Derivative Instruments and Hedging Activities

3 Months Ended

May 31, 2013

Derivative Instruments and Hedging Activities

Note 6. Derivative Instruments and Hedging Activities

Risk Management Objective of Using Derivatives

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage interest rate exposure with the following objectives:

• manage current and forecasted interest rate risk while maintaining optimal financial flexibility and solvency

• proactively manage the Company’s cost of capital to ensure the Company can effectively manage operations and execute its business strategy, thereby maintaining a competitive advantage and enhancing shareholder value

• comply with covenant requirements in the Company’s credit facility

Cash Flow Hedges of Interest Rate Risk

The Company utilizes interest rate derivatives to add stability to cash payments for interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Under the terms of its 2012 Credit Agreement, the Company is required to fix or cap the interest rate on at least 50% of its Term Loan exposure for a two-year period ending December 28, 2014. The requirement to fix or cap interest rates can be reduced to a one-year period provided the Company’s Senior Leverage Ratio (as defined in the 2012 Credit Agreement) is at or under 2.50:1:00 as of May 31, 2014.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income (loss) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The Company’s interest rate derivatives are used to hedge the interest payment cash flows associated with existing variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. The Company did not record any hedge ineffectiveness in earnings during the three months ended May 31, 2012 and 2013. Amounts reported in accumulated other comprehensive loss related to derivatives are reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During fiscal 2014, the Company estimates that less than $0.1 million will be reclassified as an increase to interest expense.

In February 2013, the Company entered into a two-year interest rate exchange agreement (a “Swap”), whereby the Company pays a fixed rate of 0.42% on $40 million of notional principal to Fifth Third Bank, and Fifth Third Bank pays to the Company a variable rate on the same amount of notional principal based on the one-month London Interbank Offered Rate (“LIBOR”). This agreement was the Company’s only interest rate derivative designated as a cash flow hedge of interest rate risk outstanding as of May 31, 2013.

The Company does not generally use derivatives for trading or speculative purposes.

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the balance sheet as of February 28, 2013 and May 31, 2013. The accumulated other comprehensive loss balance related to our derivative instruments at May 31, 2013 was less than $0.1 million. The fair value of the derivative instruments was estimated by obtaining quotations from the financial institution that was the counterparty to the instrument. The fair value was an estimate of the net amount that the Company would have been required to pay on May 31, 2013, if the agreement was transferred to another party or cancelled by the Company, as further adjusted by a credit adjustment required by ASC Topic 820, Fair Value Measurements and Disclosures, as discussed below. For the three months ended May 31, 2013, this credit adjustment was immaterial.

	Tabular Disclosure of Fair Values of Derivative Instruments
	Liability Derivatives
	As of February 28, 2013			As of May 31, 2013
	Balance Sheet			Balance Sheet
	Location	Fair Value		Location	Fair Value
Derivatives designated as hedging instruments
Interest Rate Swap Agreements (Long- Term Portion)	Other Noncurrent Liabilities		107	Other Noncurrent Liabilities		63
Total derivatives designated as hedging instruments		$	107		$	63

The table below presents the effect of the Company’s derivative financial instruments on the consolidated statements of operations for the three months ended May 31, 2012 and 2013.

	For the three months ended May 31,
Derivatives in Cash Flow Hedging Relationships	Amount of Gain or (Loss) Recognized in OCI on Derivative (Effective Portion)				Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)		Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)					Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded  from Effectiveness Testing)		Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
	2012		2013				2012		2013					2012		2013
Interest Rate Swap
Agreements	$	—	$	66		Interest expense	$	—	$	(22	)		N/A	$	—	$	—
Total	$	—	$	66			$	—	$	(22	)			$	—	$	—

Credit-risk-related Contingent Features

The Company manages its counterparty risk by entering into derivative instruments with financial institutions where it believes the risk of credit loss resulting from nonperformance by the counterparty is low. As discussed above, the Company’s counterparty to its interest rate swap is Fifth Third Bank.

In accordance with ASC Topic 820, the Company makes a Credit Value Adjustment (CVA) to adjust the valuation of a derivative to account for our own credit risk with respect to all derivative liability positions. The CVA is accounted for as a decrease to the derivative position with the corresponding increase or decrease reflected in other comprehensive income (loss) for derivatives designated as cash flow hedges. The CVA also accounts for nonperformance risk of our counterparties in the fair value measurement of all derivative asset positions, when appropriate. As of May 31, 2013, this CVA was immaterial to the fair value of our derivative instrument.

The Company’s interest rate swap agreement with Fifth Third Bank incorporates the loan covenant provisions of the Company’s 2012 Credit Agreement. Fifth Third Bank is a lender under the Company’s 2012 Credit Agreement. Failure to comply with the loan covenant provisions of the 2012 Credit Agreement could result in the Company being in default of its obligations under the interest rate swap agreement.

As of May 31, 2013, the Company has not posted any collateral related to the interest rate swap agreement.