Derivatives

In fiscal year 2015, the Company began using certain derivative instruments (i.e., foreign exchange contracts) to reduce exposure to the volatility of foreign currencies impacting revenues and the costs of its products.

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 twelve 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 and monitored for effectiveness on a routine basis. There were $34.4 million in peso contracts (notional value) outstanding at September 30, 2016.

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.

The Company records and presents the fair values of all of its derivative assets and liabilities in the Consolidated Balance Sheets on a net basis, since they are subject to master netting agreements. As of September 30, 2016, no netting took place, as all contracts were in the liability position.

The balance sheet classifications and fair value of derivative instruments as of September 30, 2016 are as follows (amounts in thousands):



	Fair Value of Derivative Instruments (1)
Prepaid and other current assets	$	—
Accrued expenses	2,073

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(1) Fair Value measured using Level 2 inputs by adjusting the market spot rate by forward points, based on the date of the contract. The spot rates and forward points used are based on an average rate from an actively traded market.

The impact on the Consolidated Statement of Operations for the quarter and six month period ended September 30, 2016 are as follows (amounts in thousands):



Impact of Foreign Exchange Contracts on Condensed Consolidated Statement of Operations
Statement Caption	Quarter Ended September 30, 2016			Six-Month Period Ended September 30, 2016
Net Sales	$	—		$	—
Operating costs and expenses:
Cost of sales	(1,140		)	(2,893		)
Total operating costs and expenses	(1,140		)	(2,893		)
Operating income (loss)	$	(1,140	)	$	(2,893	)

Unrealized gains and losses associated with the change in value of these financial instruments 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 income statement. When the hedged item affects income, gains or losses are reclassified from AOCI to the Consolidated Statement of Operations as Cost of sales for foreign exchange contracts to purchase such foreign currency. Any ineffectiveness, if material, in the Company’s hedging relationships is recognized immediately as a loss, within the same income statement accounts as described above; to date, there has been no ineffectiveness. Changes in derivative balances impact the line items “Prepaid and other assets” and “Accrued Expenses” on the Consolidated Balance Sheets and Statements of Cash Flows.