Derivative Instruments and Hedging Activities

Our business is exposed to market risks associated with interest rates and foreign currency exchange rates. Our risk management activities involve the use of derivative financial instruments to hedge the impact of market risk exposure related to variable interest rates and foreign currency exchange rates. To reduce the impact of these risks on earnings and increase the predictability of our cash flows, from time to time we enter into certain derivative contracts, including interest rate swaps and foreign currency exchange contracts. All derivative instruments are reflected in the accompanying condensed consolidated balance sheets at fair value.

We engage solely in cash flow hedges. Hedges of cash flow exposure are entered into to hedge a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability. Changes in the fair value of derivative instruments that are designated as cash flow hedges are deferred to the extent the hedges are effective. These changes are recorded as a component of Accumulated OCI (a component of shareholders’ equity) until the hedged transactions occur and are recognized in earnings. The ineffective portion of changes in the fair value of cash flow hedges is recognized immediately in earnings. In addition, any change in the fair value of a derivative instrument that does not qualify for hedge accounting is recorded in earnings in the period in which the change occurs.

For additional information regarding our accounting for derivative instruments and hedging activities, see Notes 2 and 18 to our 2016 Form 10-K.

Interest Rate Risk

From time to time, we enter into interest rate swaps to stabilize cash flows related to our long-term variable interest rate debt. In June 2015 we entered into various interest rate swap contracts to fix the interest rate on $187.5 million of our Nordea Q5000 Loan borrowings (Note 6). These swap contracts, which are settled monthly, began in June 2015 and extend through April 2020. Our interest rate swap contracts qualify for cash flow hedge accounting treatment. Changes in the fair value of interest rate swaps are deferred to the extent the swaps are effective. These changes are recorded as a component of Accumulated OCI until the anticipated interest is recognized as interest expense. The ineffective portion of the interest rate swaps, if any, is recognized immediately in earnings within the line titled “Net interest expense.” The amount of ineffectiveness associated with our interest rate swap contracts was immaterial for all periods presented.

Foreign Currency Exchange Rate Risk

Because we operate in various regions around the world, we conduct a portion of our business in currencies other than the U.S. dollar. We enter into foreign currency exchange contracts from time to time to stabilize expected cash outflows related to our vessel charters that are denominated in foreign currencies.

In January 2013, we entered into foreign currency exchange contracts to hedge through September 2017 our foreign currency exposure associated with the Grand Canyon charter payments ($104.6 million) denominated in Norwegian kroner (NOK591.3 million). In February 2013, we entered into similar foreign currency exchange contracts to hedge our foreign currency exposure associated with the Grand Canyon II and Grand Canyon III charter payments ($100.4 million and $98.8 million, respectively) denominated in Norwegian kroner (NOK594.7 million and NOK595.0 million, respectively), through July 2019 and February 2020, respectively. In December 2015, we de-designated the foreign currency exchange contracts associated with the charter payment obligations for the Grand Canyon II and Grand Canyon III vessels that no longer qualified for cash flow hedge accounting treatment and we re-designated the hedging relationship between a portion of these contracts and our forecasted Grand Canyon II and Grand Canyon III charter payments of NOK434.1 million and NOK185.2 million, respectively, that were expected to remain highly probable of occurring. Unrealized losses associated with the effective portion of our foreign currency exchange contracts that qualify for hedge accounting treatment are included in our Accumulated OCI (net of tax). Reflected in “Other income (expense), net” in the accompanying condensed consolidated statements of operations are changes in unrealized losses associated with the foreign currency exchange contracts that are no longer designated as cash flow hedges. Hedge ineffectiveness also is reflected in “Other income (expense), net” in the accompanying condensed consolidated statements of operations. There were no gains or losses associated with hedge ineffectiveness for the three- and six-month periods ended June 30, 2017. For the three- and six-month periods ended June 30, 2016, we recorded unrealized gains of $0.5 million and $0.1 million, respectively, related to the Grand Canyon and Grand Canyon III hedge ineffectiveness.

Quantitative Disclosures Relating to Derivative Instruments

The following table presents the balance sheet location and fair value of our derivative instruments that were designated as hedging instruments (in thousands):



	June 30, 2017			December 31, 2016
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Asset Derivative Instruments:
Interest rate swaps	Other assets, net	$	363	Other assets, net	$	451
		$	363		$	451

Liability Derivative Instruments:
Foreign exchange contracts	Accrued liabilities	$	9,710	Accrued liabilities	$	14,056
Interest rate swaps	Accrued liabilities	181		Accrued liabilities	751
Foreign exchange contracts	Other non-current liabilities	8,928		Other non-current liabilities	13,383
		$	18,819		$	28,190

The following table presents the balance sheet location and fair value of our derivative instruments that were not designated as hedging instruments (in thousands):



	June 30, 2017			December 31, 2016
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Liability Derivative Instruments:
Foreign exchange contracts	Accrued liabilities	$	3,368	Accrued liabilities	$	3,923
Foreign exchange contracts	Other non-current liabilities	4,881		Other non-current liabilities	6,808
		$	8,249		$	10,731

The following tables present the impact that derivative instruments designated as hedging instruments had on our Accumulated OCI (net of tax) and our condensed consolidated statements of operations (in thousands). We estimate that as of June 30, 2017, $6.4 million of losses in Accumulated OCI associated with our derivative instruments is expected to be reclassified into earnings within the next 12 months.



	Gain (Loss) Recognized in OCI on Derivative Instruments, Net of Tax (Effective Portion)
	Three Months Ended June 30,						Six Months Ended June 30,
	2017			2016			2017		2016

Foreign exchange contracts	$	3,191		$	674		$	5,721	$	6,496
Interest rate swaps	(15		)	(200		)	298		(1,523		)
	$	3,176		$	474		$	6,019	$	4,973



	Location of Loss Reclassified from Accumulated OCI into Earnings	Loss Reclassified from Accumulated OCI into Earnings (Effective Portion)
		Three Months Ended June 30,						Six Months Ended June 30,
		2017			2016			2017			2016

Foreign exchange contracts	Cost of sales	$	(3,771	)	$	(2,507	)	$	(6,992	)	$	(5,370	)
Interest rate swaps	Net interest expense	(178		)	(547		)	(447		)	(1,124		)
		$	(3,949	)	$	(3,054	)	$	(7,439	)	$	(6,494	)

The following table presents the impact that derivative instruments not designated as hedging instruments had on our condensed consolidated statements of operations (in thousands):



	Location of Gain Recognized in Earnings on Derivative Instruments	Gain Recognized in Earnings on Derivative Instruments
		Three Months Ended June 30,					Six Months Ended June 30,
		2017		2016			2017		2016

Foreign exchange contracts	Other income (expense), net	$	429	$	(465	)	$	481	$	2,066
		$	429	$	(465	)	$	481	$	2,066