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DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 3 Months Ended
Jan. 31, 2013
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES [Abstract]  
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 in which we enter into derivative instruments in the form of foreign currency forward exchange contracts with a financial institution.

 

These forward exchange contracts are entered into to reduce the potential effects of foreign exchange rate movements on our net equity investment in one of our foreign subsidiaries, to reduce the impact on gross profit and net earnings from sales and purchases denominated in foreign currencies, and to reduce the impact on our net earnings of foreign currency fluctuations on receivables and payables denominated in foreign currencies which are different than the subsidiaries functional currency. 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 January 31, 2013, denominated in Euros, Pounds Sterling and New Taiwan Dollars with set maturity dates ranging from February 2013 through January 2014. The contract amounts, expressed at forward rates in U.S. Dollars at January 31, 2013, were $33.8 million for Euros, $8.5 million for Pounds Sterling and $24.6 million for New Taiwanese Dollars. At January 31, 2013, we had approximately $538,000 of losses, net of tax, related to cash flow hedges deferred in Accumulated other comprehensive loss. Included in this amount are $1.0 million of unrealized losses, net of tax, related to cash flow hedge instruments that remain subject to currency fluctuation risk. The majority of these deferred losses will be recorded as an adjustment to Cost of sales and service in periods through January 2014, 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 2013. At January 31, 2013, we had $360,000 of realized gains and $137,000 of unrealized losses, 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 January 31, 2013, in Euros, Pounds Sterling, Canadian Dollars, the South African Rand, and New Taiwan Dollars with set maturity dates ranging from February 2013 through April 2013. The aggregate amount of these contracts at forward rates in U.S. Dollars at January 31, 2013 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 January 31, 2013 and October 31, 2012, all derivative instruments were recorded at fair value on the balance sheets as follows (in thousands):

 

    January 31, 2013     October 31, 2012  
    Balance sheet   Fair     Balance sheet   Fair  
Derivatives   Location   value     location   value  
                     
Designated as hedging instruments:                        
Foreign exchange forward contracts   Derivative assets   $ 101     Derivative assets   $ 705  
Foreign exchange forward contracts   Derivative liabilities   $ 1,913     Derivative liabilities   $ 492  
                         
Not designated as hedging instruments:                        
Foreign exchange forward contracts   Derivative assets   $ 31     Derivative assets   $ 3  
Foreign exchange forward contracts   Derivative liabilities   $ 970     Derivative liabilities   $ 77  

 

Effect of Derivative Instruments on Certain Condensed Consolidated Financial Statements

 

Derivative instruments had the following effects (before tax) on our Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Income, Comprehensive Income and Changes in Shareholders' Equity during the three months ended January 31, 2013 and 2012 (in thousands):

 

          Location of gain      
    Amount of gain (loss)     (loss) reclassified   Amount of gain (loss)  
    recognized in Other     from Other   reclassified from Other  
Derivatives   comprehensive loss     comprehensive loss   comprehensive loss  
    Three months ended         Three months ended  
    January 31,         January 31,  
    2013     2012         2013     2012  
Designated as hedging instruments:                                    
(Effective portion)                                    
Foreign exchange forward contracts                                    
- Intercompany sales/purchases   $ (1,544 )   $ 2,703     Cost of sales and service   $ 953     $ (676 )
                                     
Foreign exchange forward contract                                    
- Net investment   $ (173 )   $ 249                      

 

We recognized a loss of $64,000 for the three months ended January 31, 2013, and a gain of $178,000 for the three months ended January 31, 2012 as a result of contracts closed early that were deemed ineffective for financial reporting purposes and did not qualify as cash flow hedges. We recognized the following gains and losses in our Condensed Consolidated Statements of Income during the three months ended January 31, 2013 and 2012 (in thousands) on derivative instruments not designated as hedging instruments:

 

    Location of gain      
    (loss) recognized in   Amount of gain (loss)  
Derivatives   operations   Recognized in operations  
        Three months ended January 31,  
        2013     2012  
Not designated as hedging instruments:                    
                     
Foreign exchange forward contracts   Other (income)
expense, net		   $ (1,088 )   $ 1,281