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DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 9 Months Ended
Jul. 31, 2012
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
2. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

We are exposed to certain market risks relating to our ongoing business operations, including foreign currency risk, interest rate risk and credit risk. We manage our exposure to these and other market risks through regular operating and financing activities. Currently, the only risk that we manage through the use of derivative instruments is foreign currency risk.

 

We operate on a global basis and are exposed to the risk that our financial condition, results of operations and cash flows could be adversely affected by changes in foreign currency exchange rates. To reduce the potential effects of foreign exchange rate movements on our net equity investment in the gross profit and net earnings of one of our foreign subsidiaries, we enter into derivative financial instruments in the form of foreign currency forward exchange contracts with a major financial institution. We are primarily exposed to foreign currency exchange rate risk with respect to transactions and net assets denominated in Euros, Pounds Sterling, Canadian Dollars, South African Rand, Singapore Dollars, Indian Rupee, Chinese Yuan, South Korean Won, Polish Zloty, and New Taiwan Dollars.

 

We record all derivative instruments as assets or liabilities at fair value.

 

Derivatives Designated as Hedging Instruments

 

We enter into foreign currency forward exchange contracts periodically to hedge certain forecasted inter-company sales and purchases denominated in foreign currencies (the Pound Sterling, Euro and New Taiwan Dollar). The purpose of these instruments is to mitigate the risk that the U.S. Dollar net cash inflows and outflows resulting from sales and purchases denominated in foreign currencies will be adversely affected by changes in exchange rates. These forward contracts have been designated as cash flow hedge instruments, and are recorded in the Condensed Consolidated Balance Sheets at fair value in Derivative assets and Derivative liabilities. The effective portion of the gains and losses resulting from the changes in the fair value of these hedge contracts are deferred in Accumulated other comprehensive loss and recognized as an adjustment to Cost of sales and service in the period that the corresponding inventory sold that is the subject of the related hedge contract is recognized, thereby providing an offsetting economic impact against the corresponding change in the U.S. Dollar value of the inter-company sale or purchase being hedged. The ineffective portion of gains and losses resulting from the changes in the fair value of these hedge contracts is reported in Other (income) expense, net immediately. We perform quarterly assessments of hedge effectiveness by verifying and documenting the critical terms of the hedge instrument and determining that forecasted transactions have not changed significantly. We also assess on a quarterly basis whether there have been adverse developments regarding the risk of a counterparty default.

 

 

We had forward contracts outstanding as of July 31, 2012, denominated in Euros, Pounds Sterling and New Taiwan Dollars with set maturity dates ranging from August 2012 through July 2013. The contract amounts, expressed at forward rates in U.S. Dollars at July 31, 2012, were $26.2 million for Euros, $8.5 million for Pounds Sterling and $22.7 million for New Taiwanese Dollars. At July 31, 2012, we had approximately $2.1 million of gains, net of tax, related to cash flow hedges deferred in Accumulated other comprehensive loss. Of this amount, $1.1 million represents unrealized gains, net of tax, related to cash flow hedge instruments that remain subject to currency fluctuation risk. The majority of these deferred gains will be recorded as an adjustment to Cost of sales and service in periods through July 2013, when the corresponding inventory that is the subject of the related hedge contract is sold, as described above.

 

We are also exposed to foreign currency exchange risk related to our investment in net assets in foreign countries. To manage this risk, we have maintained a forward contract with a notional amount of €3.0 million. We designated this forward contract as a hedge of our net investment in Euro denominated assets. We selected the forward method under Financial Accounting Standards Board, or FASB, guidance related to the accounting for derivatives instruments and hedging activities. The forward method requires all changes in the fair value of the contract to be reported as a cumulative translation adjustment in Accumulated other comprehensive loss, net of tax, in the same manner as the underlying hedged net assets. This forward contract matures in November 2012. At July 31, 2012, we had $227,000 of realized gains and $228,000 of unrealized gains, net of tax, recorded as cumulative translation adjustments in Accumulated other comprehensive loss related to this forward contract.

 

Derivatives Not Designated as Hedging Instruments

 

We also enter into foreign currency forward exchange contracts to protect against the effects of foreign currency fluctuations on receivables and payables denominated in foreign currencies. These derivative instruments are not designated as hedges under the FASB guidance and, as a result, changes in their fair value are reported currently as Other (income) expense, net, in the Condensed Consolidated Statements of Operations consistent with the transaction gain or loss on the related receivables and payables denominated in foreign currencies.

 

We had forward contracts outstanding as of July 31, 2012, in Euros, Pounds Sterling, Canadian Dollars, the South African Rand, and New Taiwan Dollars with set maturity dates ranging from August 2012 through October 2012. The aggregate amount of these contracts at forward rates in U.S. Dollars at July 31, 2012 totaled $33.2 million.

 

 

Fair Value of Derivative Instruments

 

We recognize the fair value of derivative instruments as assets and liabilities on a gross basis on our Condensed Consolidated Balance Sheets. As of July 31, 2012 and October 31, 2011, all derivative instruments were recorded at fair value on the balance sheets as follows (in thousands):

 

  July 31, 2012     October 31, 2011   
  Balance sheet     Fair     Balance sheet     Fair  
Derivatives   Location     value     location     value  
                         
Designated as hedging instruments:                                
Foreign exchange forward contracts     Derivative assets     $ 2,514       Derivative assets     $ 634  
Foreign exchange forward contracts     Derivative liabilities     $ 367       Derivative liabilities     $ 1,492  
                                 
Not designated as hedging instruments:                                
Foreign exchange forward contracts     Derivative assets     $ 590       Derivative assets     $ 563  
Foreign exchange forward contracts     Derivative liabilities     $ 80       Derivative liabilities     $ 117  

 

Effect of Derivative Instruments on the Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Changes in Shareholders’ Equity and Income

 

Derivative instruments had the following effects on our Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Changes in Shareholders’ Equity and Income during the nine months ended July 31, 2012 and 2011 (in thousands):

 

Derivatives   Amount of gain (loss)
recognized in Other
comprehensive loss		     Location of gain
(loss) reclassified
from Other
comprehensive loss		     Amount of gain (loss)
reclassified from Other
comprehensive loss		  
    Nine months ended 
July 31,		           Nine months ended 
July 31,		  
    2012     2011           2012     2011  
Designated as hedging instruments: (Effective portion)                              
Foreign exchange forward contracts                                      
– Intercompany sales/purchases   $ 4,069     $ (1,043 )   Cost of sales and service     $ (627 )   $ 610  
                                       
Foreign exchange forward contract                                      
– Net investment   $ 484     $ (153 )                      

 

We recognized a gain of $469,000 for the nine months ended July 31, 2012, and a loss of $28,000 for the nine months ended July 31, 2011 as a result of contracts closed early that were deemed ineffective for financial reporting purposes and did not qualify as cash flow hedges.

 

 

Derivatives   Location of gain
(loss) recognized in
operations		     Amount of gain (loss)
Recognized in operations		  
      Nine months ended July 31,  
      2012     2011  
Not designated as hedging instruments:                  
                   
Foreign exchange forward contracts   Other (income)expense, net     $ 2,148     $ (461 )

 

Derivative instruments had the following effects on our Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Changes in Shareholders’ Equity and Income during the three months ended July 31, 2012 and 2011 (in thousands):

 

Derivatives   Amount of gain (loss)
recognized in Other
comprehensive loss		     Location of gain
(loss) reclassified
from Other
comprehensive loss		   Amount of gain (loss)
reclassified from Other
comprehensive loss		  
    Three months ended
July 31,		         Three months ended 
July 31,		  
    2012     2011         2012     2011  
Designated as hedging
instruments: (Effective portion)		                            
Foreign exchange forward contracts – Intercompany sales/purchases   $ 1,678     $ 370     Cost of sales and service   $ 88     $ 113  
                                     
Foreign exchange forward contract – Net investment   $ 281     $ 126                      

 

We recognized a gain of $202,000 for the three months ended July 31, 2012, and a loss of $3,000 for the three months ended July 31, 2011 as a result of contracts closed early that were deemed ineffective for financial reporting purposes and did not qualify as cash flow hedges.

 

Derivatives   Location of gain
(loss) recognized in
operations		     Amount of gain (loss)
Recognized in operations		  
      Three months ended July 31,   
      2012     2011  
Not designated as hedging instruments:                  
                   
Foreign exchange forward contracts  

Other (income) expense, net

     $ 1,099     $ 87