Derivative Instruments and Hedging Activity

6 Months Ended

Jul. 01, 2011

Derivative Instruments and Hedging Activity [Abstract]

Derivative Instruments and Hedging Activity

Note K — Derivative Instruments and Hedging Activity

The Company uses derivative contracts to hedge portions of its foreign currency exposures. The objectives and strategies for using foreign currency derivatives are as follows:

The Company sells products to overseas customers in their local currencies, primarily the euro and yen. The Company uses foreign currency derivatives, mainly forward contracts and options, to hedge these anticipated sales transactions. The purpose of the hedge program is to protect against the reduction in dollar value of the foreign currency sales from adverse exchange rate movements. Should the dollar strengthen significantly, the decrease in the translated value of the foreign currency sales should be partially offset by gains on the hedge contracts. Depending upon the methods used, the hedge contract may limit the benefits from a weakening U.S. dollar.

The use of forward contracts locks in a firm rate and eliminates any downside from an adverse rate movement as well as any benefit from a favorable rate movement. The Company may from time to time choose to hedge with options or a tandem of options known as a collar. These hedging techniques can limit or eliminate the downside risk but can allow for some or all of the benefit from a favorable rate movement to be realized. Unlike a forward contract, a premium is paid for an option; collars, which are a combination of a put and call option, may have a net premium but they can be structured to be cash neutral. The Company will primarily hedge with forward contracts due to the relationship between the cash outlay and the level of risk.

The use of foreign currency derivative contracts is governed by policies approved by the Board of Directors. A team consisting of senior financial managers reviews the estimated exposure levels, as defined by budgets, forecasts and other internal data, and determines the timing, amounts and instruments to use to hedge that exposure within the confines of the policy. Management analyzes the effective hedged rates and the actual and projected gains and losses on the hedging transactions against the program objectives, targeted rates and levels of risk assumed. Hedge contracts are typically layered in at different times for a specified exposure period in order to minimize the impact of rate movements.

The Company may also use forward contracts to hedge its precious metal exposures. The Company maintains the majority of its precious metals used in production on a consignment basis. The metal is purchased out of consignment when it is shipped to the customer and the purchase price forms the basis for the price to be charged to the customer. This allows for changes in the market prices of the precious metals in either direction to be passed through to the customer and reduces the impact changes in prices could have on the Company’s margins and operating profit. However, in certain circumstances, the Company may elect to purchase precious metals to meet a portion of its production requirements. The Company may then hedge the price exposure on this inventory by securing a forward contract. The gain or loss on the forward contract from movements in the market price will generally offset the gain or loss on the disposition of the metal. The use of precious metal derivative contracts is also governed by policies approved by the Board of Directors and monitored by a group of senior financial managers.

The Company will only enter into a derivative contract if there is an underlying identified exposure. Contracts are typically held until maturity. The Company does not engage in derivative trading activities and does not use derivatives for speculative purposes. The Company only uses currency hedge contracts that are denominated in the same currency as the underlying exposure.

All derivatives are recorded on the balance sheet at their fair values. If the derivative is designated and effective as a cash flow hedge, changes in the fair value of the derivative are recognized in other comprehensive income (OCI) until the hedged item is recognized in earnings. The ineffective portion of a derivative’s fair value, if any, is recognized in earnings immediately. If a derivative is not a hedge, changes in the fair value are adjusted through income. The fair values of the outstanding derivatives are recorded on the balance sheet as assets (if the derivatives are in a gain position) or liabilities (if the derivatives are in a loss position). The fair values will also be classified as short-term or long-term depending upon their maturity dates.

The outstanding foreign currency forward contracts had a notional value of $36.5 million as of July 1, 2011. All of these contracts were designated as and effective as cash flow hedges. There was no ineffectiveness associated with the outstanding currency contracts. The fair value of these contracts was recorded on the balance sheet as of July 1, 2011 as follows (dollars in thousands):

	Fair
Debit (credit)	Value
Other liabilities and accrued items	$	(2,059	)
Other long-term liabilities		(117	)
Total	$	(2,176	)

A summary of the hedging relationships of the outstanding derivative financial instruments designated as cash flow hedges as of July 1, 2011 and July 2, 2010 and the amounts transferred into income for the second quarter and first half then ended is as follows:

	Second Quarter Ended					First Half Ended
	July 1,			July 2,		July 1,			July 2,
(Thousands)	2011			2010		2011			2010
Derivative in cash flow hedging relationship		Foreign Currency			Foreign Currency		Foreign Currency			Foreign Currency
		Forward Contracts			Forward Contracts		Forward Contracts			Forward Contracts
Effective portion of hedge:
Gain (loss) recognized in OCI at the end of the period	$	(2,176	)	$	803
Location of gain (loss) reclassified from OCI into income		Other-net			Other-net		Other-net			Other-net
Amount of gain (loss) reclassified from OCI into income	$	(625	)	$	398	$	(1,235	)	$	388
Ineffective portion of hedge and amounts excluded from effectiveness testing:
Location of gain (loss) recognized in income on derivative		Other-net			Other-net		Other-net			Other-net
Amount of gain (loss) recognized in income on derivative	$	—		$	—	$	—		$	—

The Company secured a debt obligation with an embedded copper derivative in October 2009. The derivative provided an economic hedge for the Company’s copper inventory against movements in the market price of copper. However, the derivative did not qualify as a hedge for accounting purposes and changes in its fair value were charged against income in the period as incurred. In the first quarter 2010, the Company secured forward contracts to reduce the variability of the charges against income due to movements in the derivative’s fair value. The ineffectiveness on the embedded derivative and the forward contract was zero in the second quarter 2010 and a net $0.5 million expense in the first half of 2010 and was recorded in other-net on the Consolidated Statements of Income. The forward contract and the embedded copper derivative outstanding at the end of the second quarter 2010 matured in the third quarter of 2010. There was no derivative ineffectiveness recorded in the second quarter or first half of 2011.

During the first quarter 2011, the Company secured a forward contract to sell a specified quantity of gold. The contract served as an economic hedge of gold purchased and held in inventory for use in manufacturing products for sale in the normal course of business. No hedge designation was assigned to the contract. The contract matured in the first quarter 2011 and resulted in a loss of $0.2 million that was recorded in cost of sales on the Consolidated Statements of Income.

The Company expects to relieve $2.1 million from OCI and charge other-net on the Consolidated Statements of Income in the twelve month period beginning July 2, 2011.