Risks and Uncertainties

The risks described below stem from a consideration of the features of Ansaldo STS group’s market and business, together with the key findings of the updated risk assessment process. Risk assessment aims at identifying and evaluating the main risks that could have an impact on achieving objectives, for those processes identified as relevant, and the related mitigating actions, as well as defining additional actions to be taken to further reduce the risk or improve process performance.

Ansaldo STS’s risk assessment process is based on the Committee of Sponsoring Organisations of the Treadway Commission’s internationally-recognised Enterprise Risk Management framework (COSO report) and seeks to integrate risk assessment into the processes of planning, pursuing corporate and internal control targets in order to create value while properly managing risks and mitigation plans, in addition to exploiting any opportunities.

The key risks and uncertainties faced by Ansaldo STS S.p.A. and the group are outlined below following the classification adopted by the group (strategic, operational, financial and IT risks). Risks may exist that have not yet been identified or that are deemed immaterial but which could nonetheless impact group operations.

Reference should be made to the notes to the financial statements for information on the management of financial risks (market, liquidity and credit).

Strategic risks

Changes in the macroeconomic and market context and streamlining programmes

Ansaldo STS group operates internationally and is exposed to risks arising from macroeconomic/geopolitical changes and a reference market presenting the greatest opportunities in emerging nations and those with the highest growth rates. Projects also tend to grow in size and scope and there is an increasingly consolidated trend towards the standardisation of products and technological solutions, especially in the signalling business unit.

Although overall market volumes are growing satisfactorily, competition is more intense, pushing down prices. This market situation could negatively impact Ansaldo STS group’s competitive edge and performance, e.g., contracting margins on new orders and exposure to less advantageous contractual terms.

An additional negative effect on the competitive position of the Ansaldo STS group could derive from the market’s consolidation trend and the lack of a stable partnership in vehicle markets.

Macroeconomic and geopolitical factors that could impact the group’s operations include the growth rate in the reference countries and public spending on infrastructure. The present macroeconomic and financial uncertainty and plans to reduce public debt (both underway or announced) in various countries could generate delays or reductions in new orders, delays in payments and less favourable terms on new contracts, having a negative impact on Ansaldo STS group’s performance.

Given the many variables and uncertainties in the macroeconomic and market context, the corporate strategy may not be immediately updated and adjusted, with a negative impact on Ansaldo STS group’s competitiveness and performance.

A key element of Ansaldo STS group’s strategy is to optimise its operating structure by standardising the solutions and products offered and greater resource use efficiency/optimisation in project implementation. Streamlining projects commenced some time ago - with the latest “Value to Actions - V2A” 2014 project detailed further on - to reduce both external and internal costs via operating process optimisation. The anticipated benefits have already been seen, especially in administrative and sales overheads. Other efficiency initiatives are about to be launched, aimed at increasing benefits on contract profitability.

Progress is subject to ongoing and structured monitoring, including through a dedicated department, given the risk that plans to streamline the group’s operating structure may not be implemented as planned or that their results are weaker than expected or take longer than expected, thus negatively affecting the group’s profits.

Innovation: a competitive factor

The group’s business units feature a high level of technological innovation and this represents an important competitive factor.

Ansaldo STS group’s ability to anticipate technological changes and implement an efficient investment policy is therefore paramount. If it fails to accurately assess innovation requirements, the contents of innovation and development projects, their benefits and related priorities, the group runs the risk of delays in the availability of new products and technical solutions, instability of new products, additional development costs on projects, and lost sales.

Processes to update the product portfolio and the regular assessment of products’ technical competitiveness are in place to mitigate these risks. Furthermore, initiatives were undertaken to focus investment priorities on certain product lines.

The features and degree of technological innovation of the group’s products and technical solutions generate a risk of obsolescence. There are specific processes in place to ensure its effective management.

Operational risks

Country risk for new markets

Ansaldo STS group’s policy of penetrating new markets, particularly those with the highest rates of development, expose it to risks such as: political, social and economic instability, not accurately evaluating local legislation (as applies to companies, tax and signalling system validation), the challenge of protecting intellectual property, exchange rate fluctuations, as well as the creditworthiness of counterparties, which can negatively impact the group’s financial position and results of operations. Country risk is assessed when the group decides which offers and bids to make. How to mitigate the risk and the formalisation of any mitigating actions are also contemplated at the time the proposals are prepared.

Reference should be made to the paragraph of this report covering the halt of the contracts in Libya due to the riots in that country and the delays and extra costs accumulated on the Turkish and Greek contracts.

Reliance on public customers and long-term contracts

Group operations are highly dependent on public customers and, particularly in the transportation solutions business unit, on long-term contracts of a significant amount.

Delays, amendments, revisions or cancellations of one or more significant contracts acquired could negatively impact the company’s operations and its financial position and results of operations.

Assessing long-term contracts using the percentage of completion method requires the estimates of costs to complete the activities, project risks (technical, legal, tax and commercial) and contract progress. These estimates are based on assumptions related to the impact of future events which, by their very nature and given the complexity of the projects underway, may not occur as envisaged, thus negatively impacting the project’s financial and economic performance. Indeed, there is often an element of uncertainty related to third-party performance of civil works for transportation infrastructure and the group cannot always cover the related impacts on programs with contractual clauses.

The following factors mitigate such risks:

  • market diversification and monitoring of country and compliance risk;
  • structured project review processes involving senior management;
  • the regular review and adjustment of contract and programme estimates;
  • the adoption of risk management processes both at the time the offer is made and throughout project implementation, as well as lifecycle management processes involving the regular comparison of physical and accounting progress and project review processes.

Budgeting and risk management project planning

Ineffective project planning and control processes could mean the project team cannot implement the project within the set budget and timeframes, especially complex projects. Likewise, risk management may not be effective if based on incomplete or inaccurate information, or if it is not adequately defined and monitored. These risks could cause delays in identifying issues during project roll-out and inaccurate reporting and planning, with a consequent negative impact on the group’s financial position and results of operations.

To mitigate this risk, there are formalised and monitored processes to check physical and accounting progress and risk management, clear allocation of responsibilities within the project team, managerial review of project performance, review of the estimates at the time the bid is made and an independent review carried out by the risk management department. Specific initiatives have been launched to improve the company’s and group’s planning and control processes.

Third parties (subcontractors, sub-suppliers and partners)

Ansaldo STS group makes considerable use of subcontractors to supply subsystems or assembly and installation services and of subsuppliers for goods or services in its business. The group’s ability to fulfil its obligations to customers therefore relies on both subcontractors and subsuppliers properly fulfilling their contractual obligations.

A breach thereby could in turn cause a breach by Ansaldo STS group, negatively impacting its reputation and, unless it is possible to obtain compensation from the subcontractors and subsuppliers, the group’s financial position and results of operations.

Moreover, particularly in the transportation solutions business unit, Ansaldo STS group also carries out contracts in conjunction with other operators. In these cases, each operator generally has joint and several responsibility vis-a-vis the customer for the completion of the entire contract. In the event of a breach or damage caused to the customer by an operator, Ansaldo STS group could be called on to replace the operator causing the breach or damage, and to compensate the damage caused to the customer in full, without prejudice to the company’s right of recourse vis-a-vis the defaulting operator. If the right of recourse against the operator responsible for the breach or damage is ineffective or protracted, this could negatively impact Ansaldo STS group’ operations as well as its financial position and results of operations.

The preliminary assessment and consequent selection of partners, subcontractors and subsuppliers, particularly in new markets, may be inadequate, with negative impacts on the competitive nature of the technical solutions offered, project performance and on the effectiveness of partnership governance (for instance, differences of opinion between the partners, misalignment of risks and costs/benefits for the individual partners).

To mitigate these risks, the group has processes in place to select and evaluate subcontractors and subsuppliers, it works with known and reliable partners, it defines, agrees and manages appropriate contractual and JV clauses, it has risk management processes and it requests adequate guarantees, where applicable. There are initiatives in place to improve the processes to find potential subcontractors and subsuppliers in new markets.

Efficient technical operations and relevant technical references

Development and engineering activities carried out without a clear understanding and identification of the specific requirements, or with ineffective processes for the allocation of project resources, could negatively affect the project budget, compliance with deadlines, performance and customer satisfaction.

To mitigate this risk, the group has requirement and configuration management processes in place, which are being further improved to ensure quality, compliance with deadlines and efficiency in projects and development management.

Furthermore, if Ansaldo STS group does not have adequate market and operating references for products, this could lead to lost sales and non-compliant project implementation, negatively impacting the group’s competitiveness and its financial position and results of operations. Such risk is carefully assessed at the time the bid is considered and managed through recovery plans monitored by senior management during project roll-out.

Liability to customers or third parties for product defects or delivery delays

Technological complexity and tight delivery times for company products and systems could leave the group liable for delays in or failure to supply contractually-agreed products or services, for their non-compliance with customer requirements (for instance, due to design or construction faults) and for breaches of and/or delays in roll-out, the provision of post-sales services and product maintenance and servicing. Moreover, many products and systems supplied by the company are subject to certifications and approval, including by third-party bodies.

Such liability could be directly attributable to Ansaldo STS group or to third-party operators such as subsuppliers or subcontractors. These risks could negatively impact the group’s operations, its financial position and results of operations and its reputation, and could also result in the group incurring costs to repair faulty products or their withdrawal from the market in extreme cases. Even if adequate insurance is in place, the sum insured could be exceeded or the premiums could be raised following a claim, negatively impacting the group’s financial position and results of operations.

To mitigate these risks, the company agrees specific insurance coverage, carefully supervises its engineering, validation and returns monitoring processes and identifies mitigating actions and provides for contingencies in the bid quote in conjunction with the Risk Management process.

Legal disputes

The complexity of dealings with third parties (customers, subcontractors/subsuppliers and partners), the content of systems and products developed, as well as specific business risks expose the group to a significant risk of legal disputes. Legal disputes could also relate to the awarding of bids. The settlement of disputes could be complex and take a long time, leading to delays in completing projects and negative impacts on the group’s operations and its financial position and results of operations.

To mitigate this risk, there are risk management processes in place during both the bid and management stages, contractual clauses are examined carefully in conjunction with the legal department, and a prudent approach is adopted in recognising specific items under contract costs and provisions for risks.

Human resource management

Ansaldo STS group supplies products and systems featuring cutting-edge technology on a global scale and to do so, it requires human resources with specific expertise, which can be difficult to procure on the labour market.

The success of the business development plans, especially in new markets, also depends on the group’s ability to attract, retain and develop the skills of its human resources, particularly in order to operate in a context of a global market and group.

To mitigate this risk, human resource management policies reflect the business needs. Ansaldo STS group also has an integrated human resource management and development system under which regular checks of expertise and performance are carried out and relevant training initiatives identified, as well as enabling the best possible allocation of resources. Processes and initiatives are also in place to identify the most talented resources, with regard to both managerial and technical profiles, and plot career paths for them. Reference should be made to the section on human resources for a description of the latter.

Certain risk areas persist in relation to the effective management of project teams, which could compromise the achievement of some of the benefits expected from the organisation by bid and project team. Specific initiatives are underway to clarify and strengthen these roles within the project teams.

Health, safety and environmental compliance

Ansaldo STS group has to comply with health, safety and environmental legislation in the various countries in which it operates.

Failure to comply with such legislation as a result of operating processes which are not adequately monitored or - especially in new markets in countries where standards are below-par or that are exposed to specific risks (e.g., high crime rates or epidemic risks) - due to an inadequate evaluation of such requirements and necessary  measures, could expose the group to risks having significant impacts on its operations, its financial position and results of operations and its reputation.

To mitigate this risk, Ansaldo STS group adopts health, safety and environmental management systems ensuring rigorous compliance with legislation in accordance with best practices and subject to internal and external monitoring. These management systems are certified (to OHSAS 18001 standard for workplace safety and ISO14001 for the environment) in most of the group’s key companies.

Requirements in new markets are evaluated at the time the bid is prepared and the assistance of external consultants is also sought. Policies and procedures have also been set to ensure a consistent approach throughout the group’s various companies while still allowing for specific local legislation.

Financial risks

Ability to finance a high level of current assets and obtain guarantees

To carry out contracts Ansaldo STS group requires:

  • adequate financing of current assets;
  • bank and/or insurance guarantees issued to the customer in the various project stages (bid bond, advance payment bond, performance bond, retention money bond and warranty bond) and/or guarantees issued by the parent (parent company guarantees).

Current assets are usually funded by customer advances and progress payments.

Ansaldo STS group’s ability to obtain guarantees at good rates depends on the evaluation of its financial position and results of operations, which is usually based on various indices including the group’s own analysis of their financial position, analysis of the contract risk and experience and competitive positioning in the reference sector.

Ansaldo STS group believes it complies with the relevant parameters. At 31 December 2014, the group had guarantees of €4,052,042 thousand.

Difficulty in negotiating suitable financial terms for new contracts, payment delays and/or suspension and deterioration of existing terms of payments, or the inability or greater difficulty in obtaining guarantees at good rates, would negatively impact the group’s and the parent’s operations and financial position and results of operations.

To mitigate these risks, Ansaldo STS group has commercial and contract management policies focussed on financial aspects, centralised treasury management which optimises the cash flows of the various group companies, its financial position is solid and the contract parameters are assessed right from the time of the bid stage.

In the present economic and market context, due to new contracts which have less favourable financial terms, working capital is monitored closely and specific initiatives are in place to mitigate its impact.

Project Financing and PPP (Public and Private Partnership) transactions

At times the market offers transport systems providers the definition and management of a financing scheme, through project financing transactions, including by involving private financers.

Such transactions have various risk profiles, such as the complexity of contractual schemes offers, inaccurate preparation and re-examination of bid documentations and inappropriate assessment of partners that could led to assuming improper risks. Even a non-performance in the construction stage, especially related to construction times, and the operation stage could lead to safeguard clauses being activated and fees not being paid or invested capital being lost. Such risks could have a negative effect on the group’s financial position and results of operations.

In order to mitigate such risk, bidding process which involves all relevant company functions for an accurate assessment of the transaction, including through the use of third-party advisors and the above-mentioned risk assessment procedures during the bidding stage, including with respect to possible partners.

IT risks

IT system management

IT systems are a vital part of Ansaldo STS group’s operating structure and their management must be in line with the group’s strategic objectives. IT solutions that do not match business needs, or upgrades thereof that do not meet users’ needs, or inefficient system or outsourcer management, could compromise the efficiency and effectiveness of group operations.

Moreover, the unavailability or interruption of IT services or data loss or damage (including sensitive data or intellectual property), also as a result of hacking, could compromise group operations.

To mitigate this risk, the IT policies were set in consideration of the organisational and process change initiatives.

Moreover, Ansaldo STS group has a governance system based on best practices and follows structured and monitored processes for hardware and software management.