Note 6 – Derivative Financial Instruments

Debt Instruments

The carrying values of the company’s debt instruments vary from their fair values. The fair values were determined by reference to transacted prices of these securities (Level 2 input based on the GAAP fair value hierarchy). The estimated fair value, as well as the carrying value, of the company’s debt instruments are shown below (in thousands):


	March 31, 2018
(Dollars in thousands)
Estimated aggregate fair value	$	714,431
Aggregate carrying value ⁽¹⁾		713,747

⁽¹⁾	Long-term debt excluding the impact of unamortized debt issuance costs.

Derivative Instruments and Hedging Activities

We use derivatives to partially offset our business exposure to foreign currency risk. We may enter into forward contracts, option contracts, swaps, collars or other derivative instruments to offset some of the risk on expected future cash flows and on certain existing assets and liabilities. However, we may choose not to hedge certain exposures for a variety of reasons including, but not limited to, accounting considerations and the prohibitive economic cost of hedging particular exposures. There can be no assurance the hedges will offset more than a portion of the financial impact resulting from movements in foreign currency exchange rates.

To help protect gross margins from fluctuations in foreign currency exchange rates, certain of our subsidiaries, whose functional currency is the U.S. dollar or the Euro, hedge a portion of forecasted foreign currency costs denominated in the Mexican Peso and Polish Zloty, respectively. We may hedge portions of our forecasted foreign currency exposure up to 48 months.

We record all derivatives in the condensed consolidated balance sheets at fair value. Our accounting treatment for these instruments is based on the hedge designation. The cash flow hedges that are designated as hedging instruments are recorded in Accumulated Other Comprehensive Income (“AOCI”) until the hedged item is recognized in earnings, at which point accumulated gains or losses will be recognized in earnings and classified with the underlying hedged expense. Derivatives that are not designated as hedging instruments are adjusted to fair value through earnings in the financial statement line item to which the derivative relates. At March 31, 2018, the company held derivatives that were designated as hedging instruments as well as derivatives that did not qualify for designation as hedging instruments as discussed below.

Deferred gains and losses associated with cash flow hedges of foreign currency costs are recognized as a component of cost of sales in the same period as the related cost is recognized. Our foreign currency transactions hedged with cash flow hedges as of March 31, 2018, are expected to occur within 1 month to 48 months.

Derivative instruments designated as cash flow hedges must be de-designated as hedges when it is probable the forecasted hedged transaction will not occur in the initially identified time period or within a subsequent two-month time period. Deferred gains and losses in AOCI associated with such derivative instruments are reclassified immediately into other expense. Any subsequent changes in fair value of such derivative instruments are reflected in other expense unless they are re-designated as hedges of other transactions.

Currency option derivative contracts not designated for hedge accounting consist principally of certain option contracts to purchase the Polish Zloty and the Euro and a Euro-U.S. dollar cross currency swap. See Note 3, “Acquisition.”

Redeemable Preferred Stock Embedded Derivative

We have determined that the conversion option embedded in Series A redeemable preferred stock is required to be accounted for separately from the Series A redeemable preferred stock as a derivative liability. Separation of the conversion option as a derivative liability is required because its economic characteristics are considered more akin to an equity instrument and therefore the conversion option is not considered to be clearly and closely related to the economic characteristics of the redeemable preferred stock. This is because the economic characteristics of the redeemable preferred stock are considered more akin to a debt instrument due to the fact that the shares are redeemable at the holder’s option, the redemption value is significantly greater than the face amount, the shares carry a fixed mandatory dividend and the stock price necessary to make conversion more attractive than redemption ($56.324) is significantly greater than the price at the date of issuance ($19.05), all of which lead to the conclusion that redemption is more likely than conversion. For additional information on the redeemable preferred stock, see Note 14, “Redeemable Preferred Shares”.

We have also determined that the early redemption option upon the occurrence of a redemption event (e.g. change of control, etc.) must also be bifurcated and accounted for separately from the redeemable preferred stock at fair value, because the debt host contract involves a substantial discount (face of $150.0 million as compared to the redemption value of $300 million) and exercise of the early redemption option would accelerate the holder’s option to redeem the shares.

Accordingly, we have recorded an embedded derivative liability representing the combined fair value of the right of holders to receive common stock upon conversion of Series A redeemable preferred stock at any time (the “conversion option”) and the right of the holders to exercise their early redemption option upon the occurrence of a redemption event (the “early redemption option”). The embedded derivative liability is adjusted to reflect fair value at each period end with changes in fair value recorded in the “Change in fair value of redeemable preferred stock embedded derivative liability” financial statement line item of the company’s condensed consolidated statements of operations (see “Note 14, Redeemable Preferred Shares”).

A binomial option pricing model is used to estimate the fair value of the conversion and early redemption options embedded in the redeemable preferred stock. The binomial model utilizes a “decision tree” whereby future movement in the company’s common stock price is estimated based on the volatility factor. The binomial options pricing model requires the development and use of assumptions. These assumptions include estimated volatility of the value of our common stock, assumed possible conversion or early redemption dates, an appropriate risk-free interest rate, risky bond rate and dividend yield.

The expected volatility of the company’s equity is estimated based on the historical volatility of our common stock. The assumed base case term used in the valuation model is the period remaining until May 22, 2024 (the earliest date at which the holder may exercise its unconditional redemption option). A number of other scenarios incorporate earlier redemption dates to address the possibility of early redemption upon the occurrence of a redemption event. The risk-free interest rate is based on the yield on the U.S. Treasury zero coupon yield curve with a remaining term equal to the expected term of the conversion and early redemption options. The significant assumptions utilized in the company’s valuation of the embedded derivative at March 31, 2018 are as follows: valuation scenario terms between 3.75 and 6.14 years, volatility of 34 percent, risk-free rate of 2.5 percent to 2.6 percent related to the respective assumed terms, a risky bond rate of 19.3 percent and a dividend yield of 2.7 percent.

Based on the foregoing assumptions, the fair value of the redeemable preferred stock embedded derivative liability at March 31, 2018 is $3.8 million and the change in fair value of redeemable preferred stock embedded derivative liability during the first quarter was $0.9 million mainly due to the decline in our stock price and the reduction in the remaining term of the options used in the valuation scenarios due to the months elapsed since issuance.

The following tables display the fair value of derivatives by balance sheet line item at March 31, 2018 and December 31, 2017:


	March 31, 2018
	Other Current Assets		Other Non-current Assets		Accrued Liabilities		Other Non-current Liabilities
(Dollars in thousands)
Foreign exchange forward contracts and collars designated as hedging instruments	$	4,410		7,255		766		2,871
Foreign exchange forward contracts not designated as hedging instruments		766		—		66		—
Aluminum forward contracts designated as hedges		2		—		1,310		—
Cross currency swap not designated as hedging instrument		—		—		2,190		734
Embedded derivative liability		—		—		—		3,787

Total derivative financial instruments	$	5,178		7,255		4,332		7,392


	December 31, 2017
	Other Current Assets		Other Non-current Assets		Accrued Liabilities		Other Non-current Liabilities
(Dollars in thousands)
Foreign exchange forward contracts and collars designated as hedging instruments	$	3,065		723		4,922		8,405
Foreign exchange forward contracts not designated as hedging instruments		721		—		206		—
Aluminum forward contracts not designated as hedges		1,833		—		—		—
Cross currency swap not designated as hedging instrument		—		—		1,467		1,106
Embedded derivative liability		—		—		—		4,685

Total derivative financial instruments	$	5,619		723		6,595		14,196

The following table summarizes the notional amount and estimated fair value of our derivative financial instruments:


	March 31, 2018					December 31, 2017
	Notional U.S. Dollar Amount		Fair Value			Notional U.S. Dollar Amount		Fair Value
(Dollars in thousands)
Foreign currency forward contracts and collars designated as hedging instruments	$	514,333	$	8,028		$	397,744	$	(9,539	)
Foreign exchange forward contracts not designated as hedging instruments		29,004		700			23,305		515
Aluminum forward contracts designated as hedges		24,038		(1,308	)		—		—
Aluminum forward contracts not designated as hedges		—		—			15,564		1,833
Cross currency swap not designated as hedging instrument		30,378		(2,924	)		36,454		(2,573	)

Total derivative financial instruments	$	597,753	$	4,496		$	473,067	$	(9,764	)

Notional amounts are presented on a gross basis. The notional amounts of the derivative financial instruments do not represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates or commodity volumes and prices.

The following table provides the impact of derivative instruments designated as cash flow hedges on our statement of operations:


Three Months Ended March 31, 2018	Amount of Gain or (Loss) Recognized in AOCI on Derivatives (Effective Portion), Net of Tax		Amount of Pre-tax Gain or (Loss) Reclassified from AOCI into Income (Effective Portion)			Amount of Pre-tax Gain or (Loss) Recognized in Income on Derivatives (Amount Excluded from Effectiveness Testing)
(Dollars in thousands)
Derivative contracts	$	13,910	$	585		$	(744	)

Total	$	13,910	$	585		$	(744	)


Three Months ended March 26, 2017	Amount of Gain or (Loss) Recognized in AOCI on Derivatives (Effective Portion), Net of Tax		Amount of Pre-tax Gain or (Loss) Reclassified from AOCI into Income (Effective Portion)			Amount of Pre-tax Gain or (Loss) Recognized in Income on Derivatives (Amount Excluded from Effectiveness Testing)
(Dollars in thousands)
Derivative contracts	$	17,059	$	(2,491	)	$	168

Total	$	17,059	$	(2,491	)	$	168