Annual Financial Report

GKN plc 2013 Annual Report GKN plc has today published its 2013 Annual Report and circular to shareholdersincorporating the notice of the 2014 Annual General Meeting. Both documents canbe viewed at or downloaded from www.gkn.com/investorrelations. Copies of both documents, together with the form of proxy for the 2014 AGM,have been submitted to the National Storage Mechanism and will shortly beavailable for inspection at www.morningstar.co.uk/uk/NSM. Printed copies of these documents have today been posted to shareholders whohave requested hard copies. The 2014 AGM will be held at 2.00 pm on Thursday 1 May 2014 at the CavendishConference Centre, 22 Duchess Mews, London W1G 9DT. In compliance with DTR 6.3.5, a description of the principal risks anduncertainties, details of related party transactions and a responsibilitystatement prepared for and contained within GKN's 2013 Annual Report are setout below. A condensed set of financial statements were appended to GKN's 2013full year results announcement issued on 25 February 2014, which included anindication of important events that occurred during the year. Page references below refer to page numbers in GKN's 2013 Annual Report. Risks and uncertainties The Board is responsible for setting the Group's risk appetite and ensuringthat appropriate risk management systems are in place. The Board delegates responsibility for day to day risk management to theExecutive Committee including the identification, evaluation and monitoring ofkey risks facing the Group and the implementation of Group-wide risk managementprocesses and controls. The Executive Committee is supported in this by theSub-Committee on Governance and Risk, whose role was strengthened during theyear, particularly in regard to its responsibilities for risk assuranceprocesses. The Audit Committee keeps under review the effectiveness of the Group's riskmanagement systems and reports to the Board on the results of its review. Theoccurrence of any material control issues, serious accidents or events thathave or might have a major commercial, financial or reputational impact, or theidentification of new risks are escalated to the Board and/or Audit Committeeas appropriate. How GKN manages risk The Group has four levels of defence through which it manages significantrisks: Level 1: Risk ownership and control Our businesses are responsible for ensuring that an effective risk and controlenvironment is maintained as part of day to day operations. This includes theimplementation of procedures and controls, under the direction of the ExecutiveCommittee, which are designed to ensure compliance with the Group's definedpolicies and procedures and the GKN Code (see pages 52-54). These front linecontrols are regularly updated to respond to the Group's changing risk profile. Level 2: Monitoring and compliance Central compliance functions monitor adherence to the procedures set by theExecutive Committee and provide guidance to the businesses on theirapplication. Representatives of these functions are members of, and reporttheir findings to, the Executive Sub-Committee on Governance and Risk. TheSub-Committee reports quarterly to the Executive Committee on matters relatingto the Group's governance, risk management and assurance framework includingareas of concern or proposals for improvement. Level 3: Independent Assurance Independent assurance over the Group's risk management, control and governanceprocesses is provided by the Group's Corporate Audit team and externalassurance providers. Level 4: Oversight The Board, Executive Committee and Audit Committee provide oversight anddirection in accordance with their respective responsibilities, moreinformation on which is set out in the Governance section of this annualreport. Enterprise Risk Management GKN's enterprise risk management (ERM) programme facilitates a common,Group-wide approach to the identification, analysis and assessment of risks andthe way in which they are managed, controlled and monitored. Through the use ofan ERM software tool, risk profiling is undertaken at plant, region/businessstream/ function, divisional and corporate levels. At each level, businessrisks are reviewed formally at the half year and year end. Identify and analyse: A broad spectrum of risks are considered through the ERMprocess, including those relating to strategy, operational performance,finance, product engineering and technology, business reputation, humanresources, health and safety, and the environment. The causes and theconsequences of each risk are considered and, where appropriate, linked tostrategic and operational objectives. Manage and mitigate: Management controls designed to monitor and mitigate therisks are documented. Risk owners are assigned for each risk. Assess: The ERM tool provides a consistent set of definitions and a commonapproach to risk evaluation with specific reference to likelihood and impact. Respond: The risk response is based upon the assessment of potential riskexposure and the level of tolerance acceptable. The response reflects whetherwe `accept' the risk on the basis of its assessed level of exposure andmitigating controls currently in place, or `reduce' the risk through additionalmitigation to bring it in line with required levels of tolerance. Monitor: The output from the ERM process is regularly reviewed together withlive tracking of delivery of planned improvement actions. Principal risks and uncertainties The nature of the industries in which we operate and our chosen strategy exposethe Group to a number of inherent risks. The Board has considered carefully thenature and extent of the significant risks it is willing to take in achievingthe Group's strategic objectives and delivering a satisfactory return forshareholders. These principal risks and uncertainties are summarised belowaccording to the strategic objective to which they relate. They may also impactour strategic objective to sustain above market growth. Over time the risk profile evolves and hence the principal risks have beenupdated to reflect the Board's view of the most important risks facing theGroup at this point in time. New risks have been added in respect of JointVentures and Integrated Systems Complexity and descriptions updated for otherrisks. The nature of each principal risk is further described on pages 44 to 51together with the corresponding mitigating actions that are in place, and anoverview of the risk trend during 2013. Risk profile Risk Trend Strategic Objectives Leading in our Leveraging a Differentiating Driving Other risks chosen markets strong global ourselves operational presence through excellence technology Increasing * Highly * Laws, * Technology * People competitive regulations and capability markets and Innovation corporate * Programme reputation * Integrated management systems complexity Stable * Customer * Operating * Health & * Business concentration in global safety continuity markets * Information * Pension * Joint system funding ventures resilience Reducing * Acquisition integration HIGHLY COMPETITIVE MARKETS Risk trend Description and potential impact Mitigation ^ GKN operates in highly * Continual review of competitive markets with customer competition and market trends. decisions based typically on price, quality, technology and * Targeted investment in service. Long-term contracts for engineering and lean major programmes are subject to manufacturing resources, as highly competitive bidding well as maintaining strong processes, and the strength of customer relationships. our competitors and general market conditions continue to * Maintaining GKN's competitive drive price pressure and more position through new product challenging contractual terms. technology. Strong competition is * The Group maintains a balanced particularly evident in high portfolio of businesses across growth markets as companies its markets providing some compete to be first to market and protection against competition secure market share. An inability in individual markets or or delay in developing or countries. maintaining sufficient or appropriate engineering and manufacturing capabilities in high growth markets could further increase the risk. Customer vertical integration (including OEMs taking production in-house), the entry of new competitors or consolidation of existing competitors also contribute to increased competition. Potential impact Competition, if not mitigated, could result in reduced sales and profit margins and potentially lost growth opportunities in high growth markets. An inability to secure new business on major programmes could significantly impact future growth, cash flow and profitability. Changes during 2013 Strong competition has continued throughout 2013 with growing price pressures across the supply chains of our key markets. In automotive, competition continues to increase in high growth markets such as China and South America, and in aerospace a number of new entrants and consolidations within the market have also further increased competition. This includes the emergence of government-backed manufacturers, with OEM support, in countries with growing aviation industries. See the strategic report (page 11) for more information on the trends in each of our markets. CUSTOMER CONCENTRATION Risk trend Description and potential impact Mitigation > Significant customer * The Group regularly reviews concentration exists in the its exposure to individual automotive and aerospace customers and contracts. industries and hence a significant portion of the * The Group has extensive and Group's revenues comes from a regular dialogue with key relatively small number of customers and strong customers. Around 50% of the commercial and engineering Group's revenue is derived from relationships. its top 10 customers. * Credit exposure is actively Potential impact reviewed and managed. The insolvency of, damage to relations, or significant worsening of commercial terms with a major customer could have a material adverse impact on the Group's future results, and could result in loss of market share and future business opportunities, asset write-offs and restructuring actions. Changes during 2013 There have been no significant changes in the OEM customer landscape with the proportion of business from the Group's top 10 customers remaining stable during 2013. No individual customer accounts for more than 10% of Group revenue. See page 11 of the strategic report for more information on key customer trends and page 141 (note 19c) on Credit Risk. LAWS, REGULATIONS AND CORPORATE REPUTATION Risk trend Description and potential impact Mitigation ^ The Group is subject to * Group-wide governance policies applicable laws and regulations and procedures, ongoing in the global jurisdictions and compliance training and strong industries in which it operates. oversight, including This includes certain territories consideration of issues that where strong ethical standards could impact the corporate may not be well established and brand and reputation. certain industries which are highly regulated. Regulations * Ongoing monitoring of include those related to export regulatory developments in controls, environmental and major jurisdictions. safety requirements, tax laws, intellectual property rights, competition laws and ethical business practices. Potential impact Non-compliance could expose the Group to fines, penalties, damage to reputation, suspension or debarment from government contracting or suspension of export privileges. Changes during 2013 The Group is exposed to an ever more stringent governance and regulatory environment and has again expanded its presence in territories where ethical standards may not be as well established as in other markets. Whilst there has been little new regulation in the year, enforcement activities by the authorities in relation to existing regulations have increased. The acquisition of the aero engine division of AB Volvo in October 2012 increased the proportion of Group's business subject to export control regulations. See pages 52 to 54 and 67 to 68 for more information on governance policies and procedures. OPERATING IN GLOBAL MARKETS Risk trend Description and potential impact Mitigation > GKN operates globally and as such * The Group has a diversified our results could be impacted by portfolio of businesses across global and regional changes in its markets providing some macro-economic and political protection against individual conditions, regulatory market or country risks. environment, consumer demand and preferences, and supply chain * Lead market indicators are volatility. kept under review so that we can respond quickly to Our businesses could be impacted changing trading conditions. by changing consumer confidence and associated volatility in * Our mitigation strategy also automotive demand; challenging includes: planning, budgeting credit conditions resulting in and forecasting processes lack of access to finance by customers and end consumers; * flexible management of delay of orders for civil variable and fixed cost base, aircraft and changes in the investment spending and amount or timing of US military working capital spending; volatility in agricultural, construction, * further diversification into mining and industrial markets; other sectors which present exchange rate fluctuations; and new opportunities volatility in the supply chain. * focused restructuring Potential impact activities, where necessary, to respond to markets which Significant or prolonged economic have suppressed levels of or financial market deterioration economic activity. (including movements in exchange rates of key currencies) may materially and adversely impact the Group's operational performance and financial condition. This may include impairment of assets or site closures if fixed costs cannot be managed appropriately. It may also materially impact our customers, suppliers and other parties with whom we do business. Changes during 2013 In general, the commercial aerospace and global automotive markets have grown during 2013, however the construction, mining and industrial markets remain challenging and government spending cuts continue to impact military aerospace demand. Further commentary on the recent trends and outlook for each of our markets is set out in the Chief Executive's review on pages 12 to 14 and the Business Context on pages 10 and 11. For further details on the Group's Financial Risk Management processes regarding foreign currency exposures see page 140. JOINT VENTURES Risk trend Description and potential impact Mitigation > A sizeable portion of the Group's * The Group seeks to profits and cash flows is participate only in ventures generated by a small number of in which its interests are joint venture and equity holdings complementary to those of its over which the Group exercises partners, and has formal varying degrees of control. In systems and procedures in these circumstances, there is an place to monitor the inherent risk that the objectives performance of such business of the joint venture partners in arrangements. regard to the joint venture may diverge. * Thorough pre-transaction due diligence procedures on any Potential impact potential joint venture partner. Such a misalignment of objectives may result in the Group's inability to pursue its desired strategy as a consequence of which the Group's business and future results may be adversely affected. Changes during 2013 Whilst relationships with our joint venture partners remain strong, as the amount of revenue generated through joint ventures continues to increase, this potential risk has been included as a principal risk for the first time. During the year GKN Driveline further extended its long-standing joint venture in China to cover the complete range of GKN Driveline products. See page 135 for more information on the Group's joint ventures. TECHNOLOGY AND INNOVATION Risk trend Description and potential impact Mitigation ^ Developing innovative technologies * Regular assessment of market for our customers is critical to and technology trends and maintaining differentiation and drivers. competitive advantage. GKN may lose customers to competitors * Close relationships and offering new technologies if we technical partnerships with are unable to adapt to or take customers. advantage of market developments such as changes in legislative, * Divisional technology plans regulatory or industry aligned to emerging and requirements, competitive future trends and business technologies or consumer strategy. preferences. * Consideration of technology Potential impact plans as part of the Board's annual strategy review. The failure to launch new products, new product applications * Focused investment in or derivations of existing research and development. products to meet customer requirements could have a significant impact on future profitable growth. Changes during 2013 The speed of technological change has increased as customers seek to improve the efficiency of aircraft, cars and other vehicles with solutions that are lighter and more fuel efficient. In response, GKN is increasing the amount it invests in technology and the amount of cross-divisional projects aimed at supporting continued focus on meeting customer needs across all our markets. Further commentary on how the Group continues to differentiate itself through technology is included in the `Delivering our Strategy' section on pages 15 to 23. INTEGRATED SYSTEMS COMPLEXITY Risk trend Description and potential impact Mitigation ^ In both our Automotive and * Robust bid and contract Aerospace businesses an management processes increasing percentage of revenues including thorough reviews relate to technology delivered of contract terms and through integrated systems rather conditions, than individual components. This contract-specific risk reflects the demand from our assessments and clear customers for the design and delegations of authority for manufacture of efficient and approvals. sustainable solutions which support vehicles and aircraft * Continuous review of that are more fuel efficient and contract performance. help reduce emissions. * High levels of quality These integrated systems often assurance are embedded in involve long-term commitments in robust manufacturing relation to warranties, funding, systems. quality and safety, and technical and customer requirements. * Regular reporting and Specifically within the Aerospace monitoring of quality business, the Group has Risk and performance based upon Reward Sharing Partnerships customer KPIs. (RRSPs) with key engine manufacturers. These may contain `Pay to Play' contractual terms and formalised risk sharing arrangements that are not always within GKN management control. Potential impact A failure to understand or effectively manage programme commitments could damage customer relationships, and lead to unexpected liabilities and reduced longer term profitability. Also, as these integrated solutions are increasingly used in safety critical applications, a product failure could result in serious potential liabilities, warranty claims or product recalls and as a result adversely affect GKN's financial performance and damage our reputation. Changes during 2013 With the increasing percentage of revenues derived from integrated systems during 2013, the potential exposure has been included as a principal risk for the first time. The increased revenues and related risk trend is principally driven by the first full year effect of the acquisition of the aero engine division of AB Volvo and continued growth of all-wheel drive and eDrive solutions in GKN Driveline. See pages 10 to 11 and 30 to 31 of the strategic report for more information. PEOPLE CAPABILITY Risk trend Description and potential impact Mitigation ^ The Group's ability to deliver * Competitive reward packages its strategic objectives is together with focused training dependent upon the recruitment and development programmes. and retention of sufficiently qualified, experienced and * A culture that motivates motivated people. individuals to perform to the best of their abilities. It is critical for the Group to secure and maintain the relevant * Strong succession and capabilities in specific development programmes. geographical regions and disciplines in both existing markets and to support growth markets. Potential impact The failure to recruit or loss of key personnel or the failure to plan adequately for succession or develop the potential of employees may impact the Group's ability to deliver its strategic and financial objectives. Changes during 2013 2013 has seen a continued need for more engineering graduates and the recruitment and development of resources and capabilities aligned to our growth markets. Important change programmes were implemented in the divisions during the year to ensure alignment of the organisation structures and leadership teams with their strategic objectives. More information is available in the sustainability report on pages 56 and 57. PROGRAMME MANAGEMENT Risk trend Description and potential impact Mitigation ^ Many of the programmes entered * Robust bid procedures into by the Group are complex and including thorough reviews of lengthy, and are subject to contract terms and conditions, various performance conditions technical requirements and which must be adhered to programme cost forecasting. throughout the programme. The management of such programmes * Rigorous programme management, brings risks related to: including investment phasing and product testing * delays in product development activities. or launch schedules; * Periodic impairment reviews of * failure to meet customer capitalised development costs. specifications or predict technical problems; * Periodic review of key programmes by the Executive * inability to manufacture in Committee and the Board. time for the start of production or to required production volumes; * dependence on key or customer nominated suppliers; * failure to manage effectively internal or customer-driven change; * inability to forecast accurately and to manage costs. Potential impact Ineffective programme management could result in damage to customer relationships or cancellation of a contract resulting in claims for loss and reputational damage. Poor performance against a contract could also undermine the Group's ability to win future contracts and could also result in major cost overruns and significantly lower returns than expected. Changes during 2013 Programme management risk has continued to increase in line with the move towards common global platforms in automotive and the launch of new aircraft in aerospace, together with the application of new technologies. See pages 28 to 37 of the Business Review for more information on major new programme wins. HEALTH AND SAFETY Risk trend Description and potential impact Mitigation > We have a fundamental duty of * Consistent Group-wide care to protect our people and application of health, safety other stakeholders from harm and environmental programmes. whilst conducting our business. Whilst we manage carefully this * Health and safety audits to obligation through extensive ensure adherence to Group Group-wide processes, we policies and procedures. recognise we can never be complacent. Therefore we continue * A focus on process and to include this as a principal behavioural safety through a risk and an area which will number of Group-wide risk always be a priority for GKN. assessment and training programmes. Potential impact * Maintenance of insurance for A serious accident in the costs associated with related workplace could have a major actions or claims against the impact on employees as well as Group. their families, colleagues and communities. Such an incident could also result in legal claims where damages may not be fully insured, reputational damage and financial loss through fines by regulators. Changes during 2013 Against a target of zero preventable accidents, both our key performance measures, accident frequency rate (AFR) and accident severity rates (ASR), have shown a significant reduction in 2013. Work continues with our thinkSAFE! programme which was expanded in 2013 to include `don't WALK BY!', an awareness programme developed to encourage all employees to identify and resolve safety and environmental concerns. See pages 54 to 55 of the sustainability report for more information on the Group's health and safety performance. INFORMATION SYSTEM RESILIENCE Risk trend Description and potential impact Mitigation > The Group could be impacted * Formal risk-based governance negatively by information framework including technology security threats dedicated IT security including unauthorised access to policies and related intellectual property or other compliance processes, classified information. ongoing risk reviews, IT Interruptions to the Group's security awareness training information systems could also and robust systems and adversely affect its day to day processes to manage access, operations. information assets, threats and vulnerabilities. The inherent security threat is considered highest in our * External support and Aerospace business where data is benchmarking of best held in relation to `cutting practice information systems edge' civil aerospace technology security and resilience. and military contracts. * On-going development of Potential impact appropriate incident response plans and A major disruption to information capabilities. systems could have a significant adverse impact on the Group's * Disaster recovery operations or its ability to contingency plans which are trade. The loss of confidential regularly tested including information, intellectual at data centres where the property or controlled data could risk is deemed to be the have a significant impact on the greatest. Group's reputation with its customers and affect its ability * Executive Committee to win future contracts. oversight of IT security and assurance matters. Changes during 2013 In general, the nature and volume of information security threats to business have continued to evolve during 2013. In response, the Group has continued to strengthen its mitigating processes and controls in this area. See page 68 of the corporate governance report for more information on the Group's IT governance. ACQUISITION INTEGRATION Risk trend Description and potential impact Mitigation \/ The Group considers investment in * The Group has robust processes value-enhancing acquisitions to manage detailed integration which support the Group's plans with regular reviews by strategy and when market divisional management, the conditions are right. Executive Committee and the Board. The successful realisation of the anticipated benefits of * Post investment reviews of all acquisitions is dependent upon acquisitions. the successful integration of these businesses together with their post-acquisition performance. Potential impact A failure to integrate effectively major acquisitions could impact the business operations and result in unplanned integration or restructuring costs, unsuccessful cultural integration and prevent achievement of anticipated acquisition benefits. Changes during 2013 The risks related to post-acquisition integration have fallen during the year following the successful integration of the aero engine division of AB Volvo and subsequent formation of GKN Aerospace Engine Systems. Further information on the integration programme is given in the Business Review on pages 30 to 31. BUSINESS CONTINUITY Risk trend Description and potential impact Mitigation > A major disruption to internal * Ongoing maintenance and facilities or external supply chain replacement programmes for could be caused by natural key assets and facilities. disaster, destruction of a key facility or asset, financial * Flexible sourcing insolvency of a critical supplier arrangements for key or scarcity of supplies. supplies. The Group has a small number of * Effective supply chain facilities and assets which are key management to ensure to maintaining production levels appropriate inventory levels for major customers and internal are maintained. service levels. * Targeted incident response In addition, certain of the Group's and business continuity businesses are exposed to a higher plans. inherent risk of natural disasters because of their geographical * Monitoring of the financial locations. and operational viability of key suppliers. Potential impact A sustained disruption to internal facilities, production or supply could result in major operational disruption, a significant adverse impact on our ability to meet customer requirements, result in additional contractual liabilities and have a consequential impact on financial performance. Changes during 2013 There has been no significant change in the inherent risk profile during 2013. All divisions continue to focus on risk mitigation, including the production, refinement and testing of business continuity and disaster recovery plans, and on-going reviews of critical assets and prioritisation of capital investment. PENSION FUNDING Risk trend Description and potential impact Mitigation > The Group operates a number of * Close co-operation with defined benefit pension plans with scheme fiduciaries regarding aggregate liabilities of £1,271 management of pension scheme million at 31 December 2013. These assets and liabilities, plans are exposed to the risk of including asset selection and changes in asset values, discount hedging actions. rates, inflation and mortality assumptions. * Alternative funding and risk mitigation actions are Potential impact implemented where appropriate. Increases in the pension deficit could lead to a requirement for additional cash contributions to these schemes, thereby reducing the amount of cash available to meet the Group's other operating, investment and financing requirements. Changes during 2013 During the year, funding valuations were completed for both UK pension schemes as part of a triennial valuation cycle. As a result, the Group has agreed with the scheme trustees a plan of additional cash contributions providing certainty over the range of medium-term funding cash flows. See pages 40 to 41 and 148 to 154 for more information on the Group's pension arrangements. RELATED PARTY TRANSACTIONS In the ordinary course of business, sales and purchases of goods take placebetween subsidiaries and joint venture companies priced on an arm's lengthbasis. Sales by subsidiaries to joint ventures in 2013 totalled £44 million(2012: £65 million). The amount due at the year end in respect of such saleswas £11 million (2012: £13 million). Purchases by subsidiaries from jointventures in 2013 totalled £2 million (2012: £36 million). The amount due at theyear end in respect of such purchases was nil (2012: nil). At 31 December 2013,a Group subsidiary had £8 million payable to a joint venture company in respectof an unsecured financing facility bearing interest at 1 month LIBOR plus 1⁄8%(2012: £6 million). There was an £8 million loan receivable from a jointventure at 31 December 2013 (2012: nil), which is interest bearing at 4.5% andis due for repayment in 2016. STATEMENT OF DIRECTORS' RESPONSIBILITIES Each of the Directors as at the date of the annual report, whose names andfunctions are set out on pages 60 and 61, confirm that to the best of theirknowledge: * the Group financial statements, prepared in accordance with IFRSs as adopted by the EU, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; and * the strategic report includes a fair review of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face. In addition, the Directors consider that the annual report and accounts, takenas a whole, is fair, balanced and understandable and provides the informationnecessary for shareholders to assess the Company's performance, business modeland strategy. Approved by the Board of GKN plc and signed on its behalf by Mike Turner CBEChairman24 February 2014 CAUTIONARY STATEMENT This announcement contains forward looking statements which were made in goodfaith based on information available at 24 February 2014, being the date ofapproval of the 2013 Annual Report. It is believed that the expectationsreflected in these statements are reasonable but they may be affected by anumber of risks and uncertainties that are inherent in any forward lookingstatement which could cause actual results to differ materially from thosecurrently anticipated. Nothing in this document should be regarded as a profitsforecast.