Internal control and risk management
The Board recognises its responsibility for the internal control system and procedures of the Company. The Board is responsible for reviewing and approving the adequacy and effectiveness of the internal controls operated by the Company. These controls include financial, operational and compliance controls as well as risk management. The Board has delegated responsibility for such review to the Audit and Risk Management Committee, which is in close contact with the individuals responsible for NWR’s internal control. The Audit and Risk Management Committee receives regular reports on the performance and developments in the Group’s internal control environment. These reports are first reviewed by the Audit and Risk Management Committee and thereafter discussed in the Board.
Senior management is responsible, for the implementation of Board policies on risk and control and for identifying, approving and enforcing key policies that consider all aspects of the Company’s business. To the best knowledge of the Board the internal control and risk management systems provide a reasonable assurance that the financial reporting does not contain any errors of material importance and internal control and risk management systems worked properly in 2008.
Risk factors
Due to the nature of the business and the scope of our operations, the results of the Company may be impacted by a number of factors. Material risk factors that can possibly affect the performance of the Company can be divided into four main categories:
- operational risk;
- organisational risk;
- financial risk; and
- governmental regulation risk.
Certain details of the risk factors included in these categories are described below.
Operational risk factors
Economic conditions globally and in the CEE may continue to have an adverse effect on the Group’s business.
Recent events in the global economy and specifically, the Central and Eastern European economy have adversely affected the Group’s business, including the demand for and price of coal. The continuation, or worsening, of current global and CEE economic conditions could continue to result in a decrease in the use of coal by the Group’s Central European customers, specifically the Central European steel and coking industries, or result in decreased prices for coal and/or coke. The Group’s suppliers and customers may be affected by the economic instability, which would affect the Group’s production and supply process and could adversely affect the Group’s business, financial condition or results of operations.
Impact of health, safety and environmental exposures and related regulations on operations and reputation.
The Group’s coal mining operations are subject to significant operating risks that could result in decreased coal production, which could reduce its revenues. The Group is strongly committed to minimise risk in the health, safety and environmental areas as far as possible, however, due to the nature of its operations, there may be unforeseen events out of the control of the Group that can adversely affect the Group’s business, results of operations and financial condition.
In addition, any significant changes in government or EU regulations could adversely affect the Group’s ability to produce and sell its products in the highly competitive environment.
Fluctuations in production costs and price of commodities, specifically coal may continue to have an adverse effect on the Group’s business.
The Group’s main production expenses are contractor costs, materials, personnel costs and energy. Changes in the costs of the Group’s mining and processing operations could occur as a result of unforeseen events, including international and local economic and political events, and could result in changes in profitability or reserve estimates. Many of these factors may be beyond the Group’s control.
The Group’s long-term framework agreements provide that prices are renegotiated periodically, which may lead to lower revenues when coal prices decline. The agreements generally do not commit the Group’s customers to purchase any quantity of coal at any price beyond a one-year period. As a result, the Group’s long-term framework agreements would provide only limited price protection if coal prices decline. If the existing long-term framework agreements with the Group’s major customers were modified or terminated or if periodical renegotiated prices or volumes would not reflect the expected or historical contracted values, the Group’s revenues and operating profits could be materially adversely affected to the extent that it is unable to find alternative buyers for its coal on comparable terms as in its existing agreements.
We rely on the performance of highly skilled personnel, and if we are unable to hire and retain qualified personnel, or to retain key personnel, our business would be affected.
A shortage of skilled labour in the mining industry could result in the Group having insufficient employees to operate its business. In the event there is a continuing shortage of skilled labour, there could be an adverse impact on the Group’s labour productivity and costs and its ability to maintain or expand production. This could adversely affect the Group’s business, results of operations and financial condition.
The Group’s senior executives together have an average of approximately 18 years of experience in the coal industry, with specific experience in, among others, maintaining strong customer relations and making strategic and opportunistic acquisitions. The ability to maintain the Group’s competitive positions and to implement the Group’s business strategy is dependent on the Group’s senior management and the ability to attract and retain experienced and qualified members of management. In particular, the contributions of Mike Salamon, the Executive Chairman of NWR’s Board, Klaus-Dieter Beck, CEO and Chairman of the Board of Directors of OKD, and Marek Jelínek, the CFO of NWR, are critical to the management of the Group. If the Group is not able to continue to retain such key personnel, it may be unable to manage its growth or otherwise compete effectively in the Central European coal industry, which could adversely affect its business.
The Group may be unable to recover investments in mining projects due to adverse developments in production, transportation, energy supplies or resources.
The Group’s success of operations is largely dependent on a stable production and supply process, both towards the Group as towards its customers. Any adverse developments in any of the related processes, such as increased costs or the unavailability of production, transportation or energy supplies may negatively affect the Group’s operations.
The Group operates in a competitive environment.
The energy industry is characterised by competition, particularly with respect to price. The continued development of alternative fuel sources or new coal mines, particularly in the CEE area, could negatively impact our operating results.
The failure to acquire and develop additional reserves may adversely affect our business.
The Group’s ability to sustain or increase its current level of production depends, in part, upon its ability to acquire and develop additional coal reserves that are economically recoverable and to develop new and expand existing mining operations. The Group could be limited in acquiring its growth targets as a result of many factors, including, but not limited to:
- the Group’s ability to raise sufficient financing;
- restrictions under the Group’s existing or future debt agreements;
- competition from other coal companies for suitable properties;
- the lack of suitable acquisition candidates;
- the inability to acquire coal properties on commercially reasonable terms; and
- economic conditions in Central Europe or globally.
In addition, the involvement of many different parties in the Group’s operations as well as its acquisition projects, such as external engineers, governments, environmental groups, unions, contractors, suppliers and consultants may influence the Group’s ability to act in a timely and appropriate manner in its acquisition and expansion efforts.
We may be unable to increase efficiency or decrease costs where necessary.
The Group must continue to implement cost reduction and profit improvement initiatives to achieve its business plan and preserve its long-term prospects. These profit improvement plans depend on realising cost savings, efficiencies and synergies from the introduction of new technologies and operating processes and on the ability to appropriately balance the size of the Group’s workforce. The Group may be unable to implement one or more of its profit improvement initiatives successfully or it may experience unexpected cost increases, which could have a material adverse effect on its business, results of operations or financial position.
We are dependent on a small number of large customers.
A substantial portion of the Group’s sales volume of coal, including to its major customers, is sold under long-term framework agreements, and a substantial portion of the Group’s sales are made to a small number of customers. A decrease in demand for the Group’s products or the inability to collect payment from any customer could adversely affect the Group’s results of operations and financial condition.
Breaches in our information technology security could adversely affect our business.
IT security processes may not prevent malicious actions by individuals or groups, which may result in the theft or misappropriation of commercially sensitive information or the theft or misappropriation of funds, among other things.
Organisational risk factors
The privatisation of the Group comprising the Former OKD Group and government sales could be challenged and could result in the Company’s ownership of its business being deemed invalid or could result in additional liability being attributed to the Company, which could materially affect the Company’s business, financial condition and results of operations.
The Company’s business was privatised by the Czech government in a series of transactions throughout 1992 and 2004. These transactions involved privatisation through a voucher program and sales of shares to Karbon Invest by the National Property Fund. In addition, between 2002 and 2004, Former OKD transferred mines that have become inactive (together with certain liabilities) to Czech state public enterprises. Such transactions generally are complex and may have been implemented by the government in a way that lacked transparency or is otherwise open to criticism and adverse publicity, which may lead to attempts to unwind or otherwise challenge such transactions through legal action. In the event that the ownership of any of the Company’s subsidiaries or Company’s assets is challenged through such legal action and the Company is unable to defeat any such action, the Company risks losing or altering ownership in such companies or such assets which could materially adversely affect its business, financial condition and results of operations.
Restrictive covenants under our senior secured facilities and our Indenture may limit the manner in which we operate.
Our senior secured facilities and the Indenture governing our 7.375 per cent senior notes due 2015 contain, and any future indebtedness we incur may contain, various covenants and conditions that limit our ability to, among other things, incur additional indebtedness; make restricted payments (including dividends); create liens; transfer, convey, sell, lease or otherwise dispose of voting stock; sell assets; engage in transactions with affiliates; guarantee any debt of NWR or its subsidiaries; and consolidate, merger or sell all or substantially all of our assets. As a result of these covenants, we are limited in the manner in which we conduct our business and we may be unable to engage in favourable business activities or finance future operations or capital needs.
We are substantially owned and controlled by RPGI which is able to make important decisions about our business and capital structure; its interests may differ from the interests of our other shareholders or the holders of our Senior Notes and our lenders under our senior secured facilities.
RPGI owns a majority of the A shares of NWR. As a result, RPGI effectively controls NWR and generally has the power to elect all of the members of our board of directors, appoint new management and approve any action requiring the approval of the holders of NWR’s shares, including changes to our capital structure and approving acquisitions or sales of all or substantially all of our assets. Our Directors have the ability to control decisions affecting our capital structure, including the issuance of additional share capital, the implementation of share repurchase programmes and the declaration of dividends. The interests of RPGI may not in all cases be aligned with the interests of our other shareholders, or the holders of our Senior Notes or any other holder of our debt. If we encounter financial difficulties, or we are unable to pay our debts as they mature, the interests of RPGI might conflict with those of our other shareholders, or the holders of the Senior Notes or any other holder of our debt. RPGI may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in its judgement, could enhance its equity investment, even though such transactions might involve risks to our shareholders or holders of the Senior Notes or our other indebtedness.
Financial risk factors
Our financial results may be adversely affected by fluctuations in currency exchange rates and interest rates.
The Group’s sales are typically priced in Czech Korunas and Euros, and the Group’s direct costs, including raw materials, labour and transportation costs, are largely incurred in Czech Korunas, while other costs, such as interest expense are incurred in Czech Korunas and Euros. The mix of the Group’s revenues and costs is such that appreciation of the Czech Koruna against the Euro tends to result in a decrease in the Group’s revenues relative to its costs and a decline in its results of operations. In addition, if the Czech Koruna depreciates significantly against the Euro, the Group could have difficulty repaying or refinancing its foreign currency denominated indebtedness.
The Group’s development projects in Poland are subject to fluctuations of the Polish Zloty against the Euro and Czech Koruna. It is possible that changes in the exchange rate of the Polish Zloty may adversely affect the Group’s results of operations.
Claims by or liabilities to third parties resulting from the Company’s activities may adversely affect our profitability.
The nature of the Group’s operations may be a source for potential claims or liabilities related to damages to properties owned by third parties. Any such costs incurred for reclamation or compensation paid for property damages may require the Group to make significant payments in the future adversely impacting the Group’s business, results of operations and financial condition.
Our substantial debt or our inability to incur additional debt could adversely affect our financial condition.
As of 31 December 2008, we had substantial indebtedness, including EUR 729 million of senior secured debt incurred pursuant to our Senior Secured Facilities, and EUR 290 million of high-yield debt incurred pursuant to our 7.375 per cent Senior Notes due 2015. The requirement to service our debt makes us more vulnerable to general adverse economic conditions, requires us to dedicate a substantial portion of our cash flow from operations to payments on our debt, and limits our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate.
The Group must make significant capital expenditures in order to maintain or increase its productions levels and improve overall efficiency. The inability to finance these and any other expenditures through debt financing could have an adverse effect on the Group’s business, financial condition or results of operations.
Governmental regulation risk factors
Environmental or other regulatory requirements that may result in increases in costs or decreases in production ability or demand for coal.
Any increased local or international environmental regulations could have a significant adverse effect in the effective cost or the use of coal and as a result, decrease the demand for coal. In addition, the operations of the Group could be subject to increased environmental or other regulations, increasing the costs or decreasing the production capacity of the Group. This could have an adverse effect on the Group’s business, financial condition or results of operations.
We may be unable to obtain or renew the required permits for mining activities.
The Group may be unable to obtain and renew permits and licences necessary for our operations or mining of specific coal deposits, which would reduce our production and could adversely impact the Group’s business, financial condition and results of operation. Regulations in the environmental and safety matters in connection with coal mining are strict and complex and may change over time, making the Group’s ability to comply with the applicable requirements more difficult or even impossible, thereby precluding continuing or future mining operations.
We may face increased costs due to governmental actions.
Pursuant to the Mining Act, the Group is subject to mining concession fee payments to the Czech government, and increases in such fees in the future could adversely affect the Group’s business, results of operations and financial condition. In addition, changes and developments in economic, regulatory, administrative or other policies of Polish or Czech governments or those of the European Community, over which the Group has no control, could affect the Group’s business, prospects, financial conditions and results of operations.
Risk Management and internal audit
The Group’s risk management function and the applied system of internal control focus on the management of business risks in order to maintain and achieve business objectives. The Group’s risk management system is designed to focus its risk management activities in the areas where the specific risks exist. This is ensured by the development of local and Group-wide risk management structures and policies that are reviewed and governed by the Audit and Risk Management Committee.
The Audit and Risk Management Committee regularly reviews the risk assessment strategies and procedures as well as the risk profile throughout the Group and reports its findings to the Board.
Management has put in place significant control systems to ensure the integrity of the Group’s reporting as well as the effectiveness of the Group’s internal control and risk management structures. These controls include the establishment and functioning of various board committees throughout the Group, the Audit and Risk Management Committee and the establishment of the Group’s internal audit function.
The tasks of the Group internal audit function includes:
- ensuring coverage of main risks and internal control issues at Group level;
- overseeing and aligning operational risk and control reviews performed by local teams at subsidiary level where applicable;
- supporting the development and maintenance of a group-wide risk and internal control approach and mechanism; and
- keeping the Board apprised of issues and developments in these areas.
Additionally, the purpose of the Group internal audit function is to establish and maintain an effective and adequate organisation of active internal audit teams throughout the Group, ensuring sufficient resources in place in key positions in internal audit. In situations where there is no operating internal audit team at subsidiary level, the Group level function organises and supports the activities at such level. Depending on the nature and size of the specific subsidiary, the Group may take steps needed to establish and support a local internal audit team. In situations where the nature or size of the subsidiary does not warrant a stand-alone internal audit function, the Group level function will continue managing the internal audit activities.
The Board considers the ability to respond to changes within the relevant business environment a key element in the effectiveness of the Company’s business and its performance. This ability and the consecutive actions are continuously monitored and reviewed throughout the year.