Individual Risks

Environmental and Sectoral Risks

Sectoral risks

Based on macroeconomic changes in the international markets, the development of the following factors is of great significance for the Salzgitter Group:

prices in the sales and procurement markets,
the exchange rates (especially (USD/€) and
the prices of energy.

With a view to minimizing the associated business risks, we monitor the relevant trends and take account of them in risk forecasts. This is also valid for potential restrictions resulting from political measures affecting international business such as, for instance, a trade embargo.

Along with efforts to set in place to achieve a healthy sales structure, we are especially committed to developing new steel materials, optimizing manufacturing processes and promoting the targeted growth of our Group. We are supported in these efforts by the Research Center of Salzgitter Mannesmann Forschung GmbH (SZMF) with its application-oriented research and development for steel, our aim being to participate in shaping tomorrow’s markets as a successful supplier. In expanding our holdings portfolio by adding the Technology Division our intention is to reduce our dependency on the strongly cyclical nature of the steel industry.

We limit risks from changes in the steel sector by having a decentralized group structure enabling swift decision-making processes which allow us to adapt to new market conditions in a timely fashion. From today’s standpoint, there are no risks identifiable from developments in the relevant sectors which could constitute a threat to Salzgitter AG as a going concern.

Price risks of purchased essential raw materials

Compared with the financial year 2008, the current year saw procurement costs fall in part significantly for the important raw materials of iron ore, coal, scrap and alloys. With this reduced price level as our starting point, we are keeping a close eye on price trends in the year 2010. If economically-induced price increases should become discernable we will identify these risks at an early stage and incorporate them into our profit forecast. Fundamentally, any increase in the selling prices of our products may be able to partially or fully compensate for the higher price of input materials, as has been the case in previous years. We therefore do not expect any significant risks from this front.

Procurement risks

We counteract the potential risk of supply shortfalls of important raw materials (iron ore, coal) and energy (electricity, gas) by safeguarding the procurement in part by way of long-term framework contracts and also through procurement from several regions and/or a number of suppliers. In addition, we operate an appropriate inventory management. Our assessment of our supply sources confirms that the availability of these raw materials in the required quantity and quality is ensured. We source our electricity on a contractually secured basis where our needs exceed our own generating capacity. In order to contain the risks of further electricity price hikes, construction work has been started on two new 105 MW power-generating units at the Salzgitter location which will largely serve to cover the future requirements of Salzgitter Flachstahl GmbH (SZFG). Commissioning of these new units has been scheduled for the year 2010. For the reasons cited above, we believe that supply bottlenecks are unlikely, and we therefore do not anticipate any adverse effects.

The scheduled rail transport of iron ore and coal from our overseas port in Hamburg to the Salzgitter location is also important. Our contractual partner in guaranteeing this logistics task is Railion Deutschland AG, the freight subsidiary of Deutsche Bahn AG. We have developed detailed contingency plans to deal with any adverse events, such as strikes. This plan includes foresighted stockholding and intensive coordination between Railion and ourselves to keep train transports running regularly to the greatest possible extent. A possible alternative would be the more intensive use of the railway facilities owned by the Group, as well as using inland waterways to transport partial shipments.

Selling risks

A risk typical of our business may result from the sharp fluctuations in the prices and volumes in our target markets. In respect of the current economic environment, we refer to the outlook for the financial year 2010 under the section entitled ”Significant Events after the Reporting Date and Forecast”, see page 146.

We counteract any potential general risk to our company as a going concern by having a diversified portfolio of products, customers sectors and regional sales markets.

As effects of the economic situation in the various divisions have different impacts and thus partly compensate for one another, we achieve a certain balance in our risk portfolio. Thanks to our broad-based business and our flexible organization, we are also in a position to swiftly and effectively implement countermeasures tailored to the specific situation.

Production downtime risks

We meet the risk of unscheduled, protracted downtime of our key plant components through regular plant and facility checks, a program of preventive maintenance, as well as a continuous process of modernization and investments. To contain other possible loss or damage with the associated production downtime, as well as other conceivable compensation and liabilities claims, we have the respective insurance cover guaranteeing that the potential financial consequences are curtailed, if not fully excluded.

The scope of insurance cover is reviewed on an ongoing basis and adjusted, if necessary. Aside from cases with the requisite insurance cover already in place, we consider the probability of such events occurring, and any associated potential loss, as low.

Legal risks

In order to counteract risks arising from any potential breach of the manifold fiscal, environmental, competition-related and other rules, regulations and legal provisions, we ensure that they are stringently complied with. We seek extensive legal advice from our experts and, on a case-by-case basis, from qualified external specialists.

To coordinate the Group’s initiatives with respect to policies relating to the steel industry and its associations, as well as to ensure that these initiatives are pursued on a systematic basis, we have set up a group-internal contact desk for international affairs.

There are currently no recognizable material legal risks.

Financial risks

The coordination of funding and the management of the interest rate and currency risks of companies financially integrated into the Group is the task of Salzgitter Mannesmann GmbH (SMG). The risk horizon which has proven to be expedient is a rolling three-year period aligned to the planning framework. The guidelines issued require all companies belonging to the group of consolidated companies to hedge against financial risks at the time when they arise. For instance, risk-bearing open positions or financing in international trading must be hedged. On principle, we permit financial and currency risks only in conjunction with processes typical to steel production and trading.

In relation to the operating risks, these risks are therefore of minor importance with little impact on the risk situation of the Group.

Currency risks

Our procurement and sales transactions in foreign currencies naturally harbor currency risks. The development of the dollar, for instance, exerts a major influence on the cost of procuring raw materials and energy, as well as on selling prices in the tubes segment or mechanical engineering, for example. Although there are reverse effects, the need for dollars in procurement activities predominates, owing to the business volumes which vary greatly. We generally set off all cash flows denominated in foreign currencies within the consolidated group, a process known as netting, thereby minimizing the risk potential.

In order to limit the volatility of financial risks, we conclude derivative financial instruments with terms of up to three years, the value of which develops counter to our operational business. The development of the market value of all derivative financial instruments is determined on a monthly basis. Moreover, for the purpose of the annual financial statements, we simulate the sensitivity of these instruments in accordance with the standards laid down under IFRS 7 (see the section entitled ”Notes to the Consolidated Financial Statements” on page 162).

Default risks

The receivables risks are limited to the greatest possible extent by trade credit insurance. Due to the lack of transparency in the financial markets, trade credit insurers have responded increasingly by curtailing limits or even by fully retracting cover which, from our view, primarily affects the automotive supplier sectors and customers in Eastern Europe.

We counteract this by maintaining a stringent internal system for exposure management. Supported by a task force which spans the Group and which was specially created for this purpose, we monitor and assess developments very carefully and take this into account in our business.

We do not hedge translation risks arising from the converting of positions held in a foreign currency into the reporting currency, as these are of secondary importance in relation to the consolidated balance sheet. In this context, we refer to the information provided in the Notes to the Annual Financial Statements at company and at Group level. As a result of preventive measures, we believe that currency-related risks do not constitute a threat to the company as a going concern.

Liquidity risks

The management holding company monitors the liquidity situation within the Group by operating a central cash and interest management system for all of the companies that are financially integrated into the Group. This involves defining internal credit lines for the subsidiaries. If these subsidiaries have their own credit lines they are responsible for minimizing the associated risks themselves, and they report on the potential risks to the management companies. Risks may also arise from necessary capital and liquidity measures taken for subsidiaries and holdings if their business should develop unsatisfactorily in the longer term. However, we do not anticipate any burdens from this area of risk which could constitute a going concern risk even given the changed general conditions in the environment and the weakened business position of the subsidiaries. We counteract this risk with a rolling financial planning. Given the cash and credit lines available, we see no danger to our Group as a going concern from the current economic situation.

Interest rate risks

The cash and cash equivalents item, significant in relation to the balance sheet total, is exposed to interest rate risk. Our investment policy is oriented to the greatest possible extent towards low risk investment categories with a top credit rating while, at the same time, ensuring the availability of positions. Interest rate analyses, the results of which are directly incorporated into investment decisions, are regularly drawn up for the monitoring and control of interest rate risks.

Tax risks

The recording and documenting of tax risks are carried out by the companies integrated into the pooling of fiscal interests, in close cooperation with the holding company’s tax department. Salzgitter AG and SMG are responsible for provisioning, for example, in respect of the risks inherent in audits of its companies consolidated for tax purposes. In addition, subsidiaries with independent tax liability are responsible for their own provisioning.

In the context of former government aid to border regions, the EU Commission requires Salzgitter AG to make back payments on – from our standpoint – the legal and legitimate tax advantages accrued at that point in time. In 2008, the European Court of Justice made a decision which went largely against the company in the second instance but has referred the case back to the court of first instance. The verdict of this court is anticipated in 2010 at the earliest. Pending the successful outcome of our case, we have already remitted payment of the amount of € 17.8 million (including interest payments) claimed by the Commission.

Personnel risks

Salzgitter AG actively competes on the market to attract qualified specialists and managers. The company counters the risk of fluctuation and the associated loss of knowledge by means of broad-based personnel development measures. Specialist career paths have been explicitly introduced with the aim of creating appealing career prospects for our specialists. Another instrument the company uses is to offer attractive company pension schemes which, given the dwindling benefits under the state pension scheme, is becoming increasingly important.

Above and beyond this, we initiated the ”GO – Generation Campaign 2025 of Salzgitter AG” back in 2005 against the backdrop of the demographic development, with the aim of reacting in good time to the impact of this development on our Group, thereby securing our innovative strength and competitiveness in the long term as well. The project is focused on the systematic preparation of all employees for a longer working life. Given the manifold measures, we believe that we are well prepared in this area of risk (see the section on ”Employees” starting on page 43).

Product and environmental risks

We meet the challenge of product and environmental risks with a series of measures to secure quality. Examples include:

certification in accordance with international standards,
continuous modernization of facilities and plants,
ongoing development of our products,
extensive environmental management.

We have appointed an environmental officer for the Group whose task it is to pool and to coordinate environmental and energy policies across all companies, to represent the Group in matters relating to the environment and energy policies and to manage individual projects affecting the whole Group.

Risks from owning land and property may arise, particularly from inherited contamination. We counteract this risk, for instance, by fulfilling our remediation and clean-up duties. In terms of financial precautions, appropriate amounts of provisions are formed. There are no unmanageable circumstances arising from this type of risk.

Information technology risks

We contain the risks arising in the field of information technology (IT) by developing and maintaining a Group knowledge base for IT services in our subsidiaries. This ensures that we always remain at the forefront of technological progress.

The appropriate authority and competence granted to Group IT management in matters of general policy in this area ensures the ongoing development of our groupwide IT systems and forms the basis for the economic deployment of the required investments.

The consistent renewal of our hard- and software resources in line with the latest technology ensures that availability, maintenance and IT security are kept at the highest levels. Moreover, we operate our own computer center with high standard performance. Additional measures include streamlining the historically evolved heterogeneous IT structures in the Group bit by bit. The risks in this area are deemed manageable, and we estimate the probability of an adverse event occurring to be low.

Corporate strategy risks

We reduce our dependency on the economic cycle typical of the steel industry by expanding our holding portfolio on a selective basis.

An important step in this direction was the takeover of the KHS companies as part of Klöckner-Werke AG (KWAG) in 2007. The Services Division strengthened its telecommunications business by taking over NORTHSTAR Telecommunications GmbH. We have also achieved greater independence from the steel sector by starting to raise a notable minority interest in Aurubis AG, Europe’s largest copper producer, in 2008. For more detailed information we make reference to our explanations in the section on “Management and Control of the Company, Goals and Strategy”, page 56.

To secure our future earnings strength, we have been investing considerable sums in our Group locations in Salzgitter and Peine since 2007. Projects are being realized in spite of the economic environment – in some instances with a delay. More detailed information is contained in the sections entitled ”Management and Control of the Company, Goals and Strategy”, page 56, and ”Investments”, page 64.

By means of suitable reporting and consultation structures, participation in supervisory committees and contractual regulations we limit the risks arising from joint ventures in which we do not hold a majority stake. Hence members of Salzgitter AG’s Executive Board are represented on the Supervisory Board of EUROPIPE GmbH (EP) in order to ensure the transparency of our 50 % joint venture.

With respect to the listed KWAG we ensure our objective through the Supervisory Board’s audit committee, whose tasks include the monitoring of risk management and major risks.

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