Doing business in the pharmaceutical industry is subject to risk. ALK’s Board of Management is responsible for the ongoing management of risk, including risk mapping, assessment of probabilities and potential consequences and launch of risk-reducing measures. Reporting to the Board of Directors’ audit committee is done on an annual basis.
The following risks are of particular significance to ALK.
Commercial risks
Risks related to the development of new drugs
The future success of ALK depends on the company’s ability to successfully identify, develop and market new, innovative drugs, which involves significant risks. A pharmaceutical drug must be subjected to very extensive and lengthy clinical trials to document aspects such as safety and efficacy before it can be approved for marketing. In the course of the development process, the outcome of these trials is subject to significant risks. Even though substantial resources are invested in the development process, the trials may produce negative results. Delays in obtaining regulatory approvals – or failure to obtain such approvals – may also have a major impact on the ability of ALK to achieve its long-term goals. ALK and its collaborative partners perform thorough risk assessments of the research and development programmes throughout the development and registration processes to optimize the probability of the products reaching the market.
Risks related to regulation and price control
ALK’s products are subject to a large number of statutory and regulatory requirements with respect to issues such as safety, efficacy and production. In most of the countries in which ALK operates, prescription drugs are subject to reimbursement from and price control by national authorities. This often results in major price differences in the individual markets. Regulatory requirements and intervention, as well as price control, may therefore have a significant impact on the company’s earnings capacity.
Risks related to commercialization
If ALK and its partners succeed in developing new products and obtaining regulatory approval for them, the ability to generate revenue depends on the products being accepted by physicians and patients. The degree of market acceptance of a new product or drug candidate depends on a number of factors, including demonstration of clinical efficacy and safety, cost-effectiveness, convenience and ease of administration, potential advantage over alternative treatment methods, competition, and marketing and distribution support. If ALK’s new products fail to achieve market acceptance, this could have a significant influence on the company’s ability to generate revenue. ALK regularly conducts extensive surveys of market conditions and similar factors and expends significant resources on providing information on its products to physicians and patients. Commercialization is a crucial part of the company’s strategic basis and strategic activities.
ALK’s products may be associated with allergic reactions of varying extent, duration and severity. If such events occur in unexpected situations, they may have an impact on the company’s earnings and sales. Due to the potentially serious consequences, it is crucial for ALK to keep an eye on product quality and safety, both in clinical development and in sales and marketing activities. If, despite the high level of quality and safety, a situation should occur in which it is necessary to recall a product, ALK has set up procedures to ensure that this can be done swiftly and efficiently.
Risks related to dependence on third parties
ALK has partnership agreements with third parties with a view to commercializing the company’s products on a number of markets and with parties supplying important input for key production processes. Although there are financial incentives for all of ALK’s partners to fulfil their contractual obligations, there can be no assurance that they will actually do so. The factors that motivate ALK’s partners to develop and commercialize products may be affected by conditions and decisions beyond ALK’s control. The agreement with Merck (formerly Schering-Plough) entitles ALK to receive certain milestone payments. These payments will depend on continuing favourable results in the development of the pharmaceutical products for which ALK’s partner holds the license rights. Moreover, reliance on suppliers and third-party manufacturers entails risks which ALK would not be subject to if the company possessed the necessary in-house manufacturing capabilities. Such risks include but are not limited to:
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Reliance on a third party for regulatory compliance and quality assurance.
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Possible breach of a manufacturing agreement by a third party due to factors beyond ALK’s control and influence.
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Reliance on the ability of a third party to deliver and scale up the volume of production.
ALK manages these risks through contractual relations, thorough planning and monitoring and through joint steering committees that work together with these external parties.
Risks related to competition
ALK operates in markets characterized by intense competition. If, for instance, a competitor launches a new and more effective treatment of allergy, it may have a material impact on ALK’s sales. A competitive market may also lead to market-driven price reductions or price reductions dictated by the regulatory authorities. Both competition and price are risks that may have a material impact on ALK’s ability to achieve its long-term goals. ALK therefore monitors economic developments, the competitive situation and initiatives on all important markets.
Risks related to patents and intellectual property rights
Patents and other intellectual property rights are important for developing and retaining ALK’s competitive strength. The risk that ALK infringes patents or trademark rights held by other companies, as well as the risk that other companies may attempt to infringe the patents and trademark rights of ALK are monitored and, if necessary, suitable measures are taken.
Risks related to production and quality
ALK has concentrated most of its production capacity at plants in Denmark, France, Spain and the USA. Although the plants are located in areas that have not historically been hit by natural disasters, this geographical diversification calls for risk planning in order to avoid emergency situations, such as lack of or poor access to raw materials, for instance pollen. This planning includes the prevention of unwanted events and preventive inventory management; an example is the build-up of contingency inventories in order to ensure an unbroken chain of production.
Production and manufacturing processes are also subjected to periodic and routine inspections by the regulatory authorities as a regular part of their monitoring process in order to ensure that all manufacturers observe the prescribed requirements and standards. Meeting these quality standards is a prerequisite for the company’s competitive strength. ALK’s production processes and quality standards have been developed and optimized over many years.
Risks related to key employees
ALK is dependent on being able to attract and retain employees in key positions. A loss of key employees may have a material impact on the company’s market and research efforts. ALK manages this risk, among other things, by continuously offering its staff professional development opportunities and competitive compensation.
Risks related to financial reporting
ALK has designed a number of internal control and risk management systems to ensure that its financial statements provide a true and fair view in accordance with the International Financial Reporting Standards as adopted by the EU and with a number of other disclosure requirements to the annual reports of listed companies. The systems also support appropriate accounting policies and accounting estimates.
ALK’s risk management and internal controls in connection with the financial reporting process, including IT and tax, are designed with a view to managing rather than eliminating the risk of errors and omissions in the Group’s financial reporting.
Control environment
The primary responsibility for the Group’s risk management and internal controls in relation to the financial reporting process rests with the Board of Directors and the Board of Management. These two boards are responsible for establishing and approving general policies, procedures and controls in key areas connected with the financial reporting process.
The Board of Management is responsible for the day-to-day maintenance of an efficient control environment and risk management systems in connection with the financial reporting process. Managers at various levels are responsible within their respective areas.
The policies, procedures and manuals that have been adopted are available on the Group’s intranet, and the importance of compliance with these precepts is regularly emphasized. Guidelines for persons authorized to sign for the company are provided through a formalized and documented distribution of responsibilities. The risk of fraud is mitigated through organizational segregation of incompatible functions and the use of preventive and detective internal controls. The controls are both IT-based and manual.
ALK’s control environment consists of its organizational structure and internal guidelines, which are based on legislation and applicable recommendations.
Risk assessment
There is a relatively greater risk of error in items in the financial statements that are based on estimates or that are generated through complex processes. ALK performs continual risk assessments to identify such items and to assess the scope of the related risks.
Note 2 to the financial statements 2009 (‘Significant accounting estimates and judgements’) contains a description of the estimates and assessments that are considered material to financial reporting.
Control activities
The purpose of the control activities is to prevent, detect and correct possible errors or irregularities. These activities are integrated in the company’s accounting and reporting procedures and include procedures such as certification, authorization, approval, reconciliation, results analysis, segregation of incompatible functions as well as controls relating to IT applications and general IT controls. The Group Finance function also conducts control activities aimed at ALK’s subsidiaries and selected key processes.
Information and communication
The company maintains information and communications systems to ensure that its financial reporting is correct and complete. Guidelines for reporting and end-of-month procedures are updated regularly and reviewed at least once a year. These guidelines are available to the relevant staff on ALK’s intranet. Amendments to accounting procedures are announced and explained in instructions from the Group Finance function.
Monitoring
ALK uses a comprehensive, standardized financial management system, which contributes to the monitoring of the ALK Group’s results. The system facilitates early detection and correction of possible errors and irregularities in the Group’s financial reporting.
All companies report detailed monthly accounting data that are analyzed and monitored at Group and regional level.
ALK applies a uniform accounting practice in accordance with IFRS, which is described in the corporate accounting manual. The accounting manual contains accounting and assessment principles and reporting instructions which must be strictly observed by all companies of the Group. The manual is updated and reviewed continually, and compliance with the manual is monitored at Group level.
The Board of Management informs the Board of Directors on the degree of compliance with the principles and instructions in the manual.
Financial risks
Due to the nature of its operations, investments and financing, ALK is exposed to fluctuations in exchange rates and interest rates. The ALK Group’s financial risks are managed from headquarters, based on policies approved by the Board of Directors. The objective of ALK’s financial risk management is to reduce the sensitivity of earnings to fluctuations in exchange rates, interest rates, liquidity and changes in credit rating. Group policy is to refrain from active financial speculation. See note 35 of the annual report 2009 for a specification of the Group’s hedging of currency, interest rate and credit risks and the use of derivative financial instruments.
Foreign exchange risk
The general objective of ALK’s foreign exchange risk management is to limit and delay any adverse impact of exchange rate fluctuations on earnings and cash flows and thus increase the predictability of the financial results.
The most significant financial risk in ALK relates to exchange rate fluctuations. The greatest exposure is to USD and GBP. In 2009, 9% of ALK’s revenue was denominated in USD, 7% in GBP and 74% in EUR. ALK’s sales are not deemed to be exposed to EUR due to Denmark’s participation in the European exchange rate cooperation.
A 10% increase in the exchange rate of USD would increase revenue by approximately DKK 15 million. The same would apply to GBP. All things being equal, a 10% increase in the exchange rate of USD is estimated to reduce EBIT by approximately DKK 15 million net, primarily because purchases of adrenaline products are denominated in USD. A 10% increase in the exchange rate of GBP would increase EBIT by approximately DKK 10 million. A drop in the exchange rates would have the opposite effect. Exchange rate risks relating to operations are primarily hedged by matching receipts and payments in the same currencies and by forward exchange contracts and options. Moreover, ALK is exposed to exchange rate risks when intercompany balances and net assets of foreign subsidiaries are translated into DKK. In accordance with the accounting policies, such currency translation adjustments are recognized in the income statement and in equity, respectively.
Foreign exchange exposure relating to future transactions and assets and liabilities is evaluated and hedged by instruments such as forward exchange contracts. This serves to limit the impact on the financial results of any exchange rate fluctuations. The exchange rate exposure relating to net investments in foreign subsidiaries is not hedged by forward exchange contracts.
Interest rate and liquidity exposure
At the end of the financial year, net interest-bearing assets stood at approximately DKK 400 million. A change in the interest rate level by 1 percentage point would, consequently, correspond to a change in interest income of approximately DKK 4 million. It is not expected that the interest rate exposure will be hedged as this is not considered financially viable.
Cash is invested in credit-worthy, liquid, interest-bearing instruments with relatively short duration. The liquidity risk is considered to be minimal due to the company’s current capital structure.
Credit exposure
The credit exposure in connection with financial instruments is managed by contracting only with institutions with satisfactory credit-worthiness, in Denmark as well as abroad. In accordance with ALK’s credit-risk policy, such institutions must have a minimum credit rating of AA or similar.
Trade receivables are monitored closely at the local level and are distributed on a number of markets and customers. The credit risk is therefore considered to be low.