Derivative Instruments and Hedging Activities

6 Months Ended

Jul. 02, 2016

Derivative Instruments and Hedging Activities [Abstract]

Derivative Instruments and Hedging Activities

Note 5 – Derivative Instruments and Hedging Activities

The Company's earnings and cash flows are subject to fluctuations due to changes in commodity prices, foreign currency exchange rates, and interest rates. The Company uses derivative instruments such as commodity futures contracts, foreign currency forward contracts, and interest rate swaps to manage these exposures.

All derivatives are recognized in the Condensed Consolidated Balance Sheets at their fair value. On the date the derivative contract is entered into, it is either a) designated as (i) a hedge of a forecasted transaction or the variability of cash flow to be paid or received  (cash flow hedge), or (ii) a hedge of the fair value of a recognized asset or liability (fair value hedge) or b) not designated in a hedge accounting relationship, even though the derivative contract was executed to mitigate an economic exposure, as the Company does not enter into derivative contracts for trading purposes (economic hedge).  Changes in the fair value of a derivative instrument that is qualified, designated and highly effective as a cash flow hedge are recorded in accumulated other comprehensive income (AOCI), to the extent effective, until they are reclassified to earnings in the same period or periods during which the hedged transaction affects earnings.  Changes in the fair value of a derivative instrument that is qualified, designated and highly effective as a fair value hedge, along with the gain or loss on the hedged recognized asset or liability that is attributable to the hedged risk, are recorded in current earnings.  Changes in the fair value of undesignated derivative instruments and the ineffective portion of designated derivative instruments are reported in current earnings.

The Company documents all relationships between hedging instruments and hedged items, as well as the risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair value hedges to specific assets and liabilities in the Condensed Consolidated Balance Sheets and linking cash flow hedges to specific forecasted transactions or variability of cash flow.

The Company also assesses, both at the hedge's inception and on an ongoing basis, whether the designated derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flow or fair values of hedged items.  When a derivative is determined not to be highly effective as a hedge or the underlying hedged transaction is no longer probable of occurring, hedge accounting is discontinued prospectively, in accordance with the derecognition criteria for hedge accounting.

Commodity Futures Contracts

Copper and brass represent the largest component of the Company's variable costs of production.  The cost of these materials is subject to global market fluctuations caused by factors beyond the Company's control.  The Company occasionally enters into forward fixed-price arrangements with certain customers; the risk of these arrangements is generally managed with commodity futures contracts.   These futures contracts have been designated as cash flow hedges.  

At July 2, 2016, the Company held open futures contracts to purchase approximately $22.3 million of copper over the next 18 months related to fixed price sales orders.  The fair value of those futures contracts was a $1.7 million net gain position, which was determined by obtaining quoted market prices (level 1 within the fair value hierarchy).  In the next 12 months, the Company will reclassify into earnings realized gains or losses relating to cash flow hedges.  At July 2, 2016, this amount was approximately $979 thousand of deferred net gains, net of tax.

The Company may also enter into futures contracts to protect the value of inventory against market fluctuations.   These futures contracts have been designated as fair value hedges.  At July 2, 2016, the Company held open futures contracts to sell approximately $15.5 million of copper over the next six months related to copper inventory.  The fair value of those futures contracts was a $498 thousand net loss position, which was determined by obtaining quoted market prices (level 1 within the fair value hierarchy).  

Interest Rate Swap

On February 20, 2013, the Company entered into a two-year forward-starting interest rate swap agreement with an effective date of January 12, 2015, and an underlying notional amount of $200.0 million, pursuant to which the Company receives variable interest payments based on one-month LIBOR and pays fixed interest at a rate of 1.4 percent.  Based on the Company's current variable premium pricing on its Term Loan Facility, the all-in fixed rate as of the effective date is 2.7 percent.  The interest rate swap will mature on December 11, 2017, and is structured to offset the interest rate risk associated with the Company's floating-rate, LIBOR-based Term Loan Facility Agreement.  The swap was designated and accounted for as a cash flow hedge from inception.

The fair value of the interest rate swap is estimated based on the present value of the difference between expected cash flows calculated at the contracted interest rate and the expected cash flows at the current market interest rate using observable benchmarks for LIBOR forward rates at the end of the period (level 2 within the fair value hierarchy).  Interest payable and receivable under the swap agreement is accrued and recorded as an adjustment to interest expense.  The fair value of the interest rate swap was a $2.4 million loss position at July 2, 2016, and there was $1.5 million of deferred losses, net of tax, included in AOCI that are expected to be reclassified into interest expense over the term of the hedged item.

The Company presents its derivative assets and liabilities in the Condensed Consolidated Balance Sheets on a net basis by counterparty. The following table summarizes the location and fair value of the derivative instruments and disaggregates our net derivative assets and liabilities into gross components on a contract-by-contract basis:

	Asset Derivatives								Liability Derivatives
		Fair Value								Fair Value
(In thousands)	Balance Sheet Location	July 2,  2016				December 26, 2015			Balance Sheet Location	July 2,  2016				December 26, 2015
Hedging instrument:
Commodity contracts - gains	Other current assets		$	1,761			$	60	Other current liabilities		$	24			$	238
Commodity contracts - losses	Other current assets			(85	)			—	Other current liabilities			(522	)			(1,864	)
Interest rate swap	Other assets			—				—	Other liabilities			(2,407	)			(1,692	)
Total derivatives (1)			$	1,676			$	60			$	(2,905	)		$	(3,318	)
(1) Does not include the impact of cash collateral received from or provided to counterparties.

The following tables summarize the effects of derivative instruments on our Condensed Consolidated Statements of Income:

		Three Months Ended								Six Months Ended
(In thousands)	Location	July 2, 2016				June 27, 2015				July 2, 2016				June 27, 2015
Fair value hedges:
(Loss) gain on commodity contracts (qualifying)	Cost of goods sold		$	(332	)		$	1,256			$	(383	)		$	1,468
Gain (loss) on hedged item - Inventory	Cost of goods sold			288				(1,403	)			350				(1,650	)
Undesignated derivatives:
Gain on commodity contracts (nonqualifying)	Cost of goods sold			1,326				1,046				1,820				1,279

The following tables summarize amounts recognized in and reclassified from AOCI during the period:

	Three Months Ended July 2, 2016
(In thousands)	Gain (Loss) Recognized in AOCI (Effective Portion), Net of Tax				Classification Gains (Losses)	Loss (Gain) Reclassified from AOCI (Effective Portion), Net of Tax
Cash flow hedges:
Commodity contracts		$	2,464		Cost of goods sold		$	(1,359	)
Interest rate swap			(115	)	Interest expense			59
Other			(349	)	Other			—
Total		$	2,000		Total		$	(1,300	)

	Three Months Ended June 27, 2015
(In thousands)	Gain (Loss) Recognized in AOCI (Effective Portion), Net of Tax				Classification Gains (Losses)	Loss (Gain) Reclassified from AOCI (Effective Portion), Net of Tax
Cash flow hedges:
Commodity contracts		$	(1,159	)	Cost of goods sold		$	(81	)
Interest rate swap			267		Interest expense			63
Other			7					—
Total		$	(885	)			$	(18	)

	Six Months Ended July 2, 2016
(In thousands)	Gain (Loss) Recognized in AOCI (Effective Portion), Net of Tax				Classification Gains (Losses)	Loss (Gain) Reclassified from AOCI (Effective Portion), Net of Tax
Cash flow hedges:
Commodity contracts		$	3,337		Cost of goods sold	$	(1,291	)
Interest rate swap			(585	)	Interest expense		128
Other			(295	)	Other		—
Total		$	2,457			$	(1,163	)

Derivative instrument information (continued):

	Six Months Ended June 27, 2015
(In thousands)	Gain (Loss) Recognized in AOCI (Effective Portion), Net of Tax				Classification Gains (Losses)	Loss (Gain) Reclassified from AOCI (Effective Portion), Net of Tax
Cash flow hedges:
Commodity contracts		$	(885	)	Cost of goods sold	$	490
Interest rate swap			(765	)	Interest expense		131
Other			(72	)	Other		—
Total		$	(1,722	)		$	621

The Company enters into futures and forward contracts that closely match the terms of the underlying transactions.  As a result, the ineffective portion of the open hedge contracts through July 2, 2016 was not material to the Condensed Consolidated Statements of Income.

The Company primarily enters into International Swaps and Derivatives Association master netting agreements with major financial institutions that permit the net settlement of amounts owed under their respective derivative contracts. Under these master netting agreements, net settlement generally permits the Company or the counterparty to determine the net amount payable for contracts due on the same date and in the same currency for similar types of derivative transactions. The master netting agreements generally also provide for net settlement of all outstanding contracts with a counterparty in the case of an event of default or a termination event.  The Company does not offset fair value amounts for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral.  At July 2, 2016 and December 26, 2015, the Company had recorded restricted cash in other current assets of $1.0 million and $2.6 million, respectively, as collateral related to open derivative contracts under the master netting arrangements.