Risk and Opportunity Report
Entrepreneurial activities are always associated with uncertainties and risks. This is particularly true for the fast-paced sports and lifestyle industry in which PUMA operates. Due to the global nature of business in this industry, PUMA is constantly exposed to risks and opportunities that must be identified and managed. Here, we need an effective risk and opportunity management through which risks and opportunities can be systematically recognized and monitored. A risk is defined as one or more future events with unplanned, adverse effects for the company up to and including any threat to the continued existence of the company. Similarly, an opportunity is defined as one or more events with unplanned, positive consequences for the company.
The members of the PUMA SE Management Board, who acted as managing directors through July 2018, have overall responsibility for the risk and opportunity management system. The “Risk Management Committee” (hereinafter “RMC”) is a management-level committee responsible for the design and monitoring of the risk management system, thereby acting as the first point of contact for risk report preparation. The task of operationally coordinating and implementing the Group-wide risk management system has been transferred to Group Internal Audit & GRC (Governance, Risk Management & Internal Control). Opportunity management is not part of risk management. Individual interviews (risk interviews) are conducted with select executives at the management level below the Management Board (risk owners) throughout the company at regular intervals (currently twice a year). The objective of these interviews is to systematically identify, validate and categorize risks and record countermeasures. The Group Internal Audit & GRC department provides a uniform framework for the assessment of risks. The assessment considers probability of occurrence, the potential effect, and the control of the risk in question.
The risks identified and assessed during the risk interviews are presented to the RMC in an aggregated form (the risk heat map). The RMC consists of a fixed group of executives from various corporate divisions, including the Management Board. The position of RMC Chairman is always filled by a member of the Management Board. The results of the RMC meetings are reported to the Audit Committee (sub-committee of the Supervisory Board) by the Chair of the RMC and the Head of the Group Internal Audit & GRC department. An integrated GRC tool used to document the risk management processes is available to the Group Internal Audit & GRC department and to the risk owners.
PUMA also has a comprehensive reporting and controlling system, which is an essential component of its risk management approach. PUMA’s reporting and controlling system is based on monthly financial reporting as well as the review and plausibility reports on reported information issued by Controlling.
Managers analyze opportunities and risks in annual planning discussions around the world, setting targets and defining courses of action based on the results. The comprehensive reporting system continuously monitors and generates reports on compliance with the set targets. This enables PUMA to promptly identify any deviations or negative developments, and to initiate any necessary countermeasures in a timely manner.
Risk and Opportunity Categories
As a Group that operates internationally, PUMA is exposed to global macroeconomic developments and the associated risks. For example, economic developments in important sales markets may have an effect on consumer behavior. This can have positive or negative effects on the planned sales and results. Likewise, political changes, exchange rate fluctuations, changes to the legal framework, such as in connection with a disorderly Brexit, and social developments may have an effect.
Overall, PUMA manages these challenges with geographic diversification and the development of alternative scenarios for the possible occurrence of serious events. This applies in particular to political developments and possible changes of legal framework conditions which are continuously monitored by PUMA.
Brand image and brand desirability are of key importance for PUMA, as consumer behavior can have a negative effect on the brand as well as a positive one. Accordingly, PUMA has formulated the guiding principle of “We want to become the fastest sports brand in the world” in order to underline the company’s long-term direction and strategy. The FOREVER FASTER brand promise does not just stand for PUMA’s product range as a sports company, but also applies to all company processes.
PUMA manages brand image risks in particular through cooperation with brand ambassadors who embody the core of the brand and PUMA’s brand values (“courageous”, “confident”, “determined” and “fun-loving”), and have a large potential for influencing PUMA’s target group. PUMA has therefore strengthened its position as a sports brand through its partnerships with top athletes such as sprint legend Usain Bolt, star striker Antoine Griezmann and Formula One star Lewis Hamilton. In football, PUMA entered into long-term sponsorship agreements with leading clubs such as Borussia Mönchengladbach, Olympique Marseille and AC Milan in 2018. PUMA’s return to basketball in 2018 is also in this context. PUMA reaches young trendsetters via brand ambassadors and collaborations from the cultural and fashion scene, such as Jay-Z, Cara Delevingne and Selena Gomez.
Counterfeit products can cause damage to consumer confidence in the brand and can devalue PUMA’s brand image. For this reason, PUMA has made fighting brand piracy a top priority. PUMA’s intellectual property team does more than just protect a strong global intellectual property portfolio of brands, designs and patents. PUMA also works closely with customs and other law-enforcement authorities around the world and provides input regarding the implementation of effective laws to protect intellectual property.
Sourcing and the Supply Chain
The majority of PUMA products is produced in selected markets in Asia, in particular in China, Vietnam, Bangladesh and India. Production in these countries and transport to distribution countries is associated with significant risks for PUMA. For instance, certain risks may result from factors such as exchange rate fluctuations, changes in taxes and customs duties or trade restrictions, but also natural disasters and political instability, as well as the international threat of terrorism.
Moreover, risks may result from an overdependence on individual manufacturers. The portfolio is regularly reviewed and adjusted to avoid creating a dependence on individual suppliers and sourcing markets. Generally, long-term master framework agreements are agreed upon to secure production capacities required in the future.
Furthermore, there is a risk that suppliers will violate core ILO (International Labour Organization) labor standards, not comply with environmental standards or use hazardous chemicals in production. This would violate PUMA requirements to suppliers and also result in negative reporting. Adherence to applicable standards is ensured through regular audits of supplier companies.
Climate change and increasing customer requirements with regard to sustainability are leading to a stronger ecological focus both in our own locations and along the production and supply chain. More efficient use of resources as well as minimization of CO2 emissions and use of sustainable materials in production are expressions of PUMA’s sustainability strategy.
Product and Market Environment
The risk posed by market-specific product influences, in particular the risk of substitutability in the highly competitive sport and lifestyle market is decisively countered by the early recognition and taking advantage of relevant consumer trends. Only those companies that identify these trends at an early stage will be able to gain an edge over their competitors.
Targeted investments in product design and product development are to ensure that the characteristic PUMA design of the entire product range is consistent with the overall brand strategy (FOREVER FASTER), thereby creating a unique level of brand recognition. PUMA is focusing, for example, on the expansion and improvement of the product range for women as part of the “The future is female” initiative.
Retail and e-commerce
PUMA operates various distribution channels (including traditional trade, PUMA’s own retail stores and e-commerce platforms) in order to reduce the dependency on individual distribution paths. The focus on the company’s own retail stores and its own e-commerce platforms should furthermore ensure that PUMA products are presented exclusively in the desired brand environment.
Distribution through the company’s own retail stores and e-commerce platforms is, however, also associated with various risks for PUMA. This includes the necessary investments in expansion and infrastructure, setting up stores, higher fixed costs and leases with long-term lease obligations which can have an adverse impact on profitability should business decline. On the other hand, extending the value chain can deliver higher gross profit margins and provide better control over distribution. In addition, PUMA-owned retail stores can deliver the PUMA brand experience directly to the end customer.
In order to avoid risks and take advantage of opportunities, PUMA performs in-depth location and profitability analyses before making investment decisions. As a result of the company’s reporting and controlling system, negative trends can be detected early on, and the countermeasures required to manage individual stores can be taken accordingly. In e-commerce, global activities are harmonized and investments in the IT platform are made to further optimize purchase transaction settlement and further improve the purchasing experience for consumers.
Reporting in the Media
A negative media report about PUMA, such as a product recall, infringement of laws, or internal or external requirements, can also do significant damage to the brand and ultimately result in the loss of sales and profit, regardless of whether these events actually happened or were just rumors. PUMA manages this risk by way of careful press and PR work, which is managed from the Group’s headquarters in Herzogenaurach, Germany. In addition, PUMA regularly seeks an open dialog with key external stakeholders (e.g. NGOs), and this has been institutionalized in the “Global Stakeholder Dialogues” which take place regularly.
Organizational Challenges and Project Risks
The organizational structure of PUMA with the Group’s headquarters in Herzogenaurach, a central sourcing organization and globally positioned distribution companies, gives the Group a global orientation. This results in a risk for PUMA that the flows of goods and information are not sufficiently supported by modern IT infrastructure. For this reason, existing business processes must be continually optimized and adapted. This is carried out systematically through targeted optimization projects, which are planned and managed centrally by a staff member.
The creative potential and commitment and performance of PUMA employees are important factors for the success of any business and the source of significant opportunities as well. PUMA encourages independent thinking and action, which are key in an open corporate culture with flat hierarchies.
PUMA’s human resources strategy seeks to ensure the long-term sustainability of this successful philosophy. To achieve this goal, a control process is in place to detect and assess human-resource risks. Accordingly, special attention has been paid to managing talent, identifying key positions and high-potential individuals, and optimizing talent placement and succession planning. PUMA has instituted additional national and global regulations and guidelines to ensure compliance with legal provisions. PUMA will continue to make targeted investments in the human-resource needs of particular functions or regions in order to meet the future requirements of its corporate strategy.
As an internationally operating Group, PUMA is exposed to various legal risks. These include contractual risks or risks that a third party could assert claims and litigation for infringement of its trademark rights, patent rights or other rights. The continuous monitoring of contractual obligations and the integration of internal and external legal experts in contractual matters is to ensure that any legal risks are avoided.
PUMA is exposed to the risk that employees violate laws, directives and company standards (compliance violations). These risks, such as theft, fraud, breach of trust, embezzlement and corruption, as well as deliberate misrepresentations in financial reporting, may lead to significant monetary and reputational damage. PUMA therefore makes use of various tools to manage these risks. They include an integrated compliance management system, the internal control system, Group controlling and the internal audit department. As part of the Compliance Management System, awareness measures are carried out on important compliance subjects, such as corruption prevention and cartel law and corresponding guidelines are introduced in the Group. PUMA employees also have access to an integrity system for reporting unethical behavior.
As an international company, PUMA is subject to currency risks resulting from the disparity between the respective amounts of currency used on the purchasing and sales sides and from exchange-rate fluctuations.
PUMA’s biggest sourcing market is Asia, where most payments are settled in US dollars (USD), while sales of the PUMA Group are mostly invoiced in other currencies. PUMA manages currency risk in accordance with internal guidelines. Currency forward contracts are used to hedge existing and future financial liabilities in foreign currencies.
To hedge signed or pending contracts against currency risk, PUMA only concludes currency forward contracts on customary market terms with reputable international financial institutions. As of the end of 2018, the net requirements for the 2019 planning period were adequately hedged against currency effects.
Foreign exchange risks may also arise from intra-group loans granted for financing purposes. Currency swaps and currency forward transactions are used to hedge currency risks when converting intra-group loans denominated in foreign currencies into the functional currencies of the Group companies (Euro).
In order to disclose market risks, IFRS 7 requires sensitivity analyses that show the effects of hypothetical changes in relevant risk variables on earnings and equity. The periodic effects are determined by relating the hypothetical changes caused by the risk variables to the balance of the financial instruments held as of the balance sheet date. The underlying assumption is that the balance as of the balance sheet date is representative for the entire year.
Currency risks as defined by IFRS 7 arise on account of financial instruments being denominated in a currency that is not the functional currency and is monetary in nature. Differences resulting from the conversion of the individual financial statements to the Group currency are not taken into account. All non-functional currencies in which PUMA employs financial instruments are generally considered to be relevant risk variables.
Currency sensitivity analyses are based on the following assumptions:
Material primary monetary financial instruments (cash and cash equivalents, receivables, interest-bearing debt, liabilities from finance leases and non-interest-bearing liabilities) are either denominated directly in the functional currency or transferred into the functional currency through the use of currency forward contracts.
Currency forward contracts used to hedge against payment fluctuations caused by exchange rates are part of an effective cash-flow hedging relationship pursuant to IAS 39. Changes in the exchange rate of the currencies underlying these contracts have an effect on the hedge reserve in equity and the fair value of these hedging contracts.
Because of its business activities, PUMA is exposed to default risk that is managed by continuously monitoring outstanding receivables and recognizing impairment losses, where appropriate. The default risk is limited where possible by credit insurance and the maximum default risk is reflected by the carrying amounts of the financial assets recognized on the balance sheet. Furthermore, default risks result to a lesser extent from the counterparty’s other contractual financial obligations such as bank deposits and derivative financial instruments.
PUMA continually analyzes short-term funding requirements through rolling cash flow planning at the level of the individual companies in coordination with the central treasury department. In order to ensure solvency, financial flexibility and a strategic liquidity cushion at all times, a liquidity reserve is maintained in the form of cash and confirmed credit lines.
In 2018, the PUMA Group implemented an independent financing concept after the distribution of the majority shareholding of Kering S.A. A syndicated credit line of € 350.0 million was taken out for this purpose. The syndicated credit line was not utilized as of December 31, 2018.
To finance medium and long-term funding requirements that cannot be covered directly from the cash flow from operating activities, promissory note loans were issued for the first time in July 2018 in four tranches, one tranche each with a variable and fixed coupon over 3 years (total € 100.0 million) and one tranche each over 5 years (total € 60.0 million).
At PUMA, changes in interest rates do not have a significant impact on interest rate sensitivity and therefore do not require the use of interest rate hedging instruments.
PUMA’s risk management system allows the company to fulfill the legal requirements pertaining to corporate control and transparency. In 2018, there was no material change in the assessment of the risk situation. The Management assumes that, in an overall assessment of the company’s risk situation, the risks are limited and manageable. Due to the extremely solid balance sheet structure, in particular the high equity ratio and the positive business outlook, the management does not see any substantial threat to the continued existence of the PUMA Group.
Main features of the internal control and risk management system as it relates to the Group’s accounting process
PUMA SE’s Management Board is responsible for the preparation and accuracy of the annual financial statements, the consolidated financial statements and the combined management report of PUMA SE. The consolidated financial statements were prepared in accordance with the International Financial Reporting Standards that apply in the EU, the requirements of the German Commercial Code (HGB), the German Stock Corporation Act (AktG) and the German SE Implementation Act (SEAG). Certain disclosures and amounts are based on current estimates made by management and the Management Board.
The company’s Management Board is responsible for maintaining and regularly monitoring a suitable internal control and risk management system covering the consolidated financial statements and the disclosures in the combined management report. This control and risk management system is designed to ensure the compliance and reliability of the internal and external accounting records, the presentation and accuracy of the consolidated financial statements, and the combined management report and the disclosures contained therein. It is based on a series of process-integrated monitoring steps and encompasses the measures necessary to accomplish these, internal instructions, organizational and authorization guidelines, the PUMA Code of Ethics, a clear separation of functions within the Group and the dual-control principle. The adequacy and operating effectiveness of these measures are regularly reviewed by the Group Internal Audit & GRC department.
For monthly financial reporting and consolidation, PUMA has a Group-wide reporting and controlling system that allows it to regularly and promptly detect deviations from projected figures and accounting irregularities and, where necessary, to take countermeasures.
The risk management system can regularly, as well as on an ad-hoc basis, identify events that could affect the company’s economic performance and its accounting process so that it can analyze and evaluate the resulting risks and take the necessary actions to counter them.
In preparing the consolidated financial statements and the combined management report, it is also sometimes necessary to make assumptions and estimates that are based on the information available on the balance sheet date and which will affect the reported amounts and recognition of assets and liabilities, income and expenses, contingent liabilities, and other data that must be reported, as well as how these are classified.
The Supervisory Board’s Audit Committee meets regularly with the independent, statutory auditors, the Management Board, and the Group Internal Audit & GRC department to discuss the results of the statutory audits of the financial statements and of the audit review with regard to the internal control and risk management system as it relates to the accounting process. The auditor reports to the Supervisory Board during the balance-sheet meeting on the results of annual and consolidated financial statements.
In addition to the risk and opportunity management described, the Group Internal Audit & GRC department carries out so-called “internal control self-assessments” (ICSA) at the process level for all essential business processes. In these, process owners evaluate the existing control framework on the basis of best-practice standards. The objective is to continuously improve the internal control system and to identify specific risks at process level. The results of the ICSA are reported to the Audit Committee and are used specifically by the Group Internal Audit & GRC department in risk-oriented audit planning.