5. ON-BALANCE SHEET DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

9 Months Ended

Jul. 31, 2013

Derivative Instruments and Hedging Activities Disclosure [Abstract]

5. On-Balance Sheet Derivative Instruments and Hedging Activities

Derivative Financial Instruments

The Company uses stand-alone derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates. These transactions involve both credit and market risk.  The notional amount is an amount on which calculations, payments, and the value of the derivative are based.  The notional amount does not represent direct credit exposure.  Direct credit exposure is limited to the net difference between the calculated amount to be received and paid, if any. Such difference, which represents the fair value of the derivative instrument, is reflected on the Company’s consolidated balance sheet as an unrealized gain or loss on derivatives.

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements.  The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and currently has no reason to believe that any counterparties will fail to fulfill their obligations.

Risk Management Policies - Hedging Instruments

The Company uses long-term variable rate debt as a source of funds for use in the Company’s general business purposes.  These debt obligations expose the Company to variability in interest payments due to changes in interest rates.  If interest rates increase, interest expense increases.  Conversely, if interest rates decrease, interest expense decreases.  Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore, generally hedges a portion of its variable-rate interest obligations.  To meet this objective, management enters into interest rate swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments on a portion of its debt.

On October 5, 2007, the Company entered into an interest rate swap agreement (old swap) in conjunction with an amendment to its credit facility with Bank of America.  The intent of the instrument was to fix the interest rate on at least 75% of the outstanding balance on the term loan (the swapped amount) with Bank of America as required by the facility.  The old swap fixed the interest rate for the swapped amount related to the previous facility at 4.87% and was to mature in January 2014.

On April 5, 2010, the Company entered into an interest rate swap agreement (offsetting swap) to offset the old swap for which it receives 1.40% of the scheduled balance of the old term loan. The offsetting swap effectively removed any exposure to change in the fair value of the old swap and set a fixed net payment schedule based on the scheduled balance of the old term loan until January 2014 when both swaps were to mature.   In addition, the Company entered into a swap agreement (new swap) to fix the interest rate of up to 75% of the outstanding balance of the term note at 4.76% (2.01% plus the applicable margin, 2.75%).  The term note was re-financed in March 2013 and the new swap matured in April 2013.

In March 2013, the Company terminated the old and offsetting swaps and settled the remaining liability of $27,670 associated with them. The settlement was expensed during the three months ended April 30, 2013. In addition, the Company entered into a new interest rate swap agreement (latest swap) for the purpose of fixing at least 75% of the term loan under the Agreement with Bank of America. The latest swap fixes the rate on at least 75% of the outstanding balance of the term loan at 3.18% (.68% plus the applicable margin under the Agreement, 2.50%) until March 2016.

As of July 31, 2013, the total notional amount of the new swap agreement was $7,857,000.  On that date, the variable rate on the remaining portion of the term note was 2.69%.

At July 31, 2013 and October 31, 2012, the net unrealized loss or gain relating to interest rate swaps was recorded in current and long term liabilities and long term assets.  The current portion is the valuation of the hedged instrument over the next twelve months while the balance of the unrealized loss makes up the long term portion.  For the effective portion of the hedges, which is the new swap at October 31, 2012 and the latest swap at July 31, 2013, changes in the fair value of interest rate swaps designated as hedging instruments to mitigate the variability of cash flows associated with long-term debt are reported in other comprehensive income or loss net of tax effects. The amounts relating to the old swap previously reflected in accumulated other comprehensive income were amortized to earnings over the remaining term of the undesignated cash flow hedge.  Payments on the old swap, and receipt of income on the offsetting swap, are reported as gain or loss on derivatives and an adjustment to other comprehensive income or loss net of tax effects.

The table below details the adjustments to other comprehensive income (loss), on a before-tax and net-of tax basis, for the fiscal quarters ended July 31, 2013 and 2012.

	Before-Tax			Tax Benefit			Net-of-Tax
Three Months Ended July 31, 2012
Loss on interest rate swap	$	(35,180	)	$	14,072		$	(21,108	)
Amortization of loss on derivative undesignated as cash flow hedge		37,885			(15,154	)		22,731
Reclassification adjustment for loss in income		67,135			(26,854	)		40,281
Net unrealized gain	$	69,840		$	(27,936	)	$	41,904
Three Months Ended July 31, 2013
Gain on interest rate swap		24,898			(9,959	)		14,939
Reclassification adjustment for loss in income		9,877			(3,951	)		5,926
Net unrealized gain	$	34,775		$	(13,910	)	$	20,865

The reclassification adjustments of $9,877 and $67,135 represent interest the Company paid in excess of the amount that would have been paid without the interest rate swap agreement during the quarters ended July 31, 2013 and 2012, respectively. These amounts were reclassified from accumulated other comprehensive loss and recorded in consolidated statements of operations as interest expense.  No other material amounts were reclassified during the quarters ended July 31, 2013 and 2012.

The table below details the adjustments to other comprehensive income (loss), on a before-tax and net-of tax basis, for the nine months ended July 31, 2013 and 2012.

	Before-Tax			Tax Benefit (Expense)			Net-of-Tax
Nine months Ended July 31, 2012
Loss on interest rate swap	$	(124,514	)	$	49,805		$	(74,709	)
Amortization of loss on derivative undesignated as cash flow hedge		113,655			(45,461	)		68,194
Reclassification adjustment for loss in income		224,400			(89,760	)		134,640
Net unrealized gain	$	213,541		$	(85,416	)	$	128,125
Nine months Ended July 31, 2013
Loss on interest rate swap	$	(27,653	)	$	11,061		$	(16,592	)
Amortization of loss on derivative undesignated as cash flow hedge		25,110			(10,044	)		15,066
Reclassification adjustment for loss in income		96,938			(38,775	)		58,163
Net unrealized gain	$	94,395		$	(37,758	)	$	56,637

The reclassification adjustments of $96,938 and $224,400 represent interest the Company paid in excess of the amount that would have been paid without the interest rate swap agreements during the nine months ended July 31, 2013 and 2012, respectively. These amounts were reclassified from accumulated other comprehensive loss and recorded in the condensed consolidated statements of operations as interest expense.  No other material amounts were reclassified during the nine months ended July 31, 2013 and 2012.

In the nine months ended July 31, 2013 the fair value of the swap entered into during the quarter resulted in an unrealized loss on derivative liability at the end of the period of $32,786. Also, as of that date, the estimated net amount of the existing loss that is reported in accumulated other comprehensive income that is expected to be reclassified into earnings within the next twelve months is $33,202, net of tax.

Derivatives designated as hedging instruments include interest rate swaps classified as liabilities on the Company’s balance sheet with a fair value of $33,202 at July 31, 2013 and $64,603 at October 31, 2012.  There were no derivatives other than the interest rate swap designated as a hedging instrument as of July 31, 2013. As of October 31, 2012 there were derivatives consisting of interest rate swaps not designated as hedging instruments classified as liabilities on the Company’s consolidated balance sheet with a fair value of $62,577. During the first nine months of fiscal years 2013 and 2012, cash flow hedges are deemed 100% effective. During the quarter ended July 31, 2013, the only derivative was a cash flow hedge. The net loss on interest rate swaps not designated as cash flow hedges, classified as a loss on derivatives on the Company’s statements of operations, amounted to $4,119 for the quarter ended July 31, 2012. The net gain on interest rate swaps not designated as cash flow hedges, classified as a gain on derivatives on the Company’s statements of operations, amounted to $16,505 and $3,973 for the nine months ended July 31, 2013 and 2012, respectively.