14. DERIVATIVE FINANCIAL INSTRUMENT – Cash Flow Hedges

The Company has a risk management policy to manage foreign currency risk relating to inventory purchases by its subsidiaries that are denominated in foreign currencies. As such, the Company may employ hedging and derivative strategies to limit the effects of changes in foreign currency on its operating income and cash flows. The financial impact of these hedging instruments is primarily offset by corresponding changes in the underlying exposures being hedged. The Company achieves this by closely matching the notional amount, terms and conditions of the derivative instrument with the underlying risk being hedged. The Company does not use derivative instruments for trading or speculative purposes.

For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents at inception the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company will formally assess at least quarterly whether the financial instruments used in hedging are “highly effective” at offsetting changes in cash flows of the related underlying exposures. For purposes of assessing hedge effectiveness, the Company uses the forward method, and assesses effectiveness based on the changes in both spot and forward points of the hedging instrument. If and when a derivative is no longer expected to be “highly effective,” hedge accounting is discontinued and hedge ineffectiveness, if any, is included in current period earnings. As of May 5, 2018, there was no hedge ineffectiveness.

The Company’s United Kingdom subsidiary is exposed to foreign currency risk from inventory purchases. In order to mitigate the financial risk of settlement of inventory at various prices based on movement of the U.S. dollar against the British pound, the Company entered into foreign currency forward exchange contracts (the “Hedging Instruments”). These are formally designated and “highly effective” as cash flow hedges. The Company will hedge approximately 45% of its U.S. dollar denominated purchases. All changes in the Hedging Instruments’ fair value associated with inventory purchases are recorded in equity as a component of accumulated other comprehensive income until the underlying hedged item is reclassified to earnings. The Company records the foreign currency forward exchange contracts at fair value in its consolidated balance sheets. The cash flows from derivative instruments that are designated as cash flow hedges are classified in the same category as the cash flows from the underlying hedged items. In the event that hedge accounting is discontinued, cash flows subsequent to the date of discontinuance are classified within investing activities. The Company considers the classification of the underlying hedged item’s cash flows in determining the classification for the designated derivative instrument’s cash flows. The Company classifies derivative instrument cash flows from hedges of foreign currency risk on the settlement of inventory as operating activities.

The Company’s Hedging Instruments were classified within Level 2 of the fair value hierarchy. The following table summarizes the effects, fair value and balance sheet classification of the Company’s Hedging Instruments.

Derivatives Designated As Hedging Instruments

Balance sheet location

May 5,
2018

February 3,
2018

(in thousands)

Foreign currency forward exchange contract (inventory purchases)

Accounts Payable

108

649

The following table summarizes the effect and classification of the Company’s Hedging Instruments.

Three Months Ended

Derivatives Designated As Hedging Instruments

Statement of
Operations Location

May 5,
2018

April 29,
2017

(in thousands)

Foreign currency forward exchange contract (inventory purchases):

Loss (Gain) reclassified from accumulated other comprehensive loss to income

Cost of goods sold

163

(41

)

The notional amounts outstanding of foreign exchange forward contracts were $10.4 million and $6.0 million at May 5, 2018 and February 3, 2018, respectively. Such contracts expire through January 2019.

Accumulated other comprehensive loss included a net deferred loss for Hedging Instruments in the amount of $0.1 million and $0.6 million at May 5, 2018 and February 3, 2018, respectively. The net deferred loss will be reclassified from accumulated other comprehensive loss to costs of goods sold during the next twelve months when the inventory is sold.