Annual Report 2016
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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. Our risk policy is designed to enable us to grow sustainably and profitably. We aim to reduce the risks associated with our business and where possible avoid them completely. At the same time our global alignment and our extensive product range offer a wealth of opportunities. This includes in particular any opportunities that arise on the basis of our research and development activities, as well as any that are linked to the quality and cost effectiveness of our products. Our competitive position is also being strengthened by optimising our global sales and production network. We always review opportunities to expand our global presence and are able to achieve this through start-ups and acquisition projects.

We see opportunities and risks as possible future developments or events that may lead to forecast or target deviation. The deviation can be both positive and negative. In order to manage the varied opportunities and risks professionally and efficiently, we align our actions accordingly and focus 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 our 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. We classify risks as qualitative and quantitative risks:

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 still be able to evaluate them, however, we make estimates of the probability of occurrence and scope. With respect to probability of occurrence, the extent to which the information indicating the potential risk is detailed must be determined. The scope describes the potential influence of the individual risk on the earnings before interest and taxes (EBIT) of the KSB Group or the respective Group company.

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 probability of occurrence in combination with the potential amount of loss.

In order to assess whether qualitative and quantitative individual risks are significant for us, we classify them as acceptable, neutral or significant risks. We consider as material for the KSB Group all individual risks categorised as neutral or significant that are detailed in the “Individually assessed opportunities and risks” section. The relevant classification can be determined from the matrices below:

QUALITATIVE RISKS

QUANTITATIVE RISKS

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

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 gives us 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 have been assigned in KSB’s risk management system are shown and explained in the figure below.

The overall responsibility for risk management lies with the Board of Management of KSB AG. It reports to the Supervisory Board during regular Audit Committee meetings and is monitored by the latter. The Board of Management is supported by the Chief Compliance Officer and the Group Finance and Accounting department. 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. It ensures that there is a systematic link with the Group accounting process. The Board of Management 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. Particularly critical topics are reported on an ad-hoc basis by the managers in charge. In contrast, opportunities are not taken into account in this system, but are examined separately in consultation with segment managers and regional managers.

With regard to financial risks we also make 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.

Risk Management at KSB

The Internal Audits department is integrated into the risk management system as part of our 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 recognised risks and the countermeasures introduced in response forms an integral part of the reporting to the Board of Management and the Audit Committee of the Supervisory Board.

Our risk management system is regularly reviewed and promptly updated where necessary, for example, in the event of relevant legal or organisational changes. In addition, our auditor examines 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 our Group companies. Functional separation and the principle of dual control are observed; this is ensured by the audits carried out by our 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 us to identify significant changes early on, which we then examine 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. We employ 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 methods that must be applied to compile the consolidated financial statements are defined in writing in a manual that we update and revise on a continual basis. This also includes the guidelines for posting intra-group transactions. We continually analyse new accounting principles and other official announcements with regard to their relevance and impact on the consolidated financial statements. We adapt our guidelines and manual where necessary and communicate any changes immediately to our companies. Accounting KSB Group monitors compliance with these regulations. This enables us to reduce the risk of compiling inappropriate financial statements or failing to publish them by the defined deadlines.

We automatically process the financial statement information for all Group companies using certified and tested standard consolidation software. Systematic checks are implemented to help us 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 our IT system. This ensures the correct processing of data.

To enable a seamless and accurate accounting process, we only assign employees to this task who have the appropriate specialist know-how. These employees are trained on a regular basis to make sure that their expert knowledge remains up to date.

We have defined access authorisations 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 – unless stipulated otherwise – include the qualitative and quantitative gross risks classified as significant or neutral and the main opportunities for our business development. The main influencing factor remains the economic development. All other opportunities and risks are assessed as secondary.

Markets / Competition

Risks

Our business and the opportunities available to us are affected by changes in the economic and political environments. The key economic factors, once again in the current year, include oil prices, which have yet to reach a satisfactory level despite climbing in 2016. In the absence of a continued recovery, the oil-producing countries’ financial strength would be hampered and with it their options for new investments. We counter this risk, which is classed as “significant” by intensifying our contacts with companies and institutions that are making purchases within the means available to them. In this way we aim to limit the negative impact on our business.

There is still the risk of falling demand in the petrochemical industry in China, which would impair order intake for our pumps and valves. We are responding to this risk by monitoring our orders on hand and by offering the available products for other fields of application.

The political situation in various parts of the world remains critical, not least the general situation in Turkey and Ukraine. The destabilisation of Syria, Libya, Yemen and Iraq following internal and external conflicts is having an impact beyond national borders, affecting these countries’ neighbours too. Both private companies and government institutions are very reticent with regard to investment in new plant. It is possible that the conflicts could spread further, which would place additional constraints on our business opportunities in this region.

Given the political differences between Russia and the USA, and between Russia and most European countries, East / West relations remain very strained. This is also evident from economic life, with Russian companies increasingly ordering products that have been made in Russia or involve a high proportion of local value added. Our KSB company in Moscow has reacted to this development, setting up a local assembly site in leased premises for industrial and water engineering pumps. Additionally, we are also planning to establish our own production site.

In South Africa, political tensions in conjunction with economic shortcomings are hampering progress. This is affecting the business prospects of our local production and sales company. Consequently, it is intensifying its sales activities in other countries in southern Africa, primarily Zambia.

We manage the risk of fluctuations in the economy and in demand by remaining active in several market sectors and industries with different economic cycles. Furthermore we are monitoring the development of the economic environment for our market sectors. If necessary, we adjust capacities, relocate production facilities and implement cost-cutting measures.

Political relations between various European countries and Iran improved in 2016, providing a foundation for improved business activities but also posing the risk of US business suffering as a result.

Asia remains our most important sales market for power plant equipment, including pumps and valves. However, competition in China has intensified again, not least due to the negative economic development. For the KSB Group, this has created increased pricing pressure and thus represents a “significant” risk. Political decisions too, such as the postponement or even abandonment of energy projects in several Chinese provinces, have impacted negatively on our business performance. In order to tap into the Asian market more widely, we have agreed a strategic alliance with our 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.

Opportunities

As detailed in the report on expected developments, the water and waste water market is continuing to develop positively, resulting in large-scale project orders in North Africa and the Middle East, as well as in France, China and the USA. With expert staff on the ground, we can provide clients with technical and commercial advice, and therefore see good opportunities to contribute to these and other projects.

In Brazil, the difficult economic situation, particularly in the oil and gas sector, has prompted several of our competitors to scale back their activities. This has extended to the closure of plants and sales offices. From KSB’s perspective, there are therefore opportunities to win market share again when the economy starts moving upwards.

The expansion of our service network improves our opportunities in several countries to offer classic services such as inspections, maintenance and repairs. At the same time, however, our new service centres could provide a base from which to offer retrofit services and our energy-saving concepts to a broader range of customers. Where this is successful, we can become involved in the modernisation of existing plant and, in particular, convert inefficient plants to energy-saving operation.

Projects / Products

Risks

The markets’ requirements for our products are constantly changing. We will only succeed if we meet our delivery deadlines and offer technically advanced products in good quality at affordable prices. To minimise the risk of delivery delays, which can lead to an adverse effect on our reputation with customers and also result in financial penalties, we constantly monitor our sales and manufacturing operations. If we discover that machinery needs to be renewed or capacities expanded, we examine these investment projects as part of a step-by-step approval process. By doing this, we counter the risk of schedule and cost overruns.

Regular market analysis and monitoring minimise the risk that our products will become technically obsolete or that we offer them at prices not acceptable in the market. At the same time, we are 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 we have introduced across the Group.

In our business, there are special requirements when it comes to the processing of large-scale projects with long terms. There are also always associated risks. There may be cost overruns, tighter import regulations, staff shortages, technical difficulties or quality problems – including possible penalties – that reduce our margins. We therefore train our employees in project management and equip them with specialist knowledge. This enables them to identify the risks associated with longer-term orders at an early stage. With this in mind, our project managers are also 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. We limit technical risks to the extent that we define intermediate steps for development work and subject partial solutions to assessments. This also applies to pumps that we provide 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. We minimise financial risks by using appropriate contractual clauses, and ensure that advances cover the costs incurred.

We set aside suitable provisions for warranty obligations and contractual penalty risks. These amounted to € 50 million in the consolidated financial statements for 2016 compared with € 52 million in the previous year; beyond this there is no other major residual risk (net risk).

Opportunities

In the course of 2016 we partially renewed our water and waste water product portfolio, improving our offering with energy-efficient components. This provides good opportunities to benefit from the growing demand from the customer industry, particularly as our product’s low electricity consumption is increasingly becoming a purchasing argument for operators of waterworks, waste water treatment plants and the connected pumping stations. Our new packaged pump station with integrated solids separation system for pumped drainage applications will open up new sales opportunities in several Eastern European countries this year.

Over the current year we will able to supply equipment suppliers for heating and air-conditioning systems with a full range of our own glandless pumps, covering all needs from detached family homes to large-scale industrial or hotel complexes. This extended range improves our opportunities to sell to original equipment manufacturers and large-scale plant engineering contractors. Where fire protection systems are also needed in industrial applications and building services, we are now able to offer our certified butterfly valves for fire protection.

The successive expansion of our range of mechanical seals produced in-house forms part of our efforts to extend our value added and cut external purchasing costs. With the 25 pump type series that we are now fitting with these components, we can offer our customers a high-quality technical solution that will have a positive impact on their maintenance and repair costs. To this extent there is a good opportunity to record more significant increases in the quantity sold of these seals.

We are supporting plant engineering contractors in the energy and industry sectors as they strive to achieve standardisation and modularisation. Through framework agreements, we can offer the most appropriate system components with short delivery times. In this way, we have the chance to extend and consolidate our business relations with major customers over the long term.

Finance / Liquidity

Risks

As a group with global operations, we are exposed to a wide variety of currency risks. We counter these with foreign exchange hedges. However, our global manufacturing network also offers us 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 for us. We use bank loans subject to variable interest rates to counter the interest rate risk by hedging our future interest payment flows accordingly.

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 our assumptions, this would have positive or negative effects on our business volumes and our earnings. A strict receivables management system and the use of trade credit insurance helps us avoid situations where receivables cannot be collected from our customers.

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

Persistent recessions or newly emerging crisis may adversely affect the financial situation of our customers. Delayed payments and credit losses as a result of this can place a burden upon our results of operations. The same effect might occur if the foreign exchange regulations become stricter for individual countries. We counter this by means of a strict receivables management system and intensive customer contacts. Our Italian company, whose product range includes high-efficiency motors, experienced a deterioration in its financial situation during the reporting year. Some service companies in France also suffered as a result of the persistently difficult economic situation in the country, with an impact on business development and thus on economic and financial solvency, as well as medium-term business prospects. We are therefore reviewing the strategic direction and organisational structures of our service activities there. Where deemed appropriate, we will merge individual units and also exit from any areas from which we do not expect long-term profitability.

Changing market conditions mean that our business models need to be fundamentally reviewed time and time again. This can also mean that we have to adjust our product range accordingly.

As regards tax matters, the global orientation of our activities must be taken into consideration. Based on our operative activities in numerous countries with varying tax laws and administrative interpretation, differentiated assessment is required for measuring our 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, we counteract the risk of having to pay back taxes. As we continually monitor unclear issues, we can generally classify the probability of occurrence. Should a need for subsequent payment arise, we create the corresponding provisions in good time. In the 2016 consolidated financial statements, we set aside € 1.3 million for circumstances that are classified as a significant or neutral risk. In addition, there are contingent liabilities expected to total up to € 7.4 million.

Opportunities

By the end of 2016 the US dollar had reached its highest level for 14 years against other major currencies, based on the expectation that the new government would work to generate economic impetus. If the dollar remains strong against the euro, exporting European products to the US market could become easier, provided that the general trading conditions do not change. Contracts that we post in US dollars would also, after conversion to our Group currency, result in higher amounts than if exchange rates remained unchanged.

Procurement

Risks

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

In the context of our procurement strategy, we are also careful to avoid becoming dependent on individual suppliers. If local conditions mean that it is impossible to ensure sufficient diversification in this regard, we make use of additional foreign business partners.

Our suppliers are also further developing their product ranges. In some cases, this results in changes to the specifications for the materials that we require. We consistently monitor any potential impact on the quality of our products. Should risks emerge, we reserve higher volumes based on the original material structure, where possible, and assess alternative procurement sources.

Opportunities

In order to make our products more competitive, our global purchasing managers are closely involved in the “design-to-cost” process. Through this process we manage the conception and development of our products to ensure that the resulting market opportunities are optimised, including from a pricing perspective. To this end, Purchasing can influence design considerations in the interests of cost-optimised procurement.

For the purposes of standardising and harmonising our processes, smaller KSB companies are also increasingly making use of uniform ERP systems. This standardisation increases the transparency of our procurement processes and makes it easier to pool the procurement of the same or similar parts, thereby saving costs. Using SAP software, we are also creating end-to-end electronic processes from the placing of an order through to payment, accelerating the entire workflow and reducing the likelihood of errors.

Technology / Research and Development

Risks

It is essential to our future success that we have a product and service range that is suited to the market in terms of technology, price and delivery time. The changing needs of our customers and new standards and regulations – especially in promising markets such as China – require that we continuously develop and improve our 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, we are constantly updating our 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. This close integration also enables us to respond to new market trends more quickly than our competitors.

Opportunities

We are keeping a close eye on our markets and are actively involved in the development of new technologies. In this way, we are able to find appropriate solutions to match our customers’ needs at an early stage. By implementing these solutions in the form of innovative products and services, we are able to offer the type of product benefits that our customers value.

In addition to further developments in hydraulics, materials technology and automation, we also monitor the technical options presented by digitally networked systems with a high level of information transparency. Using interdisciplinary teams we are currently looking into the opportunities in relation to serving our customers. In early 2017 we created a special unit which is dedicated to developing and fleshing out new business models on the basis of Industry 4.0 within the scope of four projects.

Other business-specific risks – Environment

Risks

Our 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, which in some cases exceed the prescribed environmental standards. If we discover any contamination, we set aside provisions to meet the liabilities for the necessary clean-up work. In the 2016 consolidated financial statements, these amounted to just under € 1 million for significant or neutral risks.

As part of acquisition projects, we examine properties for possible contamination before purchase. We take account of critical issues by way of corresponding contractual regulations with the seller and implement appropriate measure in consultation it.

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

Opportunities

Our activities as an industrial company inevitably present risks to humans and to nature. Using a global environmental management system, we recognise any hazards in good time, implementing protective measures as and when required. This puts us in a good position to prevent damage and any resulting financial consequences. By having our production and service plants checked by auditors and certified according to international standards, we and our customers are both assured that KSB companies respect the environment. This is an important prerequisite for many business relations. It offers KSB the opportunity to present itself to the market as an environmentally sound company. Our commitment to the UN Global Compact, too, allows us to meet the expectations of our customers and thus improve our sales prospects.

We also conduct regular energy audits, complying with the implementation, at national level, of an EU Regulation. Ultimately, these analyses reveal potential for additional energy savings by renovating our production halls, through smart management of our production facilities and through instructions to the operators of machine tools.

In some countries, tax incentives are available for companies with an environmental and energy management system. Through our certified systems we have always been able to provide the relevant documentation in this regard.

It is clear to us that the trend towards effective environmental protection and greater energy efficiency among our customers is ongoing worldwide. This will continue to have a positive impact on demand for our products and services. Our customers can, for example, use our FluidFuture concept to cut their electricity consumption. A system analysis is used to ensure that pumps and valves are properly designed and to provide information on the benefits of using high-efficiency pumps, valves and drives.

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

Risks

To achieve our growth and profitability business objectives, we need qualified employees at all our 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 if economic recovery sets in. We counter 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 our 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. To limit this risk, we validate alternative models.

Like all companies, KSB has to adapt to new market conditions. We are currently implementing a global efficiency improvement programme, which also encompasses staff reduction measures. By seeking out socially responsible solutions in the areas of the company concerned and by keeping our employees up to date at all times, we are aiming to keep motivation high and to avoid the departure of employees from key positions.

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 our employees include dishonest conduct or violations of laws, that could damage the image of KSB. We counter these risks and safeguard our reputation among our customers by organising regular compliance training and through individual initiatives in critical regions.

Legal disputes cannot always be avoided within the framework of our business activities. These are usually disputes arising from operations, generally involving unclear warranty issues. If as a result of these issues we expect negative effects on the success of our business, we set aside corresponding provisions, which cover not only the anticipated amount of loss, but also the costs of proceedings. To rule out a net risk, the 2016 consolidated financial statements include about € 3 million for those cases classified as significant or neutral risks. We have also created provisions for litigation with authorities and for staff matters. These amount to just under € 2 million to cover any cases we classify as significant or neutral within our risk assessment methodology.

The manipulation and loss of electronic data can lead to serious commercial disadvantages. We limit this risk by means of adequate security systems and access procedures. An increased centralisation of the IT systems of our various operating units assists us in this. In this way, we implement high security standards and thus reduce the risk of data loss or corruption.

Opportunities

In 2016 we carried out a survey of 11,000 employees across ten countries in order to pinpoint the company’s strengths and weaknesses. Based on the feedback from approximately 8,700 members of staff, we developed measures that should already be helping to further improve the fundamentals of our work, including customer focus, innovation, cooperation and performance management in the current year. Provided these measures are successful, we can expect to see even greater commitment from our employees, thereby further increasing our company’s value for our customers. At the same time, we also expect the measures triggered by our staff’s responses to strengthen KSB’s reputation as an employer. This will make it easier for us to attract the experts and managers that we need.

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. Particularly in Eastern Europe, uncertainty regarding political risk is of great significance to the Pumps and Valves segments, and to a lesser degree to Service. At the same time, the still comparatively low price of oil and worsening payment morale also harbour risk potential for future business transactions. A quicker-than-expected return to political stability, combined with a calming of the currency turmoil, would probably have positive repercussions. This would also be the case were the oil price to experience another recovery matching that of 2016. Conversely, a continuation of the political uncertainty, combined with persistent depreciation tendencies among some currencies or a permanently low oil price, would have a negative impact on our business. As regards our main influencing factor, the economic situation, we estimate the risk to be slightly higher compared with the previous year. We nonetheless hope that our measures, intended to foster growth, will provide us with considerable support in achieving our goals. Furthermore, the political crises and future development of the oil price mean both opportunities and risks for all segments. Our customers are also often affected by recessions and more intense competition, which can compromise their ability to pay in individual cases.

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

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 the Board of Management. We base the nature and scope of all financial transactions exclusively on the requirements of our business and do not lend ourselves to business of a speculative nature. The aim is to ensure liquidity at all times and to finance our activities under optimal conditions. With respect to our export business, we hedge foreign exchange and credit risks to the greatest extent possible. We continuously improve our receivables management methods with the goal of settling our outstanding amounts by their due dates.

We are exposed to the following financial risks as a consequence of our business activities:

On the one hand, we are exposed to credit risk. We define credit risk as potential default or delays in the receipt of contractually agreed payments. We are 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. Finally, we are exposed to market risk. The risk of 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 for us.

We use foreign exchange hedges to reduce the risks from transactions involving different currencies. These are generally currency forwards, which we use 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 € 269.8 million (previous year: € 254.0 million). Foreign currency items denominated in US dollars account for the major volume hedged by forwards. By strengthening our production sites worldwide, we can realise “natural” currency hedging in currency markets that continue to be volatile.

To minimise interest rate risks, we concluded interest rate swaps to hedge cash flows from underlyings amounting to € 39.5 million (previous year: € 39.5 million). Underlyings and hedge transactions share the same variable interest rates and maturities (1 year).

We limit all these risks through an appropriate risk management system, defining how these risks are addressed through guidelines and work instructions. In addition, we monitor the current risk characteristics and continuously provide the information obtained in this way to the Board of Management 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 BY THE BOARD OF MANAGEMENT

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 has not changed materially in comparison with the previous year, but there has been a change in the assessment of various individual risks as a result of our measures and, in part, of other internal and external aspects. Overall, we assume there will be moderate economic recovery over the next year. Our structural measures will afford us additional support in achieving our objectives. However, there are risks associated with an economic slowdown in the growth markets, particularly China, as well as with negative developments that could stem from regions in Eastern Europe, the Middle East, Turkey or parts of Africa experiencing political unrest. This similarly applies to future changes in the price of oil, as well as to volatile currencies. Such circumstances would have a negative effect on our business volumes as well as our planned earnings.

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

The risk management system in place, as well as the related organisational measures, allow the Board of Management to identify risks in a timely manner and to take adequate measures. In view of the somewhat uncertain situation, the focus of activities in 2017 will continue to be on the management of market risks. The Board of Management states that, based on the risk management system established by the KSB Group, at present there are no risks that could lead to a lasting and significant impact on the net assets, financial position and results of operations of the KSB Group.

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