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Derivative Instruments and Hedging Activities
The company is exposed to foreign currency exchange rate risk arising from transactions in the normal course of business, such as sales to third party customers, sales and loans to wholly owned foreign subsidiaries, foreign plant operations, and purchases from suppliers. The company actively manages the exposure of its foreign currency market risk by entering into various hedging instruments, authorized under company policies that place controls on these activities, with counterparties that are highly rated financial institutions. The company’s hedging activities involve the primary use of forward currency contracts. The company uses derivative instruments only in an attempt to limit underlying exposure from foreign currency exchange rate fluctuations and to minimize earnings and cash flow volatility associated with foreign currency exchange rate changes. Decisions on whether to use such contracts are made based on the amount of exposure to the currency involved, and an assessment of the near-term market value for each currency. The company’s policy does not allow the use of derivatives for trading or speculative purposes. The company’s primary foreign currency exchange rate exposures are with the Euro, the Australian dollar, the Canadian dollar, the British pound, the Mexican peso, and the Japanese yen against the U.S. dollar. The company also has exposure with the Romanian New Lei against the Euro and U.S. dollar as a result of its new manufacturing facility in Romania.
Cash flow hedges. The company recognizes all derivative instruments as either assets or liabilities at fair value on its consolidated balance sheet and formally documents relationships between cash flow hedging instruments and hedged items, as well as its risk-management objectives and strategy for undertaking hedge transactions. This process includes linking all derivatives to the forecasted transactions, such as sales to third parties and foreign plant operations. Changes in the fair value of outstanding derivative instruments that are designated and qualify as a cash flow hedge are recorded in other comprehensive income (“OCI”), except for the ineffective portion, until net earnings is affected by the variability of cash flows of the hedged transaction. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in net earnings. The consolidated statement of earnings classification of effective hedge results is the same as that of the underlying exposure. Results of hedges of sales and foreign plant operations are recorded in net sales and cost of sales, respectively, when the underlying hedged transaction affects net earnings. The maximum amount of time the company hedges its exposure to the variability in future cash flows for forecasted trade sales and purchases is two years.
The company formally assesses at a hedge’s inception and on an ongoing basis whether the derivatives that are used in the hedging transaction have been highly effective in offsetting changes in the cash flows of the hedged items and whether those derivatives may be expected to remain highly effective in future periods. When it is determined that a derivative is not, or has ceased to be, highly effective as a hedge, the company discontinues hedge accounting prospectively. When the company discontinues hedge accounting because it is no longer probable, but it is still reasonably possible that the forecasted transaction will occur by the end of the originally expected period or within an additional two-month period of time thereafter, the gain or loss on the derivative remains in accumulated other comprehensive loss (“AOCL”) and is reclassified to net earnings when the forecasted transaction affects net earnings. However, if it is probable that a forecasted transaction will not occur by the end of the originally specified time period or within an additional two-month period of time thereafter, the gains and losses that were accumulated in OCI are recognized immediately in net earnings. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the company carries the derivative at its fair value on the balance sheet, recognizing future changes in the fair value in other income, net. For the third quarter of fiscal 2011, there were no gains or losses on contracts reclassified into earnings as a result of the discontinuance of cash flow hedges. As of July 29, 2011, the notional amount outstanding of forward contracts designated as cash flow hedges was $89.4 million.
Derivatives not designated as hedging instruments. The company also enters into forward currency contracts to mitigate the change in fair value of specific assets and liabilities on the consolidated balance sheet. These contracts are not designated as hedging instruments. Accordingly, changes in the fair value of hedges of recorded balance sheet positions, such as cash, receivables, payables, intercompany notes, and other various contractual claims to pay or receive foreign currencies other than the functional currency, are recognized immediately in other income, net, on the consolidated statements of earnings together with the transaction gain or loss from the hedged balance sheet position.
The following table presents the fair value of the company’s derivatives and consolidated balance sheet location.
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Asset Derivatives |
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Liability Derivatives |
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July 29, 2011 |
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July 30, 2010 |
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July 29, 2011 |
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July 30, 2010 |
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|
|
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Balance |
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Balance |
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Balance |
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Balance |
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|
|
|
|
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Sheet |
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Fair |
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Sheet |
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Fair |
|
Sheet |
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Fair |
|
Sheet |
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Fair |
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(Dollars in thousands) |
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Location |
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Value |
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Location |
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Value |
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Location |
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Value |
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Location |
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Value |
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Derivatives Designated as Hedging Instruments |
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Foreign exchange contracts |
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Prepaid expenses |
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$ |
— |
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Prepaid expenses |
|
$ |
— |
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Accrued liabilities |
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$ |
961 |
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Accrued liabilities |
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$ |
268 |
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Derivatives Not Designated as Hedging Instruments |
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Foreign exchange contracts |
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Prepaid expenses |
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— |
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Prepaid expenses |
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— |
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Accrued liabilities |
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3,212 |
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Accrued liabilities |
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791 |
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Total Derivatives |
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$ |
— |
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|
|
$ |
— |
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|
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$ |
4,173 |
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|
$ |
1,059 |
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The following table presents the impact of derivative instruments on the consolidated statements of earnings for the company’s derivatives designed as cash flow hedging instruments for the three and nine months ended July 29, 2011 and July 30, 2010, respectively.
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Location of Gain (Loss) |
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Gain (Loss) |
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Location of Gain |
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Recognized in Income |
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Recognized in Income |
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Gain (Loss) |
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(Loss) Reclassified |
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Gain (Loss) |
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on Derivatives |
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on Derivatives |
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|
|
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Recognized in OCI on |
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from AOCL |
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Reclassified from |
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(Ineffective Portion |
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(Ineffective Portion and |
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|
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Derivatives |
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into Income |
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AOCL into Income |
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and excluded from |
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Excluded from |
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(Effective Portion) |
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(Effective Portion) |
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(Effective Portion) |
|
Effectiveness Testing) |
|
Effectiveness Testing) |
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(Dollars in thousands) |
|
July 29, |
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July 30, |
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|
|
July 29, |
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July 30, |
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|
|
July 29, |
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July 30, |
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For the three months ended |
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2011 |
|
2010 |
|
|
|
2011 |
|
2010 |
|
|
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2011 |
|
2010 |
|
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Foreign exchange contracts |
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$ |
732 |
|
$ |
428 |
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Net sales |
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$ |
(1,992 |
) |
$ |
8 |
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Other income, net |
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$ |
(353 |
) |
$ |
51 |
|
|
Foreign exchange contracts |
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(28 |
) |
154 |
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Cost of sales |
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387 |
|
178 |
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Total |
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$ |
704 |
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$ |
582 |
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|
|
$ |
(1,605 |
) |
$ |
186 |
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July 29, |
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July 30, |
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|
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July 29, |
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July 30, |
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|
|
July 29, |
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July 30, |
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|
For the nine months ended |
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2011 |
|
2010 |
|
|
|
2011 |
|
2010 |
|
|
|
2011 |
|
2010 |
|
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Foreign exchange contracts |
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$ |
(6,387 |
) |
$ |
(1,917 |
) |
Net sales |
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$ |
(4,582 |
) |
$ |
(1,518 |
) |
Other income, net |
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$ |
(711 |
) |
$ |
(126 |
) |
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Foreign exchange contracts |
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1,200 |
|
405 |
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Cost of sales |
|
761 |
|
273 |
|
|
|
|
|
|
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Total |
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$ |
(5,187 |
) |
$ |
(1,512 |
) |
|
|
$ |
(3,821 |
) |
$ |
(1,245 |
) |
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As of July 29, 2011, the company anticipates reclassifying approximately $0.5 million of losses from AOCL to earnings during the next 12 months.
The following table presents the impact of derivative instruments on the consolidated statements of earnings for the company’s derivatives not designated as hedging instruments.
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Gain (Loss) Recognized in Net Earnings |
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|
|
|
|
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Three Months Ended |
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Nine Months Ended |
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|
|
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Location of Gain (Loss) |
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July 29, |
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July 30, |
|
July 29, |
|
July 30, |
|
|
(Dollars in thousands) |
|
Recognized in Net Earnings |
|
2011 |
|
2010 |
|
2011 |
|
2010 |
|
|
|
|
|
|
|
|
|
|
|
|
|
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Foreign exchange contracts |
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Other income, net |
|
$ |
543 |
|
$ |
2,247 |
|
$ |
(8,966 |
) |
$ |
6,449 |
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