Quarterly report pursuant to Section 13 or 15(d)

Derivatives

v3.19.2
Derivatives
3 Months Ended
Jun. 30, 2019
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivatives Derivatives
Certain of the Company’s foreign operations expose the Company to fluctuations in currency exchange rates. These fluctuations may impact the value of the Company’s cash payments, assets, and liabilities in terms of the Company’s functional currency. The Company enters into derivative financial instruments to protect the value of certain obligations and its net investment in its TOKIN subsidiary in terms of its functional currency, the U.S. dollar. The Company’s primary exposure to foreign currency exchange rate risk relates to (i) intercompany financings with TOKIN, (ii) its net investment in TOKIN, and (iii) certain operating expenses at the Company’s Mexican facilities.
    The principal objective of such arrangements is to minimize the risks and/or costs associated with the Company’s operating and financial structure as well as to hedge specific anticipated transactions. The Company does not utilize derivatives for speculative or other purposes other than currency risk management. The use of derivative financial instruments carries certain risks, including the risk that any counterparty to a contractual arrangement may not be able to perform under the agreement. To mitigate this risk, historically the Company has only entered into derivative financial instruments with a counterparty that is a major financial institution with a high credit rating. The Company does not anticipate that the counterparty will fail to meet its obligations.
Each derivative instrument that qualifies for hedge accounting is expected to be highly effective at reducing the risk associated with the exposure being hedged, and the Company monitors each instrument for effectiveness on a quarterly basis. The Company formally documents all relationships between hedging instruments and hedged items, as well as risk management objectives and strategies for undertaking various hedge transactions.
Changes in fair value of all its derivative instruments are reported in earnings or in AOCI, depending on whether the derivative is designated as part of a hedge transaction, and if so, the type of hedge transaction. The Company records all derivative financial instruments on its Condensed Consolidated Balance Sheets at fair value. Certain of the derivative
instruments are subject to master netting agreements and are presented in the Condensed Consolidated Balance Sheets on a net basis. If the Company were to account for the asset and liability balances of those derivative contracts on a gross basis, the amounts presented in the Consolidated Balance Sheets would be adjusted from the current net presentation to the gross amounts as detailed in the table below.
The balance sheet classifications and fair value of derivative instruments designated as hedges as of June 30, 2019 and March 31, 2019 are as follows (amounts in thousands):
 
 
 
 
Fair Value of Derivative Instruments
 
 
 
 
June 30, 2019
 
March 31, 2019
 
 
Balance Sheet Location
 
As Presented
 
Offset
 
Gross
 
As Presented
 
Offset
 
Gross
Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cross-currency swaps
 
Other assets
 
$

 
$

 
$

 
$
4,577

 
$

 
$
4,577

Foreign exchange contracts
 
Prepaid and other current assets
 
706

 
633

 
1,339

 
564

 
645

 
1,209

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cross-currency swaps
 
Other non-current obligations
 
$
3,145

 
$

 
$
3,145

 
$

 
$

 
$

Foreign exchange contracts
 
Accrued expenses
 

 
633

 
633

 

 
645

 
645


Fair Value Hedging Strategy
The Company entered into two cross-currency swaps designated as fair value hedges on November 7, 2018 to hedge the foreign currency risk on the Intercompany Loans. These agreements were contracts to exchange floating-rate payments in one currency with floating-rate payments in another currency. Changes in the fair value of these cross-currency swaps due to changes in foreign currency exchange rates were recognized in earnings upon the recognition of the change in the fair value of the hedged intercompany financings. The notional value of these contracts was JPY 31.6 billion or $279.7 million at March 31, 2019.
The Company terminated these contracts with the counterparty on May 28, 2019, and received proceeds of $6.5 million for the combined fair value of these contracts at the time of termination.
Hedges of Net Investments in Foreign Operations Strategy
The Company entered into a cross-currency swap designated as a net investment hedge on November 7, 2018 to hedge the JPY currency exposure of the Company’s net investment in TOKIN. This agreement is a contract to exchange fixed-rate payments in one currency for fixed-rate payments in another currency. Changes in the fair value of this swap are recorded in equity as a component of AOCI in the same manner as foreign currency translation adjustments. In assessing the effectiveness of this hedge, the Company uses a method based on changes in spot rates to measure the impact of the foreign currency exchange rate fluctuations on both its foreign subsidiary net investment and the related swap. Under this method, changes in the fair value of the hedging instrument other than those due to changes in the spot rate are initially recorded in AOCI as a translation adjustment, and then are amortized into other (income) expense, net in the Condensed Consolidated Statement of Operations using a systematic and rational method over the instrument’s term. Changes in the fair value associated with the effective portion (i.e. those changes due to the spot rate) are recorded in AOCI as a translation adjustment and are released and recognized in earnings only upon the sale or liquidation of the hedged net investment. The terms of this cross-currency swap are as follows:
An amortizing cross-currency swap with an initial notional value of JPY 33.0 billion. The notional amount is amortized by approximately JPY 1.4 billion every six months and matures on September 30, 2024. Interest payments are made by the Company in JPY on March 31 and September 30 of each year based on the JPY notional value and a fixed rate of 2.61%. The Company receives interest in USD on March 31 and September 30 of each year based on the USD equivalent of the JPY notional value and a fixed rate of 6.25%.
The notional value of this contract was JPY 31.6 billion or $279.7 million at June 30, 2019 and March 31, 2019, respectively.
Cash Flow Hedging Strategy
Foreign Exchange Contracts
Certain operating expenses at the Company’s Mexican facilities are paid in Mexican Pesos. In order to hedge a portion of these forecasted cash flows, the Company purchases foreign exchange contracts, with terms generally less than fifteen months, to buy Mexican Pesos for periods and amounts consistent with underlying cash flow exposures. These contracts are designated as cash flow hedges at inception.
Unrealized gains and losses associated with the change in fair value of the foreign exchange contracts are recorded in AOCI. Changes in the derivatives’ fair values are deferred and recorded as a component of AOCI until the underlying transaction is settled and recorded to the Condensed Consolidated Statement of Operations. When the hedged item affects income, gains or losses are reclassified from AOCI to the Condensed Consolidated Statement of Operations as Cost of Sales for foreign exchange contracts to purchase such foreign currency. The notional value of outstanding Peso contracts was $100.7 million and $74.3 million as of June 30, 2019 and March 31, 2019, respectively.
Cross-Currency Swaps
On May 28, 2019, the Company entered into two cross-currency swaps designated as cash flow hedges to hedge the foreign currency risk on the principal payments on the Intercompany Loans. These agreements are contracts to exchange floating-rate payments in one currency with fixed-rate payments in another currency. The Company uses these cross-currency swaps to hedge the changes in cash flows on the Intercompany Loans due to changes in foreign currency exchange rates. For this hedging program, the Company records the remeasurement of the Intercompany Loans due to changes in foreign currency exchange rates each period. Changes in the fair value of these cross-currency swaps are initially recorded in AOCI each period with an immediate reclassification into earnings for the change in fair value attributable to the fluctuations in foreign currency exchanges. The Company excludes the change in the fair value of these cross-currency swaps due to changes in interest rates from the assessment of hedge effectiveness. Changes in fair value of the swaps associated with changes in interest rates are initially recorded as a component of AOCI and recognized into other (income) expense, net in the Consolidated Statement of Operations using a systematic and rational method over the instrument’s term. The terms of the two cross-currency swaps designated as cash flow hedges are as follows:
An amortizing cross-currency swap with an initial notional value of JPY 15.1 billion. The notional value is amortized by approximately JPY 1.4 billion every six months and matures on September 30, 2024. The Company receives interest in JPY on March 31 and September 30 of each year based on the JPY notional value and JPY Libor plus 2.00%. Interest payments are made in USD on March 31 and September 30 of each year based on the USD equivalent of the JPY notional value and a fixed rate of 4.88%.
A non-amortizing cross-currency swap with a notional value of JPY 16.5 billion maturing on September 30, 2024. The Company receives interest in JPY on March 31 and September 30 of each year based on the JPY notional value and JPY Libor plus 2.25%. Interest payments are made in USD on March 31 and September 30 of each year based on the USD equivalent of the JPY notional value and a fixed rate of 5.26%.
The notional value of these contracts were JPY 31.6 billion, or $288.9 million as of June 30, 2019.
Hedging Strategy Impact on Statements of Operations
The following tables present gain and loss activity for the three months ended June 30, 2019 and 2018 for derivative instruments designated as hedges (amounts in thousands):
 
 
 
 
 
 
Three Months Ended June 30, 2019
 
 
 
 
 
 
Gain (Loss)
Derivative Instrument
 
Hedge Designation
 
Location of Gain (Loss) Recognized in Statements of Operations
 
Recognized in AOCI
 
Reclassified from AOCI to Income
 
Recorded Directly to Income
Cross-currency swaps (1)
 
Fair Value 
 
Other income/expense, net
 
$
(346
)
 
$
(1,622
)
 
$
3,337

Cross-currency swaps (2)
 
Net Investment  
 
Other income/expense, net
 
(2,006
)
 
2,655

 

Cross-currency swaps (3)
 
Cash Flow
 
Other income/expense, net
 
(2,231
)
 
3,909

 

Foreign exchange contracts (4)
 
Cash Flow
 
Cost of sales
 
527

 
385

 

 
 
 
 
 
 
Three-Months Ended June 30, 2018
 
 
 
 
 
 
Gain (Loss)
Derivative Instrument
 
Hedge Designation
 
Location of Gain (Loss) Recognized in Statements of Operations
 
Recognized in AOCI
 
Reclassified from AOCI to Income
 
Recorded Directly to Income
Foreign exchange contracts (4)
 
Cash Flow
 
Cost of sales
 
(3,795
)
 
643

 

_________________
(1) Amounts recognized in AOCI represent the change in the fair value of the derivative instruments related to the excluded components. Amounts reclassified from AOCI to income represent amortization of excluded components based upon the instruments' periodic coupons. Amounts recorded directly to income represent the change in the fair value of the derivative instruments related to the effective portion of the qualifying hedge.
(2) Amounts recognized in AOCI represent the total change in the fair value of the derivative instrument. Amounts recorded to AOCI are recorded within foreign currency translation. Amounts reclassified from AOCI to income represent amortization of excluded components based on the instrument's periodic coupon.
(3) Amounts recognized in AOCI represent the total change in the fair value of the derivative instruments. Amounts reclassified from AOCI to income represent the change in the fair value of the derivative instruments related of the effective portion of the qualifying hedges, as well as amortization of the excluded components based upon the instruments' periodic coupons. For the three months ended June 30, 2019, the amount reclassified to income from AOCI includes $4.7 million in gains related to the effective portion of the hedges and $0.8 million in losses related to amortization of the excluded components.
(4) Amounts recognized in AOCI represent the total change in the fair value of the derivative instruments. Amounts reclassified from AOCI to income represent the change in the fair value of the derivative instruments pertaining to the settlement of the qualifying hedged item (effective portion).

The following tables present the total amount of each income and expense line item presented in the Condensed Statements of Operations in which the results of fair value and cash flow hedges are recorded and the effects of those hedging strategies on income (amounts in thousands):
 
 
Three Months Ended June 30, 2019
 
Three Months Ended June 30, 2018
 
 
Cost of sales
 
Other income (expense), net
 
Cost of sales
 
Other income (expense), net
Total income (expense) in Statements of Operations
 
$
(223,614
)
 
$
726

 
$
(232,795
)
 
$
11,371

 
 
 
 
 
 
 
 
 
Fair value hedging impact
 
 
 
 
 
 
 
 
Cross-currency swaps:
 
 
 
 
 
 
 
 
Gain (loss) on hedged item
 

 
(3,337
)
 

 

Gain (loss) on derivative instrument (1)
 

 
1,715

 

 

 
 
 
 
 
 
 
 
 
Cash flow hedging impact
 
 
 
 
 
 
 
 
Cross-currency swaps:
 
 
 
 
 
 
 
 
Gain (loss) reclassified from AOCI to income (2)
 

 
3,909

 

 

Foreign exchange contracts:
 
 
 
 
 
 
 
 
Gain (loss) reclassified from AOCI to income (3)
 
385

 

 
643

 

_________________
(1) Amounts recognized in income includes the change in the fair value of the derivative instruments related to the effective portion of the qualifying hedges and amortization of the excluded components.
(2) Net losses of $8.5 million are expected to be reclassified from AOCI into income within the next 12 months.
(3) Net gains of $1.5 million are expected to be reclassified from AOCI into income within the next 12 months.