Derivative Instruments and Hedging Activities

3 Months Ended

Apr. 01, 2017

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments and Hedging Activities

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 a hedge of (i) a forecasted transaction or the variability of cash flow to be paid (cash flow hedge) or (ii) 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 that is qualified, designated and highly effective as a cash flow hedge are recorded in stockholders’ equity within 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 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 derivatives executed as economic hedges and the ineffective portion of designated derivatives are reported in current earnings.

The Company documents all relationships between derivative instruments and hedged items, as well as the risk-management objective and strategy for undertaking various hedge transactions.  This process includes linking all derivative instruments 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 derivative instruments that are used in hedging transactions are highly effective in offsetting changes in cash flow or fair values of hedged items.  When a derivative instrument 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 April 1, 2017, the Company held open futures contracts to purchase approximately $20.1 million of copper over the next nine months related to fixed price sales orders.  The fair value of those futures contracts was a $178 thousandnet 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 April 1, 2017, this amount was approximately $92 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.  At April 1, 2017, the Company held open futures contracts to sell approximately $38.6 million of copper over the next six months related to copper inventory.  The fair value of those futures contracts was a $293 thousandnet gain 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 revolving credit facility, the all-in fixed rate is 2.46 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 at inception. During the fourth quarter of 2016, the Company discontinued hedge accounting prospectively.

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 $295 thousandloss position at April 1, 2017, and there was $405 thousand of deferred losses, net of tax, included in AOCI that are expected to be reclassified into interest expense over the term of the interest rate swap.

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 the 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	April 1, 2017		December 31, 2016			Balance Sheet Location	April 1, 2017			December 31, 2016
Hedging instrument:
Commodity contracts - gains	Other current assets	$	600	$	1,013		Other current liabilities	$	68		$	564
Commodity contracts - losses	Other current assets	—		(148		)	Other current liabilities	(197		)	(920		)
Interest rate swap	Other current assets	—		—			Other current liabilities	(295		)	(787		)
Total derivatives (1)		$	600	$	865			$	(424	)	$	(1,143	)

⁽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 the Company’s Condensed Consolidated Statements of Income:

		For the Quarter Ended
(In thousands)	Location	April 1, 2017			April 2, 2016
Fair value hedges:
Gain (loss) on commodity contracts (qualifying)	Cost of goods sold	$	—		$	213
Gain (loss) on hedged item - inventory	Cost of goods sold	—			(247		)
Undesignated derivatives:
(Loss) gain on qualifying contracts (nonqualifying)	Cost of goods sold	(1,095		)	234

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

	For the Quarter Ended April 1, 2017
(In thousands)	(Loss) Gain Recognized in AOCI (Effective Portion), Net of Tax			Classification Gains (Losses)	Loss Reclassified from AOCI (Effective Portion), Net of Tax
Cash flow hedges:
Commodity contracts	$	(563	)	Cost of goods sold	$	352
Interest rate swap	—			Interest expense	149
Other	118			Other	—
Total	$	(445	)	Total	$	501

	For the Quarter Ended April 2, 2016
(In thousands)	Gain (Loss) Recognized in AOCI (Effective Portion), Net of Tax			Classification Gains (Losses)	Loss Reclassified from AOCI (Effective Portion), Net of Tax
Cash flow hedges:
Commodity contracts	$	873		Cost of goods sold	$	68
Interest rate swap	(470		)	Interest expense	69
Other	54			Other	—
Total	$	457		Total	$	137

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 April 1, 2017 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 April 1, 2017 and December 31, 2016, the Company had recorded restricted cash in other current assets of $2.0 million and $1.4 million, respectively, as collateral related to open derivative contracts under the master netting arrangements.