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Financial Instruments and Risk Management
 6 Months Ended
Aug. 31, 2012
Financial Instruments and Risk Management  
Financial Instruments and Risk Management

Note 12 – Financial Instruments and Risk Management

 

Foreign Currency Risk - Our functional currency is the U.S. Dollar. By operating internationally, we are subject to foreign currency risk from transactions denominated in currencies other than the U.S. Dollar (“foreign currencies”).  Such transactions include sales, certain inventory purchases and operating expenses. As a result of such transactions, portions of our cash, trade accounts receivable and trade accounts payable are denominated in foreign currencies.  During the three- and six-month periods ended August 31, 2012, approximately 16 percent of our net sales revenue was in foreign currencies.  During the three- and six-month periods ended August 31, 2011, approximately 17 and 19 percent, respectively, of our net sales revenue was in foreign currencies.  In each of the periods, sales were primarily denominated in British Pounds, Euros, Mexican Pesos, Canadian Dollars, Japanese Yen, Australian Dollars, Chilean Pesos, Peruvian Soles, and Venezuelan Bolivares Fuertes. We make most of our inventory purchases from the Far East and use the U.S. Dollar for such purchases.  In our consolidated condensed statements of income, exchange gains and losses resulting from the remeasurement of foreign taxes receivable, taxes payable, deferred tax assets, and deferred tax liabilities are recognized in their respective income tax lines, and all other foreign exchange gains and losses from remeasurement are recognized in SG&A.  For the three- and six-month periods ended August 31, 2012, we recorded net foreign exchange gains (losses), including the impact of currency hedges and currency swaps, of $0.77 and ($0.17) million, respectively, in SG&A and ($0.03) and $0.16 million, respectively, in income tax expense.  For the three- and six-month periods ended August 31, 2011, we recorded net foreign exchange gains (losses), including the impact of currency hedges, of ($0.05) and ($0.20) million, respectively, in SG&A and ($0.04) and ($0.08) million, respectively, in income tax expense.

 

We have historically hedged against certain foreign currency exchange rate risk by using a series of forward contracts designated as cash flow hedges to protect against the foreign currency exchange risk inherent in our forecasted transactions denominated in currencies other than the U.S. Dollar.  We do not enter into any forward exchange contracts or similar instruments for trading or other speculative purposes.

 

Interest Rate Risk – Interest on our outstanding debt as of August 31, 2012 is both floating and fixed.  Fixed rates are in place on $100.00 million of Senior Notes due January 2018 at 3.90 percent and floating rates are in place on $161.00 million in advances against our Credit Agreement and $75.00 million of Senior Notes due June 2014.  If short-term interest rates increase, we will incur higher interest rates on any outstanding balances under the Credit Agreement. The floating rate Senior Notes due June 2014 reset as described in Note 10, and have been effectively converted to fixed rate debt using an interest rate swap, as described below.

 

We manage our floating rate debt using an interest rate swap.  As of August, 31, 2012, the swap converted an aggregate notional principal amount of $75.00 million from floating interest rate payments under our Senior Notes due June 2014 to fixed interest rate payments at 6.01 percent.  In the swap transaction, we maintain contracts to pay fixed rates of interest on an aggregate notional principal amount of $75.00 million at a rate of 5.11 percent on our Senior Notes due June 2014, while simultaneously receiving floating rate interest payments set at 0.46 percent as of August 31, 2012 on the same notional amounts. The fixed rate side of the swap will not change over its life. The floating rate payments are reset quarterly based on three-month LIBOR. The resets are concurrent with the interest payments made on the underlying debt. Changes in the spread between the fixed rate payment side of the swap and the floating rate receipt side of the swap offset 100 percent of the change in any period of the underlying debt’s floating rate payments. The swap is used to reduce our risk of increased interest costs; however, when interest rates drop significantly below the swap rate, we lose the benefit that our floating rate debt would provide if not managed with a swap. The swap is considered 100 percent effective.

 

In addition, during August 2012, we entered into two foreign currency swaps maturing October 2012, which we accounted for as cash flow hedges.

 

The fair values of our various derivative instruments are as follows:

 

FAIR VALUES OF DERIVATIVE INSTRUMENTS

(in thousands)

August 31, 2012

 

 

 

 

 

 

 

 

Prepaid

 

Accrued

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

Expenses

 

 

 

 

 

 

 

Final

 

 

 

and Other

 

and Other

 

Other

 

 

 

 

 

Settlement

 

Notional

 

Current

 

Current

 

Liabilities,

 

Designated as hedging instruments

 

Hedge Type

 

Date

 

Amount

 

Assets

 

Liabilities

 

Noncurrent

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency contracts - sell Canadian

 

Cash flow

 

12/2012

 

$

7,000

 

$

-    

 

$

209

 

$

-    

 

Foreign currency contracts - sell Euro

 

Cash flow

 

2/2013

 

€

10,000

 

-    

 

104

 

-    

 

Foreign currency contracts - sell Pounds

 

Cash flow

 

2/2013

 

£

4,500

 

-    

 

9

 

-    

 

Foreign currency swaps - buy Canadian

 

Cash flow

 

10/2012

 

$

2,400

 

36

 

-    

 

-    

 

Interest rate swap

 

Cash flow

 

6/2014

 

$

75,000

 

-    

 

3,574

 

3,574

 

Total fair value

 

 

 

 

 

 

 

$

36

 

$

3,896

 

$

3,574

 

 

February 29, 2012

 

 

 

 

 

 

 

 

Prepaid

 

Accrued

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

Expenses

 

 

 

 

 

 

 

Final

 

 

 

and Other

 

and Other

 

Other

 

 

 

 

 

Settlement

 

Notional

 

Current

 

Current

 

Liabilities,

 

Designated as hedging instruments

 

Hedge Type

 

Date

 

Amount

 

Assets

 

Liabilities

 

Noncurrent

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency contracts - sell Canadian

 

Cash flow

 

12/2012

 

$

7,000

 

$

-    

 

$

163

 

$

-    

 

Interest rate swap

 

Cash flow

 

6/2014

 

$

75,000

 

-    

 

3,531

 

5,022

 

Total fair value

 

 

 

 

 

 

 

$

-    

 

$

3,694

 

$

5,022

 

 

The pre-tax effect of derivative instruments for the periods covered in the accompanying consolidated condensed financial statements are as follows:

 

PRE-TAX EFFECT OF DERIVATIVE INSTRUMENTS

(in thousands)

 

 

Three Months Ended August 31,

 

 

 

 

Gain \ (Loss)

 

 

Gain \ (Loss) Reclassified

 

 

 

 

 

 

 

 

Recognized in OCI

 

 

from Accumulated Other

 

 

 

Gain \ (Loss) Recognized

 

 

 

 

(effective portion)

 

 

Comprehensive Loss into Income

 

 

 

as Income (1)

 

 

 

 

2012

 

 

2011

 

 

Location

 

 

2012

 

 

 

2011

 

 

 

Location

 

 

2012

 

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency contracts - ordinary and cash flow hedges

 

$

(933

)

$

499

 

 

SG&A

 

$

11

 

 

$

(125

)

 

 

SG&A

 

$

14

 

$

(115)

 

Interest rate swaps - cash flow hedges

 

 

(457

)

 

(846

)

 

Interest expense

 

 

(980

)

 

 

(1,103

)

 

 

 

 

 

-    

 

 

-      

 

Total

 

$

(1,390

)

$

(347

)

 

 

 

$

(969

)

 

$

(1,228

)

 

 

 

 

$

14

 

$

(115)

 

 

 

 

 

 

 

Six Months Ended August 31,

 

 

 

 

Gain \ (Loss)

 

 

Gain \ (Loss) Reclassified

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recognized in OCI

 

 

from Accumulated Other

 

 

 

Gain \ (Loss) Recognized

 

 

 

 

(effective portion)

 

 

Comprehensive Loss into Income

 

 

 

as Income (1)

 

 

 

 

2012

 

 

2011

 

 

Location

 

 

2012

 

 

 

2011

 

 

 

Location

 

 

2012

 

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency contracts - ordinary and cash flow hedges

 

$

(23

)

$

12

 

 

SG&A

 

$

37

 

 

$

(269

)

 

 

SG&A

 

$

49

 

$

(178)

 

Interest rate swaps - cash flow hedges

 

 

(501

)

 

(3,288

)

 

Interest expense

 

 

(1,906

)

 

 

(2,629

)

 

 

 

 

 

-    

 

 

-      

 

Total

 

$

(524

)

$

(3,276

)

 

 

 

$

(1,869

)

 

$

(2,898

)

 

 

 

 

$

49

 

$

(178)

 

 

(1)  The amounts shown represent the ineffective portion of the change in fair value of cash flow hedges.

 

We expect net losses of $0.29 million associated with foreign currency contracts and a foreign currency swap, and a loss of $3.57 million associated with our interest rate swap, currently reported in accumulated other comprehensive loss, to be reclassified into income over the next twelve months. The amount ultimately realized, however, will differ as exchange rates and interest rates change and the underlying contracts settle.

 

Counterparty Credit Risk - Financial instruments, including foreign currency contracts, foreign currency swaps and interest rate swaps, expose us to counterparty credit risk for nonperformance. We manage our exposure to counterparty credit risk by only dealing with counterparties who are substantial international financial institutions with significant experience using such derivative instruments. Although our theoretical credit risk is the replacement cost at the then- estimated fair value of these instruments, we believe that the risk of incurring credit risk losses is remote.