Material operational risks

HUGO BOSS summarizes risks associated with the suppliers and sourcing markets, as well as quality, logistics and sales and distribution risks under significant operational risks.

Risks associated with the suppliers and sourcing markets

Risks associated with the suppliers and sourcing markets exist in connection with a possible dependence on individual suppliers or production sites, a possible increase in product costs as well as any possible discrepancy between production and sales.

HUGO BOSS attaches key importance to the careful selection of suppliers and the establishment and maintenance of long-term strategic relationships. However, there is a risk that production from one or more suppliers may break down due to supplier-related factors or incidents affecting a particular region. An excessive dependency on individual suppliers or production sites could therefore lead to disruptions in the Group’s supply chain and therefore to sales risks. The Group therefore ensures as balanced a distribution of sourcing volumes as possible. The production and sourcing process is always coordinated centrally. Supplier relationships are regularly monitored and evaluated with the aim of identifying risks at the earliest possible opportunity and introducing appropriate measures to ensure the supply of goods. Indeed, the largest external supplier made up 9% in fiscal year 2018, and the largest single external production site made up about 5% of the total sourcing volume (2017: 9% and 5% respectively). Sourcing and Production

In view of the earthquake risk and possible risks as a result of ongoing political uncertainties, a particularly wide range of measures have been implemented at the Company’s largest production site in Turkey in order to limit the impact on the sales of HUGO BOSS of a possible downturn in production. For the majority of production volumes, emergency plans are in place to transfer production to external suppliers. Also, the financial risk in the unlikely event of an earthquake is covered by insurance as far as possible. Given the measures that have been implemented, Management estimates overall that risks from dependence on individual suppliers or the regional distribution of the sourcing volume are unlikely to occur. The associated financial impact however could still be high.

Increasing wages for production employees, in particular in emerging economies, as well as an increase in the price of relevant raw materials to the Group such as cotton, wool and leather may lead to higher product costs and so have a negative influence on the gross profit margin and ultimately on the profitability of the Group. HUGO BOSS counters this risk with margin-based collection planning, measures to improve efficiency in the production and sourcing processes, continuous optimization in the use of materials and regular review of its pricing policy. It is assumed at present that risks from higher production costs are possible, and these may have a significant negative impact on the development of earnings.

The forecasting of sales volumes, planning of production capacities and allocation of raw materials and finished goods as part of the sourcing processes involves scheduling risks. Deviations from an appropriate allocation can lead to excess allocation resulting in high inventory levels on the one hand. On the other, it can also lead to insufficient allocation and the risk of failing to benefit from sales opportunities. In order to reduce this risk, the Group is making great efforts to continually improve the forecast quality and to keep making the goods management more flexible across channels and markets. In view of the large volumes involved, the risk is considered likely. The associated financial impact could be high depending on their magnitude.

Overall, the aggregate potential impact of risks associated with suppliers and sourcing markets is considered to be high. Aggregated together, the likelihood of occurrence is considered as possible.

Quality risks

When sourcing materials and manufacturing its products, HUGO BOSS sets exacting standards with regard to quality. Thorough quality controls at all stages and the incorporation of customer feedback should contribute to the continuous improvement of the production process. Also, both the Company’s own production sites as well as those belonging to partners are regularly monitored to make sure they comply with central quality guidelines. Incoming goods checks as well as intensive quality tests at the Metzingen site should also ensure the quality standards at HUGO BOSS. Nevertheless, the Group considers a certain amount of product returns for quality reasons to be possible. However, the impact on the development of earnings is considered as significant despite the recognition of appropriate provisions for returned goods and the regular review of the amounts recognized. Sourcing and Production

Logistics risks

HUGO BOSS is exposed to logistics risks, which mainly relate to the temporary downtime or loss of warehouse locations and an accompanying potential loss of turnover. The storage of all raw materials and finished goods is concentrated in a few chosen sites. Therefore, the distribution centers for hanging garments, flat-packed goods and the European online business, all located in the immediate vicinity of the headquarters in Metzingen, form the core of the Group-wide logistics network. The three sites guarantee the highest quality standards and are operated independently by HUGO BOSS, as are several smaller regional distribution centers. Business Activities and Group Structure

The adherence to comprehensive fire protection and safety measures is continuously monitored at all warehouse locations. HUGO BOSS has also taken out insurance to cover the direct financial risk from a loss of goods or equipment in warehouses. Despite the measures implemented, the likelihood of occurrence of logistics risks is considered to be possible. The associated financial impact can potentially be significant.

Sales and distribution risks

Sales and distribution risks exist in connection with the Group’s own retail activities, in particular with regard to inventory management as well as slow-moving goods and the resulting impairment. In the wholesale channel the sales risks mainly refer to a possible dependency on individual wholesale partners as well as bad debts.

The aim of the centrally organized inventory management system is the forward-looking and optimal allocation of the inventory across the Group while at the same time ensuring that it remains flexible, in order to be able to react to any increase or decrease in demand at short notice. Downturns in demand or erroneous assessments of sell-through rates can potentially have a negative impact on inventory turnover. HUGO BOSS therefore aims to continuously improve its inventory management system. The countermeasure of granting additional discounts necessarily translates to a reduced gross profit margin and is therefore continually monitored by the Group controlling department. A centrally managed pricing policy differentiated retail formats and collections adjusted to the respective distribution channel serve to further improve the efficiency of sales floor space.

Inventory risks may result from inventory items being kept in storage for longer and a potential reduction in their marketability as a consequence. According to the net realizable value principle, impairments on inventories are recognized accordingly and are monitored on a monthly basis. As part of the process, system-based analyses of movement rate, range of coverage and net realizable value are applied in a uniform manner across the Group. Sufficient write-downs were recognized as of the reporting date from the Management’s perspective. Notes to the Consolidated Financial Statements, Note 12

Attention is paid to ensuring a balanced customer structure to avoid a potential overdependence on individual customers in the wholesale channel. The Group controlling department constantly monitors key indicators such as the order intake, sales and supply rates and reports on these to the Management on a regular basis. If risks occur, countermeasures can be adopted promptly. Group Management

In its wholesale business, the Group is exposed to a bad debt risk based on the potential insolvency of individual trading partners and a concentration of bad debts in the event of an economic slowdown in individual markets. The Group-wide receivables management follows uniform regulations, for example regarding the credit rating checks and the setting and observance of customer credit limits, monitoring of the age structure of receivables and the handling of doubtful accounts. In specific cases, this means that deliveries are only made upon prepayment or business is discontinued with customers with an unsatisfactory credit rating. The internal audit function regularly checks compliance with the Group guidelines. As of the reporting date, there was no concentration of default risks caused by significant overdue payments by individual customers, so the possible receivable default risk was estimated as low overall. Notes to the Consolidated Financial Statements, Note 13

In summary, the Management estimates the likelihood of occurrence of sales risks as possible. The cumulative financial impact is largely classed as high due to the potential discounts and impairments.