Effects of spreading of infectious diseases
The spreading of global health emergencies or pandemic affecting the population (i.e. COVID-19) can lead, in addition to a deterioration of the macroeconomic scenario, to a slowdown in the business operations due to the measures issued by national and foreign authorities, the unavailability of staff, difficulties encountered by both public and private customers and the intermittent supply chain, with an adverse impact on the Group’s results.
Leonardo has adopted processes that support the identification, management and monitoring of those events that can have a significant potential impact on the Company’s resources and business. These processes are the responsibility of decision-making inter-functional committees, which have been appropriately set up, and are aimed at maximising the timeliness and efficacy of the measures taken.
The change in the level of expenditure of national governments and public institutions
may affect business performance and may influence R&D work, particularly in the aeronautics and defence and security systems sectors
The major customers of the Group are national governments or public institutions. Moreover, the Group takes part in numerous international programmes funded by the European Union or in multinational collaborations. Therefore, it is affected by geopolitical and economic factors, the reduction in the expense policies of the public institutions, in addition to the medium/long-term plans of the countries that are considered individually and as a whole within common defence programmes. Geopolitical and economic scenarios mostly characterised by an increasing uncertainty, represent important challenges for the companies operating on foreign markets. The expenditure programmes adopted by governments may be subject to delays, changes under way, annual reviews or cancellations, in particular in periods with high instability or critical periods in macroeconomic terms, with effects on the Group's volumes, results and indebtedness.
The acquisition of contracts, especially outside Europe, may be affected by local preferences for certain products.
Moreover, any possible pressure on public budgets might further reduce their contribution to research and development activities (R&D).
In Italy, in particular, R&D expenditure in the aeronautics sector is financed under Law 808/1985, which is an essential support to research activities. Failure to bring funding levels into line with those of other European competitors might adversely affect the Group's ability to compete successfully, thus giving rise to possible impacts on the time-to-market of products under development.
The Group pursues an international diversification policy, in order to reduce the effects of cuts made by each country, placing it in its main markets, as well as in emerging markets marked by significant growth rates, in the Aeronautics and Defence markets. The ongoing monitoring of its performance in the major countries ensures a timely alignment of activities planned with customer needs.
The Group operates in civil sectors that are highly exposed to growing levels of competition
In civil sectors, the slowdown in demand due to customers' reduced spending capacity may lead to delays or reductions in the acquisition of new orders, or to their acquisition on less favourable terms than in the past. In these markets there are highly innovative competitors, especially in adjacent markets of information technology and consumer electronics, which maintain high and ongoing R&D investments by leveraging significant economies of scale. Competitors in adjacent markets already operate in the security market and are offering themselves as new entrants in the aerospace and defence sectors, especially in the field of electronics, with advanced and often cheaper technology solutions.
These factors contribute to a growing complexity of the prospective target scenario characterised, however, by growing competition and could reduce production volumes and profit margins, as well as increase the Group's financial requirements.
The Group’s goal is to increase its industrial efficiency, diversify its customer base and improve its ability to perform contracts, while reducing overhead costs with a view to enhance its competitive capacity.
The Group maintains its competitive positioning on markets by ensuring highly qualitative and innovative product standards, while continuing to pay constant attention to exploiting and updating its technological edge with the constant trend toward the environmental sustainability. The organisational "One Company" structure ensures a higher ability to compete in domestic and foreign markets, as well as a strengthening of the synergies between company functions involved in the development of new products.
The capacity for innovation and growth depends on the strategic planning and management of skills, on the attraction and development of talents
The constant technological innovation and the growing complexity of the Group's businesses require constant alignment of skills, in order to provide high added-value products and services and consolidate the role of System Integrator and Prime Contractor. A lack of specialist expertise might impact on the full achievement of the corporate objectives, including possible repercussions in terms of time-to-market of new products and services, as well as of access to emerging business segments.
The Group continued to implement the action plans aimed at attracting, retaining and motivating people, managing talents, providing ongoing specialist training, insourcing core competencies and defining succession plans. The purpose of these plans is to ensure an adequate level of technical, specialist and managerial skills necessary to achieve the Group's strategic objectives and business sustainability in the medium- to long-term. Training and collaboration programmes are also in place with schools and universities, and projects have been started to promote the study of technical and scientific subjects (STEM, Science, Technology, Engineering and Mathematics) with the aim of creating specific expertise in the high technology sectors and supporting social and economic growth.
The Group operates in some business segments through partnerships or joint ventures
The Group’s corporate strategies contemplate the possibility of gaining business opportunities partly through joint ventures or commercial alliances in order to integrate its technology portfolio or strengthen its presence in the market. The operation of partnerships and joint ventures is subject to management risks and uncertainties, mainly due to possible divergences between partners about the identification and achievement of operational and strategic objectives involving markets, technologies and products, as well as to the difficulty of resolving any possible conflict relating to core business operations. Moreover, in joint ventures, situations of decision-making "deadlock" might ultimately lead to the liquidation of the joint venture itself or to the disposal of the investment by the Group, with the risk of not obtaining the expected benefits.
The Group systematically carries out due diligence activities following the completion of partnerships and joint ventures. At this purpose, the active involvement of its top management in any related operation is aimed, among other things, at directing its strategies and identifying and managing any critical issue in a timely fashion.
The Group is exposed to the risk of fraud or illegal activities on the part of employees and third parties
The Group makes every effort in terms of organisation, controls, internal procedures and training to ensure compliance with any and all anti-corruption laws applicable in the domestic and foreign markets in which it operates; however, the possibility cannot be ruled out of employees or third parties behaving in an ethically incorrect or not fully compliant manner. This may also expose the Group to financial responsibility and generate adverse reputational effects, nor can we rule out the possibility of judicial authorities initiating proceedings aimed at establishing any possible liability attributable to the Group, the results and timing of which are difficult to determine and which are likely to entail temporary suspensions from the market concerned.
The Group has set out a model of responsible business conduct aimed at preventing, identifying and responding to the risk of corruption, based on:
• Spreading a company culture, values and rules of conduct, based on the principle of zero-tolerance for corruption;
• Promoting anti-corruption commitment, starting with Top management, adopting a "Tone from the Top" approach;
• Providing training courses for the entire corporate population, and specifically for resources involved in processes that are most exposed to the risk of corruption (Council Programme).
In 2018 Leonardo S.p.a. was the first company in the world's top ten in Aerospace, Defence and Security to obtain ISO 37001 certification, the first international standard on anti-corruption management systems. The certification was confirmed during 2019.
Specific actions have also been taken in the responsible management of the supply chain, through the strengthening of supplier qualification, selection and management processes. A specific risk analysis tool is applied to the assignment of tasks to promoters and sales advisors as part of structured due diligence audits based on international best practices.
The settlement of legal disputes can be extremely complex and might require a considerable period of time.
The Group is party to judicial, civil and administrative proceedings; for some of these, the Group has established a specific provision for risks and charges in the consolidated financial statements to cover any potential liabilities. Some of these proceedings in which the Leonardo Group is involved – for which a negative outcome is unlikely or that cannot be quantified – are not covered by the provision.
As more fully explained in paragraph “Provisions for risks and contingent liabilities” of the explanatory notes to the consolidated financial statements, in the past certain Group subsidiaries and the Parent Company itself were involved in judicial investigations, some of which are still underway. Further developments presently unforeseeable and indefinable, together with the possible consequential impact on Leonardo’s reputation, could have a significant impact on the Group’s financial position, results of operations and cash flows as well as on its relationships with customers.
The Group regularly monitors potential and existing disputes, taking the necessary corrective actions and adjusting its provisions for risks on a quarterly basis.
The Group operates in particularly complex and regulated markets, which require compliance with specific regulations (e.g. export control)
Defence solutions are of particular importance in terms of compliance with regulatory obligations and, therefore, their export must comply with foreign policy guidelines and is subject to restrictions and prior authorization, based on specific regulations and agreements that may change in relation to the evolution of the geo-political scenario and of international economic interests (such as, for example, Italian Law 185/1990 and the U.S. International Traffic in Arms Regulations - ITAR and the Export Administration Regulations - EAR), as well as of compliance with customs regimes applicable to any and all products offered by the Group. The prohibition on, limitation or any possible revocation (for example in the case of embargoes or geopolitical conflicts) of export authorisations for defence or dual-use products, as well as failure to comply with any applicable customs regime, may have substantial adverse effects on the Group's business, financial position, results of operations and cash flows. Moreover, failure to comply with these regulations could also make it impossible for the Group to operate in specific regulated areas.
The Group ensures, through specific functions, a timely implementation and management of the formalities required by the relevant regulations, monitoring their updating on an ongoing basis in order to allow the day-to-day performance of commercial and operational activities, in compliance with the provisions of law and with any possible authorisation and/or limitation.
The Group operates through a number of industrial plants and processes that may expose it to risks to the health and safety of workers and to environmental risks.
The Group's activities are subject to compliance with laws, rules and regulations governing the protection of workers’ health and safety. Specifically, Legislative Decree 81/2008 provides for a health and safety management system for preventive and permanent work, through the identification of risk factors and sources, the elimination or reduction of risk, the ongoing monitoring of preventive measures implemented, the development of a corporate strategy to be implemented through the participation of all stakeholders in the working communities. The mentioned rule of Law also proposes to plan measures that are considered to be appropriate to ensure the improvement of safety levels over time, including through the adoption of codes of conduct and good practices.
The Group's activities are subject to compliance with laws, rules and regulations governing the protection of environment and energy management, which imply specific environmental permits aimed at ensuring the compliance with restrictions and conditions on emissions into the atmosphere, water discharges, storage and use of chemicals (e.g. REACH Regulation and RoHS Directive) and waste management and disposal.
In order to protect the health and safety of its workers, the Group constantly monitors trends in accident frequency and severity rates, in relation to which improvement objectives are set out, checking whether the safety measures adopted are effective.
Risks to the workers’ health and safety are based on the principle of zero tolerance, in strict compliance with the relevant regulations, and are managed through targeted risk analyses, specific action and training plans, within the framework of a precise system of proxies and powers for each relevant matter, aimed at ensuring that the action taken complies with the Group’s guidelines. The Group also confirms its commitment to extend the coverage in terms of Health and Safety System, for example through the OHSAS 18001 certification.
The Group complies with the ever-increasing limits and restrictions imposed by the environmental protection regulations as regards sites and production processes. The Group also confirms its commitment to extent coverage in terms of Environmental Management System, for example through the ISO 14001 certification. The Group regularly performs environmental assessments of sites and monitoring, and it also takes out specific insurance policies in order to mitigate the consequences of unexpected events.
The Group defines its industrial strategy also taking into consideration environmental sustainability objectives, in order to face the uncertainties linked, among other things, to climate change
The Group's activities may be subject to transition risks towards an economy with low polluting emissions, with possible impacts on business processes, with particular reference to production processes, as well as on the products and services offered.
Corporate sites and assets may also be affected by natural events (floods, drought, fires and others) generated by the effects of climate change.
The Group pursues an industrial strategy aimed improving the efficiency of its production systems and processes on an ongoing basis for the reduction of energy consumption and atmospheric emissions and, thanks also to the participation, as a partner of excellence, in the main European programs for research and innovation such as Horizon 2020 to which Phase 2 of Clean Sky and SESAR is linked, it develops low environmental impact technological solutions which are functional to the fight against climate change.
The Group takes out specific insurance policies in order to cover against any possible consequence arising from disastrous weather and natural events.
Breaches of information security obligations can cause damage to the Group, its customers and suppliers and pose a threat to the security of citizens and critical infrastructures
Companies are required to face the risks associated with information security, deriving from cyber-attacks, increased digitalization and the use of innovative technologies.
Computer incidents, business interruption, the leakage of data and information, including personal data, may compromise the business but also the Group’s image, especially in the case of theft of third-party data stored in its archives.
IT incidents in the supply chain might have repercussions on the Group's operations.
The Group manages cyber security through dedicated controls and training for the entire corporate population, as well as processes, procedures and specific technologies for the prediction, prevention, detection and management of potential threats and for responding to them. Leonardo is ISO 27001 certified and is constantly engaged in management and improvement activities aimed at maintaining the certification itself.
Leonardo also benefits from substantial experience in the field of cyber security, in addition to that already available to its Corporate staff, gained on the market through the competent business Division and partnerships established with its partners and institutional stakeholders, in addition to a plan to develop and improve the professional skills of its staff.
Leonardo continues to take any action to extend computer data processing methods and processes to its own suppliers.
The Group operates significantly on long-term contracts at a given price for supplies of highly complex products, systems and services
The Group supplies very complex products, systems and services due to their advanced technological content under long-term contracts at a fixed all-inclusive price. Given a fierce competition in the market concerned, contract terms and conditions generally include challenging levels of requirement and stringent execution times. If, due to the occurrence of risk events, the Group does not perform the contract in compliance with quality requirements and within the required time limit, the customer is entitled to apply penalties and other contract clauses that might have an adverse economic and financial impact on the Group.
In order to recognise revenues and margins in the income statement of each period, the Group adopts the percentage-of-completion method, which requires: (i) an estimate of the costs necessary to carry out the contract, including contingency to cover project risks, as well as the costs of any related mitigation action and (ii) checking the state of progress of the activities. An unexpected increase in the costs incurred while performing the contract might determine a reduction in profitability or a loss.
Leonardo, starting with the business proposal stage, considers the project’s main performance and financial parameters in order to assess its performance throughout the entire life cycle and carries out risk analyses systematically. The Group reviews the estimated costs of contracts regularly. Project risks with similar frequency throughout the related life cycle are managed systematically through the detection, assessment, mitigation and monitoring of risks with the definition and management of appropriate contingencies, in order to protect the financial margins of the projects themselves. Risk management is carried out by project teams (IPT - Integrated Project Team) led by Project Managers and supported by Risk Managers.
The Group is committed to improving its industrial efficiency and its ability to meet customer specifications on time.
The risks of proper performance of contracts, associated with the liability to customers or third parties, also depend on the supply and sub-supply chain
The Group purchases, in very substantial proportions with respect to its sales, industrial products and services, materials and components, equipment and subsystems; it may therefore incur liability to its customers for operational, legal or financial risks attributable to third parties outside the Group, who operate as suppliers or sub-suppliers. The Group’s dependence on suppliers for certain business activities might give rise to difficulties in maintaining quality standards and meeting delivery times.
The Group chooses its suppliers by implementing specific selection criteria and monitors their performance, results of operations and financial position. The Group is also committed to improving efficiency and developing its supply chain, especially through targeted actions aimed at certain areas of strategic importance and/or critical expenditure. In particular, Leonardo has in progress the LEAP2020 programme (Leonardo Empowering Advanced Partnerships), provided for in the 2018-2022 Industrial Plan and aimed at establishing a new relationship between the Company and its Italian and international suppliers, based on an industrial and supply chain approach.
The programme sets out a model for the selection and appointment of "partners for growth" based on an objective assessment of suppliers in terms of capacity, performance, competitiveness, transparency, traceability and process sustainability.
In addition, contract procurement forms provide clauses for exchange of information with the supply chain on project risks.
The Group is required to fulfil direct or indirect offset obligations in certain countries
Some international customers require the application of some types of offset related to the award of contracts in the aerospace and defence sector.
Together with supply contracts, the Group may therefore undertake offset obligations that require procurement or manufacturing support at local level, technology transfer and investments in industrial projects in the customer's country.
Failure to meet offset obligations may result in the application of penalties and, in certain cases, might prevent the Group from participating in contract award procedures in the countries concerned.
The Group manages offset risks by means of appropriate analyses carried out from the offering phase within the project teams, which also appoint an Offset Manager for the division concerned.
It has also set up a dedicated central organisational unit to guide and supervise offset activities.
A substantial amount of consolidated assets is attributable to intangible assets, goodwill in particular
The recoverability of amounts recognised in intangible assets (including goodwill and development costs) is linked to the implementation of future plans and the business plans for the relevant products.
The Group implements a policy of monitoring and limiting amounts capitalised under intangible assets, with specific regard to development costs, and carries out ongoing monitoring of performance under scheduled plans, taking any necessary corrective action in the event of unfavourable trends. These updates affect the expected cash flows used for impairment tests when assessing the fairness of the values recorded in the financial statements.
The Group’s debt shows high level and could have an impact on the Group’s operational and financial strategies
The debt level, beside impacting the profitability as an effect of the related borrowing costs, could affect the Group’s strategy, limiting its operational flexibility. Potential future liquidity crises could also restrict the Group’s ability to repay its debts.
Leonardo pursues an ongoing strategy of limiting its debt by paying steady attention to cash generation, which is used, market conditions permitting, to partially reduce the existing debt. As a matter of fact, the financial measures adopted during the years on the bond and bank market have ensured sources of liquidity that meet the Group’s short- and medium/long-term financial requirements.
The Group’s credit rating is also linked to the opinions of the credit rating agencies
All Group bond issues are given a medium-term financial credit rating by the international agencies Moody’s Investors Service (Moody’s), Standard and Poor’s and Fitch. A possible downgrade in the Group’s credit rating could severely limit its access to funding sources, as well as increase its borrowing costs for existing and future loans, which would have a negative impact on the business prospects, performance and financial results.
The Group is actively engaged in reducing its debt as required by the Industrial Plan. The Group’s financial policies and careful selection of investments and contracts involve being constantly alert to maintaining a balanced financial structure.
In seeking out strategies to pursue, the Group always takes into account the potential impact such could have in the indicators used by the credit rating agencies.
The Group realises part of its revenues in currencies other than the currencies in which costs are incurred, exposing it to the risk of exchange-rate fluctuations. A part of consolidated assets is denominated in US dollars and pound sterling
The Group reports a significant portion of revenues and costs in currencies other than euro (mainly in dollars and pounds). Accordingly, any negative changes in the reference exchange rate might have negative effects (transaction risk).
Moreover, the Group made significant investments in the United Kingdom (Brexit took place on 31 January 2020, with a transitional phase until December 2020) and in the United States of America, which might have a negative impact on the Group balance sheet and income statement due to the translation of the financial statements of foreign investees (translation risk).
The Group continuously applies an organised hedge policy to combat transaction risk for all contracts using the financial instruments available on the market.
Moreover, in intercompany financing activities denominated in currencies other than the euro individual positions are hedged at the central level.
The Group is a sponsor of defined-benefit pension plans in the UK and the US and of other minor plans in Europe
Under the pension schemes reserved for employees who mainly operate in the United Kingdom and in the United States, the Group is required to ensure a specific future retirement benefit level for employees participating in the plan. In said countries the pension funds in which the Group participates invest resources in the plan assets (stocks, bonds, etc.) that might not be sufficient to cover the agreed-upon benefits. If the value of plan assets is less than the agreed-upon benefit level, the Group duly recognises the amount of the deficit among liabilities, with consequent adverse effects on its financial position, results of operations and cash flows.
The Group monitors pension funds’ investment plans and strategies on an ongoing basis and takes immediate deficit corrective action when necessary.
The UK leaving the European Union and transition phase 2020 (Brexit)
Following the UK leaving the EU, the Parties could not reach, at the conclusion of the planned negotiations, a deal on a future partnership and, at the same time they could decide not to extend the transition period lasting until 31 December 2020.
The complex negotiations and the relative implications could end in a “no deal” thus requiring, unless already in place, arrangements between the United Kingdom and the single country involved. In the event of a no-deal, there would be a discontinuous cooperation that could affect defence programmes.
Leonardo keeps an eye on the progress of the negotiations between the UK and the EU, beside supporting the relevant institutional bodies and associations (in the defence sector) in their actions.
Moreover, based on internal analyses recently performed, the Company has identified a first set of management measures to cope, if necessary, with the “no deal” situation, especially in relation to the management of customs operations.