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DERIVATIVE FINANCIAL INSTRUMENTS
 3 Months Ended
Apr. 30, 2017
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. However, some of our foreign operations have a functional currency other than the U.S. dollar. 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 or long-term assets or other current or long-term 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 FASB Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging.

Cash Flow Hedges

We enter into foreign currency forward contracts designated as cash flow hedges (to sell Canadian dollars and purchase U.S. dollars) for forecasted inventory purchases in U.S. dollars by our foreign subsidiaries. These hedges have terms of up to 18 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 selling, general and administrative expenses. Based on the rates in effect as of April 30, 2017, we expect to reclassify a net pre-tax gain of approximately $944,000 from OCI to cost of goods sold over the next 12 months.

We also enter into non-designated foreign currency forward contracts (to sell Australian dollars and purchase U.S. dollars) to reduce the exchange risk associated with our assets and liabilities denominated in a foreign currency. Any foreign exchange gains or losses related to these contracts are recognized in selling, general and administrative expenses.

As of April 30, 2017 and May 1, 2016, we had foreign currency forward contracts outstanding (in U.S. dollars) with notional values as follows:

 

In thousands      April 30, 2017        May 1, 2016  

Contracts designated as cash flow hedges

    $ 19,200      $ 27,150  

Contracts not designated as cash flow hedges

    $ 48,000      $ 43,000  

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 selling, general and administrative expenses. 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 weeks ended April 30, 2017 and May 1, 2016.

The effect of derivative instruments in our Condensed Consolidated Financial Statements during the thirteen weeks ended April 30, 2017 and May 1, 2016, pre-tax, was as follows:

 

In thousands      April 30, 2017        May 1, 2016  

Net gain (loss) recognized in OCI

    $ 892      $ (2,933 ) 

Net gain (loss) reclassified from OCI to cost of goods sold

    $ 21      $ 409  

Net foreign exchange gain (loss) recognized in selling, general and administrative expenses:

      

Instruments designated as cash flow hedges 1

    $ 8      $ 23  

Instruments not designated or de-designated

    $ 341      $ (3,342 ) 
                   
1 Changes in fair value of the forward contract related to interest charges (or forward points).

 

The fair values of our derivative financial instruments are presented below according to their classification in our Condensed Consolidated Balance Sheets. All fair values were measured using Level 2 inputs as defined by the fair value hierarchy described in Note I.

 

In thousands      April 30, 2017       May 1, 2016  

Derivatives designated as cash flow hedges:

     

Other current assets

    $ 925     $ —    

Other long-term assets

    $ 52     $ —    

Other current liabilities

    $ —       $ (2,160 ) 

Derivatives not designated as hedging instruments:

     

Other current liabilities

    $ (83 )    $ (287 ) 
                  

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.