Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are potentially exposed to market risks associated with changes in foreign currency translation rates, interest rates and commodity prices. We selectively use financial instruments to reduce these risks. All transactions related to risk management techniques are authorized and executed pursuant to our policies and procedures. Analytical techniques used to manage and monitor foreign currency translation and interest rate risk include market valuations and sensitivity analysis.
We have estimated our market risk exposure using sensitivity analysis. To test the sensitivity of our market risk exposure, we have estimated the changes in fair value of market risk sensitive instruments assuming a hypothetical 10 percent adverse change in market prices or rates. The results of the sensitivity analyses are summarized below.
Foreign Currency Risk
We generate a substantial portion of our revenues in international markets, principally Germany and other countries in the European Union, Switzerland and Japan, which exposes our operations to the risk of exchange rate fluctuations. The impact of currency exchange rate movement can be positive or negative in any period. Our costs related to sales in foreign currencies are largely denominated in the same respective currencies, reducing our transaction risk exposure. However, for foreign currency denominated sales in certain regions, such as Japan, where we do not incur significant costs denominated in Japanese Yen, we are more exposed to the impact of foreign currency fluctuations.
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For sales not denominated in U.S. dollars, if there is an increase in the rate at which a foreign currency is exchanged for U.S. dollars, it will require more of the foreign currency to equal a specified amount of U.S. dollars than before the rate increase. In such cases, if we price our products in the foreign currency, we will receive less in U.S. dollars than we would have received before the rate increase went into effect. If we price our products in U.S. dollars and competitors price their products in local currency, an increase in the relative strength of the U.S. dollar could result in our prices not being competitive in a market where business is transacted in the local currency. For example, if the U.S. dollar strengthened against the Japanese Yen, our Japanese-based competitors would have a greater pricing advantage over us. Our revenue by geography was as follows (dollars in millions):
2020
2019
2018
Percentage of
Percentage of
Percentage of
Revenue
Revenue
Revenue
Revenue
Revenue
Revenue
United States
$
455.9
22.9
%
$
529.8
25.6
%
$
489.4
25.8
%
Europe
764.7
38.5
718.8
34.7
701.3
37.0
Asia Pacific
629.1
31.7
651.0
31.4
549.2
29.0
Rest of world
137.8
6.9
173.0
8.3
155.7
8.2
Total revenue
$
1,987.5
100.0
%
$
2,072.6
100.0
%
$
1,895.6
100.0
%
Changes in foreign currency exchange rates increased our revenue by approximately 1.4% in the year ended December 31, 2020 and decreased our revenue by approximately 2.7% in the year ended December 31, 2019.
Assets and liabilities of our foreign subsidiaries, where the functional currency is the local currency, are translated into U.S. dollars using period end exchange rates, or historical rates, as appropriate. Revenues and expenses of foreign subsidiaries are translated at the average exchange rates in effect during the year. Adjustments resulting from financial statement translations are included as a separate component of shareholders’ equity. In the years ended December 31, 2020 and 2019, we recorded net gains of $22.0 million and net losses of $20.0 million, respectively, from currency translation adjustments. A 10% depreciation in functional currencies, relative to the U.S. dollar, at December 31, 2020, would have resulted in a reduction of shareholders’ equity of approximately $170.1 million. Gains and losses resulting from foreign currency transactions are reported in interest and other income (expense), net in the consolidated statements of income and comprehensive income. Our foreign currency translation gain (loss), net were net losses of $7.9 million and $3.3 million for years ended December 31, 2020 and 2019, respectively.
The impact of currency exchange rate movement can be positive or negative in any period. We periodically enter into foreign currency contracts in order to minimize the volatility that fluctuations in currency translation have on our monetary transactions. Under these arrangements, we typically agree to purchase a fixed amount of a foreign currency in exchange for a fixed amount of U.S. Dollars or other currencies on specified dates with maturities of less than twelve months, with some agreements extending to longer periods. These transactions do not qualify for hedge accounting and, accordingly, the instrument is recorded at fair value with the corresponding gains and losses recorded in the consolidated statements of income and comprehensive income.
At December 31, 2020 and 2019, we have entered into several cross-currency and interest rate swap agreements with a notional value of $150 million of U.S. dollar to Swiss Franc and a notional value of $355 million of U.S. dollar to Euro hedge the variability in the movement of foreign currency exchange rates on portions of our Euro and Swiss Franc denominated net asset investments. Under the U.S. GAAP hedge accounting guidance, changes in fair value of the derivative that relates to changes in the foreign currency spot rate are recorded in the currency translation adjustment in comprehensive income (loss) and remain in accumulated comprehensive income (loss) in stockholders’ equity until the sale or substantial liquidation of the foreign operation. The difference between the interest rate received and paid under the interest rate cross-currency swap derivative agreement is recorded in interest income in the statement of income.
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From time to time, we have entered into forward currency contracts designed to minimize the volatility that fluctuations in foreign currency have on our cash flows related to purchases and sales denominated in foreign currencies. Under these arrangements, we agree to purchase a fixed amount of a foreign currency in exchange for a fixed amount of U.S. Dollars or other currencies on specified dates typically with maturities of less than twelve months with some agreements extending to longer periods. These transactions are recorded at fair value with the corresponding gains and losses recorded in interest and other income (expense), net in the unaudited condensed consolidated statements of income and comprehensive income. At December 31, 2020 and 2019, we had forward currency contracts with notional amounts aggregating $278.3 million and $74.4 million, respectively. We will continue to evaluate our currency risks, and in the future, may utilize foreign currency contracts more frequently.
Interest Rate Risk
We regularly invest excess cash in short-term investments that are subject to changes in interest rates. We believe that the market risk arising from holding these financial instruments is minimal because of our policy of investing in short-term financial instruments issued by highly rated financial institutions.
Our exposure related to adverse movements in interest rates is derived primarily from outstanding floating rate debt instruments that are indexed to short-term market rates. We currently have a higher level of fixed rate debt than variable rate debt, which limits the exposure to adverse movements in interest rates.
Commodity Price Risk
We are exposed to certain commodity risks associated with prices for various raw materials. The prices of copper and certain other raw materials, particularly niobium-tin, used to manufacture superconductors have increased significantly over the last decade. Copper and niobium-tin are the main components of low temperature superconductors and continued commodity price increases for copper and niobium, as well as other raw materials, may negatively affect our profitability. We have arrangements with certain customers under which it has a firm committment to deliver copper based on superconductor wire at a fixed price. In order to minimize the volatility that fluctuations in the price of copper have on our sales of these commodities, we enter into commodity hedge contracts. At December 31, 2020 and 2019, we had fixed price commodity contracts with notional amounts aggregating $8.8 million and $5.6 million, respectively. The fair value of the fixed price commodity contracts at December 31, 2020 and 2019 was $3.1 million and $0.3 million, respectively. As commodity contracts settle, gains (losses) as a result of changes in fair values are adjusted to the contracts with the customers through revenues. We will continue to evaluate our commodity risks and may utilize commodity forward purchase contracts more frequently in the future.
Inflation Risk
We do not believe inflation had a material impact on our business or operating results during any of the periods presented.
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