Understanding Our Key Risks- Dechra Pharmaceuticals PLC Annual Report 2019

Principal Risks

The SET has identified and agreed key risks with the Board. Of these, a number are deemed to be generic risks facing every business, including failure to comply with financial reporting regulation, foreign exchange, IT systems failure and non-compliance with legislation. The risk profile opposite, therefore, details the nine principal risks that are specific to our business and provides information on:

their prioritisation;
how they link to Group strategy;
their potential impact on the business; and
what controls are in place to mitigate them.

The risk profile is shown post mitigation.

Emerging Risks

Given current geopolitical uncertainty we have identified three emerging risks as detailed below:

Taxation	The Group's effective tax rate (ETR) is subject to taxation policy in the territories in which it operates. The Group has benefited in the year from the reduction in corporate tax rate in the USA for the Tax Cuts and Jobs Act and is expected to benefit from the reduction in the Netherlands corporate tax rate in 2020. We continue to monitor developments in the tax reform globally which may cause future movements in the Group's ETR. The EU is currently challenging the legality of the UK Controlled Foreign Company (CFC) tax legislation from which the Group benefits. We continue to monitor developments. The Group currently benefits from patent and innovation box tax incentives. The Group's ETR will increase as qualifying patents expire.
Brexit	The decision by the UK to leave the European Union (EU) has created volatility in markets and uncertainty about how future trading relationships, regulatory processes and supply chains will operate. Our priority is to maintain continuity of supply of our products to our customers in the UK and the EU, and we have increased inventory accordingly. We have established a cross-functional team to assess and monitor the situation and have completed the implementation of a hard Brexit mitigation plan as outlined below: We have transferred our UK registered Marketing Authorisations for products that are sold in the EU to a subsidiary in the Netherlands; and We have transferred the analytical testing methods for products manufactured at our Skipton facility to our laboratories in Bladel and Zagreb. These changes will enable us to batch release UK manufactured products within the EU in the event that there will be no mutual recognition of quality standards.
Iran	We continue to monitor the potential impact of US sanctions on our existing business with Iran, the world's fourth largest poultry market, where we currently sell approximately £1.0 million per annum of products that are on the UN exempt sanctions list.

Risk	Potential Impact	Control and Mitigating Actions	Trends
1 Market Risk: The emergence of veterinary buying groups and corporate customers. We sell and promote primarily to veterinary practices and distribute our products through wholesaler and distributor networks in most markets. In a number of mature markets, veterinarians are establishing buying groups to consolidate their purchasing, and corporate customers are also emerging.	The emergence of corporate customers and buying groups represents an opportunity to increase sales volumes and revenue but may result in reduced margins.	We manage and monitor our national and European pricing policies to deliver equitable pricing for each customer group. Our relationships with larger customers are managed by key account managers. Our marketing strategy is designed to support veterinarians in retaining customers by promoting the benefits of our product portfolio in our major therapeutic areas.	Continuing customer consolidation in our EU markets
2 Product Development and Launch Risk: Failure to deliver major products either due to pipeline delays or newly launched products not meeting revenue expectations. The development of pharmaceutical products is a complex, risky and lengthy process involving significant financial, R&D and other resources. Products that initially appear promising may be delayed or fail to meet expected clinical or commercial expectations or face delays in regulatory approval. It can also be difficult to predict whether newly launched products will meet commercial expectations.	A succession of clinical trial failures could adversely affect our ability to deliver shareholder expectations and could also damage our reputation and relationship with veterinarians. Our market position in key therapeutic areas could be affected, resulting in reduced revenues and profits. Where we are unable to recoup the costs incurred in developing and launching a product this would result in impairment of any intangible assets recognised.	Potential new development opportunities are assessed from a commercial, financial and scientific perspective by a multi-functional team to allow senior management to make decisions on which ones to progress. The pipeline is discussed regularly by senior management, including the Chief Executive Officer and Chief Financial Officer. Regular updates are also provided to the Board. Each development project is managed by co-project leaders who chair project team meetings. Before costly pivotal studies are initiated, smaller proof of concept pilot studies are conducted to assess the effects of the drug on target species and for the target indication. In respect of all new product launches a detailed marketing plan is established and progress against that plan is regularly monitored. The Group has a detailed market knowledge and retains close contact with customers through its management and sales teams which are trained to a high standard.	Delay in delivery of some projects
3 Supply Chain Risk: Inability to maintain supply of key products due to manufacturing, quality or product supply problems in our own facilities or from third party suppliers. We rely on third parties for the supply of all raw materials for products that we manufacture in-house. We also purchase many of our finished products from third party manufacturers.	Raw material supply failures may cause: increased product costs due to difficulties in obtaining scarce materials on commercially acceptable terms; product shortages due to manufacturing delays; or delays in clinical trials due to shortage of trial products. Shortages in manufactured products and third party supply failures on finished products may result in lost sales.	We monitor the performance of our key suppliers and act promptly to source from alternative suppliers where potential issues are identified. The top ten Group products are regularly reviewed in order to identify the key suppliers of materials or finished products. We maintain buffer stocks and/or dual sourcing arrangements of key products. Contracts with suppliers are reviewed from both a commercial and legal perspective to enable reassignment of the contract should there be a change of control of any of the contracting parties. Processes are in place to monitor and improve product robustness, including Quality and Technical analyses of key products and engagement with internal and external Regulatory stakeholders. A business continuity plan is in place at Skipton and similar plans are being developed for other sites. A project is in progress to review and improve our supply planning processes.	Growth in our product portfolio and increased complexity in our supply network
4 Competitor Risk: Competitor products launched against one of our leading brands (e.g. generics or a superior product profile). We depend on data exclusivity periods or patents to have exclusive marketing rights for some of our products. Although we maintain a broad portfolio of products, our unique products like Vetoryl and Felimazole have built a market which may be attractive to competitors.	Revenues and margins may be adversely affected should competitors launch a novel or generic product that competes with one of our unique products upon the expiry or early loss of patents. Costs may increase due to defensive marketing activity.	We focus on lifecycle management strategies for our key products such that they can fulfil evolving customer requirements. Product patents are monitored and defensive strategies are developed towards the end of the patent life or the data exclusivity period. We monitor market activity prior to competitor products being launched, and develop a marketing response strategy to mitigate competitor impact.	Impact of competitor launches on our key products reduced
5 Regulatory Risk: Failure to meet regulatory requirements. We conduct our business in a highly regulated environment, which is designed to ensure the safety, efficacy, quality, and ethical promotion of pharmaceutical products. Failure to adhere to regulatory standards or to implement changes in those standards could affect our ability to register, manufacture or promote our products. Brexit presents uncertainty regarding the regulatory standards and transitional arrangements between the UK and the EU.	Delays in regulatory reviews and approvals could impact the timing of a product launch and have a material effect on sales and margins. Any changes made to the manufacturing, distribution, marketing and safety surveillance processes of our products may require additional regulatory approvals, resulting in additional costs and/or delays. Brexit transition may result in additional regulatory and quality control requirements and associated costs. Non-compliance with regulatory requirements may result in delays to production or lost sales.	The Group strives to exceed regulatory requirements and ensure that its employees have detailed experience and knowledge of the regulations. Manufacturing and Regulatory teams have established quality systems and standard operating procedures in place. Regular contact is maintained with all relevant regulatory bodies in order to build and strengthen relationships and facilitate good communication lines. The Regulatory and Legal teams keep updated in respect of changes with a view to ensuring that the business is equipped to deal with, and adhere to, such changes. Where changes are identified which could affect our ability to market and sell any of our products, a response team is created in order to mitigate the risk. We have appointed a new Global Quality Director with additional resources to improve oversight and performance monitoring across our end-to-end supply chain. External consultants are used to audit our manufacturing quality systems.
6 People Risk: Failure to resource the business to achieve our strategic ambitions, particularly on geographical expansion and acquisition. As Dechra expands into new markets and acquires new businesses or science, we recognise that we may need new people with different skills, experience and cultural knowledge to execute our strategy successfully in those markets and business areas. In the UK, the uncertainty created by Brexit could impact the hiring and retention of staff in some areas.	Failure to recruit or develop good quality people could result in: capability gaps in new markets; challenges in integrating new acquisitions; or overstretched resources. This could delay implementation of our strategy and we may not meet shareholders' expectations.	The Group HR Director reviews the organisational structure with the SET and the Board twice a year to aim to ensure that the organisation is fit for purpose and to assess the resourcing implications of planned changes or strategic imperatives. A development programme is in place to identify opportunities to recruit new talent and develop existing potential.
7 Antibiotic Regulatory Risk: Continuing pressure on reducing antibiotic use. The issue of the potential transfer of antibacterial resistance from food producing animals to humans is subject to regulatory discussions. In some countries this has led to government recommendations on reducing the use of antibiotics in food producing animals.	Reduction in sales of our antimicrobial product range. Our reputation could be adversely impacted if we do not respond appropriately to government recommendations.	Regular contact is maintained with relevant veterinary authorities to enable us to have a comprehensive understanding of regulatory changes. We strive to develop new products and minimise antimicrobial resistance concerns.	Antibiotic sales are stable or growing in most EU markets
8 Acquisition Risk: Identification of acquisition opportunities and their potential integration. Identification of suitable opportunities and securing a successful approach involves a high degree of uncertainty. Acquired products or businesses may fail to deliver expected returns due to over-valuation or integration challenges.	Failure to identify or secure suitable targets could slow the pace at which we can expand into new markets or grow our portfolio. Acquisitions could deliver lower profits than expected or result in intangible assets impairment.	We have defined criteria for screening acquisition targets and we conduct commercial, clinical, financial and legal due diligence. The Board reviews acquisition plans and progress regularly and approves all potential transactions. The SET manages post acquisition integration and monitors the delivery of benefits and returns.	Implementation of standard integration planning, resourcing and execution processes
9 Retention of People Risk: Failure to retain high calibre, talented senior managers and other key roles in the business. Our growth plans and future success are dependent on retaining knowledgeable and experienced senior managers and key staff.	Loss of key skills and experience could erode our competitive advantage and could have an adverse impact on results. Inability to attract and retain key personnel may weaken succession planning.	The Nomination Committee oversees succession planning for the Board and the SET. Succession plans are in place for the SET together with development plans for key senior managers. Remuneration packages are reviewed on an annual basis in order to help ensure that the Group can continue to retain, incentivise and motivate its employees.	Challenges in attracting talent for key roles in some geographies and specialist functions

Link to Strategic Growth Driver and Enabler

Risk

Potential Impact

Control and Mitigating Actions

Trends

Market Risk:
The emergence of veterinary buying groups and corporate customers.

We sell and promote primarily to veterinary practices and distribute our products through wholesaler and distributor networks in most markets.

In a number of mature markets, veterinarians are establishing buying groups to consolidate their purchasing, and corporate customers are also emerging.

The emergence of corporate customers and buying groups represents an opportunity to increase sales volumes and revenue but may result in reduced margins.

We manage and monitor our national and European pricing policies to deliver equitable pricing for each customer group.

Our relationships with larger customers are managed by key account managers.

Our marketing strategy is designed to support veterinarians in retaining customers by promoting the benefits of our product portfolio in our major therapeutic areas.

Continuing customer consolidation in our EU markets

Product Development and Launch Risk:
Failure to deliver major products either due to pipeline delays or newly launched products not meeting revenue expectations.

The development of pharmaceutical products is a complex, risky and lengthy process involving significant financial, R&D and other resources.

Products that initially appear promising may be delayed or fail to meet expected clinical or commercial expectations or face delays in regulatory approval.

It can also be difficult to predict whether newly launched products will meet commercial expectations.

A succession of clinical trial failures could adversely affect our ability to deliver shareholder expectations and could also damage our reputation and relationship with veterinarians.

Our market position in key therapeutic areas could be affected, resulting in reduced revenues and profits.

Where we are unable to recoup the costs incurred in developing and launching a product this would result in impairment of any intangible assets recognised.

Potential new development opportunities are assessed from a commercial, financial and scientific perspective by a multi-functional team to allow senior management to make decisions on which ones to progress.

The pipeline is discussed regularly by senior management, including the Chief Executive Officer and Chief Financial Officer. Regular updates are also provided to the Board.

Each development project is managed by co-project leaders who chair project team meetings.

Before costly pivotal studies are initiated, smaller proof of concept pilot studies are conducted to assess the effects of the drug on target species and for the target indication.

In respect of all new product launches a detailed marketing plan is established and progress against that plan is regularly monitored.

The Group has a detailed market knowledge and retains close contact with customers through its management and sales teams which are trained to a high standard.

Delay in delivery of some projects

Supply Chain Risk:
Inability to maintain supply of key products due to manufacturing, quality or product supply problems in our own facilities or from third party suppliers.

We rely on third parties for the supply of all raw materials for products that we manufacture in-house. We also purchase many of our finished products from third party manufacturers.

Raw material supply failures may cause:

increased product costs due to difficulties in obtaining scarce materials on commercially acceptable terms;
product shortages due to manufacturing delays; or
delays in clinical trials due to shortage of trial products.

Shortages in manufactured products and third party supply failures on finished products may result in lost sales.

We monitor the performance of our key suppliers and act promptly to source from alternative suppliers where potential issues are identified.

The top ten Group products are regularly reviewed in order to identify the key suppliers of materials or finished products.

We maintain buffer stocks and/or dual sourcing arrangements of key products.

Contracts with suppliers are reviewed from both a commercial and legal perspective to enable reassignment of the contract should there be a change of control of any of the contracting parties.

Processes are in place to monitor and improve product robustness, including Quality and Technical analyses of key products and engagement with internal and external Regulatory stakeholders.

A business continuity plan is in place at Skipton and similar plans are being developed for other sites.

A project is in progress to review and improve our supply planning processes.

Growth in our product portfolio and increased complexity in our supply network

Competitor Risk:
Competitor products launched against one of our leading brands (e.g. generics or a superior product profile).

We depend on data exclusivity periods or patents to have exclusive marketing rights for some of our products.

Although we maintain a broad portfolio of products, our unique products like Vetoryl and Felimazole have built a market which may be attractive to competitors.

Revenues and margins may be adversely affected should competitors launch a novel or generic product that competes with one of our unique products upon the expiry or early loss of patents.

Costs may increase due to defensive marketing activity.

We focus on lifecycle management strategies for our key products such that they can fulfil evolving customer requirements.

Product patents are monitored and defensive strategies are developed towards the end of the patent life or the data exclusivity period.

We monitor market activity prior to competitor products being launched, and develop a marketing response strategy to mitigate competitor impact.

Impact of competitor launches on our key products reduced

Regulatory Risk:
Failure to meet regulatory requirements.

We conduct our business in a highly regulated environment, which is designed to ensure the safety, efficacy, quality, and ethical promotion of pharmaceutical products.

Failure to adhere to regulatory standards or to implement changes in those standards could affect our ability to register, manufacture or promote our products.

Brexit presents uncertainty regarding the regulatory standards and transitional arrangements between the UK and the EU.

Delays in regulatory reviews and approvals could impact the timing of a product launch and have a material effect on sales and margins.

Any changes made to the manufacturing, distribution, marketing and safety surveillance processes of our products may require additional regulatory approvals, resulting in additional costs and/or delays.

Brexit transition may result in additional regulatory and quality control requirements and associated costs.

Non-compliance with regulatory requirements may result in delays to production or lost sales.

The Group strives to exceed regulatory requirements and ensure that its employees have detailed experience and knowledge of the regulations.

Manufacturing and Regulatory teams have established quality systems and standard operating procedures in place.

Regular contact is maintained with all relevant regulatory bodies in order to build and strengthen relationships and facilitate good communication lines.

The Regulatory and Legal teams keep updated in respect of changes with a view to ensuring that the business is equipped to deal with, and adhere to, such changes.

Where changes are identified which could affect our ability to market and sell any of our products, a response team is created in order to mitigate the risk.

We have appointed a new Global Quality Director with additional resources to improve oversight and performance monitoring across our end-to-end supply chain.

External consultants are used to audit our manufacturing quality systems.

People Risk:
Failure to resource the business to achieve our strategic ambitions, particularly on geographical expansion and acquisition.

As Dechra expands into new markets and acquires new businesses or science, we recognise that we may need new people with different skills, experience and cultural knowledge to execute our strategy successfully in those markets and business areas.

In the UK, the uncertainty created by Brexit could impact the hiring and retention of staff in some areas.

Failure to recruit or develop good quality people could result in:

capability gaps in new markets;
challenges in integrating new acquisitions; or
overstretched resources.

This could delay implementation of our strategy and we may not meet shareholders' expectations.

The Group HR Director reviews the organisational structure with the SET and the Board twice a year to aim to ensure that the organisation is fit for purpose and to assess the resourcing implications of planned changes or strategic imperatives.

A development programme is in place to identify opportunities to recruit new talent and develop existing potential.

Antibiotic Regulatory Risk:
Continuing pressure on reducing antibiotic use.

The issue of the potential transfer of antibacterial resistance from food producing animals to humans is subject to regulatory discussions.

In some countries this has led to government recommendations on reducing the use of antibiotics in food producing animals.

Reduction in sales of our antimicrobial product range.

Our reputation could be adversely impacted if we do not respond appropriately to government recommendations.

Regular contact is maintained with relevant veterinary authorities to enable us to have a comprehensive understanding of regulatory changes.

We strive to develop new products and minimise antimicrobial resistance concerns.

Antibiotic sales are stable or growing in most EU markets

Acquisition Risk:
Identification of acquisition opportunities and their potential integration.

Identification of suitable opportunities and securing a successful approach involves a high degree of uncertainty.

Acquired products or businesses may fail to deliver expected returns due to over-valuation or integration challenges.

Failure to identify or secure suitable targets could slow the pace at which we can expand into new markets or grow our portfolio.

Acquisitions could deliver lower profits than expected or result in intangible assets impairment.

We have defined criteria for screening acquisition targets and we conduct commercial, clinical, financial and legal due diligence.

The Board reviews acquisition plans and progress regularly and approves all potential transactions.

The SET manages post acquisition integration and monitors the delivery of benefits and returns.

Implementation of standard integration planning, resourcing and execution processes

Retention of People Risk:
Failure to retain high calibre, talented senior managers and other key roles in the business.

Our growth plans and future success are dependent on retaining knowledgeable and experienced senior managers and key staff.

Loss of key skills and experience could erode our competitive advantage and could have an adverse impact on results.

Inability to attract and retain key personnel may weaken succession planning.

The Nomination Committee oversees succession planning for the Board and the SET.

Succession plans are in place for the SET together with development plans for key senior managers.

Remuneration packages are reviewed on an annual basis in order to help ensure that the Group can continue to retain, incentivise and motivate its employees.

Challenges in attracting talent for key roles in some geographies and specialist functions