Every human activity involves taking risks. As long as organizations are concerned, it is not possible to create value without taking risks.
Risk management is therefore part and parcel of every business activity: in a constantly changing business environment characterized by extremely volatile and unstable global market conditions risk management is even more important and calls organizations to identify risks and take advantage of opportunities.
Amplifon, in line with the most advanced management systems and best practices for the design and implementation of internal control and risk management systems, and the Corporate Governance Code issued by the Corporate Governance Committee of the Italian Stock Exchange to which it adheres, pays the utmost attention to the identification, assessment and management of risk.
Risk management is an ongoing activity which, based on the initial identification and assessment of the events that could negatively impact the ability of the Group and its subsidiaries to reach targets (particularly strategic goals), includes the definition which steps need to be taken to respond to the risk, implementation and subsequent updates which take place at least one a year at a Group level.
Risk management is entrusted to the Group’s top management, Market Directors and local Management teams which are supported by the Group Risk and Compliance Officer who use self-assessment techniques to gather information and assess risk, as well as find ways to address and mitigate them.
The management and updating of the risks identified is supported and monitored through a continuous dialogue between Group and local management, as well as with the Group Risk and Compliance Officer. At least once a year, during the annual risk review, the Chief Executive Officer contributes directly to the mapping of the Group’s risk with a view to identifying priorities in order to align risk with strategies.
- Political, economic, social, legal and regulatory environment
The Amplifon Group operates in the “medical” sector which is regulated differently in different countries. A change in regulations (for example, in reimbursement conditions, the way in which coverage is calculated, in the ability to access national health coverage, in the role of the ENT doctors and, more in general, in the laws relating to hearing aids), does and will have a significant and immediate impact on performances, similar to the negative repercussions that affected the Netherlands in 2013, Switzerland and New Zealand in 2011, and the positive ones that affected Germany beginning year-end 2013 and New Zealand mid- 2014, as would any changes in social policies which result in the public sector having a larger or smaller role in the treatment of hearing pathologies.
Typically the impact on the market of any regulatory changes relating to refunds is felt for a limited time of between two and six quarters, after which the market returns to the pre-change growth rates. It is more difficult to understand the possible impact of changes in the regulations governing the final sale price of hearing aids, as any changes can cause an immediate decline in unit prices and, consequently, in results, while the recovery in market growth is much slower. In the Netherlands, for example, the regulatory changes implemented early 2013 caused results to drop sharply in 2013, while volumes didn’t pick-up until 2014 and the recovery in sales and profitability is still well below the levels recorded prior to the changes.
Well aware that other unexpected and unforeseen changes could take place in addition to those mentioned above (in Switzerland, New Zealand, the Netherlands and Germany), including in light of the widespread adoption of austerity programs and the growing attention of the media and social networks on the hearing aid sector, the Group has implemented a series of measures which ensure the ability to react in a timely manner to these events with a view to reducing the impact of any unfavourable changes or maximizing the upside in the event the changes are favourable.
More in detail: (i) regular reporting has been introduced in order to monitor the main changes in regulations, analyze the impact and address compliance strategies, that are discussed with the Corporate management and approved by headquarters; (ii) mapping of the sector regulations in all countries of operation has been initiated, together with monitoring by a specific corporate function of regulatory changes in close cooperation with the Group’s Compliance division with the support of Legal Affairs; (iii) mapping of trade bodies and associations in the Group’s countries of operation has been initiated, including to ensure that Amplifon’s managers are sufficiently involved in determining the strategies to be undertaken; (iv) a program to monitor news, information and discussions relating to the hearing aid sector on the main media and social networks has been put into place.
The market sector in which the Amplifon Group operates is less sensitive than others to fluctuations in the general economic cycle, but it is, however, influenced. More specifically, the current volatility of the global markets lessens the visibility of future results with the risk that lower or less buoyant sales will, in the short term, have a direct impact on margins due to the cost structure of the stores which is largely fixed. In the United States, where the Group’s business model is based on commercial partners and other indirect channels, the economic performance and financial solidity of the latter must be monitored carefully in order to react quickly, including by repositioning stores as was done in the period 2011-2014 with some of the Miracle Ear franchise stores that were part of structures managed by partners who were experiencing difficulties.
With regard to demographic changes, there are a number of factors including the growing number of senior citizens (baby boomers), the increased average life expectancy and the declining age at which the hearing aid market is being accessed, which represent both a great opportunity and a risk, as the opportunity could be missed as a result of the failure to correctly forecast the penetration rate and, consequently, to calculate the growth opportunities. In the marketing plans, therefore, particular attention is paid to interpreting trends, developing both communication and technology by making significant investments in digital marketing, CRM systems, as well as the continuous assessment of the campaigns/activities.
- Competition & the market
The arrival of new market competitors and players, like optical chains, able to take advantage of distribution channels comprised of existing stores, as well as hearing aid manufacturers who can benefit from higher margins as a result of their manufacturing activities, or on-line retailers, could result in greater price pressure (Amplifon, which stands out for the quality of the service provided, has high fixed costs and any pressure on retail prices would cause, at least in the short term, margins to shrink) and also represent an obstacle to external growth due to increased competition for acquisition targets.
The risk that new players may enter the market could also be increased by regulatory changes relating to store personnel qualified to sell hearing aids in the event qualifications should become less stringent (as has already happened in some countries) and/or professions like audiologist/hearing aid specialist become more accessible, which would make it easier to recruit these professionals.
Both organic growth, supported with investments in store renovation, new openings and increased productivity, and marketing, particularly digital marketing, as well as external growth, through new acquisitions, are key to countering competition and developing the market. These activities call for significant financial resources and the Group, after completely restructuring its debt in 2013 through capital market issues with long term maturities falling due beginning in 2018, pays the utmost attention to both treasury management, as well as to the continuous maintenance of existing credit lines and relationships with both banks and capital market investors, in order to be able to dedicate the greatest possible amount of cash, operating cash flow and “new finances” to new important investment activities and growth.
In the United States where the Group is totally focused on the indirect channel, the growth is, above all, linked to the ability to attract new partners and take advantage of growth opportunities presented by the market. After the rationalization that in 2014 resulted in a new focus on the channels that ensure the greatest volumes and are the most attractive to new partners (Elite wholesale, Miracle Ear and Amplifon Hearing Health Care, formerly Hear PO), an important plan calling for substantial investments in all types of marketing was implemented.
- Organization and Processes
In the current economic situation, characterized by extreme volatility in factors that can significantly impact business, the ability to implement strategic measures in a timely manner is vital in all the countries where the Group operates. It follows that the corporate processes must be adequately structured, applied and monitored in order to maximize operating efficiency, as well as control the performance indicators of each single point of sale. These processes are even more important with acquisitions as it is crucial to assess all the risks arising from these transactions: mistakes in assessing those risks, like slow and delayed integration of acquired businesses, could result in significantly higher costs and inefficiencies for the Group.
Over time the Group has implemented, in all the main countries of operation, a number of projects to standardize IT processes, compliance with the administrative/accounting procedures defined in Law 262/2005 and the Business Performance Management projects in the stores, with a view to more effective monitoring and international comparison, along with the worldwide cash pooling project the purpose of which is to manage liquidity more efficiently, as well as monitor the Group’s daily cash position in order to take timely action with regard to any critical areas; the Group has completed deployment in Italy and started deployment in Australia, Spain and the Netherlands of a new proprietary front office system (FOX) developed based on the experience matured by Amplifon over the years and began. This system allows for more efficient and effective management of all store activities, and also makes customer information available immediately. It will be installed gradually in all the countries where the Group has directly operated stores.
Similarly, the growing number of countries in which the Group operates and the number of projects to be implemented, has made it necessary to possess the knowhow needed to develop and carry out these same projects and, therefore, the IT structures have been reinforced with a particular focus on project management.
Rapid implementation of strategic decisions is ensured by an organization based on uniform geographical regions and a leadership team that works with the Chief Executive Officer, along with the Vice Presidents of the three geographical regions (EMEA, Americas and APAC), the corporate heads of the various functions (innovation and development, HR, administration and finance, purchasing).
- Human Resources
One of Amplifon’s strengths is its customer service. Human resources, therefore, are very important in this regard, but they also present certain issues and areas of risk. Specifically:
• limited availability of hearing aid specialists, the difficulty of attracting new ones while also running the risk that others begin working for the competition can significantly affect the Group’s organic growth, together with the risk of losing customers and increased labour costs due to salary increases;
• deficiencies in staff’s technical and sales skills can lead to ineffective sales teams in certain countries and could pose a significant risk to the ability to reach organic growth targets;
• the risk that the sales force commits illegal acts or violates the Group’s rules.
The Group has taken the following steps to mitigate these risks:
• defined a Code of Conduct, which has been distributed in all countries of operation and in Italy the Internal Organizational Model was adopted pursuant to Legislative Decree 231/2001;
• drawn up a profile of the ideal hearing aid specialist in order to assure that recruitment methods reflect the Group’s commercial policies. Steps have also been taken to increase the supply of hearing aid specialists through agreements with universities and specialized institutes;
• increased and centralized coordination of the internal training programs carried out by the countries;
• increased the attention being paid to store procedures through both the development of a new procedure focused on providing excellent customer service and the definition of a standardized store manual in order to facilitate rapid implementation in countries where the Group’s presence is more recent.
- Currency risk
This includes the following types:
• foreign exchange transaction risk, that is the risk of changes in the value of a financial asset or liability, of a forecasted transaction or a firm commitment, changes due to exchange rate fluctuations;
• foreign exchange translation risk, that is the risk that the translation of the assets, liabilities, costs and revenues relating to net investment in a foreign operation into the reporting currency gives rise to an exchange gain or loss.
The Amplifon Group’s foreign exchange transaction risk is largely limited as each country is largely autonomous in the operation of its business, sustaining costs in the same currency as it realizes revenue, with the exception of Israel, where purchases are made in Euros and US dollars.
The size, however, of the subsidiary with respect to the Group and the fact that the products purchased subject to currency risk represent only a small part of total costs, ensures that any significant currency volatility will not have a material impact on the subsidiary or the Group.
The foreign exchange transaction risk, therefore, derives primarily from intragroup transactions (medium-long term and short term loans, charge backs for intercompany service agreements) which result in currency risk for the companies operating in currencies other than that of the intragroup transaction. Additionally, investments in financial instruments denominated in a currency different from the investor’s home currency can result in foreign exchange transaction risk. Foreign exchange translation risk arises from investments in the United States, United Kingdom, Switzerland, Hungary, Turkey, Poland, Israel, Australia, New Zealand, India, Egypt and Brazil.
The group’s strategy aims to minimize the impact of currency volatility on the income statement and calls for significant positions in foreign currency to be hedged against foreign exchange risk. These include: (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 between Amplifon S.p.A. and the Group companies in the United Kingdom and Australia.
The intercompany loans between the Australian and New Zealand companies, between the American and Canadian companies, as well as the loan granted Amplifon S.p.A. to the English subsidiary, are considered equity investments insofar as the loans are non-interest-bearing and not expected to be repaid. The impact of exchange differences is recognized directly in the translation reserve at equity without passing through the income statement.
The risks arising from other intragroup transactions (two loans granted to the Hungarian subsidiary and the Brazilian holding, as well as a loan granted to the Turkish subsidiary which was repaid in full in 2015) are not hedged as the amounts are not material.
In light of the above, during the year currency fluctuations did not result in significant foreign exchange gains or losses being recognized in the Amplifon Group’s consolidated financial statements. In accordance with the Group Treasury Policy foreign exchange translation risk was not hedged. The impact of the foreign exchange translation risk can be seen, as a whole, in the Group’s Euro denominated EBITDA which rose 4.3 percentage points with respect to the Group’s total EBITDA.
- Interest rate risk
Interest rate risk includes the following situations:
• fair value risk, namely the risk that the value of a fixed rate financial asset or liability changes due to fluctuations in market interest rates;
• cash flow risk, namely the risk that the future cash flows of a floating rate financial asset or liability fluctuate due to changes in market interest rates.
In the Amplifon Group fair value risk arises on the issue of fixed rate bonds (private placement and Eurobond).The cash flow risk derives from floating rate bank loans.
The Group’s strategy is to minimize cash flow risk, especially with respect to long-term exposures, through a balanced division between fixed- and floating-rate loans, judging whether to switch floating-rate borrowings to fixed-rate when each loan is taken out, as well as over the life of the loans including in light of the current market rates. In any event, at least 50% of the debt must be hedged against interest rate risk. At 31 December 2015, all the medium/long debt (€376 million) is linked to fixed rate capital market issues which to date have yet to be converted to floating rate debt as currently interest rates are low and the possibility that they will increase is limited. The risk, therefore, is that any conversions of debt from fixed to floating could result in financial costs that are, as a whole, higher with respect to the current fixed rate.
- Credit risk
Credit risk is the risk that the issuer of a financial instrument defaults on its obligations resulting in a financial loss for the holder/investor.
In the Amplifon Group credit risk arises from:
- sales made as part of ordinary business operations;
- the use of financial instruments that require settlement of positions with other counterparties;
- from the sale of Group-owned American stores to franchisees, with the payment spread over up to 12 years, following the transformation of the subsidiary Sonus’s business model from the direct to the indirect channel;
- the loans granted to indirect channel and commercial partners in the United States and in Spain for investments and business development.
With regard to the risk under (i) above, the only positions with a high unit value are amounts due from Italian public-sector entities for which the risk of insolvency - while existing - is remote and further mitigated by the fact that they are factored without recourse, on a quarterly basis, by specialized factoring companies. Conversely, the credit risk arising from sales with private individuals based on instalment payment plans is increasing, as is that arising from sales to US indirect channel firms (wholesalers and franchisees). This credit risk, however, is spread out over a number of partners and the amount owed by any single partner does not exceed a few million US dollars. Due to typical business risks, some may not be able to honor their debts. This would result in higher working capital and credit losses. While each subsidiary is responsible for collection of receivables, the Group has set up a centralized system of monthly reporting relative to trade receivables in order to monitor the composition and due dates for each country, and shares credit recovery initiatives and policies with local management. With regard to private customers, who are largely paying cash, installment or financed sales have been limited to a maximum term of 12 months and, when possible, are managed by external finance companies which advance the whole amount of the sale to Amplifon. The situation of the indirect channel in the US is closely monitored by local management.
The risk referred to in (ii) above, notwithstanding the inevitable uncertainties linked to sudden and unforeseeable counterparty default, is managed by diversifying the main national and international investment grade financial institutions and through the use of specific counterparty limits with regard to both liquidity invested and/or deposited and to the notional amount of derivative contracts. The counterparty limits are higher if the counterparty has a Standard & Poor’s and Moody’s short term rating equal to at least A-1 and P-1, respectively. The Group’s CEO and CFO may not carry out transactions with non-investment grade counterparties unless specifically authorized to do so.
With regard to the risk referred to in (iii) above, in the event payments fail to be made on the stores sold, ownership will revert back to Amplifon, while the loans made in the US referred to in (iv) above, are generally personally guaranteed by the beneficiaries and repayments are typically made when the invoices for the purchases of hearing aids are paid.
- Price risk
This arises from the possibility that the value of a financial asset or liability may change due to changes in market prices (other than those caused by currency or interest-rate fluctuations) due to both characteristics specific to the financial asset or liability or the issuer, as well as market factors. This risk is typical of financial assets not listed on an active market, which may not be easy to liquidate at a level 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.
- Liquidity risk
This risk often arises when an entity is experiencing difficulty finding sufficient funds to meet its obligations and includes the risk that the counterparties that have granted loans or lines of credit may request repayment. This risk, which had become particularly significant due, initially, to the 2008 financial crisis and, more recently, to the sovereign debt crisis affecting the peripheral Euro zone countries and the single currency itself, while smaller, still exists.
In this situation the Group continues to pay the utmost attention to cash flow and debt management, maximizing the positive cash flow from operations, while also monitoring credit lines in order to ensure adequate availability of irrevocable long term credit lines even though after the capital market transactions completed in 2013 debt is largely long term with the first significant portion falling due only as of mid-2018.
These activities, along with the liquidity, current credit lines and the positive cash flow that the Group continues to generate, lead us to believe that, at least in the short term, liquidity risk is not significant.
- Hedging instruments
Hedging instruments are used by the Group exclusively to mitigate, in line with company strategy, interest rate and currency risk and comprise exclusively financial derivatives. In order to maximize the effectiveness of these hedges the Group’s strategy calls for:
• large counterparties with high credit ratings and transactions that fall within the limits determined in the treasury policy in order to minimize counterparty risk;
• the use of instruments that match, to the extent possible, the characteristics of the risk hedged;
• monitoring of the effectiveness of the instruments used in order to check and, possibly, optimize the structure of the instruments used to achieve the purposes of the hedge.