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Financial Instruments and Fair Value Measurements
 12 Months Ended
Dec. 31, 2011
Financial Instruments and Fair Value Measurements

9. Financial Instruments and Fair Value Measurements

 

Financial Instruments

 

A financial instrument is cash or a contract that imposes an obligation to deliver, or conveys a right to receive cash or another financial instrument. The carrying values of cash and cash equivalents, accounts receivable and accounts payable are considered to be representative of fair value because of the short maturity of these instruments. The estimated fair value of the Company’s senior secured and senior notes (fixed rate debt) at December 31, 2011 and 2010, per quoted market sources, was $179,156 and $187,798, respectively. The face amount of these financial instruments at December 31, 2011 and 2010 was $175,000.

 

  

Derivative Instruments and Hedging Activities

 

On December 31, 2011, the Company had open foreign currency forward contracts, fixed price commodity contracts and an interest rate swap. These contracts are used solely for hedging and not for speculative purposes. Management believes that its use of these instruments to reduce risk is in the Company’s best interest. The counterparties to these financial instruments are financial institutions with investment grade credit ratings.

 

The Company conducts business internationally and therefore is exposed to foreign currency exchange rate risk. The Company uses derivative financial instruments as cash flow and fair value hedges to mitigate its exposure to fluctuations in foreign currency exchange rates by reducing the effect of such fluctuations on foreign currency denominated intercompany transactions and other foreign currency exposures. The currencies currently hedged by the Company include the euro, Swedish krona and Mexican peso. In certain instances, the foreign currency forward contracts do not qualify for hedge accounting and are marked to market, with gains and losses recognized in the Company’s consolidated statement of operations as a component of other expense (income), net. The Company’s foreign currency forward contracts substantially offset gains and losses on the underlying foreign currency denominated transactions. As of December 31, 2011, the Company held foreign currency forward contracts to reduce the exposure related to the Company’s euro-denominated and Swedish krona-denominated intercompany loans. These contracts expire on March 30, 2012. For the year ended December 31, 2011, the Company recognized a $225 gain related to the euro and Swedish krona contracts. The Company also holds contracts intended to reduce exposure to the Mexican peso. In August of 2011, the Company entered into three foreign currency forward contracts related to the Mexican peso. The first contract was for $28,223 of Mexican peso equivalents and expired monthly from August 2011 to December 2011. The second and third contracts are for $30,000 and $10,000, respectively, of Mexican peso equivalents and expire monthly from January 2012 to December 2012. Additionally, in December of 2011, the Company entered into a foreign currency forward contract for $15,000 of Mexican peso equivalents which expire monthly throughout 2012. These contracts were executed to hedge forecasted transactions and are accounted for as cash flow hedges. The effective portion of the unrealized gain or loss is deferred and reported in the Company’s consolidated balance sheets as a component of accumulated other comprehensive income (loss). The Company’s expectation is that the cash flow hedges will be highly effective in the future. The effectiveness of the transactions has been and will be measured on an ongoing basis using regression analysis.

 

To mitigate the risk of future price volatility and, consequently, fluctuations in gross margins, the Company entered into fixed price commodity contracts with a financial institution to fix the cost of a portion of the Company’s copper purchases as copper is a significant raw material. In March 2011, the Company entered into fixed price commodity contracts for 1,200 pounds of copper covering the period from April 2011 to December 2012. In May 2011, the Company entered into two fixed price commodity contracts for copper. The first contract was for 933 pounds of copper which covered the period from June 2011 to December 2011. The other commodity contract was for 2,000 pounds of copper and covers the period from January 2012 to December 2012. In August of 2011, the Company entered into two additional commodity contracts for copper. The first contract was for 801 pounds of copper and covered the period from October 2011 to December 2011. The second contract was for 3,500 pounds of copper and covers the period from January 2012 through December of 2012. In September of 2011, the Company entered into an additional fixed price commodity contract for copper. This contract was for 1,000 pounds of copper and covers the period from January 2012 to December 2012. All of these contracts represent a portion of the Company’s copper purchases. These contracts were executed to hedge a portion of forecasted transactions and the contracts are accounted for as cash flow hedges. The unrealized gain or loss for the effective portion of the hedges is deferred and reported in the Company’s consolidated balance sheets as a component of accumulated other comprehensive income (loss). Using regression analysis, the Company has concluded that these cash flow hedges are highly effective. The effectiveness of the transactions has been and will be measured on an ongoing basis using regression analysis.

 

On October 4, 2010, the Company entered into a fixed-to-floating interest rate swap agreement (the “Swap”) with a notional amount of $45,000 to hedge its exposure to fair value fluctuations on a portion of its senior secured notes. The Swap was designated as a fair value hedge of the fixed interest rate obligation under the Company’s $175,000 9.5% senior secured notes due October 15, 2017. Under the Swap, the Company pays a variable interest rate equal to the six-month London Interbank Offered Rate (“LIBOR”) plus 7.19% and it receives a fixed interest rate of 9.5%. The Swap requires semi-annual settlements on April 15 and October 15. The difference between amounts to be received and paid under the Swap is recognized as a component of interest expense, net on the consolidated statements of operations. The Swap reduced interest expense by $473 and $200 for the years ended December 31, 2011 and 2010, respectively. The critical terms of the Swap are aligned with the terms of the senior secured notes, including maturity of October 15, 2017, resulting in no hedge ineffectiveness. The unrealized gain or loss for the effective portion of the hedge is deferred and reported in the Company’s consolidated balance sheets as an asset or liability as applicable, with the offset to the carrying value of the senior secured notes.

 

  

The notional amounts and fair values of derivative instruments in the consolidated balance sheets are as follows:

 

          Prepaid expenses and other        
          current assets / other     Accrued expenses and other  
    Notional amounts (A)     long-term assets     current liabilities  
As of December 31   2011     2010     2011     2010     2011     2010  
Derivatives designated as hedging                                                
instruments:                                              
Cash Flow Hedge:                                                
Forward currency contracts   $ 55,000     $ -     $ -     $ -     $ 4,158     $ -  
Fixed price commodity contracts     6,500       -       -       -       3,564       -  
                                                 
Fair Value Hedge:                                                
Interest rate swap contract     45,000       45,000       1,078       -       -       3,017  
      106,500       45,000       1,078       -       7,722       3,017  
                                                 
Derivatives not designated as hedging                                                
instruments:                                                
Forward currency contracts     25,894       26,917       2       108       -       -  
Total derivatives   $ 132,394     $ 71,917     $ 1,080     $ 108     $ 7,722     $ 3,017  

 

(A) Notional amounts represent the gross contract / notional amount of the derivatives outstanding.

 

Amounts recorded for the cash flow hedges in other comprehensive income (loss) in shareholders’ equity and in net income for the year ended December 31, 2011 are as follows:

 

          Amount of loss        
    Amount of loss     reclassified from     Location of loss  
    recorded in other     other comprehensive     reclassified from other  
    comprehensive     income (loss) into net     comprehensive income  
    income (loss)     income     (loss) into net income  
Derivatives designated as cash flow hedges:                        
Forward currency contracts   $ 7,118     $ 2,960       Cost of goods sold  
Fixed price commodity contracts     4,686       1,122       Cost of goods sold  
Total derivatives designated as cash flow hedges   $ 11,804     $ 4,082          

 

These derivatives will be reclassified from other comprehensive (loss) income to the consolidated statement of operations through December 2012.  The Company has measured the ineffectiveness of the forward currency and commodity contracts and any amounts recognized in the consolidated financial statements were immaterial for the year ended December 31, 2011.

 

Fair Value Measurements

 

The following table presents our assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy. The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value.

 

  

As of December 31               2011     2010  
          Fair value estimated using              
    Fair value     Level 1 inputs (A)     Level 2 inputs (B)     Level 3 inputs (C)     Fair value  
                               
Financial assets carried at fair value:                                        
                                         
Available for sale security   $ -     $ -     $ -     $ -     $ 274  
Interest rate swap contract     1,078       -       1,078       -       -  
Forward currency contracts     2       -       2       -       108  
                                         
Total financial assets carried at fair value   $ 1,080     $ -     $ 1,080     $ -     $ 382  
                                         
Financial liabilities carried at fair value:                                        
                                         
Interest rate swap contract   $ -     $ -     $ -     $ -     $ 3,017  
Forward currency contracts     4,158       -       4,158       -       -  
Fixed price commodity contracts     3,564       -       3,564       -       -  
                                         
Total financial liabilities carried at fair value   $ 7,722     $ -     $ 7,722     $ -     $ 3,017  

 

(A) Fair values estimated using Level 1 inputs, which consist of quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. The available for sale security, which was disposed of in 2011, was an equity security that was publically traded.

 

(B) Fair values estimated using Level 2 inputs, other than quoted prices, that are observable for the asset or liability, either directly or indirectly and include among other things, quoted prices for similar assets or liabilities in markets that are active or inactive as well as inputs other than quoted prices that are observable. For forward currency, commodity hedge and interest rate swap contracts, inputs include foreign currency exchange rates, commodity indexes and the six-month forward LIBOR.

 

(C) Fair values estimated using Level 3 inputs consist of significant unobservable inputs. The Company did not have any fair value estimates using Level 3 inputs at December 31, 2011 and 2010.

 

For the year ended December 31, 2011, the Company recorded a fair value adjustment for nonfinancial assets of $4,945 related to the BCS goodwill. The Company utilized Level 3 inputs to estimate the fair value adjustment. For additional information, see the discussion of Goodwill and Other Intangible Assets in Note 2. No adjustments to fair value were required for nonfinancial assets for the year ended December 31, 2010.