Most significant business risks and risk management

Significant short-term risks and uncertainties 

Half Yearly Report January 1 - June 30, 2017 (published July 20, 2017)

Caverion's typical operational risks relate to its services and project business. These include risks related to tendering (e.g. calculation and pricing), contractual terms and conditions, partnering, subcontracting, procurement and price of materials, availability of qualified personnel and project management. To manage these risks, risk assessment and review processes for both the sales and execution phase have been introduced, and risk reservations have been increased. Given the specific risks related to project business, the Group Project Business Unit was established in the beginning of 2017 and is dedicated to the overall improvement of project risk management, to steering the project portfolio and to improve project management capabilities. Despite all actions taken there is a risk that some project risks materialise, which could have a negative impact on Caverion’s financial performance and position. Project risk assessment is an ongoing process in the company, and it is possible that risks may be identified in the other currently running and new projects.

Caverion completed a thorough project risk assessment during 2016, which resulted in significant project write-downs and provisions during 2016. There is also remaining risk in these projects. Although improved project controls have been implemented, it is possible that some of the identified remaining risks may materialise, which could lead to further project write-downs and provisions, in addition to the ones already made in the first half of 2017, and to disputes and litigations. It is also possible that new risks may emerge in these projects.

According to Group policy, write-offs or provisions are booked on receivables when it is evident that no payment can be expected. Caverion Group follows a policy in valuing trade receivables and the bookings include estimates and critical judgements. The estimates are based on experience on realised write-offs in previous years, empirical knowledge of debt collection, customer-specific collaterals and analyses as well as the general economic situation of the review period. Caverion completed several risk assessments related to POC and trade receivables in its project portfolio during 2016, which led to write-downs on receivables during 2016. Most of these write-downs related to POC receivables. A further review and risk assessment will be continued during 2017. There are certain individual larger receivables where the company is taking significant actions to negotiate and collect the receivables. There is remaining risk in the identified receivables, and it cannot be excluded that there is also risk associated with other receivables.

Given the nature of Caverion’s business, Group companies are involved in disputes and legal proceedings in several projects. These disputes and legal proceedings typically concern claims made against Caverion for allegedly defective or delayed delivery. In some cases, the collection of receivables by Caverion may result in disputes and legal proceedings. There is a risk that the client presents counter claims in these proceedings. The outcome of disputes and legal proceedings is difficult to predict. Write-downs and provisions are booked following the applicable accounting rules.

The investigation of violations of competition law related regulations in the technical services industry in Germany continues. As part of the investigation German authorities have searched information from various technical services providers, including Caverion. Caverion co-operates with the local authorities. Based on the currently available information, it is still not possible to evaluate the magnitude of the potential risk for Caverion related to these issues. The timing of the closing of the investigations is also unknown. It is possible that the costs, sanctions and indemnities can be material.

As part of this co-operation Caverion has identified activities during 2009-2011 that are likely to fulfil the criteria of corruption or other criminal commitment in one of its client project executed in that time. Caverion has brought its findings to the attention of the authorities and supports them to further investigate the case. It is possible that these infringements will cause considerable damage to Caverion in terms of fines, civil claims as well as legal expenses. However, the magnitude of the potential damage cannot be assessed at the moment. Caverion is monitoring the situation and will disclose any relevant information as applicable under regulations.

Caverion is implementing a robust compliance programme. As part of the programme all employees must complete an annual e-learning module and further training is given across the organisation. All employees are required to comply with Caverion’s Code of Conduct, which sets zero tolerance on bribery and corruption.

Goodwill recognised on Caverion’s balance sheet is not amortised, but it is tested annually for any impairment. The amount by which the carrying amount of goodwill exceeds the recoverable amount is recognised as an impairment loss through profit and loss. If negative changes take place in Caverion’s result and growth development, this may lead to an impairment of goodwill, which may have an unfavourable effect on Caverion’s result of operations and shareholders’ equity.

Caverion’s external loans are subject to a financial covenant based on the ratio of the Group’s net debt to EBITDA. Breaching this covenant would give the lending parties the right to declare the loans to be immediately due and payable. Caverion and its lending parties confirmed the EBITDA calculation principles related to the Group’s financial covenant (net debt to EBITDA) in December 2016. Furthermore, Caverion concluded an amendment with its lending parties related to the maximum level of the financial covenant in the Q1/2017 testing in March 2017. On June 9, 2017 Caverion issued a EUR 100 million hybrid bond which is treated as equity under IFRS. The hybrid bond issue improved the Group’s liquidity and capital structure, hence also the financial covenant level. At the same time the company agreed on a maximum level of the financial covenant for the Q2/2017 and Q3/2017 testings. The project write-downs made in 2017 have burdened the company’s financial covenant level in the first half of 2017 and the remaining project risks may result in further project write-downs in the second half of 2017. The level of the financial covenant ratio is continuously monitored and evaluated against actual and forecasted EBITDA and net debt figures.

Caverion’s business typically involves granting of guarantees in favour of customers or other stakeholders, especially in large projects, e.g. for advance payments received, for performance of contractual obligations, and for defects during the warranty period. Such guarantees are typically granted by financial intermediaries on behalf of Caverion. There is no assurance that the company would have continuous access to sufficient guarantees from financial intermediaries at competitive terms or at all, and the absence of such guarantees could have an adverse effect on Caverion’s business and financial condition. To manage this risk, Caverion’s target is to maintain several guarantee facilities in the different countries where it operates.

Financial risks are described in more detail in the Financial Statements note 30 and in the financial tables to this Half Yearly Report under note 5.

Caverion has made significant investments in IT and system development. There is a risk that the expected functionalities and pay-back are not fully materialised.