Note 6. Derivative Financial Instruments

ASC 815-10 requires enhanced disclosures regarding an entity’s derivative and hedging activities as provided below.

The Company’s risk management objective is to use the most efficient and effective methods available to us to minimize, eliminate, reduce or transfer the risks which are associated with fluctuation of exchange rates between the Canadian and U.S. dollar and the Euro and the U.S. dollar.  

When the Company’s Canadian subsidiary receives a significant new U.S. dollar order, management will evaluate different options that may be available to mitigate future currency exchange risks. The decision to hedge future sales is not automatic and is decided case by case. The Company will only use hedge instruments to hedge firm existing sales orders and not estimated exposure, when management determines that exchange risks exceeds desired risk tolerance levels.  The forward currency contracts used to hedge future sales are designated as cash flow hedges under ASC 815-10 provided certain criteria are met.  

The Company enters into forward currency exchange contracts to the extent possible in relationship such that the exchange gains and losses on the assets and liabilities denominated in other than the reporting units’ functional currency would be offset by the changes in the market value of the forward currency exchange contracts it holds.  The forward currency exchange contracts that the Company has to offset existing assets and liabilities denominated in other than the reporting units’ functional currency have been determined not to be considered a hedge under ASC 815-10. Items denominated in other than a reporting units functional currency includes U.S. denominated accounts receivables and accounts payable held by our Canadian subsidiary and certain intercompany receivables and payables between foreign subsidiaries and the Company, one of the Company’s other subsidiaries or subsidiary of the PM Group.

As required, forward currency contracts are recognized as an asset or liability at fair value on the Company’s Consolidated Balance Sheet. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative 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 (date of sale). Gains or losses on cash flow hedges when recognized into income are included in net revenues. Gains and losses on the derivative instruments representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. The Company expects minimal ineffectiveness as the Company has hedged only firm sales orders and has not hedged estimated exposures. As of December 31, 2015, the Company had no outstanding forward currency contracts that were in place to hedge future sales. Therefore, there are currently no unrealized pre-tax gains or loss which will reclassified from other comprehensive income into earnings during the next 12 months.  For instruments not qualifying as cash flow hedges under ASC 815—10, the Company records at the balance sheet date the forward currency exchange contracts at its market value with any associated gain or loss being recorded in current earnings. Both realized and unrealized gains and losses related to forward currency contracts are included in current earnings and are reflected in the Statement of Income in the other income expense section on the line titled foreign currency transaction gains (losses).

At December 31, 2015, the Company had entered into forward currency exchange contracts. The contracts obligate the Company to purchase CDN $5,602. The contracts mature between March 3, 2016 and March 31, 2016.  Under the contract, the Company will purchase Canadian dollars at exchange rates between .7211 and .7516. The Canadian to US dollar exchange rates was $.7225 at December 31, 2015. At December 31, 2015, the Company had forward currency contracts to sell Euros. The contracts obligate the Company to sell €1,300 in total. The contracts, which are in various amounts, mature between February 10, 2016 and July 1, 2016. Under the contracts, the Company will sell Euros at exchange rates between $1.1419 and $1.4307. The Euro to US dollar exchange rate was 1.0859 at December 31, 2015. The unrealized currency exchange asset is reported under prepaid expense and other if it is an asset or under accrued expenses if it is a liability on the balance sheet at December 31, 2015 and 2014.

 

The Company’s PM Group has an intercompany receivable denominated in Euros from its Chilean subsidiary. At December 31, 2015, the Company has entered into two forward contracts that mature on January 6, 2016.  The purpose of which is to mitigate the income effect related to this intercompany receivable that results with a change in exchange rate between the Euro and the Chilean peso. The first contract obligates the Company to purchase €2,600 at $1.148. The second contract obliges the Company to sell 1,840,000 Chilean pesos at an exchange rate of 616.4567 per U.S. dollar. These two contracts achieve the desired purpose as U.S. dollar amounts involved in the two forward contracts offset each other.

Interest Rate Swap Contracts

The Company uses financial instruments available on the market, including derivatives, solely to minimize its cost of borrowing and hedge the risk of interest rate and exchange rate fluctuation. In January 2009, prior to the January 15, 2015 acquisition date, PM Group entered into the following contracts in order to hedge the interest rate risk related to its term loans with two financial institutions:

A contract signed by PM Group, for an original notional amount of € 20,000 (€ 20,000 at December 31, 2015, maturing on February 3, 2017 with interest payable every February 3 and August 3 each year. PM Group pays interest at a rate of 3.48% and receives from the counterparties interest at the Euro Interbank Offered Rate (“Euribor”) for the period in question.

A contract signed by PM Group, for an original notional amount of € 8,496 (€ 739 at December 31, 2015), maturing on January 29, 2016 with interest payable every January 30 and July 30 each year. PM Group pays interest at a rate of 2.99% and receives from the counterparties interest at the Euribor rate for the period in question.

 

As of December 31, 2015, the Company had the following forward currency contracts and interest rate swaps:

 

 

The following table provides the location and fair value amounts of derivative instruments that are reported in the Consolidated Balance Sheet as of December 31, 2015 and 2014:

Total derivatives not designated as a hedge instrument

 

 

The following tables provide the effect of derivative instruments on the Consolidated Statement of Income for 2015, 2014 and 2013:

 

 

The following table shows the beginning and ending amounts of gains and losses related to hedges which have been included in Other Comprehensive Income and related activity net of income taxes for December 31, 2015 and 2014: