Further progress has been made during the year in developing a more mature risk management environment and to ensure controls remain robust

Terry Twigger

Audit Committee Chair

Dear Shareholder

As Chairman of the XP Power Audit Committee, I am pleased to present the 2018 Audit Committee Report to Shareholders and to be able to confirm, on behalf of the Board, that the Annual Report is fair, balanced and understandable.

It has been another year of change with the acquisitions of Comdel in September 2017 and Glassman in May 2018 against a background of continuing organic growth. Further progress has been made during the year in developing a more mature risk management environment and to ensure controls remain robust. This is primarily supported by the internal audit programme which was focused on probing into financial controls in certain regions, reviewing the export control procedures and performing an assessment of the Group's approach to Treasury and the associated controls. These reviews continue to provide insightful perspectives, which have led to improvements in processes and controls and inform future reviews.

The report aims to provide the following information:

• The Audit Committee's principal responsibilities and its governance.
• The key activities which were reviewed by the Audit Committee, including those items of regular annual review and other current areas of focus.
• The discussions and actions undertaken, in conjunction with the external auditor, on any significant judgements and/or issues.
• Details of the ongoing review of the external auditor and the amount of non-audit work undertaken.

I believe that the audit committee has the necessary experience, expertise and financial understanding supported by the internal and external auditors to fulfil its responsibilities and to continue to monitor and contribute to the various improvement initiatives.

The Audit Committee is satisfied that the Company has maintained sound risk management and internal controls throughout the year, and that the internal audit programme has been planned and sufficiently resourced to confirm that these controls are effective.

It was anticipated that the external audit would be retendered in 2019. However, the Group is upgrading its ERP system in 2019 and 2020 which will improve the embedded controls and change the approach to the audit. After careful consideration the audit committee has concluded that the retendering of the external audit should now take place in 2021. As a result, the Audit Committee has recommended to the Board that the re-appointment of PricewaterhouseCoopers LLP should be proposed at the forthcoming Annual General Meeting, and I hope that you will support me in this resolution.

5 March 2019

Members of the audit committee

Terry Twigger (Chair), Independent Non-Executive Director

Peter Bucher, Independent Non-Executive Director (retired 31 December 2018)

Polly Williams, Independent Non-Executive Director

Governance

The current Audit Committee members are all independent Non-Executive Directors and have financial and/or related business experience gained in senior positions in other diverse organisations. Terry Twigger has been the Audit Committee Chair since 2015 and the Board is satisfied that Terry has recent and relevant financial experience.

Performance evaluation of the audit committee

During the year, the Audit Committee reviewed its performance as part of the Board's updated evaluation process. The Committee considered it had adequate qualifications and skills to perform its responsibilities, particularly through Terry Twigger's financial and management background and Polly Williams' financial and audit experience.

Meetings of the audit committee

The Audit Committee met four times during 2018 with attendance on the dates as follows:

Peter Bucher was unable to attend the January meeting due to a prior commitment.

The Chief Financial Officer and Group Financial Controller were involved at each of the meetings as were the external auditor, PricewaterhouseCoopers LLP, and the outsourced internal audit firm, Deloitte LLP. The Committee also discussed matters with both the external auditor and internal auditor without the Group's management being present.

The Audit Committee supports the Board and reports to it on a regular basis, certainly no less frequently than at every Board meeting following a meeting of the Audit Committee.

There is an annual cycle of items that are considered by the Audit Committee. The timetable of these items is scheduled in accordance with the requirement of the annual audit cycle and any other requirements of the Audit Committee.

Responsibilities of the audit committee

The Committee is responsible for, amongst other things:

• Ensuring that the financial performance of the Group is properly reported and monitored;
• Advising the Board on whether it believes the annual report and accounts, taken as a whole, is fair, balanced and understandable;
• Compliance with legal requirements;
• Adoption and correct implementation of accounting standards;
• Meeting the requirements of the UK Listing Authority;
• Assessing the Group's internal control processes and assurance framework;
• Reviewing any instances of fraud or whistle-blowing:
• Supervising the relationship and performance of the external and internal auditors; and
• Reviewing the nature and extent of audit and non-audit services provided to the Group by the external auditors.

The Terms of Reference of the Audit Committee are available in the Corporate Governance section of the Company's website xppowerplc.com.

Activities of the audit committee

• Examining the 31 December 2017 Annual Report and the 30 June 2018 Half Year Report to assess whether the reports, taken as a whole, were fair, balanced and understandable prior to recommending these to the Board for approval.
• Reviewing and challenging areas of significant risk and judgement and the level of disclosure. Some of these are described in the 'Significant risks and judgements in the financial reporting' below.
• Probing and recommending for approval the going concern basis of preparation, the long-term viability statement and associated risk assumptions, the accounting policies and disclosures, the financial reporting issues and the assumptions and adjustments made.
• Continuing to evolve the Group's risk and compliance framework by guiding the outsourced internal auditors, Deloitte LLP, and reviewing the work scopes of the target areas within the total audit universe.
• Reviewing the findings of the internal audit work and the follow-ups of reviews done in the previous year.
• Reviewing the effectiveness of the Group's internal controls and disclosures made in the Annual Report and Financial Statements.
• Challenging the assumptions and analysis produced by management in relation to the Group's long-term viability statement.
• Reviewing the results of the finance functions' peer-to-peer balance sheet reviews.
• Appraising the Group's tax and treasury functions with a focus on areas prone to significant change.
• Assessing the accounting principles to be adopted in the preparation of the 2018 accounts.

The Audit Committee is satisfied that the Company has maintained appropriate risk management and internal controls throughout the year.

Significant risks and judgements in the financial reporting

In relation to the 31 December 2018 Annual Financial Statements included in this report, the Audit Committee considered the following topics:

Goodwill

The carrying value of goodwill is a significant item within the Group's balance sheet and is prone to further increase while the Group remains acquisitive. It has also increased in 2018 with the acquisition of Glassman HV. Impairment assessments, performed annually, require judgements in relation to discount rates and future growth forecasts to generate discounted cash flows for the cash generating units. The Committee ascertains that appropriate sensitivity analysis is conducted by the external auditor on the Company's impairment calculations. It also assesses the carrying value in the context of the Groups wider net asset value and market capitalisation. After consideration, the Committee was satisfied that there was no indication of impairment.

Capitalised product development

The Group's product development activity leads to direct costs associated with new products being capitalised and amortised over the useful life of the products. The carrying value of the product development costs is rising in line with increased product development as the business has grown. The future success and the useful lives of these products require a degree of judgement. The Committee regularly assesses the revenue streams of capitalised products that have been released for sale against their carrying value. The Committee also reviews a projection of the estimated future carrying values. The Committee was satisfied with the judgements used.

Deferred tax on unremitted earnings

The Group does not currently record deferred tax on the unremitted earnings held in Group subsidiaries. The Board recognises that where there is no intention to repatriate these earnings to the parent Company, deferred tax should not be provided. The Committee receives periodic updates on the unremitted earnings position including forward projections. The Committee determined that there is no specific requirement to move earnings currently held in subsidiaries.

Inventory

The carrying value of the Group's inventory has been a focus for the Committee particularly with the increase in Group inventory as result of the prevailing market conditions. The high product mix focus on customer fulfilment and the effect of certain service level agreements with customers are recognised factors in the inventory levels. In addition, lean factory initiatives, rapid growth and an acquisition are further reasons for an overall increase in inventory during the year on top of the increase as result of the significant extension in component lead times from suppliers. Exposure to the risk of inventory obsolescence remains an area of ongoing review and wall-to-wall stock counts, witnessed by the external auditor, were performed at all key sites across the Group and appropriate provisions for loss and delinquency were made. The Company's peer-to-peer balance sheet reviews and reviews by the Group Financial Controller, which are reviewed by the Committee, includes testing of the provision. The Committee was satisfied with the provision.

Business combination

Following the acquisition of the business and assets of Glassman HV Inc on 25 May 2018, the Company has performed an assessment of identifying and valuing the intangible assets with the help of a third-party valuer; a process that involves judgement. The Committee verified that the external auditor had independently assessed these calculations and were satisfied with the values attributed to the intangible assets.

Internal control

The Board is ultimately responsible for the Group's system of internal controls and the ongoing assessment of these further details of which are included in C.2 Risk Management and Internal Control of the Corporate Governance section in the Corporate Governance Report.

Internal audit

As the Group continues to expand in scale and complexity, the remit of the independent internal audit process by Deloitte, LLP has also increased. The committee reviewed the risk framework to ensure it remains appropriate in combination with the Board's risk monitoring process to identify areas for risk assurance work and internal audits to be carried out. These included an assessment of the Export Controls, the adequacy of the Treasury controls and function and a site visit to the Vietnam factory to assess business continuity and disaster recovery. These reviews indicated a number of areas requiring improvements, which are being addressed by management. During 2018 a Controls Self-Assessment programme has been implemented and the first results of these will be available for review early in 2019. There are a number of other reviews due to report in early 2019 including IT General Controls and Post Acquisition reviews.

Findings and control observations from the reviews are rated and presented to the Committee for comment or further action. The recommendations made by the internal auditors are assessed by management and addressed accordingly within an agreed timeline. The internal auditor regularly follows up on these actions and keeps the Committee informed on progress against the agreed timeline.

In addition to the internal audit, the Group's Financial Controllers conduct a formal process of peer-to-peer balance sheet reviews, the results of which are reported to the Audit Committee. The Committee reviews and approves the scope and schedule for these reviews as a means of providing a secondary level of comfort over the financial controls.

External audit

The current external auditor, PricewaterhouseCoopers LLP, was appointed in 2007. The current audit engagement partner's term began in 2014 with a maximum term of five years and he is rotating off the engagement after the 2018 audit; his successor was interviewed by the Committee and has shadowed the current partner through 2018. In line with best practice, as recommended by the Financial Reporting Guideline, the external audit is anticipated to be retendered no later than 2021. This has been delayed from previous expected timing as the Group is upgrading and significantly increasing the scope of its ERP system during 2019 and 2020 which will improve the embedded controls and change the approach to the audit. The Committee has reported to the Board that the re-appointment of PricewaterhouseCoopers LLP should be proposed at the forthcoming Annual General Meeting.

The Audit Committee keeps under review the role and independence of the external auditor. A formal statement of independence is received each year together with a report on the safeguards that are in place to maintain their independence and the internal measures to ensure their objectivity. The Committee also discusses with the external auditor areas where they have challenged management and how any disagreements have been resolved. The Committee is satisfied that this independence has been maintained.

The Committee has formalised its policy and approved a set of procedures in relation to the appointment of external auditors to undertake audit and non-audit work. Under this policy:

• The award of audit-related services to the auditors in excess of £50,000 must first be approved by the Chairman of the Audit Committee, who in his decision to approve will take into account the aggregate of audit-related revenue already earned by the auditor in that year. Audit related services include formalities relating to borrowing, shareholder and other circulars, regulatory reports, work relating to disposals and acquisitions, tax assurance work and advice on accounting policies;
• The award of tax consulting services to the auditors in excess of £50,000, subject to compliance with the EU member state restrictions, must first be approved by the Chairman of the Audit Committee; and
• The award of other non-audit related services to the auditors in excess of £20,000 must first be approved by the Chairman of the Audit Committee.

During the year, no non-audit fees were paid to the auditor (2017: nil).