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DERIVATIVE FINANCIAL INSTRUMENTS
 6 Months Ended
Aug. 02, 2015
DERIVATIVE FINANCIAL INSTRUMENTS

NOTE H. DERIVATIVE FINANCIAL INSTRUMENTS

We have retail and/or e-commerce businesses in Canada, Australia and the United Kingdom, and operations throughout Asia and Europe, which expose us to market risk associated with foreign currency exchange rate fluctuations. Substantially all of our purchases and sales are denominated in U.S. dollars, which limits our exposure to this risk. While the impact of foreign currency exchange rate fluctuations was not significant to us in the second quarter of fiscal 2015, we continue to see volatility in the exchange rates in the countries in which we do business. As we continue to expand globally, the foreign currency exchange risk related to the transactions of our foreign subsidiaries may increase. To mitigate this risk, we hedge a portion of our foreign currency exposure with foreign currency forward contracts in accordance with our risk management policies. We do not enter into such contracts for speculative purposes.

The assets or liabilities associated with the derivative instruments are measured at fair value and recorded in either other current assets or other current liabilities. As discussed below, the accounting for gains and losses resulting from changes in fair value depends on whether the derivative instrument is designated as a hedge and qualifies for hedge accounting in accordance with the Financial Accounting Standards Board Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging.

Cash Flow Hedges

We enter into foreign currency forward contracts designated as cash flow hedges for forecasted inventory purchases in U.S. dollars by our foreign subsidiaries. These hedges generally have terms of up to 12 months. All hedging relationships are formally documented, and the forward contracts are designed to mitigate foreign currency exchange risk on hedged transactions. We record the effective portion of changes in the fair value of our cash flow hedges in other comprehensive income (“OCI”) until the earlier of when the hedged forecasted inventory purchase occurs or the respective contract reaches maturity. Subsequently, as the inventory is sold to the customer, we reclassify amounts previously recorded in OCI to cost of goods sold. Changes in the fair value of the forward contract related to interest charges or “forward points” are excluded from the assessment and measurement of hedge effectiveness and are recorded immediately in other income (expense), net within selling, general and administrative expenses. Based on the rates in effect as of August 2, 2015, we expect to reclassify a net pre-tax gain of approximately $981,000 from OCI to cost of goods sold over the next 12 months.

We also enter into non-designated foreign currency forward contracts to reduce the exchange risk associated with our assets and liabilities denominated in a foreign currency. Any foreign exchange gains (losses) related to these contracts are recognized in other income (expense), net.

 

As of August 2, 2015, and August 3, 2014, we had foreign currency forward contracts outstanding (in U.S. dollars) as follows:

 

In thousands    August 2, 2015      August 3, 2014  

Contracts to sell Canadian dollars and buy U.S. dollars

      

Contracts designated as cash flow hedges

      $  12,500         $  24,400   

Contracts not designated as cash flow hedges 1

      $           0         $           0   

Contracts to sell Australian dollars and buy U.S. dollars

      

Contracts not designated as cash flow hedges

      $  35,000         $  10,410   
1  These contracts are no longer designated as cash flow hedges as the related inventory purchases have occurred.

Hedge effectiveness is evaluated prospectively at inception, on an ongoing basis, as well as retrospectively using regression analysis. Any measureable ineffectiveness of the hedge is recorded in other income (expense), net. No gain or loss was recognized for cash flow hedges due to hedge ineffectiveness and all hedges were deemed effective for assessment purposes for the thirteen and twenty-six weeks ended August 2, 2015 and August 3, 2014.

The effect of derivative instruments in our Condensed Consolidated Financial Statements, pre-tax, was as follows:

 

In thousands   Thirteen
Weeks Ended
August 2, 2015		    

Thirteen

Weeks Ended

August 3, 2014

     Twenty-Six
Weeks Ended
August 2, 2015		    

Twenty-Six

Weeks Ended

August 3, 2014

  

Net gain (loss) recognized in OCI

     $   1,084        $   22        $    571        $  (202 ) 

Net gain reclassified from OCI into cost of goods sold

     $      643        $ 287        $    911        $   520   

Net foreign exchange gain (loss) recognized in other income (expense):

        

Instruments designated as cash flow hedges1

     $       (26 )      $  (53 )      $     (42 )      $    (87 ) 

Instruments not designated or de-designated2

     $   2,023        $   36        $ 2,405        $   620   
1  Changes in fair value of the forward contract related to interest charges or “forward points.”
2  Changes in fair value subsequent to de-designation for instruments no longer designated as cash flow hedges, and changes in fair value related to instruments not designated as cash flow hedges.

The fair values of our derivative financial instruments are presented below. All fair values for these derivatives were measured using Level 2 inputs as defined by the fair value hierarchy described in Note I.

 

In thousands    Balance sheet location    August 2, 2015      August 3, 2014  

Derivatives designated as hedging instruments:

         

Cash flow hedge foreign currency forward contracts

    Other current assets      $  610         $ 150   

Cash flow hedge foreign currency forward contracts

    Other current liabilities      0         (198 ) 

Total, net

           $  610         $  (48 ) 

Derivatives not designated as hedging instruments:

         

Foreign currency forward contracts

    Other current assets      $    79         $     0   

Foreign currency forward contracts

    Other current liabilities      0         $  (16 ) 

Total, net

           $    79         $  (16 ) 

We record all derivative assets and liabilities on a gross basis. They do not meet the balance sheet netting criteria as discussed in ASC 210, Balance Sheet, because we do not have master netting agreements established with our derivative counterparties that would allow for net settlement.