was also expected to be on October 11, 2019.

The net amounts paid or received on a quarterly basis are recorded in Other expense, net, in the condensed consolidated statements of operations. The Company paid net amounts of $2.7 million and $18.0 million related to cross currency swaps for the three and nine months ended September 28, 2014, respectively.

Other Activities:

The Company enters into certain derivative contracts in accordance with its risk management strategy that do not meet the criteria for hedge accounting but which have the economic impact of largely mitigating foreign currency or interest rate exposures. The Company maintained foreign currency forward contracts with a total notional amount of $1.6 billion and $1.0 billion that did not meet the criteria for hedge accounting as of September 28, 2014 and December 29, 2013, respectively. These forward contracts are accounted for on a full mark-to-market basis through current earnings, with gains and losses recorded as a component of other income/(expense), net. Net unrealized gains/(losses) related to outstanding contracts totaled $87.0 million and $(1.3) million as of September 28, 2014 and December 29, 2013, respectively. These contracts are scheduled to mature within one year.

Concentration of Credit Risk:

Counterparties to currency exchange and interest rate derivatives consist of major international financial institutions. The Company continually monitors its positions and the credit ratings of the counterparties involved and, by policy, limits the amount of credit exposure to any one party. While the Company may be exposed to potential losses due to the credit risk of non-performance by these counterparties, losses are not anticipated. The Company closely monitors the credit risk associated with its counterparties and customers and to date has not experienced material losses.

- Definition

The entire disclosure for derivative instruments and hedging activities including, but not limited to, risk management strategies, non-hedging derivative instruments, assets, liabilities, revenue and expenses, and methodologies and assumptions used in determining the amounts.

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+ Details

H. J. Heinz Corp II 10-Q