Derivative Financial Instruments

Our earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates and interest rates. We selectively use derivative financial instruments including foreign currency forward contracts and interest rate swaps to manage our exposure to these risks.

The use of derivative financial instruments exposes the Company to credit risk, which relates to the risk of nonperformance by a counterparty to the derivative contracts. We manage our credit risk by entering into derivative contracts with only highly rated financial institutions and by using netting agreements.

The effective portion of derivative gains and losses are recorded in accumulated other comprehensive (loss) income until the hedged transaction affects earnings upon settlement, at which time they are reclassified to cost of goods sold or net sales. If it is probable that an anticipated hedged transaction will not occur by the end of the originally specified time period, we reclassify the gains or losses related to that hedge from accumulated other comprehensive (loss) income to other income (expense).

On April 1, 2018, the company adopted the provisions of ASU 2017-12 "Derivatives and Hedging (Topic 815): Target Improvements to Accounting for Hedging Activities". As a result, hedge effectiveness was reviewed qualitatively by verifying that the critical terms of the hedging instrument and the forecasted transaction continue to match, and that there have been no adverse developments that have increased the risk that the counterparty will default. No recognition of ineffectiveness was recorded in our Condensed Consolidated Statement of Earnings for the nine months ended September 30, 2018.

Foreign Currency Hedges

In January of 2016, we began using forward contracts to mitigate currency risk related to a portion of our forecasted foreign currency revenues and costs. The currency forward contracts are designed as cash flow hedges and are recorded in the Condensed Consolidated Balance Sheets at fair value.

We continue to monitor the Company’s overall currency exposure and may elect to add cash flow hedges in the future. At September 30, 2018, we had a net unrealized gain of $867 in accumulated other comprehensive (loss) income, of which $644 is expected to be reclassified to income within the next 12 months. At September 30, 2017 we had a net unrealized gain of $350 in accumulated other comprehensive (loss) income. The notional amount of foreign currency forward contracts outstanding was $19.2 million at September 30, 2018.

Interest Rate Swaps

We use interest rate swaps to convert the revolving credit facility’s variable rate of interest into a fixed rate. In the second quarter of 2012, CTS entered into four separate interest rate swap agreements to fix interest rates on $50,000 of long-term debt for the periods January 2013 to January 2017. In the third quarter of 2012, we entered into four additional interest rate swap agreements to fix interest rates on $25,000 of long-term debt for the periods January 2013 to January 2017. In the third quarter of 2016, we entered into three additional interest rate swap agreements to fix interest rates on $50,000 of long-term debt for the periods August 2017 to August 2020. The difference to be paid or received under the terms of the swap agreements will be recognized as an adjustment to interest expense when settled.

These swaps are treated as cash flow hedges and consequently, the changes in fair value were recorded in other comprehensive (loss) income. The estimated net amount of the existing gains that are reported in accumulated other comprehensive (loss) income that are expected to be reclassified into earnings within the next twelve months is approximately $616.

The location and fair values of derivative instruments designated as hedging instruments in the Condensed Consolidated Balance Sheets as of September 30, 2018, are shown in the following table:



	As of
	September 30,		December 31,
	2018		2017
Interest rate swaps reported in Other current assets	$	616	$	278
Interest rate swaps reported in Other assets	$	742	$	693
Foreign currency hedges reported in Other current assets	$	864	$	—
Foreign currency hedges reported in Accrued liabilities	$	—	$	(742	)

The Company has elected to net its foreign currency derivative assets and liabilities in the balance sheet in accordance with ASC 210-20 (Balance Sheet, Offsetting). On a gross basis, there were foreign currency derivative assets of $864 and foreign currency derivative liabilities of $0.

The effect of derivative instruments on the Condensed Consolidated Statements of Earnings is as follows:



	Three Months Ended						Nine Months Ended
	September 30,			September 30,			September 30,			September 30,
	2018			2017			2018			2017
Foreign Exchange Contracts:
Gain (loss) recognized in Net sales	$	152		$	(194	)	$	115		$	(253	)
(Loss) gain recognized in Cost of goods sold	(52		)	268			88			182
Gain (loss) recognized in Selling, general and administrative expense	3			21			(2		)	31
Loss recognized in Other income	—			(2		)	(1		)	(11		)

Interest Rate Swaps:
Benefit recorded in Interest expense	$	114		$	12		$	284		$	12
Total gain (loss)	$	217		$	105		$	484		$	(39	)