An ongoing activity
We dedicate constant attention to identifying and managing events that could have a negative impact to the achievement of our objectives and that seldom present important opportunities.
Risk assessment process
Sound risk management makes company decisions more knowledgeable; it reduces results’ volatility compared to target and creates a competitive advantage. We therefore focus on risk management very closely: this is why we have introduced internal processes in line with the most advanced managerial systems, with best practices in terms of internal control and risk management systems and with the recommendations of the Corporate Governance Code for listed companies.
The risk management system not only allows us to identify and evaluate major events, incidents and circumstances that may negatively impact the achievement of our objectives, but it also allows us to set out response actions to tackle the group's major risks. It is therefore a continuous, articulated activity.
The main financial risks are, however, constantly examined and monitored by the Corporate Finance function.
In order to keep our risk assessment always up-to-date and to implement the response actions, the group's top management is in regular contact with Country General Managers and Country Leadership Teams. The Group Risk and Compliance Officer performs a key role in this process, collecting information and risk assessments, as well as encouraging proposals for response actions and mitigation.
engagement with local leadership teams
Each function within each country identifies, describes, assesses and manages at least 3 risks.
The 5 most important risks for the country are selected out of those identified by the country functions. The contributor is the management team under the responsibility of the General Manager.
Country risks are then discussed with the regional Executive Vice-Presidents.
Selection of the main risks
The CEO, supported by the Group Risk & Compliance Officer, selects the main risks at Group level from those identified at country level and at corporate level.
Since 2019 the risk assessment activities also include environmental, social and governance topics.
Main external risks
Competition and the Market
The Amplifon Group operates in sector which has witnessed the arrival of new players in individual markets, like optical chains, retail distributors (including pharmaceutical companies) and on-line retailers positioned in the mid- to low- end of the market. Moreover, in recent years, there have been operations leading to the vertical integration of hearing aid manufacturers which acquired important retail chains. To address this risk, we are investing significant resources in brand differentiation, in our value proposition, as well as the engagement and development of our employees.
Another important risk in this area is the vertical integration of the hearing aid manufacturers. More specifically, in the last few years two of them (Sonova and William Demant) have acquired two primary retail chains (Audionova and Audika, respectively) at significant multiples causing, in addition to an increase in sector concentration and competition, the market to look for higher multiples. In order to address these risks, when developing its purchasing strategy, the Group also considers the competitive positioning of its suppliers and, with regard to acquisitions and development specifically, has strengthened both the corporate and the country teams in order to assess all opportunities more carefully.
The arrival of new competitors on the market, in addition to being a potential obstacle to external growth due to increased competition for acquisition targets, increases the risk of greater price pressure which for Amplifon, a company that stands out for the quality of the service provided with high fixed costs, could mean lower margins, at least in the short term. It should also be noted typically the new players are part of big, complex entrepreneurial organizations which also has a positive effect on competitive dynamics relating to ethics and compliance.
On the other hand, changing demographics and factors like 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, could drive market growth and, therefore, represent both an opportunity and, if the opportunity is missed completely or in part, a risk. In the marketing plans, therefore, particular attention is paid to understanding all the signals pointing to these types of trends and influencing them through the development of both communications and technology by making significant investments in digital marketing, CRM systems, as well as the continuous assessment of the outcomes of the campaigns/ activities.
For Amplifon, therefore, it is extremely important to maintain a sustainable position in the high end of the market, and to differentiate from the competition through organic growth, supported by investments in the renewal of stores, new openings, increased productivity and marketing, particularly with regard to the new brand image and digital marketing, as well as external growth through acquisitions such as, for example, the GAES Group acquisition completed at the end of 2018.
These activities call for significant financial resources and the Group, pays the utmost attention to both treasury management, as well as to the negotiation of new loans (the €530 million investment in GAES was financed entirely using new medium-long term loans), continuous maintenance of existing credit lines and management of relationships with both banks and capital market investors, in order to easily finance new investments and growth, as well as repayments, while also maintaining adequate available cash including thanks to operating cash flow.
Political and regulatory environment
We operate in a “medical” sector which is regulated differently in different countries. A change in regulations may have a direct, and potentially significant, negative or positive impact on the market and performances. Such changes may regard:
- reimbursement conditions and the way it is calculated
- the ability to access national health coverage
- the role of the ENT doctors and hearing aid specialists
- the requisites needed to sell hearing aids and related services
- the laws relating to hearing aids and/or social policies which result in a bigger or smaller role of the public sector in the treatment of hearing disorders
Typically, the impact on the market of any regulatory changes relating to refunds is felt for a limited period of time, between two and six quarters, after which the market returns to the pre-change growth rates. The impact of changes in regulations, including those governing the final sale price of hearing aids, however, lasts longer. On the one hand, there is a strong decline in the revenue per unit and, consequently, in the bottom line and, on the other hand, it takes longer to recover from the effects these changes have on penetration rates and market growth. There are also systems in which insurance companies call for periodic tenders which grants the latter with increasingly greater contractual power which results in price pressure.
In the medium term the regulatory changes focused on reducing the requisites needed to sell and customize hearing aids in order to increase access to the hearing solutions market (like the separate after sales care providers called for in new French laws or the ability to sale hearing aids over the counter without requiring specialized professional assistance introduced in the US’s OTC Hearing Aid Act) in the medium term open the market to less complicated and less performing products, as well as an increase in competition with new potential players who can access the market more easily and cause a loss of market share and increase price pressure. The long-term effects, however, are difficult to foresee in a context characterized by the presence of numerous stakeholders.
Well aware that other unexpected and unforeseen changes could take place in addition to those mentioned above, including in light of the widespread adoption of austerity programs and the growing attention that the media, social networks and different regulatory authorities are paying to the hearing aid sector, the Group has implemented a series of measures which ensure the ability to constantly monitor and 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 favorable, including through advocacy (including by joining the most important trade associations).
More in detail, the dedicated Corporate division is strengthened continuously in order to:
- develop and maintain continuous monitoring of regulatory changes and their repercussions in all the countries where the Group operates;
- define the responsibilities (local or central) in managing current or potential problems;
- develop, including with the support of outside experts, plans of action relative
We operate in a market sector that is less sensitive than others to fluctuations in the general economic cycle.
We stand out for the quality of its customer assistance provided during the selection process and the personalization of the hearing solutions provided, combining technology with a human touch in order to provide customers with the best service possible and, at the same time, build a strong element of competitive differentiation. The failure to satisfy customers could, therefore, create a significant risk for the company.
In order to monitor and increase customer service and satisfaction Amplifon has not only developed a new store protocol focused on customer service excellence, but is also investing significant resources in the development of its own product line, as well as technologies and tools to remain in constant contact with its customers and test the “remote fitting & tuning” activities with a view to providing an even better “customer experience”. Customer
satisfaction surveys are also conducted regularly, as is continuous training of the hearing aid specialists and sales policies focused on customer satisfaction are developed continuously.
The auto-fitting or self-fitting solutions work for minor hearing loss. More than 70% of the Group’s customers, however, have average or significant hearing loss so these technological developments should not have a significant impact on Amplifon.
The development of an alternative to the hearing aid as a remedy for hearing loss (e.g. surgical techniques or the use of pharmaceuticals) would have a very significant impact, but the risk is considered very remote.
Main internal risks
Organization and processes
In the current economic situation, characterized by extreme volatility, and in light of the Group’s strategy to grow both internally (opening of new stores) and externally (through acquisitions), the organizational ability to define corporate processes capable of providing the information needed to make decisions in a timely manner, while also supporting operational efficiency and controls, is extremely important. The swift implementation of our strategic initiatives is also key.
These processes are even more important with acquisitions, particularly large ones like the GAES Group acquisition made at the end of 2018. In order to avoid additional costs and inefficiencies it is crucial to assess and proactively manage all the risks arising from these transactions, as well as those arising from a slow and prolonged integration of acquired businesses. In the case of the GAES Group acquisition the Group immediately organized a specific task force, coordinated directly by the CEO, with resources dedicated to the rapid integration of GAES in the Group processes relative to all the divisions (information technology, sales, marketing, human resources, finance and control, legal affairs, logistics, etc).
The rapid implementation of the strategic choices is guaranteed thanks to an organization based on macro-geographic areas and a leadership team that works with the CEO comprised of, in addition to the Vice Presidents of the three macro geographic areas (EMEA, America, Asia Pacific), the heads of the different corporate divisions (strategic business development, human resources, marketing, administration and finance, purchasing).
With a view to ensuring even greater coordination and effective implementation of its strategies, the Group continues to invest sizeable financial resources in the strengthening of corporate structures and in the development of unique and global solutions for the key processes:
- In order to differentiate its offering and to ensure the best customer service, the Group has developed its own line of products which, after being launched on the Italian market will gradually be rolled out in other countries and, at the same time, a specific programme, the Retail Excellence Programme, was developed which aims to define all the stores procedures designed to maximize the “Customer Experience”, as well as the efficacy and efficiency of the sales process. The success of this programme is based on the involvement of both regional and store personnel and, therefore, change management activities, along with appropriate HR management, are key.
- The focus of marketing is increasingly on digital marketing which will become key to continuous customer engagement, on the effectiveness and efficacy of the campaigns and the media-mix, and the development and implementation of a single CRM solution, as well as websites with new, innovative functions (such as making appointments and a personal area for customers). This will require significant investments and a series of tools and activities will be used to carefully measure their profitability.
- Furthermore, after having implemented in all the main countries numerous projects relating to the adequacy and compliance of accounting procedures pursuant to Law 262/2005, Business Performance Management in the stores with a view to more effective monitoring and international comparison, 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 launched a program focused on the implementation of a new ERP Cloud system which will support the Group’s processes relating, particularly to Finance, Human Resources and Procurement.
For us the quality of customer service in a strong growth business environment is one of our key strengths: the quality of our people, particularly those in contact with customers, as well those who have managerial and strategic positions, is very important.
Human resources management presents certain issues and areas of risk. Specifically:
- limited availability of hearing aid specialists in a particular market, 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 labor costs due to salary increases;
- deficiencies in staff’s technical and sales skills can lead to ineffective sales in few 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 possible lack of an adequate pipeline of internal resources capable of assuming managerial and strategic roles could slow down the integration of acquisitions and, in general, hinder the Group’s ability to grow.
The Group has taken the following steps to address the above-mentioned risks:
- defined and included its values in a Code of Conduct, which has been distributed in all countries of operation, implemented the Internal Organizational Model adopted pursuant to Legislative Decree 231/2001 in Italy and defined a Group anti-corruption policy;
- defined a profile of the ideal hearing aid specialist in order to assure that recruitment methods reflect the Group’s commercial policies. Relationships are also maintained with universities and industry trade associations in order to increase, including through specialization programs, the amount of hearing aid specialists on the market;
- strengthened both corporate and country Human Resources divisions;
- developed and gone live with the Global Career Website, as well local career websites, in order to facilitate the recruiting of key talent including by providing more detailed information about the company, the Group and the opportunities it can provide, with particular focus also on the new business segments in need of new expertise (for example, Digital);
- increased internal training and developed centralized coordination of the training carried out in individual countries;
- standardized the system used to map talent and the internal succession processes on both a global and local level, as well as by function;
- implemented a structured performance management system with a view to aligning individual objectives, corporate strategies, the incentive system and the results achieved, as well as providing all employees and staff members with a valid tool to support their professional development;
- 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.
The main financial risks are constantly examined and monitored by the Corporate Finance function. With a view to structured management of treasury activities and financial risks, in 2012 the Group finalized and adopted a Treasury Policy which contains guidelines for the management of:
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 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;
- Canada, where a small part of the purchase costs are incurred in US dollars;
- Central and South America, where the subsidiaries of the GAES Group (acquired at the end of 2018) use euros to pay GAES SA in Barcelona.
The size, however, of the subsidiaries 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 intercompany 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 intercompany 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, Canada, the United Kingdom, Switzerland, Hungary, Turkey, Poland, Israel, Australia, New Zealand, India, Egypt and, as result of the GAES Group acquisition year-end 2018, in Chile, Argentina, Ecuador, Colombia, Panama and Mexico.
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 through specific derivative instruments. These include:
- bonds issued in US dollars by Amplifon S.p.A. and subscribed by Amplifon USA Inc;
- intercompany loans in currencies other than the Euro between Amplifon S.p.A. and the Group companies in the United Kingdom.
The loans between the Australian and New Zealand companies, between the American and Canadian companies, as well as the loan granted by GAES SA to its Mexican and Colombian subsidiaries, 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 intercompany transactions worth less than €1 million (or the equivalent if denominated in another currency) 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.
The foreign exchange translation risk, in accordance with the Group Treasury Policy, is not hedged. Overall the impact of the foreign exchange translation risk can be seen in the Group’s Euro denominated EBITDA which was about €5.8 million lower than 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). 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 mix of fixed- and floating-rate loans and assessing 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 2018, the Group’s medium/long term debt is explained for €790 million by floating-rate bank loans (€530 million of which relates to the loan taken out for the GAES Group acquisition), €465 million of which had been swapped to fixed-rate debt at the date of this report, and for €100 million (at the hedging rate) by 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.
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 loans granted to members of the indirect channel and commercial partners in the United States and in Spain for investments and business development;
- from the residual amount receivable for the sale of the American subsidiary Sonus in the period 2010-2011 which was switched from the direct to the indirect channel.
With regard to the risk under (1) 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 to private individuals based on installment payment plans is increasing, as is the credit risk arising from sales to US indirect channel operators (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 commercial policies with local management. With regard to private customers, the majority of which do, however, use cash, payment options like installment plans or loans (with terms limited to a few months) are offered. These are managed by external finance companies which advance the whole amount of the sale to Amplifon, while the situation of the indirect channel in the US is closely monitored by local management.
The risk referred to in (2) above, notwithstanding the inevitable uncertainties linked to sudden and unforeseeable counterparty default, is managed by making diversified investments with the main national and international investment grade financial institutions and through the use of specific counterparty limits with regard to both invested and/or deposited liquidities and to the notional amount of derivatives. 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. Transactions with non-investment grade counterparties are not allowed unless specifically authorized by the Group’s CEO and CFO.
With regard to the risk referred to in (3) above, in the event payments fail to be made on the stores sold, ownership will revert back to Amplifon, while the receivables referred to in (4) above, are generally personally guaranteed by the beneficiaries and repayments are typically made when the invoices for the purchases of hearing aids are paid.
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 and/or lines of credit may request repayment. In this situation, including because of the sizeable financial commitment assumed with the GAES Group acquisition, the Group continues to pay the utmost attention to cash flow and debt management, maximizing the positive cash flow from operations, while also carefully monitoring credit lines and the refinancing of debt reaching maturity.
The available credit lines amounted to €285 million (of which €135 irrevocable) at the end of the year, while debt is medium-long term with the first significant maturity, which cannot be extended, in 2021.
We believe, therefore, including in light of the positive cash flow that the Group continues to generate, that at least in the short term, liquidity risk is not significant.
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 which fall within the limits determined in the treasury policy in order to minimize counterparty risk;
- the use of instruments which match, to the extent possible, the characteristics of the risk hedged;
- monitoring of the adequacy of the instruments used in order to check and, possibly, optimize the structure of the instruments used to achieve the purposes of the hedge.
The derivatives used by the Group are generally plain vanilla financial instruments. More in detail, the types of derivatives used include:
- cross-currency swaps;
- foreign exchange forwards.