Principles of risk management
KION encounters business risks that may jeopardise its business objectives. Risk management, like opportunity management, therefore forms an integral part of the Company's day-to-day management. To ensure that the risk management systems are fully integrated into KION's overall financial planning and reporting process, they are located in the Group Accounting & Finance function.
The procedures governing the KION Group's risk management activities are laid down in internal risk guidelines. For certain types of risk, such as financial risk or risks arising from financial services, the relevant departments also have guidelines that are specifically geared to these matters and describe how to deal with inherent risks. Risk management is organised in such a way that it directly reflects the structure of the Group itself. Consequently, risk officers supported by risk managers have been appointed for each company and each division. A central Group risk manager is responsible for the implementation of risk management processes in line with procedures throughout the Group. His or her remit includes the definition and implementation of standards to ensure that risks are uniformly captured and evaluated.
The risk management process is organised on a decentralised basis. Firstly, a group-wide risk catalogue is used to capture the risks attaching to each company. Each risk must be captured individually. If the losses caused by a specific risk or the likelihood of this risk occurring exceed a defined limit, the KION Group's Executive Board and its Accounting & Finance function are notified immediately. Each risk is documented in a specially developed module within the internet-based reporting system used for the entire planning and reporting process.
The risks reported by the individual companies are combined to form divisional risk reports as part of a rigorous reporting process. To this end, minuted risk management meetings are held once a quarter. Moreover, material risks are discussed at the quarterly business review meetings. The divisional risk reports are then used to compile an overall risk portfolio for the KION Group as a whole. To support this, additional meetings are held each quarter with relevant departments of the holding company in order to identify and assess risk, above all Company-wide, cross-brand risk affecting areas such as treasury, purchasing, tax, human resources and financial services. The Executive Board of KION GROUP GmbH and the Supervisory Board's audit committee are informed of the Group's risk position at least once a quarter.
Material features of the internal control and risk management system pertaining to the (Group) accounting process
The main objectives of the special accounting-related internal control system are to avoid the risk of material misstatements in financial reporting, to identify material mismeasurement and to ensure compliance with applicable regulations and internal work instructions. There can, however, be no absolute certainty that these objectives are achieved in full and at all times.
Material processes and controls in the (Group) accounting process
For its (Group) accounting process, KION has defined suitable structures and processes within its internal control and risk management system and implemented them in the organisation. Changes to the law, accounting standards and other pronouncements are continually analysed with regard to their relevance and effect on the consolidated financial statements; the relevant changes are then incorporated into the Group's internal policies and systems.
Besides defined control mechanisms, this special accounting-related internal control system includes, for example, system-based and manual reconciliation processes, separation of functions, the double-checking principle and adherence to policies and instructions.
The employees involved in the Group's accounting process receive regular training in this field. Throughout the accounting process, the local companies are supported by central points of contact. The consolidated accounts are drawn up centrally using data from the consolidated subsidiaries. A consolidation department with specially trained employees carries out the consolidation activities, reconciliations and monitoring of the stipulated deadlines and processes. This team monitors the system-based controls and supplements them with manual checks. The entire accounting process contains a number of specific approval stages. Employees with the relevant expertise provide support on specialist questions and complex issues. The central Internal Audit department also checks, among other things, the reliability of the accounting work by the subsidiaries in Germany and abroad. It focuses primarily on the following aspects:
- compliance with legal requirements, directives from the Executive Board, other policies and internal instructions;
- integrity and effectiveness of the internal control systems for avoiding financial losses;
- correct performance of tasks and compliance with business principles;
- formal and material correctness of the accounting and of the financial reporting that is based on the accounting.
Cyclical fluctuations in macroeconomic activity affect the market for industrial trucks. Customers' decisions on whether to invest, particularly in new trucks, depend to a large degree on the macroeconomic situation and conditions in their particular sector. During an economic downturn, such as the financial and economic crisis of 2008–2009, customers tend to postpone their purchases of new trucks. Although demand for services is less cyclical, it correlates with the degree of utilisation in the truck fleet – which usually declines during difficult economic periods. As KION can only adjust its fixed costs to fluctuations in demand to a limited extent, reductions in revenue impact on earnings.
Various measures aimed at making cost structures more flexible – such as the consolidation of production facilities – help to contain the earnings risk arising from reductions in revenue caused by economic conditions. Diversification of the customer base in terms of industry and region as well as expansion of service activities also play a role in mitigating risk. Moreover, KION closely monitors the market and its competitors so that it can identify market risks at an early stage and adjust its production capacities in good time.
Despite KION’s strong growth in emerging markets, the proportion of revenue it earns in the euro zone continues to be high. As a result, the market conditions that prevail in the euro zone impact significantly on KION's financial performance. Budget consolidation in affected euro-zone countries has resulted in faltering economic growth and higher unemployment. Doubts surrounding the stability of the financial system and the continued existence of the single currency have not been allayed, despite a tangible calming of the markets as a result of steps taken by the European Central Bank and politicians. These doubts are now compounded by fears about the high level of government debt in the United States and the declining pace of growth in China. Overall, these factors could reduce customers' willingness to invest and the resulting demand for KION products.
Current developments, above all in Europe, are making it increasingly difficult to gauge demand patterns reliably. The precise timing and even the extent of any change in the markets remain uncertain. KION therefore continually monitors macroeconomic and market conditions so that it can react at an early stage. Besides global economic growth, KION also analyses exchange rates, price stability, the consumer and investment climate, foreign trade activity and political stability in its key sales markets.
Due to the strained financial and economic situation in the euro zone, risk management analyses its possible impact on the Group’s financial position and financial performance on an ongoing basis. In addition to continuous screening and monitoring, separate observations are regularly made in its risk reports concerning the risks surrounding the member state financial crisis.
The markets in which KION operates are characterised by strong competition, including with regard to prices. Although KION's strengths (see Business model and market positioning section) have enabled it to charge appropriate prices until now, competition risks could have a negative impact on the Group's business situation and financial performance.
Manufacturers from Asia have cost advantages in production due to the currency situation and also because local labour costs are lower. Competition is therefore very fierce, particularly in the lower price segment and in emerging markets. Building on their local competitive advantages, Asian manufacturers – especially those from China – are also looking for opportunities to expand. Although customers' high quality expectations and service needs form a barrier to growth for many of these manufacturers, this situation is likely to intensify competition in future.
It is also conceivable that competitors will join forces and their resulting greater competitiveness will be detrimental to KION's sales opportunities. Moreover, predictions of higher volumes and margins may lead to overcapacity, which would put increased pressure on prices.
Alliances, partnerships, acquisitions and other measures are playing an increasing role in improving KION's competitiveness in terms of resources, market access and product range. The steps that KION is taking to mitigate its competition risk include making its plants more efficient and securing low-cost sources of supply, for example through its strategic partnership with Weichai Power. KION also continually evaluates its options for strengthening and consolidating its position in emerging markets.
Research and development risks
KION's market position and business performance depend to a large extent on its ability to remain a leading provider of technology. This requires the Group to continually develop products that meet customer expectations and comply with changing regulatory and technological requirements. To this end, KION must anticipate customers' needs and quickly bring new products to market. If the Company does not succeed in doing this, its technological and competitive position could be compromised in the long term.
KION counteracts research and development risks by carefully managing customer relations (see Customers section), focusing on customer benefits (TCO) in its product development (see Research and development section) and ensuring close cooperation between sales and development teams in order to continuously incorporate customer requirements into the development process.
The innovations developed by KION and its subsidiaries are comprehensively protected by intellectual property rights, in particular patents. Nevertheless, there is always the possibility that products or product components will be imitated. There is also a risk that patent applications will not be successful.
A mainstay of KION's strategy is the exploitation of potential offered by fast-growing regions in respect of strategic partnerships, joint ventures and the acquisition of local providers. One of the risks of such alliances and acquisitions is that the expected benefits will materialise only partly or not at all. For example, the organisational integration of new units can harm financial performance for a variety of reasons. Other strategic risks arise from having inadequate experience of specific political, economic or cultural parameters in target markets and if there is a lack of attractive strategic partners or companies suitable for acquisition. It is also possible that a partner will collaborate with competitors if exclusivity agreements are not in place.
KION mitigates such strategic risks by, for example, carrying out in-depth market research, conducting thorough evaluation procedures and drafting appropriate contracts – including as part of its strategic partnership with Weichai Power.
In the course of that partnership, Weichai Power acquired the majority of KION’s hydraulics business. To build its industrial trucks, LMH requires hydraulic components that are manufactured by the affiliated company Linde Hydraulics. Because LMH is highly dependent on these components, their supply is secured by detailed contractual agreements. LMH also has access to patents and other intellectual property rights that are important to its business activities. This mitigates the risks resulting from no longer having unrestricted access to the hydraulics business.
Procurement and sales risks
Procurement activities constitute a potential risk for the KION Group in terms of the lack of availability of parts and components for logistical or qualitative reasons, and the rising cost of raw materials, energy, base products and intermediate products. As a result, there is always the possibility that KION will face backlogs in the supply of individual raw materials and components. KION obtains some of its key components, such as combustion engines, tyres, high-performance forged and electronic parts, from a limited number of core suppliers.
Although there were no substantial supply bottlenecks in 2012, the risk of supply bottlenecks – such as in the event of a shortage of raw materials – cannot be eliminated. It is also possible that suppliers will get into economic difficulty and be unable to fulfil orders. KION mitigates this risk through appropriate diversification of its supplier structure in the context of a global procurement organisation. In addition, the supplier development department, which focuses on making improvements to supplier production processes, helps suppliers to ensure the cost efficiency and qualitative excellence of their processes.
Price changes present another procurement-related risk. In 2012 only around 27 per cent of the cost of materials for new trucks was directly influenced by changes in commodity prices. Moreover, conditions on the commodity markets typically affect component prices after a delay of three to six months. KION endeavours to pass on price increases to customers but cannot always do so entirely due to market pressures.
The main sales risks – besides a drop in revenue caused by market conditions – result from dependence on individual customers and sectors. For example, it is possible that customers would postpone or cancel orders during a period of economic difficulty. Significant cancellations have not occurred in the past years, however. It is also conceivable that customers would face a liquidity shortfall and therefore be unable to fulfil their payment obligations immediately or even at all. In terms of its customer portfolio, KION is currently not particularly dependent on any individual sector. Its business is also highly diversified from a regional perspective. In addition, KION supplies companies of all sizes. The risk of possible payment defaults, which experience has shown is low for KION, can be reduced further by realising collateral.
High-quality products and a high level of delivery reliability are key aspects of KION's premium positioning. Delays in delivery or a rise in the number of complaints could harm this position and, as a result, KION's financial situation.
KION's closely integrated manufacturing network presents a heightened risk to its ability to deliver goods on time in the event of operational disruptions or lengthy periods of production downtime at individual sites. To mitigate these risks, the KION Group carries out preventive maintenance, implements fire protection measures, trains its staff and builds a pool of external suppliers.
The Company has taken out a commercially appropriate level of insurance cover against loss. Quality assurance is a high priority throughout the value chain and reduces possible quality-related risks arising from the products and services provided. KION mitigates its quality-related risks significantly by applying rigorous quality standards to its development activities, conducting stringent controls throughout the process chain and maintaining close contact with customers and suppliers.
Key measures related to consolidation of the European production facilities were completed in 2012 with the closure of plants in Italy and France. However, there is a risk that further structural measures and reorganisation projects, such as the process of restructuring the container handler and heavy-duty forklift business in Merthyr Tydfil, will not be implemented in future owing to disruption of production or strikes. Furthermore, costs may also be incurred by the environmental restoration of sites that have housed production facilities for many years, for example work required due to contamination. Any damage to the environment may also lead to legal disputes and give rise to reputational risk. To mitigate these risks, KION undertakes restructuring measures only after a comprehensive planning process and works closely with employee representatives to ensure HR measures are implemented with the minimum possible social impact.
Tight integration between the different sites and with customers and other companies means that KION also relies on its IT systems working flawlessly. KION mitigates any IT risks – which can in part arise from the consolidation of IT systems and infrastructure – by continuously working on developing a robust, expandable and flexible IT systems landscape. Internal IT resources are pooled in KION Information Management Services GmbH, which has well-established processes for portfolio management and project planning and control. Quality assurance also takes place via external independent audits. Various technical and organisational measures protect the data of KION and its Group companies against unauthorised access, misuse and loss. To that end, authorisation to access the group infrastructure is verified and logged, and a virus scanner and firewall systems are also used.
Despite considerable improvements in the funding situation during the year under review, the Group remains dependent on debt financing to a significant degree. This results in obligations relating to interest and capital repayments. Group Treasury is responsible for ensuring that this does not hinder international growth and that sufficient financial resources are always available for this purpose.
The main types of financial risks managed by Group Treasury, including risk from funding instruments, are liquidity, exchange-rate, interest-rate and counterparty risk. Credit risk consists solely of counterparty risks attaching to financial institutions. Risk management procedures issued by Group Treasury stipulate how to deal with the aforementioned risks. In contrast, the individual Group companies directly manage counterparty risks involving customers.
Acquisition financing as part of the Senior Facility Agreement essentially provides the Group with the flexibility needed to meet the requirements of the lending covenants. Accordingly, the KION Group has secured acquisition finance in the form of committed credit lines. The individual tranches have varying maturities from the end of 2013 to 2018. During the year under review, KION significantly reduced its financial liabilities by converting a shareholder loan and receiving the contribution by Weichai Power as part of a resolution to carry out a capital increase (see Financial position section). In the course of negotiating with its lenders, KION GROUP GmbH also managed to extend the due date of its existing credit facilities with a total volume of more than €1 billion. In addition, €483 million of KION’s original acquisition finance was funded by issuing a corporate bond for a total of €500 million in April 2011, which will mature in 2018.
The term of the revolving loan facility was extended considerably in the year under review (see Financial position section). Other steps to ensure the Company's long-term funding are also regularly pursued. As contractually agreed, the capex facility was reduced by approximately €56 million over the course of 2012.
The Company generally refers to credit ratings to manage counterparty risk when depositing funds with a financial institution. Deposits are also restricted to the limits covered by the deposit protection fund run by the Federal Association of German Banks.
KION only uses derivatives to hedge underlying operational transactions; they are not used for speculative purposes. Records are kept of the type of financial instruments used, the limits governing their use and the group of banks acting as counterparties.
Group Treasury rigorously complies with and monitors the strict separation of functions between the front, middle and back offices. Each Group company's liquidity planning is broken down by currency and incorporated into KION's financial planning and reporting process. Group Treasury checks the liquidity planning and uses it to determine the funding requirements of each company.
KION is exposed to currency risk because of the high proportion of its business conducted in currencies other than the euro. Normally, at least 50 per cent of the currency risk related to the planned operating cash flows based on liquidity planning is hedged by currency forwards in accordance with the relevant guideline. The KION Group uses interest-rate and currency-related derivatives – primarily interest-rate swaps and currency swaps – to hedge the interest-rate and currency risks arising in connection with the acquisition finance. Approximately 65 per cent of the currency risk arising from the US dollar tranche is hedged by currency forwards with an average €-US$ exchange rate of around 1.29. At the end of 2012 around 48 per cent of the interest-rate risk was hedged by interest-rate swaps. The need to add new hedging instruments or replace ones that expire is reviewed on an ongoing basis.
The funds raised for acquisitions also give rise to risks for KION in terms of compliance with certain financial covenants specified in the loan agreement. These covenants could limit the Company's flexibility with regard to its ongoing strategic development. This risk continues to apply in view of the current uncertain economic and financial market environment. However, the Company is mitigating it by continuing steadfastly with steps to boost efficiency and by ensuring sufficient flexibility when defining new lending agreements. KION complied with all the lending covenants in the reporting year.
Accounting risks arising from goodwill and the brands
Goodwill and the brands represented 33 per cent of total assets as at 31 December 2012 (31 December 2011: 35 per cent). Pursuant to IFRS, these assets are not amortised and their measurement depends, above all, on future expectations. If these future expectations are not fulfilled, there is a risk that impairment losses will have to be recognised on these assets.
Risks from financial services
The funding terms and conditions faced by the lenders themselves (manifested, for example, in the payment of liquidity premiums on interbank lending) may result in a future shortage of lines of credit and/or increased financing costs for companies. However, the Group currently does not expect any further changes in its lines of credit or any excessive increases in margins. KION's leasing activities mean that it may be exposed to residual value risks from the marketing of trucks that are returned by the lessee at the end of a long-term lease and subsequently sold or re-leased. Residual values in the markets for used trucks are therefore constantly monitored and forecast. KION regularly assesses its overall risk position arising from financial services.
The risks identified are immediately taken into account by the Company in the costing of new leases by recognising writedowns or valuation allowances and adjusting the residual values. Risk-mitigating factors include the demand for used trucks, which stabilises the residual values of KION's industrial trucks. The majority of the residual values have underlying remarketing agreements that transfer any residual-value risk to the leasing company. This had a positive impact on the 2012 financial results. Group-wide standards to ensure that residual values are calculated conservatively, combined with an IT system for residual-value risk management, reduce risk and provide the basis on which to create the transparency required.
KION mitigates its liquidity risk and interest-rate risk by ensuring that most of its transactions and funding loans have matching maturities. Long-term leases are primarily based on fixed-interest agreements. The credit facilities provided by various banks ensure that the Group has sufficient liquidity. Moreover, KION offers the majority of financial services indirectly via selected financing partners that bear the risks of the finance transaction. In order to exclude exchange-rate risk, KION generally funds its leasing business in the local currency used in each market.
Because of low default rates, counterparty risk has not been significant to date in the KION Group. The Group has not identified any material changes between 2011 and 2012. KION also mitigates any losses from defaults by its receipt of the proceeds from the sale of repossessed trucks. It also primarily offers financial services indirectly via selected financing partners, and KION bears the counterparty risk in under 5 per cent of cases. The credit risk management system was updated during 2012 in preparation for the pooling of financial services activities in a separate segment. In particular, this involved revising the regulations concerning the process organisation as well as processes for risk management and control.
Human resources risks
KION relies on having highly qualified managers and experts in key roles. If they left, it could have a long-term adverse impact on the Group's prospects.
That is why KION actively engages in HR work aimed at identifying and developing young professionals with high potential who already work for the Company and retaining them over the long term, thereby enabling succession planning for key roles across the Group. KION also positions itself in the external market as an employer of choice. This will enable it to make strategic additions to its portfolio of existing staff and, in this way, avert the risk of possibly losing expertise and thereby becoming less competitive.
The relocation of production and other restructuring measures may result in a risk of strikes and reactions of other kinds by the workforce. As demonstrated several times in the past, this risk is contained by collaborating closely with employee representatives, and, if job losses are necessary, taking comprehensive steps to ensure they are achieved with the minimum possible social impact.
The legal risks arising from KION's business are typical of those faced by any company operating in this sector. The Group companies are a party in a number of pending lawsuits in various countries. The individual companies cannot assume with any degree of certainty that it will win any of the lawsuits or that the existing risk provision in the form of insurance or provisions will be sufficient in each individual case. However, the KION Group is not expecting any of these existing legal proceedings to have a material impact on its financial position or financial performance. These lawsuits relate, among other things, to liability risks, especially as a result of legal action brought by third parties because, for example, the Company's products were allegedly faulty or the Company allegedly failed to comply with contractual obligations.
The KION Group has taken measures to prevent it from incurring financial losses as a result of these risks. Although legal disputes with third parties have been insignificant both currently and in the past, the Company has a centralised reporting system to record and assist pending lawsuits. In addition to the high quality and safety standards applicable to all users of the Company's products, with which it complies when it develops and manufactures the products, it has also taken out the usual types of insurance to cover any third-party claims. These issues are also tackled by teams whose members come from a variety of functions. The aim of the teams is to identify and minimise risks, for example the risks arising from inadequate contractual arrangements. A further objective of this cooperation across functions is to ensure compliance with mandatory laws, regulations and contractual arrangements at all times.
External risks arise as a result of constant changes in the Company's political, legal and social environment. Because it operates in countries in which the political or legal situation is uncertain, KION is exposed to the consequent risk of government regulation, capital controls and expropriations. Although fairly unlikely, natural disasters and terrorist attacks constitute a further risk to KION's financial position and financial performance.
In 2012 KION continuously analysed the risks arising, in particular, from the financial crisis and the performance of the real economy in addition to its normal quarterly risk reporting. Particular attention was paid to the potential impact of financial instability in some economies and financial institutions in the context of the sovereign debt crisis in the euro zone. As far as possible, risk prevention measures were initiated at an early stage where risks were identified.
As conditions in the financial markets eased in the second half of 2012 and global growth is expected to pick up slightly in 2013, KION is acting under the assumption that the economic environment will be somewhat more favourable in 2013 than in the year under review. The situation in the global markets remains challenging, however. Uncertainties in the euro zone, the high level of government debt in the United States and comparatively muted growth prospects in the developed markets all continue to pose a substantial threat to growth.
As things stand at present, there are no indications of any risks that could jeopardise the Company's continuation as a going concern.