Derivative Financial Instruments

9 Months Ended

Sep. 30, 2012

Derivative Financial Instruments

8. Derivative Financial Instruments

The Company’s Korean subsidiary, MagnaChip Semiconductor, Ltd., entered into option, forward and zero cost collar contracts to hedge the risk of changes in the functional-currency-equivalent cash flows attributable to currency rate changes on U.S. dollar denominated revenues.

Details of derivative contracts as of September 30, 2012 are as follows:

Date of transaction	Type of derivative	Total notional amount		Month of settlement
August 19, 2011	Forward	$	54,000	October to December 2012
March 23, 2012	Zero cost collar	$	54,000	January to March 2013
May 18, 2012	Zero cost collar	$	54,000	April to June 2013

The option, forward and zero cost collar contracts qualify as cash flow hedges under ASC 815, “Derivatives and Hedging,” (“ASC 815”), since at both the inception of the contracts and on an ongoing basis, the hedging relationship was and is expected to be highly effective in achieving offsetting cash flows attributable to the hedged risk during the term of the contracts. The Company is utilizing the “hypothetical derivative” method to measure the effectiveness by comparing the changes in value of the actual derivative versus the change in fair value of the “hypothetical derivative.”

The fair values of the Company’s outstanding forward and zero cost collar contracts recorded as assets and liabilities as of September 30, 2012 and December 31, 2011 are as follows:

Derivatives designated as hedging instruments:		September 30, 2012		December 31, 2011
Asset Derivatives:
Zero cost collars	Other current assets	$	74	$	—
Liability Derivatives:
Forward	Derivative liabilities	$	1,818	$	6,801
Zero cost collars	Derivative liabilities	$	—	$	2,956

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (“AOCI”) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative, representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness, are recognized in current earnings.

The following table summarizes the impact of derivative instruments on the consolidated statement of operations for the three months ended September 30, 2012 and 2011:

Derivatives in ASC 815 Cash Flow Hedging Relationships	Amount of Gain (Loss) Recognized in AOCI on Derivatives (Effective Portion)					Location of Gain (Loss) Reclassified from AOCI into Statement of Income (Effective Portion)		Amount of Gain (Loss) Reclassified from AOCI into Statement of Income (Effective Portion)					Location of Gain (Loss) Recognized in Statement of Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)	Amount of Gain (Loss) Recognized in Statement of Income on Derivatives (Ineffective Portion and Amount Excluded from Effectiveness Testing)
	3Q, 2012		3Q, 2011					3Q, 2012			3Q, 2011			3Q, 2012		3Q, 2011
Forward	$	2,338	$	(8,044	)		Net sales	$	(2,783	)	$	—	Other income (expenses) — Others	$	619	$	171
Zero cost collars		1,681		(8,245	)		Net sales		—			1,536	Other income (expenses) — Others		76		(729	)
Total	$	4,019	$	(16,289	)			$	(2,783	)	$	1,536		$	695	$	(558	)

The following table summarizes the impact of derivative instruments on the consolidated statement of operations for the nine months ended September 30, 2012 and 2011:

Derivatives in ASC 815 Cash Flow Hedging Relationships	Amount of Gain (Loss) Recognized in AOCI on Derivatives (Effective Portion)					Location of Gain (Loss) Reclassified from AOCI into Statement of Income (Effective Portion)		Amount of Gain (Loss) Reclassified from AOCI into Statement of Income (Effective Portion)						Location of Gain (Loss) Recognized in Statement of Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)	Amount of Gain (Loss) Recognized in Statement of Income on Derivatives (Ineffective Portion and Amount Excluded from Effectiveness Testing)
	9M, 2012		9M, 2011					9M, 2012			9M, 2011				9M, 2012		9M, 2011
Options	$	—	$	(85	)		Net sales	$	—		$	(829	)	Other income (expenses) — Others	$	—	$	(18	)
Forward		1,953		(5,337	)		Net sales		(2,783	)		10,771		Other income (expenses) — Others		1,132		435
Zero cost collars		1,421		(4,791	)		Net sales		(1,529	)		1,536		Other income (expenses) — Others		349		(614	)
Total	$	3,374	$	(10,213	)			$	(4,312	)	$	11,478			$	1,481	$	(197	)

The estimated net loss as of September 30, 2012 that is expected to be reclassified from accumulated other comprehensive income (loss) into earnings within the next twelve months is $1,714 thousand.

The Company’s option, forward and zero cost collar contracts are subject to termination upon the occurrence of the following events:

(i) On the last day of a fiscal quarter, the sum of qualified and unrestricted cash and cash equivalents held by the Company is less than $30 million.

(ii) The rating of the Company’s debt is B- or lower by Standard & Poor’s Ratings Group or any successor rating agency thereof (“S&P”) or B3 or lower by Moody’s Investor Services, Inc. or any successor rating agency thereof (“Moody’s”) or the Company’s debt ceases to be assigned a rating by either S&P or Moody’s.

In addition, the Company is required to deposit cash collateral with Goldman Sachs International Bank (“GS”), the counterparty to the option, forward and zero cost collar contracts, for any exposure in excess of $5 million.