Derivatives

ASC 815 requires companies to recognize all derivative instruments in the consolidated balance sheet as either assets or liabilities at fair value. The accounting for changes in fair value of a derivative is dependent upon whether or not the derivative has been designated and qualifies for hedge accounting treatment and the type of hedging relationship. For derivatives designated and qualifying as hedging instruments, the company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation.

Cash Flow Hedging Strategy

The company uses derivative instruments in an attempt to manage its exposure to transactional foreign currency exchange risk and interest rate risk. Foreign forward exchange contracts are used to manage the price risk associated with forecasted sales denominated in foreign currencies and the price risk associated with forecasted purchases of inventory over the next twelve months.

The company recognizes its derivative instruments as assets or liabilities in the consolidated balance sheet measured at fair value. A majority of the company’s derivative instruments are designated and qualify as cash flow hedges. Accordingly, the effective portion of the gain or loss on the derivative instrument 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. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the fair value of the hedged item, if any, is recognized in current earnings during the period of change.

To protect against increases/decreases in forecasted foreign currency cash flows resulting from inventory purchases/sales over the next year, the company utilizes foreign currency forward contracts to hedge portions of its forecasted purchases/sales denominated in foreign currencies. The gains and losses are included in cost of products sold and selling, general and administrative expenses on the consolidated statement of comprehensive income (loss). If it is later determined that a hedged forecasted transaction is unlikely to occur, any prospective gains or losses on the forward contracts would be recognized in earnings. The company does not expect any material amount of hedge ineffectiveness related to forward contract cash flow hedges during the next twelve months.

The company has historically not recognized any material amount of ineffectiveness related to forward contract cash flow hedges because the company generally limits its hedges to between 50% and 90% of total forecasted transactions for a given entity’s exposure to currency rate changes and the transactions hedged are recurring in nature. Furthermore, most of the hedged transactions are related to intercompany sales and purchases for which settlement occurs on a specific day each month. Forward contracts with a total notional amount in USD of $45,421,000 and $126,456,000 matured for the three and nine months ended September 30, 2017 compared to $59,663,000 and $171,889,000 matured for the three and nine months ended September 30, 2016, respectively.

Outstanding foreign currency forward exchange contracts qualifying and designated for hedge accounting treatment were as follows (in thousands USD):



	September 30, 2017					December 31, 2016
	Notional Amount		Unrealized Net Gain (Loss)			Notional Amount		Unrealized Net Gain (Loss)
USD / AUD	$	4,341	$	16		$	5,841	$	316
USD / CAD	554		53			2,604		(18		)
USD / CNY	954		17			11,252		(301		)
USD / CHF	90		—			370		15
USD / EUR	42,200		(1,403		)	60,387		1,826
USD / GBP	1,645		(22		)	3,253		(75		)
USD / NZD	6,930		67			9,650		(64		)
USD / SEK	1,027		(112		)	4,923		146
USD / MXP	1,517		142			6,148		(417		)
EUR / AUD	139		3			506		6
EUR / GBP	12,184		398			14,511		(686		)
EUR / NOK	704		1			2,503		(25		)
EUR / NZD	3,133		(9		)	3,777		16
GBP / AUD	137		8			503		34
GBP / CHF	135		(1		)	215		(10		)
GBP / SEK	952		74			1,389		(42		)
CHF / DKK	60		4			595		(2		)
DKK / SEK	1,352		56			31,978		49
NOK / CHF	349		(23		)	1,335		(13		)
NOK / SEK	810		40			2,618		21
	$	79,213	$	(691	)	$	164,358	$	776

Derivatives Not Qualifying or Designated for Hedge Accounting Treatment

The company utilizes foreign currency forward contracts that are not designated as hedges in accordance with ASC 815. These contracts are entered into to eliminate the risk associated with the settlement of short-term intercompany trading receivables and payables between Invacare Corporation and its foreign subsidiaries. The currency forward contracts are entered into at the same time as the intercompany receivables or payables are created so that upon settlement, the gain/loss on the settlement is offset by the gain/loss on the foreign currency forward contract. No material net gain or loss was realized by the company in 2017 or 2016 related to these contracts and the associated short-term intercompany trading receivables and payables.

Foreign currency forward exchange contracts not qualifying or designated for hedge accounting treatment, as well as ineffective hedges, entered into in 2017 and 2016, respectively, and outstanding were as follows (in thousands USD):



	September 30, 2017					December 31, 2016
	Notional Amount		Gain (Loss)			Notional Amount		Gain (Loss)
AUD / USD	$	12,300	$	122		$	5,800	$	204
CNY / USD	3,354		56			5,556		(24		)
EUR / USD	2,145		(159		)	—		—
GBP / USD	496		(18		)	—		—
NZD / USD	4,000		47			—		—
DKK / CHF	120		7			—		—
AUD / NZD	2,602		9			3,264		15
EUR / NOK	7		—			—		—
	$	25,024	$	64		$	14,620	$	195

The fair values of the company’s derivative instruments were as follows (in thousands):



	September 30, 2017				December 31, 2016
	Assets		Liabilities		Assets		Liabilities
Derivatives designated as hedging instruments under ASC 815
Foreign currency forward exchange contracts	$	997	$	1,688	$	2,535	$	1,759
Derivatives not designated as hedging instruments under ASC 815
Foreign currency forward exchange contracts	241		177		219		24
Total derivatives	$	1,238	$	1,865	$	2,754	$	1,783

The fair values of the company’s foreign currency forward exchange contract assets and liabilities are included in Other Current Assets and Accrued Expenses, respectively in the Consolidated Balance Sheets. The effect of derivative instruments on Accumulated Other Comprehensive Income (OCI) and the Statement of Comprehensive Income (Loss) and was as follows (in thousands):



Derivatives in ASC 815 cash flow hedge relationships	Amount of Gain (Loss) Recognized in Accumulated OCI on Derivatives (Effective Portion)			Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)			Amount of Gain (Loss) Recognized in Income on Derivatives (Ineffective Portion and Amount Excluded from Effectiveness Testing)
Three months ended September 30, 2017
Foreign currency forward exchange contracts	$	(578	)	$	(395	)	$	(121	)
Nine months ended September 30, 2017
Foreign currency forward exchange contracts	$	(1,149	)	$	205		$	(114	)
Three months ended September 30 2016
Foreign currency forward exchange contracts	$	828		$	698		$	30
Nine months ended September 30, 2016
Foreign currency forward exchange contracts	$	(103	)	$	1,072		$	72

Derivatives not designated as hedging instruments under ASC 815							Amount of Gain (Loss) Recognized in Income on Derivatives
Three months ended September 30, 2017
Foreign currency forward exchange contracts							$	(53	)
Nine months ended September 30, 2017
Foreign currency forward exchange contracts							$	64
Three months ended September 30, 2016
Foreign currency forward exchange contracts							$	271
Nine months ended September 30, 2016
Foreign currency forward exchange contracts							$	(106	)

The gains or losses recognized as the result of the settlement of cash flow hedge foreign currency forward contracts are recognized in net sales for hedges of inventory sales and in cost of product sold for hedges of inventory purchases. For the three and nine months ended September 30, 2017, net sales were increased by $399,000 and $165,000 while cost of product sold was increased by $837,000 and decreased by $35,000 for a net pre-tax realized loss of $438,000 and gain of $200,000, respectively. For the three and nine months ended September 30, 2016, net sales were increased by $1,417,000 and $2,826,000 while cost of product sold was increased by $619,000 and $1,576,000 for net realized pre-tax gains of $798,000 and $1,250,000, respectively.

A loss of $53,000 and gain of $64,000 was recognized in selling, general and administrative (SG&A) expenses for the three and nine months ended September 30, 2017, respectively, compared to a gain of $271,000 and a loss of $106,000 for the three and nine months ended September 30, 2016, respectively, related to forward contracts not designated as hedging instruments that were entered into to offset gains/losses that were also recorded in SG&A expenses on intercompany trade receivables or payables. The gains/losses on the non-designated

hedging instruments were substantially offset by gains/losses on intercompany trade payables.

The company's derivative agreements provide the counterparties with a right of set off in the event of a default that would enable the counterparty to offset any net payment due by the counterparty to the company under the applicable agreement by any amount due by the company to the counterparty under any other agreement. For example, the terms of the agreement would permit a counterparty to a derivative contract that is also a lender under the company's Credit Agreement to reduce any derivative settlement amounts owed to the company under the derivative contract by any amounts owed to the counterparty by the company under the Credit Agreement. In addition, the agreements contain cross-default provisions that could trigger a default by the company under the agreement in the event of a default by the company under another agreement with the same counterparty. The company does not present any derivatives on a net basis in its financial statements, other than the conversion and bond hedge derivatives which are presented net on the Condensed Consolidated Statement of Comprehensive Income (Loss), and all derivative balances presented are subject to provisions that are similar to master netting agreements.

During the first quarter of 2016, the company entered into privately negotiated convertible 2021 note hedges and 2021 warrants in connection with its sale of $150,000,000 in aggregate principal amount of the company’s 5.00% Convertible Senior Notes due 2021. The 2021 warrants, which increased paid in capital by $12,376,000, are clearly and closely related to the convertible 2021 notes and thus classified as equity. The 2021 note hedge asset and 2021 convertible debt conversion liability were recorded, based on initial fair values, as an asset of $27,975,000 and a liability of $34,480,000, respectively, and these fair values are updated quarterly with the offset to the income statement.

During the second quarter of 2017, the company entered into privately negotiated convertible 2022 note hedges and warrants in connection with its sale of $120,000,000 in aggregate principal amount of the company’s 4.50% Convertible Senior Notes due 2022. The 2022 warrants, which increased paid in capital by $14,100,000, are clearly and closely related to the convertible 2022 notes and thus classified as equity. The 2022 note hedge assets and 2022 convertible debt conversion liability were recorded, based on initial fair values, as an asset of $24,780,000 and a liability of $28,859,000, respectively, and these fair values are updated quarterly with the offset to the income statement. See "Long-Term Debt" in the notes to the Consolidated Financial Statements included elsewhere in this report for more detail.

The fair values of the outstanding convertible note derivatives as of September 30, 2017 and their effect on the Statement of Comprehensive Income (Loss) were as follows (in thousands):



				Gain (Loss)						Gain (Loss)
	Fair Value			Three Months Ended						Nine Months Ended
	September 30, 2017			September 30, 2017			September 30, 2016			September 30, 2017			September 30, 2016
Convertible 2021 debt conversion long-term liability	$	(47,557	)	$	(15,330	)	$	7,732		$	(16,849	)	$	13,579
Convertible 2022 debt conversion long-term liability	(47,738		)	(14,487		)	—			(18,879		)	—
Convertible 2021 note hedge long-term asset	41,619			14,189			(6,540		)	16,148			(11,297		)
Convertible 2022 note hedge long-term asset	41,660			13,078			—			16,880			—
Net fair value and net gains (losses) on convertible debt derivatives	$	(12,016	)	$	(2,550	)	$	1,192		$	(2,700	)	$	2,282

The 2021 and 2022 convertible debt conversion liability amounts and the 2021 and 2022 note hedge asset amounts are included in Other Long-Term Obligations and Other Long-Term Assets, respectively, in the company's Consolidated Balance Sheets.