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Financial Instruments and Fair Value Measurements
 3 Months Ended
Mar. 31, 2012
Financial Instruments and Fair Value Measurements

(4) 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 notes with a face value of $175,000 (fixed rate debt) at March 31, 2012 and December 31, 2011, per quoted market sources, was $184,844 and $179,156, respectively.

 

Derivative Instruments and Hedging Activities

 

On March 31, 2012, 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.

 

Foreign Currency Exchange Rate Risk

 

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 condensed consolidated statement of operations as a component of other expense (income), net.

 

The Company’s foreign currency forward contracts significantly offset gains and losses on the underlying foreign currency denominated transactions as follows:

 

Euro-denominated and Swedish krona-denominated Foreign Currency Forward Contracts

 

As of March 31, 2012, the Company held foreign currency forward contracts with an underlying notional amount of $27,007 to reduce the exposure related to the Company’s euro-denominated and Swedish krona-denominated intercompany loans. These contracts expire on June 29, 2012. Due to their short term nature, the euro-denominated and Swedish krona-denominated foreign currency forward contracts have not been designated as hedging instruments. For the three months ended March 31, 2012, the Company recognized a loss of $877 related to the euro and Swedish krona currency forward contracts.

 

Mexican Peso-denominated Foreign Currency Forward Contracts – Cash Flow Hedge

 

The Company holds foreign currency forward contracts to fix a portion of peso-denominated expenditures incurred at the Company’s Mexican manufacturing locations. The notional amounts of the peso-denominated contracts at March 31, 2012 total $54,750 and expire ratably on a monthly basis as follows:

 

$41,250 notional Period from April 2012 through December 2012
$13,500 notional Period from January 2013 through December 2013

  

These contracts were executed to hedge forecasted transactions and are accounted for as cash flow hedges. As such, the effective portion of the unrealized gain or loss is deferred and reported in the Company’s condensed consolidated balance sheets as a component of accumulated other comprehensive income. 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.

 

 

Commodity Price Risk - Cash Flow Hedge

 

To mitigate the risk of future price volatility and, consequently, fluctuations in gross margins, the Company entered into fixed price commodity contracts with financial institutions to fix the cost of a significant portion of the Company’s 2012 copper purchases as copper is a significant raw material.

 

The Company has the following fixed priced commodity contracts at March 31, 2012 with an aggregate notional amount of $4,875, which expire ratably on a monthly basis over the period from April through December 2012, compared to an aggregate notional amount of $6,500 at December 31, 2011.

 

These contracts were executed to hedge a portion of forecasted copper purchases and 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 condensed consolidated balance sheets as a component of accumulated other comprehensive income. 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.

 

Interest Rate Risk - Fair Value Hedge

 

The Company has 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 approximately 26.0% 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. 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 condensed consolidated balance sheets as an asset or liability as applicable, with the offset to the carrying value of the senior secured notes.

 

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 condensed consolidated statements of operations.

 

The Swap reduced interest expense by $225 and $205 for the three months ended March 31, 2012 and 2011, respectively.

 

 

The notional amounts and fair values of derivative instruments in the condensed 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  
    March 31,     December 31,     March 31,     December 31,     March 31,     December 31,  
    2012     2011     2012     2011     2012     2011  
Derivatives designated as hedging instruments:                                              
Cash Flow Hedge:                                                
Forward currency contracts   $ 54,750     $ 55,000     $ 414     $ -     $ -     $ 4,158  
Fixed price commodity contracts     4,875       6,500       -       -       880       3,564  
                                                 
Fair Value Hedge:                                                
Interest rate swap contract     45,000       45,000       1,164       1,078       -       -  
      104,625       106,500       1,578       1,078       880       7,722  
                                                 
Derivatives not designated as hedging instruments:                                                
Forward currency contracts     27,007       25,894       -       2       23       -  
Total derivatives   $ 131,632     $ 132,394     $ 1,578     $ 1,080     $ 903     $ 7,722  

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

 

Amounts recorded for the cash flow hedges in other comprehensive income in shareholders’ equity and in net income for the three months ended March 31, 2012 are as follows:

 

          Amount of loss      
    Amount of gain     reclassified from     Location of loss
    recorded in other     other comprehensive     reclassified from other
    comprehensive     income into net     comprehensive income
    income     income     into net income
Derivatives designated as cash flow hedges:                    
Forward currency contracts   $ 4,548     $ 24     Cost of goods sold
Fixed price commodity contracts     2,332       352     Cost of goods sold
Total derivatives designated as cash flow hedges   $ 6,880     $ 376      

 

These derivatives will be reclassified from other comprehensive income to the condensed consolidated statement of operations through December 2013.  The Company has measured the ineffectiveness of the forward currency and commodity contracts and any amounts recognized in the condensed consolidated financial statements were immaterial for the three months ended March 31, 2012.

 

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.

 

                March 31,           December 31,  
    2012     2011  
    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:                                        
                                         
Interest rate swap contract   $ 1,164     $ -     $ 1,164     $ -     $ 1,078  
Forward currency contracts     414       -       414       -       2  
                                         
Total financial assets carried at fair value   $ 1,578     $ -     $ 1,578     $ -     $ 1,080  
                                         
Financial liabilities carried at fair value:                                        
                                         
Forward currency contracts   $ 23     $ -     $ 23     $ -     $ 4,158  
Fixed price commodity contracts     880       -       880       -       3,564  
                                         
Total financial liabilities carried at fair value   $ 903     $ -     $ 903     $ -     $ 7,722  

 

(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 Company did not have any fair value estimates using Level 1 inputs at March 31, 2012 or December 31, 2011.

 

(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 March 31, 2012 or December 31, 2011.