Quarterly report pursuant to Section 13 or 15(d)

Derivative Financial Instruments

v3.4.0.3
Derivative Financial Instruments
3 Months Ended
Mar. 31, 2016
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Financial Instruments
DERIVATIVE FINANCIAL INSTRUMENTS
We are exposed to market risk from changes in foreign exchange rates that could impact our results of operations, cash flows and financial condition. AWI enters into derivative contracts, including contracts to hedge our foreign currency exchange rate exposures. Exposure to individual counterparties is controlled and derivative financial instruments are entered into with a diversified group of major financial institutions. Forward swap contracts are entered into by AWI for periods consistent with underlying exposure and do not constitute positions independent of those exposures. At inception, hedges designated as hedging instruments are formally documented as either (1) a hedge of a forecasted transaction or “cash flow” hedge, or (2) a hedge of the fair value of a recognized liability or asset or “fair value” hedge. Derivatives are formally assessed both at inception and at least quarterly thereafter, to ensure that derivatives used in hedging transactions are highly effective in offsetting changes in either the fair value or cash flows of the hedged item. If it is determined that a derivative ceases to be a highly effective hedge, or if the anticipated transaction is no longer probable of occurring, hedge accounting is discontinued, and any future mark-to-market adjustments are recognized in earnings. Derivative financial instruments are used as risk management tools and not for speculative trading purposes.
Counterparty Risk
AWI only enters into derivative transactions with established counterparties having a credit rating of BBB or better. Counterparty credit default swap levels and credit ratings are monitored on a regular basis. All of AWI’s derivative transactions with counterparties are governed by master International Swap and Derivatives Association agreements (“ISDAs”) with netting arrangements. These agreements can limit exposure in situations where gain and loss positions are outstanding with a single counterparty. AWI neither posts nor receives cash collateral with any counterparty for its derivative transactions. These ISDAs do not have any credit contingent features; however, a default under AWI’s bank credit facility would trigger a default under these agreements. Exposure to individual counterparties is controlled, and thus the risk of counterparty default is negligible.
Currency Rate Risk – Sales and Purchases
We manufacture and sell our products in a number of countries throughout the world and, as a result, we are exposed to movements in foreign currency exchange rates. To a large extent, our global manufacturing and sales provide a natural hedge of foreign currency exchange rate movement, as foreign currency expenses generally offset foreign currency revenues. We manage our cash flow exposures on a net basis and use derivatives to hedge the majority of our unmatched foreign currency cash inflows and outflows. Before considering the impacts of any hedging, our major foreign currency exposures as of March 31, 2016, based on operating profits by currency, are to the Canadian dollar, Chinese renminbi and the Australian dollar.
We use foreign currency forward exchange contracts to reduce our exposure to the risk that the eventual net cash inflows and outflows resulting from the sale of products to foreign customers and purchases from foreign suppliers will be adversely affected by changes in exchange rates. These derivative instruments are used for forecasted transactions and are classified as cash flow hedges. These cash flow hedges are executed quarterly, generally up to 15 months forward. The notional amount of these hedges was $25.5 million and $34.9 million at March 31, 2016 and December 31, 2015, respectively. Gains and losses on these instruments are recorded in Other comprehensive income (loss), to the extent effective, until the underlying transaction is recognized in earnings. The mark-to-market gains or losses on ineffective portions of hedges are recognized in Selling, general and administrative expense. The earnings impact of the ineffective portion of these hedges was not material for the three months ended March 31, 2016 and 2015.
Financial Statement Impacts
The following tables detail amounts related to our derivatives designated as hedging instruments as of March 31, 2016 and December 31, 2015. We had no derivative assets or liabilities that were not designated as hedging instruments at March 31, 2016 or December 31, 2015. The derivative asset and liability balances below are gross amounts; we have not netted assets with liabilities.
 
Derivative Assets
 
Derivative Liabilities
 
 
 
Fair Value
 
 
 
Fair Value
(Dollars in millions)
Balance Sheet Location
 
March 31, 2016

 
December 31, 2015
 
Balance Sheet Location
 
March 31, 2016

 
December 31,
2015
Foreign exchange contracts
Prepaid expenses and other current assets
 
$
0.8

 
$
3.2

 
Accounts payable and accrued expenses
 
$
0.3

 
$
0.3


 
Amount of Gain (Loss) Recognized in Accumulated Other Comprehensive Income (“AOCI”) (Effective Portion)
 
Location of Gain (Loss) Reclassified from AOCI into Income (Effective Portion)
 
Gain (Loss) Reclassified from AOCI into Income (Effective Portion)
 
Three Months Ended March 31,
 
 
 
Three Months Ended March 31,
(Dollars in millions)
2016
 
2015
 
 
 
2016
 
2015
Foreign exchange contracts – purchases
$
(0.3
)
 
$
(0.6
)
 
Cost of goods sold
 
$
(0.1
)
 
$
(0.2
)
Foreign exchange contracts – sales
(1.1
)
 
2.7

 
Net sales
 
1.0

 
1.2

Total
$
(1.4
)
 
$
2.1

 
 
 
$
0.9

 
$
1.0



As of March 31, 2016, the amount of existing gains in AOCI expected to be recognized in earnings over the next twelve months is $0.5 million.

There was no gain or loss recognized in earnings for derivative instruments not designated as hedging instruments in the three months ended March 31, 2016 or 2015.