Half Year Report 2012

Adecco Group –
Notes to consolidated financial statements (unaudited)
in millions, except share and per share information

Note 6 – Financial instruments

In accordance with Accounting Standards Codification (“ASC”) 815, “Derivatives and Hedging” (“ASC 815”), all derivative instruments are initially recognised at fair value as either other current assets, other assets, accounts payable and accrued expenses, or other liabilities in the accompanying consolidated balance sheets regardless of the purpose or intent for holding the derivative instruments. The derivatives are subsequently remeasured to fair value at the end of each reporting period. For derivative instruments designated and qualifying as fair value hedges, changes in the fair value of the derivative instruments as well as the changes in the fair value of the hedged item attributable to the hedged risk are recognised within the same line item in earnings. Any cash flow impact on settlement of these contracts is classified within the consolidated statements of cash flows according to the nature of the hedged item. For derivative instruments designated and qualifying as cash flow hedges, the effective portion of the changes in the fair value of derivative instruments is initially recorded as a component of accumulated other comprehensive income/(loss), net, in shareholders’ equity and reclassified into earnings in the same period during which the hedged transaction impacts earnings. The ineffective portion of the change in fair value of the derivative instruments is immediately recognised in earnings. The cash flow impact on settlement of these contracts is classified according to the nature of the hedged item. For derivative instruments designated and qualifying as net investment hedges, changes in the fair value of the derivative instruments are recorded as a component of accumulated other comprehensive income/(loss), net, in shareholders’ equity to the extent they are considered effective. These gains or losses will remain in equity until the related net investment is sold or otherwise disposed. The cash flow impact on settlement of these contracts is classified as cash flows from investing activities.

For derivative instruments that are not designated or that do not qualify as hedges under ASC 815, the changes in the fair value of the derivative instruments are recognised in other income/(expenses), net, within the consolidated statements of operations. Any cash flow impact on settlement of these contracts is classified as cash flows from investing activities.

Risk and use of derivative instruments

The Company conducts business in various countries and funds its subsidiaries in various currencies, and is therefore exposed to the effects of changes in foreign currency exchange rates. In order to mitigate the impact of currency exchange rate fluctuations, the Company assesses its exposure to currency risk and hedges certain risks through the use of derivative instruments. The Company has also issued fixed rate long-term notes. Accordingly, the Company manages exposure to changes in fair value of fixed interest long-term debt through the use of derivative instruments.

The main objective of holding derivative instruments is to minimise the volatility of earnings arising from these exposures in the absence of natural hedges. The responsibility for assessing exposures as well as entering into and managing derivative instruments is centralised in the Company’s treasury department. The activities of the treasury department are covered by corporate policies and procedures approved by the Board of Directors, which generally limit the use of derivative instruments for trading and speculative purposes. Group management approves the hedging strategy and monitors the underlying market risks.

Fair value of non-derivative financial instruments

The following table shows the carrying value and the fair value of non-derivative financial instruments as of June 30, 2012 and December 31, 2011:

 

30.06.2012

31.12.2011

in EUR

Carrying value

Fair value

Carrying value

Fair value

 

 

 

 

 

Non-derivative financial instruments

 

 

 

 

Current assets:

 

 

 

 

• Cash and cash equivalents

447

447

532

532

• Short-term investments

2

2

2

2

• Trade accounts receivable, net

3,914

3,914

3,725

3,725

Current liabilities:

 

 

 

 

• Accounts payable

601

601

541

541

• Short-term debt

183

183

160

160

• Current maturities of long-term debt (Level 1)

368

371

76

76

Non-current liabilities:

 

 

 

 

• Long-term debt (Level 1)

1,142

1,222

1,190

1,236

The Company uses the following methods and assumptions to estimate the fair value of each class of non-derivative financial instruments:

  • Cash equivalents, trade accounts receivable, net, accounts payable, and short-term debt
    The carrying amount approximates the fair value given the short maturity of such instruments.
  • Short-term investments
    The fair value for these instruments is based on quoted market prices.
  • Long-term debt, including current maturities
    The fair value of the Company’s publicly traded long-term debt is estimated using quoted market prices. The fair value of other long-term debt is estimated by discounting future cash flows using interest rates currently available for similar debt with identical terms, similar credit ratings, and remaining maturities.

Fair value of derivative financial instruments

The following table shows the notional amount and the fair value of derivative financial instruments as of June 30, 2012 and December 31, 2011:

 

 

Notional amount

Fair value

in EUR

Balance sheet location

30.06.2012

31.12.2011

30.06.2012

31.12.2011

 

 

 

 

 

 

Derivative assets

 

 

 

 

 

Derivatives designated as hedging
instruments under ASC 815:

 

 

 

 

 

• Interest rate swaps

Other current assets

150

 

4

 

• Interest rate swaps

Other assets

175

425

5

13

Derivatives not designated as hedging
instruments under ASC 815:

 

 

 

 

 

• Foreign currency contracts

Other current assets

563

1,071

8

48

• Cross-currency interest rate swaps

Other current assets

43

209

3

16

• Cross-currency interest rate swaps

Other assets

 

42

 

4

• Interest rate swaps

Other current assets

150

 

3

 

• Interest rate swaps

Other assets

 

50

 

2

 

 

 

 

 

 

Derivative liabilities

 

 

 

 

 

Derivatives not designated as hedging
instruments under ASC 815:

 

 

 

 

 

• Foreign currency contracts

Accounts payable and accrued expenses

957

787

(10)

(38)

• Interest rate swaps

Accounts payable and accrued expenses

150

 

(1)

 

• Interest rate swaps

Other liabilities

 

50

 

(1)

• Interest rate swaption

Accounts payable and accrued expenses

50

 

(2)

 

• Interest rate swaption

Other liabilities

 

50

 

(1)

 

 

 

 

 

 

Total net derivatives

 

 

 

10

43

In addition, accrued interest receivable on interest rate swaps of EUR 2 and EUR 10 was recorded in other current assets as of June 30, 2012 and December 31, 2011, respectively. Accrued interest payable on cross-currency interest rate swaps and interest rate swaps of EUR 2 was recorded in accounts payable and accrued expenses as of December 31, 2011, whereas the accrued interest payable on cross-currency interest rate swaps and interest rate swaps as of June 30, 2012 was not significant.

The fair value of interest rate swaps, foreign currency contracts, cross-currency interest rate swaps, and interest rate swaption is calculated by using the present value of future cash flows based on observable market inputs. The Company adds an adjustment for non-performance risk in the recognised measure of fair value of derivative instruments as well as a liquidity charge represented by the bid-ask spread of the outstanding derivatives. The non-performance adjustment reflects the Credit Default Swap (“CDS”) applied to the exposure of each transaction. The Company uses the counterparty CDS spread in case of an asset position and its own CDS spread in case of a liability position. As of June 30, 2012 and December 31, 2011, the total impact of non-performance risk and liquidity risk was a loss of EUR 1 and EUR 4, respectively.

Fair value hedges

Interest rate swaps with a notional amount of EUR 150 that contain a receipt of fixed interest rate payments and payment of floating interest rate payments have been designated as fair value hedges of the EUR 333 7-year fixed rate guaranteed notes due 2013 issued by Adecco International Financial Services BV. The outstanding contracts have an original contract period of four to seven years and expire in 2013.

Interest rate swaps with a notional amount of EUR 125 that contain a receipt of fixed interest rate payments and payment of floating interest rate payments have been designated as fair value hedges of the EUR 356 5-year guaranteed Euro medium-term notes due 2014 issued by Adecco International Financial Services BV. The contracts have an original contract period of three to five years and expire in 2014.

Interest rate swaps with a notional amount of EUR 50 that contain a receipt of fixed interest rate payments and payment of floating interest rate payments have been designated as fair value hedges of the EUR 500 7-year guaranteed Euro medium-term notes due 2018 issued by Adecco International Financial Services BV. The outstanding contract has an original contract period of six years and expires in 2018.

For the six months ended June 30, 2012 and June 30, 2011, the gain and loss on the hedged fixed rate notes attributable to the hedged benchmark interest rate risk and the offsetting loss and gain on the related interest rate swaps, both reported as interest expense, are as follows:

in EUR

Location of gain/(loss)
on derivative recognised
in earnings

Gain/(loss) on derivative
recognised in earnings

  Hedged item

Location of gain/(loss)
on related hedged item
recognised in earnings

Gain/(loss) on related
hedged item recognised
in earnings

Derivative

2012

2011

2012

2011

 

 

 

 

 

 

 

 

Interest rate swaps  

Interest expense

 

(8)

  Long-term debt  

Interest expense

 

8

In addition, the net swap settlements that accrue each period are also reported in interest expense. No significant gains or losses were recorded in the first six months of 2012 or in the first six months of 2011, due to ineffectiveness in fair value hedge relationships. No significant gains or losses were excluded from the assessment of hedge effectiveness of the fair value hedges in the first six months of 2012 or the first six months of 2011.

Cash flow hedges

No significant gains or losses on cash flow hedges were recognised in other comprehensive income/(loss) as of June 30, 2012. The effective portion of gains on cash flow hedges that was recognised in other comprehensive income/(loss), net, amounted to EUR 2 as of June 30, 2011. As of June 30, 2012 and December 31, 2011, gains relating to cash flow hedges included as a component of accumulated other comprehensive income/(loss), net, amounted to EUR 2 in both periods. No significant gains or losses were recorded in the first six months of 2012 or the first six months of 2011, due to ineffectiveness in cash flow hedge relationships. In the first six months of 2012 and the first six months of 2011, no significant gains or losses were excluded from the assessment of hedge effectiveness of the cash flow hedges. No significant reclassifications into earnings of gains and losses that are reported in accumulated other comprehensive income/(loss), net, are expected within the next 12 months.

Net investment hedges

As of June 30, 2012 and December 31, 2011, the net loss relating to net investment hedges included as a component of accumulated other comprehensive income/(loss), net, amounted to EUR 75 and EUR 74, respectively, resulting from net investment hedges terminated in 2005. No reclassifications of losses reported in accumulated other comprehensive income/(loss), net, into earnings are expected within the next 12 months.

Other hedge activities

The Company has entered into certain derivative contracts that are not designated or do not qualify as hedges under ASC 815. Forward foreign currency contracts and cross-currency interest rate swaps are used to hedge the net exposure of subsidiary funding advanced in the local operations’ functional currency. Contracts are entered into in accordance with the approved treasury policies and procedures and represent economic hedges. Gains and losses on these contracts are recognised in earnings and are included in other income/(expenses), net, in the accompanying consolidated statements of operations.

In connection with these activities, the Company recorded a net loss of EUR 1 in both the six months ended June 30, 2012 and the six months ended June 30, 2011, as follows:

in EUR

Location of
gain/(loss)
on derivative
recognised
in earnings

Gain/(loss) on derivative
recognised in earnings

  Hedged item

Location of
gain/(loss)
on related
hedged item
recognised in
earnings

Gain/(loss) on related
hedged item recognised
in earnings

Derivative

2012

2011

2012

2011

 

 

 

 

 

 

 

 

Cross-currency
interest rate
swaps

Other income/
(expenses), net

 

21

  Loans and
  receivables to/
  from subsidiaries

Other income/
(expenses), net

 

(22)

Foreign currency
contracts

Other income/
(expenses), net

(20)

(46)

  Cash, loans, and
  receivables to/
  from subsidiaries  

Other income/
(expenses), net

19

46

In the six months ended June 30, 2012, an expense of EUR 1 was recorded in other income/(expenses), net, related to swaption not designated as hedging instruments under ASC 815. No significant amounts were included in other income/(expenses), net, for the six months ended June 30, 2011 in relation to interest rate swaps and swaption not designated as hedging instruments under ASC 815.

Credit risk concentration

Financial instruments that potentially expose the Company to concentrations of credit risk consist principally of cash investments, short-term investments, trade accounts receivable, and derivative financial instruments. The Company places its cash and short-term investments in major financial institutions throughout the world, which management assesses to be of high credit quality, in order to limit the exposure of each investment.

Credit risk with respect to trade accounts receivable is dispersed due to the international nature of the business, the large number of customers, and the diversity of industries serviced. The Company’s receivables are well diversified and management performs credit evaluations of its customers and, where available and cost-effective, utilises credit insurance.

To minimise counterparty exposure on derivative instruments, the Company enters into derivative contracts with several large multinational banks and limits the exposure in combination with the short-term investments with each counterparty.