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 both the three- and nine-months ended November 30, 2017 and 2016, approximately 12% of our net sales revenue was in foreign currencies. These sales were primarily denominated in British Pounds, Euros, Mexican Pesos and Canadian Dollars. We make most of our inventory purchases from the Far East and primarily use the U.S. Dollar for such purchases. In our consolidated condensed statements of operations, 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 of the balance sheet are recognized in SG&A.

For the three- and nine-months ended November 30, 2017, we recorded net foreign exchange gains (losses) from remeasurement, including the impact of foreign currency hedges and cross-currency debt swaps, of $(2.2) and $(1.5) million, respectively, in SG&A, and $(0.1) and $(0.7) million, respectively, in income tax expense. For the three- and nine-months ended November 30, 2016, we recorded net foreign exchange gains (losses) from remeasurement, including the impact of foreign currency hedges and cross-currency debt swaps, of $(0.1) and $(0.6) million, respectively, in SG&A, and $(0.2) million and $(0.1) million, respectively, in income tax expense.

We hedge against certain foreign currency exchange rate risk by using a series of forward contracts designated as cash flow hedges and mark-to-market derivatives to manage 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 November 30, 2017 is both floating and fixed. Fixed rates are in place on $20 million of Senior Notes at 3.9% and floating rates are in place on the balance of all other debt outstanding, which totaled $410.3 million as of November 30, 2017. If short-term interest rates increase, we will incur higher interest rates on any future outstanding balances of floating rate debt.

Borrowings under the Credit Agreement accrue interest (at the Company’s election) based on either a base rate, plus a margin of up to 1.00%, or the applicable LIBOR plus a margin of up to 2.00%, in each case, as determined by the Company’s leverage ratio, calculated pursuant to the Company’s Credit Agreement. During September 2017, the Company effectively converted $100 million of the outstanding principal balance under the Credit Agreement to fixed rate debt using an interest rate swap. The swap converted the total aggregate notional principal from floating LIBOR interest rate payments to fixed interest rate payments at rates ranging from approximately 1.5% to 2.1% for annual periods through December 2021, as compared to the one-month LIBOR rate of approximately 1.4% as of November 30, 2017. 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. Therefore, the swap is considered 100 percent effective.

The following table summarizes the fair values of our derivative instruments as of the end of the periods shown:

FAIR VALUES OF DERIVATIVE INSTRUMENTS


	November 30, 2017
					Prepaid				Accrued
					Expenses				Expenses
		Final			and Other				and Other		Other
(in thousands)		Settlement	Notional		Current		Other		Current		Liabilities,
Derivatives designated as hedging instruments	Hedge Type	Date	Amount		Assets		Assets		Liabilities		Non-current
Foreign currency contracts - sell Euro	Cash flow	12/2018	€	32,250	$	-	$	2	$	1,381	$	-
Foreign currency contracts - sell Canadian Dollars	Cash flow	12/2018	$	27,750		252		16		-		-
Foreign currency contracts - sell Pounds	Cash flow	01/2019	£	20,400		-		-		765		32
Foreign currency contracts - sell Mexican Pesos	Cash flow	05/2018	$	45,000		-		-		159		-
Interest rate swap	Cash flow	12/2021	$	100,000		134		619		-		-
Subtotal						386		637		2,305		32

Derivatives not designated under hedge accounting
Foreign currency contracts - cross-currency debt swaps - Euro	(1)	4/2020	$	5,280		-		-		-		65
Foreign currency contracts - cross-currency debt swaps - Pound	(1)	4/2020	$	6,395		-		-		-		413
Subtotal						-		-		-		478
Total fair value					$	386	$	637	$	2,305	$	510


	February 28, 2017
					Prepaid				Accrued
					Expenses				Expenses
		Final			and Other				and Other		Other
		Settlement	Notional		Current		Other		Current		Liabilities,
Derivatives designated as hedging instruments	Hedge Type	Date	Amount		Assets		Assets		Liabilities		Non-current
Foreign currency contracts - sell Euro	Cash flow	2/2018	€	27,500	$	727	$	-	$	-	$	-
Foreign currency contracts - sell Canadian Dollars	Cash flow	6/2018	$	26,000		155		32		-		-
Foreign currency contracts - sell Pounds	Cash flow	2/2018	£	13,500		548		-		-		-
Foreign currency contracts - sell Mexican Pesos	Cash flow	2/2018	$	59,600		-		-		47		-
Subtotal						1,430		32		47		-

Derivatives not designated under hedge accounting
Foreign currency contracts - cross-currency debt swap - Euro	(1)	1/2018	$	10,000		705		-		-		-
Total fair value					$	2,135	$	32	$	47	$	-

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These are foreign currency contracts for which we have not elected hedge accounting. We refer to them as “cross-currency debt swaps”. They, in effect, adjust the currency denomination of a portion of our outstanding debt to the Euro and British Pound, as applicable, for the notional amounts reported, creating an economic hedge against currency movements.

The following table summarizes the pre-tax effect of derivative instruments for the periods shown:

PRE-TAX EFFECT OF DERIVATIVE INSTRUMENTS


	Three Months Ended November 30,
	Gain (Loss)				Gain (Loss) Reclassified from
	Recognized in OCI				Accumulated Other Comprehensive					Gain (Loss) Recognized
	(effective portion)				Income (Loss) into Income					As Income
(in thousands)	2017		2016		Location	2017		2016		Location	2017		2016
Currency contracts - cash flow hedges	$	2,928	$	2,049	SG&A	$	1,328	$	522		$	-	$	-
Interest rate swaps - cash flow hedges		753		-	Interest expense		-		-	Interest expense		(48)		-
Cross-currency debt swaps - principal		-		-			-		-	SG&A		(419)		493
Cross-currency debt swaps - interest		-		-			-		-	Interest Expense		74		-
Total	$	3,681	$	2,049		$	1,328	$	522		$	(393)	$	493


	Nine Months Ended November 30,
	Gain (Loss)				Gain (Loss) Reclassified from
	Recognized in OCI				Accumulated Other Comprehensive					Gain (Loss) Recognized
	(effective portion)				Income (Loss) into Income					As Income
(in thousands)	2017		2016		Location	2017		2016		Location	2017		2016
Currency contracts - cash flow hedges	$	(1,275)	$	2,319	SG&A	$	2,208	$	505		$	-	$	-
Interest rate swaps - cash flow hedges		753		-	Interest expense		-		-	Interest expense		(48)		-
Cross-currency debt swaps - principal		-		-			-		-	SG&A		(1,183)		528
Cross-currency debt swaps - interest		-		-			-		-	Interest Expense		74		35
Total	$	(522)	$	2,319		$	2,208	$	505		$	(1,157)	$	563

We expect pre-tax net losses of $2.1 million associated with foreign currency contracts currently reported in accumulated other comprehensive income, to be reclassified into income over the next twelve months. The amount ultimately realized, however, will differ as exchange rates vary and the underlying contracts settle.

Counterparty Credit Risk - Financial instruments, including foreign currency contracts and cross currency debt 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 losses is remote.