The general macroeconomic scenario
The severe recession that began in the second half of 2008 was followed in the second half of 2009 by a general economic recovery, thanks in part to the expansive economic policies implemented by the governments of industrialized countries, more substantial in the Far East, India and Brazil, but also significant in the United States, where GDP grew by over 5% in the last quarter of the year. However, it remained modest in Continental Europe and the United Kingdom, for which private analysts and international bodies have predicted a maximum growth of 2% in 2010.
Nevertheless, certain weaknesses could affect the recovery of Western economies. In particular, the unemployment rate, which is forecast to rise again next year – albeit only slightly – could have a marked impact on any hope of the rapid return of private consumption to pre-crisis levels.
The situation is such that interest rates, which have remained low throughout the period, have no room for further reductions and may rise slightly in the coming months.
Risks for the Amplifon Group
Given its business, the Amplifon Groups is exposed chiefly to the following financial risks:
- interest rate
This risk includes the following:
- foreign exchange transaction risk, i.e. the risk that the value of a financial asset or liability may vary due to exchange-rate fluctuations;
- foreign exchange translation risk, i.e. the risk that the conversion of assets, liabilities, costs and income relating to a net investment in a foreign operation into the currency used for consolidated financial reports may determine a positive or negative difference between the balances of the converted items.
In the Amplifon Group, the foreign exchange transaction risk is largely limited by the fact that each country is virtually autonomous in managing its business and bears its costs in the same currency as that of its income. The risk thus stems mainly from intercompany transactions (loans, clearing accounts and charge-backs under intercompany service agreements) that generate exposure to currency risk for any company that has a functional currency other than that in which the intercompany transaction is conducted. Additionally, exposure to foreign exchange transaction risk arises from investments in listed financial instruments denominated in a currency other than the investing company’s functional currency. Foreign exchange translation risk arises on investments in the United States, the United Kingdom, Switzerland, Hungary and Egypt.
The Group’s strategy is to minimize the impact on profits of changes in currency rates and envisages hedging risks arising from financial positions denominated in any currency other than that used for the individual company’s accounts, and specifically: (i) bonds issued in US dollars by Amplifon S.p.A. and subscribed by Amplifon USA Inc.; (ii) intercompany loans in currencies other than the euro made between Amplifon Spa and Group companies resident in the UK, the US or Switzerland; (iii) charge-backs under intercompany service agreements that generate liability positions in euros in UK, Swiss or US subsidiaries.
The remaining risks arising from other intercompany transactions and listed instruments in foreign currency are not significant given their total value, and therefore are not hedged.
Based on the foregoing considerations, the exchange-rate fluctuations that occurred in 2009 had no significant effects on the Amplifon Group’s consolidated financial statements.
With regard to foreign exchange translation risk, considering the fact that individual countries earn income and pay expenses in their own currency, and that most of the margins are achieved in countries using the same currency as the Group, no hedging is undertaken, also given the potential complexity involved in this.
This risk includes the following:
- fair-value risk, i.e. the risk that the value of a fixed-rate financial asset or liability may change due to changes in market interest rates
- cash-flow risk, i.e. the risk that the future cash flow of a variable-rate financial asset or liability may fluctuate due to changes in market interest rates
In the Amplifon Group, fair-value risk stems from the issue of fixed-rate bonds (private placements). The cash-flow risk arises when entering into variable-rate bank borrowings.
The Group’s strategy aims to minimize cash-flow risk, especially on long-term exposures, by balancing fixed- and variable-rate borrowings and deciding – on a case-by-case basis for each loan – when the liability should be changed from a variable to a fixed rate. At 31 December 2009, of the medium/long-term debt (including short-term portions) amounting to €228 million, the sum of €133 million, or about 58% of the debt, was switched to a fixed rate using suitable hedging instruments. Based on the foregoing considerations, the interest-rate fluctuations that occurred in 2009 had no significant effects on the Amplifon Group’s consolidated accounts.
Credit risk means the possibility that the issuer of a financial instrument defaults on its obligations and causes a financial loss to the holder. In the Amplifon Group credit risk arises from:
(i) sales made in the normal course of business
(ii) the use of financial instruments requiring settlement of the counterparty’s positions
The risk for point (i) concerns only the significant exposure to Italian public bodies as debtors and, though real, the risk of their insolvency is remote. Additionally, the credit risk arising from sales to customers that have been granted payment in instalments and arising from the sales in the United States through the indirect channel (wholesalers and franchisees) is greater than in previous years. Due to the recent economic and financial crisis, some customers may not be able to meet their obligations. This has caused a risk of increased working capital and debtor losses. Through its corporate departments, the Group has set up a system of monthly reporting on its debtors to monitor their composition and due dates for each country, and decide – with the local management – how to
proceed to recover overdue accounts and decide on credit policy. In particular, with regard to private customers, most of which pay cash, instalment terms and financed sales have been limited to a maximum of 12 months and, where possible, they are managed by external finance companies that advance the entire amount of the sale to Amplifon; with regard to the indirect channel in the United States, the situation is closely monitored by the local management team.
Despite the inevitable uncertainties due to potential sudden and unforeseen default by counterparties, the risk noted under point (ii) is managed by diversifying the main investment-grade domestic and international financial institutions. Considering the limited number of transactions currently in place, there is an inevitable concentration of risk, mainly with respect to the currency and interest-rate hedges of private placements stipulated with a single counterparty.
This arises from the possibility that the value of a financial asset or liability may oscillate due to changes in market prices (other than those caused by currency or interest-rate fluctuations), whether these changes arise from specific characteristics of the financial asset/liability or the issuer of the financial liability, or are caused by market factors. This risk is typical of financial assets not listed on an active market, which cannot always be realised in the short term at a value close to their fair value.
In the Amplifon Group price risk arises from certain financial investments in listed instruments, mainly bonds. Given the size of these investments, this risk is not significant and therefore is not hedged.
This risk often arises from the possibility that an entity may have difficulty finding sufficient funds to meet its obligations. It includes the risk that the counterparties that have granted loans or lines of credit may request repayment. This risk became significant with the financial crisis as of the second half of 2008; it steadily diminished in 2009, although it was always present.
The Group is thus paying the utmost attention to cash flow and debt management, maximizing cash flow from operations and constantly renegotiating its lines of credit and medium/long-term loans as they expire. In 2009 the Group negotiated new irrevocable medium/long-term credit lines totalling €35 million. Given these transactions – together with existing liquidity, borrowings and lines of credit, and the cash flow that the Group continues to generate – we are confident that, at least in the short term, the liquidity risk is not significant. Indeed, the liquidity available in the accounts at 31 December 2009 is sufficient on its own to meet all the Group’s scheduled obligations through the first half of 2011.
In keeping with company strategy, the Group uses hedging instruments solely to mitigate interest-rate and currency risks, and these instruments are represented exclusively by financial derivatives. In order to maximize the economic effectiveness of these hedges, the Group’s strategy prescribes that:
- the counterparties be large in size and have a high credit standing in order to minimize counterparty risk;
- the instruments used match the characteristics of the risk they hedge as much as possible;
- the performance of the instruments used be monitored, not least in order to check and, if necessary, optimize the appropriateness of the structure of the instruments used to attain the aims of the hedge.
The derivatives generally used by the Group are the plain-vanilla type. Specifically, the following types of derivatives are used:
- cross-currency swaps
- interest-rate swaps
- interest-rate collars
- forward forex transactions
On initial recognition these instruments are measured at fair value; on subsequent balance-sheet dates the fair value of derivatives must be re-measured and:
(i) if these instruments fail to satisfy the requisites of hedge accounting, any changes in fair value that occur after initial recognition are taken to profit and loss;
(ii) if these instruments subsequently fail to satisfy the requisites of a fair-value hedge, from that date any changes in the fair value of the derivative are taken to profit and loss; at the same time any changes in fair value due to the hedged risk are recognized as impairment losses of the hedged item and in profit and loss; any ineffectiveness of the hedge is recognized in profit and loss in an item separate from that in which changes in the fair value of the hedging instrument and the hedged item are recognized;
(iii) if these instruments satisfy the requisites of a cash-flow hedge, from that date any changes in the fair value of the derivative are taken to equity; changes to the fair value of the derivative taken to equity are taken to profit and loss in the period in which the hedged transaction impacts the income statement.
The Group’s hedging strategy is recognized in the accounts as described above starting from the time at which the following conditions are satisfied:
- the hedging relationship, its purpose and the overall strategy are formally defined and documented; the documentation includes the identification of the hedging instrument, the hedged item, the nature of the risk to be neutralized, and the procedures whereby the entity will assess the effectiveness of the hedge;
- the effectiveness of the hedge may reliably be assessed and there is a reasonable expectation, confirmed by ex post evidence, that the hedge will be highly effective for the period in which the hedged risk is present;
- if the hedged risk involves possible changes in cash flow arising from a future transaction, the latter is highly probable and has exposure to changes in cash flow that could affect profit and loss.
Derivatives are recognized as assets if their fair value is positive and as liabilities if it is negative. These amounts are disclosed as current assets or liabilities if they relate to derivatives that fail to satisfy the requisites of a hedge; otherwise they are recognized according to the purpose of the hedge.
If the hedged item is recognized as a current asset or liability, the hedge’s positive or negative fair value is disclosed as a current asset or liability; if the hedged item is recognized as a non-current asset or liability, the hedge’s positive or negative fair value is recognized as a non-current asset or liability.
The Group does not have any net investment hedges.
Any intercompany hedges are eliminated when the consolidated accounts are drawn up.