Annual General Meeting 2005 / Haldex Dear honored shareholders, As a rule, any fiscal year will have both positive and negative aspects, and fiscal 2004 was no exception. But overall the Group s operations moved onward and upward, and 2004 can be characterized as quite a good year for Haldex. On the plus side, we can note that The commercial vehicle market is in the midst of a cyclical upturn, and demand for our products increased. We increased our market shares in a numerous product areas. We landed a number of important new deals, with a combined value of roughly BSEK 4.5. We made a number of changes to improve our future cost structure. We reached a decision, which will be important to our future, to invest in local production in China. And we made considerable improvements in terms of the Group s earnings and profitability. We might also note the following on the minus side: We were only able to pass only part of sharp international cost increases for materials on to our customers, which limited the improvement in Group earnings. The continued weakening of the dollar had an unfavorable impact on earnings. One of our restructuring projects experienced delays, resulting in unplanned expenses. Problems arose in connection with the production of brake lining products at our plant in Alabama, which negatively affected the unit s earnings. And cash flow was negatively affected by an increase in working capital due to expanding business volumes and expenses incurred as a result of restructuring efforts. 1 (12)
Haldex operates in four product areas, which serve four different customer segments within the vehicle industry: Brake systems for heavy vehicles, i.e. heavy trucks, trailers and buses; this is our biggest business area, and accounts for roughly 60% of Group sales. Hydraulic power systems and components are supplied to three of our four customer segments: heavy vehicles, industrial vehicles and engines. Spring wire products that meet extremely strict performance requirements for use in engines and transmissions. Electronically controlled four-wheel drive systems for cars. Our choices of these niches have a historical basis and, with the exception of the four-wheel drive operations, date back to 1985, when the Group was formed through the consolidation of a number of different vehicle component companies. These businesses are operated as separate entities, although they have the business logic of the vehicle industry in common and, to some extent, share both customers and technologies. Taken collectively, the units offer a degree of size as a supplier to increasingly globalized and consolidated vehicle customers. Economies of scale can be exploited in certain areas, such as purchasing, IT and administration. Geographic expansion is facilitated by sharing sales companies and production units. 2 (12)
Haldex s mission is to offer proprietary vehicle technology solutions to the global vehicle industry within specific niches. We focus on products that improve safety (such as brake systems), the environment (such as several of our diesel engine products) and vehicle dynamics (such as four-wheel drive and ABS systems). Increasingly strict requirements from both vehicle users and lawmakers are driving developments within these focus areas and enabling a rate of growth that outstrips the average rate for the vehicle manufacturing industry as a whole. Our vision is for Haldex to be, within its areas of operation, the vehicle industry s first choice as a long-term supplier. We will contribute to building society by providing vehicle technology that provides safe and environmentally efficient transportation and satisfies both customers and society. 3 (12)
We will achieve profitable growth by staying at the cutting edge of technology, and by developing skilled and motivated employees. We will strive to achieve an intermediate goal of BSEK 10 in annual sales during the 2006-2008 period. This diagram shows the growth in the production of heavy trucks and trailers in our primary markets in North America (the blue curve) and Europe (the red curve). Nearly 70% of the Group s total sales derive from the heavy vehicles customer segment. This includes all sales from our brake operations, as well as parts of the sales from our hydraulics and spring wire operations. As a result, Haldex s market conditions are defined to a large extent by trends in the production of heavy trucks and trailers. It is readily apparent that heavy vehicle production fluctuates sharply over time, particularly in North America, and that we are involved in a cyclical industry. Following the last peak year, 1999, production in North America fell by 50%, and remained at a low level over the three years from 2001 2003. This was one of the deepest and most prolonged downturns in memory. Production in Europe also declined, after peaking in 2000. There was a sharp turnaround in 2004. Production of heavy trucks and trailers increased a combined 36% in North American and 15% in Europe. On the other hand, the aftermarket, which accounts for roughly half of our sales, changes only marginally from year to year, and serves to exert a stabilizing effect on both upturns and downturns. All in all, and including the aftermarket, our served brake market in North America and Europe grew roughly 13%. However, this growth amounts to only 8% when expressed in Swedish kronor, due to the weakening of the dollar. This may be compared with the 11% sales increase for our brake operations. 4 (12)
Generally speaking, the Group s market conditions appear to be favorable, both at present and for a number of years to come. Heavy vehicles are in the midst of a cyclical upturn. Industrial vehicles, such as construction machinery, are also in the midst of a cyclical upturn. Controllable four-wheel drive systems comprise a rapidly growing niche in the car segment. New geographic markets such as those in Brazil, China, India and Russia are demanding modern vehicle technology to an increasing extent. And stricter safety and environmental requirements are resulting in new regulations that demand new technologies and create new business opportunities. In 2004 and early 2005 we were able to announce a number of important new deals, with a combined order value of some BSEK 4.5 over their respective contract terms. 5 (12)
Land Rover and VW nominated Haldex as a supplier of four-wheel drive systems for future platforms, with deliveries set to begin late 2006 and at the end of 2007. These orders are worth MSEK 800 and BSEK 2, respectively. Scania chose Haldex as a supplier of disc brakes starting at the end of 2006; the order is worth roughly MSEK 500. This is a strategically important deal in combination with earlier disc brake orders from Volvo and Renault. DaimlerChrysler is switching to Haldex as its supplier of fuel transfer pumps for several different diesel engine series. We have long held a strong position in this niche in the USA, but this represents a breakthrough in Europe, and has led to production investments at our German plant in Hof. Deliveries will commence in 2005, and the order is worth roughly MSEK 300. We received from Scania and Volvo our first orders for the Alfdex system, which was developed jointly with Alfa Laval and offers an efficient solution for the new environmental requirements that will be imposed on certain types of diesel engine emissions. Delivery is scheduled to begin at the end of 2005, and the orders are worth MSEK 50 and MSEK 400 respectively. Finally, we received a breakthrough order for brake system compressors from a leading diesel engine manufacturer. Compressors in brake systems are normally mounted on the diesel engine. Delivery is set to begin in 2005, and the order is worth roughly MSEK 500. The prices of certain materials rose sharply in 2004. Increased demand from the expanding economies in countries such as China also created an imbalance, resulting in shortages and higher prices. It is difficult to pass these cost increases on to customers in industries which, like the vehicle industry, are especially competitive. However, we see that some truck manufacturers have now raised or plan to raise the prices of their trucks. In the case of Haldex, significant increases in material prices have pertained mainly to steel components, aluminum components and cast iron. This diagram illustrates how the material surcharge added to the base price increased month by month before leveling out during the final months of 2004. The Group s extra material costs thus totaled roughly MUSD 1.5 (about MSEK 10) per month after September. The material surcharge for 2004 as a whole totaled roughly MSEK 85. Of this MSEK 85, we were able to pass MSEK 25 on to our customers in 2004. The net amount, MSEK 60, thus encumbered earnings. This corresponds to barely 1% of the operating margin. 6 (12)
We have now been able to get acceptance of certain price increases from customers, which successively will improve the situation. But the vehicle industry s long tradition of annual price decreases impeded and delayed negotiations for adjustments in sale prices. The term price increase has not been part of the vocabulary used in subcontractors traditional dialogue with vehicle makers either. In the case of Haldex, the possibilities for passing on increased material costs have varied among the different product areas. With respect to our spring wire operations, we have so far been able to pass on the entire increase in the price of steel. The spring manufacturers who buy our wire products in various steel alloys understand that basically they are just buying steel, albeit with value added, and that higher steel prices consequently must have an impact. Within our four-wheel drive operations, we have been able to solve most of these problem by deferring previously agreed price reductions. In the hydraulics area, higher material costs have been mitigated in large part through selective increases in sale prices, and by switching to lower-priced subcontractors. We have dealt with material costs through selective increases in sale prices, lowering costs by changing suppliers, and through design changes in connection with our brake operations as well. Changes in suppliers and design modifications are, however, subject to significant quality controls, and the associated testing processes take a long time. Customer approval is often necessary as well. While we have been able, after some delays, to unilaterally raise sale prices in the aftermarket, price discussions with truck makers have proceeded slowly, and only toward the end of the year did we begin to see a greater understanding and acceptance of certain price hikes. The bulk of the net effect of higher material costs on the Group has thus derived from our brake operations. Ongoing price and cost measures will gradually improve this situation. We made a number of changes during the year with a view to creating a better cost structure. The biggest step was to discontinue our machining operations at the German plant in Heidelberg, which manufactures various brake products. The move affected some 90 people, and reduced the number of employees by nearly half. The machining operations were outsourced to subcontractors in Eastern Europe. Final assembly and product development operations are still ongoing in Heidelberg. The restructuring cost of MSEK 57 was allocated during fiscal 2003, but the effect on cash flow occurred mainly during 2004. The project has gone 7 (12)
according to plan, and the annual savings are estimated at MSEK 40. We began to see the positive effects of the move during the latter part of 2004. The English plant in Blackburn, which manufactured certain brake components, was shut down in 2004. As in the case of Heidelberg, the machining operations were relocated to subcontractors in Eastern Europe. The final assembly and testing operations were relocated to a newly built plant in Hungary. The Hungarian plant was dedicated in October 2004, and is intended to serve as a shared Group unit for the final assembly and testing of certain products for the European market. The investment totaled MSEK 25, and the plant will have some 125 employees once its capacity is fully realized. In North America, production of brake cylinders was relocated from the plant in Iola, Kansas to Haldex s plant in Mexico, which also produces brake cylinders. The portion of the Mexican production that pertains to deliveries to the European market will be relocated to Hungary in 2005. Finally, a project was started with a view to consolidating the brake relining centers that Haldex operates in the USA. The first phase pertained to the western part of the USA, where six such centers were to be consolidated into one. The project ran into problems and, instead of being cost-neutral for the calendar year, as had been planned, generated roughly MSEK 10 in additional expenses. The project will be completed in 2005, and will then yield the savings originally planned. We are, however, postponing our plans to effect a corresponding consolidation in the eastern half of the country until further notice. The annual positive effect on earnings from these structural measures is estimated at MSEK 60-70. The Group s earnings and profitability improved substantially in 2004, despite the negative impact of rising material prices and a weaker dollar on earnings. Improved market conditions and increased market shares resulted in our order intake increasing to BSEK 6.9, a 15% rise. The increase was 21% after adjusting for currency exchange effects. This figure does not include the major new deals I mentioned earlier, which are worth BSEK 4.5. These deals will not be recorded as order intake until a later stage, i.e. when the delivery requisitions are made. With high capacity utilization at our plants, sales increased 12% to BSEK 6.8. This represents an increase of 17% after adjusting for currency exchange effects. 8 (12)
Group earnings before tax increased 44% to MSEK 256. This comparison excludes the reserve for restructuring in Heidelberg, which was posted in 2003. If this reserve is included in the 2003 earnings, the Group earnings before tax more than doubled in 2004. Earnings per share after tax increased by a factor of 2.5, or 157%, to SEK 8.16, as compared to SEK 3.18 for 2003. Earnings were negatively affected by MSEK15 compared with 2003 as a result ofchanges in currency exchange rates, i.e. primarily with respect to the weaker dollar. The improvement in earnings was thus commensurately stronger after adjusting for currency exchange effects. The Group s profit margin rose 1.6 %-points to 4.7%. As noted earlier, the net negative effect of increases in material prices corresponded to roughly 1%-point of the profit margin. The return on capital employed increased to 11.7%, an improvement of nearly 5%-points compared to 2003. Our goal in terms of return on capital employed is 15% as an average over a business cycle, which we have achieved or surpassed in all the cycles that have occurred since the Group was formed 20 years ago in 1985. However, the return will need to be on the order of 20% in 2005 and 2006 if we are to achieve our 15% goal for the present cycle, which began with the peak year in 1999 and will probably run through 2006. So far in the ongoing cycle, the returned has averages only 9.5 %. There are several reasons why we have seen a lower average return during the current business cycle, the most important of which are: the unusually pronounced and prolonged market decline in North America, which decreased the brake market there by 50%; the expensive introduction phases for two entirely new products, namely our four-wheel drive systems and disc brakes; substantial non-recurring expenses for restructuring, particularly in Heidelberg; and, during 2004, the sharply increasing costs of materials. The price of the Haldex share rose 14% in 2004, closing at SEK 116.50. At the end of March this year, the share price had increased with additional 15% to about SEK 135, corresponding to a total market capitalization of roughly BSEK 3. 9 (12)
Those truly far-sighted shareholders who have owned our stock since the formation of the Group in 1985 have seen our market capitalization increase roughly eleven-fold, from MSEK 265 MSEK in 1985 to roughly BSEK 3 in March 2005, or an average of about 14% per year over 20 years. In addition to this has come an average annual dividend of roughly 2.5%. Including the new shares issue of 300 MSEK in 1998, the average yearly total shareholder s return during the 20- year period has been 10 %. Our strategy for achieving our financial goals and growing in a manner consistent with our vision is to reduce the size gap between ourselves and our chief competitors with respect to our brake operations, and to continue to develop our other businesses. The strategic cornerstones of this building process are: First, to improve the Group s cost structure, which means, among other things, doing more of our manufacturing and purchasing in low-cost countries. The structural measures we implemented during 2004 exemplify this approach. Second, to strengthen our presence in new, growing markets such as those in Brazil, China, India and Russia. At year-end 2003 we acquired a production unit in Brazil; at the end of 2003 we increased our ownership stake in the Indian plant to 60%, and in 2004 we expanded the production program there for the Indian market; we started a sales office in Russia, and made the decision to start manufacturing brake and hydraulic products and valve spring wire in China. Third, to strengthen and broaden our product program in the brake area for heavy vehicles, which is weaker than our product program for trailers. During 2004 we continued development and began the market introduction of ABS systems for heavy vehicles. We had previously offered ABS systems for trailers only. We have nearly completed development of an entirely new, modular product program for drying and managing compressed air in brake systems. We have landed additional disc brake deals for heavy vehicles, and have come up with a business arrangement concerning compressors for brake systems that has resulted in a breakthrough and a major new deal in North America. 10 (12)
Fourth, to develop a new generation of four-wheel drive systems, mainly to reduce costs, but also to expand this area of applications and make us more competitive overall. During 2004 we made substantial progress in this effort, and we are already working on customer projects based on the new designs. Fifth, to develop new technologies and thereby realize new business opportunities within the diesel engine segment. Working in this area in cooperation with Alfa Laval over the last few years, we have developed a separation system, known as Alfdex, that cleans oil-bearing crankcase gases from diesel engines. New environmental regulations require such cleaning, and in 2004 we landed our first series deliveries to Scania and Volvo, with more to come. We have also developed a system, known as Varivent, that uses the surplus energy in diesel engine exhaust gases to recirculate them. This recirculation results in lower nitrous oxide levels in the emissions, which is another new environmental requirement. Varivent enables significant reductions in fuel consumption compared with other recirculating pump systems. Our system is currently being tested by customers. Sixth, to defend our world-leading position in the field of high-quality spring wire products for combustion engines. We have done this in 2004 by continuing to develop our production process so as to eliminate costs and ensure consistent quality. Last year we also invested in boosting our capacity so that we can handle our increased market shares. In 2004 we made the decision begin manufacturing of valve spring wire in China in order to ensure a strong future position in the growing Asian market. And seventh, to seek out and make appropriate acquisitions or enter into suitable cooperative arrangements that are consistent with our mission. The Alfdex project together with Alfa Laval is a successful example of how the strengths of different companies can be combined to create exciting new business opportunities. During 2004 we engaged in negotiations concerning cooperative arrangements mainly in Asia (Japan and China), but also in Brazil, although these negotiations have produced no concrete results as yet. We were also involved in several acquisition projects which, however, we ultimately declined due to price level considerations. 11 (12)
A few final thoughts about the near future Continued growth is expected in the production of heavy trucks and trailers during 2005. The rate of growth will, however, not be as high as in 2004. Including the aftermarket, which grows only marginally and accounts for roughly half of the sales for our brake operations, this means that the total market for heavy vehicle brake equipment in North America and Europe will grow roughly 6%, assuming no changes in currency exchange rates or sale prices. Car production in our primary markets in America and Europe is expected to remain generally unchanged. We will begin delivering four-wheel drive systems for a new VW platform, the Passat platform, at the end of 2005, but this will provide only a limited sales boost in 2005. As a result, the increase in our sales of four-wheel drive systems will derive mainly from the full-year effects of our deliveries for three new Ford cars, which began halfway through 2004. The Group s sales for 2005 are expected to total somewhat in excess of BSEK 7, while the volume increases, combined with the effects of our restructuring measures and price adjustments tied to higher material prices, are expected to result in a substantial improvement in earnings. Finally, Mr. Chairman, I would like to welcome my successor, Joakim Olsson, as he takes over as President and CEO on June 1st. Joakim, I wish you the very best of luck, and hope that you can take Haldex to new heights. Thank you. 12 (12)