Fair Value Information and Derivative Financial Instruments

The Company measures and records financial instruments at their fair value. A hierarchy is used for those instruments measured at fair value that distinguishes between assumptions based upon market data (observable inputs) and the Company's assumptions (unobservable inputs). The hierarchy consists of three levels:

Level 1 — Quoted market prices in active markets for identical assets and liabilities;

Level 2 — Inputs other than Level 1 inputs that are either directly or indirectly observable; and

Level 3 — Other significant unobservable inputs developed using estimates and assumptions developed by the Company, which reflect those that a market participant would use.

The following table summarizes the financial instruments measured at fair value in the Consolidated Balance Sheet as of December 31, 2012:



			Fair Value Measurements
(Thousands)	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Other Significant Unobservable Inputs (Level 3)
Financial Assets
Directors’ deferred compensation investments	$	1,742	$	1,742	$	—	$	—
Precious metal forward contracts	197		—		197		—
Foreign currency forward contracts	650		—		650		—
Total	$	2,589	$	1,742	$	847	$	—
Financial Liabilities
Directors’ deferred compensation liability	$	1,742	$	1,742	$	—	$	—
Precious metal swaps	100		—		100		—
Foreign currency forward contracts	397		—		397		—
Total	$	2,239	$	1,742	$	497	$	—

The Company uses a market approach to value the assets and liabilities for outstanding derivative contracts in the table above. Foreign currency and precious metal hedge contracts are valued through models that utilize market observable inputs including both spot and forward prices for the same underlying currencies and metals. The carrying values of the other working capital items and debt on the Consolidated Balance Sheet approximate their fair values as of December 31, 2012.

The Company uses derivative contracts to hedge portions of its foreign currency exposures and may also use derivatives to hedge a portion of its precious metal exposures. The objectives and strategies for using derivatives in these areas are as follows:

Foreign Currency. The Company sells products to overseas customers in their local currencies, primarily the euro and yen. The Company secures 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 the dollar value of 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.

Precious Metals. The Company maintains the majority of its precious metal production requirements on consignment in order to reduce its working capital investment and the exposure to metal price movements. When a precious metal product is fabricated and ready for shipment to the customer, the metal is purchased out of consignment at the current market price. The price paid by the Company forms the basis for the price charged to the customer. This methodology allows for changes in either direction in the market prices of the precious metals used by the Company to be passed through to the customer and reduces the impact changes in prices could have on the Company's margins and operating profit. The consigned metal is owned by financial institutions who charge the Company a financing fee based upon the current value of the metal on hand.

In certain instances, a customer may want to establish the price for the precious metal at the time the sales order is placed rather than at the time of shipment. Setting the sales price at a different date than when the material would be purchased potentially creates an exposure to movements in the market price of the metal. Therefore, in these limited situations, the Company may elect to enter into a forward contract to purchase precious metal. The forward contract allows the Company to purchase metal at a fixed price on a specific future date. The price in the forward contract serves as the basis for the price to be charged to the customer. By doing so, the selling price and purchase price are matched and the Company's price exposure is reduced.

The Company refines precious metal containing materials for its customers and typically will purchase the refined metal from the customer at current market prices. In limited circumstances, the customer may want to fix the price to be paid at the time of the order as opposed to when the material is refined. The customer may also want to fix the price for a set period of time. The Company may then elect to enter into a hedge contract, either a forward contract or a swap, to fix the price for the estimated quantity of metal to be purchased thereby reducing the exposure to adverse movements in the price of the metal.

The Company may from time to time elect to purchase precious metal and hold in its inventory rather than on consignment due to potential credit line limitations or other factors. These purchases are typically held for a short duration. A forward contract will be secured at the time of the purchase to fix the price to be used when the metal is transferred back to the consignment line, thereby limiting any price exposure during the time when the metal was owned.

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. 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. Foreign currency contracts are typically layered in at different times for a specified exposure period in order to minimize the impact of market rate movements.

The use of derivatives is governed by policies adopted by the Audit Committee of the Board of Directors. The Company will only enter into a derivative contract if there is an underlying identified exposure. Contracts are typically held to maturity. The Company does not engage in derivative trading activities and does not use derivatives for speculative purposes. The Company only uses hedge contracts that are denominated in the same currency or metal as the underlying exposure.

The following table summarizes the notional amount and the fair value of the Company’s outstanding derivatives as of December 31, 2012 and 2011:



	December 31, 2012					December 31, 2011
(Thousands)	Notional Amount		Fair Value			Notional Amount		Fair Value
Asset (liability)
Foreign currency forward contracts
Yen	$	8,024	$	650		$	12,096	$	(480	)
Euro	21,047		(397		)	26,466		1,879
Total	$	29,071	$	253		$	38,562	$	1,399
Precious metal contracts
Forward contracts	$	14,623	$	197		$	8,795	$	249
Swaps	11,673		(100		)	6,964		(198		)
Total	$	26,296	$	97		$	15,759	$	51

The fair values of the outstanding derivatives are recorded 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 balance sheet classification of the outstanding derivatives at December 31, 2012 and 2011 was as follows:



	December 31,
(Thousands)	2012			2011
Asset (liability)
Prepaid expenses	$	847		$	2,128
Other liabilities and accrued items	(497		)	(678		)
Total	$	350		$	1,450

All of the foreign currency and precious metal derivative contracts outstanding at December 31, 2012 and 2011 were designated as cash flow hedges.

A summary of the hedging relationships of the outstanding derivative financial instruments designated as cash flow hedges as of December 31, 2012 and 2011 and the pre-tax amounts transferred into income for the twelve months then ended follows.



	Effective Portion of Hedge						Ineffective Portion of Hedge
	Recognized in OCI at End of Period		Reclassified from OCI into Income During Period				Recognized in Income on Derivative During Period
(Thousands)	Recognized in OCI at End of Period		Location	Amount			Location	Amount
Gain (loss)
2012
Foreign currency contracts	$	253	Other-net	$	1,839		Other-net	$	—
Precious metal contracts	97		Cost of sales	(598		)	Cost of sales	—
Total	$	350		$	1,241			$	—
2011
Foreign currency contracts	$	1,399	Other-net	$	(2,809	)	Other-net	$	—
Precious metal contracts	51		Cost of Sales	—			Cost of Sales	—
Total	$	1,450		$	(2,809	)		$	—

Total derivative ineffectiveness expense was zero in 2012 and 2011 and $0.6 million in 2010. The ineffectiveness recorded in 2010 was associated with copper-based derivatives that were secured in 2009 and 2010 that provided an economic hedge but did not qualify as a hedge for accounting purposes. These derivatives matured during 2010.

In addition to the precious metal contracts that were outstanding at December 31, 2011, during 2011, the Company secured various forward contracts to sell specified quantities of gold. The contracts served as economic hedges of gold purchased and held in inventory for use in manufacturing products for sale in the normal course of business. No hedge designations were assigned to the contracts since they typically matured in the same quarter as they were initially secured. A loss of $1.2 million was recognized upon maturity of these contracts in 2011 and was recorded in cost of sales on the Consolidated Statement of Income. An equal and offsetting gain was recorded in cost of sales in 2011 as a result of the sale of the underlying gold inventory.

The Company expects to relieve the entire balance in OCI as of December 31, 2012 and credit other-net and cost of sales on the Consolidated Statement of Income in 2013.