Derivative Financial Instruments and Fair Value Measurements

9 Months Ended

Sep. 30, 2011

Derivative Financial Instruments and Fair Value Measurements [Abstract]

Derivative Financial Instruments and Fair Value Measurements

NOTE 4.     Derivative Financial Instruments and Fair Value Measurements

We are exposed to credit loss in the event of nonperformance by counterparties to the extent of the fair values of the outstanding interest rate swap agreements and foreign currency exchange contracts, but we do not anticipate nonperformance by any of the counterparties.  For further information on our derivative financial instruments, see Note 6 of the notes to the consolidated financial statements included in KCI's Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

Interest Rate Protection

At September 30, 2011 and December 31, 2010, we had 19 and 18 interest rate swap agreements in effect, respectively, pursuant to which we have fixed the rate on an aggregate of $525.0 million and $444.5 million, respectively, in notional amounts of our outstanding variable rate debt at weighted average interest rates of 0.789% and 1.226%, respectively, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the senior credit agreement.

As of September 30, 2011, we had also entered into additional interest rate swap agreements to convert $125.0 million of our variable rate debt to a fixed rate basis at interest rates ranging from 0.810% to 0.816%, exclusive of the Eurocurrency Rate Loan Spread as disclosed in the senior credit agreement.  These agreements become effective on December 31, 2011 and were designated as cash flow hedge instruments.

As a result of the interest rate swap agreements in effect as of September 30, 2011 and December 31, 2010, approximately 99.6% and 93.2%, respectively, of our long-term debt outstanding, including the Convertible Notes, was subject to a fixed interest rate.

The interest rate swap agreements have quarterly interest payments, based on three-month LIBOR, due on the last day of March, June, September and December.  The fair value of the swap agreements was zero at inception.  At both September 30, 2011 and December 31, 2010, the aggregate fair value of our interest rate swap agreements was negative and was recorded as a liability of approximately $1.7 million.  This amount was also recorded in other comprehensive income, net of tax.  No asset derivatives were held as of September 30, 2011 and December 31, 2010 related to our interest rate swap agreements.  The ineffective portion of these interest rate swaps was not significant for the third quarter or first nine months of 2011 and 2010.  Effective October 2011, we elected to use one-month LIBOR for amounts outstanding under the 2016 Senior Credit Facility.  As a result of this election, the ineffective portion of the interest rate swaps will likely increase.  As of September 30, 2011 and December 31, 2010, the amount of hedge loss to be reclassified from Accumulated Other Comprehensive Income over the next 12 months was approximately $1.7 million for both periods.  If our interest rate protection agreements were not in place, interest expense would have been approximately $0.6 million and $2.3 million lower for the third quarter and first nine months of 2011, respectively, and $2.0 million and $7.6 million lower during the same periods of the prior year.

Foreign Currency Exchange Risk Mitigation

At September 30, 2011 and December 31, 2010, we had foreign currency exchange contracts to sell or purchase $50.1 million and $92.1 million, respectively, of various currencies.  The periods of the foreign currency exchange contracts generally do not exceed one year and correspond to the periods of the exposed transactions or related cash flows.

Fair Value Measurements

The following tables set forth the location and aggregate fair value amounts of all derivative instruments with credit-related contingent features (dollars in thousands):

	Asset Derivatives					Liability Derivatives
	Balance	Fair Value				Balance	Fair Value
	Sheet	September 30,		December 31,		Sheet	September 30,		December 31,
	Location	2011		2010		Location	2011		2010
Derivatives
designated as
hedging
instruments
	Prepaid					Accrued
Interest rate	expenses					expenses
swap agreements	and other	$	-	$	-	and other	$	1,681	$	1,677
Derivatives not
designated as
hedging
instruments
Foreign currency	Prepaid					Accrued
exchange	expenses					expenses
contracts	and other		1,172		364	and other		306		3,425
Total derivatives		$	1, 172	$	364		$	1,987	$	5,102

The location and net amounts reported in the condensed consolidated statements of earnings under the caption “interest expense” or included in our condensed consolidated balance sheets under the caption “accumulated other comprehensive income” (“OCI”) for derivatives designated as cash flow hedging instruments under the Derivatives and Hedges topic of the Codification are as follows (dollars in thousands):

	Three months ended September 30,
	Effective portion
Derivatives	Amount of						Location of gain (loss)	Amount of gain (loss)
designated as	gain (loss)						reclassified from	reclassified from
cash flow hedging	recognized in						accumulated	accumulated
instruments	OCI on derivative						OCI into income	OCI into income
	2011			2010				2011			2010
Interest rate swap agreements	$	(52	)	$	(926	)	Interest expense	$	(396	)	$	(1,281	)
	Nine months ended September 30,
	Effective portion
Derivatives	Amount of						Location of gain (loss)	Amount of gain (loss)
designated as	gain (loss)						reclassified from	reclassified from
cash flow hedging	recognized in						accumulated	accumulated
instruments	OCI on derivative						OCI into income	OCI into income
		2011			2010				2011			2010
Interest rate swap agreements	$	(1,512	)	$	(1,719	)	Interest expense	$	(1,509	)	$	(4,968	)

KCI’s foreign currency exchange contracts are not designated as hedging instruments under the Derivatives and Hedges topic of the Codification.  The gain or loss recognized on the foreign currency exchange contracts is included in the condensed consolidated statements of earnings under the caption “Foreign currency gain (loss).”  The following table summarizes the composition of foreign currency gain (loss) (dollars in thousands):

	Three months ended						Nine months ended
	September 30,						September 30,
	2011			2010			2011			2010
Foreign currency exchange contracts gain (loss)	$	1,082		$	(7,741	)	$	(1,933	)	$	1,071
Other foreign currency transaction gain (loss)		(3,199	)		9,889			(209	)		(4,190	)
	$	(2,117	)	$	2,148		$	(2,142	)	$	(3,119	)

Certain of KCI’s derivative instruments contain provisions that require compliance with the restrictive covenants of our credit facilities.  For further information regarding the restrictive covenants of our credit facilities, see Note 17 of the notes to the consolidated financial statements included in KCI's Annual Report on Form 10-K for the fiscal year ended December 31, 2010 and Note 3 of the notes to the condensed consolidated financial statements included in KCI’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2011.

If we default under our credit facilities, the lenders could require immediate repayment of the entire principal.  If those lenders require immediate repayment, we may not be able to repay them which could result in the foreclosure of substantially all of our assets.  In these circumstances, the counterparties to the derivative instruments could request immediate payment or full collateralization on derivative instruments in net liability positions.  All of our derivative counterparties are also parties to our credit facilities.

No collateral has been posted by KCI in the normal course of business.  If the credit-related contingent features underlying these agreements were triggered on September 30, 2011, KCI could be required to settle or post the full amount as collateral to its counterparties.