The Group has well-established annual and ongoing risk management processes to identify and assess risks. Nonetheless, renewed emphasis, encouraged by the more recently appointed Non-Executive Directors, coupled with the introduction of internal audit reviews, has strengthened these processes.
The Group's principal risks have been mapped onto a detailed risk universe from which key areas for business focus can be identified. This helps facilitate further discussions on risk appetite and draws out the risks that require a greater level of attention in terms of audit or assessment.
Our risk assessment
The key risks that have been identified and the mitigating actions are summarised in this section and classified according to:
- The assessment of their level of impact to the viability of the business if they occurred – ranging from severe to minor;
- The likelihood of a risk occurring – ranging from high to low; and
- The direction in which they are trending – risks are classified according to whether they are assessed as becoming more likely to occur, less likely to occur or whether the risk of occurrence remains unchanged.
Although the attributes assigned to the identified risks are judgemental and qualitative in nature, the Board regards the methodology as useful in determining the focus that should be given to each risk.
This is not an exhaustive list of risks that the Board has identified and considered but does include all risks which are assessed as having a severe or moderate impact to the business if they occurred.
The Board determines the appropriate level of risk for operating the business and pursuing their vision and strategic objectives. A key focus for the Board is minimising the Group's exposure to financial, operational, human, legislative and reputational risks.
Our risk management framework
Identifying, assessing and mitigating risk at Group level. Setting the risk appetite for the Group
Identifying, assessing and mitigating risk across functional areas
A robust risk assessment has been carried out at Board level and where possible actions set to mitigate and / or reduce the identified risk. The Board acknowledges that it is responsible for the Group's internal controls and for reviewing their effectiveness. XP Power has an ongoing process for identifying, evaluating and managing the significant risks faced by the Group; these identified risks and processes are documented, reviewed and updated at Board meetings.
Audit committee and internal audit
The Audit Committee ensures that the Group is effectively managing risk and internal control procedures. This is achieved through:
- The Audit Committee reviewing the effectiveness of internal controls.
- An internal audit and risk assurance programme.
A key control procedure is the day-to-day supervision of the business; this is supported by managers within the Group's companies. These include:
- Authority matrices are in place to clearly define who is able to authorise particular transactions, transfer funds, commit Company resources and enter into particular agreements.
- Monthly reporting of management accounts and key metrics to senior management with performance measured to budget and material variances reported to the Board.
- Quality control checks throughout our manufacturing process, burn in, electrical testing to detect early failures, 100% functional testing, and quality inspection.
- Disaster recovery and business continuity plans are in place at all facilities, documented and communicated to key personnel to help cope with unexpected events.
Heat map of the identified risks indicating the likelihood and level of impact
- An event that causes a disruption to one of our manufacturing facilities.
- Product recall.
- Competition from new market entrants and new technologies.
- Fluctuations of revenues, expenses and operating results due to an economic shock.
- Dependence on key customers/suppliers.
- Cybersecurity/information systems failure.
- Risks relating to regulation, compliance and taxation.
- Strategic risk associated with valuing or integrating new acquisitions.
- Loss of key personnel or failure to attract new personnel.
- Exposure to exchange rate fluctuations.
No change to risk
Increase in risk
Decrease in risk
|Risks that could have a severe impact on the Company's business and possibly on the viability of the Company's business|
|Risk||Explanation of risk||Mitigation||Assessed trend|
An event causes a disruption to our manufacturing facilities
An event that results in the temporary or permanent loss of a manufacturing facility would be a serious issue. As the Group manufactures 80% of revenues, this would undoubtedly cause at least a short-term loss of revenues and profits and disruption to our customers and therefore damage to reputation.
- We now have two facilities (China and Vietnam) where we are able to produce power supplies. However, not all power converter series can be produced in both facilities.
- We have disaster recovery plans in place for both facilities.
- We have undertaken a risk review with the manufacturing management to identify and assess risks which could cause a serious disruption to manufacturing, and then identified and implemented actions to reduce or mitigate these risks where possible.
A product recall due to a quality or safety issue would have serious repercussions to the business in terms of potential cost and reputational damage as a supplier to critical systems.
- We perform 100% functional testing on all own-manufactured products and 100% hi-pot testing, which determines the adequacy of electrical insulation on own-manufactured products. This ensures the integrity of the isolation barrier between the mains supply and the end user of the equipment. We also test all the medical products we manufacture to ensure the leakage current is within the medical specifications.
- Where we have contracts with customers, we limit our contractual liability regarding recall costs.
- No single customer project accounts for more than 4% of overall revenue.
|Risks that could have a moderate impact on the Company's business and possibly on the viability of the company's business|
|Risk||Explanation of risk||Mitigation||Assessed trend|
Competition from new market entrants and new technologies
The power supply market is diverse and competitive. The Directors believe that the development of new technologies could give rise to significant new competition to the Group, which may have a material effect on its business. At the lower end of the Group's target market, in terms of both power range and programme size, the barriers to entry are lower and there is, therefore, a risk that competition could quickly increase, particularly from emerging low cost manufacturers in Asia.
- The Group reviews activities of its competition, in particular product releases, and stays up-to-date with new technological advances in our industry, especially those relating to new components and materials. The Group also tries to keep its cost base competitive by operating in low cost geographies where appropriate.
- The general direction of our product roadmap is to move away from lower complexity products and to increase our engineering solutions capabilities as to reduce the inherent market competitiveness.
Fluctuations of revenues, expenses and operating results due to an economic shock
The revenues, expenses and operating results of the Group could vary significantly from period to period as a result of a variety of factors, some of which are outside its control. These factors include: general economic conditions; adverse movements in interest rates; conditions specific to the market; seasonal trends in revenues, capital expenditure and other costs; and the introduction of new products or services by the Group, or by its competitors. In response to a changing competitive environment, the Group may elect from time to time to make certain pricing, service, marketing decisions or acquisitions that could have a short-term material adverse effect on the Group's revenues, results of operations and financial condition.
- Although not immune from an economic shock or the cyclicality of the capital equipment markets, the Group's diverse customer base, geographic spread and revenue annuities reduce exposure to this risk.
- The Group's business model is not capital intensive and the strong profit margins lead to healthy cash generation which also helps mitigate risks from these external factors.
- The Group benefits from good order exposure 12 months out allowing it to recognise market changes and mitigate the impact.
Dependence on key customers/ suppliers
The Group is dependent on retaining its key customers and suppliers.
Should the Group lose a number of its key customers or key suppliers, this could have a material impact on the Group's financial condition and results of operations. However, for the year ended 31 December 2018, no single customer accounted for more than 14% of revenue.
- The Group mitigates this risk by providing excellent service. Customer complaints and non-conformances are reviewed monthly by members of the Executive Leadership team.
- As the proportion of our own-manufactured products has increased, the reliance on suppliers for third party product has been mitigated proportionally. There has been a shift from a finished goods risk to a raw materials risk.
- We conduct regular audits of our key suppliers and in addition keep large amounts of safety inventory of key components.
|Risks that could have a minor impact on the Company's business and possibly on the viability of the Company's business|
|Risk||Explanation of risk||Mitigation||Assessed trend|
Cybersecurity/ information systems failure
The Group is reliant on information technology in multiple aspects of the business from communications to data storage. Assets accessible online are potentially vulnerable to theft and customer channels are vulnerable to disruption. Any failure or downtime of these systems or any data theft could have a significant adverse impact on the Group's reputation or on the results of operations.
- The Group has a defined Business Impact Assessment which identifies the key information assets; replication of data on different systems or in the Cloud; an established backup process in place as well as a robust anti-malware solution on our networks.
- Internally produced training materials are used to educate users regarding good IT security practice and to promote the Group's IT policy.
- A cyber assessment carried out by the outsourced internal auditor resulted in recommendations that are being implemented to further mitigate cyber risk and safeguard the Group's assets.
Risks relating to regulation, compliance and taxation
The Group operates in multiple jurisdictions with applicable trade and tax regulations that vary. Failing to comply with local regulations or a change in legislation could impact the profits of the Group. In addition, the effective tax rate of the Group is affected by where its profits fall geographically. The Group's effective tax rate could therefore fluctuate over time and have an impact on earnings and potentially its share price.
- An outsourced internal audit function provides risk assurance in targeted areas of the business and recommendations for improvement. The scope of these reviews includes behaviour, culture and ethics.
- The Group hires employees with relevant skills and uses external advisers to keep up-to-date with changes in regulations and to remain compliant.
Strategic risk associated with valuing or integrating new acquisitions
The Group may elect from time to time to make strategic acquisitions. A degree of uncertainty exists in valuation and in particular in evaluating potential synergies. Post-acquisition risks arise in the form of change of control and integration challenges. Any of these could have an effect on the Group's revenues, results of operations and financial condition.
- Preparation of robust business plans and cash projections with sensitivity analysis and the help of professional advisers if appropriate.
- Post-acquisition reviews are performed to extract "lessons learned".
Loss of key personnel or failure to attract new personnel
The future success of the Group is substantially dependent on the continued services and continuing contributions of its Directors, senior management and other key personnel. The loss of the services of key employees could have a material adverse effect on the Group's business.
- The Group undertakes performance evaluations and reviews to help it stay close to its key personnel as well as annual employee engagement surveys. Where considered appropriate, the Group also makes use of financial retention tools such as equity awards.
Exposure to exchange rate fluctuations
The Group deals in many currencies for both its purchases and sales including US Dollars, Euros and its reporting currency Pounds Sterling. In particular, North America represents an important geographic market for the Group where virtually all the revenues are denominated in US Dollars. The Group also sources components in US Dollars and the Chinese Yuan. The Group therefore has an exposure to foreign currency fluctuations. This could lead to material adverse movements in reported earnings.
- The Group reviews balance sheet and cash flow currency exposures and where considered appropriate, uses forward exchange contracts to hedge these exposures. Any forward contract requires the approval of both the Chief Executive Officer and Chief Financial Officer.
- The Group does not hedge any translation of its subsidiaries' results to Sterling for reporting purposes.
Brexit and foreign exchange
The weakening of Sterling versus the US Dollar in the period following the United Kingdom referendum on EU membership in June 2016 had a material effect on the presentation of our financial results in both 2016 and 2017.
Approximately 84% of our revenues (2017: 82%) are denominated in US Dollars and the translation of these revenues into Sterling for reporting purposes has had a beneficial effect. However, the majority of our cost of sales and a large proportion of our operating expenses are also denominated in US Dollars. While a stronger US Dollar helps our overall gross margin in absolute terms (albeit to a limited degree) it also has the effect of reducing the gross margin percentage as costs rise disproportionately to the revenues. We estimate that our reported 2018 gross margin percentage could be approximately 40bps (2017: 60bps) higher as a result.
In terms of the broader economic impacts of Brexit on our business, we do not consider that they will be material. Our products are made in Asia and are already imported into Europe where we have warehouses in both Germany and the United Kingdom and hence we could ship our product destined for the European Union directly into Germany or another appropriate location.
In accordance with provision C.2.2 of the 2016 revision of the UK Corporate Governance Code, the Directors are required to assess the prospects of the Company over a period longer than the 12 months required by the "Going Concern" provision.
In making the assessment, the Directors considered a three-year financial model including the Group Annual Plan for 2019 and strategic financial plan for the years beyond this. The Directors assessed the viability of the Company over a three-year period as this timeframe is within the Group's strategic financial planning period used to evaluate performance and liquidity and aligns with the design-in cycle for which the Group has visibility.
In determining the viability term, the Board assessed the deliberately austere scenarios against the controls in place to prevent or mitigate the risks occurring.
It also considered them against the Group's current banking facilities, a revolving credit facility of US$105 million which expires in September 2021, within the three-year lookout period. Based on the strategic plan an extension to the facility is reasonable and is assumed in the financial model.
The Company has a business model where its products are designed into numerous applications, with numerous customers, in numerous geographies. The Company's products are all designed into capital equipment which is generally in production for a number of consecutive years, resulting in a revenue annuity. This diversity and revenue annuity are both deemed important factors in mitigating many of the risks that could affect the long-term viability of the Group. Nevertheless, the Directors' obligation is to assess the Company's viability in conjunction with the principal risks that could cause a severe but plausible threat. The major risks set out in the Managing Our Risks section were each modelled in a hypothetical and deliberately austere scenario to help determine the potential effect, primarily to cash flow.
The financial model was stress-tested with scenarios which considered the principal risks identified in the Group's annual risk assessment process. Certain subjective assumptions and judgments were made to achieve this. Given the cash generative nature of the business, each risk scenario occurring in isolation did not breach the Group's theoretical borrowing facility headroom. The most severe threats occurring in isolation were found to be a serious and prolonged systems failure, such as to our ERP or CRM systems, or a significant & permanent economic collapse/significant competition scenario.
Scenarios were also prepared to model the unlikely event of more than one risk occurring at the same time. A combination of a temporary or permanent disruption at one of our facilities together with a serious and prolonged economic shock and a combination of tax and regulations compliance failure together with a serious and prolonged economic shock was modelled. In neither of these two scenarios did the Group breach its theoretical borrowing capacity. Based on this assessment, the Directors confirm that they have a reasonable expectation that the Company is viable for at least a period of three years to 31 December 2021.