Operating risks

Operating risks

SOCIO-POLITICAL RISKS RELATED TO THE GROUP'S OPERATIONS AT GLOBAL LEVEL, INCLUDING IN EMERGING COUNTRIES

The Group operates on a global basis, with a strong presence in various geographical markets.

In particular, the Group:

(i) has a strong export vocation, as its turnover is mainly achieved in markets other than the Italian market;

(ii) is present abroad not only through commercial subsidiaries, but also with industrial companies and production plants located in different geographical areas (Poland, Russia, China, Sweden, Czech Republic, India, USA).

This geographical diversity exposes the Group to risks arising from operating in more than one international market, including the risk that changes in political and socio-economic conditions in one geographical area will affect the Group's production and distribution in that area.

In addition, the Group also conducts its business in countries with economic and political systems in which different factors of potential instability are present, including: (i) political and economic instability; (ii) boycotts and embargoes that could be imposed by the international community; (iii) unfavorable changes in government policies, particularly with respect to foreign investment; (iv) significant fluctuations in interest and exchange rates; (v) expropriation or forced purchases of assets; (vi) bureaucratic requirements that are difficult to implement; (vii) inability to protect certain legal and contractual rights in certain jurisdictions; (viii) imposition of taxes, duties or other unexpected payments; and (ix) currency controls that could limit remittance of funds or currency conversion; and (x) widespread corruption.

Operations in emerging markets may also be affected by difficulties typical of the economies of developing countries, such as, by way of example, transportation difficulties, lack of infrastructure, greater difficulty in obtaining skilled labor.

In addition, the primary or secondary legislation of emerging countries, or the interpretation thereof, may be subject to unpredictable changes, or there may be a limited number of precedents linked to the interpretation, implementation and application of such legislation.

Ultimately, despite the fact that global distribution and operations in emerging countries clearly represent significant opportunities for the Group to take advantage of the development potential of the various geographical areas involved, it cannot be ruled out that the occurrence of one or more of the above-mentioned risks could have a negative impact on the Group's operations and financial position, results of operations and prospects. Therefore, the Group carefully monitors the situation in the various countries with a view to taking timely action in the event of significant negative changes in the reference scenarios.

 

RISKS CONNECTED WITH THE HIGH LEVEL OF COMPETITIVENESS OF THE SECTORS IN WHICH THE GROUP OPERATES AND ITS ABILITY TO CONTINUE TO INNOVATE PRODUCTS, INCLUDING IN RELATION TO ONGOING TECHNOLOGICAL DEVELOPMENTS IN THE SECTOR AND INVESTMENT IN RESEARCH AND DEVELOPMENT

The market segments in which the Group operates are characterized by a high level of competition in terms of product quality, innovation, economic conditions, energy efficiency as well as performance reliability and safety, and by the presence of competition from other major international industrial groups.

The Group's ability to produce value also depends on the ability of its companies to offer products that are innovative in terms of technology and in line with market trends.

From this point of view, the Group has proved in the past to be a reference operator in terms of technological innovation, also thanks to a policy of promoting the resources dedicated to the development of its products, which it intends to maintain in the future, continuing to make use of consolidated collaboration relationships with prestigious universities both in Italy and abroad.

However, should the Group be unable to develop and continue to offer innovative and competitive products compared with those of its main competitors in terms of, amongst other things, price, quality and functionality, or should there be delays in the market launch of strategic models for its business, the Group's market share could fall, with a negative impact on its business, equity and/or financial position, economic results and prospects.

To mitigate exposure to such risks, the Group constantly monitors the reference market and the intermediate results generated in the various phases of the research and development process, in order to select and pursue only the most reliable initiatives, or those with the highest probability of success and economic and financial return, also pursuing a policy of progressive diversification and enrichment of its product portfolio and continuous development of the range.

 

RISKS CONNECTED WITH THE CONCENTRATION OF SALES

Despite the fact that there is no customer of the Group that, on its own, accounts for more than 5% of its consolidated turnover[1] and despite the fact that the Group's top 10 customers together account for a percentage of consolidated turnover equal to 30%, the static exchangers sector (in which the Group is included in the list of preferred suppliers of all the most important European manufacturers of refrigeration units and achieved in the year 2018 61, 2% of its turnover) and that of glass doors for refrigerated counters (in which the Group achieved 3.0% of its turnover in FY 2019) are characterized by the strong commercial leadership exercised by the leading manufacturers.

Consequently, if the supply to one of the customers to whom the Group sells in the aforementioned sectors were to cease, the Group companies operating in these sectors would find it difficult to recover the lost turnover by turning to other customers and there could be a negative impact on the Group's results of operations and/or financial position.

The Group regularly takes steps to diversify the risk associated with the concentration of sales, by regularly carrying out commercial surveys aimed at finding new customers both in Italy and abroad through the activities of the sales offices of all Group companies.

 

RISKS RELATED TO PRODUCT QUALITY AND PRODUCT LIABILITY

The Group's products are primarily intended for commercial and industrial refrigeration and must comply with different quality and safety standards in the various jurisdictions in which they are marketed. There is therefore a risk that a product does not meet the quality and safety standards required by the regulations in force in those jurisdictions. This could justify the return of such a product, incurring additional manufacturing costs.

The recurrence of product defect events has historically been very limited and absolutely physiological for the sector in which it operates; in the cases in which they have occurred, the Group company involved has agreed corrective action with the customer, activating, where necessary, the insurance policies stipulated for this purpose.

Moreover, as Group products are usually part of more complex products, the malfunction of a component supplied by the Group could lead to recalls of a number of products sold and/or installed by Group customers.

It should also be noted that the Group manufactures product categories that use carbon dioxide (rather than freon) as a refrigerant gas. Although carbon dioxide has a lower environmental impact than more commonly used refrigerants, due to its high operating pressures it presents a higher risk profile during the production and testing stages and in the event of manufacturing defects emerging during installation and/or operation in the field.

Finally, it should be pointed out that some Group products are intended for applications on power generation plants, whose supply contracts usually provide, in the event of malfunction or defects, for suppliers to accept liability also for damages resulting from said malfunction or defect, which are difficult to estimate and not proportionate to the value of the supply made. To date, in a small number of cases customers have reported product malfunctions, which have been resolved with on-site interventions by Group technicians.

In this regard, the Group applies strict control standards for its products: it has a quality risk management protocol that includes various activities and procedures to protect product quality; there is also a structure dedicated to quality control, carried out directly at production units and at suppliers' premises.

In order to deal with these potential liabilities, which have historically been modest, the Group has taken out insurance cover for all products on the market, the maximum amount of which is considered adequate for the risks and is constantly monitored.

In addition, the Group has set up a special product warranty fund to cover potential product defects, based on prudent criteria and statistical data.

 

CREDIT-RELATED RISKS

The Group is exposed to credit risk deriving from commercial transactions, with exposure to potential losses deriving from failure by commercial counterparties to meet their obligations. Trade credit risk is monitored on the basis of formalized procedures for the selection and assessment of the customer portfolio, for the definition of credit limits for each individual customer, for monitoring expected cash flows and for any recovery actions. In some cases, customers are asked to provide additional guarantees, primarily in the form of sureties.

Moreover, any delays in payment by customers could result in the Group having to finance the related working capital requirements.

Proof of the good results achieved are the historically low levels of losses on receivables recorded.

 

RISKS CONNECTED WITH TRENDS IN RAW MATERIAL PRICES

The Group's production costs are influenced by the prices of raw materials, primarily copper and aluminum. Most of the raw materials are purchased in the European Union. The related risks are related both to the fluctuation of the prices of these materials on the reference markets (on which they are quoted in USD) and to the fluctuation of the Euro/USD exchange rate (since the Group purchases in Euro, while quotations are made in USD), as well as to the reliability and policies of the mining and/or processing companies.

The fluctuation in the availability and price of the above-mentioned materials may be significant, depending on various factors, including the economic cyclical nature of the reference markets, supply conditions and other factors that are beyond the Group's control and difficult to predict (such as, for example: problems inherent in the extraction or processing capacity of individual suppliers that could hinder or delay delivery of the raw materials ordered; management and/or industrial decisions by individual suppliers that lead to the interruption of the extraction or processing of raw materials and the consequent greater difficulty of finding these raw materials in the reference market in the immediate future; the occurrence of significant delays in the transport and delivery of these raw materials to Group companies).

Finally, it should be noted that the volatility of oil prices affects (in addition to the price of raw materials) the investments made at global level in the power generation market, making it difficult to predict the performance of this market segment.

 

RISKS CONNECTED WITH ANY PROCUREMENT DIFFICULTIES AND RELATIONS WITH SUPPLIERS

The Group purchases not only raw materials but also semi-finished materials and components (including motors, electronic components, headers, sheet metal, distributor groups) from external parties. It is therefore exposed to risks deriving from relations with these third-party producers and suppliers, which may not guarantee the current continuity of supply of such materials and components in the future. In particular, the Group is exposed to the risk of procurement difficulties with regard to the supply of large EC technology electronic motors, due to the strong concentration of the worldwide supply of these motors in the hands of two manufacturers, who may not be able to continue to guarantee a supply of these components capable of meeting market demands.

The Group manages the aforesaid risks by means of: (a) a model for ongoing assessment of the reliability of each recurrent supplier, in terms of both quality and cost-effectiveness of the products manufactured; (b) checks on the economic evaluation of suppliers and, consequently, on the respective allocation of adequate production volumes to each; (c) assessment of the services rendered by suppliers on the basis of their performance in terms of logistics and the timeliness of their deliveries, and on the consequent decisions taken from time to time. Nevertheless, it cannot be ruled out that one or more of the suppliers from which Group companies obtain supplies may fail to meet their contractual obligations, or that their supplies may no longer be continuous; this could entail additional costs or prevent delivery to customers in accordance with the agreed timetables and/or specifications, with consequent negative effects on the Group's operations and its income statement, balance sheet and/or financial position.

 

RISKS RELATING TO THE CONSEQUENCES OF ANY INTERRUPTIONS TO COMPANY OPERATIONS

The Group operates a production process, with fixed costs associated with the operation of the plants. The Group is therefore exposed to the risk deriving from the interruption of production activities in one or more of its plants, due, by way of example, to accidents, plant breakdowns, computer system malfunctions, revocation or contestation of permits or licenses by the competent public authorities, strikes or lack of workforce, natural disasters, significant interruptions to supplies of raw materials or energy, or finally man-made disasters such as accidents, fires, acts of terrorism. In particular, the interruption of production activities could lead to a partial failure to absorb the fixed costs associated with production and/or make the Group temporarily unable to meet customer demand on time.

Although Group companies have taken out loss of profit and all-risk insurance policies against damage from fire and natural disasters, whose limits and deductibles are deemed adequate in view of the possible damage that could be caused, any significant interruption of business at their industrial plants, whether due to the above-mentioned events or to other events beyond the Group's control, could have an adverse effect on their operations and on their financial position, results of operations and prospects.

 

RISKS RELATING TO ENVIRONMENTAL ISSUES

The industrial production carried out by the Group with its own plants and equipment could, in certain cases of serious breakdown or damage to such equipment or catastrophic events, cause damage to third parties, accidents or environmental damage. This risk is also linked to the presence in the plants of products that are potentially dangerous for the environment, such as flammable materials and chemical products.

Although the Group does its utmost to prevent this type of risk, in the event of accidents or environmental damage, it would be exposed to unpredictable and huge compensation obligations and to liability, including criminal liability, vis-à-vis the damaged parties and/or the competent authorities, and could suffer interruptions to production activities with possible negative effects on its business, economic and financial situation, results of operations and prospects.

Although Group companies have taken out insurance policies to cover civil liability deriving from such events, the maximum amounts of which are deemed adequate in relation to the estimated risk in question, it cannot, however, exclude the occurrence of damages whose compensation exceeds the maximum amounts provided for by the policies themselves.

The Group, through dedicated offices, continues to carry out all the activities necessary to guarantee respect for the environment and optimization of the use of energy sources and natural resources. Moreover, research and development activities are always geared towards products with a lower environmental impact in terms of both energy consumption and the use of refrigerants and noise reduction.

 

RISKS INHERENT IN THE STRATEGY OF GROWTH BY EXTERNAL LINES

The Group's strategy, aimed at expanding into new markets and developing and diversifying its product portfolio, is based on growth through acquisitions and the development of joint ventures. Therefore, the Group is exposed to the typical risks inherent in external growth initiatives.

Although the Group carries out financial, accounting, tax and legal due diligence prior to making acquisitions, joint ventures or investments, there may be cases where such activity does not allow all the potential or current significant liabilities of the entity acquired to be identified, nor to lead to an adequate determination of the purchase price.

The integration of new entities subject to acquisition is also an organizationally complex process, which may not take place according to the timeframe initially assumed and may involve unexpected costs and, therefore, may compromise or delay the benefits expected from the acquisition.

In order to mitigate these risks, the Group carries out careful due diligence (business, accounting, financial, fiscal, legal and environmental) on the companies subject to possible acquisition, with the support of highly qualified and well-known consultants. It also activates structured integration processes by deploying dedicated inter-functional teams to best meet deadlines and exploit all possible synergies.

 

RISKS RELATED TO THE COVID-19 HEALTH EMERGENCY

The pandemic linked to the spread of COVID-19, even if subject to containment actions, may continue to have important consequences on the health, social and economic levels throughout the world (with very different impacts from country to country). The main risks refer to the worsening of the global macroeconomic scenario, the deterioration of the credit profile of customers and countries and the slowdown of commercial activities due to the reduction in demand, the negative impacts on supply chains, on sales prices and purchase costs of raw materials and on the availability and price of financial resources.

As reported in the section "Significant events during the first half of the year" in the Management Report as of June 30, 2020, the Group immediately set up a special crisis committee to manage the emergency as best as possible and protect the health of all staff. “Smart working" was launched very quickly for all departments that are able to carry out their activities using this method, which is still partially used, and the use of all the instruments granted to make labor costs more flexible (social safety nets). Great attention was paid to monitoring the situation of customers and suppliers in order to better manage production capacity and delivery times to the market (promptly dealing with critical issues relating to supplies and the movement of goods). Production and logistic flexibility has been significantly increased, allowing the transfer of production from factories in lockdown to active ones, thus ensuring continuity of supply to strategic customers.

Given the uncertainty of the moment, the Group is unable to determine the precise impact of the pandemic. The macroeconomic scenario, due to COVID-19, is difficult to predict and visibility is limited. Therefore, it is very difficult to make reliable forecasts regarding the trend of commercial, economic and financial results. The potential effects on the financial statements for the current year and future years cannot be precisely determined at present and will be constantly monitored by management. In this regard, reference should be made to the sensitivity analyses conducted on compliance with the 2020-23 business plan approved by the Board of Directors on April 6, 2020, which, it should be remembered, included initial forecasts regarding the effects that the pandemic could have. For further information, reference should be made to note 3.1 to the condensed interim consolidated financial statements as at June 30, 2020.

In this context, the Group will maintain its constant commitment to improving its strategic positioning in all the markets in which it operates. It will be very important in this phase to manage, in the short term, the contingent situation, without, however, ever letting this distract attention from the objectives of volume growth and profitability in the medium and long term.

[1] Half-yearly financial report as at 30.06.2020.