Delivery of the Company’s commercial objectives is dependent on a number of key arrangements with customers, suppliers and distributors. A large proportion of our revenue derives from sales to the major UK retailers who are themselves under significant pressure due to continuing structural changes in grocery retailing. New strategic initiatives around ‘Cake on the go’, our planned expansion into the chilled Grocery segment and increased focus on International markets expose us to risks and uncertainties associated with operating in new categories, markets and/or customers. Growth may not be as strong as expected and/or may take longer than expected to be delivered. However ‘Cake on the go’ is considered to be the lowest risk of these new initiatives. We have a key licensing agreement for use of the Cadbury brand (which runs at least until 30 June 2017 with an extension currently being negotiated). Failure to renew this license could have implications for our Cadbury manufacturing site at Moreton. Other licensing agreements include Loyd Grossman (which continues until 2026 but is dependent on achieving performance targets) and a new agreement with Paul Hollywood to support a range of home baking products introduced to the market in the last quarter of 2015/16, also subject to performance targets.
We have worked closely with our major customers to agree business plans that are strategically aligned and reflect mutual growth opportunities and have strengthened customer relationships through our category management activities. Strategic initiatives to grow our business with discounters, convenience, online and international markets will broaden our customer base and reduce the dependence on major retailers. We have significantly increased our investment in our commercial teams to support our growth plans. The non-branded business has seen substantial growth. The ‘Cake on the go’ offering aims to grow our share in the convenience market. New strategic initiatives are being implemented in a measured way through phased entry and are supported by trials where appropriate. In addition we expect that the new co-operation agreement with Nissin, announced in March 2016, will support our growth initiatives and create mutual opportunities to leverage brands, technology, presence in international markets and customer relationships. We enjoy good relationships with our licensed brand owners and are engaged in appropriate commercial discussions with them. This is supported by successful recent innovation activity, particularly with Cadbury.
There is a risk that commodity prices may increase over the time frame of our strategic plan which could impact margins and/or our ability to invest in marketing and capital expenditure activities. Additionally, if the upcoming referendum results in the UK leaving the EU, the subsequent forecasted devaluation of sterling would have an adverse impact on imported raw material costs, only partially offset by positive currency benefits in our international business.
Hedging activity and ongoing supplier risk management and price negotiation processes are in place to mitigate the impacts of commodity price inflation. Appropriate assumptions for movements in commodities and foreign exchange have already been reflected in the current budget and business plan. If commodity price increases are significant, we could seek to recover these through price increases to our customers.
The business may be subject to significant new regulatory compliance requirements as a result of Government policies, including potential measures to address the obesity issue which could adversely impact our business, particularly in Sweet Treats. New legislation on the National Living Wage and the Apprenticeship Levy could also adversely affect margins. Corporate tax legislation changes, although currently unconfirmed, could impact our ability to utilise tax losses in future.
We are taking pro-active steps to reduce the sugar and calorie content in our products and have published a nutrition strategy with ten commitments to healthier choices (for further information see page 22 of annual report 2015/16). Innovation activities are also focused on improving health aspects of our product portfolio. We actively engage in regulatory discussions with trade bodies such as the Food and Drink Federation (FDF). The business is currently reviewing its short and long-term strategy with regard to the National Living Wage and Apprenticeship Levy. We will monitor changes to tax legislation and review our tax strategy accordingly.
The Group could be exposed to reputational and/or financial risks through the activities and performance of its Hovis Joint Venture and the Knighton Foods business, previously a joint venture and now fully controlled by the Group.
Under certain circumstances, as a result of English statute law, the Group could also have some residual liability for certain operational properties held by Hovis under long-term leases, although this element of risk is currently considered to be remote.
The Group has senior executive representation on the Board of Hovis and has fully written off its investment in this company. Hovis has independent sources of finance which are non-recourse to the Group. In the event that the Group becomes liable for Hovis property obligations we would seek to sub-let these properties or surrender the leases. The Group has assumed control of the Knighton Foods business in order to address operational issues.
The Group supports a number of significant pension schemes which are in deficit on an aggregate level. The resulting balance sheet liability may fluctuate due to factors outside the Group’s control
The Group has agreed deficit funding payments which (unless the Group resumes payment of dividends) are fixed until the end of 2019. The RHM Pension Scheme, which is the largest scheme, has a sophisticated investment strategy which is designed to minimise risk while earning long-term returns in line with the scheme’s funding requirements. The scheme makes use of swaps and other financial derivatives in order to hedge interest rate and inflation exposures. The smaller Premier Foods schemes have a much lower funding position and therefore less ability to hedge. These schemes are more reliant on cash contributions from the Group as well as positive investment returns to reach a satisfactory long-term funding position. The Group enjoys close relationships with the various Trustees, through regular meetings with the Trustee Chairs through the Pension Liaison Forum and attendance, by invitation, of the CFO and members of his team at investment committee meetings. A triennial valuation will be concluded later in 2016 but this will not affect deficit contributions until 2020.
Delivery of our strategy is dependent on the organisation’s ability to minimise operational disruption from issues with facilities, IT and factory infrastructure, as well as procurement and logistics functions.
We have crisis management processes in place and business continuity plans are reviewed and refreshed on an ongoing basis. The financial impact of material site issues is mitigated by insurance cover. Systems resilience is built in through the deployment of dual data centres and will be enhanced following the completion of a re-hosting project in early 2016/17. Procurement category strategy plans are in place to monitor and mitigate risk around key suppliers.
A major disruption at one of our operating sites could impact service levels.
Crisis management processes are in place and business continuity plans are refreshed across all operational and administrative sites. Insurance cover is also in place to mitigate the short-term financial impact of site disruption.
The business is exposed to risks around food contamination with hazardous products as well as food authenticity. A major food safety incident could result in financial, regulatory as well as reputational impacts.
We have an ongoing program of food safety audits at sites and suppliers and strong process controls in this area, including a best-in-class laboratory for food testing. The surveillance program also includes licensed products and audits of licensed manufacturers. We have signed up with SEDEX to promote ethical trading.
The business is dependent on a number of core IT systems, the breakdown of which could result in operational disruption. The business could also be impacted by security breaches, including the evolving threat of cyber security which could lead to damage to assets, loss of commercially sensitive information or reputational damage. Increasing reliance on Cloud technology for storage of information also carries evolving security risks.
Systems resilience is built on through the deployment of dual data centres and the recent completion of the Connect Program, an initiative to update legacy systems. A re-hosting project was completed in 2016 which will further improve our resilience and Disaster Recovery capability. There is a regular penetration testing program in place to assess network vulnerabilities and DR plans are in place and tested on an agreed cycle.
Security of supply could be disrupted by commodity price fluctuations, key supplier performance, relationship and solvency issues, as well as global political and economic unrest.
There are extensive Procurement category strategies in place to review risks for key categories, market trends and potential supplier issues. Supplier relationships are monitored and managed on a day to day basis by the Buying teams. Commodity price fluctuations are monitored and appropriate hedging strategies implemented by the Procurement and Treasury teams. The business has recently completed the supplier reduction program and is further enhancing supplier partnering strategies, for example through a supplier innovation initiative.
The business is subject to a number of legal and regulatory compliance requirements and must continually monitor new and emerging legislation, in areas such as Health & Safety, the listing regime, competition law, food safety, labelling regulations and environmental standards.
Leading food industry processes are in place to manage Health & Safety and food safety issues, including an ongoing programme of internal and external audits. There are dedicated legal and regulatory teams in place to monitor changes in legislation, ensure compliance across the organisation and defend against litigation where necessary.
Health & Safety is a key priority for the business. As well as the human cost, a serious workplace injury of fatality could carry financial and reputational risks as well as legal consequences under applicable regulation.
We have a zero tolerance policy towards workplace incidents and a best in class process for managing health and safety, including TOPS tours and a regular cycle of inspections and specialist health and safety audits across all sites.
The business must comply with government and EU codes around advertising and food labelling, as well as changing legislation on healthy eating, for example restrictions on salt and sugar content. We also need to maintain compliance with ethical trading standards.
We have a dedicated Regulatory team in place to monitor changes in legislation and ensure compliance across the business. We are also a member of SEDEX as part of our ethical assurance program.
The business could be exposed to financial and/or operational risks as a result of failure to observe laws and regulations or commercial claims e.g. for breach of copyright.
We have a dedicated Legal team in place to provide guidance to the business and ensure legal compliance. They are supported by external expertise when necessary.
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