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Annual Report 2008 - AMG Advanced Metallurgical Group NV

Annual Report 2008 - AMG Advanced Metallurgical Group NV

Risks Risks faced by

Risks Risks faced by AMG can broadly be categorized as: • Strategic: includes risks related to marketing and sales strategy, product innovation, technology innovation, overall raw material sourcing decisions, capacity decisions and acquisitions • Operational: includes risks related to executing the strategic direction, supply of raw materials, production, maintenance of production equipment, distribution of products, labor relations, human resources, IT infrastructure, health, safety and environmental, and sales and marketing • Market and external: includes risks related to global and regional economic conditions, market supply/demand characteristics, metal prices, substitution, foreign exchange rates, customer and competitor actions and community relations • Financial: includes risks related to accuracy and timeliness of financial reporting, compliance with IFRS accounting standards, compliance with AFM and Euronext Amsterdam requirements, currency fluctuations, budgeting, metal price and currency hedging, treasury and tax functions • Regulatory: includes risks related to the political, environmental and legislative environment Current global economic conditions also have a significant influence on AMG’s financial performance. Specifically, many of AMG’s products are used in the energy, infrastructure and transportation industries. Slowdown in demand from those industries will reduce AMG’s financial performance. AMG’s business is global in nature. Regional diversification may help mitigate localized economic slowdowns. Current global economic uncertainty also negatively influences AMG’s financial performance. Uncertainty increases the difficulty of near-term and long-term planning, specifically as it relates to planning production levels, securing raw materials, entering into sales contracts, investing in capital expenditures, staffing levels and financing needs. AMG, like most industrial companies, faces a combination of risks. It is not the intention to provide details on each risk posed to AMG in this report. The six risks most pertinent to the business are described in detail below. Customer Risk AMG is exposed to an increasing risk of customers defaulting on accounts receivable or not performing on their contracts. The current economic crisis compounds this risk as once sound companies may fail quickly because of existing leverage or lack of financing options. This risk is most profound in the Advanced Materials Division, at Timminco and at GK where reduced global demand may lead to customers not honoring contract commitments by not purchasing contracted volumes of material or not paying contracted prices. To mitigate this risk, AMG has insured some of its accounts receivable and has set credit limits on its customers, which it closely monitors. The Engineering Systems Division collects prepayments from most of its customers. As a result of the prepayments for vacuum furnaces systems, the Engineering Systems Division mitigates a portion of a customer’s payment and performance risk. Metal Price Volatility Risk AMG is exposed to risk in the prices of certain metals. Risk can arise from changes in price between purchase, process and sale of the metals to end-price risk for metals when raw materials are purchased under fixed price contracts. Most metals AMG processes and sells, such as chromium metal, tantalum, graphite, ferrotitanium and antimony trioxide cannot be hedged on an exchange. To mitigate price risk for these metals, AMG seeks to enter into complementary raw material supply agreements and sales agreements whereby the price is determined by the same index. AMG also attempts to time its raw material purchases with sales orders from customers. Further mitigation comes from establishing low-cost long positions in key raw materials through ownership positions in mining activities 30 Report of the Manaagement Board | Risk Management and Internal Control

(tantalum, niobium, graphite, quartz), through structured long-term supply contracts (in ferrovanadium and ferronickel-molybdenum), or long-term fixed price sales contracts (Timminco’s UMSi). Despite this mitigation, AMG retains some exposure to price volatility, most significantly in vanadium. Success of the mitigation plans is dependent on the severity of metal price volatility and counterparties performing under their contracts. The Company hedges exchange-traded metals, such as aluminum, when possible. In its aluminum business, AMG also sells conversion services with no metal price risk. Currency Risk AMG’s largest currency risk exists where it incurs more costs in one currency than it generates revenues in that currency. The single largest sensitivity of this nature exists for the Euro. Risk also exists with the British Pound and Brazilian Real. At Timminco, risk exists with the Canadian Dollar. AMG may enter into currency hedges to mitigate this risk. AMG also faces currency risk when it enters into a fixed price contract to sell a product – a vacuum furnace for example – in one currency while the costs incurred are in another and the currency might vary between the time a price is fixed with a customer and when that transaction is closed. AMG typically enters into currency hedges to mitigate this risk. Capacity Utilization Risk Reduced capacity utilization results in fewer economies of scale and higher per unit costs. If AMG is not able to pass on its increased costs, financial results will be negatively impacted. Business Strategy and Innovation Risk The continued growth of AMG’s business requires the development of new products and new production processes. Developing and investing in these new products and production processes involves risks. The most significant risk at this moment is the balance between the appropriate levels of investment in innovation to secure future growth versus the need to preserve cash to withstand the economic crisis. Additionally, AMG continues to face risks in the scale-up of new production facilities/methods and in new technologies or products. In particular, AMG faces risk in the scale-up of its solar silicon business at its Timminco facility. Financing Risk The current economic crisis has severely restricted AMG’s ability to access the capital markets – debt or equity. A prolonged restriction on accessing the capital markets and additional financing may negatively affect AMG’s ability to fund future innovations and capital projects. At December 31, 2008, AMG had very low leverage levels (net debt 0.5x 2008 EBITDA), liquidity in excess of $245 million and a bank facility that does not mature until August 2012. In addition to the most pertinent risks described above, other risks faced by AMG include the following. Supply Risk AMG’s Advanced Materials Division is dependent on supplies of metals and metal containing raw materials for the production of its products. Some of these raw materials are available from only a few sources or a few countries. In order to mitigate the risk of supplies becoming difficult to source, AMG enters into longer-term contracts with its suppliers when practical. AMG’s Engineering Systems Division is dependent on a limited number of suppliers for many of the components of its vacuum furnace systems as a result of its stringent quality requirements. To mitigate this risk, the Engineering Systems Division has insourced the production of its DSS furnaces for the solar industry. Personnel Risk AMG’s workforce is highly educated and highly skilled, which contributes greatly to AMG’s success. High employee turnover or loss to a competitor of key personnel, who take with them know-how, is a risk to AMG. Many incentives, financial and other, are used to maintain a motivated workforce. Report of the Management Board | Risk Management and Internal Control 31

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