Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A Quantitative and Qualitative Disclosures About Market Risk
The Company manufactures, markets, and sells its products throughout the world and, as a result, is subject to changing economic conditions, which could reduce the demand for its products.
Direct Material Costs
The Company is exposed to risks arising from price changes for certain direct materials and assembly components used in its operations. The largest of such costs incurred by the Company are for steel, plastics, textiles, wood particleboard and aluminum components. The impact from changes in all commodity prices increased the Company's costs by approximately $55.3 million during fiscal 2022 compared to the prior year. The impact from changes in commodity prices lowered the Company's costs by approximately $0.9 million during fiscal 2021 as compared to fiscal 2020. Note that these changes include the impact of Chinese tariffs on the Company's direct material costs.
The market prices for commodities will fluctuate over time and the Company acknowledges that such changes are likely to impact its costs for key direct materials and assembly components. Consequently, it views the prospect of such changes as an outlook risk to the business.
Shortages and disruption in the steel industry as a result of the COVID-19 pandemic negatively impacted the availability of steel. While this reduction in availability has not had a significant impact on our ability to produce and deliver products to our customers, it has negatively impacted the cost of procuring steel. Significant increases in raw materials can be difficult to offset with price increases due to existing contractual agreements with customers as well as difficulty finding effective financial instruments to hedge these changes. In the short term, our gross margin has been and is expected to be negatively impacted by significant increases in these costs. Our profitability could be negatively impacted in the long term if we are not able to pass along these higher raw material costs to our customers.
Foreign Exchange Risk
The Company primarily manufactures its products in the United States, United Kingdom, Canada, China, Italy, India, Mexico and Brazil. It also sources completed products and product components from outside the United States. The Company's completed products are sold in numerous countries around the world. Sales in foreign countries as well as certain expenses related to those sales are transacted in currencies other than the Company's reporting currency, the U.S. dollar. Accordingly, production costs and profit margins related to these sales are affected by the currency exchange relationship between the countries where the sales take place and the countries where the products are sourced or manufactured. These currency exchange relationships can also impact the Company's competitive positions within these markets.
In the normal course of business, the Company enters into contracts denominated in foreign currencies. The principal foreign currencies in which the Company conducts its business are the British pound sterling, euro, Canadian dollar, Japanese yen, Mexican peso, Hong Kong dollar, Chinese renminbi, and the Danish krone. As of May 28, 2022, the Company had outstanding 22 forward currency instruments designed to offset either net asset or net liability exposure that is denominated in non-functional currencies.
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(In millions, except number of forward contracts)
Net Asset Exposure
Currency Number of Forward Contracts Net Exposure
USD 6 39.2
EUR 4 66.6
NOK 1 14.0
SEK 1 23.4
GBP 1 1.7
ZAR 1 19.4
Net Liability Exposure
Currency Number of Forward Contracts Net Exposure
USD 6 14.9
CAD 2 15.9
GBP 1 41.5
As of May 29, 2021, t he Company had outstanding, 16 forward currency instruments designed to offset either net asset or net liability exposure that is denominated in non-functional currencies.
(In millions, except number of forward contracts)
Net Asset Exposure
Currency Number of Forward Contracts Net Exposure
USD 7 58.8
EUR 3 44.3
NOK 1 10.0
SEK 1 17.5
GBP 1 2.0
Net Liability Exposure
Currency Number of Forward Contracts Net Exposure
USD 2 3.1
CAD 1 1.9
The cost of the foreign currency hedges and remeasuring all foreign currency transactions into the appropriate functional currency resulted in a net gain of $3.3 million in fiscal 2022 in contrast to net gain of $0.8 million in fiscal 2021 included in net earnings. These amounts are included in Other expense (income), net in the Consolidated Statements of Comprehensive Income. Additionally, the cumulative effect of translating the balance sheet and income statement accounts from the functional currency into the United States dollar decreased the accumulated comprehensive loss component of total stockholders' equity by $90.0 million compared to an increase of $52.1 million as of the end of fiscal 2022 and 2021, respectively.
Interest Rate Risk
The Company enters into interest rate swap agreements to manage its exposure to interest rate changes and its overall cost of borrowing. The Company's interest rate swap agreements were entered into to exchange variable rate interest payments for fixed rate payments over the life of the agreement without the exchange of the underlying notional amounts. The notional amount of the interest rate swap agreements is used to measure interest to be paid or received and does not represent the amount of exposure to credit loss. The differential paid or received on the interest rate swap agreements is recognized as an adjustment to interest expense.
These interest rate swap derivative instruments are held and used by the Company as a tool for managing interest rate risk. They are not used for trading or speculative purposes. The counterparties to the swap instruments are large financial institutions that the Company believes are of high-quality creditworthiness. While the Company may be exposed to potential losses due to the credit risk of non-performance by these counterparties, such losses are not anticipated.
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In September 2016, the Company entered into an interest rate swap agreement. The interest rate swap is for an aggregate notional amount of $150.0 million with a forward start date of January 3, 2018 and a termination date of January 3, 2028. As a result of the transaction, the Company effectively converted indebtedness anticipated to be borrowed on the Company’s revolving line of credit up to the notional amount from a LIBOR-based floating interest rate plus applicable margin to a 1.949% fixed interest rate plus applicable margin under the agreement as of the forward start date. See Note 6 for information on the replacement of LIBOR with SOFR in our credit agreement.
In June 2017, the Company entered into an additional interest rate swap agreement. The interest rate swap is for an aggregate notional amount of $75.0 million with a forward start date of January 3, 2018 and a termination date of January 3, 2028. As a result of the transaction, the Company effectively converted its revolving line of credit up to the notional amount from a LIBOR-based floating interest rate plus applicable margin to a 2.387% fixed interest rate plus applicable margin under the agreement as of the forward start date.
In January, 2022, the Company entered into a third interest rate swap agreement. The interest rate swap is for an aggregate notional amount of $575.0 million with a forward start date of January 31, 2022 and a maturity date of January 29, 2027. The interest rate swap locked in the Company’s interest rate on forecasted outstanding borrowings of the Company. The Company effectively will convert LIBOR-based floating interest rate plus applicable margin indebtedness to a 1.689% fixed interest rate plus applicable margin under the agreement as of the forward start date.
The fair market value of the effective interest rate swap instruments was a net asset of $31.9 million at May 28, 2022 compared to a net liability of $14.4 million at May 29, 2021. All cash flows related to the Company's interest rate swap instruments are denominated in U.S. Dollars. For further information, refer to Note 6 and Note 12 of the Consolidated Financial Statements.
Expected cash outflows (notional amounts) over the next five years and thereafter related to debt instruments are as follows.
(In millions) 2023 2024 2025 2026 2027 Thereafter Total (1)
Long-Term Debt Instruments:
Interest rate 1.689% (2)
$ — $ — $ — $ — $ 575.0 $ — $ 575.0
Interest rate 1.949% (2)
$ — $ — $ — $ — $ 150.0 $ — $ 150.0
Interest rate 2.387% (2)
$ — $ — $ — $ — $ 75.0 $ — $ 75.0
(1) Amount does not include the recorded fair value of the swap instruments.
(2) The Company's revolving credit facility and Term Loans have a variable interest rate, but due to the interest rate swaps, the rate on $150.0 million, $75.0 million and $575.0 million will be fixed at 1.689%, 1.949% and 2.387%, respectively.
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