DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company selectively uses derivative instruments to reduce market risk associated with changes in foreign currency, commodities, stock-based compensation liabilities and interest rates. Under Company policy, the use of derivatives is restricted to those intended for hedging purposes; the use of any derivative instrument for speculative purposes is strictly prohibited. A description of each type of derivative utilized by the Company to manage risk is included in the following paragraphs. In addition, refer to Note 11, “Fair Value Measurements,” of the notes to consolidated financial statements for information related to the fair value measurements and valuation methods utilized by the Company for each derivative type.
The Company has global operations and participates in the foreign exchange markets to minimize its risk of loss from fluctuations in foreign currency exchange rates. The Company primarily uses foreign currency exchange contracts to hedge certain of its foreign exchange rate exposures. The Company hedges 70% to 90% of the nominal amount of each of its known foreign exchange transactional exposures.
The Company has entered into cross-currency interest rate swaps to selectively hedge portions of its net investment in Japan. The currency effects of the cross-currency interest rate swaps are reflected in the accumulated other comprehensive income (AOCI) account within shareholders’ equity attributable to Johnson Controls, Inc. where they offset gains and losses recorded on the Company’s net investment in Japan. At September 30, 2013 the Company had five cross-currency interest rate swaps outstanding totaling 25 billion yen. At September 30, 2012, the Company had three cross-currency interest rate swaps outstanding totaling 20 billion yen.
The Company uses commodity contracts in the financial derivatives market in cases where commodity price risk cannot be naturally offset or hedged through supply base fixed price contracts. Commodity risks are systematically managed pursuant to policy guidelines. As cash flow hedges, the effective portion of the hedge gains or losses due to changes in fair value are initially recorded as a component of AOCI and are subsequently reclassified into earnings when the hedged transactions, typically sales or costs related to sales, occur and affect earnings. Any ineffective portion of the hedge is reflected in the consolidated statements of income. The maturities of the commodity contracts coincide with the expected purchase of the commodities. The Company had the following outstanding commodity hedge contracts that hedge forecasted purchases:
|
| | | | | | | | |
| | | | Volume Outstanding as of |
Commodity | | Units | | September 30, 2013 | | September 30, 2012 |
Copper | | Pounds | | 14,705,000 |
| | 13,135,000 |
|
Lead | | Metric Tons | | 23,900 |
| | 21,200 |
|
Aluminum | | Metric Tons | | 2,709 |
| | 2,868 |
|
Tin | | Metric Tons | | 2,052 |
| | 1,344 |
|
The Company selectively uses equity swaps to reduce market risk associated with certain of its stock-based compensation plans, such as its deferred compensation plans. These equity compensation liabilities increase as the Company’s stock price increases and decrease as the Company’s stock price decreases. In contrast, the value of the swap agreement moves in the opposite direction of these liabilities, allowing the Company to fix a portion of the liabilities at a stated amount. As of September 30, 2013 and 2012, the Company had hedged approximately 4.4 million and 4.5 million shares of its common stock, respectively.
The Company selectively uses interest rate swaps to reduce market risk associated with changes in interest rates for its fixed-rate notes. As fair value hedges, the interest rate swaps and related debt balances are valued under a market approach using publicized swap curves. Changes in the fair value of the swap and hedged portion of the debt are recorded in the consolidated statements of income. In the second quarter of fiscal 2011, the Company entered into a fixed to floating interest rate swap totaling $100 million to hedge the coupon of its 5.8% notes which matured on November 15, 2012, two fixed to floating interest rate swaps totaling $300 million to hedge the coupon of its 4.875% notes which matured on September 15, 2013 and five fixed to floating interest rate swaps totaling $450 million to hedge the coupon of its 1.75% notes maturing March 1, 2014. In the fourth quarter of fiscal 2013, the Company entered into a fixed to floating interest rate swap totaling approximately $125 million to hedge the coupon of its 7.70% notes maturing March 1, 2015. Additionally, in the fourth quarter of fiscal 2013, the Company entered into four fixed to floating interest rate swaps totaling $800 million to hedge the coupon of its 5.50% notes maturing January 15, 2016. There were ten interest rate swaps outstanding as of September 30, 2013 and eight interest rate swaps outstanding as of September 30, 2012.
In September 2005, the Company entered into three forward treasury lock agreements to reduce the market risk associated with changes in interest rates associated with the Company’s anticipated fixed-rate note issuance to finance the acquisition of York International Corp. (cash flow hedge). The three forward treasury lock agreements, which had a combined notional amount of $1.3 billion, fixed a portion of the future interest cost for 5-year, 10-year and 30-year notes. The fair value of each treasury lock agreement, or the difference between the treasury lock reference rate and the fixed rate at time of note issuance, is amortized to interest expense over the life of the respective note issuance. In January 2006, in connection with the Company’s debt refinancing, the three forward treasury lock agreements were terminated.
The following table presents the location and fair values of derivative instruments and hedging activities included in the Company’s consolidated statements of financial position (in millions):
|
| | | | | | | | | | | | | | | |
| Derivatives and Hedging Activities Designated as Hedging Instruments under ASC 815 | | Derivatives and Hedging Activities Not Designated as Hedging Instruments under ASC 815 |
| September 30, 2013 | | September 30, 2012 | | September 30, 2013 | | September 30, 2012 |
Other current assets | | | | | | | |
Foreign currency exchange derivatives | $ | 19 |
| | $ | 14 |
| | $ | 14 |
| | $ | 8 |
|
Commodity derivatives | 8 |
| | 11 |
| | — |
| | — |
|
Interest rate swaps | 2 |
| | 2 |
| | — |
| | — |
|
Cross-currency interest rate swaps | 7 |
| | 1 |
| | — |
| | — |
|
Other noncurrent assets | | | | | | | |
Interest rate swaps | 3 |
| | 6 |
| | — |
| | — |
|
Equity swap | — |
| | — |
| | 183 |
| | 123 |
|
Total assets | $ | 39 |
| | $ | 34 |
| | $ | 197 |
| | $ | 131 |
|
| | | | | | | |
Other current liabilities | | | | | | | |
Foreign currency exchange derivatives | $ | 21 |
| | $ | 17 |
| | $ | 11 |
| | $ | 9 |
|
Commodity derivatives | 3 |
| | — |
| | — |
| | — |
|
Current portion of long-term debt | | | | | | | |
Fixed rate debt swapped to floating | 452 |
| | 401 |
| | — |
| | — |
|
Long-term debt | | | | | | | |
Fixed rate debt swapped to floating | 927 |
| | 456 |
| | — |
| | — |
|
Total liabilities | $ | 1,403 |
| | $ | 874 |
| | $ | 11 |
| | $ | 9 |
|
The following tables present the location and amount of the effective portion of gains and losses gross of tax on derivative instruments and related hedge items reclassified from AOCI into the Company’s consolidated statements of income for the fiscal years ended September 30, 2013 and 2012 and amounts recorded in AOCI net of tax in the consolidated statements of financial position (in millions):
|
| | | | | | | | | | |
| | Location of Gain (Loss) Reclassified from AOCI into Income | | Amount of Gain (Loss) Reclassified from AOCI into Income |
Derivatives in ASC 815 Cash Flow Hedging Relationships | | | Year Ended September 30, |
| | 2013 | | 2012 |
Foreign currency exchange derivatives | | Cost of sales | | $ | 1 |
| | $ | (19 | ) |
Commodity derivatives | | Cost of sales | | 2 |
| | (25 | ) |
Forward treasury locks | | Net financing charges | | 2 |
| | 2 |
|
Total | | | | $ | 5 |
| | $ | (42 | ) |
|
| | | | | | | | |
Derivatives in ASC 815 Cash Flow Hedging Relationships | | Amount of Gain (Loss) Recognized in AOCI on Derivative |
| September 30, 2013 | | September 30, 2012 |
Foreign currency exchange derivatives | | $ | (3 | ) | | $ | (3 | ) |
Commodity derivatives | | 3 |
| | 7 |
|
Forward treasury locks | | 7 |
| | 8 |
|
Total | | $ | 7 |
| | $ | 12 |
|
|
| | | | | | | | | | |
| | Location of Gain (Loss) Recognized in Income on Derivative | | Amount of Gain (Loss) Recognized in Income on Derivative |
Derivatives in ASC 815 Fair Value Hedging Relationships | | | Year Ended September 30, |
| | 2013 | | 2012 |
Interest rate swap | | Net financing charges | | $ | (2 | ) | | $ | (8 | ) |
Fixed rate debt swapped to floating | | Net financing charges | | 2 |
| | 9 |
|
Total | | | | $ | — |
| | $ | 1 |
|
|
| | | | | | | | | | |
| | Location of Gain (Loss) Recognized in Income on Derivative | | Amount of Gain (Loss) Recognized in Income on Derivative |
Derivatives Not Designated as Hedging Instruments under ASC 815 | | | Year Ended September 30, |
| | 2013 | | 2012 |
Foreign currency exchange derivatives | | Cost of sales | | $ | (8 | ) | | $ | 23 |
|
Foreign currency exchange derivatives | | Net financing charges | | 25 |
| | (19 | ) |
Foreign currency exchange derivatives | | Provision for income taxes | | (5 | ) | | 1 |
|
Equity swap | | Selling, general and administrative | | 65 |
| | 6 |
|
Total | | | | $ | 77 |
| | $ | 11 |
|
The amount of gains recognized in cumulative translation adjustment (CTA) within AOCI on the effective portion of outstanding net investment hedges was $4 million and $1 million at September 30, 2013 and 2012, respectively. For the years ended September 30, 2013 and 2012, no gains or losses were reclassified from CTA into income for the Company’s outstanding net investment hedges, and no gains or losses were recognized in income for the ineffective portion of cash flow hedges.
