Cardinal Health 2013 Annual Report Download - page 46

Cardinal Health, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
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and amount of EBITDA estimates and changes in probability assumptions with respect
to the timing and likelihood of achieving the EBITDA targets. As a result of changes
in our estimate of performance in future periods, coupled with the progress of
discussions with the former owners regarding an early termination and settlement, we
recorded a $71 million decrease in fair value of the obligation to $4 million at June 30,
2012. We terminated and settled the remaining contingent consideration obligation in
July 2012 for $4 million.
11. 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.
(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.