Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
General
Market risk is the volatility of future earnings and cash flows that may result from changes in interest rates and foreign currency exchange rates. The value of a financial instrument may change as a result of changes in the interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market risk sensitive instruments. Market risk is attributable to all market sensitive financial instruments including foreign currency receivables and payables.
Our exposure to market risk is a function of our expenses and revenue generating activities in foreign currencies. The objective of market risk management is to avoid excessive exposure to our earnings and equity of such market driven losses. We manage market risk through our treasury operations using financial instruments. Our senior management and our board of directors approve our treasury operations’ objectives and policies. The responsibilities of our treasury operations include management of cash resources, including borrowing strategies, implementing hedging strategies for foreign currency exposures, and ensuring compliance with market risk limits and policies.
Components of Market Risk
Foreign Currency Risk. We are exposed to foreign currency exchange rate risk. Our revenues are primarily denominated in the U.S. dollar representing 86.2% of our total revenues and the U.K. pound sterling representing 10.1% of our total revenues for fiscal 2023. A significant portion of our expenses are incurred in the Indian rupee, the Philippine peso and the U.K. pound sterling, representing 28.5%, 8.2% and 3.1%, respectively, of our total expenses for fiscal 2023. We also incur expenses in the U.S. dollar and currencies of other countries where we have operations. The exchange rates among the Indian rupee, the Philippine peso, the U.K. pound sterling and the U.S. dollar have fluctuated within the fiscal 2023, over the recent years and may fluctuate in the future.
Our foreign currency exchange rate risk primarily arises from our foreign currency revenues, expenses incurred by our subsidiaries, including foreign subsidiaries in foreign currencies and foreign currency accounts receivable and payable. The average exchange rate of the U.S dollar against the Indian rupee increased from 78.81 for fiscal 2022 to 82.60 for fiscal 2023, representing a depreciation of 4.8% against the U.S dollar. The average exchange rate of the U.S dollar against the Philippine peso increased from 54.47 for fiscal 2022 to 55.56 for fiscal 2023, representing a depreciation of 2.0% against the U.S dollar. The average exchange rate of the U.K. pound sterling against the U.S. dollar increased from 1.23 for fiscal 2022 to 1.25 for fiscal 2023, representing an appreciation of 1.3% against the U.S dollar. Based upon our level of operations for fiscal 2023 and excluding any hedging arrangements that we had in place during that period, a 10% appreciation/depreciation in the Indian rupee, the Philippine peso and the U.K. pound sterling against the U.S. dollar would have increased/decreased our revenues by approximately $7.4 million, $0.6 million and $9.3 million, respectively and increased/decreased our expenses incurred by approximately $39.7 million, $11.4 million and $4.3 million, respectively for fiscal 2023.
In order to mitigate our exposure to foreign currency fluctuation risks and minimize the earnings and cash flow volatility associated with forecasted transactions denominated in certain foreign currencies, we enter into foreign currency forward contracts designated as cash flow hedges. These contracts must be settled on the day of maturity or may be canceled subject to the receipts or payments of any gains or losses respectively, equal to the difference between the contract exchange rate and the market exchange rate on the date of cancellation. We do not enter into foreign currency forward contracts for speculative or trading purposes. As such, we may not purchase adequate contracts to insulate ourselves from the foreign exchange currency risks. In addition, any such contracts may not perform effectively as a hedging mechanism. We may, in the future, make changes to our hedging policies, and have done so in the past. The principal foreign currencies that are hedged are the Indian rupee and the Philippine peso.
The impact related to these foreign currency forward contracts on earnings and/or cash flows is immaterial as the impact of the maturing cash flow hedges in respective periods are intended to primarily offset the foreign currency impact on the related expenses. Further, some of our client contracts include protection against foreign currency exchange rate fluctuations which minimizes the impact of volatility in the exchange rates on our operating results.
As of December 31, 2023 and 2022, we had outstanding cash flow hedges with notional amounts of $722.8 million and $841.6 million, respectively, with the maximum outstanding term of approximately 42 months and 45 months, respectively. The mark-to-market gain/(loss), net upon fair valuation of outstanding cash flow hedges as of December 31, 2023 and 2022 was $5.4 million and $(14.2) million, respectively, and is included in “Accumulated other comprehensive income/(loss)” on our consolidated balance sheets. For fiscal 2023 and 2022, we recognized $5.7 million and $4.3 million, respectively, as foreign exchange loss from maturing cash flow hedges, which was largely offset by the foreign exchange translation gain on the related expenses.
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We also enter into foreign currency forward contracts from time to time to hedge our intercompany balances and other monetary assets and liabilities denominated in currencies other than functional currencies , against the risk of fluctuations in foreign currency exchange rates associated with remeasurement of such assets and liabilities to functional currency. These foreign currency forward contracts do not qualify as fair value hedges under ASC Topic 815, Derivatives and Hedging . Changes in the fair value of these financial instruments are recognized in our consolidated statements of income and are included in “Foreign exchange gain, net.” These financial instruments mitigate balance sheet risk due to foreign currency exchange rate movements as gains and losses on the settlement of these financial instruments are intended to offset the revaluation gains and losses on the foreign currency denominated monetary assets and monetary liabilities being hedged. Foreign currency forward contracts with notional amounts of the U. S. dollar (USD) 170.5 million, the U.K. pound sterling (GBP) 14.5 million, the Euro (EUR) 5.2 million, South African rand (ZAR) 150.2 million and the Australian dollar (AUD) 3.5 million were outstanding as of December 31, 2023 compared to USD 164.0 million, GBP 8.4 million, EUR 2.0 million and AUD 2.0 million outstanding as of December 31, 2022. The fair values of these financial instruments as of December 31, 2023 and 2022 were insignificant and are included in the “Foreign exchange gain, net” in our consolidated statements of income. As of December 31, 2023 and 2022, the outstanding derivative instruments had maturities of a maximum of 31 days, each.
Interest Rate Risk. We are also exposed to interest rate risk arising from our indebtedness. In order to mitigate our exposure to fluctuations in interest rates and minimize the earnings and cash flow volatility associated with floating rate indebtedness, we enter into interest rate swaps to hedge cash flow risks on our revolving credit facility having floating interest rate obligations. The swap transaction involves the exchange of fixed for floating interest payments. However, in circumstances where we believe additional fixed-rate debt would be beneficial, we may choose to terminate a previously executed swap, or swap certain floating interest payments to fixed.
As described in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we held our $300.0 million revolving credit facility and a letter of credit sub-facility pursuant to our Credit Agreement dated November 21, 2017. The revolving credit facility originally had a maturity date of November 21, 2022 and was voluntarily pre-payable from time to time without premium or penalty. On April 18, 2022, we entered into the 2022 Credit Agreement, that provides for a $400.0 million revolving credit facility and a letter of credit sub-facility. We have an option to increase the commitments under the 2022 Credit Agreement by up to an additional $200.0 million. The revolving credit facility has a maturity date of April 18, 2027 and is voluntarily pre-payable from time to time without premium or penalty.
The 2022 Credit Agreement bears interest at a rate equal to specified prime rate (alternate base rate) or adjusted SOFR plus, in each case, an applicable margin. The applicable margin is tied to our total net leverage ratio and ranges from 0% to 0.75% per annum on loans pegged to the specified prime rate, and 0.88% to 1.75% per annum on loans pegged to the adjusted SOFR. The revolving credit commitments under 2022 Credit Agreement are subject to a commitment fee which is also tied to our total net leverage ratio, and ranges from 0.13% to 0.28% per annum on the average daily amount by which the aggregate revolving commitments exceed the sum of outstanding revolving loans and letter of credit obligations. A 50 basis point increase or decrease in interest rates would have impacted our interest expense for fiscal 2023 by approximately $1.1 million.
We manage a portion of our interest rate risk related to our revolving credit facility having variable interest rate obligations by entering into interest rate swaps under which we receive floating rate payments based on SOFR and make payments based on a fixed rate. As of December 31, 2023 and 2022, we had outstanding interest rate swaps having a notional amount of $75.0 million, each.
We had cash, cash equivalents and short-term investments totaling $290.8 million and $297.7 million as of December 31, 2023 and 2022, respectively. These amounts were invested principally in a short-term investment portfolio primarily comprised of highly-rated debt mutual funds, money market funds and time deposits. We do not make such investments for trading or speculative purposes. The cash and cash equivalents are held for potential acquisitions of complementary businesses or assets, capital expenditures, working capital requirements and general corporate purposes. We believe that we have no material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. The interest income from these funds is subject to fluctuations due to changes in interest rates. Declines in interest rates would reduce our future investment income. A 50 basis point increase or decrease in short term rates would have impacted our interest and dividend income for fiscal 2023 by approximately $0.9 million.
Credit Risk. As of December 31, 2023 and 2022, we have accounts receivable, net $308.1 million and $259.2 million, respectively. We believe that our credit policies reflect normal industry terms and business risk. We do not anticipate non-performance by the counterparties and, accordingly, do not require collateral. Credit losses and write-offs of accounts receivable balances historically have not been material. No single client owed more than 10% of our accounts receivable, net as on December 31, 2023 and 2022.
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