Financial Instruments and Risk Management

9 Months Ended

Nov. 30, 2011

Financial Instruments and Risk Management

Financial Instruments and Risk Management

Note 15 – Financial Instruments and Risk Management

Foreign Currency Risk - Our functional currency is the U.S. Dollar. By operating internationally, we are subject to foreign currency risk from transactions denominated in currencies other than the U.S. Dollar (“foreign currencies”).  Such transactions include sales, certain inventory purchases and operating expenses. As a result of such transactions, portions of our cash, trade accounts receivable and trade accounts payable are denominated in foreign currencies.  During the three- and nine-month periods ended November 30, 2011, approximately 20 and 19 percent, respectively, of our net sales revenue were in foreign currencies.  These sales were primarily denominated in British Pounds, Euros, Mexican Pesos, Canadian Dollars, Japanese Yen, Australian Dollars, Chilean Pesos, Peruvian Soles and Venezuelan Bolivares Fuertes. During the three- and nine-month periods ended November 30, 2010, approximately 16 and 13 percent, respectively, of our net sales revenue were in foreign currencies.  These transactions were primarily denominated in British Pounds, Euros, Mexican Pesos, Canadian Dollars, Chilean Pesos, Peruvian Soles, and Venezuelan Bolivares Fuertes.  We make most of our inventory purchases from the Far East and use the U.S. Dollar for such purchases.  In our consolidated condensed statements of income, exchange gains and losses resulting from the remeasurement of foreign taxes receivable, taxes payable, deferred tax assets and deferred tax liabilities, are recognized in their respective income tax lines, and all other foreign exchange gains and losses are recognized in SG&A.  For the three- and nine-month periods ended November 30, 2011, we recorded net foreign exchange gains (losses), including the impact of currency hedges, of ($1.44) and ($1.64) million, respectively, in SG&A and $0.14 and $0.06 million, respectively, in income tax expense.  For the three- and nine-month periods ended November 30, 2010, we recorded net foreign exchange gains (losses), including the impact of currency hedges, of $0.40 and $0.49 million, respectively, in SG&A and ($0.05) and $0.09 million, respectively, in income tax expense.

We have historically hedged against certain foreign currency exchange rate-risk by using a series of forward contracts designated as cash flow hedges to protect against the foreign currency exchange risk inherent in our forecasted transactions denominated in currencies other than the U.S. Dollar.  We do not enter into any forward exchange contracts or similar instruments for trading or other speculative purposes.

Interest Rate Risk – Interest on our long-term debt outstanding as of November 30, 2011 is both floating and fixed.  Fixed rates are in place on $103.00 million of Senior Notes at rates ranging from 3.90 to 7.24 percent and floating rates are in place on $70.00 million in advances against our 2010 RCA and $75.00 million of Senior Notes.  If short-term interest rates increase, we will incur higher interest rates on any outstanding balances under the 2010 RCA. The floating rate Senior Notes reset, as described in Note 13, and have been effectively converted to fixed rate debt using an interest rate swap, as described below.

We manage a portion of our floating rate debt using an interest rate swap (the “swap”).  As of November 30, 2011, we had a swap that converted an aggregate notional principal of $75.00 million from floating interest rate payments under our 10 year Senior Notes to fixed interest rate payments at 6.01 percent.  In the swap transaction, we maintain contracts to pay fixed rates of interest on an aggregate notional principal amount of $75.00 million at a rate 5.11 percent on our 10 year Senior Notes, while simultaneously receiving floating rate interest payments set at 0.37 percent as of November 30, 2011 on the same notional amounts.  The fixed rate side of the swap will not change over the life of the swap.  The floating rate payments are reset quarterly based on three month LIBOR.  The resets are concurrent with the interest payments made on the underlying debt. Changes in the spread between the fixed rate payment side of the swap and the floating rate receipt side of the swap offset 100 percent of the change in any period of the underlying debt’s floating rate payments.  The swap is used to reduce the Company’s risk of increased interest costs; however, when interest rates drop significantly below the swap rate, we lose the benefit that our floating rate debt would provide, if not managed with a swap. The swap is considered 100 percent effective.

The following table summarizes the fair values of our various derivative instruments at November 30, 2011 and February 28, 2011:

FAIR VALUES OF DERIVATIVE INSTRUMENTS IN THE CONSOLIDATED BALANCE SHEETS
(in thousands)
November 30, 2011
									Accrued
									Expenses
		Final			Derivative		Derivative		and Other		Derivative
		Settlement	Notional		Assets,		Assets,		Current		Liabilities,
Designated as hedging instruments	Hedge Type	Date	Amount		Current		Noncurrent		Liabilities		Noncurrent
Foreign currency contracts - sell Pounds	Cash flow	2/2012	£	4,000	$	94	$	-	$	-	$	-
Foreign currency contracts - sell Canadian	Cash flow	12/2012	$	9,000	45		23		-		-
Foreign currency contracts - sell Euros	Cash flow	2/2012	€	2,000	-		-		95		-
Subtotal					139		23		95		-
Interest rate swap	Cash flow	6/2014	$	75,000	-		-		3,468		5,707
Total fair value					$	139	$	23	$	3,563	$	5,707
February 28, 2011
									Accrued
									Expenses
		Final			Derivative		Derivative		and Other		Derivative
		Settlement	Notional		Assets,		Assets,		Current		Liabilities,
Designated as hedging instruments	Hedge Type	Date	Amount		Current		Noncurrent		Liabilities		Noncurrent
Foreign currency contracts - sell Pounds	Cash flow	2/2012	£	7,000	$	-	$	-	$	197	$	-
Foreign currency contracts - sell Canadian	Cash flow	12/2012	$	13,000	-		-		208		191
Foreign currency contracts - sell Euros	Cash flow	2/2012	€	5,000	-		-		374		-
Subtotal					-		-		779		191
Interest rate swaps	Cash flow	6/2014	$	125,000	-		-		3,785		5,840
Total fair value					$	-	$	-	$	4,564	$	6,031

The pre-tax effect of derivative instruments for the three- and nine-month periods ended November 30, 2011 and 2010 is as follows:

PRE TAX EFFECT OF DERIVATIVE INSTRUMENTS
(in thousands)
	Three Months Ended November 30,
	Gain \ (Loss)						Gain \ (Loss) Reclassified
	Recognized in OCI						from Accumulated Other							Gain \ (Loss) Recognized
	(effective portion)						Comprehensive Loss into Income							as Income (1)
	2011			2010			Location	2011			2010			Location	2011			2010
Currency contracts - ordinary and cash flow hedges	$	682		$	(702	)	SG&A	$	(75	)	$	(38	)	SG&A	$	40		$	(41	)
Interest rate swaps - cash flow hedges	187			(187		)	Interest expense	(922		)	(1,490		)		-			-
Total	$	869		$	(889	)		$	(997	)	$	(1,528	)		$	40		$	(41	)
	Nine Months Ended November 30,
	Gain \ (Loss)						Gain \ (Loss) Reclassified
	Recognized in OCI						from Accumulated Other							Gain \ (Loss) Recognized
	(effective portion)						Comprehensive Loss into Income							as Income (1)
	2011			2010			Location	2011			2010			Location	2011			2010
Currency contracts - ordinary and cash flow hedges	$	694		$	72		SG&A	$	(344	)	$	112		SG&A	$	(138	)	$	(76	)
Interest rate swaps - cash flow hedges	(3,101		)	(4,324		)	Interest expense	(3,551		)	(4,502		)		-			-
Total	$	(2,407	)	$	(4,252	)		$	(3,895	)	$	(4,390	)		$	(138	)	$	(76	)

(1)  The amounts shown represent the ineffective portion of the change in fair value of a cash flow hedge.

We expect net gains of $0.02  million associated with foreign currency contracts that are currently reported in accumulated other comprehensive loss to be reclassified into income over the next twelve months. The amount ultimately realized, however, will differ as exchange rates change and the underlying contracts settle.

Counterparty Credit Risk - Financial instruments, including foreign currency contracts and interest rate swaps, expose us to counterparty credit risk for non-performance.  We manage our exposure to counterparty credit risk through only dealing with counterparties who are substantial international financial institutions with significant experience using such derivative instruments.  Although our theoretical credit risk is the replacement cost at the then-estimated fair value of these instruments, we believe that the risk of incurring credit risk losses is remote.

Risks Inherent in Cash, Cash Equivalents and Investment Holdings – Our cash, cash equivalents and investments are subject to interest rate risk, credit risk and liquidity risk.  Cash consists of both interest bearing and non-interest bearing disbursement or short-term investment accounts.  Cash equivalents consist of commercial paper and money market investment accounts.  Investments consist of BAA3 to AAA rated ARS and mutual funds.  The following table summarizes our cash, cash equivalents and investments at November 30, 2011 and February 28, 2011:

CASH, CASH EQUIVALENTS AND INVESTMENTS

(in thousands)

	November 30, 2011			February 28, 2011
	Carrying		Range of	Carrying		Range of
	Amount		Interest Rates	Amount		Interest Rates
Cash and cash equivalents
Cash, interest and non-interest-bearing accounts - unrestricted	$	31,171	0.00 to 1.70%	$	16,587	0.00 to 1.60%
Cash, interest and non-interest-bearing accounts - restricted	2,114		0.00 to 1.25%	2,611		0.00 to 1.25%
Commercial paper	-			1,560		0.13%
Money market funds	2,134		0.01 to 4.92%	6,435		0.03 to 3.27%
Total cash and cash equivalents	$	35,419		$	27,193
Investments:
Auction rate securities	$	-		$	20,711	1.76 to 8.47%
Mutual funds, principally equity based	-			1,233
Total investments	$	-		$	21,944

Our cash balances at November 30, 2011 and February 28, 2011 include restricted cash of $2.11 and $2.61 million, respectively, denominated in Venezuelan Bolivares Fuertes, shown above under the heading “Cash, interest and non-interest-bearing accounts – restricted.”  The balances arise from our operations within the Venezuelan market.  Until we are able to repatriate cash from Venezuela, we intend to use these cash balances in-country to continue to fund operations. We do not otherwise rely on these restricted funds as a source of liquidity.

At November 30, 2011, most of our cash equivalents are in money market accounts; therefore, we believe there is no material interest rate, credit or liquidity risk. During the fiscal quarter ended November 30, 2011, we sold all our mutual fund holdings paying out all proceeds in satisfaction of an associated Kaz deferred compensation plan.

At February 28, 2011, we held investments in ARS collateralized by student loans (with underlying maturities from 18 to 35 years).  Substantially all of the collateral was guaranteed by the U.S. government under the Federal Family Education Loan Program.  Liquidity for these securities was normally dependent on an auction process that reset the applicable interest rate at pre-determined intervals, ranging from 7 to 35 days.  Beginning in February 2008, the auctions for the ARS held by us and others were unsuccessful, requiring us to hold them beyond their typical auction reset dates. Auctions fail when there is insufficient demand.  However, this did not represent a default by the issuer of the security. Upon an auction’s failure, the interest rates reset based on a formula contained in the security agreement.  Our subsequent valuation of the securities was based on the assumption that they continued to accrue interest until one of the following occurred: the auction succeeded; the issuer called the securities; or the securities matured.

At February 28, 2011, we had cumulative pre-tax unrealized losses on our ARS of $1.34 million, reflected in accumulated other comprehensive loss in our accompanying consolidated condensed balance sheet, net of related tax effects of  $0.46 million. The recording of this unrealized loss was not a result of the quality of the underlying collateral, but rather a markdown reflecting a lack of liquidity and other market conditions at that time.  For the three- and nine-month periods ended November 30, 2011, we liquidated $0.15 and $3.25 million, respectively, of ARS at par.  For the three- and nine-month periods ended November 30, 2010, we liquidated $0.10 and $0.30 million, respectively, of ARS at par.  On September 15, 2011, the Company entered into an agreement to sell its then remaining portfolio of $18.90 million par value ARS for approximately 96 percent of par. The transaction settled in the fiscal quarter ended November 30, 2011.