Derivative Financial Instruments

9 Months Ended

Sep. 30, 2011

Derivative Financial Instruments

Derivative Financial Instruments

5. Derivative Financial Instruments

The company’s risk management objective is to ensure that business exposures to risk that have been identified and measured and are capable of being controlled are minimized using the most effective and efficient methods to eliminate, reduce, or transfer such exposures.  Operating decisions consider associated risks and structure transactions to avoid risk whenever possible.

Use of derivative instruments is consistent with the overall business and risk management objectives of the company.  Derivative instruments may be used to manage business risk within limits specified by the company’s risk policy and manage exposures that have been identified through the risk identification and measurement process, provided that they clearly qualify as “hedging” activities as defined in the risk policy.  Use of derivative instruments is not automatic, nor is it necessarily the only response to managing pertinent business risk.  Use is permitted only after the risks that have been identified are determined to exceed defined tolerance levels and are considered to be unavoidable.

The primary risks managed by the company by using derivative instruments are interest rate risk, commodity price risk and foreign currency exchange risk.  Interest rate swap and cap instruments are entered into to manage interest rate or fair value risk.  Forward contracts on various commodities are entered into to manage the price risk associated with forecasted purchases of materials used in the company’s manufacturing process.  The company also enters into various foreign currency derivative instruments to manage foreign currency risk associated with the company’s projected foreign currency denominated purchases, sales, and receivable and payable balances.

ASC Topic 815-10, “Derivatives and Hedging,” requires companies to recognize all derivative instruments as either assets or liabilities at fair value in the statement of financial position.  In accordance with ASC Topic 815-10, the company designates forward commodity contracts, foreign currency exchange contracts, and interest rate swaps and caps contracts as cash flow hedges of forecasted purchases of commodities and currencies, and variable rate interest payments.  Also in accordance with ASC Topic 815-10, the company designates fixed-to-float interest rate swaps as fair market value hedges of fixed rate debt, which synthetically swap the company’s fixed rate debt to floating rate debt.

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.  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.  In the next twelve months the company estimates $5.2 million of unrealized and realized losses net of tax related to commodity price and currency exchange rate hedging will be reclassified from Other Comprehensive Income into earnings.  Foreign currency and commodity hedging is generally completed prospectively on a rolling basis for between twelve and twenty-four months depending on the type of risk being hedged.

Regarding the fair market value hedges related to the Notes (see Note 9, Debt), the risk management objective is to offset the changes in fair value of the company’s fixed-rate debt associated with the risk of variability in the six-month U.S. LIBOR rate.  In essence, the objective is to economically change the company’s fixed-rate debt to variable rate debt.  The swap includes an embedded call feature to match the terms of the call embedded in the debt. Changes in the fair value of the interest rate swap (which includes an embedded mirror image option) are expected to offset changes in the fair value of the debt due to changes in the U.S. LIBOR rate (the designated benchmark interest rate).  In order to meet the risk management objective, the company entered into an interest rate swap with the same critical terms (notional amounts, re-pricing dates, call schedule, and index on which the variable rate is based) as the Company’s fixed-rate debt.  Since the critical terms of the hedging instrument match the critical terms of the company’s fixed rate debt, the company expects the interest rate swap to offset the changes in fair value of the debt attributable to the variability in the six-month US LIBOR rate.  The company is applying the “shortcut method” outlined in ASC 815-20-25-102 through 25-117 and accordingly, since all of the requirements under ASC 815-20-25-104 through 25-105 for the assumption of no ineffectiveness have been met, the company believes that the hedging relationship is effective.

As of September 30, 2011 and December 31, 2010, the company had the following outstanding commodity and currency forward contracts that were entered into to hedge forecasted transactions:

	Units Hedged
Commodity	September 30, 2011	December 31, 2010		Type
Aluminum	1,460	688	MT	Cash Flow
Copper	790	312	MT	Cash Flow
Natural Gas	215,463	304,177	MMBtu	Cash Flow
Steel	11,937	—	Tons	Cash Flow

	Units Hedged
Short Currency	September 30, 2011	December 31, 2010	Type
Canadian Dollar	29,954,694	21,186,951	Cash Flow
Chinese Renminbi	46,406,557	—	Cash Flow
European Euro	74,872,056	43,440,929	Cash Flow
South Korean Won	1,970,968,575	2,245,331,882	Cash Flow
Singapore Dollar	6,720,000	4,140,000	Cash Flow
United States Dollar	10,314,400	8,828,840	Cash Flow
British Pound	—	399,999	Cash Flow

The total notional amount of the company’s receive-floating/pay-fixed interest rate swaps of the company’s term loans was $650.8 million on December 31, 2010.  These hedges were dedesignated, offset, and written off on June 30, 2011.  The total notional amount of the company’s interest rate caps entered into during the third quarter 2011 was $450.0 million on September 30, 2011.  These interest rate derivative instruments effectively cap the company’s future interest rate exposure for the notional value of its variable term debt at a LIBOR rate of 3.00% plus the applicable spread per the New Senior Credit Agreement.

The company monetized the derivative asset related to its fixed-to-float interest rate swaps and received $21.5 million in the third quarter of 2011.  The gain is treated as an increase to the debt balances for each of the senior notes and will be amortized to interest expense over the life of the original swap.

The designated fair market value hedges of fixed-to-float swaps of the company’s 9.50% Senior Notes due 2018 (the “2018 Notes”) was $125.0 million and $200.0 million as of September 30, 2011 and December 31, 2010, respectively.  The designated fair market value hedges of fixed-to-float swaps of the company’s 8.50% Senior Notes due 2020 (the “2020 Notes”) was $200.0 million and $300.0 million as of September 30, 2011 and December 31, 2010, respectively.

For derivative instruments that are not designated as hedging instruments under ASC Topic 815-10, the gains or losses on the derivatives are recognized in current earnings within cost of sales or other income, net in the Consolidated Statements of Operations.

As of September 30, 2011 and December 31, 2010, the company had the following outstanding currency forward contracts that were not designated as hedging instruments:

	Units Hedged
Short Currency	September 30, 2011	December 31, 2010	Recognized Location	Purpose
British Pound	—	8,172,569	Other income, net	Accounts Payable and Receivable Settlement
Euro	20,732,338	7,732,026	Other income, net	Accounts Payable and Receivable Settlement
United States Dollar	38,879,449	33,158,979	Other income, net	Accounts Payable and Receivable Settlement
Japanese Yen	190,000,000	—	Other income, net	Accounts Payable and Receivable Settlement

The fair value of outstanding derivative contracts recorded as assets in the accompanying Consolidated Balance Sheet as of September 30, 2011 and December 31, 2010 was as follows:

		ASSET DERIVATIVES
		September 30, 2011		December 31, 2010
(in millions)	Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments
Foreign exchange contracts	Other current assets	$	0.6	$	1.8
Commodity contracts	Other current assets	—		1.1
Interest rate cap contracts	Other non-current assets	0.4		—
Total derivatives designated as hedging instruments		$	1.0	$	2.9

		ASSET DERIVATIVES
		September 30, 2011		December 31, 2010
(in millions)	Balance Sheet Location	Fair Value
Derivatives NOT designated as hedging instruments
Foreign exchange contracts	Other current assets	$	—	$	0.5
Total derivatives NOT designated as hedging instruments		$	—	$	0.5
Total asset derivatives		$	1.0	$	3.4

The fair value of outstanding derivative contracts recorded as liabilities in the accompanying Consolidated Balance Sheet as of September 30, 2011 and December 31, 2010 was as follows:

		LIABILITY DERIVATIVES
		September 30, 2011		December 31, 2010
(in millions)	Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments
Foreign exchange contracts	Accounts payable and accrued expenses	$	5.9	$	0.6
Interest rate swap contracts: Fixed-to-float	Other non-current liabilities	3.0		38.4
Commodity contracts	Accounts payable and accrued expenses	2.8		0.3
Total derivatives designated as hedging instruments		$	11.7	$	39.3

		LIABILITY DERIVATIVES
		September 30, 2011		December 31, 2010
(in millions)	Balance Sheet Location	Fair Value
Derivatives NOT designated as hedging instruments
Foreign exchange contracts	Accounts payable and accrued expenses	$	0.7	$	—
Interest rate swap contracts: Float-to-fixed	Other non-current liabilities	11.9		—
Total derivatives NOT designated as hedging instruments		$	12.6	$	—
Total liability derivatives		$	24.3	$	39.3

The effect of derivative instruments on the consolidated statement of operations for the three-months ended September 30, 2011 and September 30, 2010 for gains or losses initially recognized in Other Comprehensive Income (OCI) in the Consolidated Balance Sheet was as follows:

	Amount of Gain or (Loss) Recognized in						Location of Gain or (Loss)	Amount of Gain or (Loss) Reclassified
	OCI on Derivative (Effective Portion,						Reclassified from	from Accumulated OCI into Income
	net of tax)						Accumulated	(Effective Portion)
Derivatives in Cash Flow Hedging	September 30,			September 30,			OCI into Income	September 30,			September 30,
Relationships	2011			2010			(Effective Portion)	2011			2010
Foreign exchange contracts	$	(6.1	)	$	5.2		Cost of sales	$	0.7		$	(1.7	)
Interest rate swap & cap contracts	0.2			(1.8		)	Interest expense	—			(2.5		)
Commodity contracts	(2.0		)	0.3			Cost of sales	(0.1		)	0.3
Total	$	(7.9	)	$	3.7			$	0.6		$	(3.9	)

	Location of Gain or (Loss)
	Recognized in Income on	Amount of Gain or (Loss) Recognized in Income on
	Derivative (Ineffective	Derivative (Ineffective Portion and Amount Excluded
	Portion and Amount	from
Derivatives	Excluded from	Effectiveness Testing)
Relationships	Effectiveness Testing)	September 30, 2011			September 30, 2010
Commodity contracts	Cost of sales	$	(0.1	)	$	0.1
Total		$	(0.1	)	$	0.1

	Location of Gain or (Loss)
	Recognized	Amount of Gain or (Loss) Recognized in Income on
Derivatives Not Designated as	in Income on	Derivative
Hedging Instruments	Derivative	September 30, 2011		September 30, 2010
Foreign exchange contracts	Other income	$	1.5	$	(0.6	)
Interest rate swaps	Other income	2.4		—
Total		$	3.9	$	(0.6	)

The effect of derivative instruments on the consolidated statement of operations for the nine-months ended September 30, 2011 and September 30, 2010 for gains or losses initially recognized in Other Comprehensive Income (OCI) in the Consolidated Balance Sheet was as follows:

	Amount of Gain or (Loss) Recognized in						Location of Gain or (Loss)	Amount of Gain or (Loss) Reclassified
	OCI on Derivative (Effective Portion,						Reclassified from	from Accumulated OCI into Income
	net of tax)						Accumulated	(Effective Portion)
Derivatives in Cash Flow Hedging	September 30,			September 30,			OCI into Income	September 30,			September 30,
Relationships	2011			2010			(Effective Portion)	2011			2010
Foreign exchange contracts	$	(4.2	)	$	0.5		Cost of sales	$	4.1		$	(4.2	)
Interest rate swap & cap contracts	1.3			(8.8		)	Interest expense	(5.3		)	(7.9		)
Commodity contracts	(2.3		)	(0.5		)	Cost of sales	0.2			0.8
Total	$	(5.2	)	$	(8.8	)		$	(1.0	)	$	(11.3	)

Derivatives	Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from	Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
Relationships	Effectiveness Testing)	September 30, 2011			September 30, 2010
Commodity contracts	Cost of sales	$	(0.1	)	$	0.1
Total		$	(0.1	)	$	0.1

Derivatives Not Designated as	Location of Gain or (Loss) Recognized in Income on	Amount of Gain or (Loss) Recognized in Income on Derivative
Hedging Instruments	Derivative	September 30, 2011			September 30, 2010
Foreign exchange contracts	Other income	$	(1.2	)	$	(0.4	)
Interest rate swaps	Other income	2.4			$	—
Total		$	1.2		$	(0.4	)

The effect of Fair Market Value designated derivative instruments on the consolidated statement of operations for the three-months ended September 30, 2011 and September 30, 2010 for gains or losses recognized through income was as follows:

Derivatives Designated as Fair Market Value	Location of Gain or (Loss) Recognized in	Amount of Gain or (Loss) Recognized in Income on Derivative
Instruments under ASC 815	Income on Derivative	September 30, 2011		September 30, 2010
Interest rate swap contracts	Interest expense	$	7.1	$	—
Total		$	7.1	$	—

The effect of Fair Market Value designated derivative instruments on the consolidated statement of operations for the nine-months ended September 30, 2011 and September 30, 2010 for gains or losses recognized through income was as follows:

Derivatives Designated as Fair Market Value	Location of Gain or (Loss) Recognized in	Amount of Gain or (Loss) Recognized in Income on Derivative
Instruments under ASC 815	Income on Derivative	September 30, 2011		September 30, 2010
Interest rate swap contracts	Interest expense	$	18.8	$	—
Total		$	18.8	$	—