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 months ended May 31, 2019 and 2018, approximately 12% and 13% of our net sales revenue was denominated in foreign currency, respectively. These sales were primarily denominated in Euros, British Pounds, Canadian Dollars and Mexican Pesos. We make most of our inventory purchases from the Far East and primarily use the U.S. Dollar for such purchases. In our condensed consolidated 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 are recognized in SG&A. We recorded net exchange gains (losses) from foreign currency fluctuations, including the impact of currency hedges and the cross-currency debt swap, of $0.8 million and $(1.7) million in SG&A during the three months ended May 31, 2019 and 2018, respectively.

We hedge against certain foreign currency exchange rate-risk by using a series of forward contracts and zero-cost collars designated as cash flow hedges and mark-to-market derivatives 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. The effective portion of the changes in fair value of these instruments is reported in OCI and reclassified into SG&A in the same period they are settled. The ineffective portion, which is not material for any year presented, is immediately recognized in SG&A.

Interest Rate Risk - Interest on our outstanding debt as of May 31, 2019 is based on floating interest rates. If short-term interest rates increase, we will incur higher interest expense on any future outstanding balances of floating rate debt. Floating interest rates are hedged with interest rate swaps to effectively fix interest rates on $225.0 million of the outstanding principal balance under the Credit Agreement, which totaled $303.2 million (excluding prepaid finance fees) as of May 31, 2019.

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



(in thousands)	May 31, 2019
Derivatives designated as hedging instruments	Hedge Type	Final Settlement Date	Notional Amount		Prepaid Expenses and Other Current Assets		Other Assets		Accrued Expenses and Other Current Liabilities		Other Liabilities, Non-current
Zero-cost collar - Euro	Cash flow	2/2020	€	9,500	$	105	$	—	$	—	$	—
Foreign currency contracts - sell Euro	Cash flow	1/2020	€	13,500	907		—		—		—
Foreign currency contracts - sell Canadian Dollars	Cash flow	2/2020	$	12,000	282		—		—		—
Zero-cost collar - Pounds	Cash flow	2/2020	£	4,500	52		—		—		—
Foreign currency contracts - sell Pounds	Cash flow	11/2020	£	13,250	797		110		—		—
Foreign currency contracts - sell Mexican Pesos	Cash flow	09/2019	$	20,000	—		—		17		—
Interest rate swaps	Cash flow	1/2024	$	225,000	—		—		997		4,030
Subtotal					2,143		110		1,014		4,030

Derivatives not designated under hedge accounting
Foreign currency contracts - cross-currency debt swap - Euro	(1)	04/2020	€	5,280	331		—		—		—
Foreign currency contracts - cross-currency debt swaps - Pound	(1)	04/2020	£	6,395	60		—		—		—
Subtotal					391		—		—		—
Total fair value					$	2,534	$	110	$	1,014	$	4,030



(in thousands)	February 28, 2019
Derivatives designated as hedging instruments	Hedge Type	Final Settlement Date	Notional Amount		Prepaid Expenses and Other Current Assets		Other Assets		Accrued Expenses and Other Current Liabilities		Other Liabilities, Non-current
Zero-cost collar - Euro	Cash flow	02/2020	€	9,500	$	11	$	—	$	—	$	—
Foreign currency contracts - sell Euro	Cash flow	01/2020	€	29,000	1,047		—		—		—
Foreign currency contracts - sell Canadian Dollars	Cash flow	02/2020	$	16,000	168		—		—		—
Zero-cost collar - Pounds	Cash flow	05/2020	£	4,500	—		—		200		—
Foreign currency contracts - sell Pounds	Cash flow	05/2020	£	19,500	248		—		—		13
Foreign currency contracts - sell Mexican Pesos	Cash flow	09/2019	$	30,000	—		—		58		—
Interest rate swaps	Cash flow	01/2024	$	225,000	512		—		—		339
Subtotal					1,986		—		258		352

Derivatives not designated under hedge accounting
Foreign currency contracts - cross-currency debt swap - Euro	(1)	04/2020	€	5,280	—		218		—		—
Foreign currency contracts - cross-currency debt swaps - Pound	(1)	04/2020	£	6,395	—		—		—		292
Subtotal					—		218		—		292
Total fair value					$	1,986	$	218	$	258	$	644


(1)	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 pre-tax effect of derivative instruments for the periods shown is as follows:



	Three Months Ended May 31,
	Gain (Loss) Recognized in OCI (effective portion)						Gain (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income						Gain (Loss) Recognized As Income
(in thousands)	2019			2018			Location	2019			2018		Location	2019		2018
Currency contracts - cash flow hedges	$	(186	)	$	4,576		SG&A	$	(1,218	)	$	687		$	—	$	—
Interest rate swaps - cash flow hedges	(5,200		)	(61		)	Interest expense	—			—		Interest expense	154		75
Cross-currency debt swaps - principal	—			—				—			—		SG&A	464		423
Cross-currency debt swaps - interest	—			—				—			—		Interest Expense	74		74
Total	$	(5,386	)	$	4,515			$	(1,218	)	$	687		$	692	$	572

We expect pre-tax net gains of $1.1 million associated with foreign currency contracts and interest rate swaps 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.