Derivative Instruments and Hedging Activities

12 Months Ended

Sep. 30, 2019

Derivative Instruments and Hedging Activities

Derivative Instruments and Hedging Activities

NOTE 14—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

In order to manage our exposure to fluctuations in interest and foreign currency exchange rates we utilize derivative financial instruments such as forward starting swaps and foreign currency forwards for periods typically up to five years. We do not use any derivative financial instruments for trading or other speculative purposes.

All derivatives are recorded at fair value, however, the classification of gains and losses resulting from changes in the fair values of derivatives are dependent on the intended use of the derivative and its resulting designation. If a derivative is designated as a fair value hedge, then a change in the fair value of the derivative is offset against the change in the fair value of the underlying hedged item and only the ineffective portion of the hedge, if any, is recognized in earnings. If a derivative is designated as a cash flow hedge, then the effective portion of a change in the fair value of the derivative is recognized as a component of accumulated other comprehensive income (loss) until the underlying hedged item is recognized in earnings, or the forecasted transaction is no longer probable of occurring. If a derivative does not qualify as a highly effective hedge, any change in fair value is immediately recognized in earnings. We formally document all hedging relationships for all derivative hedges and the underlying hedged items, as well as the risk management objectives and strategies for undertaking the hedge transactions. We classify the fair value of all derivative contracts as current or noncurrent assets or liabilities, depending on the realized and unrealized gain or loss position of the hedged contract at the balance sheet date, and the timing of future cash flows. The cash flows from derivatives treated as hedges are classified in the Consolidated Statements of Cash Flows in the same category as the item being hedged.

The following table shows the notional principal amounts of our outstanding derivative instruments as of September 30, 2019 and 2018 (in thousands):

	Notional Principal
	September 30, 2019		September 30, 2018
Instruments designated as accounting hedges:
Foreign currency forwards	$	143,164	$	169,406
Interest rate swaps		95,000		—
Instruments not designated as accounting hedges:
Foreign currency forwards	$	24,220	$	27,909

Included in the amounts not designated as accounting hedges at September 30, 2019 and 2018 were foreign currency forwards with notional principal amounts of $14.0 million and $14.7 million, respectively, that have been designed to manage exposure to foreign currency exchange risks, and for which the gains or losses of the changes in fair value of the forwards has approximately offset an equal and opposite amount of gains or losses related to the foreign currency exposure. Unrealized gains of $0.0 million and $0.2 million were recognized in other income (expense), net for the fiscal years ended September 30, 2019 and 2018, respectively, related to foreign currency forward contracts not designated as accounting hedges.

During fiscal 2019, we entered into agreements related to the construction and leasing of two buildings on our existing corporate campus in San Diego. This will allow us to consolidate virtually all of our San Diego operations in a single location and accommodate the expected growth of our business. Under these agreements a financial institution will own the buildings, and we will lease the property for a term of five years upon their completion. In conjunction with these agreements, we entered into pay-variable/receive-fixed interest rate swaps with a group of financial institutions to mitigate variable interest rate risk associated with these future lease obligations. The interest rate swaps contain forward starting notional principal amounts which align with our expected lease payments. These interest rate swaps were designated as effective cash flow hedges at September 30, 2019, and as such, unrealized gains/losses are included in accumulated other comprehensive income (loss). Unrealized gains as a result of changes in the fair value of the interest rate swaps were $0.2 million for the year ended September 30, 2019.

The notional principal amounts for outstanding derivative instruments provide one measure of the transaction volume outstanding and do not represent the amount of our exposure to credit or market loss. Credit risk represents our gross exposure to potential accounting loss on derivative instruments that are outstanding or unsettled if all counterparties failed to perform according to the terms of the contract, based on then-current interest or currency exchange rates at each respective date. Our exposure to credit loss and market risk will vary over time as a function of interest and currency exchange rates. The amount of credit risk from derivative instruments and hedging activities was not material for the fiscal years ended September 30, 2019 and 2018. Although the table above reflects the notional principal amounts of our foreign exchange instruments, it does not reflect the gains or losses associated with the exposures and transactions that the foreign exchange instruments are intended to hedge. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and losses on the underlying exposures, will depend on actual market conditions during the remaining life of the instruments.

We generally enter into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. We present our derivative assets and derivative liabilities at their gross fair values. We did not have any derivative instruments with credit-risk related contingent features that would require us to post collateral as of September 30, 2019 or 2018.

The table below presents the fair value of our derivative financial instruments that qualify for hedge accounting as well as their classification in the Consolidated Balance Sheets (in thousands):

		Fair Value
	Balance Sheet Location	September 30, 2019		September 30, 2018
Asset derivatives:
Foreign currency forwards	Other current assets	$	2,635	$	1,803
Foreign currency forwards	Other assets		619		314
Forward starting swap	Other assets		240		—
		$	3,494	$	2,117
Liability derivatives:
Foreign currency forwards	Other current liabilities	$	529	$	1,657
Foreign currency forwards	Other noncurrent liabilities		228		75
Total		$	757	$	1,732

The tables below present gains and losses recognized in other comprehensive income (loss) related to derivative financial instruments designated as cash flow hedges, as well as the amount of gains and losses reclassified into earnings (in thousands):

	September 30, 2019				September 30, 2018
			Gains (losses)				Gains (losses)
	Gains (losses)		reclassified into				reclassified into
	recognized in		earnings -		Gains (losses)		earnings -
Derivative Type	OCI		Effective Portion		recognized in OCI		Effective Portion
Foreign currency forwards	$	4,344	$	1,945	$	(45)	$	(1,239)

The amount of unrealized gains and losses from derivative instruments and hedging activities classified as not highly effective did not have a material impact on the results of operations for the years ended September 30, 2019 or 2018. The amount of estimated unrealized net gains from cash flow hedges which are expected to be reclassified to earnings in the next twelve months is $1.5 million, net of income taxes.