Opportunities and Risks Report

As an organisation that operates throughout the world, the KSB Group is exposed to macroeconomic, sector-typical, financial and company-specific risks. The risk policy is designed to enable KSB to grow sustainably and profitably. The KSB Group aims to reduce the risks associated with its business and where possible avoid them completely. At the same time its global alignment and extensive product range offer a wealth of opportunities. This includes but is not limited to any opportunities that arise on the basis of research and development activities, as well as any that are linked to the quality and cost effectiveness of products. KSB’s competitive position is also being strengthened by optimising the global sales and production network. KSB always reviews opportunities to expand its global presence and is able to achieve this through start-ups and acquisition projects.

The Group sees opportunities and risks as possible future developments or events that may lead to departures from forecast or targets. The departure can be both positive and negative. In order to manage the varied opportunities and risks professionally and efficiently, the Group aligns its actions accordingly and focuses upon the respective situation when selecting the persons responsible. In doing so, Controlling, Finance and Accounting as well as Internal Audits perform important monitoring tasks.

RISK MANAGEMENT SYSTEM

KSB has implemented a Group-wide risk management system for identifying and assessing relevant risks and reporting these to Group headquarters. The risk management process of the KSB Group consists of the successive phases of identification, assessment, management, control, documentation and communication of risks. The six phases form a continuous and IT-based closed-loop system. This is documented in KSB’s risk management manual as well as the management responsibility and the description of all relevant tasks.

Managers are encouraged to take timely action to define and implement measures to limit or avoid damage that may result from the occurrence of risk events. All corporate and central functions and Group companies, including Group companies that are not consolidated, are included in the risk management system. The responsible managers are required to supply their relevant key business and financial indicators each month. As well as creating quarterly forecasts on business trends, they also twice a year report the recognised risks for the next 24 months from the reporting date for the categories of market and competitive risks, technological risks, project- and product-related risks, financial risks and procurement risks. Other business risks (environmental, human resources, etc.) are also reported in this cycle to the Risk Managers at the Group headquarters. A distinction is made between qualitative risks and quantitative risks, not considering any action that has been taken or planned:

Qualitative risks are long-term developments that could have a negative impact on the KSB Group and which cannot or cannot yet be thoroughly quantified due to a lack of precise information. In order to be able to evaluate them all the same, however, estimates of the probability of occurrence and scope are made using defined evaluation categories. With respect to probability of occurrence, the extent to which the information indicating the potential risk is detailed must be determined.

Quantitative risks are those risks with possible monetary impact on the earnings of the KSB Group or the respective Group company. They are evaluated taking into account the specifically calculated probability of occurrence in combination with the potential amount of loss.

The scope or amount of loss describes the potential influence of the individual risk on the redefined key indicator of earnings before finance income / expense and income tax (EBIT) of the KSB Group or the respective Group company, not considering any action that has been taken or planned.

In order to assess whether qualitative and quantitative individual risks are material for KSB, they are classified as acceptable, neutral or significant risks. All individual risks categorised as neutral or significant that are detailed in the “Individually assessed opportunities and risks” section are considered to be material for the KSB Group. The relevant classification can be determined from the matrices below:

Qualitative risks

Quantitative risks

Evaluation of the amount of loss at KSB is based on just three possible classifications: low, medium and high. The following criteria apply:

Classification of amount of loss
Amount of loss in € thousands
Magnitude Sales revenue Low Medium High
Small companies Up to € 20 million 50 – 125 125 – 250 > 250
Medium-sized companies € 20 to € 80 million 75 – 250 250 – 500 > 500
Large companies, holding companies, organisational units From € 80 million 100 – 500 500 – 1.000 >1.000

This approach offers the necessary transparency to identify risks in their entirety and to manage them effectively, professionally and in an economically responsible manner.

The bodies to which specific responsibilities and competencies were assigned in KSB’s risk management system in the reporting year are shown and explained in the diagram below.

Risk management at KSB

As the legal representative, KSB Management SE assumes overall responsibility for risk management. KSB Management SE reports to the Supervisory Board of KSE SE & Co. KGaA via its Managing Directors during regular Audit Committee meetings and is monitored by the latter. The Managing Directors are supported by the Chief Compliance Officer and the Group Finance and Accounting department of KSB SE & Co. KGaA. The latter coordinates the risk management process at Group level and investigates all reported risks to determine whether they are relevant for the financial statements. This ensures that there is a systematic link with the Group accounting process. The Managing Directors and the Supervisory Board’s Audit Committee receive at least two risk reports per financial year. These reports include all the risks that are categorised as significant or neutral that exceed pre-defined threshold values individually or collectively, not considering any action that has been taken or planned (gross risk). Particularly critical topics are reported on an ad-hoc basis by the managers in charge. In contrast, opportunities are not taken into account in KSB’s current risk management system. They are reported separately by segment managers and regional managers purely in qualitative terms, without further quantification.

With regard to financial risks KSB makes use of additional risk identification, assessment, management and communication. The central Finance department is responsible for this task which is described in further detail later in this section.

Compliance risks are dealt with by the Chief Compliance Officer, who is assigned to the Legal and Compliance, Patents and Trademarks staff function. The Chief Compliance Officer is supported by the members of the Compliance Committee and the Compliance Managers of the individual companies.

The Internal Audits department is integrated into the risk management system as part of the internal control system. When planning audits, it prioritises areas according to potential risks and is provided with all the necessary information. The auditors ensure that all audited units adhere to the applicable guidelines, actively participate in the risk management system, and control or avoid their risks. Information obtained by Internal Audits on both the identified risks and the countermeasures initiated in response forms an integral part of the reporting to the Managing Directors and to the Audit Committee of the Supervisory Board.

The risk management system is regularly reviewed and promptly updated where necessary, for example, in the event of relevant legal or organisational changes. In addition, the auditors examine within the scope of the annual audit the early risk detection system, establishing that it is present and checking that it is fit for purpose.

INTERNAL CONTROL SYSTEM AND RISK MANAGEMENT SYSTEM WITH REGARD TO THE GROUP ACCOUNTING PROCESS

The accounting-related internal control system (ICS) contributes towards ensuring proper financial reporting. The aim is to ensure that the consolidated financial statements and group management report comply with all relevant regulations. Key elements of the ICS are – as well as the risk management system described above – guidelines and regulations, which include standard accounting and measurement policies. They must be applied to the full extent by all Group companies. There is a separation of functions and the four-eye principle is applied. This is ensured by the audits carried out by the Internal Audits department.

In addition, the Accounting department carries out regular analytical plausibility checks using time series analyses and actual / budget variance analyses. This enables KSB to identify significant changes early on, which are examined for accounting and measurement discrepancies. The resulting findings are then discussed at management level.

The responsibility for Group accounting lies with the employees in the central Accounting KSB Group department. KSB employs the services of qualified external reviewers for certain calculations as part of financial reporting (such as the calculation of complex pension obligations using actuarial assumptions).

Binding schedules and guidelines apply to accounting within the KSB Group and to accounting at each individual subsidiary. The accounting and measurement methods that must be applied to compile the consolidated financial statements are defined in writing in a manual that is updated and revised on a continual basis. This also includes the guidelines for posting intra-group transactions. New accounting principles and other official announcements are continually analysed with regard to their relevance and impact on the consolidated financial statements. Guidelines and manual are adapted where necessary and any changes communicated immediately to the companies. Accounting KSB Group monitors compliance with these regulations. This reduces the risk of compiling inappropriate financial statements or failing to publish them by the defined deadlines.

The financial statement information for all Group companies is automatically processed using certified and tested standard consolidation software. Systematic checks are implemented to help validate the data. Employees in Accounting KSB Group verify any warning signals that arise before using the data. The sequence of the processing steps is strictly specified through the use of the consolidation monitor within the IT system. This ensures the correct processing of data.

To enable a seamless and accurate accounting process, only employees who have the appropriate specialist know-how are assigned to this task. These employees are trained on a regular basis to make sure that their expert knowledge remains up to date. Since the year under review, the process is also supported by a harmonised chart of accounts used throughout the Group.

Access authorisations have been defined for the accounting-related IT system. This protects the data against unauthorised access as well as improper usage and modification. The data is checked at many stages, helping to ensure the processing quality. Alongside regular system reviews by the auditors, these checks contribute to limiting operational risks.

INDIVIDUALLY ASSESSED OPPORTUNITIES AND RISKS

The categories presented below include the gross risks classified as significant or neutral and the main opportunities for business development as at 31 December 2018. Where risks are not designated as significant, they were classified as neutral risks.

Markets / Competition

Risks

The business opportunities of KSB are again affected by changes in the economic and political environments in the current reporting year. The Group manages the risk of fluctuations in the economy and in demand by remaining active in several markets and industries with different economic cycles. Furthermore KSB is monitoring the development of the economic environment for its markets. If necessary, capacities are adjusted, production facilities relocated and cost-cutting measures implemented.

Asia remains the most important sales market for power plant equipment, including pumps and valves. The competitive situation in China has not eased by comparison with the previous year. The associated increased pressure on prices thus also constitutes a “significant” risk in the current financial year. Political decisions too, such as the postponement or even abandonment of energy projects in several Chinese provinces, have impacted negatively on business performance. In order to tap into the Asian market more widely, KSB agreed a strategic alliance with a long-term partner, the Chinese SEC Group, in late 2015. This aims at closer cooperation so that KSB can achieve success in Asian power plant projects outside of China.

The risk from the political situation in various parts of this world, however, regained in significance year on year. Most important in this context is the development of relations between the United States and Iran. Due to the US sanctions against Iran, there are no opportunities to continue ongoing projects in Iran. Consequently, there is a risk that the costs already incurred on local projects have to be borne without consideration. The protectionist tariff policy of the United States also weighs on business due to the associated global decline in demand. The worsening of the conflict in the Middle East, especially in Saudi Arabia, Qatar, Iran and Israel, as well as the development of the political situation in Turkey, may have a negative impact on business. In addition, the East / West relations that are under considerable strain given the political differences between Russia and the USA, and between Russia and most European countries, continue to be significant. This also becomes apparent in the Russian government’s import substitution programme. Russian companies are to increasingly order products that have been made in Russia or involve a high proportion of local value added. The KSB company in Moscow has prepared for this development, setting up a local assembly site for industrial and water engineering pumps in leased premises. Additionally, KSB completed the establishment of its own production site, which is due to start operating in 2019.

The departure of the United Kingdom from the European Union harbours risks both for the local sales and service company and for the other units with business partners in the United Kingdom. In general, there is still uncertainty about the future provisions; however, delays in goods trade, for example, may result from increased border checks. In total, the United Kingdom accounts for 1.2 % of sales revenue in the Group.

Opportunities

Major contracts for infrastructure development projects are to be awarded in the two Asian growth countries China and India in 2019. Due to KSB’s strong presence in these countries, there is a good chance that it will be involved as a supplier of pumps, valves and services. The expansion of nuclear energy continues in China and India, for which local plant engineering contractors require high-safety pumps and valves. In addition, owing to targeted activities in the service market KSB expects to be able to sell more services and spare parts in China, in particular.

By broadening its portfolio of pumps to API  specifications the KSB Group has steadily improved its position in the oil processing industry since 2016. Here, the order situation is expected to improve over 2018.

From 2020, new regulations of the International Maritime Organisation IMO will apply. According to this specialised UN agency, all ships on the high seas will have to use fuel with a substantially lower sulphur content to reduce air pollution from ships worldwide. Refineries will invest in the technology for processes to produce this fuel. This should increase demand for refinery pumps. Moreover, ships which continue to use fuel with a high sulphur content will be retrofitted with exhaust gas cleaning systems. This would have a correspondingly positive impact on order intake.

Projects / Products

Risks

The markets’ requirements for the products of the KSB Group are constantly changing. The Group will only succeed if it meets its delivery deadlines and offers technically advanced products in good quality at affordable prices. To minimise the risk of delivery delays, which can lead to an adverse effect on KSB’s reputation with customers and also result in financial penalties, it constantly monitors its sales and manufacturing operations. If it discovers that machinery needs to be renewed or capacities expanded, these investment projects are examined as part of a step-by-step approval process. By doing this, KSB counters the risk of schedule and cost overruns that is rated as “significant”.

Regular market analysis and monitoring minimise the risk that products will become technically obsolete or are offered at prices not acceptable in the market. At the same time, KSB is exposed to the risk posed by cheap products from Eastern Europe and Asia that compete with KSB’s portfolio. This calls for continuous quality management, which has been introduced across the Group.

In KSB’s business, there are special requirements when it comes to the processing of large-scale projects with long contract terms. There are also always associated risks. There may be cost overruns, tighter import regulations, staff shortages, technical difficulties or quality problems – including possible contractual penalties – that reduce margins. KSB therefore trains its employees in project management and equips them with specialist knowledge. This enables them to identify the risks associated with longer-term orders at an early stage. In addition, project managers are provided with appropriate management tools. Decisions are made in conjunction with clearly structured authorisation processes.

There are also technical and financial risks to orders with newly designed products. Technical risks are limited to the extent that intermediate steps for development work are defined and partial solutions are subjected to assessments. This also applies to pumps that are to be provided within the framework of a major contract running over a number of years for the construction of a new type of power plant in China. Commercial risks are minimised by using appropriate contractual clauses. Care is taken to ensure that advance payments usually cover the costs incurred. Suitable provisions are set aside for warranty obligations and contractual penalty risks. These amounted to € 46 million in the consolidated financial statements for 2018 compared with € 51 million in the previous year; beyond this KSB sees no other major residual risk (net risk).

Opportunities

Submersible borehole pumps, like those required in well fields, in mining and on drilling platforms, are increasingly used in higher performance ranges. Accordingly, KSB has extended the portfolio to include pumps which – with drive ratings up to 5 MW – deliver flow rates of up to 5,000 m³ per hour. For heads up to 1,500 m KSB, as one of only two producers worldwide, has also been offering double-entry submersible borehole pumps since 2018, which offer relatively greater protection against failure. This competitive edge improves KSB’s position as a supplier for major, technically sophisticated projects.

At the ACHEMA 2018 industry fair KSB presented new digital products that are used for service activities. They include use of a control system that records status data of pumps in a system. It indicates to the customer – or alternatively, KSB directly – when servicing is required. When the system is commissioned or on-site repairs are carried out, KSB is able to provide local specialist personnel with direct and appropriate support using Augmented Reality Service  technology without specialists having to travel to the site. This saves the customer time and expense. These and other innovative services enable the KSB Group to consolidate its market position and to improve order opportunities.

Finance / Liquidity

Risks

As a group with global operations, KSB is exposed to a wide variety of currency risks. This significant risk is countered with foreign exchange hedges. However, the global manufacturing network also offers the opportunity to benefit from currency effects and to use these where appropriate in competition with other manufacturers. In addition to uncertainties regarding exchange rates, interest rate developments on the capital markets play a role. In material individual cases in the past KSB countered the interest rate risk involved in bank loans subject to variable interest rates by hedging future interest payment flows accordingly. In the current financial year KSB saw no need for such hedging.

Alongside the euro, the most important currencies for the KSB Group are the US dollar, the Indian rupee, the Brazilian real and the Chinese yuan. If the exchange rate differs from the assumptions made, this would have positive or negative effects on business volumes and earnings. A strict receivables management system and the use of trade credit insurance helps KSB avoid situations where receivables cannot be collected from customers.

Risks regarding margins and liquidity are typical of the project business. As well as the continued pressure on selling prices, which is reducing profit margins, these include unfavourable contract conditions such as reduced advances and tougher contractual penalties. As KSB complies exactly with the approval processes in the quotation phase, this risk is minimised. At the same time, this enables KSB to recognise and avoid liquidity shortages. Where necessary, sufficient liquidity is secured by agreeing appropriate credit lines early on.

Persistent recessions or newly emerging crisis may adversely affect the financial situation of customers. Resulting delays in payment and bad debts which were rated as “significant” in the financial year would weigh on the results of operations. The same effect might occur if the foreign exchange regulations become stricter for individual countries. KSB counters this by means of a strict receivables management system and intensive customer contacts.

Changing market conditions mean that business models need to be fundamentally reviewed and the product range adjusted accordingly time and again. A further potential consequence of market developments that exert a permanent strain is an impairment loss on goodwill and assets. If impairment testing in accordance with IAS 36 shows a need for impairment, KSB recognises a corresponding expense in the financial year. There is also a residual risk with regard to the development of premises that cannot be controlled and on which the earnings are based. In the current financial year an impairment loss of € 20.6 million was incurred in respect of goodwill of the South Korean company KSB Seil Co., Ltd. Based on current estimates, a residual risk of € 0.8 million remains for the future. For other companies with goodwill we have taken into account the risk assessment through sensitivity analyses to estimate the risk of impairment. Further information can be found in the Notes to the consolidated financial statements in Section IV. Balance Sheet Disclosures under “Intangible assets”.

As regards tax matters, the global orientation of the activities of the KSB Group must be taken into consideration. Based on its operative activities in numerous countries with varying tax laws and administrative interpretation, differentiated assessment is required for measuring tax obligations. Uncertainty may arise due to different interpretations by taxable entities on the one hand and local finance authorities on the other. These may come to light during audits. By cooperating closely with external local tax specialists, KSB counteracts the risk of having to pay back taxes. As KSB continually monitors unclear issues, it can generally classify the probability of occurrence. Should a need for subsequent payment arise, the corresponding provisions are created in good time. In the 2018 consolidated financial statements, like in the previous year, we did not set aside any provisions for circumstances that are classified as a significant or neutral risk. In addition, there are contingent liabilities in the expected amount of € 1.5 million (previous year: € 1.6 million).

Concentration on a small number of customers entails dependencies which, in the event of the loss of a customer, could result in a material slump in order intake and sales revenue and thus to a burden on earnings for some French service companies. The pressure which individual customers can exert on the company in these cases rises and may result in increasing concessions having to be made by the supplier. If individual Group entities find themselves in such a situation, losses are in part offset by their parent company. If the situation continues, KSB will consider reorganisation measures or a review of the business model of the company in question.

Procurement

Risks

Commodity prices and procurement times are subject to strong market-related fluctuations. This may adversely affect KSB’s earnings situation if it does not manage to make up for cost increases or pass them onto its customers. Delays or bottlenecks in the supply chain for raw materials and components may negatively impact KSB’s business operations. If KSB does not benefit promptly from declining procurement prices, the persistent pressure on the selling price of products would have a negative impact on earnings.

In the context of the procurement strategy, KSB is also careful to avoid becoming dependent on individual suppliers and thereby counteract the risk of a supplier default. If local conditions mean that it is impossible to ensure sufficient diversification in this regard, KSB will make use of additional foreign business partners. In selected cases, external expertise is integrated into our company, not least to make the best possible use of capacity.

Opportunities

KSB reorganised global purchasing and continued to improve processes to increase the efficiency of work in this area in 2018. This also applies to the increased number of online measures through which KSB makes a global comparison of purchasing terms and conditions for goods and services with little investment. The Group will benefit from these measures in the current year.

The changes support the competitiveness of KSB and also provide the foundation for the successful digitalisation of purchasing. In this way KSB secures the opportunities for having permanent access to the best suppliers. It also enhances its appeal to talented buyers who help achieve KSB’s corporate goals.

Technology / Research and Development

Risks

It is essential to future success to have a product and service range that is suited to the market in terms of technology, price and delivery time. The changing needs of customers and new standards and regulations – especially in promising markets such as China – require the continuous development and improvement of products and services. Research and development required for adjustments consumes significant financial and human resources, with no guarantee of success in either the medium or the long term.

To avoid any negative impact on earnings, it is important to recognise the market-related or technical risks early on. To this end, the KSB Group is constantly updating the development process, which incorporates various control levels. As sales employees are regularly included in this process, risks arising from changes in markets or applications can be taken into account in good time in the evaluation.

Opportunities

In the Business Innovation Lab KSB works in interdisciplinary teams to explore new business models on the basis of digital technologies. By including plant-based data KSB is able to offer its customers solutions to make their liquid transport methods more secure and more efficient while ensuring a higher level of transparency of their processes. Several of these models are currently undergoing testing for functionality and marketability. They are applied in line with the business opportunities they offer.

Through the digital transformation approach there is a greater focus on the permanent external monitoring and communication of systems. Sensors and communications modules are becoming an integral part of this new type of system. The new cloud-based system for continuous pump monitoring enables customers to order support services before problems materialise, which ultimately benefits KSB’s business. The Group is also investigating approaches for self-learning monitoring software, the electronic change of fixed speeds – as an alternative to mechanical adjustments – as well as the miniaturisation of power electronics and its integration in the motor.

A particular focus of development activity in past years has been on pumps for the oil and gas industry which are in compliance with the API standard. The programme launched in 2016 was continued in the year under review and the portfolio expanded to include further sizes and additional versions, which increases the likelihood of order successes.

Other business-specific risks – Environment

Risiks

KSB’s business activities, primarily in the area of production, are subject to numerous environmental protection laws and regulations. Environmental damage of any kind (for example, groundwater contamination, renovation needed due to outdated construction materials or unpleasant odours arising from the use of chemicals) may result in losses not covered by an insurance policy. Therefore, at all company sites officers monitor compliance with laws and regulations as well as with internal KSB rules. If KSB discovers any contamination, it sets aside provisions to meet the liabilities for the necessary clean- up work. In the 2018 consolidated financial statements, these amounted to just under € 0.2 million for significant or neutral risks, as in the previous year.

As part of acquisition projects, KSB examines properties for possible contamination before purchase. Critical issues are taken into account by way of corresponding contractual regulations with the seller and appropriate measures are implemented in consultation with the seller.

In markets where environmental regulations are becoming more stringent, there is a risk that KSB products and own or purchased services may cause infringements that lead to KSB losing its market authorisation and which damage KSB’s reputation. A change in rules on liability in environmental protection can also increase the risks for business success. As a member of national and international professional associations the KSB Group becomes aware of imminent changes in environmental law early on. The legal frameworks that are in place in its Operational Units are continually updated, enabling KSB to ensure that its employees always abide by the applicable law. This is also monitored by external auditors as part of the management certifications.

Opportunities

At KSB, environmental management is combined with an active and forward-looking approach as well as internal processes that enable permanent cost reductions. This applies, for instance, to all measures that reduce energy consumption in production, service and in the administrative areas. Inversely, the KSB Group offers the users of its products the opportunity to reduce their electricity costs by selecting energy-efficient KSB products.

Hazards to people and nature may emanate from the production and processing methods of manufacturing companies. The global environmental management system helps identify these risks early on and initiate protective measures in good time. KSB thereby not only prevents pollution, but also its financial consequences.

Drawing on a functioning and certified environmental management system, KSB fulfils a requirement of numerous public-sector customers, large companies and entire industries such as the automotive sector. For them, evidence of an environmental management system is an increasingly important criterion in the selection of suppliers. By having its production and service plants checked by auditors and certified to international standards, the KSB Group and its customers are both assured that KSB companies respect the environment. KSB’s commitment to the UN Global Compact  also meets the expectations of its customers and improves order opportunities with companies that pick their suppliers with a view to their responsibility for the environment and society, among other things.

Other business-specific risks – Human resources, legal aspects and IT

Risks

To achieve its growth and profitability business objectives, KSB needs qualified employees at all locations, including technical specialists. Due to the demographic change in some countries, the competition for these and other highly skilled professionals is increasing, and will intensify in the course of the economic recovery. KSB counters this risk with demand-oriented measures, systematic human resources planning and international recruitment processes.

Changing market conditions can have a negative impact on the funded status of pension obligations. Strong fluctuations in the evaluation of capital market interest rates to be paid may have a considerable impact on the Group’s earnings and the equity carried on the balance sheet. Alternative models are validated to mitigate this risk.

Changes to our processes and organisational structure, such as the introduction of shared services centres, require clearly defined project responsibilities and valid project plans, as well as the selection of suitably qualified external partners. This helps to avoid teething troubles when changes are introduced to structures and processes, as such problems could impact on the expected cost benefits.

Other potential risks associated with the activities of KSB’s employees include dishonest conduct or violations of laws, which could damage the image of KSB. The KSB Group counters these risks and safeguards its reputation among customers by organising regular compliance training and through individual initiatives in critical regions.

Legal disputes cannot always be avoided within the framework of business activities. These are usually disputes arising from operations, generally involving unclear warranty issues. If as a result of these issues KSB expects negative effects on the success of its business, corresponding provisions are set aside, which cover not only the anticipated amount of loss, but also the costs of proceedings. To rule out a net risk, the 2018 consolidated financial statements include about € 2 million (previous year: € 1 million) for those cases classified as significant or neutral risks. Provisions for litigation with authorities and for staff matters have been created in the amount of just under € 2 million overall (previous year: € 3 million) to cover any cases classified as significant or neutral within the risk assessment methodology. Overall, the risk from legal disputes in the financial year is rated to be significant.

Government decisions, such as cost sharing for projects to expand infrastructure in the vicinity of KSB properties, may also adversely affect KSB’s earnings.

The manipulation and loss of electronic data can lead to serious commercial disadvantages. KSB limits this risk by means of adequate security systems and access procedures. An increased centralisation of the IT systems of the various operating units assists KSB in this. In this way, high security standards are implemented and the risk of data loss or corruption is reduced.

KSB seeks to counter increased external fraud activities by raising awareness of fraud attempts. At the same time, KSB is increasing its compliance requirements.

Opportunities

2018 saw the launch of a programme designed to enhance KSB’s appeal as an employer and improving the opportunities for identifying and retaining the right employees for forward-looking positions. This applies, for example, to young talent to help shape the Group’s digital transformation. Target group-appropriate recruitment processes were developed for these and other specialists, at times departing from the traditional avenues of personnel recruitment.

Moreover, the introduction of a global HR management system is being prepared, which will form the basis of strategic human resources planning. The improved transparency of employee-related data will enable KSB to deploy people in an optimum way, taking into account their individual knowledge and skills, and to open new career opportunities for them, including in other countries.

IMPORTANT OPPORTUNITIES AND RISKS BY SEGMENT

As in the previous year, the opportunities and risks for the Pumps, Valves and Service segments are most influenced by economic development. The future development of China remains important to KSB. A material factor for Pumps and Valves, and to a lesser extent for Service, continues to lie in the uncertainties regarding the political risk, which have increased in some countries compared with the previous year. Political decisions in China regarding energy projects and the East / West relations, which remain under considerable strain, and as of this year also the relations between the United States and Iran, constitute material risks for the business of the KSB Group. KSB adjusted its strategy accordingly and discontinued its business with Iran. Nevertheless, a risk remains with regard to projects started and the associated outstanding payments. Worsening payment morale also bears corresponding risk potential for future business. As regards the economic development, the risk assessment compared with the previous year has changed in that the conflict in the Middle East could lead to an oil crisis and is thus a significant risk for the KSB Group. The economic development in general continues to be the most significant risk due to the difficulty of assessability. By contrast, the KSB Group continues to hope that the measures intended to foster growth will provide it with considerable support in achieving its goals. KSB’s customers are also often affected by recessions and more intense competition, which can decrease their ability to pay in individual cases.

Negative currency changes in growth countries could threaten exports, in particular those from KSB’s European plants. But this would also enable the production facilities in the countries affected to benefit from such developments and to increase their export volumes.

The scope of opportunities has not changed materially since the previous year.

RISK REPORT ON THE UTILISATION OF FINANCIAL INSTRUMENTS

Central financial management in the KSB Group performs its duties within the framework of the guidelines laid down by KSB Management SE as the legal representative. The KSB Group bases the nature and scope of all financial transactions exclusively on the requirements of its business. It does not lend itself to business of a speculative nature. The aim is to ensure liquidity at all times and to finance activities under optimal conditions. With respect to the export business, foreign exchange and credit risks are hedged to the greatest extent possible. KSB continuously improves its receivables management methods with the goal of settling outstanding amounts by their due dates.

KSB is exposed to the following financial risks as a consequence of its business activities:

On the one hand, KSB is exposed to credit risk, which is defined as potential default or delays in the receipt of contractually agreed payments. It is also exposed to liquidity risk, which is the risk that an entity will be unable to meet its financial obligations, or will be unable to meet them in full. In addition, KSB is exposed to market price risk. Exchange rate or interest rate changes may adversely affect the economic position of the Group. Risks from fluctuations in the prices of financial instruments are not material.

Foreign exchange hedges are used to reduce the risks from transactions involving different currencies. These are generally currency forwards, which KSB uses both for transactions that have already been recognised and for future cash flows from orders still to be processed. At year end, the notional volume of currency forwards used to hedge exchange rate risks was € 238.3 million (previous year: € 276.5 million). Foreign currency items denominated in US dollars account for the major volume hedged by forwards. By strengthening its production sites worldwide, KSB can make use of “natural” currency hedging in currency markets that continue to be volatile.

To minimise interest rate risks, interest rate swaps are concluded in material individual cases to hedge cash flows from underlyings. No hedging via interest rate swaps took place in the current financial year.

All these risks are limited through an appropriate risk management system, defining how these risks are addressed through guidelines and work instructions. In addition, the current risk characteristics are continuously monitored and the information obtained in this way is provided to the Managing Directors and the Supervisory Board in the form of standardised reports and individual analyses.

For more information on the three risk areas and the impact on the balance sheet, see the Notes, Section VI. Additional Disclosures on Financial Instruments.

OVERALL ASSESSMENT OF OPPORTUNITIES AND RISKS

The opportunities and risks for the KSB Group are mainly derived from macroeconomic influencing factors and their effects on the global mechanical engineering markets and the competition.

The overall risk situation as at the reporting date of 31 December 2018 tightened compared with the previous year. This is due to the political developments described in the risk situation by segment and their impact on the markets. Moreover, geopolitical instabilities, decisions on sanctions and volatile currencies had a negative impact on business volume and on planned earnings. Overall, KSB expects an economic performance in line with the IMF forecast for next year.

In this environment, the KSB Group continues to rely on its ability to match capacities and resources to the changing market conditions. A solid financial position and an efficient cost structure are vital in order to maintain long-term competitiveness. KSB is convinced that it can continue to successfully overcome the risks arising from the above-mentioned challenges.

The scope of opportunities has not changed materially since the previous year.

The risk management system in place as well as the related organisational measures allow KSB Management SE as the legal representative to identify risks in a timely manner and to take adequate measures. In view of the somewhat uncertain situation, the focus of activities in 2019 will continue to be on the management of market risks. The legal representative states that, based on the risk management system established by the KSB Group, at present there are no risks that threaten business continuity and could lead to a lasting and material impact on the net assets, financial position and results of the KSB Group.

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