27th Mar 2009 16:36
GKN plc
2008 ANNUAL REPORT
In compliance with paragraph 9.6.1 of the Listing Rules, GKN plc has today submitted to the UK Listing Authority two copies of each of the documents listed below:
(a) 2008 Annual Report;
(b) Circular to shareholders incorporating the Notice of the 2009 Annual General Meeting (which will be held at 2.00 pm on Thursday 7 May 2009 at the Cavendish Conference Centre, 22 Duchess Mews, London W1G 9DT); and
(c) Proxy form for the 2009 Annual General Meeting.
Copies of the above documents will be available for inspection at the UK Listing Authority's Document Viewing Facility which is situated at:
Financial Services Authority
25 The North Colonnade
Canary Wharf
London
E14 5HS
The documents are being despatched to shareholders today. The 2008 Annual Report and 2009 AGM Circular are also available on GKN's website at www.gkn.com.
In compliance with paragraph 6.3.5 of the Disclosure and Transparency Rules (DTR), a description of the principal risks and uncertainties, details of related party transactions and a responsibility statement are set out below in full unedited text. A condensed set of financial statements were appended to GKN's 2008 full year results announcement issued on 26 February 2009, which included an indication of important events that occurred during the year.
Page references below refer to page numbers in the Annual Report. References to notes to the financial statements refer to notes in the Annual Report.
RISKS AND UNCERTAINTIES
Set out below are those risks which could have a material impact on the Group's future performance and cause financial results to differ materially from expected and historical performance. Additional risks not currently known or which are currently regarded as immaterial could also adversely affect future performance.
The current global economic recession has magnified existing risks and created new ones. The Group has an extensive risk management structure in place designed to identify and assess the likelihood and consequences of these risks and to manage the actions necessary to mitigate their impact. A detailed description of the Group's procedures to manage risk is given in the corporate governance report on pages 57 and 58.
Financial risk
The Group is exposed to a variety of market related risks, including refinancing risks and the effects of changes in foreign currency exchange rates and interest rates. In the normal course of business, the Group also faces risks that are either non-financial or non-quantifiable, including country and credit risk.
Refinancing risk
Committed revolving credit facilities totalling £350 million mature in July 2010 and all or part of these facilities would normally be refinanced during 2009. The terms of the refinancing, including the time frame, cost and quantum, are expected to be more onerous given the current credit market conditions. This is likely to be further exacerbated by the downgrade of the Group's credit rating to sub-investment grade in January 2009.
Currency risk
The Group has transactional currency exposures arising from sales or purchases by operating subsidiaries in currencies other than the subsidiaries' functional currency, the most significant being the US dollar and the euro. Under the Group's foreign exchange policy, transaction exposures are hedged, once they are known, mainly through the use of forward foreign exchange contracts.
The Group has a significant investment in overseas operations, particularly in continental Europe and the Americas. As a result, the sterling value of the Group's balance sheet can be affected by movements in exchange rates. In prior years, the Group sought to mitigate the effect of these translational currency exposures by matching the net investment in overseas operations with currency borrowings, synthetically created using forward foreign exchange contracts. This policy was suspended at the end of 2008 due to the continuing volatility of foreign currencies against sterling.
Interest rate risk
The Group operates an interest rate policy designed to minimise interest cost and reduce volatility in reported earnings. To achieve this, it maintains a target range of fixed and floating rate debt for discrete annual periods. Interest rates on all debt capital market issues remain at fixed rates whilst the balance of debt is at floating rates. At 31 December 2008, 83% of the Group's gross financial liabilities were at fixed rates of interest, whilst the weighted average period in respect of which interest has been fixed was 7 years.
Credit risk
The Group is exposed to credit-related losses in the event of non-performance by counterparties to financial instruments, which include trade debtors.
Credit risk relating to financial institutions is mitigated by the Group's policy of selecting only counterparties with a strong investment graded long term credit rating, normally at least AA- or equivalent, and assigning financial limits to individual counterparties.
With the concentration of customers noted below, the financial failure of any one of them could have a material impact on performance. Increasing emphasis is placed on the monitoring of credit exposures in the current economic climate, with regular reporting to divisional management and the Executive Committee. In addition, credit terms and overdue debtors are closely monitored and appropriate action taken. At 31 December 2008 the largest individual debtor balance was 0.7% of Group sales. (For further information see note 19 to the financial statements.)
In addition to the inherent specific financial risks and their management referred to above, there are other, more general, financial risks that could have a material adverse effect on the business, its financial condition or results of its operations.
Pension and retiree medical risk
We operate both defined benefit (DB) and defined contribution (DC) pension plans, together with retiree medical and life insurance arrangements. The majority of the DB plans are in the UK, North America and continental Europe. Retiree medical arrangements are limited to North America and the UK, where all schemes are closed. Funded obligation deficits, mostly in the US and UK, increased by £402 million to £435 million at 31 December 2008. Unfunded obligation deficits, primarily in continental Europe, increased by £101 million to £399 million.
Deterioration in asset values, changes to real long term interest rates or the strengthening of longevity assumptions could lead to a further increase in the deficit or give rise to an additional funding requirement. Furthermore, foreign exchange rate volatility can impact pension fund values.
Taxation risk
The Group operates in over 30 countries and as a consequence is subject to many complex tax laws and tax authority audit procedures.
Amounts accrued for tax liabilities are based upon management's judgement taking into account their interpretation of tax law in each country and the likelihood of settlement where there is a tax dispute. Actual tax liabilities could differ from the accruals made by management and the difference would give rise to an adjustment in a subsequent period, which could have a material impact on the Group's income statement and/or cash position.
Market and customer related risk
Global economic and political risk
GKN operates in a number of emerging markets including Asia Pacific and Latin America. Whilst exposed to a wide range of risks including political, regulatory, environmental and socio-economic, it is also in a position to benefit from potentially significant growth opportunities and a diversified business base.
Cyclical nature of markets
Approximately 57% of 2008 sales of subsidiaries were to automotive vehicle manufacturers and 23% for original equipment on aircraft or aircraft components.
The automotive industry, in common with other capital goods industries, is affected by macro-economic conditions and consumer demand and preferences. Economic conditions became extremely challenging in many of the world's economies in 2008. There has been a material deterioration in the number of vehicles manufactured and sold, which is likely to continue throughout 2009 and potentially beyond.
The military aircraft element of our business is affected by political and budgetary considerations, particularly in the US. Civil demand is affected by the number of passenger miles flown and revenue per seat which, in turn, is a function of economic growth, fuel costs, personal spending power and perceived security risk. In the civil aerospace market, the current economic conditions are beginning to impact demand with a further softening anticipated during 2009 and 2010.
The availability of credit to consumers and airlines could impact purchases of vehicles and aircraft with a consequential effect on the level of build rates and orders in all of our businesses.
The Group seeks to mitigate these risks by acting aggressively to reduce its cost base when demand for its products fall, through plant rationalisations, short-time working, Lean manufacturing techniques and other cost base reduction initiatives.
Competitive markets and competition
The Group's markets are very competitive and our ability to compete for contracts depends on the effectiveness of our products and our ability to manage costs and maintain customer relationships.
Customer concentration and relationships
The Group portfolio is built around a broad-based, diversified business across a wide range of geographic, customer and product offerings. The nature of the automotive and aerospace industries does mean, however, that a significant degree of customer concentration exists. Approximately 60% of our sales revenue is from 25 major global customers. The loss of, or damage to, certain of these relationships, particularly in the light of the rapid decline in automotive volumes seen in the latter part of 2008, or a significant worsening of commercial terms with these customers could have a material impact on the Group's results. The Group is not dependent on contractual or other arrangements with any individual customer.
Technological change
The markets for our products and services are characterised by evolutionary change driven by consumer preference for increased safety and environmentally friendly vehicles and aircraft. Many of the Group's products are technologically advanced or use leading edge processes in their manufacture. In order to maintain the competitiveness of our products, we make focused investment in research and development to achieve technological leadership in our key businesses and retain the competitive advantage which this leadership provides.
Acquisitions
The Group has grown both organically and through acquisition. Capturing the value and integrating the operations and people of acquired businesses is a complex process. The Group manages the associated risks by carrying out extensive pre-acquisition due diligence, carefully managing the integration process and carrying out post-acquisition audits.
Manufacturing and operational risk
Manufacturing strategy
Strategies are developed with the objective of manufacturing in the most competitive locations for our customers' requirements. Failure to meet customer requirements upon relocation of production could impact upon both short and longer term customer relationships. We have considerable experience of implementing operational change and a wealth of experience to draw on to minimise this risk. In the current economic climate, the Group is undertaking strenuous efforts to align its cost base through the flexing of variable costs (labour and material) as well as fixed cost reductions to lower our breakeven point.
Product quality and liability
The nature of our products means that we face an inherent risk of product liability claims if failure results in any claim for injury or consequential loss. However, our customers require high levels of quality assurance and manufacturing systems in place to ensure that our quality record is world class in both Automotive and Aerospace. Appropriate levels of insurance are in place covering product liability, although the Group does not generally insure against the cost of product warranty or recall.
Supply chain
The Group's manufacturing processes may have dependencies on the availability of specific equipment and raw materials. An inability to supply because of their non-availability would affect sales and relationships with customers. Active monitoring of the financial viability of our suppliers is undertaken and contingency plans exist, including second sourcing of key materials, to ensure continuity of supply. In most cases this would result in additional costs which may or may not be recoverable. Furthermore, close relationships with our supply base and clear communication of movements in demand help to support continuity of supply. GKN's sales to original equipment manufacturers could also be adversely affected by the failure of other tier one suppliers.
Commodities
The Group has ongoing exposure to the price of a number of commodities, in particular steel, titanium, aluminium, copper, nickel and molybdenum. This exposure is managed by entering into supply contracts to reduce short term volatility of price and supply. In addition, where commodity costs increase, agreements are in place to surcharge customers in order to protect the Group's profitability.
IT systems reliability, security and change
Our IT systems and networks are secured by back-up systems, hardware, virus protection and other measures but any interruption could lead to disruption in service. A breakdown of security or damage arising from any cause could affect our operational performance or revenue.
Management resources
Active management of our people around the world is critical to the success of our business. Training and development initiatives and reward systems are in place to support the recruitment and retention of appropriately qualified and skilled personnel. It is also essential that key technical staff remain in place to support the Group's engineering skill base. Furthermore, as restructuring takes place, we ensure that we do not diminish the overall capability of the Group.
Environmental risk
The environmental laws of various countries and our customers' requirements impose obligations on our businesses to operate in an environmentally friendly way. Failure to do so could result not only in financial consequences but also in damage to our reputation and may impact shareholder value as well as our employees and communities in which we operate. In environmental terms, our manufacturing processes are not inherently high risk, nevertheless, great care is taken to prevent any adverse impact arising. Further details of how this is managed are given on pages 46 and 48.
RELATED PARTY TRANSACTIONS
In the ordinary course of business, sales and purchases of goods take place between subsidiaries and joint venture companies priced on an 'arm's length' basis. Sales of product by subsidiaries to joint ventures in 2008 totalled £74 million (2007 - £70 million). The amount due at the year end in respect of such sales was £11 million (2007 - £8 million) (see note 16). Purchases by subsidiaries from joint ventures in 2008 totalled £11 million (2007 - £10 million). The amount due at the year end in respect of such purchases was £3 million (2007 - £2 million) (see note 17).
At 31 December 2008 a Group subsidiary had nil receivable (2007 - £2 million receivable) from a joint venture in respect of a short term financing facility bearing interest at LIBOR plus 1% (see note 16).
DIRECTORS' RESPONSIBILITY STATEMENT
The Annual Report contains a responsibility statement in compliance with DTR 4.1.12 signed on behalf of the Board by Roy Brown, Chairman. This states that on 25 February 2009, the date of approval of the Annual Report, the Directors (whose names and functions are listed below) confirm that to the best of their knowledge:
the Group financial statements, prepared in accordance with International Financial Reporting Standards 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 to be included in the consolidation taken as a whole; and
the management report (which comprises the Directors' report and the business review) 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.
Directors
Roy Brown, Chairman
Sir Kevin Smith, Chief Executive
William Seeger, Jr, Finance Director
Marcus Bryson, Chief Executive Aerospace
Andrew Reynolds Smith, Chief Executive Powder Metallurgy, OffHighway and Industrial Services
Nigel Stein, Chief Executive Automotive
Helmut Mamsch, non-executive Director
Sir Christopher Meyer, non-executive Director
Richard Parry-Jones, non-executive Director
John Sheldrick, non-executive Director
Sir Peter Williams, non-executive Director
G Denham
Company Secretary
27 March 2009
CAUTIONARY STATEMENT
This announcement contains forward looking statements which were made in good faith based on information available at 25 February 2009, being the date of approval of the 2008 Annual Report. It is believed that the expectations reflected in these statements are reasonable but they may be affected by a number of risks and uncertainties that are inherent in any forward looking statement which could cause actual results to differ materially from those currently anticipated.
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