Derivatives

ASC 815 requires companies to recognize all derivative instruments in the consolidated balance sheet as either assets or liabilities at fair value. The accounting for changes in fair value of a derivative is dependent upon whether or not the derivative has been designated and qualifies for hedge accounting treatment and the type of hedging relationship. For derivatives designated and qualifying as hedging instruments, the company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation.

Cash Flow Hedging Strategy

The company uses derivative instruments in an attempt to manage its exposure to transactional foreign currency exchange risk and interest rate risk. Foreign forward exchange contracts are used to manage the price risk associated with forecasted sales denominated in foreign currencies and the price risk associated with forecasted purchases of inventory generally over the next twelve months.

The company recognizes its derivative instruments as assets or liabilities in the consolidated balance sheet measured at fair value. A majority of the company’s derivative instruments are designated and qualify as cash flow hedges. Accordingly, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the fair value of the hedged item, if any, is recognized in current earnings during the period of change.

To protect against increases/decreases in forecasted foreign currency cash flows resulting from inventory purchases/sales generally over the next year, the company utilizes foreign currency forward contracts to hedge portions of its forecasted purchases/sales denominated in foreign currencies. The gains and losses are included in cost of products sold and selling, general and administrative expenses on the consolidated statement of comprehensive income (loss). If it is later determined that a hedged forecasted transaction is unlikely to occur, any prospective gains or losses on the forward contracts would be recognized in earnings. The company does not expect any material amount of hedge ineffectiveness related to forward contract cash flow hedges during the periods covered by the hedges.

The company has historically not recognized any material amount of ineffectiveness related to forward contract cash flow hedges because the company generally limits its hedges to between 50% and 90% of total forecasted transactions for a given entity’s exposure to currency rate changes and the transactions hedged are recurring in nature. Furthermore, the majority of the hedged transactions are related to intercompany sales and purchases for which settlement occurs on a specific day each month. Forward contracts with a total notional amount in USD of $59,663,000 and $171,889,000 matured for the three and nine months ended September 30, 2016, respectively, compared to $38,020,000 and $100,657,000 matured for the three and nine months ended and September 30, 2015, respectively.

Outstanding foreign currency forward exchange contracts qualifying and designated for hedge accounting treatment were as follows (in thousands USD):



	September 30, 2016					December 31, 2015
	Notional Amount		Unrealized Net Gain (Loss)			Notional Amount		Unrealized Net Gain (Loss)
USD / AUD	$	1,848	$	(68	)	$	2,910	$	(83	)
USD / CAD	2,860		139			3,893		181
USD / CNY	8,440		(97		)	16,786		(282		)
USD / EUR	20,380		(175		)	72,758		2,681
USD / GBP	470		64			3,862		22
USD / NZD	1,205		10			4,893		37
USD / SEK	1,156		(2		)	5,128		39
USD / MXP	8,015		(271		)	8,494		(284		)
EUR / AUD	172		(9		)	669		(10		)
EUR / CAD	55		6			1,283		(17		)
EUR / CHF	615		(16		)	1,944		(17		)
EUR / GBP	8,845		1,151			36,567		(424		)
EUR / SEK	509		9			2,464		(42		)
EUR / NOK	760		(10		)	3,375		(55		)
EUR / NZD	1,328		248			3,609		476
AUD / NZD	90		4			352		8
GBP / AUD	214		(48		)	830		(46		)
GBP / CHF	146		20			463		(7		)
GBP / SEK	562		77			2,067		(1		)
DKK / SEK	9,358		(41		)	37,293		46
NOK / SEK	930		(43		)	3,524		(39		)
	$	67,958	$	948		$	213,164	$	2,183

Derivatives Not Qualifying or Designated for Hedge Accounting Treatment

The company also utilizes foreign currency forward contracts that are not designated as hedges in accordance with ASC 815. These contracts are entered into to eliminate the risk associated with the settlement of short-term intercompany trading receivables and payables between Invacare Corporation and its foreign subsidiaries. The currency forward contracts are entered into at the same time as the intercompany receivables or payables are created so that upon settlement, the gain/loss on the settlement is offset by the gain/loss on the foreign currency forward contract. No material net gain or loss was realized by the company in 2016 or 2015 related to these contracts and the associated short-term intercompany trading receivables and payables.

Foreign currency forward exchange contracts not qualifying or designated for hedge accounting treatment, as well as ineffective hedges, entered into in 2016 and 2015, respectively, and outstanding were as follows (in thousands USD):



	September 30, 2016					December 31, 2015
	Notional Amount		Gain (Loss)			Notional Amount		Gain (Loss)
AUD / USD	$	10,101	$	(122	)	$	8,051	$	337
CAD / USD	—		—			5,762		(4		)
CNY / USD	5,978		(15		)	9,943		(441		)
EUR / USD	—		—			2,118		53
DKK / USD	—		—			7,927		125
GBP / USD	626		85			4,526		(106		)
MXP / USD	416		(54		)	—		—
NOK / USD	—		—			1,838		(18		)
EUR / NOK	7		(1		)	—		—
EUR / SEK	65		1			—		—
	$	17,193	$	(106	)	$	40,165	$	(54	)

The fair values of the company’s derivative instruments were as follows (in thousands):



	September 30, 2016				December 31, 2015
	Assets		Liabilities		Assets		Liabilities
Derivatives designated as hedging instruments under ASC 815
Foreign currency forward exchange contracts	$	1,907	$	959	$	3,626	$	1,443

Derivatives not designated as hedging instruments under ASC 815
Foreign currency forward exchange contracts	72		178		517		571
Total derivatives	$	1,979	$	1,137	$	4,143	$	2,014

The fair values of the company’s foreign currency forward exchange contract assets and liabilities are included in Other Current Assets and Accrued Expenses, respectively in the Consolidated Balance Sheets.

The effect of derivative instruments on Accumulated Other Comprehensive Income (OCI) and the Statement of Comprehensive Income (Loss) and was as follows (in thousands):



Derivatives in ASC 815 cash flow hedge relationships	Amount of Gain (Loss) Recognized in Accumulated OCI on Derivatives (Effective Portion)			Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)			Amount of Gain (Loss) Recognized in Income on Derivatives (Ineffective Portion and Amount Excluded from Effectiveness Testing)
Three months ended September 30, 2016
Foreign currency forward exchange contracts	$	828		$	698		$	30
Nine months ended September 30, 2016
Foreign currency forward exchange contracts	$	(103	)	$	1,072		$	72
Three months ended September 30, 2015
Foreign currency forward exchange contracts	$	(833	)	$	(281	)	$	—
Nine months ended September 30, 2015
Foreign currency forward exchange contracts	$	854		$	457		$	—

Derivatives not designated as hedging instruments under ASC 815							Amount of Gain (Loss) Recognized in Income on Derivatives
Three months ended September 30, 2016
Foreign currency forward exchange contracts							$	271
Nine months ended September 30, 2016
Foreign currency forward exchange contracts							$	(106	)
Three months ended September 30, 2015
Foreign currency forward exchange contracts							$	172
Nine months ended September 30, 2015
Foreign currency forward exchange contracts							$	113

The gains or losses recognized as the result of the settlement of cash flow hedge foreign currency forward contracts are recognized in net sales for hedges of inventory sales and in cost of product sold for hedges of inventory purchases. For the three and nine months ended September 30, 2016, net sales were increased by $1,417,000 and $2,826,000 while cost of product sold was increased by $619,000 and $1,576,000 for net pre-tax realized gains of $798,000 and $1,250,000, respectively. For the three and nine months ended September 30, 2015, net sales were decreased by $1,087,000 and $1,865,000 while cost of product sold was decreased by $971,000 and $2,935,000 for a net realized pre-tax loss of $116,000 and a net realized pre-tax gain of $1,070,000, respectively.

A gain of $271,000 and a loss of $106,000 were recognized in selling, general and administrative (SG&A) expenses for the three and nine months ended September 30, 2016 compared to gains of $172,000 and $113,000 for the three and nine months ended September 30, 2015, respectively, principally related to forward contracts not designated as hedging instruments that were entered into to offset gains/losses that were also recorded in SG&A expenses on intercompany trade receivables or payables. Any gains/losses on the non-designated hedging instruments were substantially offset by gains/losses also recorded in SG&A expenses on intercompany trade payables.

The company's derivative agreements provide the counterparties with a right of set off in the event of a default that would enable the counterparty to offset any net payment due by the counterparty to the company under the applicable agreement by any amount due by the company to the counterparty under any other agreement. For example, the terms of the agreement would permit a counterparty to a derivative contract that is also a lender under the company's Amended and Restated Credit Agreement to reduce any derivative settlement amounts owed to the company under the derivative contract by any amounts owed to the counterparty by the company under the Amended and Restated Credit Agreement. In addition, the agreements contain cross-default provisions that could trigger a default by the company under the agreement in the event of a default by the company under another agreement with the same counterparty. The company does not present any derivatives on a net basis in its financial statements, other than the conversion and bond hedge derivatives which are presented net on the Condensed Consolidated Statement of Comprehensive Income (Loss), and all derivative balances presented are subject to provisions that are similar to master netting agreements.

During the first quarter of 2016, the company entered into privately negotiated convertible note hedges and warrants in connection with its sale of $150,000,000 in aggregate principal amount of the company’s 5.00% Convertible Senior Notes due 2021. The warrants, which increased paid in capital by $12,376,000, are clearly and closely related to the convertible notes and thus classified as equity. The note hedge assets and conversion liabilities were recorded, based on initial fair values, as an asset of $27,975,000 and a liability of $34,480,000, respectively, and these fair values are updated quarterly with the offset to the income statement. See "Long-Term Debt" in the notes to the Consolidated Financial Statements included elsewhere in this report for more detail. The fair values of the outstanding convertible note derivatives as of September 30, 2016 and their effect on the Statement of Comprehensive Income (Loss) were as follows (in thousands):



				Gain (Loss)
				Three Months Ended			Nine Months Ended
	Fair Value			September 30, 2016			September 30, 2016
Convertible debt conversion long-term liability	$	(20,901	)	$	7,732		$	13,579
Convertible note hedge long-term asset	16,678			(6,540		)	(11,297		)
	$	(4,223	)	$	1,192		$	2,282

The convertible debt conversion liability and the note hedge asset amounts are included in Other Long-Term Obligations and Other Long-Term Assets, respectively, in the company's Consolidated Balance Sheets.