2018 Annual Report and Notice of AGM

The success of the Group's acquisition strategy depends on identifying available and suitable targets, obtaining any consents or authorisations required to carry out an acquisition and procuring the necessary financing, be this from equity, debt or a combination of the two. In making acquisitions, there is a risk of unforeseen liabilities being later discovered which were not uncovered or known at the time of the due diligence process, particularly in the context of limited access in public bids. Further, as per the Group's strategy to buy and improve good but underperforming manufacturing businesses, once an acquisition is completed, there are risks that the Group will not succeed in driving strategic operational improvements to achieve the expected post-acquisition trading results or value which were originally anticipated, that the acquired products and technologies may not be successful or that the business may require significantly greater resources and investment than anticipated. If anticipated benefits are not realised or trading by acquired businesses falls below expectations, it may be necessary to impair the carrying value of these assets. The Group's return on shareholder investment may fall if acquisition hurdle rates are not met. The Group's financial performance may suffer from goodwill or other acquisition-related impairment charges, or from the identification of additional liabilities not known at the time of the acquisition.

In line with our strategy and depending where the Group is within the "Buy, Improve, Sell" cycle, the expected timing of any disposal of businesses is considered as a principal risk which could have a material impact on the Group strategy. Further, due to the Group's global operations, there may be a significant impact on the timings of disposals due to political and macroeconomic factors. Depending on the timings of disposals and nature of businesses' operations there may be long-term liabilities which could be retained by the Group following a disposal. Insufficient allowance for such retained liabilities may affect the Group's financial position.

The Group operates, through manufacturing and/or sales facilities, in numerous countries and is affected by global economic conditions. Businesses are also affected by government spending priorities and the willingness of governments to commit substantial resources. Current global economic and financial market conditions, including headwinds in the automotive sector, any fluctuation in commodity prices, the potential for a significant and prolonged global recession and any uncertainty in the political environment may materially and adversely affect the Group's operational performance, financial condition and could have significant impact on timing of acquisitions and disposals.

A recession may also materially affect customers, suppliers and other parties with which the Group does business. Adverse economic and financial market conditions may cause customers to terminate existing orders, to reduce their purchases from the Group, or to be unable to meet their obligations to pay outstanding debts to the Group. These market conditions may also cause our suppliers to be unable to meet their commitments to the Group or to change the credit terms they extend to the Group's businesses.

Whilst it is anticipated that the UK will leave the EU in 2019, there continues to be some uncertainty in the UK regarding the nature of Brexit and what this will mean for business and the UK economy. Whilst Brexit is not isolated as a principal risk to the Group as a whole, it does present potential risks that the business units continue to monitor and assess closely relating to potential changes to the cross-border trade and regulatory environment. The Board continues to assess and review mitigation plans.

Prior to the GKN acquisition, the majority of the Group's revenue was generated in North America, which this year has experienced challenges such as increasing tariffs from the US/China trade war. Whilst the impact from Brexit is expected to be minimal in respect of North America operations, since acquiring GKN a larger proportion of the Group's revenue is now generated from the UK and European-based GKN Aerospace and GKN Automotive divisions. Therefore, the GKN Automotive and Aerospace divisions continue to assess the potential short-to medium-term impact of changes to international trading relationships, border controls, supply chain friction and customs tariffs following a 'No Deal' Brexit and if the UK reverts to WTO rules. However, the Group's geographically balanced manufacturing footprint is expected to mitigate negative impacts which may arise from such changes on the Group as a whole.

The Group operates in competitive markets throughout the world and is diversified across a variety of industries and production and sales geographies. This provides a degree of Group-level impact mitigation from the potential commercial challenges and market disruptions that face each of the divisions.

Each division is exposed to particular commercial and market risks, which are primarily accentuated where customer/ competitor concentration is high within their respective market segments.

Melrose operates a decentralised control and management structure which empowers divisional management teams to take full responsibility for planning, mitigating, navigating and responding to the specific commercial risks and challenges facing their respective businesses. Melrose senior management monitor the aggregated impact of such risks and provides active support to the divisional management teams in fulfilling their responsibilities.

Common commercial risk areas that potentially affect a large proportion of the Melrose businesses include those related to production quality assurance, health and safety performance, customer concentration and uncertainties related to future customer demand, the impact of increased competitive pressures on the maintenance/improvement of market share, potential disruptions to supply chains and increases to the price of raw materials, technological innovation and market disruption, and the performance and management of programme partners.

The success of the Group is built upon strong management teams. As a result, the loss of key personnel could have a significant impact on performance, at least for a time. The loss of key personnel or the failure to plan adequately for succession or develop new talent may impact the reputation of the Group or lead to a disruption in the leadership of the business. Competition for personnel is intense and the Group may not be successful in attracting or retaining qualified personnel, particularly engineering professionals.

There is a risk that the Group may not always be in complete compliance with laws, regulations or permits, for example concerning environmental requirements. The Group could be held responsible for liabilities and consequences arising from past or future environmental damage, including potentially significant remedial costs. There can also be no assurance that any provisions for expected environmental liabilities and remediation costs will adequately cover these liabilities or costs.

The Group operates in highly regulated sectors, which has been accentuated by the GKN acquisition. In addition, new legislation, regulations or certification requirements may require additional expense, restrict commercial flexibility and business strategies or introduce additional liabilities for the Group or Directors. For example, the Group's operations are subject to anti-bribery and anti-corruption, anti-money laundering, competition, anti-trust and trade compliance laws and regulations. Failure to comply with certain regulations may result in significant financial penalties, debarment from government contracts and/or reputational damage and impact our business strategy.

Information security and cyber threats are an increasing priority across all industries and remain a key UK government agenda item.

Like many businesses, Melrose recognises that the Group may have a potential exposure in this area. Potential exposure to such risks has increased in the year due to the scale, complexity and public-facing nature of the acquisition of GKN. In addition, Melrose recognises that the inherent security threat is considered highest in GKN Aerospace where data is held in relation to civil aerospace technology and controlled military contracts.

Due to the global nature of operations and volatility in the foreign exchange market, exchange rate fluctuations have and could continue to have a material impact on the reported results of the Group.

The Group is exposed to three types of currency risk: transaction risk, translation risk and risk that when a business that is predominantly based in a foreign currency is sold, it is sold in that foreign currency. The Group's reported results will fluctuate as average exchange rates change. The Group's reported net assets will fluctuate as the year-end exchange rate changes.

The defined benefit pension schemes acquired with GKN were proportionately less well funded and higher profile than those of the 2017 Group.

Any shortfall in the Group's defined benefit pension schemes may require additional funding. As at 31 December 2018, the Group's pension schemes had an aggregate deficit, on an accounting basis, of £1,413 million. Changes in discount rates, inflation, asset values or mortality assumptions could lead to a materially higher deficit. For example, the cost of a buyout on a discontinued basis uses more conservative assumptions and is likely to be significantly higher than the accounting deficit.

Alternatively, if the plans are managed on an ongoing basis, there is a risk that the plans' assets, such as investments in equity and debt securities, will not be sufficient to cover the value of the retirement benefits to be provided under the plans. The implications of a higher pension deficit include a direct impact on valuation, implied credit rating and potential additional funding requirements at subsequent triennial reviews. In the event of a major disposal that generates significant cash proceeds which are returned to the shareholders, the Group may be required to make additional cash payments to the plans or provide additional security.

The ability to raise debt or to refinance existing borrowings in the bank or capital markets is dependent on market conditions and the proper functioning of financial markets. As set out in more detail in the Finance Director's review on pages 46 to 47 of the Annual Report, the Group has term loans of US$960m and £100m and revolving credit facilities comprising US$2 billion, €0.5 billion and £1.1 billion.

In addition, the GKN net debt at acquisition included capital market borrowings across three unsecured bonds which in total amount to £1.1 billion. These bonds remain outstanding as at 31 December 2018 and further detail is provided in the Finance Director's review on pages 46 to 47 of the Annual Report.

Furthermore, in line with the Group's strategy, investment is made in the businesses (capital expenditure in excess of depreciation) and there is a requirement to assess liquidity and headroom when new businesses are acquired. In addition, the Group may be unable to refinance its debt when it falls due.