As filed with the Securities and Exchange Commission on May 27, 2005
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
o | REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 |
OR |
|
ý |
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2004 |
|
OR |
|
o |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number: 001-16429
ABB Ltd
(Exact name of registrant as specified in its charter)
Switzerland
(Jurisdiction of incorporation or organization)
Affolternstrasse 44
CH-8050 Zurich
Switzerland
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Title of each class |
Name of each exchange on which registered |
|
---|---|---|
American Depositary Shares, each representing one Registered Share |
New York Stock Exchange | |
Registered Shares, par value CHF 2.50 |
New York Stock Exchange* |
Securities registered or to be registered pursuant to Section 12(g) of the Act: None.
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None.
Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report: 2,070,314,947 Registered Shares
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý No o
Indicate by check mark which financial statement item the registrant has elected to follow.
Item 17 o Item 18 ý
|
|
Page |
||
---|---|---|---|---|
PART I | 4 | |||
Item 1. |
Identity of Directors, Senior Management and Advisers |
4 |
||
Item 2. |
Officer Statistics and Expected Timetable |
4 |
||
Item 3. |
Key Information |
4 |
||
Item 4. |
Information on the Company |
20 |
||
Item 5. |
Operating and Financial Review and Prospects |
43 |
||
Item 6. |
Directors, Senior Management and Employees |
114 |
||
Item 7. |
Major Shareholders and Related Party Transactions |
126 |
||
Item 8. |
Financial Information |
130 |
||
Item 9. |
The Offer and Listing |
133 |
||
Item 10. |
Additional Information |
139 |
||
Item 11. |
Quantitative and Qualitative Disclosures About Market Risk |
155 |
||
Item 12. |
Description of Securities Other than Equity Securities |
156 |
||
PART II |
157 |
|||
Item 13. |
Defaults, Dividend Arrearages and Delinquencies |
157 |
||
Item 14. |
Material Modifications to the Rights of Security Holders and Use of Proceeds |
157 |
||
Item 15. |
Controls and Procedures |
157 |
||
Item 16A. |
Audit Committee Financial Expert |
158 |
||
Item 16B. |
Code of Ethics |
158 |
||
Item 16C. |
Principal Accountant Fees and Services |
158 |
||
Item 16D. |
Exemptions from the Listing Standards for Audit Committees. |
159 |
||
Item 16E. |
Purchases of Equity Securities by the Issuer and Affiliated Purchasers. |
160 |
||
PART III |
161 |
|||
Item 17. |
Financial Statements |
161 |
||
Item 18. |
Financial Statements |
161 |
||
Item 19. |
Exhibits |
162 |
i
ABB Ltd is a corporation organized under the laws of Switzerland. In this report, "the ABB Group," "ABB," "we," "our" and "us" refer to ABB Ltd and its consolidated subsidiaries (unless the context otherwise requires). We also use these terms to refer to ABB Asea Brown Boveri Ltd and its subsidiaries prior to the establishment of ABB Ltd as the holding company for the entire ABB Group in 1999, as described in this report under "Item 4. Information on the CompanyIntroductionHistory of the ABB Group." Our American Depositary Shares (each representing one of our registered shares) are referred to as "ADSs." The registered shares of ABB Ltd are referred to as "shares."
Our principal corporate offices are located at Affolternstrasse 44, CH-8050 Zurich, Switzerland, telephone number +41-43-317-7111.
FINANCIAL AND OTHER INFORMATION
ABB Ltd has prepared its statutory unconsolidated financial statements in accordance with the Swiss Federal Code of Obligations. The consolidated financial statements of ABB Ltd, including the notes thereto, as of December 31, 2004, 2003 and 2002 and for the years then ended (our "Consolidated Financial Statements") have been prepared in accordance with United States generally accepted accounting principles ("U.S. GAAP").
In this report: (i) "$," "U.S. dollars" and "USD" refer to the lawful currency of the United States of America; (ii) "CHF" and "Swiss francs" refer to the lawful currency of Switzerland; (iii) "€," "EUR" and "euro" refer to the lawful currency of the participating member states of the European Union (the "EU"); (iv) "SEK" and "Swedish krona" refer to the lawful currency of Sweden; (v) "£," "sterling," "pounds sterling" and "GBP" refer to the lawful currency of the United Kingdom; (vi) "Norwegian krone" refers to the lawful currency of Norway; and (vii) "Chinese renminbi" refers to the lawful currency of the People's Republic of China.
Except as otherwise stated, all monetary amounts in this report are presented in U.S. dollars. Where specifically indicated, amounts in Swiss francs have been translated into U.S. dollars. These translations are provided for convenience only, and they are not representations that the Swiss franc could be converted into U.S. dollars at the rate indicated. These translations have been made using the noon buying rate in the City of New York for cable transfers as certified for customs purposes by the Federal Reserve Bank of New York as of December 31, 2004, unless otherwise indicated. The noon buying rate for Swiss francs on December 31, 2004 was $1.00 = CHF 1.1412. The noon buying rate for Swiss francs on May 25, 2005 was $1.00 = CHF 1.2264.
This report includes forward-looking statements. These forward-looking statements can be identified by the use of forward-looking terminology, including the terms "believes," "estimates," "anticipates," "expects," "intends," "may," "will," or "should" or, in each case, their negative, or other variations or comparable terminology. These forward-looking statements include all matters that are not historical facts. They appear in a number of places throughout this report and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects, growth, dispositions, strategies and the countries and industry in which we operate.
These forward-looking statements include, but are not limited to the following:
1
By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. We caution you that forward-looking statements are not guarantees of future performance and that the actual results of our operations, financial condition and liquidity, and the development of the countries and the industries in which we operate may differ materially from those described in or suggested by the forward-looking statements contained in this report. In addition, even if our results of operations, financial condition and liquidity, and the development of the countries and the industries in which we operate, are consistent with the forward-looking statements contained in this report, those results or developments may not be indicative of results or developments in subsequent periods. Important factors that could cause actual results to differ materially from our expectations are contained in cautionary statements in this report and include, without limitation, the following:
2
We urge you to read the sections of this report entitled "Item 3. Key InformationRisk Factors," "Item 4. Information on the Company" and "Item 5. Operating and Financial Review and Prospects" for a more complete discussion of the factors that could affect our future performance and the countries and industries in which we operate. In light of these risks, uncertainties and assumptions, the forward-looking circumstances described in this report and the assumptions underlying them may not occur.
Except as required by law or applicable stock exchange rules or regulations, we undertake no obligation to update or revise publicly any forward-looking statement, whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to us or to persons acting on our behalf are expressly qualified in their entirety by the cautionary statements referred to above and contained elsewhere in this report.
3
Item 1. Identity of Directors, Senior Management and Advisers
Not applicable
Item 2. Officer Statistics and Expected Timetable
Not applicable
Item 3. Key Information
The following table presents our selected financial and operating information at the dates and for each of the periods indicated. You should read the following information together with the information contained in "Item 5. Operating and Financial Review and Prospects," as well as our Consolidated Financial Statements and the notes thereto, included elsewhere in this report.
Our selected financial data are presented in the following tables in accordance with U.S. GAAP and have been derived from our published consolidated financial statements.
The consolidated financial statements and other financial data included in this report reflect restatements we made in September 2004, when we restated certain financial statements contained in our annual report for the year ended December 31, 2003, as published in our Form 20-F filed with the U.S. Securities and Exchange Commission in April 2004. The amendments reflected restatements of our consolidated financial statements at December 31, 2003 and 2002 and for each of the years in the three-year period ended December 31, 2003, and of certain financial data at December 31, 2001 and 2000, and for the year ended December 31, 2000. These changes were intended to correct the effect of earnings overstatements by the medium-voltage business unit of our Power Technologies division in Italy on its previously reported financial statement results.
The cumulative effect of these overstatements on our earnings before interest and taxes and net income was approximately $73 million and $89 million, respectively, from the first quarter of 1998 through the end of March 2004. The negative impact on income tax expense results from the inability to claim tax benefits under Italian tax law for adjustments made to improperly filed tax returns for the years 1998 through 2002, as well as a reassessment of the probability of realization of our deferred tax assets due to a cumulative loss position after the restatement. As compared with financial data originally published, the corrections increased net loss by $12 million ($0.01 per share basic and diluted), $36 million ($0.04 and $0.03 per share basic and diluted, respectively) and $14 million ($0.02 per share basic and diluted) in 2003, 2002 and 2001, respectively, decreased net income by $17 million ($0.01 and $0.02 per share basic and diluted, respectively) and $6 million ($0.01 per share basic and diluted) in 2000 and 1999, respectively, and decreased stockholders' equity by $109 million at December 31, 2003.
Our consolidated financial statements at and for each of the years ended December 31, 2004, 2003, 2002 and 2001 were audited by Ernst & Young AG, except for the 2001 consolidated financial statements of ABB Holdings Inc., a wholly owned subsidiary, the 2004, 2003, 2002 and 2001 financial statements of Jorf Lasfar Energy Company, a corporation in which we have a 50 percent interest, the 2002 and 2001 consolidated financial statements of Swedish Export Credit Corporation, in which we had a 35 percent interest at December 31, 2002, and the 2001 financial statements of Scandinavian Reinsurance Company Limited, a then wholly owned subsidiary, which were audited by other independent auditors.
4
Our consolidated financial statements at and for the year ended December 31, 2000, before the restatement described above with respect to the earnings overstatement at one of our Italian subsidiaries and before reclassifications for operations discontinued, were audited jointly by Ernst & Young AG and KPMG Klynveld Peat Marwick Goerdeler SA. The Consolidated Financial Statements at December 31, 2002, 2001 and 2000 and for each of the years ended December 31, 2001 and 2000, have not been audited after the reclassifications of certain businesses between continuing operations and discontinued operations. The Consolidated Financial Statements at December 31, 2001 and 2000, and for the year ended December 31, 2000, have not been audited after the restatements described above.
INCOME STATEMENT DATA:
|
Year ended December 31, |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
2001 |
2000 |
|||||||||||
|
(audited) |
(audited) |
(audited) |
(unaudited) |
(unaudited) |
|||||||||||
|
(U.S. dollars in millions, except per share data) |
|||||||||||||||
Revenues | $ | 20,721 | $ | 20,427 | $ | 19,472 | $ | 20,058 | $ | 20,052 | ||||||
Cost of sales | (15,757 | ) | (15,928 | ) | (15,098 | ) | (15,211 | ) | (14,920 | ) | ||||||
Gross profit | 4,964 | 4,499 | 4,374 | 4,847 | 5,132 | |||||||||||
Selling, general and administrative expenses |
(3,786 |
) |
(3,917 |
) |
(4,050 |
) |
(4,030 |
) |
(4,082 |
) |
||||||
Amortization expense(1) | (45 | ) | (31 | ) | (45 | ) | (203 | ) | (196 | ) | ||||||
Other income (expense), net(2) | (49 | ) | (194 | ) | (80 | ) | (158 | ) | 273 | |||||||
Earnings before interest and taxes | 1,084 | 357 | 199 | 456 | 1,127 | |||||||||||
Interest and dividend income |
164 |
152 |
194 |
353 |
381 |
|||||||||||
Interest and other finance expense | (387 | ) | (569 | ) | (327 | ) | (580 | ) | (452 | ) | ||||||
Income (loss) from continuing operations before taxes and minority interest | 861 | (60 | ) | 66 | 229 | 1,056 | ||||||||||
Provision for taxes |
(311 |
) |
(245 |
) |
(81 |
) |
(85 |
) |
(309 |
) |
||||||
Minority interest | (102 | ) | (66 | ) | (111 | ) | (69 | ) | (47 | ) | ||||||
Income (loss) from continuing operations | 448 | (371 | ) | (126 | ) | 75 | 700 | |||||||||
Income (loss) from discontinued operations, net of tax(3) | (483 | ) | (408 | ) | (693 | ) | (755 | ) | 726 | |||||||
Cumulative effect of change in accounting principles (SFAS 133), net of tax(4) | | | | (63 | ) | | ||||||||||
Net income (loss) | $ | (35 | ) | $ | (779 | ) | $ | (819 | ) | $ | (743 | ) | $ | 1,426 | ||
Basic earnings (loss) per share(5): |
||||||||||||||||
Income (loss) from continuing operations | $ | 0.22 | $ | (0.30 | ) | $ | (0.11 | ) | $ | 0.07 | $ | 0.59 | ||||
Net Income (loss) | $ | (0.02 | ) | $ | (0.64 | ) | $ | (0.74 | ) | $ | (0.66 | ) | $ | 1.21 | ||
Diluted earnings (loss) per share(5): | ||||||||||||||||
Income (loss) from continuing operations | $ | 0.22 | $ | (0.30 | ) | $ | (0.27 | ) | $ | 0.07 | $ | 0.59 | ||||
Net Income (loss) | $ | (0.02 | ) | $ | (0.64 | ) | $ | (0.86 | ) | $ | (0.66 | ) | $ | 1.20 |
5
BALANCE SHEET DATA:
|
December 31, |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
2001 |
2000 |
|||||||||||
|
(audited) |
(audited) |
(unaudited) |
(unaudited) |
(unaudited) |
|||||||||||
|
(U.S. dollars in millions) |
|||||||||||||||
Cash and equivalents | $ | 3,676 | $ | 4,783 | $ | 2,529 | $ | 2,470 | $ | 1,234 | ||||||
Marketable securities and short-term investments | 524 | 473 | 589 | 1,236 | 2,349 | |||||||||||
Total assets | 24,677 | 30,401 | 29,522 | 32,313 | 30,967 | |||||||||||
Long-term borrowings | 4,901 | 6,290 | 5,358 | 5,010 | 3,760 | |||||||||||
Total debt(6) | 5,534 | 7,934 | 7,935 | 9,739 | 7,262 | |||||||||||
Capital stock and additional paid-in capital | 3,083 | 3,067 | 2,027 | 2,028 | 2,082 | |||||||||||
Total stockholders' equity | 2,824 | 2,917 | 931 | (8) | 1,938 | (8) | 5,147 | (8) | ||||||||
Net operating assets(7) | $ | 9,622 | $ | 9,857 | $ | 9,870 | $ | 9,396 | $ | 10,922 |
CASH FLOW DATA:
|
Year ended December 31, |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
2001 |
2000 |
|||||||||||
|
(audited) |
(audited) |
(audited) |
(audited) |
(unaudited) |
|||||||||||
|
(U.S dollars in millions) |
|||||||||||||||
Net cash provided by (used in) operating activities | $ | 962 | $ | (173 | ) | $ | | $ | 1,983 | $ | 747 | |||||
Net cash provided by (used in) investing activities | 354 | 754 | 2,651 | (1,218 | ) | (489 | ) | |||||||||
Net cash provided by (used in) financing activities | $ | (2,805 | ) | $ | 1,603 | $ | (2,793 | ) | $ | 677 | $ | (392 | ) |
OTHER FINANCIAL AND OPERATING DATA:
|
Year ended December 31, |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
2001 |
2000 |
||||||||||
|
(audited) |
(audited) |
(audited) |
(unaudited) |
(unaudited) |
||||||||||
|
(U.S dollars in millions) |
||||||||||||||
Purchases of property, plant and equipment | $ | 543 | $ | 547 | $ | 602 | $ | 761 | (8) | $ | 553 | ||||
Depreciation and amortization(1) | 633 | 585 | 611 | 787 | (8) | 836 | |||||||||
Research and development | 690 | 635 | 572 | 602 | 661 | ||||||||||
Order-related development(9) | $ | 727 | $ | 886 | $ | 719 | $ | 824 | $ | 973 |
6
7
Payment of dividends is subject to general business conditions, the ABB Group's current and expected financial condition and performance and other relevant factors including growth opportunities.
Dividends may be paid only if ABB Ltd has sufficient distributable profits from previous fiscal years or sufficient free reserves to allow the distribution of a dividend. In addition, at least 5 percent of ABB Ltd's annual net profits must be retained and booked as legal reserves, unless these reserves already amount to 20 percent of ABB Ltd's share capital. As a holding company, ABB Ltd's main sources of income are dividend, interest and debt payments from its subsidiaries. At December 31, 2004, of the CHF 8,911 million of stockholders' equity recorded in the unconsolidated statutory financial statements of ABB Ltd prepared in accordance with Swiss law, CHF 5,176 million was attributable to the share capital, CHF 1,780 million was attributable to legal reserves, CHF 412 million was attributable to reserves for treasury, CHF 1,533 million was attributable to other reserves and CHF 11 million was available for distribution.
ABB Ltd may only pay out a dividend if it has been proposed by a shareholder or the board of directors of ABB Ltd, approved at a general meeting of shareholders and the statutory auditors confirm that the dividend conforms to statutory law and the articles of incorporation of ABB Ltd. In practice, the shareholders' meeting usually approves dividends as proposed by the board of directors, if the board of directors' proposal is confirmed by the statutory auditors.
Dividends are usually due and payable no earlier than three trading days after the shareholders' resolution. Dividends not collected within five years after the due date accrue to ABB Ltd and are allocated to its other reserves. For information about the deduction of withholding taxes from dividend payments, see "Item 10. Additional InformationTaxation."
We have established a dividend access facility for shareholders who are resident in Sweden under which these shareholders may register with VPC AB (Sweden) ("VPC"), as holder of up to 600,004,716 shares, and receive dividends in Swedish kronor equivalent to the dividend paid in Swiss francs without deduction of Swiss withholding tax. For further information, see "Item 10. Additional InformationTaxation."
Because ABB Ltd pays cash dividends, if any, in Swiss francs (subject to the exception for certain shareholders in Sweden described above), exchange rate fluctuations will affect the U.S. dollar amounts received by holders of ADSs upon conversion of those cash dividends by Citibank, N.A., the depositary, in accordance with the Amended and Restated Deposit Agreement dated May 7, 2001.
The following table sets forth in Swiss francs and in U.S. dollars the dividend paid per share with respect to the years ended December 31, 2004, 2003, 2002, 2001 and 2000. On May 12, 2005, at the annual general meeting of shareholders, the shareholders decided that no dividend would be paid with respect to the year ended December 31, 2004.
Year ended December 31, |
Dividend per share |
||||
---|---|---|---|---|---|
|
(CHF) |
($) |
|||
2004 | | | |||
2003 | | | |||
2002 | | | |||
2001 | | | |||
2000 | 0.75 | 0.43 | (1) |
8
You should carefully consider all of the information set forth in this report and the following description of risks and uncertainties that we currently believe may exist. Our business, financial condition or results of operations could be adversely affected by any of these risks. Additional risks of which we are unaware or that we currently deem immaterial may also impair our business operations. This annual report also contains forward-looking statements that involve risks and uncertainties. Our results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those described below and elsewhere in this annual report. See "Forward-Looking Statements."
We are subject to ongoing litigation and potentially substantial liabilities arising out of asbestos claims.
Companies in the ABB group are subject to thousands of lawsuits brought by plaintiffs seeking compensation for personal injuries allegedly resulting from exposure to asbestos. In the United States, our Combustion Engineering subsidiary has been a co-defendant in a large number of these lawsuits, and a smaller number of claims have been brought against two other subsidiaries, ABB Lummus Global Inc. ("Lummus") (which is part of our Oil, Gas and Petrochemicals business and was formerly a subsidiary of Combustion Engineering) and Basic Incorporated ("Basic") (which was a subsidiary of Combustion Engineering and of Asea Brown Boveri Inc. ("Asea Brown Boveri") and is now a subsidiary of ABB Holdings Inc. ("Holdings") following the merger in December 2004 of Asea Brown Boveri into Holdings).
Since early 2003, we and our subsidiaries have been seeking to resolve our asbestos-related liabilities principally through a proposed plan of reorganization under Chapter 11 of the U.S. Bankruptcy Code for our subsidiary Combustion Engineering. In March 2005, following the ruling of the U.S. Court of Appeals for the Third Circuit in December 2004 (the "Third Circuit Decision") that reversed the lower courts' approval of the original plan, we reached agreement with various parties on basic terms for a modified plan of reorganization for Combustion Engineering (the "Modified CE Plan") and a separate plan of reorganization under Chapter 11 of the U.S. Bankruptcy Code for Lummus (the "Lummus Plan"). The proposed plans do not address Basic, and we expect that Basic's asbestos-related liabilities will have to be resolved through its own bankruptcy or similar U.S. state court liquidation proceeding, or through the tort system.
We and various other interested parties are now working to reach agreement on open issues, details relating to the Modified CE Plan and the Lummus Plan and the form and substance of the operative documents and related Bankruptcy Court motions and other pleadings. We cannot be certain when those negotiations will be concluded or whether or on what terms the parties will resolve outstanding issues. The Modified CE Plan and the Lummus Plan will become effective only if different classes of their respective creditors vote in favor of the respective plans. The Modified CE Plan and the Lummus Plan will be subject to the approval of the Bankruptcy and District Courts, as well as to further judicial review if appeals are made. While we believe that the Modified CE Plan and the Lummus Plan are consistent with the Third Circuit Decision and other applicable laws and precedents, we cannot be certain whether the courts will approve the plans, nor can we predict whether the plans will receive the needed creditor votes.
We cannot be certain of the duration of the asbestos-related litigation process, its outcome or its eventual cost to us. We do not know whether any plan of reorganization for Combustion Engineering or Lummus will ultimately be confirmed or whether asbestos-related liabilities of any other ABB group entities would be resolved by any such plan. If for any reason a Chapter 11 plan relating to Combustion Engineering is not eventually confirmed, Combustion Engineering could be required to enter a Chapter 7 proceeding. If for any reason a Chapter 11 plan relating to Lummus is not eventually confirmed, we expect that Lummus' asbestos-related liabilities will have to be resolved through the tort system.
9
If any ABB group entities are not included in the protection offered by the channeling injunction entered pursuant to any Combustion Engineering plan that is confirmed, such entities could be required to resolve in the tort system, or otherwise, current and future asbestos-related claims that are asserted against such entities. Such events would be subject to numerous uncertainties, risk and expense.
All of these factors make the ultimate outcome of our efforts to resolve the asbestos-related claims against Combustion Engineering and our other subsidiaries uncertain, and, moreover, could cause our obligations to make payments in respect of asbestos-related claims, indemnity payments and related defense costs to significantly exceed our estimates. From time to time we update our forecasts to take into consideration developments regarding any plan of reorganization, recent claims experience and other developments and such updates may affect our estimates of future asbestos-related liabilities and costs. Any expenses incurred or increases to our asbestos reserves as a result of a delay or abandonment of any plan of reorganization for Lummus or Combustion Engineering, revised forecasts, adverse jury verdicts or court decisions or other negative developments involving resolution of our asbestos-related liabilities, whether through the bankruptcy courts, liquidation proceedings or the tort system, may cause the value or trading prices of our securities to decrease significantly. These negative developments could also cause our credit ratings to be downgraded, restrict our access to the capital markets or otherwise have a material adverse effect on our financial condition, results of operations, cash flows and liquidity.
If we are not able to comply with the covenants contained in our new $1 billion credit facility, our financial position may be adversely affected.
We are party to a three-year $1 billion credit facility that became available in December 2003. It contains certain financial covenants in respect of minimum interest coverage, maximum net leverage and a minimum level of consolidated net worth, as well as specific negative pledges. If we are unable to comply with the covenants in the credit facility, we may be required to renegotiate the facility with our lenders or to replace it in order not to default under it. We can offer no assurance that we would be able to renegotiate or replace the facility on terms that are acceptable to us, if at all. We have never drawn any funds under the facility and we currently do not intend to draw on it. See "Item 5. Operating and Financial Review and ProspectsLiquidity and Capital ResourcesCredit Facilities."
Our ability to bid for large contracts depends on our ability to obtain performance guarantees from financial institutions.
In the normal course of our business and in accordance with industry practice, we provide performance guarantees on large projects, including long-term operation and maintenance contracts, which guarantee our own performance. These guarantees may include guarantees that a project will be completed or that a project or particular equipment will achieve defined performance criteria. If we fail to attain the defined criteria, we must make payments in cash or in kind. Performance guarantees frequently are requested in relation to bids for large projects, both in our core power and automation businesses and in our Oil, Gas and Petrochemicals business.
Some customers require that performance guarantees be issued by a financial institution in the form of a letter of credit, surety bond or other financial guarantee. In considering whether to issue a guarantee on our behalf, financial institutions consider our credit ratings. Our current credit rating and financial position have not prevented us from obtaining such guarantees from financial institutions, but they can make and have made the process more difficult and expensive. If, in the future, we cannot obtain such a guarantee from a financial institution on reasonable terms, we could be prevented from bidding on or obtaining the contract or our costs would be higher, which would reduce the profitability of the contract. If we cannot obtain sufficient guarantees from financial institutions in the future, there could be a material impact on our business, financial condition, results of operations or liquidity.
10
We have retained performance guarantees related to our divested power generation business.
We have retained performance guarantees related to the power generation business that we contributed to the former ABB ALSTOM POWER joint venture. The guarantees primarily consist of performance guarantees, advance payment guarantees, product warranty guarantees and other miscellaneous guarantees under certain contracts such as indemnification for personal injuries and property damages, taxes and compliance with labor laws, environmental laws and patents. The guarantees are related to projects that are expected to be completed by 2015 but in some cases the guarantees have no definite expiration. ALSTOM and its subsidiaries have primary responsibility for performing the obligations that are the subject of the guarantees. In connection with the sale to ALSTOM of our interest in the joint venture in May 2000, ALSTOM, (the parent company), and ALSTOM POWER (the former joint venture entity) have undertaken jointly and severally to fully indemnify us and hold us harmless against any claims arising under these guarantees. Due to the nature of product warranty guarantees and certain other guarantees, we are unable to develop an estimate of the maximum potential amount of future payments for these guarantees. Our best estimate of the total maximum potential exposure under all quantifiable guarantees we issued on behalf of our former power generation business was approximately $875 million as of December 31, 2004. This maximum potential exposure, as required by Financial Accounting Standards Board Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, is based on the original guarantee or contract amount and does not reflect our assessment of actual exposure under the guarantees.
As of December 31, 2004, no losses have been recognized in connection with the guarantees relating to the divested power generation business. We have not concluded that a loss is probable under these guarantees and, therefore, we have not recorded a provision as of December 31, 2004. However, if we are required to fund payments under these guarantees following a failure of the divested power generation business to perform its obligations, and if ALSTOM does not to fulfill its undertaking to indemnify us, we could incur material losses. See "Item 5. Operating and Financial Review and ProspectsOff Balance Sheet ArrangementsGuarantees."
Undertaking long-term fixed price projects exposes our businesses to risk of loss.
We derive a portion of our revenues from long-term, fixed price or turnkey projects that are awarded on a competitive basis and can take many months, or even years, to complete. Such contracts involve substantial risks, including the possibility that we may underbid and the fact that we typically assume substantially all of the risks associated with completing the project and the post-completion warranty obligations. We also assume the project's technical risk, meaning that we must tailor our products and systems to satisfy the technical requirements of a project even though, at the time we are awarded the project, we may not have previously produced such a product or system. The revenue, cost and gross profit realized on such contracts can vary, sometimes substantially, from our original projections because of changes in conditions, including but not limited to:
11
These risks are exacerbated if the duration of the project is long-term because there is an increased risk that the circumstances upon which we originally bid and developed a price will change in a manner that increases our costs. In addition, we sometimes bear the risk of delays caused by unexpected conditions or events. The contracts for our long-term, fixed-price projects often make us subject to penalties if we cannot complete portions of the project in accordance with agreed-upon time limits.
Historically, we have incurred significant losses as a result of performing long-term projects on a fixed-price or turnkey basis. For example, in 2003 the operating income of the downstream part of our Oil, Gas and Petrochemicals business was adversely affected by cost overruns amounting to $399 million, primarily relating to four large, long-term, fixed-price projects which had been contracted prior to 2002. In 2004 no significant losses were reported from such long-term projects. In view of the potential for losses from such contracts, we have been seeking to reduce our involvement with new long-term, fixed-price contracts and have instead been pursuing contracts with a cost-reimbursement element. However, because we still do enter into new contracts on a fixed price basis and continue to have substantial obligations under long-term, fixed-price contracts, we still face the risk of significant losses on these types of contracts.
In connection with long-term projects, we routinely undertake substantial customer- and project-specific development efforts to develop or adapt equipment and systems to the unique needs of our customers in connection with specific orders or projects. We had expenditures of $727 million, $886 million, and $719 million, or approximately 3.5 percent, 4.3 percent and 3.7 percent of annual consolidated revenues, in 2004, 2003 and 2002, respectively, on such order-related development activities. Order-related development amounts are initially recorded in inventories as part of the work in progress of a contract and then are reflected in cost of sales at the time revenue is recognized in accordance with our accounting policies. If our revenues on these projects are insufficient, we must write off the associated order-related development expenditures. Additionally, to the extent that order-related development expenditures in a specific project exceed expectations, the profit margin on that project will be adversely affected.
We may expend significant resources, both in management time as well as money, on bidding for projects that we are not awarded.
Our international operations expose us to the risk of fluctuations in currency exchange rates.
Exchange rate fluctuations have had, and could continue to have, a material impact on our operating results, the comparability of our results between periods, the value of assets or liabilities as recorded on our consolidated balance sheet and the price of our securities. Foreign exchange rate changes resulted in an increase in our reported revenues and earnings before interest and taxes of 6 percent and 18 percent in 2004 and 12 percent and 42 percent in 2003, respectively. Changes in exchange rates can unpredictably and adversely affect our consolidated operating results, and could result in exchange losses.
Currency Translation Risk. The results of operations and financial position of most of our non-U.S. companies are initially recorded in the currency, which we call "local currency," of the country in which the respective company resides. That financial information is then translated into U.S. dollars at the applicable exchange rates for inclusion in our Consolidated Financial Statements. The exchange rates between local currencies and the U.S. dollar fluctuate substantially, which has a significant translation effect on our reported consolidated results of operations and financial position. In 2004 as in 2003, the U.S. dollar continued to depreciate against most of the currencies in which our companies reported results of operations. In particular, the exchange rates between the U.S. dollar and the EUR and the U.S. dollar and the CHF at December 31, 2004, 2003, and 2002, were as follows.
12
Exchange rates into U.S. dollars
|
At December 31, |
||||||||
---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||||
EUR 1.00 | $ | 1.37 | $ | 1.26 | $ | 1.05 | |||
CHF 1.00 | $ | 0.88 | $ | 0.81 | $ | 0.72 |
The average exchange rates between the U.S. dollar and the EUR and the U.S. dollar and the CHF for the years ended December 31, 2004, 2003 and 2002, were as follows.
Exchange rates into U.S. dollars
|
For the year ended December 31, |
||||||||
---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||||
EUR 1.00 | $ | 1.25 | $ | 1.13 | $ | 0.94 | |||
CHF 1.00 | $ | 0.81 | $ | 0.75 | $ | 0.64 |
Increases and decreases in the value of the U.S dollar versus local currencies will affect the reported value of our local currency assets, liabilities, revenues and costs in our Consolidated Financial Statements, even if the value of these items has not changed in local currency terms. These translations could significantly and adversely affect our results of operations and financial position from period to period.
Currency Transaction Risk. Currency risk exposure also affects our operations when our sales are denominated in currencies that are different from those in which our manufacturing costs are incurred. In this case, if after the parties agree on a price, the value of the currency in which the purchase price is to be paid weakens relative to the currency in which we incur manufacturing costs, there would be a negative impact on the profit margin for any such transaction. This transaction risk may exist regardless of whether or not there is also a translation risk as described above.
In 2004, approximately 84 percent of our consolidated revenues were generated in local currencies and translated into U.S. dollars. Of that amount, the following percentages were reported in the following local currencies:
In 2004, approximately 83 percent of our consolidated cost of sales and selling, general and administration expenses were reported in currencies other than U.S. dollars. Of that amount, the following percentages were reported in the following currencies:
13
Currency exchange rate fluctuations in those currencies in which we incur our principal manufacturing expenses may adversely affect our ability to compete with companies whose costs are incurred in other currencies. If our principal expense currencies appreciate in value against such other currencies, our competitiveness may be weakened.
Our hedging activities may not protect us against the consequences of significant fluctuations in exchange rates on our earnings and cash flows.
Our policy is to hedge material net currency exposures by entering into offsetting transactions with third party financial institutions. Given that, and the effective horizons of our risk management activities and the anticipatory nature of the exposures intended to be hedged, there can be no assurance that our currency hedging activities will fully offset the adverse financial impact resulting from unfavorable movements in foreign exchange rates. In addition, the timing of the accounting for recognition of gains and losses related to a hedging instrument may not coincide with the timing of gains and losses related to the underlying economic exposures.
We operate in very competitive markets and could be adversely affected if we fail to keep pace with technological changes.
We operate in very competitive environments in several specific respects, including product performance, developing integrated systems and applications that address the business challenges faced by our customers, pricing, new product introduction time and customer service. The relative importance of these factors differs across the geographic markets and product areas that we serve. The markets for our products and services are characterized by evolving industry standards (particularly for our automation technology products and systems), rapidly changing technology (in both our power and automation businesses) and increased competition as a result of deregulation (particularly for our power technology products and systems). For example, for a number of years power transmission and distribution providers throughout the world have been undergoing substantial deregulation and privatization. This has increased their need for timely product and service innovations that increase efficiency and allow them to compete in a deregulated environment. Additionally, the continual development of advanced technologies for new products and product enhancements is an important way in which we maintain acceptable pricing levels. If we fail to keep pace with technological changes in the industrial sectors that we serve, we may experience price erosion and lower margins.
The principal competitors for our automation technology products and services include Emerson Electric Co., Honeywell International, Inc., Invensys plc, Schneider Electric S.A. and Siemens AG. We primarily compete with Areva S.A., Schneider Electric SA and Siemens AG in sales of our power technology products and systems to our utilities customers. The principal competitors with our Oil, Gas and Petrochemicals business include Bechtel Group, Inc., UOP LLC, Fluor Corporation, Halliburton Company and Technip-Coflexip S.A. All of our competitors are sophisticated companies with significant resources that may develop products and services that are superior to our products and services or may adapt more quickly than we do to new technologies, industry changes or evolving customer requirements. Our failure to anticipate or respond quickly to technological developments or customer requirements could adversely affect our business, results of operations, financial condition and liquidity.
Industry consolidation could result in more powerful competitors and fewer customers.
Competitors of all of our business divisions are consolidating. In particular, the automation industry is undergoing consolidation that is reducing the number but increasing the size of companies that compete with us. As our competitors consolidate, they likely will increase their market share, gain economies of scale that enhance their ability to compete with us and/or acquire additional products and technologies that could displace our product offerings.
14
Our customer base also is undergoing consolidation. Consolidation among our customers' industries (such as the marine and cruise industry, the automotive, aluminum, steel, pulp and paper, pharmaceutical industries and the oil and gas industry) could affect our customers and their relationships with us. If one of our competitors' customers acquires any of our customers, we may lose its business. Additionally, as our customers become larger and more concentrated, they could exert pricing pressure on all suppliers, including ABB. For example, in an industry such as power transmission, which historically has consisted of large and concentrated customers such as utilities, price competition can be a factor in determining which products and services will be selected by a customer.
Our business is affected by the global economic and political climate.
Adverse changes in economic conditions or the political climate could have a material adverse effect on our business, financial condition, results of operations and liquidity. The business environment is influenced by numerous political uncertainties, which will continue to affect the global economy and the international capital markets. In periods of slow economic growth or decline, our customers are more likely to decrease expenditures on the types of products and systems we supply and we are more likely to experience decreased revenues as a result. Our Power Technologies division is affected by the level of investments by utilities, and our Automation Technologies division is affected by conditions in a broad range of industries, including the automotive, pharmaceutical, pulp and paper, metals and minerals and manufacturing and consumer industries. Our Oil, Gas and Petrochemicals business is affected by conditions in the oil, gas and petrochemicals industry, including the level of market growth in low hydrocarbon cost regions and high economic growth regions.
We have retained liability for environmental remediation costs relating to businesses that we sold in 2000, and we could be required to make payments in respect of these retained liabilities in excess of established reserves.
We have retained liability for environmental remediation costs at two sites in the United States that were operated by our nuclear technology business, which we sold in April 2000 to British Nuclear Fuels plc ("BNFL"). We have retained all environmental liabilities associated with our Combustion Engineering subsidiary's Windsor, Connecticut facility and a portion of the liabilities associated with our ABB C-E Nuclear Power, Inc. subsidiary's Hematite, Missouri facility. The primary environmental liabilities associated with these sites relate to the costs of remediating radiological and chemical contamination upon decommissioning the facilities. Based on information that BNFL has made publicly available, we believe remediation may take until 2013 at the Hematite site and until 2008 at the Windsor site. At the Windsor site, we believe that a significant portion of such remediation costs will be the responsibility of the U.S. government pursuant to federal law, although the exact amount of such responsibility cannot reasonably be estimated. In connection with the sale of the nuclear business in April 2000, we established a reserve of $300 million in respect of estimated remediation costs related to these facilities. Expenditures charged to the remediation reserve were $10 million, $6 million and $12 million during 2004, 2003 and 2002, respectively. It is possible that we could be required to make expenditures in excess of the reserve, in a range of amounts that cannot reasonably be estimated. See "Item 5. Operating and Financial Review and ProspectsEnvironmental Liabilities
We are subject to environmental laws and regulations in the countries in which we operate. We incur costs to comply with such regulations, and our ongoing operations may expose us to environmental liabilities.
Our operations are subject to U.S., European and other laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. Our manufacturing facilities use and produce paint residues, solvents, metals, oils and related residues. We use petroleum-based insulation in transformers, PVC resin to manufacture PVC cable and chloroparafine as a flame retardant. We use inorganic lead as a counterweight in robots that we
15
produce. These are considered to be hazardous substances in many jurisdictions in which we operate. We may be subject to substantial liabilities for environmental contamination arising from the use of such substances. All of our manufacturing operations are subject to ongoing compliance costs in respect of environmental matters and the associated capital expenditure requirements.
In addition, we may be subject to significant fines and penalties if we do not comply with environmental laws and regulations including those referred to above. Some environmental laws provide for joint and several strict liability for remediation of releases of hazardous substances, which could result in our liability for environmental damage without regard to our negligence or fault. Such laws and regulations could expose us to liability arising out of the conduct of operations or conditions caused by others, or for our acts which were in compliance with all applicable laws at the time the acts were performed. Additionally, we may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances. Changes in the environmental laws and regulations, or claims for damages to persons, property, natural resources or the environment, could result in substantial costs and liabilities to us.
We may be the subject of product liability claims.
We may be required to pay for losses or injuries purportedly caused by the design, manufacture or operation of our products and systems. Additionally, we may be subject to product liability claims for the improper installation of products and systems designed and manufactured by others.
Product liability claims brought against us may be based in tort or in contract, and typically involve claims seeking compensation for personal injury or property damage. If the claimant runs a commercial business, claims are often made also for financial losses arising from interruption of operations consequential to property damage. Because of our broad offering of products, these claims arise in different contexts, including the following:
If we were to incur a very large product liability claim, our insurance protection might not be adequate or sufficient to cover such a claim in terms of paying any awards or settlements, and/or paying for our defense costs. Further, some claims may be outside the scope of our insurance coverage. If a litigant were successful against us, a lack or insufficiency of insurance coverage could result in an adverse effect on our business, financial condition, results of operations and liquidity. Additionally, a well-publicized actual or perceived problem could adversely affect our market reputation which could result in a decline in demand for our products.
Our operations in emerging markets expose us to risks associated with conditions in those markets.
An increasing amount of our operations are conducted in the emerging markets of Latin America, Asia, the Middle East and Africa. In 2004, approximately 35 percent of our consolidated revenues were generated from these emerging markets. Operations in emerging markets can present risks that are not encountered in countries with well-established economic and political systems, including:
16
In addition, the legal and regulatory systems of the emerging markets identified above are less developed and less well-enforced than in industrialized countries. Therefore, our ability to protect our contractual and other legal rights in those regions could be limited. We cannot offer any assurance that our exposure to conditions in emerging markets will not adversely affect our business, financial condition, results of operations and liquidity.
We may encounter difficulty in managing our business due to the global nature of our operations.
We operate in approximately 100 countries around the world and, as of December 31, 2004, employed approximately 102,500 people. As of December 31, 2004, approximately 59 percent of our employees were located in Europe, approximately 16 percent in the Americas, approximately 16 percent in Asia and approximately 9 percent in the Middle East and Africa. In order to manage our day-to-day operations, we must overcome cultural and language barriers and assimilate different business practices. In addition, we are required to create compensation programs, employment policies and other administrative programs that comply with the laws of multiple countries. We also must communicate and monitor group-wide standards and directives across our global network. Our failure to successfully manage our geographically diverse operations could impair our ability to react quickly to changing business and market conditions and to enforce compliance with group-wide standards and procedures.
Our reputation and our ability to do business may be impaired by corrupt behavior by any of our employees or agents or those of our subsidiaries.
There is a risk that our employees or agents may take actions that violate either the U.S. Foreign Corrupt Practices Act (FCPA) or legislation promulgated pursuant to the 1997 OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions or other applicable anti-corruption regulations. Such actions have resulted, and could in the future result, in monetary penalties against us or our subsidiaries and could damage our reputation and ability to do business. Further, detecting, investigating and resolving such actions could be expensive and could consume significant time and attention of our senior management. While we and our subsidiaries are committed to conducting business in a legal and ethical manner, our internal control systems have not been, and in the future may not be, completely effective to prevent and detect such improper activities by our employees and agents.
In 2004, we agreed to a civil settlement and paid civil penalties in connection with FCPA violations in Nigeria, we discovered earnings overstatements and related improper payments by one of our units in Italy (and as a result in 2004 we restated our consolidated financial statements as of December 31, 2003 and 2002 and for each of the years in the three year period ended December 31, 2003) and we discovered and reported to European authorities anticompetitive practices by employees in our gas insulated switchgear business.
17
On April 19, 2005, we voluntarily disclosed to the U.S. Department of Justice and the U.S. Securities Exchange Commission certain suspect payments made by employees of ABB network management, a specialized U.S.-based business unit. The suspect payments became apparent during an internal investigation following the dismissal of two managers from the company in mid-2004. The payments were made to intermediaries in Latin America and in the Middle East in connection with the company's business, which is control software for utility customers. We are continuing our investigation and compliance review of this business.
If these payments are found to have been illegal, we could be subject to civil and criminal penalties. There can be no assurance that any governmental investigation or our investigation of these matters will not conclude that violations of applicable laws have occurred or that the results of these investigations will not have a material adverse effect on our business and results of operations.
For more information, see "Item 8. Financial InformationLegal Proceedings."
Our Oil, Gas and Petrochemicals business may experience losses if the oil and gas industry generally experiences a downturn.
Our Oil, Gas and Petrochemicals business, which is part of our Non-core activities, depends on the condition of the oil and gas and chemical industry and particularly on capital expenditure budgets of the companies engaged in the downstream refining and petrochemicals segments. The prices of oil and gas and their uncertainty in the future, along with forecasted growth in world oil and gas demand, strongly influence the extent of investment in downstream production activities. Demand for our Oil, Gas and Petrochemicals services will also be affected by refinery margins and prices for petrochemical products such as ethylene and polypropylene.
Refining budgets may be impacted by slower growth in transport fuel demands in China and other growing economies, reduction in fuel usage due to high gasoline prices in the Western economies and slowdown in implementing clean fuels regulations.
Petrochemicals investments, which are normally cyclical and which have been on a high growth pattern in the Middle East and China, may flatten or decline if there is a slowdown in consumption of plastics or if there are political or social events which disrupt business in the Middle East.
Increases in the costs of our raw materials may adversely affect our financial performance.
We purchase large amounts of commodity-based raw materials, including steel, copper, aluminum, and oil. Prevailing prices for such commodities are subject to fluctuations in response to changes in supply and demand and a variety of additional factors beyond our control, such as global political and economic conditions. Historically, prices received for some of these raw materials has been volatile and unpredictable, and such volatility is expected to continue. Therefore, commodity price changes may result in unexpected increases in raw material costs, and we may be unable to increase our prices to offset these increased costs without suffering reduced volume, revenue and operating income. We do not fully hedge against changes in commodity prices and our hedging procedures may not work as planned.
We depend on third parties to supply raw materials and other components and may not be able to obtain sufficient quantities of these materials, which could limit our ability to manufacture products on a timely basis and could harm our profitability. Any supply interruption in a limited or sole-sourced component or raw material could materially harm our ability to manufacture our products until a new source of supply, if any, could be found. We may be unable to find a sufficient alternative supply channel in a reasonable time period or on commercially reasonable terms, if at all. If our suppliers are unable to deliver sufficient quantities of these materials on a timely basis, the manufacture and sale of our products may be disrupted and our sales and profitability could be materially adversely affected.
18
If we are unable to successfully address the material weaknesses in our internal control over financial reporting, our ability to report our financial results on a timely and accurate basis may be adversely affected. As a result, investors could lose confidence in our financial reporting, which may harm our business and the trading price of our stock.
Effective internal control is necessary for us to provide reliable financial reports, and effective disclosure controls are important in enabling us to meet our reporting obligations under the U.S. federal securities laws and other relevant rules and regulations. The Sarbanes-Oxley Act of 2002 requires, among other things, that we maintain adequate internal control structure and procedures for financial reporting. If we can not provide reliable reports, our business and operating results could be harmed. In connection with their evaluation of our disclosure controls and procedures as of December 31, 2004, our Chief Executive Officer and Chief Financial Officer determined that several areas of our internal control over financial reporting need improvement, including a material weakness arising from our September 2004 restatement of our consolidated financial statements as of December 31, 2003 and 2002 and for each of the years in the three year period ended December 31, 2003 and data for 2004 and prior years, and a material weakness resulting from a series of significant deficiencies in our financial reporting process (including, significant deficiencies that were identified in prior years but had not yet been remediated). Based on their evaluation of our disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer were not able to conclude that as of December 31, 2004 our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. We have begun executing a remediation plan to address these weaknesses in our internal controls over financial reporting, as discussed in Item 15 "Controls and Procedures."
In April 2005, in accordance with our 2004 civil settlement with the U.S. Securities and Exchange Commission, we appointed an independent consultant to review our policies and procedures as they relate to compliance with the books and records, internal accounting controls and anti-bribery provisions of the FCPA. The consultant is expected submit a report in August 2005 documenting findings and making recommendations (the "Report") to our Board of Directors. Within ninety days after receiving the Report, we are required to adopt the recommendations contained in the Report, except in certain limited circumstances. We cannot predict what conclusions the independent consultant will reach, or what changes we will make to our controls and procedures following recommendations by the independent consultant. See "Item 8. Financial InformationLegal Proceedings."
Unless and until we successfully address the material weaknesses and significant deficiencies, and any other inadequacies in our internal controls and disclosure controls and procedures, our ability to manage our business and to report on a timely and accurate basis may be adversely affected. Any failure to improve our internal control to address these identified material weaknesses and significant deficiencies could also cause investors to lose confidence in our reported financial information, which could have a negative impact on the trading price of our securities.
19
Item 4. Information on the Company
We are a global provider of power and automation technologies that enable utility and industry customers to improve performance while lowering environmental impact. We serve electric, gas and water utilities, as well as industrial and commercial customers, with a broad range of products, systems and services for power transmission, distribution and power plant automation. We also deliver automation systems for measurement, control, motion, protection and plant optimization across a full range of industries. We apply our expertise to develop creative ways of integrating our products and systems with our customers' business processes to enhance their productivity and efficiency.
History of the ABB Group
The ABB Group was formed in 1988 through a merger between Asea AB and BBC Brown Boveri AG. Initially founded in 1883, Asea AB was a major participant in the introduction of electricity into Swedish homes and businesses and in the development of Sweden's railway network. In the 1940s and 1950s, Asea AB expanded into the power, mining and steel industries. Brown Boveri & Cie. (later renamed BBC Brown Boveri AG) was formed in Switzerland in 1891 and initially specialized in power generation and turbines. In the early to mid-1900s, it expanded its operations throughout Europe and broadened its business operations to include a wide range of electrical engineering activities.
In January 1988, Asea AB and BBC Brown Boveri AG each contributed almost all of their businesses to newly formed ABB Asea Brown Boveri Ltd, of which they each owned 50 percent. In 1996, Asea AB was renamed ABB AB and BBC Brown Boveri AG was renamed ABB AG. In February 1999, the ABB Group announced a group reconfiguration designed to establish a single parent holding company and a single class of shares. ABB Ltd was incorporated on March 5, 1999, under the laws of Switzerland. In June 1999, ABB Ltd became the holding company for the entire ABB Group. This was accomplished by having ABB Ltd issue shares to the shareholders of ABB AG and ABB AB, the two publicly traded companies that formerly owned the ABB Group. The ABB Ltd shares were exchanged for the shares of those two companies, which, as a result of the share exchange and certain related transactions, became wholly owned subsidiaries of ABB Ltd, and are no longer publicly traded. ABB Ltd shares are currently traded on the SWX Swiss Exchange (virt-x), the Stockholm Exchange, the New York Stock Exchange (in the form of American Depositary Shares), the Frankfurt Exchange and the London Stock Exchange.
Organizational Structure
We manage our business based on a divisional structure. Each of our divisions manages several business areas, which in turn are subdivided into business units.
Our core business consists of two divisions, Power Technologies and Automation Technologies, and our management intends to continue to focus its attention on, and future investments in, these divisions. In addition, certain of our operations are classified in Non-core activities and Corporate/Other.
Non-core activities comprise businesses and activities that are not integral to our focus on power and automation technologies and that we are considering for sale, winding down or otherwise exiting.
Effective January 1, 2003, some business areas within our business divisions were reorganized or combined. Consequently, the results of operations in 2002 for certain of the affected business areas are not directly comparable to our results in 2003. When our results of operations in 2003 on a business area basis are not directly comparable to our results of operations in 2002, we combine the results of
20
the affected business areas to create an aggregated basis on which we can compare and discuss our results of operations.
Effective January 1, 2005, some business areas within our business divisions were combined. These changes are further discussed within the "Our business divisions" section below.
The following table sets forth the amount and percentage of ABB Ltd. revenues derived from each of our business divisions for the fiscal years ended December 31, 2004, 2003 and 2002, based on our current organizational structure:
|
Revenues Year ended December 31, |
Percentage of Revenues Year ended December 31, |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
2004 |
2003 |
2002 |
|||||||||
(U.S dollars in millions) | (%) | ||||||||||||||
Power Technologies | $ | 8,755 | $ | 7,598 | $ | 6,814 | 41 | 35 | 33 | ||||||
Automation Technologies | 11,030 | 9,628 | 8,201 | 51 | 45 | 40 | |||||||||
Non-Core Activities | 1,693 | 4,322 | 5,614 | 8 | 20 | 27 | |||||||||
Subtotal | 21,478 | 21,548 | 20,629 | 100 | 100 | 100 | |||||||||
Corporate/Other and Eliminations | (757 | ) | (1,121 | ) | (1,157 | ) | |||||||||
Consolidated Revenues | $ | 20,721 | $ | 20,427 | $ | 19,472 | |||||||||
For a breakdown of our consolidated revenues derived from each geographic region in which we operate, see "Item 5. Operating and Financial Review and ProspectsAnalysis of Results of OperationsRevenues."
Our principal corporate offices are located at Affolternstrasse 44, CH-8050 Zurich, Switzerland, telephone number +41-43-317-7111. Our agent for U.S. federal securities law purposes is ABB Holdings Inc., located at 501 Merritt 7, Norwalk, Connecticut 06851.
Power Technologies Division
Overview
The Power Technologies division serves electric, gas and water utilities as well as industrial and commercial customers, with a broad range of products, systems and services for power transmission, distribution and power plant automation. Key technologies include high- and medium-voltage switchgear, high-voltage power converters, advanced cables for underground and undersea power transmission, electrical transformers, and products and systems to automate and control power plants, electrical and other utility networks. The division had 149 manufacturing plants and 40,500 employees as of January 1, 2005.
Power Industry Background
The portions of an electricity grid that operate at highest voltages are "transmission" systems, while those at lower voltages are "distribution" systems. Transmission systems link power generation sources to distribution systems. Distribution networks then branch out over shorter distances to carry electricity from the transmission system to end users. These electricity networks incorporate sophisticated devices to control and monitor operations and to prevent damage from failures or stresses.
Electricity is transformed at different stages in the delivery process between the source and the ultimate end user. For example, electrical power is often generated in large power plants at 10 to 20
21
kilovolts. Because this voltage is too low to be transmitted efficiently, transformers are used to increase the voltage of electricity (up to 1,100 kilovolts) for long-distance transmission. This reduces losses and increases the amount of power that can be carried per line.
Transformers are also used to decrease the voltage at the local end for distribution to end users, such as residential, commercial or industrial consumers. An electric utility distribution system comprises distribution substations and networks, both overhead and underground. Some large industrial and commercial facilities receive electricity at higher voltage levels from the transmission or distribution network, while most industrial, commercial and residential users receive electricity from distribution network feeders at lower voltages.
There is a global trend toward deregulation and privatization of the power industry, which is creating a more competitive environment for our customers. This trend is evident in the United States, parts of Latin America and Western Europe, particularly in the United Kingdom and the Nordic countries. It is accelerating elsewhere in Europe and is developing in other regions. The creation of a free market for electricity requires our customers to become more cost- efficient and reliable to compete as a lowest-cost provider among power suppliers. Grid operators must be able to deliver power to customers that are hundreds or thousands of miles away within a few minutes. As more disturbance-sensitive loads (such as computers and telecommunications systems) have been added to networks, demand for reliable, high-quality electricity is increasing. Power suppliers can achieve this efficiency and reliability in a number of ways, including the following:
Business Areas
The following table sets forth the approximate proportion of the Power Technologies division's revenue generated in 2004 by each of the business areas in the division:
Business Area |
Proportion of Division Revenues |
||
---|---|---|---|
Transformers | 26 | % | |
Power Systems | 22 | % | |
Medium-Voltage Products | 19 | % | |
High-Voltage Products | 17 | % | |
Utility Automation Systems | 16 | % |
Through 2003 and 2004, two of the division's business areasPower Systems and Utility Automation Systemsprimarily provided engineering services drawing on the ABB Group's complete range of products and services. The other three business areasHigh-Voltage Products, Medium-Voltage Products, and Transformersmainly consisted of product manufacturing businesses. As of January 1, 2005, the Power Technologies division simplified its structure from five into two business areas, organized around products and systems, in order to further improve efficiency and cost competitiveness. The Power Technology Systems business area offers systems for power transmission, distribution grids and power plants. The Power Technology Products business area incorporates ABB's manufacturing network for power technologies, such as switchgear, breakers, transformers and cables.
22
Transformers
Effective January 1, 2004, the Power Technologies division merged its Power Transformers business area with its Distribution Transformers business area to form a single Transformers business area. The merger was intended to reduce product overlaps, eliminate redundant research and development efforts and improve supply chain management. The two former business areas already shared many production locations prior to their merger.
The Transformers business area designs and manufactures power transformers (72.5 to 800 kilovolts) for utility, transportation and industrial customers, as well as transformer components such as bushings and tap changers. The business area also produces insulation material. Transformers are typically used for power transmission and distribution systems, such as in large substations. Generator transformers are used in power generation when it is necessary to increase power voltage from a power plant for long-distance transmission. Industrial transformers are mainly delivered to the steel and aluminum industry, which need their own high-voltage transformers and substations on-site to service their heavy electricity requirements. Finally, the business area produces traction transformers used in electric locomotives. Customers in the components business come both from the transformer and electrical motor industry. The business area also provides a wide range of transformer service and retrofit solutions for utilities and industry customers.
The business area also manufactures distribution transformers for use in industrial facilities, commercial buildings and utility distribution networks to step down electrical voltage to the levels needed by end users. The business area manufactures and sells a full range of power distribution transformers (up to 72.5 kilovolts), including oil-type, dry-type and special application distribution transformers. Although oil-type transformers are more commonly used, demand for dry-type transformers is growing because they minimize fire hazards and have applications in high-density office buildings, windmills, offshore drilling platforms, naval vessels and high-volume industrial plants.
Power Systems
Our Power Systems business area undertakes turnkey contracts to install and upgrade transmission and distribution systems incorporating components manufactured by this division and the Automation Technologies division, as well as those manufactured by third parties.
We are a leader in high-voltage direct current ("HVDC") technology. HVDC transmission is an advanced technology for transporting electricity over long distances. It reduces power losses, increases system stability and provides a more controllable flow than high-voltage alternating current. An HVDC transmission system typically includes converters, which change alternating current to direct current and then back to alternating current when it reaches the terminal point, and transmission lines, either above or below ground. Advances in converter and cable technology have enabled us to introduce a system called HVDC Light. Converter stations for HVDC Light are approximately one-fifth the size of conventional HVDC technology for the same rated power. HVDC Light extends the range of applications for high-voltage direct current. Typical applications include interconnection of separate networks that operate on different frequencies or provide variational power quality, such as wind parks. The system can also be used as a substitute for local power generation in remote areas, islands or oil platforms.
We also provide flexible alternating current (AC) transmission systems ("FACTS") to enhance power grid stability, improve power quality and thus increase transmission capability. FACTS devices include series compensators, static VAR compensators ("SVCs") and SVC Light (based on the same unique technology as HVDC Light).
HVDC, HVDC Light, FACTS, and SVC Light systems rely on advanced power semiconductor components. Our in-house power semiconductor unit enables us to develop and manufacture
23
tailor-made components to maximize the performance of these systems. This business area supplies power semiconductor devices to other ABB businesses and to external customers in the power transmission and distribution, drives, and transportation markets.
The Power Systems business area also supplies substations to interconnect electricity grids operating on different voltage levels, to sectionalize portions of the grid and to protect the electrical system against damage from outside sources such as lightning and overload. By sectionalizing the grid, power can be rerouted from portions of the transmission system that are experiencing problems to sections that are functioning properly, thereby enhancing the overall reliability of the power supply. This business area delivers complete air and gas insulated substations for power transmission. Substations are also necessary in a power distribution network to sectionalize and reduce the voltage of the main power lines and cables to the lower voltages required for efficient distribution and consumption. For power distribution, this business area sells traditional custom-engineered substations as well as compact, modular substations, which require less space than a conventional substation and thus are particularly well suited for urban settings. It also offers prefabricated secondary substations that can be installed more quickly than traditional substations, and which transform electricity to consumer-level voltages.
Power Systems also delivers the engineering, procurement and construction ("EPC") of overhead transmission lines, one of the main subsystems in a transmission network. ABB in-house engineering and manufacturing of steel transmission towers and composite insulators also add value in the delivery of a transmission line project. Power Systems also provides studies on the design of new transmission lines and system optimization that take into account technical, economic and environmental considerations.
This business area offers service contracts and support for management of existing power transmission and distribution assets, including both ABB products and those manufactured by third parties. In addition, it offers asset management services including technical consulting (system diagnostics, network analysis, planning and optimization), commercial consulting (cost reduction programs, investment strategies, reengineering of business processes) and execution (maintenance strategies, logistics).
Medium-Voltage Products
The Medium-Voltage Products business area develops products and systems that reduce outage times and improve power quality and control, which are key to improving operational efficiency of both utility and industrial customers. It supplies switching equipment both directly to end users and through distributors and original equipment manufacturers ("OEMs"). Most of its products provide connections between higher voltage substations and lower voltage uses. It produces a comprehensive line of medium-voltage equipment (1 to 50 kilovolts), including products such as indoor and outdoor switch disconnectors, breakers, reclosers, fuses, contactors, instrument transformers and sensors as well as air- and gas-insulated switchgear, motor control centers, and ring main units for primary and secondary distribution. It also produces indoor and outdoor modular systems, compact substations and power distribution centers. As with the High-Voltage Products business area, many of its components form part of the offering of the Power Systems business area. In addition, a significant portion of its products are sold through external channel partners such as OEMs.
High-Voltage Products
The High-Voltage Products business area provides power utilities with electricity transmission equipment that allows them to operate more efficiently and with lower environmental impact, both of which are significant business concerns in the market in which our customers operate. The business area manufactures the principal components of power transmission systems (50 to 800 kilovolts),
24
including air- and gas-insulated switchgear, cables, capacitors, high-voltage circuit breakers, grounding switches and instrument transformers. This business area is also responsible for the entire ABB portfolio of low, medium and high voltage capacitors and surge arresters. Its products and components also include circuit breaker drives and cable accessories. Some of the business area's products are integrated into the offering of the Power Systems business area or are sold through external channel partners such as engineering, procurement and construction firms.
Utility Automation Systems
Our Utility Automation Systems business area applies its power industry and automation expertise to integrate products manufactured by both the Power Technologies and the Automation Technologies divisions, as well as those of third parties, to provide utility customers with automation systems tailored for their generating plants or transmission and distribution networks.
In the area of power plant automation, the Utility Automation Systems business area offers complete system integration of instrumentation, control and electrical ("ICE") equipment for the power generation market. The services offered by the business area include combustion management, plant performance optimization, condition monitoring and asset management.
For water plants, the business area offers system integration for all ICE applications in water systems, including automation services for water treatment plants, distribution systems, waste water collection systems and wastewater treatment. The business area offers turnkey pumping stations and control systems for water leakage management, lift-station monitoring and optimization of plant performance.
The Utility Automation Systems business area offers high-end supervisory control and data acquisition ("SCADA") systems to power and gas customers. SCADA systems are used to monitor and control energy transmission, distribution and power generation management systems. They are also used to operate market systems for power networks by tracking energy costs, end-user consumption and retail and wholesale prices, among other things. In addition, this business area offers customer care systems and asset management systems for electrical networks, district heating networks and gas networks. These allow utilities to optimize their business by improving the performance of their installed network equipment to meet changing customer requirements and new market conditions.
This business area also provides system integration for substations used in power generation, transmission and distribution. Its offering includes small electrical SCADA systems, wide area protection systems, feeder automation systems and power system monitoring, which provides real-time information that enables utilities to make informed system-related decisions.
The business area provides wireless and fixed communication systems for power, water and gas utilities, including both operational and corporate communication networks. It offers fiber optics, microwave radio and power line applications for data networking and broadband network management, as well as teleprotection and substation communication networks and voice switching management systems.
The Utility Automation Systems business area offers a range of service capabilities aimed at reducing the in-house operational and maintenance requirements of utility customers. It offers service contracts for spare parts management, support agreements, software and hardware upgrades and retrofits, service consulting, asset management and training.
Customers
The Power Technologies division's principal customers are electric, gas and water utilities, owners and operators of power transmission systems, utilities that own or operate networks and owners and operators of power generating plants. Other customers include gas transmission companies, local
25
distribution companies and multi-utilities, which are involved in the transmission or distribution of more than one commodity. The division also serves industrial and commercial customers, such as operators of large commercial buildings and heavy industrial plants. In 2004, the division's ten largest customers accounted for approximately 14 percent of the division's orders received.
Geographic Markets
The following table sets forth the proportion of Power Technologies division's revenues derived from each geographic region (based on the location of the customer, which may be different from the ultimate destination of the products' end use) in which the ABB Group operates:
|
Year ended December 31, |
|||
---|---|---|---|---|
|
2004 |
2003 |
||
|
(percent) |
|||
Europe | 39 | 38 | ||
The Americas | 22 | 25 | ||
Asia | 25 | 24 | ||
Middle East and Africa | 14 | 13 | ||
Total | 100 | 100 | ||
Sales and Marketing
The Power Technologies division sells its products individually through its three product business areas and as parts of larger systems through its two systems business areas. Most product sales are made through the division's own direct sales force, which is enhanced by industrial representatives and agents where appropriate. In 2004, direct sales accounted for a majority of the division's total product sales, and sales through external channel partners, such as wholesalers, distributors and OEMs, accounted for the remainder. Sales in the systems business areas are handled primarily by the division's specialized sales engineering teams, although these divisions use system integrators and other third-party sellers from time to time.
Competition
On a global basis, the Power Technologies division's principal competitors are Areva, Schneider and Siemens. In the distribution transformers market, the division also competes with companies such as Cooper Cameron and Howard Industries. In the utility automation area, the division's principal competitors are ALSTOM, Emerson, GE Harris, Honeywell, Invensys and Siemens.
Research and Development
Research and development expenses that were not order-related for the Power Technologies division amounted to approximately $210 million for 2004. The division's research and development activities in 2004 primarily related to streamlining product portfolios in all business areas. The aim is to increase product standardization and thus improve the efficiency of our design, supply, manufacturing, sales and distribution functions. Related research has focused on technologies that enable faster production cycles, mainly in the areas of new materials and design. In the Utility Automation Systems business area, research continued to focus on the standardization of controls and protection systems, with the goal of reducing costs in the production of substation automation systems, power plant controls and SCADA systems. In addition, order-related research and development expenses for the Power Technologies division amounted to $179 million during 2004. A significant part of this amount was spent in the Systems business area.
26
Capital Expenditures
The Power Technologies division's capital expenditures for property, plant and equipment were $137 million in 2004, compared to $120 million and $116 million in 2003 and 2002, respectively. Principal investments in 2004 included investments to replace existing equipment, particularly in Sweden, the United States, China and Germany, mainly in the Power Transformers business area. Geographically, in 2004, Europe accounted for about 63 percent of the capital expenditure, with about 12 percent in the Americas, about 20 percent in Asia and about 5 percent in Middle East and Africa. Asia and Middle East experienced increases in the total amount of capital expenditure, particularly in China, India and Saudi Arabia.
Automation Technologies Division
Overview
The Automation Technologies division provides products, systems, software and services for the automation and optimization of industrial and commercial processes. Key technologies include measurement and control, instrumentation, process analysis, drives and motors, power electronics, robots and low- voltage products. This division had approximately 150 manufacturing, software and application centers and 55,000 employees as of January 1, 2005.
We are a recognized market leader in our core automation products and systems, with particular strength in process automation systems (including supervisory control and data acquisition, or SCADA, systems), quality control systems, advanced robotics, process instrumentation (including analytical measurement devices), electrical machines and alternating current, or AC, drives.
The Automation Technologies division offers its products, both as separately sold devices and as part of a total automation system, through one product-based business area and two primarily system and service-based business areas, as discussed below. The division focuses on developing synergies and efficiencies among its business areas, such as common marketing, software re-use and streamlined geographic sales and service networks.
Automation Industry Background
Our customers use automation technologies primarily to improve product quality, productivity and consistency in industrial and manufacturing applications. The automation market can be divided into three sectors:
27
of climate, lighting and security, as well as software for optimal management of the energy cost of buildings.
The Automation Technologies division manufactures products and systems relating to all three sectors, primarily focusing on process automation products and systems, as well as robotics technologies for factory automation. The division provides to its customers the full range of ABB's products on a stand-alone basis, or as part of systems involving conceptual design, detailed engineering, project management, installation and commissioning, as well as after-sales services and system optimization during the full life span of the system.
In mid-2001, this division entered into a ten-year strategic alliance with The Dow Chemical Company ("Dow") in which Dow agreed to use our Industrial IT automation systems in nearly all of its new automation projects, as well as in retrofits of existing systems. Another significant strategic cooperation was forged in 2001 through a framework agreement with the original equipment manufacturer York International (U.S.), a long-time customer, for simplified account service, pricing and joint development spanning multiple product lines. In late 2002, the division was awarded two contracts for long-term asset management services totaling more than $130 million at papermaker Carter Holt Harvey Limited (New Zealand) and petrochemical leader ENI Group (Italy). The division has similar strategic relationships with nearly 100 customers, and has been successful in expanding the scope of such agreements over time to cover additional ABB products and services. Significant agreements during 2003 included a frame agreement with transportation leader Bombardier for up to $500 million in power and automation technologies, signed in cooperation with our Power Technologies division, and a $34 million contract extension to provide site service, spare parts and modifications to oil producer Statoil.
In December 2003, this division commercially released the latest version of its Industrial IT process automation platform, called System 800xA. This system extends the capability of traditional process control systems, introducing advanced functions such as batch management, asset optimization and field device integration which "plug in" to a common user environment. The same user interface may also be used to manage components of existing multiple ABB control systems that have been installed in the market over the past approximately 20 years. In this way, System 800xA gives customers a way to migrate to new functions one step at a time, rather than having to make a large-scale capital investment to replace their entire control system. By creating a common user interface that can be used to manage multiple systems, the System 800xA also reduces the research and development investment needed to achieve a "one size fits all" solution across our large installed systems base.
Our customers are increasingly under pressure to deliver their products more quickly to their customers and to respond rapidly to changing customer preferences. At the same time, constant price pressure requires them to find ways to decrease production costs. Furthermore, as the quality of products becomes more equalized among our customers' competitors, our customers increasingly focus on design and branding to distinguish their products from those of their competitors. This change in focus means that much of the manufacturing and production activities are outsourced to sub-suppliers, which may manufacture products for a number of different companies in a given industry. The consolidation in the manufacturing role enables the sub-suppliers to provide products at a lower cost and presents further opportunities for ABB to provide flexible solutions for automation. Another growing practice among our customers is the outsourcing of non-core tasks such as maintenance and facilities management services. The division has sought to capitalize on this trend by providing an increasing number of service arrangements covering overall plant maintenance and asset optimization.
28
Business Areas
Effective January 1, 2004, the Automation Technologies division merged its six business areas into three business areas as part of its drive to further simplify and focus the business and to improve efficiency. The three business areas are:
The following table sets forth the approximate amount of the Automation Technologies division's revenue generated in 2004 by each of the business areas in the division:
Business Area |
Proportion of Division Revenues |
||
---|---|---|---|
Automation Products | 47 | % | |
Process Automation | 40 | % | |
Manufacturing Automation | 13 | % |
Automation Products
The Automation Products business area manufactures low-voltage circuit breakers, switches and control products to protect people, installations and electronic equipment from electrical overloads. It also manufactures instrumentation products to measure and control the flow of fluids.
This business area makes line protection products, wiring accessories and enclosures and cable systems that are primarily used for control and protection in building installations. It also produces European Installation Bus/Powernet systems, which integrate and automate a building's electrical installations, ventilation, security and data communication networks. Although it provides low-voltage products and systems for building automation, this business area is not involved in the execution of building system projects and installations (which is the business of the non-core Building Systems business area).
The process instrumentation products manufactured by this business area interact with the division's Open Control System products and include products for the measurement of process variables such as pressure, temperature, volume and flow. The increasing sophistication of many process automation systems often requires thousands of measurement points for such variables. These instrumentation products are sold separately or in combination with control systems. The various analytical measurement devices produced by this business area form an important part of instrumentation and control systems. These devices measure chemical characteristics while process instrumentation products measure physical characteristics.
This business area also develops low-voltage and medium-voltage AC drive products and systems for industrial, commercial and residential applications. Drives provide motion and torque while adding control and efficiency to equipment such as fans, pumps, compressors, conveyors, kilns, centrifuges, mixers, hoists, cranes, extruders, printing machinery and textile machines. Our drives are used in the building automation, marine, power, transportation and manufacturing industries, among others.
The Automation Products business area also produces a range of power electronics products. It produces static excitation and synchronizing systems that provide stability for power stations, as well as high power rectifiers that convert AC power to DC power for very high-amperage applications such as furnaces in zinc plants and aluminum and magnesium smelters. The business area also manufactures
29
frequency converters that use state-of-the-art semiconductor technology to convert electrical power into the type and frequency required by individual customers.
In addition, this business area supplies a comprehensive range of electrical motors and generators, including high-efficiency motors that conform to leading environmental and efficiency standards. Efficiency is an important criterion for selection by customers, because electric motors account for nearly two-thirds of the electricity consumed by industrial plants. This business area manufactures synchronous motors for the most demanding applications and a full range of low and high-voltage induction motors.
Process Automation
The Process Automation business area offers integrated process control and information management systems for a variety of industries, primarily pulp and paper, minerals and mining, chemicals and pharmaceuticals, oil and gas, and the marine industry.
Our control systems are used in such applications as batch management, asset optimization, energy management and safety control. They are the hubs that link instrumentation, devices and systems for control and supervision of an industrial process and enable customers to integrate their production systems with their enterprise, resource and planning systems, thereby providing a link to their ordering, billing and shipping processes. This link allows customers to manage their entire manufacturing and business process based on real-time access to plant information. Additionally, it allows customers to employ information received from instrumentation and measurement products to increase production efficiency, optimize their assets and reduce environmental waste.
The business area emphasizes Open Control Systems, including batch control systems, supervisory control and data acquisition systems, and, to a lesser but increasing extent, programmable logic controls ("PLCs") and remote terminal units ("RTUs").
Batch control systems control the production of a variety of products in shorter runs, such as certain pharmaceuticals and food and beverage products. Supervisory control and data acquisition systems are used to collect and manage data over wide areas or long distances such as those involved in operating electric power networks.
The business area's product offerings for the pulp and paper industries include quality control systems for pulp and paper mills, control systems, drive systems, on-line sensors, actuators and field instruments. On-line sensors measure product properties, such as weight, thickness, color, brightness, moisture content and additive content. Actuators allow the customer to make automatic adjustments during the production process to improve the quality and consistency of the product. Field instruments measure properties of the process, such as flow rate, chemical content and temperature.
We offer our customers in the metals and minerals industries specialized products and services, as well as total production systems. We design, plan, engineer, supply, erect and commission electric equipment, drives, motors and equipment for automation and supervisory control within a variety of areas including mining, mineral handling, aluminum smelting, hot and cold steel applications and cement production.
In the oil and gas sector, we provide onshore, offshore and subsea production technology, gas gathering and processing, refining, transportation and distribution applications. In the pharmaceuticals and fine chemicals areas, the business area provides software and solutions for applications including manufacturing, packaging, quality control and compliance with regulatory agencies.
30
In the marine field, we provide global shipbuilders with power and automation technologies for luxury cruise liners, ferries, tankers, offshore oil rigs and special purpose vessels. We design, engineer, build, supply and commission electrical systems and software for marine power generation, power distribution and diesel electric propulsion, as well as turbochargers to improve efficiency for diesel and gasoline engines.
We also offer full-service contracts across all of our customer segments, in which we take over in-house maintenance activities for customers and apply strategies to reduce overall maintenance costs and helps optimize these investments.
Manufacturing Automation
The Manufacturing Automation business area develops and manufactures industrial robots and related equipment for the automotive industry and other manufacturing industries. This business area designs, installs and commissions automation systems for customers in the automotive industry and their sub-suppliers, incorporating software developed by its engineers into its range of products, as well as those manufactured by the Power Technologies division. The products and systems are used in such areas as press shop, body shop, paint shop, power train assembly, trim and final assembly.
In addition to serving the automotive industry, this business area provides complete production automation systems for industry segments ranging from metal and glass fabrication to telecommunications. Manufacturers use our flexible automation and advanced robotics products for applications involving multiple tasks such as welding, material handling, painting, picking, packing and palletizing. For example, we provide painting systems for mobile phones, as well as robot cells to produce base stations for telecom companies. This business area incorporates software developed by its engineers into its automation products and the power products manufactured by the Power Technologies division to maximize energy efficiency and provide a secure power supply for manufacturing lines. Our services include design and project management, engineering, installation, training and life-cycle care of the complete production line.
Customers
The Automation Technologies division's end customers are primarily companies in the chemical, life sciences (pharmaceuticals), automotive, marine, turbocharging, metals, minerals, mining, cement, paper, petroleum, food and beverage, printing and building industries. In each of these industries, we sell both through direct sales forces as well as through third-party channels, such as distributors, wholesalers, installers, system integrators and OEMs.
Geographic Markets
The following table sets forth the proportion of Automation Technologies division's revenues derived from each geographic region (based on the location of the customer which may be different from the ultimate destination of the products' end use) in which the ABB Group operates:
|
Year Ended December 31, |
|||
---|---|---|---|---|
|
2004 |
2003 |
||
|
(percent) |
|||
Europe | 60 | 61 | ||
The Americas | 15 | 17 | ||
Asia | 19 | 16 | ||
Middle East and Africa | 6 | 6 | ||
Total | 100 | 100 | ||
31
The ultimate destination of our products' end use is relevant for the Automation Technologies division as some global distributors and wholesalers in Europe sell our products in Asia, the Americas and Middle East and Africa. We estimate this volume to be approximately 10 percent of the division revenues, divided between the ultimate destinations of Asia, the Americas and Middle East and Africa.
Sales and Marketing
In each of the Automation Technologies division's business areas, sales are made both through direct sales forces as well as through third-party channel partners, such as distributors, wholesalers, installers and OEMs. The proportion of direct sales compared to channel partner sales varies among the different industries, product technologies and geographic markets. For the division as a whole, the majority of the products are sold through channel partners, with the remainder being sold through the division's own direct sales channels.
Competition
The Automation Technologies division's principal competitors vary by product line but include Alstom, Emerson, Fanuc, General Electric, Honeywell, Invensys, Metso Automation, Rockwell Automation, Schneider, Siemens, Voith AG, Aspen Technologies, and Yokogawa Electric Corporation.
Research and Development
Research and development expenses that were not order-related for the Automation Technologies division amounted to approximately $370 million for 2004. In addition, order related research and development expenses for the Automation Technologies division amounted approximately to $146 million during 2004 with around 40 percent share coming from the Process Automation business area and approximately equal share of the remaining amount coming from the other two business areas.
An important focus of the division's research programs is the group-wide commitment to Industrial IT. The Automation Technologies division is responsible for the development of the Industrial IT platform architecture and the base Industrial IT control products and systems. As a result, the division's research is heavily focused on intelligent, "information enabled" products and devices that may be integrated easily to provide better access to real-time information across the business enterprise. Increasing "productization" of automation technologies is intended to yield a growing portfolio of reusable building blocks that may be easily deployed and bundled by customers, channel partners and the division itself.
Capital Expenditures
The Automation Technologies division's capital expenditures for property, plant and equipment were $186 million in 2004, compared to $154 million and $130 million in 2003 and in 2002, respectively. Principal investments in 2004 were primarily related to ordinary course purchases of machinery and equipment mainly in Germany, Italy, France, Sweden, Finland and Switzerland. Geographically, in 2004, Europe accounted for about 82 percent of the capital expenditure, with about 6 percent in the Americas, about 11 percent in Asia and 1 percent in the Middle East and Africa.
Non-Core Activities
These activities at December 31, 2004 constituted primarily the Oil, Gas and Petrochemicals, Building Systems, New Ventures, Equity Ventures and Structured Finance business areas and a number of other activities, including Customer Service Workshops and the Logistic Systems business areas. Non-core activities generated revenues in 2004 of approximately $1.7 billion, and had approximately 5,000 employees at December 31, 2004.
32
The following is a description of our principal businesses in the Non-Core Activities division.
Oil, Gas and Petrochemicals
Our Oil, Gas and Petrochemical business is a full service engineering business that principally serves the downstream oil, gas and petrochemicals markets. The downstream markets typically relate to the processing and transportation of hydrocarbon raw materials in and through refineries, petrochemical and chemical plants and pipelines. In addition to offering engineering, procurement and construction (or EPC) project expertise to engineering and project management services, this business area also licenses process technologies to the refining, petrochemical and polymer industries. This business area has particular expertise in ethylene process technologies through ABB Lummus Global, which is a part of the Oil, Gas and Petrochemical business. Ethylene is used as a raw material in a wide variety of plastics. This business area also provides modernization and maintenance services for refining and petrochemicals facilities in the downstream market. In 2002, we initiated a more selective process to effect a strategic shift in the types of projects for which we bid, from large, long term projects with fixed-price contracts to narrower-scope projects with reimbursable contracts. We believe projects with reimbursable contracts are lower risk projects, as reimbursable contracts allow a more balanced sharing of risks and opportunities between customer and contractor. In July 2004, we divested substantially all of our oil, gas and petrochemicals business operating in the upstream oil, gas and petrochemicals markets. We refer to this divested portion as the Upstream Oil, Gas and Petrochemicals business. We are currently winding down our Floating Production Systems business, which is a part of this business area, and sold our related intellectual property in this business in 2005. In December 2004, we reclassified our remaining Oil, Gas and Petrochemicals business into continuing operations within non-core activities from discontinued operations as it did not meet the accounting criteria required to be classified in discontinued operations.
Building Systems
Our Building Systems business area designs, builds and maintains installations for industrial, infrastructure and commercial facilities. Following our decision in 2002 to divest our Building Systems business area, we substantially reduced the number of businesses held in the Building Systems business area during 2003 and 2004. However, we remain involved in a number of these divested businesses through a combination of technology licenses, supplier relationships and participation on such businesses' board of directors. In addition, in February 2004 we sold our Building Systems business located in Switzerland, but retained a 10 percent equity interest. During 2004, we took steps to close down the Building Systems businesses in the United States and Egypt and to sell the business in Hong Kong. In 2004, revenues for the Business Systems business area were generated principally in Germany.
New Ventures
Our New Ventures business area was established in 2001 as a business incubator that would find, develop and invest in new and mature business opportunities, both internally and externally. New Ventures had three investment portfolios, two of which focused on investment opportunities externally, and one of which focused on opportunities internally. This business area also directly managed several majority-owned companies. Since October 2002, we have been restructuring the New Ventures business area to transfer core activities to other business areas and to dispose of the remaining businesses. At December 31, 2004, this business area principally consisted of the Distributed Energy business and certain portfolio investments in emerging technology businesses.
Equity Ventures
Our Equity Ventures business area focused its activities on investments in and the operation of independent power projects that would provide business opportunities for our former power generation
33
division or that would develop opportunities to sell our equipment and systems. At December 31, 2004, this business area managed investments in power plants in Brazil, Colombia, India, Morocco and the Ivory Coast and an airport in South Africa. Our Equity Ventures business has not pursued further project development or significant additional investments since its classification to Non-core activities in 2002.
Structured Finance
Our Structured Finance business area provided financing, including export, trade and project financing, and asset-based leasing and lending. We sold a significant part of this business area in 2002 and we continued our divestments in 2003 and 2004, including the sale of certain lease and loan portfolios, ownership interests in infrastructure projects and other financial assets. At December 31, 2004, the Structured Finance business area consisted of a portfolio of loans, leases and unfunded commitments which were available for sale or run-off, with net operating assets of $524 million.
Our Other Non-core activities principally consist of our Customer Service Workshop and Logistic Systems business areas. Our Customer Service Workshop business area overhauls, repairs, rewinds and lubricates rotating machine products manufactured by the Automation Technologies division as well as those from third-party suppliers. Most of our Customer Service Workshop businesses have been transferred to the core divisions, closed or divested. The Logistic Systems business area provides air traffic management, turnkey electromechanical and airfield lighting systems, and information technology packages and automation services for airport baggage and material handling.
Corporate/Other
Our Corporate/Other division comprises headquarters and stewardship activities, research and development activities and other activities. The Corporate/Other division had approximately 1,500 employees at December 31, 2004.
Headquarters and stewardship activities include the operations of our corporate headquarters in Zurich, Switzerland, as well as corresponding local holding companies in certain countries. These activities cover staff functions with group-wide responsibilities, such as group accounting and consolidation, finance and controlling, audit, tax, financial advisory, legal affairs, risk management and insurance, communications, investor relations and human resources.
Group Research and Development consists of two Group R&D laboratories: Power Technologies and Automation Technologies. Each laboratory collaborates with universities and other external partners to support our divisions in developing cross-divisional technology platforms and focusing on core areas of power, automation and emerging technologies. The Global R&D laboratories have operations in nine countries: the United States, Sweden, Switzerland, Finland, Poland, China, Germany, Norway and India.
Other activities include our Real Estate and Group Treasury Operations. Our Real Estate business area principally manages the use of our real estate assets and facilities. Group Treasury Operations act as a cost center for internal treasury activities.
Overview
We have adopted, with effect from January 1, 2002, Statement of Financial Accounting Standards No. 144 ("SFAS 144"), Accounting for the Impairment or Disposal of Long Lived Assets. SFAS 144 broadened the presentation of discontinued operations to include disposal transactions involving less than an entire reporting segment, if certain criteria are met. The purpose of SFAS 144 was to allow for
34
historically comparable data to be available to investors without the distortions created by divestments or operation abandonments, thereby improving the predictive value of financial statements.
The following businesses and costs are included in our Consolidated Financial Statements as discontinued operations:
35
Total capital expenditures for property, plant and equipment for the ABB Group (excluding discontinued operations) amounted to $400 million, $402 million and $440 million in 2004, 2003 and 2002, respectively. The majority of the capital expenditures in 2004 related to replacement of existing equipment and improvements in existing production and testing sites, primarily in Germany, Italy, Sweden, Switzerland, China and Finland. Total divestitures of property, plant and equipment amounted to $113 million, $153 million and $459 million in 2004, 2003 and 2002, respectively. Of the total divestitures of 2004, $78 million related to the sale of our real estate properties, mainly from Switzerland, Italy and Germany. Construction in progress for property, plant and equipment as of December 31, 2004 was $122 million, mainly from Germany, Sweden, United States, Italy, Spain and Switzerland. We intend to finance our expenditures for construction in progress internally.
We purchase a variety of raw materials for use in our production and project execution processes. The main materials used in our products, by weight, are steel, copper, aluminum, mineral oil and various plastics. We also purchase a variety of fabricated products and electronic components.
We operate a worldwide supply chain management network with employees dedicated to this function in business areas and key countries. The supply chain management network uses the scale of the ABB Group to maximize the efficiency of supply networks. We expanded our eBusiness activities in recent years, including e-procurement for materials and services, and further developed advanced supplier collaboration tools and a supplier information system.
For many commodities that we purchase, including steel, fabricated copper and aluminum products and products derived from crude oil, the recovery in global economic growth, rising demand from China and changes in foreign exchange rates (particularly the U.S. dollar and the euro) have led to increases in raw materials costs for these commodities. While some of these increases will be offset through use of multi-year contracts and, in the case of copper and aluminum, through hedging, we expect prices for many of these commodities to rise in 2005 compared to 2004, which, we anticipate, will primarily impact the results of our Power Technologies division.
In the field of electronic components, subassemblies or fabricated products, prices remained stable or decreased slightly in 2004 compared to 2003. Electronic component lead times remained relatively short in the first half of the year, but increased in the second half, although there were no shortages. We expect to experience shortages and significant price increases for certain components during 2005, which we expect will primarily affect our Automation Technologies division.
There can be no assurance that our ability to obtain sufficient raw materials will not be adversely affected by unforeseen developments. In addition, the price of raw materials may vary, perhaps substantially, from year to year.
36
We hedge our exposure to commodity risk arising from the changes in prices of raw materials. We manage copper and aluminum price risk using swap and forward contracts based on the London Metal Exchange price for these commodities. Our hedging policy is designed to minimize price volatility and create a stable cost base for the ABB Group. Hedging has the effect of minimizing the unfavorable impact of price increases in commodities, but it also limits the favorable impact of decreasing prices. In most cases, the gains and losses derived from our commodity hedging transactions are deferred and reflected in the cost of goods sold when the underlying physical transaction takes place. In addition to using hedging to reduce our exposure to fluctuations in raw materials prices, in some cases we can reduce this risk by incorporating changes in raw materials prices into the prices of our products.
Each year, we invest significantly in research and development. Our research and development area focuses on developing and commercializing the core technologies of our businesses that are of strategic importance to our future growth. In 2004, 2003 and 2002, we invested $690 million, $635 million, and $572 million, respectively, or approximately 3.3 percent, 3.1 percent, and 2.9 percent of annual consolidated revenues, respectively, on research and development activities. We also had expenditures of $727 million, $886 million, and $719 million, respectively, or approximately 3.5 percent, 4.3 percent and 3.7 percent, respectively, of annual consolidated revenues in 2004, 2003 and 2002, on order-related development activities. These are customer- and project-specific development efforts that we undertake to develop or adapt equipment and systems to the unique needs of our customers in connection with specific orders or projects. Order-related development amounts are initially recorded in inventories as part of the work in progress of a contract and then are reflected in cost of sales at the time revenue is recognized in accordance with our accounting policies.
In addition to continuous product development, and order-related engineering work, we develop future technology platforms for technology applications in our automation and power businesses in our Group research and development labs, which operate on a global basis. Through active management of our investment in research and development, we seek to maintain a balance between short-term and long-term research and development programs and optimize our return on investment.
Our research and development strategy focuses on three objectives:
Universities are the incubators of future technology, and a central task of our research and development team is to transform university research into industry-ready technology platforms. We collaborate with a number of universities and research institutions to build research networks and foster new technologies. We believe these collaborations shorten the amount of time required to turn basic ideas into viable products, and they additionally help us recruit and train new personnel. We have built more than 50 university partnerships in the U.S., Europe and Asia, including long-term, strategic relationships with institutions such as Stanford University, the Massachusetts Institute of Technology, Carnegie Mellon University, Cambridge University and Imperial College London. Our collaborative projects include research on materials, sensors, micro-engineered mechanical systems, robotics, controls, manufacturing, software, distributed power and communication.
Common platforms for power and automation technologies are developed around advanced materials, efficient manufacturing, information technology and data communication, as well as sensor
37
and actuator technology. Common applications of basic power and automation technologies can also be found in power electronics, electrical insulation, and control and optimization. Our power technologies, including our insulation technologies, current interruption and limitation devices, power electronics, flow control and power protection processes, apply as much to large, reliable, blackout-free transmission systems as they do to everyday household needs. Our automation technologies, including our control and optimization processes, software technologies, power electronics, sensors and microelectronics, mechatronics and wireless communication processes, are designed to improve efficiency in plants and factories around the worldincluding our own.
Group research and development is carried out in two global laboratories for power and automation technologies, combining research units in the U.S., Europe and Asia. The cultural diversity and closeness to our customers and the world's best universities creates a breeding ground for success. We continue to expand our research and development activities in India, Singapore and China, reflecting its growth strategy in Asia. Our corporate research center in Bangalore, India was launched in early 2002. As a focal point for software research, it develops platforms for both automation and power technologies. In Chinaour fastest-growing marketresearch and development activity is focused on power transmission and distribution, manufacturing and robotics. It is centered in new facilities in Beijing and Shanghai, where our researchers are in close contact with Chinese universities and customers.
Our researchers have been recognized in recent years for contributions in areas like HCI (human-computer interface), safeguarding power transmission systems, faster and more efficient automation systems, improved electrical insulation and industrial applications of nanotechnology and wireless technology.
Our current research programs focus on:
We believe that intellectual property has become as important as tangible assets for a technology group such as ABB. Over the past ten years, we have almost doubled our total number of first patent filings, and we intend to continue our aggressive approach to seeking patent protection. Currently, we have nearly 14,000 patent applications and registrations, of which approximately 7,000 are pending applications. In 2004, we filed patent applications for more than 470 new inventions. Based on our existing intellectual property strategy, we believe that we have adequate control over our core technologies. The "ABB" trademarks and logo are protected in all of the countries in which we operate. We aggressively defend the reputation associated with the ABB brand.
38
Environmental management is one of our highest business priorities. We address environmental issues in all our business operations. Our goal is to improve our social and environmental performance continuously, and improve the quality of life in the communities and countries where we operate.
Our social and environmental efforts include:
To continuously improve the environmental performance of our own operations, we are implementing environmental management systems according to the ISO 14001 standard on all our sites. We have implemented the ISO 14001 in 96 percent of our manufacturing facilities and service workshops (approximately 390 sites) and our environmental management program now includes operations in approximately 50 countries. We also require every operating unit within the ABB Group to implement an environmental management system that aims continuously to improve its environmental performance. We are now implementing an adapted environmental management system in our non-manufacturing organizations.
We have introduced the concept of Environmental Product Declarations to communicate the environmental performance of our core products. These describe the salient environmental aspects and impacts of a product line, viewed over its complete life cycle. Declarations are based on Life Cycle Assessment studies, created according to the international standard ISO/TR 14025. To date, approximately 50 declarations have been produced for major product lines, 10 of which have been externally certified by agencies such as Det Norske Veritas (DNV) of Norway and the RINA Management System Certification Society in Italy.
We have expanded the scope of our environmental reporting in recent years. In 2004, our formal reporting system covered approximately 88 percent of our employees. The parts of our business that are not yet covered by our reporting system have very limited environmental impacts. A total of 12 accidents were reported in 2004, none of which had a material environmental impact.
One of our corporate objectives is to phase out the use of the hazardous substances that are recorded on our list of "restricted" substances. Priorities for replacement are set by each business using criteria such as the environmental aspects of alternatives, the risk of the substance escaping into the environment, how hazardous the substance is, whether we can use the substance under strict control and whether there are any technically acceptable alternatives.
39
We have retained liability for environmental remediation costs at two sites in the United States that were operated by our former nuclear business, which we have sold to BNFL. The primary environmental liabilities associated with these sites relate to the costs of remediating radiological contamination upon decommissioning the facilities. For further information, see "Item 5. Operating and Financial Review and ProspectsEnvironmental Liabilities."
Our operations are subject to numerous other governmental laws and regulations including those governing currency conversions and repatriation, taxation of foreign earnings and earnings of expatriate personnel and use of local employees and suppliers.
As a reporting company under Section 12 of the U.S. Securities Exchange Act of 1934, we are subject to the U.S. Foreign Corrupt Practices Act's antibribery provisions with respect to our conduct around the world.
Our operations are also subject to the 1997 Organization of Economic Cooperation and Development Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, as implemented by the 34 signatory countries. The convention obliges signatories to adopt national legislation that makes it a crime to bribe foreign public officials. As of December 31, 2004, those countries which have adopted implementing legislation and have ratified the convention include the United States, Switzerland and several European nations in which we have significant operations.
We and our subsidiaries conduct business in certain countries known to experience governmental corruption. While we and our subsidiaries are committed to conducting business in a legal and ethical manner, there is a risk that our employees or agents may take actions that violate either the U.S. Foreign Corrupt Practices Act or legislation promulgated pursuant to the 1997 OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions. These actions could result in monetary penalties against us or our subsidiaries and could damage our reputation and, therefore, our ability to do business.
ABB Ltd, Zurich, Switzerland is the ultimate parent company of the ABB Group, which is comprised of around 500 subsidiaries (excluding dormant companies) worldwide. Besides ABB Ltd, the only other listed company in the ABB Group is ABB Ltd, India, which is listed on the exchanges in India at Mumbai (BSE and NSE), Ahmadabad, New Delhi and Kolkata.
The following table sets forth, as of March 31, 2005, the name, country of incorporation and ownership interest of ABB Ltd of its significant subsidiaries:
Company Name / Location |
Country |
ABB Interest |
||
---|---|---|---|---|
|
|
(percent) |
||
ABB S.A., Buenos Aires | Argentina | 100.00 | ||
ABB Australia Pty Limited, Sydney | Australia | 100.00 | ||
ABB AG, Vienna | Austria | 100.00 | ||
ABB Ltda., Osasco | Brazil | 100.00 | ||
ABB Bulgaria EOOD, Sofia | Bulgaria | 100.00 | ||
ABB Inc., St. Laurent, Quebec | Canada | 100.00 | ||
ABB (China) Ltd., Beijing | China | 100.00 | ||
Asea Brown Boveri Ltda., Bogotá | Colombia | 99.99 | ||
ABB Ltd., Zagreb | Croatia | 100.00 | ||
ABB s.r.o., Prague | Czech Republic | 100.00 | ||
ABB A/S, Skovlunde | Denmark | 100.00 | ||
Asea Brown Boveri S.A., Quito | Ecuador | 96.87 | ||
40
Asea Brown Boveri S.A.E., Cairo | Egypt | 100.00 | ||
ABB AS, Tallinn | Estonia | 100.00 | ||
ABB Oy, Helsinki | Finland | 100.00 | ||
ABB S.A., Rueil-Malmaison | France | 100.00 | ||
ABB AG, Mannheim | Germany | 100.00 | ||
ABB Automation Products GmbH, Eschborn | Germany | 100.00 | ||
ABB Berteiligungs-und Verwaltungsges GmbH, Mannheim | Germany | 100.00 | ||
ABB Gebäudetechnik AG, Mannheim | Germany | 100.00 | ||
Asea Brown Boveri S.A., Metamorphossis Attica | Greece | 100.00 | ||
ABB (Hong Kong) Ltd., Hong Kong | Hong Kong | 100.00 | ||
ABB Engineering Trading and Service Ltd., Budapest | Hungary | 100.00 | ||
ABB Ltd., Bangalore | India | 52.11 | ||
ABB Ltd, Dublin | Ireland | 100.00 | ||
ABB Technologies Ltd., Tirat Carmel | Israel | 99.99 | ||
ABB S.p.A., Milan | Italy | 100.00 | ||
ABB SACE S.p.A., Sesto S. Giovanni (MI) | Italy | 100.00 | ||
ABB Technology SA, Abidjan | Ivory Coast | 99.00 | ||
ABB K.K., Tokyo | Japan | 100.00 | ||
ABB Ltd., Seoul | Korea, Republic of | 100.00 | ||
ABB Holdings Sdn. Bhd., Subang Jaya | Malaysia | 100.00 | ||
Asea Brown Boveri S.A. de C.V., Tlalnepantla | Mexico | 100.00 | ||
ABB BV, Rotterdam | Netherlands | 100.00 | ||
ABB Holdings BV, Amsterdam | Netherlands | 100.00 | ||
Luwoco Lummus Worldwide Contracting (Netherlands) B.V., The Hague | Netherlands | 100.00 | ||
ABB Limited, Auckland | New Zealand | 100.00 | ||
ABB Holding AS, Billingstad | Norway | 100.00 | ||
Asea Brown Boveri S.A., Lima | Peru | 99.99 | ||
Asea Brown Boveri Inc., Paranaque, Metro Manila | Philippines | 100.00 | ||
ABB Sp. zo.o., Warsaw | Poland | 96.01 | ||
ABB S.G.P.S, S.A., Amadora | Portugal | 100.00 | ||
Asea Brown Boveri Ltd., Moscow | Russia | 100.00 | ||
ABB Contracting Company Ltd., Riyadh | Saudi Arabia | 65.00 | ||
ABB Holdings Pte. Ltd., Singapore | Singapore | 100.00 | ||
ABB Holdings (Pty) Ltd., Sunninghill | South Africa | 80.00 | ||
Asea Brown Boveri S.A., Madrid | Spain | 100.00 | ||
ABB AB, Västeros | Sweden | 100.00 | ||
ABB Norden Holding AB, Stockholm | Sweden | 100.00 | ||
ABB Asea Brown Boveri Ltd, Zurich | Switzerland | 100.00 | ||
ABB LIMITED, Bangkok | Thailand | 100.00 | ||
ABB Holding A.S., Istanbul | Turkey | 99.95 | ||
ABB Ltd., Kiev | Ukraine | 100.00 | ||
ABB Industries (L.L.C), Dubai | United Arab Emirates | 49.00 | ||
ABB Ltd., Warrington | United Kingdom | 100.00 | ||
ABB Lummus Global Inc., Bloomfield, NJ | United States | 100.00 | ||
ABB Holdings, Inc., Norwalk, CT | United States | 100.00 | ||
ABB Inc., Norwalk, CT | United States | 100.00 | ||
Asea Brown Boveri S.A., Caracas | Venezuela | 100.00 | ||
ABB (Private) Ltd., Harare | Zimbabwe | 100.00 |
41
As of December 31, 2004, the ABB Group occupied manufacturing, production and development facilities in approximately 100 countries throughout the world with over 18 million square meters of land and over 7 million square meters of building space. The facilities consist mainly of manufacturing plants, office buildings, research centers and warehouses. A substantial portion of our production and development facilities are situated in Germany, Sweden, the United States, Switzerland, China, Finland, and Italy. We also own or lease other properties, including office buildings, warehouses, research and development facilities and sales offices in many countries. We own approximately 50 percent of the buildings and approximately 80 percent of the land on which our facilities are located and lease the remainder.
We own essentially all of the machinery and equipment used in our manufacturing operations. From time to time, we have a surplus of space arising from acquisitions, production efficiencies and/or restructuring of operations. Normally, we seek to sell such surplus space or, to a lesser extent, lease it to third parties.
It is our general policy to maintain facilities and equipment at quality levels assuring continuous production at good efficiency and safety standards. The net book value of our property, plant and equipment as of December 31, 2004 was $2,981 million, of which machinery and equipment represented $1,337 million and land and buildings represented $1,523 million and construction in progress of $121 million. We believe that our current facilities are in good condition and are adequate to meet the requirements of our present and foreseeable future industrial operations.
42
Item 5. Operating and Financial Review and Prospects
You should read the following discussion of our financial condition and results of operations in conjunction with our Consolidated Financial Statements and the related notes and other financial information contained elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties, including those discussed in "Item 3. Key InformationRisk Factors." See "Forward-looking statements" at the beginning of this annual report. The financial statements and certain financial data set forth in our Consolidated Financial Statements as of December 31, 2003 and 2002 and for each of the years in the three year period ended December 31, 2003, reflect restatements made in September 2004 of our previously issued financial statements for those periods. This restatement was intended to correct the effect of earnings overstatements by the medium-voltage business unit of our Power Technologies division (or PT-MV BAU) in Italy on its previously reported financial statement results.
Our operating performance improved significantly during 2004 following three years of substantial losses. Improved performance in our core divisions contributed to a 204 percent increase in earnings before interest and taxes, which increased $727 million to $1,084 million.
During 2004, we continued to dispose of businesses that are outside our core activities, including the Upstream Oil, Gas and Petrochemicals and the Reinsurance businesses. The net cash proceeds from these dispositions, approximately $1,182 million, helped us fund the reduction of our debt. Our total borrowings fell from approximately $7.9 billion at the end of 2003 to $5.5 billion at the end of 2004, while our cash and cash equivalents were $4.8 billion at the end of 2003 and $3.7 billion at the end of 2004.
Having made substantial progress in refocusing our business on our two core divisions, we are planning to address four key goals in 2005.
Improving Operational Performance
Our financial targets for 2005 include achieving earnings before interest and taxes (EBIT) margins of 7.7 percent for the group and 10.7 percent for the Automation Technologies division. As part of the announcement of our first quarter 2005 results, we advised that due to the ongoing volatility in the Power Technologies businesses the achievement of our previously announced 10 percent EBIT margin in 2005 for the Power Technologies division was unlikely and could no longer be reaffirmed. We have not yet announced a new EBIT margin target for that division. Margin targets exclude major acquisitions, divestitures and business closures.
We expect that the 2005 performance in our Power Technologies division will reflect higher revenues and improved capacity utilization. We further expect a positive impact from cost savings and improved efficiencies following the division's reorganization from five business areas to two effective as of January 1, 2005. In addition, we expect benefits from the implementation of a common front-end sales organization. The division performance in 2005 will reflect the reclassification of the majority of our Power Lines business unit to discontinued operations, as the exit strategy initiated in the fourth quarter 2004 is progressing as planned. A further increase in commodity prices could adversely affect the performance in the Power Technologies division in 2005.
We expect that the performance in 2005 of our Automation Technologies division will reflect the cost savings and operating efficiencies resulting from this division's reorganization from eleven business areas at the beginning of 2003 into three business areas by the end of 2004. We additionally expect that the Automation Technologies division will benefit from a risk evaluation procedure, implemented in 2003, that subjects the division's large projects to a review based on the size and complexity of each project to help mitigate the risk of booking projects that ultimately will not be profitable. Various
43
factors could also adversely affect the performance of the Automation Technologies division in 2005, including a decline in the value of the U.S. dollar against the euro or an increase in commodity prices.
The performance of our Non-core activities in 2005 will depend significantly upon the results of our Oil, Gas and Petrochemicals business. Several years ago, we decided to shift our focus in that business from long-term fixed price contracts to reimbursable contracts to reduce project execution risk. While this change in strategy has led to reduced revenues in this business, we believe that over time it will enable us to improve margins and reduce risks.
Lowering Corporate Costs
Reducing our cost base continues to be an important objective, and during 2005 we plan to focus particularly on reducing corporate costs. While cost reduction will have continuing benefits for us over the long term, it will also require us to incur additional restructuring and other related expenses in the near term.
Aligning Behavior to Rules
During the past few years, we have discovered several instances in which ABB employees have failed to comply with our policies and applicable laws. One of our highest priorities is improving the compliance culture and control mechanisms within our entire organization so similar situations can be avoided in the future.
Resolving Asbestos
In December 2004, the U.S. Court of Appeals for the Third Circuit effectively reversed the lower courts' order confirming the proposed plan of reorganization of Combustion Engineering. Resolving the asbestos-related liabilities of our subsidiaries remains a top priority. We intend to seek confirmation of a modified plan that continues to reflect the fundamental approach of the original plan to channeling claims against Combustion Engineering to a trust funded, in part, by us or other of our subsidiaries. To this end, in March 2005 we reached agreement with certain representatives of various parties on the basic terms of a modified plan, in connection with which we would increase by approximately $232 million the contributions to be made by us for the benefit of the claimants. We are now working with those parties to reach agreement on other issues relating to, and details of, the proposed modified plan and related proceedings involving Lummus and to prepare the related documentation. As soon as possible, we will submit each of the proposed plans for the approval of creditors and review by the courts.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
General
We prepare our Consolidated Financial Statements in accordance with U.S. GAAP.
The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis, including, but not limited to, those related to: costs expected to be incurred to complete projects; costs of product guarantees and warranties; provisions for bad debts; recoverability of inventories, investments, goodwill and intangible assets; income tax related costs and accruals; provisions for restructuring; gross profit margins on long-term contracts; pensions and other post-retirement benefit assumptions; and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily
44
apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We deem an accounting policy to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or if changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact our Consolidated Financial Statements. We also deem an accounting policy to be critical when the application of such policy is essential to our ongoing operations. We believe the following critical accounting policies reflect the accounting policies relating to our more significant estimates and assumptions that we use in the preparation to our Consolidated Financial Statements. These policies should be considered in reviewing our Consolidated Financial Statements.
Revenues and cost of sales recognition
We recognize revenues from the sale of manufactured products when persuasive evidence of an arrangement exists, the price is fixed and determinable, collectibility is reasonably assured and upon transfer of title, including the risks and rewards of ownership, to the customer. When multiple elements, such as products and services, are contained in a single arrangement or in a series of related arrangements with the same customer, we allocate revenue to each element based on its relative fair value, provided that such element meets the criteria for treatment as a separate unit of accounting. The allocation of the sales price between delivered elements and undelivered elements might affect the timing of revenue recognition, but would not change the total revenue recognized on the contract. Revenues from short-term or noncustomer specific contracts to deliver products or services are recognized upon completion of required services to the customer. Revenues from contracts that contain customer acceptance provisions are deferred until customer acceptance occurs, we have tested to the level required to ensure that acceptance will occur or the contractual acceptance period has lapsed. As a result, judgment in the selection of revenue recognition methods must be made.
These revenue recognition methods require the collectibility of the revenues recognized to be reasonably assured. When recording the respective accounts receivable, allowances are calculated to estimate those receivables that will not be collected. These reserves assume a level of default based on historical information, as well as knowledge about specific invoices and customers. The risk remains that a greater number of defaults will occur than originally estimated. As such, the amount of revenues recognized might exceed that which will be collected, resulting in a deterioration of earnings in the future. This risk is likely to increase during periods of significant negative industry or economic trends.
Revenues under long-term contracts are recognized using the percentage-of-completion method of accounting. We principally use the cost-to-cost or delivery events methods to measure progress towards completion on contracts. We determine the method to be used by type of contract based on our experience and judgment as to which method best measures actual progress towards completion.
The percentage-of-completion method of accounting involves the use of assumptions and projections, relating to future material, labor, construction and overhead costs. As a consequence, there is a risk that total contract costs will exceed those we originally estimated. This risk increases if the duration of a contract increases or if the project is a fixed price turnkey project, because there is a higher probability that the circumstances upon which we originally developed estimates will change, resulting in increased costs that we will not recover. Factors that could cause costs to increase include:
45
Changes in our initial assumptions, which we review on a regular basis between balance sheet dates, may result in revisions to total estimated costs, current earnings and anticipated earnings. We recognize these changes in the period in which the changes in estimate are determined. By recognizing changes in estimates cumulatively, recorded revenue and costs to date reflect the current estimates of the stage of completion. Additionally, losses on long-term contracts are recognized in the period when they are identified and are based upon the anticipated excess of contract costs over the related contract revenues. Any such losses are recorded as a component of cost of sales.
We accrue anticipated costs for warranties when we recognize the revenue on the related contracts. Warranty costs include calculated costs arising from imperfections in design, material and workmanship, performance guarantees (technical risks) and delays in contract fulfillment. Although we generally make assessments on an overall, statistical basis, we make individual assessments on contracts with risks resulting from order-specific conditions or guarantees, such as plants or installations. There is a risk that actual warranty costs may exceed the amounts provided for, which would result in a deterioration of earnings in the future when these actual costs are determined.
Revenues under cost-reimbursement contracts are recognized as costs are incurred. Shipping and handling costs are recorded as a component of cost of sales.
Accounting for discontinued operations
Our strategy is to focus on power and automation technologies for utility and industry customers. In accordance with our strategy, we have sold and plan to sell certain businesses that are not part of our core power and automation technologies businesses. Statement of Financial Accounting Standards No. 144 (SFAS 144), Accounting for the Impairment or Disposal of Long Lived Assets, broadened the presentation of discontinued operations to include disposal transactions involving less than an entire reporting segment, if certain criteria are met. The purpose of SFAS 144 is to allow for historically comparable data to be available to investors without the distortions created by divestments or the closure or abandonment of businesses, thereby improving the predictive value of financial statements. SFAS 144 requires the revenues and associated costs, net of taxes, of certain divestments and abandonments, to be classified as discontinued operations, net of taxes, below income from continuing operations in our Consolidated Income Statement and requires the related assets and liabilities to be classified as assets or liabilities held for sale and in discontinued operations in our Consolidated Balance Sheet.
In order to classify a business as a discontinued operation, SFAS 144 requires that certain criteria be met. In certain cases, significant interpretation is required to determine the appropriate classification. Changes in plans regarding the sale of a business may change our interpretation as to whether a business should be classified as a discontinued operation. Any such reclassification may have a material impact on our income from continuing operations and the individual components thereof.
In the Consolidated Statement of Cash Flows, we have included the businesses classified as discontinued operations together with continuing operations in the individual line items within cash from operating, investing and financing activities, as permitted by U.S. GAAP.
For a description of our discontinued operations, see Note 3 to our Consolidated Financial Statements.
46
Goodwill and other intangible assets impairment
We review goodwill for impairment annually on October 1 and additionally whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable in accordance with Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets. SFAS 142 requires that a two-step impairment test be performed on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. Our reporting units are one level below the reportable segments identified in Note 26 to our Consolidated Financial Statements. We use a discounted cash flow model to determine the fair value of reporting units unless there is a readily determinable fair market value. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired and no further testing is performed. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step to determine the implied fair value of the reporting unit's goodwill and compare it to the carrying value of the reporting unit's goodwill. If the carrying value of a reporting unit's goodwill exceeds its implied fair value, then we must record an impairment loss equal to the difference.
The discounted cash flow model, which we use to estimate the fair value of our reporting units is dependent on a number of factors including estimates of future cash flows, appropriate discount rates and other variables. Estimating future cash flows requires us to make significant estimates and judgments involving variables such as sales volumes, sales prices, sales growth, production and operating costs, capital expenditures, market conditions and other economic factors. We base our fair value estimates on assumptions we believe to be reasonable, but which are unpredictable and inherently uncertain. Actual future results may differ from those estimates.
We review intangible assets in accordance with SFAS 144, and accordingly test for impairment upon the occurrence of certain triggering events, such as a decision to divest a business or projected losses of an entity.
We record any related impairment charge in other income (expense), net, in our Consolidated Income Statement, unless it is related to a discontinued operation, in which case the charge is recorded in loss from discontinued operations, net of tax.
Pension and post-retirement benefits
As more fully described in Note 21 to our Consolidated Financial Statements, we operate pension plans that cover the majority of our employees. We use actuarial valuations to determine our pension and post-retirement benefit costs and credits. The amounts calculated depend on a variety of key assumptions, including discount rates and expected return on plan assets. We are required to consider current market conditions, including changes in interest rates, in selecting these assumptions. The discount rates are reviewed annually and considered for adjustment based on changes in long-term, highly rated corporate bond yields. Decreases in the discount rate result in an increase in the projected benefit obligation and to pension costs.
The expected return on plan assets is reviewed annually and considered for adjustment based on current and expected asset allocations and represents the long-term return expected to be achieved. Decreases in the expected return on plan assets result in an increase to pension costs. An increase or decrease of 0.5 percent in the expected long-term rate of asset return would have decreased or increased, respectively, the net periodic benefit cost in 2004 by approximately $30 million.
Under U.S. GAAP, we accumulate and amortize over future periods actual results that differ from the assumptions used. Therefore, actual results generally affect our recognized expense and recorded liabilities for pension and other post-retirement benefit obligations in future periods.
47
The "unfunded" balance, which can increase or decrease based on the performance of the financial markets or changes in our assumptions regarding rates, does not represent a mandatory short-term cash obligation. Instead, the unfunded balance of a pension plan is the difference between the projected obligation to employees (PBO) and the fair value of the plan assets. While we comply with appropriate statutory funding requirements, at December 31, 2004, the unfunded balance of our pension plans was $1,451 million. In accordance with Statement of Financial Accounting Standards No. 87 (SFAS 87), Employers' Accounting for Pensions, we have recorded on the Consolidated Balance Sheet a net liability of $410 million in relation to this unfunded benefit balance. The difference is primarily due to an unrecognized actuarial loss of $1,019 million, which is amortized using the "minimum corridor" approach as defined by SFAS 87.
In May 2003, the Emerging Issues Task Force of the Financial Accounting Standards Board reached a consensus on Emerging Issues Task Force No. 03-4 (EITF 03-4), Determining the Classification and Benefit Attribution Method for a "Cash Balance" Pension Plan, which requires the "traditional unit credit method" to be used for the calculation of the liability and attribution of the costs for pension plans with certain characteristics. We determined that certain of our pension plans covering the employees of Switzerland had the characteristics described in EITF 03-4 and therefore we changed the approach to calculating the PBO from the projected unit credit method to the traditional unit credit method. The change in cost attribution methods resulted in an actuarial gain of $406 million in 2003 that is included in the unrecognized actuarial loss of $1,019 million and as described above, will result in lower net pension costs in future years.
We have multiple non-pension post-retirement benefit plans. Our health care plans are generally contributory with participants' contributions adjusted annually. For purposes of estimating our health care costs, we have assumed health care cost increases per annum to be 11.76 percent for 2005, then gradually declining to 6.24 percent per annum in 2013, and to remain at that level thereafter.
Taxes
In preparing our Consolidated Financial Statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. We account for deferred taxes by using the asset and liability method. Under this method, we determine deferred tax assets and liabilities based on temporary differences between the financial reporting and the tax bases of assets and liabilities. The differences are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. We recognize a deferred tax asset when it is probable that the asset will be realized. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based upon historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. To the extent we increase or decrease this allowance in a period, we recognize the change in the allowance within provision for taxes in the Consolidated Income Statement unless the change relates to discontinued operations, in which case the change is recorded in loss from discontinued operations, net of tax. Unforeseen changes in tax rates and tax laws as well as differences in the projected taxable income compared to the actual taxable income may affect these estimates.
We operate in numerous tax jurisdictions and, as a result, are regularly subject to audit by tax authorities. Although we believe that our tax estimates are reasonable and that appropriate tax reserves have been made, the final determination of tax audits and any related litigation could be different than that which is reflected in income tax provisions and accruals.
Accounting for tax contingencies requires that an estimated loss from a contingency such as a tax claim should be accrued as a charge to income if it is probable that an asset has been impaired or a liability has been incurred, and the amount of the loss can be reasonably estimated. The required amount of provision for contingencies of any type may change in the future due to new developments.
48
Consolidation
We evaluate our investments in joint ventures and other types of investments for purposes of determining whether consolidation or the cost or equity method of accounting is appropriate. This determination is based upon our ability to retain and exercise control through our decision-making powers and our ability to exercise significant influence over the entity, as well as our ownership interests in the entity.
Material changes in our ability to retain control and exercise significant influence over an entity could change the accounting method between consolidation or the cost or equity methods, which could have a material impact on our Consolidated Financial Statements.
In January 2003 and December 2003, the Financial Accounting Standards Board issued Interpretation No. 46 (FIN 46) Consolidation of Variable Interest Entitiesan Interpretation of ARB No. 51 and revised Interpretation No. 46 (FIN 46(R)), respectively, which require variable interest entities (VIEs) to be consolidated by their primary beneficiaries. Accordingly, effective January 31, 2003, we consolidate VIEs when we are considered the primary beneficiary. Also effective January 31, 2003, previously consolidated VIEs would be deconsolidated when a triggering event, as defined by FIN 46(R), indicates we are no longer the primary beneficiary. For those VIEs where we are not the primary beneficiary, we apply our existing consolidation policies in accordance with U.S. GAAP.
In determining the primary beneficiary of a VIE, we are required to make projections of expected losses and expected residual returns to be generated by that VIE. The projected expected losses and expected residual returns are critical to the identification of the primary beneficiary. These projections require us to use assumptions, including assumptions regarding the probability of cash flows. Expected losses and expected residual returns materially different from those projected could identify another entity as the primary beneficiary. A change in the contractual arrangements or ownership between the parties involved in the VIE could have an impact on our determination of the primary beneficiary, which in turn, could have a material impact on our Consolidated Financial Statements.
Contingencies
As more fully described in Note 18 to our Consolidated Financial Statements, we are subject to proceedings, lawsuits and other claims related to asbestos, environmental, labor, product and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. A determination of the amount of provision required, if any, for these contingencies is made after analysis of each individual issue, often with assistance from both internal and external legal counsel and technical experts. The required amount of provision for a contingency of any type may change in the future due to new developments in the particular matter, including changes in approach to its resolution.
Restructuring
Certain restructuring provisions include estimates pertaining to employee termination costs and the settlements of contractual obligations resulting from our actions. Although we do not anticipate significant changes, the actual costs may differ from these estimates due to subsequent developments such as voluntary retirement of employees and other business developments. Restructuring costs are recorded in other income (expense), net, in the Consolidated Income Statements. However, restructuring costs relating to discontinued operations are recorded in loss from discontinued operations, net of tax.
49
Insurance
In April 2004, we completed the sale of substantially all of our business operating in the reinsurance industry. We refer to the divested portion of this business as the Reinsurance business. Consequently, we have reflected the results of operations of the Reinsurance business in loss from discontinued operations, net of tax, and the assets and liabilities in assets and liabilities held for sale and in discontinued operations for all periods presented.
We generally recognized premiums in earnings on a pro rata basis over the period coverage was provided. Premiums earned included estimates of certain premiums not yet collected. These premium receivables included premiums relating to retrospectively rated contracts. For such contracts, a provisional premium was collected that will eventually be adjusted. We included an estimated value of the actual premium in receivables. Unearned premiums represented the portion of premiums written that was applicable to the unexpired terms of reinsurance contracts or certificates in force. These unearned premiums were calculated by the monthly pro rata method or were based on reports from ceding companies that we reinsure.
Insurance liabilities were reflected in liabilities held for sale and in discontinued operations, in our Consolidated Balance Sheet and represented unpaid claims, losses, and related loss expenses based upon estimates for losses reported, estimates received from ceding reinsurers, and estimates of incurred but not reported losses related to direct and assumed business, less amounts ceded to reinsurers. Reserves for unreported losses were determined by an estimate established using various statistical and actuarial techniques reflecting historical patterns of development of paid and reported losses adjusted for current trends. The inherent variability of the estimate was analyzed in order to ascertain whether it was reasonable before application. We did not discount loss and loss adjustment expense reserves.
We developed our estimate considering a range of reserve estimates bounded by a high and a low estimate. The high and low ends of the range did not correspond to an absolute best and worst case scenario of ultimate settlements because such estimates may have been the result of unlikely assumptions. Our best estimate therefore did not include the set of all possible outcomes but only those outcomes that were considered reasonable. Those estimates were subject to the effects of trends in loss severity and frequency. Although considerable variability was inherent in such estimates, we believed the reserves for losses and loss adjustment expenses were adequate. The estimates were continually reviewed and adjusted as necessary as experience developed or new information became known; such adjustments were included in discontinued operations. Adjustments to reserves were reflected in the loss from discontinued operations, net of tax, in the periods in which the estimates were changed.
We reflected our liability for losses net of anticipated salvage and subrogation recoveries. Salvage and subrogation received and changes in estimates of future recoveries were reflected in current year underwriting results. We believe the liabilities for losses and loss adjustment expenses were adequate to cover the ultimate liability; however, due to the underlying risks and high degree of uncertainty associated with the determination of the liability for losses, such estimates may have been more or less than the amounts ultimately paid when the claims were settled.
We sought to reduce the loss from our underwriting liabilities by reinsuring certain levels of risks with other insurance enterprises or reinsurers. We used recoverable amounts for both paid and unpaid losses. We estimated these recoverable amounts in a manner consistent with the claim liability associated with the reinsurance policy. The risk of collectibility of these reinsurance receivables arose from disputes relating to the policy terms and the ability of the reinsurer to pay.
50
In December 2004, the Financial Accounting Standards Board issued Statement No.123(R) (SFAS 123R), Share-Based Payment, which replaces SFAS 123 and APB 25, Accounting for Stock Issued to Employees, and requires the Company to measure compensation cost for all share-based payments at fair value. On April 14, 2005, the U.S. Securities and Exchange Commission announced the adoption of a new rule that amends the compliance dates for SFAS 123R. As a result of this announcement, the Company plans to adopt SFAS 123R as of January 1, 2006. The Company will recognize share-based employee compensation cost from January 1, 2006, as if the fair-value based accounting method had been used to account for all employee awards granted, modified, or settled after the effective date and for any awards that were not fully vested as of the effective date. Based on currently existing share-based compensation plans, the Company does not expect the adoption of SFAS 123R to have a material impact on its financial position or results of operations.
In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entitiesan Interpretation of ARB No. 51. FIN 46 requires variable interest entities (VIEs) to be consolidated by their primary beneficiaries. During 2003, we adopted the requirements of FIN 46 and applied the guidance to VIEs in which we have an interest. See Note 8 to the Consolidated Financial Statements for information relating to the impact of adopting FIN 46. FIN 46 was revised in December 2003. We adopted the December revision (FIN 46R) effective March 31, 2004. The adoption of FIN 46R did not have a material impact on our financial position or results of operations.
We have implemented several major restructuring programs during the past three years (see Note 25 to the Consolidated Financial Statements).
2001 Program
Our restructuring program announced in July 2001 (the 2001 Program) was substantially completed at September 30, 2002. Restructuring charges relating to workforce reductions, lease terminations and other exit costs associated with the 2001 Program, along with changes in estimates accrued for any of these charges, are included in other income (expense), net. Termination benefits were paid to approximately 100, 2,270 and 4,000 employees in 2004, 2003 and 2002, respectively. As a result of the 2001 Program, certain assets, inventories and property, plant and equipment were identified as being impaired or would no longer be used in continuing operations. We recorded in 2002 a charge of $18 million to write down these assets to their fair values, and such costs are included in cost of sales and other income (expense), net.
Step change program
In October 2002, we announced the Step change program. The goals of the Step change program were to increase competitiveness of our core businesses, reduce overhead costs and streamline operations. At June 30, 2004, the Step Change program was substantially complete.
Restructuring charges relating to workforce reductions, lease terminations and other exit costs associated with the Step change program are included in other income (expense), net. Termination benefits were paid to approximately 950, 1,500 and 200 employees in 2004, 2003 and 2002, respectively. Workforce reductions occurred principally from production, managerial and administrative employees. Changes in management's original estimate of the amounts accrued for workforce reductions, lease terminations and other exit costs were included in other income (expense), net.
51
As a result of the Step change program, certain assets, inventories and property, plant and equipment were identified as being impaired or would no longer be used in continuing operations. We recorded $0 million, $3 million and $2 million in 2004, 2003 and 2002, respectively, to write down these assets to their fair value, and such costs were included in cost of sales and other income (expense), net.
Other
Certain restructuring programs were initiated primarily during 2003 at specified locations not included in the Step change program. The goals of these programs are to increase efficiencies by reducing headcount and streamlining operations. These programs are expected to increase productivity of the non-core businesses. Anticipated savings will be recognized through the strategic divestment of these operations.
Restructuring charges related to workforce reductions, lease terminations and other exit costs associated with these other programs are included in other income (expense), net. Termination benefits were paid to approximately 1,290 and 1,300 employees in 2004 and 2003, respectively. Workforce reductions occurred principally from production, managerial and administrative employees. Changes in management's original estimate of the amounts accrued for workforce reductions, lease terminations and other exit costs have been included in other income (expense), net.
As a result of other restructuring programs, certain assets, inventories and property, plant and equipment have been identified as being impaired or would no longer be used in continuing operations. We recorded $5 million and $11 million in 2004 and 2003, respectively, to write down these assets to fair value and such costs are included in cost of sales and other income (expense), net.
Restructuring liabilities
Restructuring liabilities consist of the following:
|
2001 Program |
Step change |
Other |
Total |
|||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Workforce reductions |
Lease terminations and other exit costs |
Workforce reductions |
Lease terminations and other exit costs |
Workforce reductions |
Lease terminations and other exit costs |
|
||||||||||||||||
|
(U.S. dollars in millions) |
||||||||||||||||||||||
Balance at January 1, 2002 | $ | 78 | $ | 39 | $ | | $ | | $ | 20 | $ | 12 | $ | 149 | |||||||||
Restructuring expense | 168 | 40 | 51 | 26 | | | 285 | ||||||||||||||||
Cash paid | (156 | ) | (29 | ) | (13 | ) | (1 | ) | | | (199 | ) | |||||||||||
Exchange rate differences | 20 | 5 | | | | | 25 | ||||||||||||||||
Changes in estimate | (16 | ) | (5 | ) | | | (9 | ) | | (30 | ) | ||||||||||||
Balance at December 31, 2002 | 94 | 50 | 38 | 25 | 11 | 12 | 230 | ||||||||||||||||
Restructuring expense | | | 181 | 56 | 110 | 25 | 372 | ||||||||||||||||
Cash paid | (99 | ) | (10 | ) | (143 | ) | (48 | ) | (43 | ) | (12 | ) | (355 | ) | |||||||||
Exchange rate differences | 14 | 9 | 24 | 4 | 7 | 3 | 61 | ||||||||||||||||
Changes in estimate | | (22 | ) | (4 | ) | | (6 | ) | | (32 | ) | ||||||||||||
Balance at December 31, 2003 | 9 | 27 | 96 | 37 | 79 | 28 | 276 | ||||||||||||||||
Restructuring expense | | | 42 | 17 | 98 | 31 | 188 | ||||||||||||||||
Cash paid | (9 | ) | (9 | ) | (137 | ) | (18 | ) | (103 | ) | (16 | ) | (292 | ) | |||||||||
Exchange rate differences | | 2 | 6 | 3 | 5 | 4 | 20 | ||||||||||||||||
Changes in estimate | | (6 | ) | (7 | ) | | (5 | ) | (5 | ) | (23 | ) | |||||||||||
Balance at December 31, 2004 | $ | | $ | 14 | $ | | $ | 39 | $ | 74 | $ | 42 | $ | 169 | |||||||||
52
We expect that we will continue to expend cash and incur restructuring expenses. In particular, we expect that we will pay in 2005 a significant portion of our total restructuring liabilities at December 31, 2004. We also expect to incur restructuring expenses in an amount equal to approximately 0.5 to 0.7 percent of our revenues in each year as part of our routine assessment of our business practices and strategy. These expenses will be recorded in cost of sales, selling, general and distribution expenses and other income (expense), net, in the Consolidated Income Statements according to the nature of the expenses, except for restructuring expenses incurred by businesses classified in discontinued operations, which will be recorded in income (loss) from discontinued operations. We expect to fund our cash expenditures under our restructuring programs through cash generated from our continuing operations. The benefits of these restructuring programs are expected to be realized through reductions in selling, general and administrative expenses and cost of sales in the subsequent years. These benefits, however, may be offset by increases in cost of sales, selling, general and administrative expenses and other income (expense), net, due to various other factors, which cannot be predicted in advance.
Cumulative
The cumulative amounts at December 31, 2004, for each plan are given below:
|
2001 Program |
Step change |
Other |
Total |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(U.S. dollars in millions) |
||||||||||||
Restructuring charge for workforce reduction | $ | 282 | $ | 274 | $ | 228 | $ | 784 | |||||
Restructuring charge for lease terminations and other | 111 | 99 | 68 | 278 | |||||||||
Changes in estimate | (49 | ) | (11 | ) | (25 | ) | (85 | ) | |||||
Total restructuring charges | $ | 344 | $ | 362 | $ | 271 | $ | 977 |
Division information
Restructuring charges by division and business activity consist of the following:
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Power Technologies | $ | 51 | $ | 61 | $ | 57 | ||||
Automation Technologies | 72 | 139 | 126 | |||||||
Non-core activities: | ||||||||||
Oil, Gas and Petrochemicals | 20 | 20 | | |||||||
Equity Ventures | | | | |||||||
Structured Finance | | | | |||||||
Building Systems | 11 | 43 | 22 | |||||||
New Ventures | 1 | 1 | 2 | |||||||
Other Non-core activities | | 47 | 15 | |||||||
Total Non-core activities | 32 | 111 | 39 | |||||||
Corporate/Other | 10 | 29 | 33 | |||||||
Total restructuring charges | $ | 165 | $ | 340 | $ | 255 |
53
ACQUISITIONS, INVESTMENTS AND DIVESTITURES
Acquisitions and investments
In 2004, 2003 and 2002, we paid aggregate consideration of $24 million, $55 million and $154 million, respectively, related to acquisitions and investments in new businesses, joint ventures and affiliated companies.
Divestitures of businesses, joint ventures and affiliated companies
In 2004, 2003 and 2002, we received cash, net of cash disposed, from sales of businesses, joint ventures and affiliated companies of $1,182 million, $543 million and $2,509 million, respectively. In relation to these dispositions we recognized net gains in 2004, 2003, and 2002 within other income (expense), net, of $52 million, $43 million and $98 million, respectively. We also recognized net losses in 2004, 2003, and 2002 within loss from discontinued operations, net of tax, of $63 million, $38 million and $194 million, respectively.
Our material and certain other dispositions are described below.
Divestitures in 2004
In December 2004, we sold our entire 15.7 percent equity interest in IXYS Corporation for approximately $42 million and recorded a gain, before tax, of $20 million in other income (expense), net.
In July 2004, we sold the Upstream Oil, Gas and Petrochemicals business to a consortium of private equity investors (collectively, the Purchasers). We received net cash proceeds of approximately $800 million, which reflects an initial sales price of $925 million adjusted for approximately $85 million of unfunded pension liabilities and changes in net working capital. We recognized in 2004 a loss on disposal of $26 million in loss from discontinued operations, net of tax. On February 9, 2005, we and the Purchasers entered into a Settlement Agreement and Amendment (the Settlement Agreement) finalizing the sales price. This Settlement Agreement contains provisions to indemnify the Purchasers with respect to certain incomplete projects. We believe the provisions we have accrued for such indemnified projects are adequate.
In June 2004, we sold a business in the Automation Technologies division operating in Sweden, for gross and net proceeds of approximately $11 million, and recorded a gain on disposal of $7 million, before tax, in other income (expense), net.
In April 2004, we completed the sale of our Reinsurance business to White Mountains Insurance Group Limited, a Bermuda based insurance holding company, receiving gross cash proceeds of $415 million and net proceeds of approximately $280 million. In anticipation of the sale of this business, we recorded in 2003 an impairment charge of $154 million in loss from discontinued operations, net of tax. We recognized in 2004 a net loss of $41 million in loss from discontinued operations, net of tax, that related primarily to currency translation effects from December 2003 through the date of sale in April 2004 (as explained in "Note 2 Significant accounting policiesTranslation of foreign currencies and foreign exchange transactions" to our Consolidated Financial Statements).
In February 2004, we sold our Swiss Building Systems business to a Swiss private equity company, for gross cash proceeds of approximately $39 million, but retained a 10 percent ownership interest. We recognized in 2004 a net gain on disposal of $12 million, before tax, in other income (expense), net.
In January 2004, we sold our MDCV (Mitsubishi-Dainichi Continuous Vulcanization) Cable Business. We recorded in 2003 asset write-downs of $10 million in anticipation of the sale of this business in loss from discontinued operations, net of tax.
54
Divestitures in 2003
In December 2003, as part of the divestment of our Structured Finance business, we sold ABB Export Bank. We received cash proceeds of approximately $50 million from the sale and recorded in 2003 a loss on disposal of $12 million, in loss from discontinued operations, net of tax.
In December 2003, as part of the divestment of the Wind Energy business (which was held in the New Ventures business area prior to its classification to discontinued operations), we sold the majority of the business for total consideration of $35 million, which included a vendor note of $10 million. We recognized in 2003 a loss on disposal from this sale of approximately $25 million in loss from discontinued operations, net of tax.
In August 2003, as part of the divestment of our Building Systems businesses, we sold to YIT Corporation of Finland our Building Systems businesses located in Sweden, Norway, Denmark, Finland, Russia and the Baltic states for consideration of $213 million. We recorded a gain on disposal of approximately $124 million, before tax, in other income (expense), net. Additionally, throughout 2003, we sold other Building Systems businesses in a number of countries, including Belgium, the Netherlands, Austria, Hungary and the United Kingdom, for aggregate proceeds of $21 million. We recorded in 2003 a loss on disposal from the sale of these businesses of approximately $41 million, before tax, in other income (expense), net.
In June 2003, we sold our entire 35 percent interest in the Swedish Export Credit Corporation to the government of Sweden for net proceeds of approximately $149 million, and recorded a loss on disposal of approximately $80 million, before tax, included in other income (expense), net.
Also in June 2003, we sold our interests in certain equity investments in Australia for cash proceeds of approximately $90 million, and recorded in 2003, a gain on disposal of approximately $28 million, before tax, in other income (expense), net.
In March 2003, we sold our aircraft leasing business for approximately $90 million. This business consisted of a portfolio of loans and leases related to commuter aircraft and helicopters used primarily in Northern Europe. We provided significant financial support to the entity formed by the buyer for the acquisition. Following the introduction of FIN 46 in 2003, we determined that this entity should be treated as a variable interest entity and, as a result of the financial support we provided, that we are the primary beneficiary of this entity. Accordingly, we consolidated this entity in our Consolidated Financial Statements.
Divestitures in 2002
In December 2002, we completed the sale of our Metering business to Ruhrgas Industries GmbH for consideration of approximately $223 million. We recorded in 2002 a loss on disposal of approximately $48 million from this sale in loss from discontinued operations, net of tax. Cash held in escrow of $15 million was released after resolution of certain disputed items in 2003.
In November 2002, we completed the sale of most of our Structured Finance business to General Electric Capital Corporation (GE) and received cash proceeds of approximately $2.0 billion, including a contingent payment of $20 million to be released to us should amounts ultimately collected by GE, from a portfolio transferred by us to GE, reach specified targets. Collection of the last portion of the contingent payment, which culminated our collection of substantially all of the contingent payment, took place on August 3, 2004. We recorded in 2002 a loss on disposal from this sale of approximately $146 million in loss from discontinued operations, net of tax. Pursuant to the sale and purchase agreement for this transaction, we provided GE with cash collateralized letters of credit in the aggregate amount of $202 million as security for certain performance-related obligations retained by us, of which approximately $63 million were outstanding as of December 31, 2004. The remaining cash collateralized letters of credit will further be reduced as our performance related obligations expire.
55
The sale and purchase agreement also provided GE with the option to require us to repurchase designated financial assets transferred to GE. The fair value of GE's right to require us to repurchase the designated assets was $11 million at December 31, 2003. On January 26, 2004, we repurchased the designated financial assets for approximately $28 million. No further obligation exists for us to repurchase any assets under the sale and purchase agreement.
In January 2002, we sold our Air Handling business for cash proceeds of $113 million, which was the sales price of $147 million less a vendor note of 39 million euro principal value (approximately $34 million at the date of issuance) issued by the purchaser, Global Air Movement (Luxembourg) Sarl. We recognized in 2002 a gain on disposal from this sale of $74 million, before tax, in other income (expense), net.
Other divestitures
In May 2003, we sold our interest in China National Petrochemical Corporation (Sinopec Corp.) for approximately $82 million and recorded in 2003 a loss on disposal of $40 million, before tax, in interest and other finance expense, net.
During 2004, 2003 and 2002, we sold several operating units and investments not described above for total proceeds of $39 million, $31 million and $209 million, respectively, and recognized net gains, before tax, on disposal of $13 million, $12 million and $24 million, respectively, in other income (expense), net. Net income from these businesses and investments was not significant in 2004, 2003 and 2002.
In addition, throughout 2003, we engaged in a number of sales and terminations of lease portfolios and individual financing receivables resulting in cash proceeds of approximately $400 million. These disposals continued in 2004, generating cash proceeds of approximately $180 million. The gains (losses) on such disposals were not material.
We report our financial results in U.S. dollars. A significant amount of our revenues, expenses, assets and liabilities are denominated in other currencies due to our global operations. As a consequence, movements in exchange rates between currencies may affect:
We must translate non-U.S. dollar denominated results of operations, assets and liabilities to U.S. dollars in our Consolidated Financial Statements. Balance sheet items are translated to U.S. dollars using year-end currency exchange rates. Income statement and cash flow items are translated to U.S. dollars using the average currency exchange rate over the relevant period. As a consequence, increases and decreases in the value of the U.S. dollar against other currencies will affect our reported results of operations in our Consolidated Income Statement and the value of certain of our assets and liabilities in our Consolidated Balance Sheet, even if our results of operations or the value of those assets and liabilities have not changed in their original currency. Because of the impact foreign exchange rates have on our reported results of operations and the reported value of our assets and liabilities, changes in foreign exchange rates could significantly affect the comparability of our reported results of operations between periods and result in significant changes to the reported value of our assets, liabilities and shareholders' equity, as has been the case during the period from 2002 through 2004.
While we operate globally and report our financial results in U.S. dollars, because of the location of our significant operations and because our headquarters are in Switzerland, exchange rate movements between the U.S. dollar and both the euro (EUR) and the Swiss franc (CHF) are of
56
particular importance to us. The decline in the value of the U.S. dollar against the euro and Swiss franc between 2002 and 2004 has had a material impact on our financial statements.
The exchange rates between the U.S. dollar and the EUR and the U.S. dollar and the CHF at December 31, 2004, 2003, and 2002, are as follows.
|
At December 31, |
||||||||
---|---|---|---|---|---|---|---|---|---|
Exchange rates into U.S. dollars |
|||||||||
2004 |
2003 |
2002 |
|||||||
EUR 1.00 | $ | 1.37 | $ | 1.26 | $ | 1.05 | |||
CHF 1.00 | $ | 0.88 | $ | 0.81 | $ | 0.72 |
The average exchange rates between the U.S. dollar and the EUR and the U.S. dollar and the CHF for the years ended December 31, 2004, 2003 and 2002, are as follows.
|
Year ended December 31, |
||||||||
---|---|---|---|---|---|---|---|---|---|
Exchange rates into U.S. dollars |
|||||||||
2004 |
2003 |
2002 |
|||||||
EUR 1.00 | $ | 1.25 | $ | 1.13 | $ | 0.94 | |||
CHF 1.00 | $ | 0.81 | $ | 0.75 | $ | 0.64 |
When we incur expenses that are not denominated in the same currency as the related revenues, foreign exchange rate fluctuations could adversely affect our profitability. To mitigate the impact of exchange rate movements on our profitability, it is our policy to enter into forward foreign exchange contracts to manage the foreign exchange risk of our operations.
In 2004, approximately 84 percent of our consolidated revenues were reported in currencies other than U.S. dollars. Of that amount, the following percentages were reported in the following currencies:
In 2004, approximately 83 percent of our consolidated cost of sales and selling, general and administration expenses were reported in currencies other than U.S. dollars. Of that amount, the following percentages were reported in the following currencies:
Foreign exchange rate changes resulted in an increase in our reported revenues and EBIT by 6 percent and 18 percent in 2004 and 12 percent and 42 percent in 2003, respectively.
We also incur expenses other than cost of sales and selling, general and administration expenses in various currencies.
The results of operations and financial position of most of our non-U.S. subsidiaries are reported in the currencies of the countries in which those subsidiaries reside. We call these "local currencies." That local currency financial information is then translated into U.S. dollars at applicable exchange rates for inclusion in our Consolidated Financial Statements.
57
The discussion of our results of operations below provides certain information with respect to orders, revenues, earnings before interest and taxes and other measures as reported in local currencies (as well as in U.S. dollars). We measure period-to-period variations in local currency results by using a constant foreign exchange rate for all periods under comparison. Differences in our results of operations as reported in local currencies as compared to our results of operations as reported in U.S. dollars are caused exclusively by changes in currency exchange rates.
While we consider our results of operations as measured in local currencies to be a significant indicator of business performance, local currency information should not be relied upon to the exclusion of U.S. GAAP financial measures. Instead, local currencies reflect an additional measure of comparability and provide a means of viewing aspects of our operations that, when viewed together with the U.S. GAAP results and our reconciliations, provide a more complete understanding of factors and trends affecting the business. Because local currency information is not standardized, it may not be possible to compare our local currency information with other companies' financial measures having the same or a similar name. Management strongly encourages investors to review our financial statements and publicly-filed reports in their entirety, and not to rely on any single financial measure.
We book and report an order when a binding contractual agreement has been concluded with the customer covering, at a minimum, the price and scope of products or services to be supplied, the delivery schedule and payment terms. The reported value of an order corresponds to the undiscounted value of revenues that we expect to recognize following our delivery of the goods or services subject to the order, less any trade discounts and excluding any value added or sales tax. The value of orders received during a given period of time represents a sum of the value of all orders received during the period, adjusted to reflect the aggregate value of any changes to the value of orders received during the period and orders existing at the beginning of the period. These adjustments, which may in the aggregate increase or decrease the orders reported during the period, may include changes in the estimated order price up to the date of contractual performance, changes in the scope of products or services ordered, cancellations of orders, returns of delivered goods, and the recognition of operating or financial services income relating to the order (except that the cancellation of orders with an expected revenue value of over $10 million that were received in a previous period are not deducted from the value of orders received during the present period, and instead, are balanced against order backlog only).
The undiscounted value of revenues we expect to generate from our orders at any point in time is represented by our order backlog. Approximately 12 percent of the value of the orders we booked in 2004 were "large orders," which we define as orders from third parties involving at least $15 million worth of products or systems. Of the total value of orders in the Power Technologies and Automation Technologies divisions in 2004, approximately 11 percent and 7 percent, respectively, represented large orders. Within Non-core activities, large orders represented 49 percent of total orders in 2004, as large orders accounted for 68 percent of the value of orders received by the Oil, Gas and Petrochemicals business.
The level of orders fluctuates from year to year. Arrangements included in particular orders can be complex and unique to the order. Portions of our business involve orders for long-term projects that can take months or years to complete and many large orders result in revenues in periods after the order is booked. However, the level of large orders and backlog, and orders and backlog generally, cannot be used to accurately predict future revenues or operating performance. Orders that are placed can be cancelled, delayed or modified by the customer. These actions can reduce or delay any future revenues from the order, or may result in the elimination of the order.
58
We evaluate the performance of our divisions based on orders received, revenues, earnings before interest and taxes (or EBIT), EBIT as a percentage of revenues (or EBIT margin) and net cash provided by (used in) operating activities. The orders, revenues and EBIT of our divisions include interdivisional transactions. In 2004, approximately 95 percent of our core divisions' orders and revenues were from third-party customers. EBIT, which is commonly referred to as operating profit, is the amount resulting from the subtraction of our cost of sales, selling, general and administrative expenses, amortization expense and other income (expense), net, from our revenues. EBIT margin is the percentage amount resulting from the division of EBIT by revenues. Net cash provided by (used in) operating activities represents the cash provided by or used in a business before cash inflows and outflows from investing and financing activities, and, as relates to our divisions, includes interdivisional transactions.
The financial statements and other financial data included in this report reflect restatements we made in September 2004, when we restated certain financial statements contained in our annual report for the year ended December 31, 2003 as published in our Form 20-F filed with the U.S. Securities and Exchange Commission in April 2004. The amendments reflected restatements of our consolidated financial statements at December 31, 2003 and 2002 and for each of the years in the three-year period ended December 31, 2003, and of certain financial data at December 31, 2001, 2000 and 1999 and for each of the years in the two-year period ended December 31, 2000. These changes were intended to correct the effect of earnings overstatements by the PT-MV BAU in Italy on its previously reported financial statement results.
The cumulative effect of these overstatements on our EBIT and net income was approximately $73 million and $89 million, respectively, from the first quarter of 1998 through the end of March 2004. The negative impact on income tax expense results from the inability to claim tax benefits under Italian tax law for adjustments made to improperly filed tax returns for the years 1998 through 2002, as well as a reassessment of the probability of realization of our deferred tax assets due to a cumulative loss position after the restatement. As compared with financial data originally published, the corrections increased net loss by $12 million ($0.01 per share basic and diluted), $36 million ($0.04 and $0.03 per share basic and diluted, respectively) and $14 million ($0.02 per share basic and diluted) in 2003, 2002 and 2001, respectively, decreased net income by $17 million ($0.01 and $0.02 per share basic and diluted, respectively) and $6 million ($0.01 per share basic and diluted) in 2000 and 1999, respectively, and decreased stockholders' equity by $109 million at December 31, 2003.
DIFFERENCES FROM PRELIMINARY EARNINGS ANNOUNCEMENT
On February 17, 2005, we announced, in an unaudited earnings release, net income for the year ended December 31, 2004 totaling $201 million. Following extensive negotiations between various representatives of asbestos claimants and us, on March 21, 2005, we announced that we reached an agreement with those parties on the basic terms of an amended plan of reorganization for Combustion Engineering and ABB Lummus Global to resolve the asbestos claims against both companies.
This event, and the resulting change in estimate relating to our potential asbestos-related liabilities, is required under accounting rules to be recorded in our results for the year ended December 31, 2004. As a result of the changes required to reflect that change in estimate, our Consolidated Financial Statements included in this report differ in certain respects from the financial information stated in the February 17, 2005 earnings release.
59
In the Consolidated Financial Statements, we have adjusted the preliminary amounts announced in the earnings release as follows:
|
Year Ended December 31, 2004 |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
Selected Financial Data |
As reported on February 17, 2005 |
Adjustments* |
As adjusted |
|||||||
|
(U.S. dollars in millions, except per share data) |
|||||||||
Loss from discontinued operations, net of tax | $ | (247 | ) | $ | (236 | ) | $ | (483 | ) | |
Net income (loss) | 201 | (236 | ) | (35 | ) | |||||
Net income (loss) per share | $ | 0.10 | $ | (0.12 | ) | $ | (0.02 | ) | ||
Accrued liabilities and other | $ | 6,200 | $ | 236 | $ | 6,436 | ||||
Total stockholders' equity | $ | 3,060 | $ | (236 | ) | $ | 2,824 |
ANALYSIS OF RESULTS OF OPERATIONS
Consolidated
Our results from operations were as follows:
|
Year ended December 31, |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||||||
|
(U.S. dollars in millions, except per share data) |
||||||||||
Orders | $ | 21,689 | $ | 19,701 | $ | 19,153 | |||||
Order backlog(1) | 12,364 | 11,306 | 12,127 | ||||||||
Revenues | 20,721 | 20,427 | 19,472 | ||||||||
Cost of sales | 15,757 | 15,928 | 15,098 | ||||||||
Selling, general and administrative expenses | 3,786 | 3,917 | 4,050 | ||||||||
EBIT | 1,084 | 357 | 199 | ||||||||
Interest and other finance expense, net | (223 | ) | (417 | ) | (133 | ) | |||||
Loss from discontinued operations | (483 | ) | (408 | ) | (693 | ) | |||||
Net loss | $ | (35 | ) | $ | (779 | ) | $ | (819 | ) | ||
Basic earnings (loss) per share: | |||||||||||
Income (loss) from continuing operations | $ | 0.22 | $ | (0.30 | ) | $ | (0.11 | ) | |||
Net loss | $ | (0.02 | ) | $ | (0.64 | ) | $ | (0.74 | ) | ||
Diluted earnings (loss) per share: | |||||||||||
Income (loss) from continuing operations | $ | 0.22 | $ | (0.30 | ) | $ | (0.27 | ) | |||
Net loss | $ | (0.02 | ) | $ | (0.64 | ) | $ | (0.86 | ) |
A more detailed discussion of the orders, revenues, cost of sales, selling, general and administrative expenses and EBIT for each of our individual divisions and segments follows in sections entitled "Power Technologies," "Automation Technologies," "Non-core activities" and "Discontinued operations" below.
60
Orders
|
Year ended December 31, |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||||||
|
(U.S. dollars in millions) |
||||||||||
Power Technologies | $ | 9,372 | $ | 7,682 | $ | 6,686 | |||||
Automation Technologies | 11,334 | 9,691 | 8,428 | ||||||||
Total Core Divisions | 20,706 | 17,373 | 15,114 | ||||||||
Non-core activities | |||||||||||
Oil, Gas and Petrochemicals | 1,216 | 1,156 | 2,123 | ||||||||
Building Systems | 388 | 1,616 | 2,351 | ||||||||
New Ventures | 41 | 45 | 70 | ||||||||
Equity Ventures | 7 | 26 | 19 | ||||||||
Structured Finance | 6 | 48 | 77 | ||||||||
Other Non-core activities | 36 | 469 | 960 | ||||||||
Total Non-core activities | 1,694 | 3,360 | 5,600 | ||||||||
Corporate/Other and inter-division eliminations. | (711 | ) | (1,032 | ) | (1,561 | ) | |||||
Total | $ | 21,689 | $ | 19,701 | $ | 19,153 |
In 2004, orders increased by $1,988 million, or 10 percent (3 percent in local currencies), to $21,689 million.
Orders received by the core divisions increased by 19 percent in 2004 (12 percent in local currencies), with orders received by the Power Technologies and Automation Technologies divisions increasing 22 percent and 17 percent (15 percent and 9 percent in local currencies), respectively. Orders received by Non-core activities decreased by 50 percent (53 percent in local currencies) in 2004 as compared to 2003. Orders valued at approximately $92 million, or 0.4 percent of 2004 orders, were received prior to 2004 and were cancelled, but not deducted from the reported value of orders received, during 2004.
In 2003, orders increased by $548 million, or 3 percent (decreased by 9 percent in local currencies), to $19,701 million from $19,153 million in 2002. This small increase in orders was due to a 40 percent (43 percent in local currencies) decline in orders received by Non-core activities that substantially offset increases in orders received by each of the Power Technologies and Automation Technologies divisions of 15 percent (5 percent and 1 percent, respectively, in local currencies). Orders valued at approximately $136 million, or 0.7 percent of 2003 orders, were received prior to 2003 and were cancelled, but not deducted from the reported value of orders received, during 2003. Orders valued at approximately $644 million, or 3.4 percent of 2002 orders, were received prior to 2002 and were cancelled, but not deducted from the reported value of orders received, during 2002.
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Europe | $ | 11,009 | $ | 11,024 | $ | 10,915 | ||||
The Americas | 3,797 | 3,227 | 3,862 | |||||||
Asia | 5,013 | 3,460 | 2,822 | |||||||
MEA | 1,870 | 1,990 | 1,554 | |||||||
Total | $ | 21,689 | $ | 19,701 | $ | 19,153 |
Orders from Europe remained flat in 2004 and 2003, but declined 8 percent and 12 percent in local currencies, respectively. Changes in our orders from Europe from 2002 to 2004 were primarily the
61
result of divestments from the Building Systems business and a shift to reimbursable contracts in the Oil, Gas and Petrochemicals business. Orders from the Americas increased 18 percent (15 percent in local currencies) during 2004, driven largely by automotive industries after a decline of 16 percent (18 percent in local currencies) during 2003.
Asian orders increased 45 percent and 23 percent (38 percent and 15 percent in local currencies) in 2004 and 2003, respectively, principally resulting from an increase in orders from China in the same respective periods driven by economic growth and infrastructure development. South Asian orders were predominantly from India, where orders grew in 2004 and 2003, following the Indian government's economic liberalization and initiatives. In 2004, orders from Middle East and Africa (MEA) declined by 6 percent (14 percent in local currencies) in 2004 compared to 2003, which included several large orders received by the Power Technologies division's Power Systems business area thereby resulting in an increase of 28 percent (20 percent in local currencies) in 2003 as compared to 2002.
Order backlog
|
At December 31, |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||||||
|
(U.S. dollars in millions) |
||||||||||
Power Technologies | $ | 6,874 | $ | 6,030 | $ | 5,682 | |||||
Automation Technologies | 4,322 | 3,826 | 3,486 | ||||||||
Non-core activities | 1,533 | 1,865 | 3,579 | ||||||||
Corporate/Other and inter-division eliminations | (365 | ) | (415 | ) | (620 | ) | |||||
Total | $ | 12,364 | $ | 11,306 | $ | 12,127 |
Order backlog increased by $1,058 million, or 9 percent (3 percent in local currencies), to $12,364 million in 2004 as an increase in order backlog in the core divisions exceeded an 18 percent decline (24 percent in local currencies) in the order backlog in Non-core activities. In 2003, order backlog decreased by $821 million, or 7 percent (17 percent in local currencies), to $11,306 million from $12,127 million in 2002, as an increase in order backlog in the core divisions was more than offset by a 48 percent (53 percent in local currencies) decline in order backlog in Non-core activities.
Revenues
|
Year ended December 31, |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||||||
|
(U.S. dollars in millions) |
||||||||||
Power Technologies | $ | 8,755 | $ | 7,598 | $ | 6,814 | |||||
Automation Technologies | 11,030 | 9,628 | 8,201 | ||||||||
Core Divisions | 19,785 | 17,226 | 15,015 | ||||||||
Non-core activities | |||||||||||
Oil, Gas and Petrochemicals | 1,079 | 1,895 | 2,321 | ||||||||
Building Systems | 508 | 1,829 | 2,375 | ||||||||
New Ventures | 49 | 53 | 50 | ||||||||
Equity Ventures | 7 | 26 | 19 | ||||||||
Structured Finance | 6 | 48 | 66 | ||||||||
Other Non-core activities | 44 | 471 | 783 | ||||||||
Total Non-core activities | 1,693 | 4,322 | 5,614 | ||||||||
Corporate/Other and inter-division eliminations | (757 | ) | (1,121 | ) | (1,157 | ) | |||||
Total | $ | 20,721 | $ | 20,427 | $ | 19,472 |
62
Revenues increased in each of 2004, 2003 and 2002, driven by growth in our core divisions partially offset by declines in Non-core activities.
Revenues increased by $294 million, or 1 percent (decreased by 5 percent in local currencies), to $20,721 million in 2004 from $20,427 million in 2003. The relatively flat revenue growth in 2004 was due to a 61 percent decrease (63 percent in local currencies) in revenues generated by Non-core activities that substantially offset revenue increases of 15 percent and 15 percent (9 percent and 7 percent in local currencies) in the Power Technologies and Automation Technologies divisions, respectively. In 2003, revenues increased by $955 million, or 5 percent (decreased by 7 percent in local currencies), to $20,427 million from $19,472 million in 2002. The increase in revenues in 2003 was due to increases in revenue of 12 percent and 17 percent (2 percent and 3 percent in local currencies) in the Power Technologies and Automation Technologies divisions, respectively, partially offset by a 23 percent decrease (36 percent in local currencies) in revenues in Non-core activities.
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Europe | $ | 10,764 | $ | 10,963 | $ | 10,461 | ||||
The Americas | 3,624 | 3,900 | 4,177 | |||||||
Asia | 4,296 | 3,519 | 2,860 | |||||||
MEA | 2,037 | 2,045 | 1,974 | |||||||
Total | $ | 20,721 | $ | 20,427 | $ | 19,472 |
European revenues decreased 2 percent (10 percent in local currencies) in 2004 after increasing 5 percent (declining 10 percent in local currencies) in 2003. These changes were primarily the result of revenue reductions associated with the Building Systems divestments in the Nordic countries, Switzerland and in the United Kingdom, substantially offset by exchange rate effects related to the declining value of the U.S. dollar over this period. Within Europe, Central and Eastern European revenues decreased in 2004 after increasing substantially in 2003. Improvement by the core divisions in this region was more than offset in 2004 by the shift to reimbursable contracts in our Oil, Gas and Petrochemicals business and the sale of businesses from the Building Systems business. Revenues from the Americas decreased 7 percent in both 2004 and 2003 (9 percent and 8 percent in local currencies respectively) across all divisions, primarily reflecting the relatively weak markets in the previous periods. North American revenues declined in 2003 reflecting a decline in sales of distribution transformers by the Power Technologies division. Revenues from Asia increased 22 percent and 23 percent (17 percent and 15 percent in local currencies) in 2004 and 2003, respectively, primarily reflecting growth in China. Revenues from India almost doubled in 2004, after a small decline in 2003. The increase in Indian revenue in 2004 was across all business areas, whereas the decline in 2003 reflects the revenues pertaining to an oil and petrochemical refinery project in India that stalled during 2003 due to complications encountered by the customer in obtaining necessary additional financing. Revenues in the MEA remained flat (decline of 6 percent in local currencies) in 2004 after a period of growth in 2003, principally due to higher revenues from an Angolan oil and gas project completed in 2003 that resulting in an increase of MEA revenues in 2003 of 4 percent (2 percent in local currencies) as compared to 2002.
Cost of sales
Cost of sales decreased by $171 million, or 1 percent (7 percent in local currencies), to $15,757 million in 2004 after increasing by $830 million, or 5 percent (decreased 7 percent in local currencies), to $15,928 million from $15,098 million in 2002.
63
Cost of sales consists primarily of labor, raw materials and related components. Cost of sales also includes provisions for warranty claims, contract losses and project penalties, as well as order-related development expenses incurred in connection with projects for which we have recognized corresponding revenues. Order-related development is recorded in cost of sales, and amounted to $727 million, $886 million and $719 million in 2004, 2003 and 2002, respectively. Order-related development amounts are initially recorded in inventories as works in progress, and reflected in cost of sales at the time revenue is recognized.
The gross profit margin on a consolidated basis and for each core division and Non-core activities, calculated as gross profit divided by revenues, were as follows.
|
Year ended December 31, |
||||||
---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||
Power Technologies | 20.3 | % | 22.0 | % | 22.1 | % | |
Automation Technologies | 29.4 | % | 29.0 | % | 29.8 | % | |
Non-core activities* | 6.7 | % | (0.5 | )% | 5.0 | % | |
Consolidated | 24.0 | % | 22.0 | % | 22.5 | % |
The gross profit margin improved in 2004 as compared to 2003, principally due an improvement in gross profit margin in the in the Oil, Gas and Petrochemicals business area from negative 9.5 percent in 2003 to 9.9 percent in 2004 following a $1,103 million reduction in costs of sales related to the winding down or culmination of long-term fixed price contracts.
Selling, general and administrative expenses
Selling, general and administrative expenses decreased by $131 million, or 3 percent (10 percent in local currencies), to $3,786 million in 2004 from $3,917 million in 2003. In 2003, selling, general and administrative expenses decreased by $133 million, or 3 percent (15 percent in local currencies), to $3,917 million from $4,050 million in 2002.
The components of selling, general and administrative expenses were as follows:
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Selling expenses | $ | 1,910 | $ | 1,830 | $ | 1,815 | ||||
General and administrative expenses | 1,876 | 2,087 | 2,235 | |||||||
Total selling, general and administrative expenses | $ | 3,786 | $ | 3,917 | $ | 4,050 | ||||
Total selling, general and administrative expenses as a percentage of revenues | 18.3 | % | 19.2 | % | 20.8 | % |
Selling, general and administrative expenses as a percentage of revenues have decreased in Power Technologies, Automation Technologies and Non-core activities in each of the past two years as compared to the previous period.
Selling expenses increased 4 percent and 1 percent (decreased 3 percent and 11 percent in local currencies) in 2004 and 2003, respectively. The increase in 2004 was due to growth in selling expense in each of the Power Technologies and Automation Technologies divisions of 13 percent (6 percent and 5 percent in local currencies, respectively), partially offset by business divestments and closures in Non-core activities.
64
General and administrative expenses decreased by 10 percent and 7 percent (16 percent and 17 percent in local currencies) in 2004 and 2003, respectively. General and administrative expenses decreased in 2004 as a result of business sales and closures in Non-core activities, partially offset by increases of 2 percent and 15 percent (a decrease of 5 percent and an increase of 5 percent in local currencies) in the Power Technologies and Automation Technologies divisions, respectively. General and administrative expenses decreased in 2003 as a result of business sales and closures in Non-core activities, as well as a decrease of 3 percent (13 percent in local currencies) in the Power Technologies division and partially offset by an increase of 6 percent (a decrease of 10 percent in local currencies) in the Automation Technologies division.
General and administrative expenses include non-order related research and development not related to a specific order or project, which increased 9 percent and 11 percent (decreased 1 percent and 1 percent in local currencies) in 2004 and 2003, respectively. Research and development costs not related to a specific order or project were $690 million, $635 million and $572 million in 2004, 2003 and 2002, respectively.
General and administrative expenses in 2002 additionally include the recovery of payments to two former chief executive officers.
Amortization expense
Amortization expense of other intangibles was $45 million, $31 million and $45 million in 2004, 2003 and 2002, respectively. Amortization expense of other intangibles primarily reflects the amortization of intellectual property related to an acquisition made in 1999 and the amortization of patents and other intangible assets from acquisitions held by the Oil, Gas and Petrochemicals business. The increase in amortization expense in 2004 was primarily due to the reclassification of the Oil, Gas and Petrochemicals business in 2004, and the related recognition of amortization expense not recorded while this business was classified in discontinued operations. Amortization of assets ceases when the assets meet the criteria to be classified as held for sale. Amortization expenses for businesses classified in discontinued operations are not recorded as an amortization expense in our consolidated results of operations. When a business is reclassified from discontinued operations, we recognize in the period of reclassification all amortization expense that would have been recognized by the reclassified business during the period of time the business was classified in discontinued operations as long as this amount is less than the fair value of the assets on the date the business is reclassified into continuing operations.
Other income (expense), net
Other income (expense), net, typically consists of: restructuring expenses; gains or losses from the sale of businesses, gains or losses from the sale or disposal of property, plant and equipment; asset write-downs; our share of income or loss from equity accounted companies, principally from our Equity Ventures business; and license income.
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Restructuring expenses | $ | (165 | ) | $ | (340 | ) | $ | (255 | ) | |
Capital gains, net | 73 | 69 | 107 | |||||||
Asset write-downs | (71 | ) | (35 | ) | (94 | ) | ||||
Income from licenses, equity accounted companies and other | 114 | 112 | 162 | |||||||
Total | $ | (49 | ) | $ | (194 | ) | $ | (80 | ) |
Restructuring expenses are described above in "Restructuring expenses".
65
Capital gains, net in 2004 included gains of $33 million on the sale of land and buildings, $20 million on the sale of our shares of IXYS Corporation and lesser amounts from a number of smaller transactions. Capital gains, net in 2003 included gains of $83 million from the sale of businesses from the Building System business area, $28 million from the sale of equity investments in Australia, $26 million from the sale of land and buildings and lesser amounts from a number of smaller transactions, partly offset by an $80 million loss on the sale of our equity interest in the Swedish Export Credit Corporation. Capital gains in 2002 included a $74 million gain on the sale of our Air Handling business, a $22 million gain from the sale of machinery, land and buildings and a number of smaller gains.
Asset write-downs in 2004 included charges of $21 million in respect of goodwill, $14 million in respect of an e-business investment, $8 million in respect of property impairments, $2 million in respect of machinery and equipment, approximately $20 million in a write-down of notes receivable in the Power Technologies division and a number of smaller write-downs. Asset write-downs in 2003 related to software, several equity investments, impairments of property and a number of smaller write-downs. Asset write-downs in 2002 included $25 million in respect of software, $30 million in respect of a number of equity investments, approximately $30 million in respect of impairments of property and a number of smaller write-downs.
License income was $24 million, $25 million and $14 million in 2004, 2003 and 2002, respectively, primarily reflecting income from liquid crystal display licenses.
Income from equity accounted companies was $87 million, $96 million and $220 million in 2004, 2003 and 2002, respectively. Included in these values is income from our investment in Jorf Lasfar, which operates a power plant in Morocco, of $68 million, $62 million and $73 million in 2004, 2003 and 2002, respectively. The decline in 2003 of income from equity accounted companies is primarily due to the sale of our investment in the Swedish Export Credit Corporation, which we divested in the second quarter of 2003.
Earnings before interest and taxes
Our EBIT for the years ended December 31, 2004, 2003 and 2002 was as follows:
|
Year ended December 31, |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||||||
|
(U.S. dollars in millions) |
||||||||||
Power Technologies | $ | 610 | $ | 595 | $ | 451 | |||||
Automation Technologies | 1,027 | 738 | 495 | ||||||||
Core Divisions | 1,637 | 1,333 | 946 | ||||||||
Non-core Activities | |||||||||||
Oil, Gas and Petrochemicals | (4 | ) | (296 | ) | (142 | ) | |||||
Building Systems | (70 | ) | (104 | ) | (113 | ) | |||||
New Ventures | (5 | ) | (21 | ) | (37 | ) | |||||
Equity Ventures | 69 | 76 | 43 | ||||||||
Structured Finance | (14 | ) | (65 | ) | 96 | ||||||
Other Non-core activities | (22 | ) | (57 | ) | (157 | ) | |||||
Total Non-core activities | (46 | ) | (467 | ) | (310 | ) | |||||
Corporate/Other and inter-division eliminations | (507 | ) | (509 | ) | (437 | ) | |||||
Total | $ | 1,084 | $ | 357 | $ | 199 |
EBIT increased by $727 million, or 204 percent (186 percent in local currencies), to $1,084 million in 2004 and by $158 million, or 79 percent (37 percent in local currencies), to $357 million in 2003.
66
The EBIT margin for our core divisions and on a consolidated basis for the years ended December 31, 2004, 2003 and 2002, are as follows:
|
Year ended December 31, |
||||||
---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||
Power Technologies | 7.0 | % | 7.8 | % | 6.6 | % | |
Automation Technologies | 9.3 | % | 7.7 | % | 6.0 | % | |
Core Divisions | 8.3 | % | 7.7 | % | 6.3 | % | |
Total | 5.2 | % | 1.7 | % | 1.0 | % |
The 2004 EBIT margin decline in the Power Technologies division principally reflected a $26 million (of which approximately $20 million was included in other income (expense) net,) write-down of notes receivable, the increase in raw materials costs (especially for steel, copper, and aluminum and transformer oil) during the year, $14 million in project-related hedging costs incurred following our decision to cease accounting for certain hedges under Statement of Accounting Financial Standards No. 133 (or SFAS 133), Accounting for Derivative Instruments and Hedging Activity and lower margin turnkey projects in the Utility Automation Systems business area including, in certain instances, cost overruns. Lower margin levels in the Power Systems business area due to continued low capacity utilization also contributed to the declining EBIT margin in 2004, caused principally by a lack of large orders received by the high voltage direct current business unit and a related declining order backlog relating to our performance in China and Brazil of orders with a combined value of approximately $553 million received in 2001. These developments were partially offset by strong, productivity-driven margin improvements in the Medium Voltage Products business area. The EBIT margin increased in 2003 as compared to 2002, primarily due to the elimination of overlapping product lines and production sites, as well as productivity improvements.
The EBIT margin in the Automation Technologies division increased in 2004 due to increases in EBIT in all business areas resulting from productivity improvements and operational excellence initiatives along with a decrease in restructuring costs in 2004 from 2003. The EBIT margin increased in all Automation Technologies business areas in 2003 as compared to 2002, primarily due to productivity improvements and cost savings programs, partially offset by higher restructuring expenses in 2003 than 2002.
The EBIT margin in Non-core activities improved in 2004 as compared to 2003, primarily due to charges and losses realized in 2003 relating to certain large projects in the Oil, Gas and Petrochemicals business, the $80 million loss on the sale of our investment in the Swedish Export Credit Corporation and the cessation or transfer of the Group Processes business. Non-core activities EBIT margin declined in 2003 due to the aforementioned items in the Oil, Gas and Petrochemicals business and the Structured Finance business.
Net interest and other finance expense
Net interest and other finance expense consists of interest and dividend income and interest and other finance expense. Interest and other finance expense includes expenses associated with the change in fair value of the embedded derivative that was in our $968 million convertible bonds, the
67
amortization of costs associated with our credit facility, the issuance of our debt securities, gains (losses) on marketable securities and interest expense on our borrowings.
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Interest and dividend income | $ | 164 | $ | 152 | $ | 194 | ||||
Interest and other finance expense | (387 | ) | (569 | ) | (327 | ) | ||||
Net interest and other finance expense | $ | (223 | ) | $ | (417 | ) | $ | (133 | ) |
Net interest and other finance expense decreased by 47 percent in 2004 after rising 214 percent in 2003.
Interest and dividend income increased in 2004 due to higher average balances of cash and marketable securities in 2004 compared to 2003, as well as higher average market interest rates. Interest and dividend income decreased in 2003 because market interest rates were lower than those in 2002 and because our divestments reduced our previous sources of dividend income.
Interest and other finance expense decreased in 2004 due to lower average debt levels in the period, partially offset by higher average interest rates on our borrowings. The debt repaid in 2004 was largely debt that had been swapped into floating interest rates. Consequently, fixed rate debt, with higher average interest rates than our floating rate debt during 2004, represented an increased proportion of our total debt balance. Interest and other finance expense in 2004 also included a $43 million non-cash gain on available for sale marketable securities contributed to our German pension funds in 2004 and a $20 million expense relating to our securitization programs. In 2003, these expenses included a $40 million loss on the sale of our shares in the China National Petrochemical Corporation (Sinopec), a $36 million impairment charge for available-for-sale marketable securities in Germany and a $21 million expense relating to our securitization programs. The change in fair value of the embedded derivative and the amortization of the related discount on issuance from our $968 million convertible bonds resulted in an expense of $52 million in 2004, as compared to an expense of $84 million in 2003 and a decrease in expense of $215 million in 2002.
Provision for taxes
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Income (loss) from continuing operations, before taxes and minority interest | $ | 861 | $ | (60 | ) | $ | 66 | |||
Provision for taxes | $ | (311 | ) | $ | (245 | ) | $ | (81 | ) | |
Effective tax rate for the year | 36.1 | % | (408.3 | )% | 122.7 | % |
The provision for taxes in 2004 was $311 million, representing an effective tax rate for the year of 36.1 percent. The provision for taxes in 2004 includes an expense relating to a valuation allowance of $107 million, predominantly relating to our operations in certain countries including Canada and France, and a benefit of approximately $45 million from the losses of a post divestment reorganization and of $39 million relating to the favorable resolution in 2004 of certain prior year tax matters.
In 2003, the loss from continuing operations before taxes and minority interest of $60 million included an $84 million expense comprising the change in fair value of the embedded derivative and the amortization of the related discount on issuance from our $968 million convertible bonds combined with the continued amortization of the discount on issuance of these bonds. Furthermore, the provision for taxes includes the release of an approximately $38 million tax provision related to a tax case ruled in our favor and an expense of approximately $16 million related to a tax claim filed in Central
68
Europe. In addition, the provision for taxes includes a valuation allowance of approximately $258 million on deferred tax assets as a result of the determination that it was more likely than not that such deferred tax assets would no longer be realized within our Oil, Gas and Petrochemicals business. The effective tax rate in 2003 applicable to income from continuing operations excluding the tax effect of these items would have been 37.5 percent.
The effective tax rate in 2002 was 122.7 percent, in part as a result of a valuation allowance of approximately $33 million on deferred tax assets in the Oil, Gas and Petrochemicals business. Furthermore, the provision for taxes in 2002 includes a valuation allowance of $17 million on deferred tax assets and an increased tax expense of $7 million related to non-deductible expenses under Italian tax law as a result of the overstatement within the PT-MV BAU in Italy. The effective tax rate in 2002 applicable to income from continuing operations excluding the tax effect of these items would have been 36.4 percent.
Income (loss) from continuing operations
Income (loss) from continuing operations increased by $819 million to an income of $448 million in 2004 compared to a loss of $371 million in 2003. The increase reflects improved EBIT and reduced net interest and other finance expense in 2004.
Income (loss) from continuing operations deteriorated by $245 million to a loss of $371 million in 2003 compared to a loss of $126 million in 2002. The deterioration reflects increased net interest and other finance expense and increased tax expense in 2003:
Loss from discontinued operations, net of tax
The loss from discontinued operations, net of tax, are as set forth below:
|
Year ended December 31, |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Discontinued operations |
|||||||||||
2004 |
2003 |
2002 |
|||||||||
|
(U.S. dollars in millions) |
||||||||||
Combustion Engineering (Asbestos) | $ | (262 | ) | $ | (142 | ) | $ | (395 | ) | ||
Powerlines | (75 | ) | (10 | ) | (17 | ) | |||||
Upstream Oil, Gas and Petrochemicals | (70 | ) | (44 | ) | 14 | ||||||
Reinsurance | (41 | ) | (97 | ) | 22 | ||||||
Wind Energy | (25 | ) | (42 | ) | (1 | ) | |||||
Foundry | (17 | ) | | | |||||||
MDCV Cables | | (24 | ) | (1 | ) | ||||||
Export Bank | | (9 | ) | 10 | |||||||
Metering | 12 | (3 | ) | (54 | ) | ||||||
Structured Finance | 14 | (29 | ) | (183 | ) | ||||||
Other abandoned or sold businesses | (19 | ) | (8 | ) | (88 | ) | |||||
Loss from discontinued operations, net of tax | $ | (483 | ) | $ | (408 | ) | $ | (693 | ) |
Tax expense, net, in discontinued operations was $41 million, $42 million and $91 million in 2004, 2003 and 2002, respectively.
A detailed discussion of the results of the significant discontinued businesses follows in the section entitled "Discontinued operations."
69
Net loss
As a result of the factors discussed above, net loss improved by $744 million to a loss of $35 million in 2004 from a loss of $779 million in 2003. The net loss in 2003 decreased by $40 million to a net loss of $779 million in 2003 from a net loss of $819 million in 2002.
Earnings (loss) per share
|
Year ended December 31, |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Basic and Diluted earnings (loss) per share |
|||||||||||
2004 |
2003 |
2002 |
|||||||||
|
(U.S. dollars) |
||||||||||
Income (loss) from continuing operations | |||||||||||
Basic | $ | 0.22 | $ | (0.30 | ) | $ | (0.11 | ) | |||
Diluted | $ | 0.22 | $ | (0.30 | ) | $ | (0.27 | ) | |||
Loss from discontinued operations | |||||||||||
Basic | $ | (0.24 | ) | $ | (0.34 | ) | $ | (0.63 | ) | ||
Diluted | $ | (0.24 | ) | $ | (0.34 | ) | $ | (0.59 | ) | ||
Net loss | |||||||||||
Basic | $ | (0.02 | ) | $ | (0.64 | ) | $ | (0.74 | ) | ||
Diluted | $ | (0.02 | ) | $ | (0.64 | ) | $ | (0.86 | ) |
Basic earnings (loss) per share is calculated by dividing income (loss) by the weighted-average number of shares outstanding during the year. Diluted earnings (loss) per share is calculated by dividing income (loss) by the weighted-average number of shares outstanding during the year, assuming that all potentially dilutive securities were exercised, if dilutive. Potentially dilutive securities comprise: outstanding written call options, if dilutive; the securities issued under our employee incentive plans, if dilutive; and shares issuable in relation to our convertible bonds, if dilutive.
Basic loss per share was $0.02 in 2004 compared to $0.64 in 2003. Basic loss per share was $0.64 in 2003 compared to $0.74 in 2002.
The difference between the basic and diluted earnings per share in 2002 primarily reflects the effect of the gain of $215 million recognized in 2002 under SFAS 133 with respect to changes in the fair value of the embedded derivative and the amortization of the related discount on issuance from our $968 million convertible bond.
Effective January 1, 2005, the business areas within the Power Technologies division were reorganized into two businesses areas. The Transformers, Medium Voltage Products and High Voltage Products business areas were combined to form the Products business area, while the Power Systems and Utility Automation Systems business areas were combined to form the Systems business area. We expect to report future financial results for the Power Technologies business area based on the Products and Systems business areas.
70
The financial results of the Power Technologies division were as follows:
|
Year ended December 31, |
||||||||
---|---|---|---|---|---|---|---|---|---|
Power Technologies |
|||||||||
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
||||||||
Orders | $ | 9,372 | $ | 7,682 | $ | 6,686 | |||
Order backlog | 6,874 | 6,030 | 5,682 | ||||||
Revenues | 8,755 | 7,598 | 6,814 | ||||||
Cost of sales | 6,976 | 5,927 | 5,306 | ||||||
Selling, general and administrative expenses | 1,097 | 1,020 | 989 | ||||||
EBIT | $ | 610 | $ | 595 | $ | 451 |
Orders
Orders increased by $1,690 million, or 22 percent (15 percent in local currencies), to $9,372 million in 2004. Orders in 2004 grew at a rate between 18 percent and 27 percent (11 percent and 19 percent in local currencies) in all business areas except for Utility Automation Systems, where orders increased approximately 12 percent (6 percent in local currencies). Both base and large orders improved in 2004, with the large order growth driven by an order for the Three Gorges project in China of approximately $390 million. Orders from other divisions were $500 million in 2004 as compared to $435 million in 2003, representing 5 percent and 6 percent of division orders, respectively.
The proportionate geographic distribution of orders of the Power Technologies division (based on the location of the customer, which may be different from the ultimate destination of the products' end use) were approximately as follows:
|
Year ended December 31, |
|||||
---|---|---|---|---|---|---|
|
2004 |
2003 |
||||
Europe | 37 | % | 40 | % | ||
The Americas | 22 | % | 22 | % | ||
Asia | 29 | % | 21 | % | ||
MEA | 12 | % | 17 | % | ||
Total | 100 | % | 100 | % |
Order growth in 2004 was particularly strong in Asia, led by China where orders almost doubled, making Asia the Power Technologies division's second largest regional source of orders. Orders also grew in Europe in 2004, which continued to be the division's largest regional source of orders. Orders in North America increased significantly while orders from South America decreased slightly. Orders from MEA were down due mainly to a lower level of large orders in 2004 than in 2003.
In 2003, orders increased by $996 million, or 15 percent (5 percent in local currencies), to $7,682 million. Orders increased in all business areas, with increases of 30 percent (20 percent in local currencies) in our Medium Voltage Products business area following growth in our base orders, and 26 percent and 16 percent (13 percent and 8 percent in local currencies) in the Utility Automation Systems and Power Systems business areas, respectively. Orders grew by 13 percent (flat in local currencies) in our High Voltage Products business area as large orders from Eastern Europe and the MEA were partially offset by a decrease from the United States. Orders in our Transformers business area increased by 5 percent (decreased by 5 percent in local currencies).
Order growth in 2003 was driven by growth in the MEA, Asia and Europe, moderated by a decrease in the Americas. Orders from other divisions were $435 million in 2003 compared to $433 million in 2002, representing 6 percent of division orders in both the periods.
71
Order backlog
Order backlog increased by $844 million, or 14 percent (7 percent in local currencies), to $6,874 million as at December 31, 2004 from $6,030 million as at December 31, 2003.
Order backlog increased by $348 million, or 6 percent (decreased by 6 percent in local currencies), to $6,030 million as at December 31, 2003 from $5,682 million as at December 31, 2002.
Revenues
The distribution of revenues of the Power Technologies division by business area for the years ended December 31, 2004 and 2003, were approximately as follows:
|
Year ended December 31, |
||||
---|---|---|---|---|---|
Business area |
|||||
2004 |
2003 |
||||
Transformers | 26 | % | 25 | % | |
Power Systems | 22 | % | 25 | % | |
Medium Voltage Products | 19 | % | 18 | % | |
High Voltage Products | 17 | % | 16 | % | |
Utility Automation Systems | 16 | % | 16 | % |
Revenues increased by $1,157 million, or 15 percent (9 percent in local currencies), to $8,755 million in 2004 from $7,598 million in 2003, principally reflecting a 22 percent (16 percent and 15 percent in local currencies, respectively) revenue growth in the Medium Voltage Products and High Voltage Products business areas, and a 19 percent (13 percent in local currencies) increase in the Transformers business area. Revenues in the Utility Automation Systems business area increased by 11 percent (5 percent in local currencies), whereas revenues in the Power Systems business area increased by 1 percent (down 5 percent in local currencies), reflecting a lower level of order backlog of large projects than in 2003.
Revenues increased by $784 million, or 12 percent (2 percent in local currencies), to $7,598 million in 2003 from $6,814 million in 2002. Revenues from our Medium Voltage Products business area increased 30 percent (20 percent in local currencies) in 2003, based mainly on growth in China and Eastern Europe, while revenues from the High Voltage Products business area increased by 8 percent (4 percent decrease in local currency terms as a result of lower order backlog at the beginning of 2003). Revenues in our Power Systems and Utility Automation Systems business areas decreased by 8 percent and 10 percent (1 percent and 1 percent in local currencies), respectively, due to a reduced number of short-term orders received in the second half of 2002. Revenues for the Power Technologies division were also negatively affected by the loss of revenues from three businesses that were divested in each of the United States, Poland and Italy.
The proportionate geographic distribution of revenues of the Power Technologies division (based on the location of the customer, which may be different from the ultimate destination of the products' end use) were approximately as follows:
|
Year ended December 31, |
|||||
---|---|---|---|---|---|---|
|
2004 |
2003 |
||||
Europe | 39 | % | 38 | % | ||
The Americas | 22 | % | 25 | % | ||
Asia | 25 | % | 24 | % | ||
MEA | 14 | % | 13 | % | ||
Total | 100 | % | 100 | % |
72
Regionally, revenues were higher in Europe, MEA and Asia. Asian revenues in 2004 reflected relatively modest growth in China, where revenues from the Power Systems business area declined from a peak in 2003. Revenue growth in the Americas in 2004 was flat, principally resulting from a decline in revenues in the United States.
Regionally, in 2003 revenues from Asia and the MEA significantly increased primarily driven by increased revenues in China and Saudi Arabia. Revenues from Europe increased in U.S. dollar terms but decreased slightly in local currencies. These increases in revenues for 2003 were partly offset by decreases in the Americas, with the Americas revenues decline in 2003 reflecting a decline in sales of distribution transformers by the Power Technologies division.
Revenues from other divisions were $499 million in 2004 (representing 6 percent of the Power Technologies division's revenues), $476 million in 2003 (representing 6 percent of division revenues) compared to $298 million in 2002 (representing 4 percent of division revenues).
Cost of sales
Cost of sales increased by $1,049 million, or 18 percent (11 percent in local currencies), to $6,976 million in 2004 from $5,927 million in 2003. The Power Technologies division's gross profit margin decreased from 22.0 percent in 2003 to 20.3 percent in 2004, reflecting higher input prices of raw materials, particularly steel, copper, aluminum and transformer oil, that principally impacted the Transformers business area, low capacity utilization of the Power Systems business area and project-related hedging costs incurred following our decision to cease accounting for certain hedges under SFAS 133, offset in part by savings in supply chain management and productivity improvements.
Cost of sales increased by $621 million, or 12 percent (2 percent in local currencies), to $5,927 million in 2003 from $5,306 million in 2002. The Power Technologies division's gross profit margin decreased from 22.1 percent in 2002 to 22.0 percent in 2003. Despite difficult markets in 2003 characterized by a less favorable product mix and price level erosion, most noticeably in our High Voltage Products and Transformers business areas, gross profit margin remained relatively flat mainly due to ongoing productivity improvements and cost savings.
Selling, general and administrative expenses
Selling, general and administration expenses increased by $77 million, or 8 percent (flat in local currencies), to $1,097 million in 2004 from $1,020 million in 2003. Expressed as a percentage of revenues, selling, general and administration expenses decreased to 12.5 percent in 2004 from 13.4 percent in 2003, reflecting productivity gains from improved sales and administrative processes and our restructuring under the Step Change program.
Selling, general and administration expenses increased by $31 million, or 3 percent (decreased by 8 percent in local currencies), to $1,020 million in 2003 from $989 million in 2002. Expressed as a percentage of revenues, selling, general and administration expenses decreased to 13.4 percent in 2003 compared to 14.5 percent in 2002, reflecting the benefits of restructuring and efficiency improvement programs.
Earnings before interest and taxes
EBIT grew $15 million, or 3 percent (2 percent decrease in local currencies) to $610 million in 2004. EBIT reflected restructuring expenses of $51 million and $61 million in 2004 and 2003, respectively.
73
EBIT margin for the Power Technologies division was 7.0 percent in 2004 compared to 7.8 percent for 2003. The decrease in EBIT margin in 2004 principally reflected the increase in raw materials costs (especially for steel, copper, aluminum and transformer oil) during the year, a $26 million (of which approximately $20 million was included in other income (expense), net) write-down of notes receivable, $14 million in project-related hedging costs incurred following our decision to cease accounting for certain hedges under SFAS 133, lower margin levels in the Power Systems business area due to continued low capacity utilization and lower margin turnkey projects in the Utility Automation Systems business area including, in certain instances, cost overruns. These decreases were partially offset by strong, productivity-driven margin improvements in the Medium Voltage Products business area.
EBIT increased by $144 million, or 32 percent (28 percent in local currencies), to $595 million in 2003 from $451 million in 2002. EBIT margin increased from 6.6 percent in 2002 to 7.8 percent in 2003, caused principally by comparatively significant improvements from the Medium Voltage Products, Utility Automation Systems and Power Systems business areas due to the elimination of overlapping product lines and production sites, as well as productivity improvements. EBIT margin in the Transformers business area remained flat.
The financial results of the Automation Technologies division were as follows:
|
Year ended December 31, |
||||||||
---|---|---|---|---|---|---|---|---|---|
Automation Technologies |
|||||||||
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
||||||||
Orders | $ | 11,334 | $ | 9,691 | $ | 8,428 | |||
Order backlog | 4,322 | 3,826 | 3,486 | ||||||
Revenues | 11,030 | 9,628 | 8,201 | ||||||
Cost of sales | 7,785 | 6,835 | 5,760 | ||||||
Selling, general and administrative expenses | 2,147 | 1,889 | 1,786 | ||||||
EBIT | $ | 1,027 | $ | 738 | $ | 495 |
Orders
Orders increased by $1,643 million, or 17 percent (9 percent in local currencies), from $9,691 million in 2003 to $11,334 million in 2004. Orders received by the Automation Products business area increased by 21 percent (13 percent in local currencies) in 2004 led by an increase in orders from process industries and building installations customers. Orders received by the Process Automation business area grew at 11 percent (3 percent in local currencies) in 2004, as growth in orders from the mining, cement, metals, the cruise and ferry and oil and gas industries exceeded declining orders from businesses operating in the chemicals, pharmaceuticals and pulp and paper markets. Orders received by the Manufacturing Automation business area increased by 23 percent (16 percent in local currencies), primarily driven by orders for automotive systems from North America and China. Orders from other divisions were $355 million in 2004, compared to $344 million in 2003 representing 3 percent and 4 percent of the division orders, respectively.
74
The proportionate geographic distribution of orders of the Automation Technologies division (based on the location of the customer, which may be different from the ultimate destination of the products' end use) were approximately as follows:
|
Year ended December 31, |
||||
---|---|---|---|---|---|
|
2004 |
2003 |
|||
Europe | 59% | 61% | |||
The Americas | 16% | 15% | |||
Asia | 19% | 18% | |||
MEA | 6% | 6% | |||
Total | 100% | 100% |
The ultimate destination of our products' end use is relevant for the Automation Technologies division as some global distributors and wholesalers in Europe sell our products in Asia, the Americas, and MEA. We estimate this volume to be approximately 10 percent of the division orders, divided between the ultimate destinations of Asia, the Americas, and MEA.
In 2004, orders from Asia increased faster than in any other region. Orders from the Americas also grew, driven by a large order from the United States automotive sector. European orders grew in 2004, as increases in orders from Western Europe, which accounted for more than 90 percent of European orders, more than offset a reduction in orders from Eastern Europe following the receipt of a large order in Poland during 2003. Orders from the MEA increased moderately.
Orders increased by $1,263 million, or 15 percent (1 percent in local currencies), to $9,691 million in 2003 compared to $8,428 million in 2002. Over this period, the Automation Products business area experienced significant growth in Asia, which was partially offset by lower orders from Europe and America. The Process Automation business area increased the volume of large orders during 2003 by approximately 87 percent (59 percent in local currencies), led by a large order for $173 million in the fourth quarter for turnkey gas compressors for a pipeline project in Poland. This increase in large orders, however, could not offset a lower volume of base orders from the paper and minerals industries. Orders in the Manufacturing Automation business area decreased on lower orders from the automotive industries in North America and Europe. Orders from other divisions were $344 million in 2003 compared to $311 million in 2002.
European orders increased, reflecting strong order increases in Eastern Europe moderated by the slower growth in Western Europe. Orders from the Americas declined in 2003, primarily reflecting lower orders from the automotive and other industrial sectors. Orders from Asia increased significantly in 2003, driven by China and India. Orders from the MEA in 2003 increased in U.S. dollar terms but decreased slightly in local currencies.
Order backlog
Order backlog increased by $496 million, or 13 percent (6 percent in local currencies), to $4,322 million as at December 31, 2004 from $3,826 million as at December 31, 2003, principally as a result of increased order intake during 2004.
Order backlog increased by $340 million, or 10 percent (decreased by 4 percent in local currencies), to $3,826 million as at December 31, 2003 from $3,486 million as at December 31, 2002.
75
Revenues
The distribution of revenues of the Automation Technologies division by business area were approximately as follows:
|
Year ended December 31, |
|||
---|---|---|---|---|
Business area |
||||
2004 |
2003 |
|||
Automation Products | 47% | 46% | ||
Process Automation | 40% | 40% | ||
Manufacturing Automation | 13% | 14% |
Revenues increased by $1,402 million, or 15 percent (7 percent in local currencies), to $11,030 million in 2004 from $9,628 million in 2003, principally due to 17 percent (9 percent in local currencies) revenue growth in the Automation Products business area. Revenues in 2004 for the Process Automation business area increased by 13 percent (5 percent in local currencies), reflecting growth in the Oil and Gas, Minerals, Turbocharging and Control Products business units moderated by declines in the Pulp and Paper and Marine business units. Our Manufacturing Automation business area, which accounted for 13 percent of Automation Technologies' 2004 revenues, grew more slowly at 4 percent (decreased 4 percent in local currencies) as a result of a weak backlog of system orders. Revenues from other divisions were $391 million in 2004 compared to $356 million in 2003 representing 4 percent of the division orders for both periods.
Revenues in the Automation Technologies division increased by $1,427 million, or 17 percent (3 percent in local currencies), to $9,628 million in 2003 compared to $8,201 million in 2002. Revenues increased 14 percent (flat in local currencies) in 2003 in the Manufacturing Automation business area. Revenues in the businesses now constituting the Automation Products and Process Automation business areas increased 17 percent (2 percent in local currencies), as sales of products and services increased and despite declining revenues generated from the paper industry. Revenues from other divisions were $356 million in 2003 compared to $328 million in 2002, representing approximately 4 percent of division revenues in both periods.
The proportionate geographic distribution of revenues of the Automation Technologies division (based on the location of the customer, which may be different from the ultimate destination of the products' end use) were approximately as follows:
|
Year ended December 31, |
||||
---|---|---|---|---|---|
|
2004 |
2003 |
|||
Europe | 60% | 61% | |||
The Americas | 15% | 17% | |||
Asia | 19% | 16% | |||
MEA | 6% | 6% | |||
Total | 100% | 100% |
The ultimate destination of our products' end use is relevant for the Automation Technologies division as some global distributors and wholesalers in Europe sell our products in Asia, the Americas, and MEA. We estimate this volume to be approximately 10 percent of the division revenues, divided between the ultimate destinations of Asia, the Americas, and MEA.
Revenues generated in Asia grew significantly in 2004, reflecting sales growth in China and India, with the result that Asia became Automation Technologies' second largest regional source of revenues. Revenues increased in Europe, which remained Automation Technologies' largest revenue contributor. Revenues from the Americas fell slightly in 2004 due to lower orders in 2003, principally from the
76
automotive industry. Revenues from the MEA increased following the receipt of several large orders in 2003.
In 2003, revenues from Europe increased, as increases in Eastern Europe were tempered by slower growth in Western Europe due to lower order backlog at the beginning of 2003. The Americas increased slightly as compared to 2002, while revenues from Asia and the MEA increased significantly, driven by higher revenues in 2003 from China, India, Algeria and the United Arab Emirates.
Cost of sales
Cost of sales increased $950 million, or 14 percent (6 percent in local currencies), to $7,785 million in 2004 from $6,835 million in 2003. The Automation Technologies division's gross profit margin increased to 29.4 percent in 2004 from 29.0 percent in 2003 following cost reduction and productivity gains from the Step Change program and operational excellence initiatives, offset in part by increasing costs for raw materials, particularly steel, copper and oil.
Cost of sales increased $1,075 million, or 19 percent (4 percent in local currencies), to $6,835 million in 2003 from $5,760 million in 2002. The Automation Technologies division's gross profit margin decreased to 29.0 percent in 2003 from 29.8 percent in 2002. Gross profit margin in 2003 decreased as savings in supply chain management and manufacturing and engineering activities were more than offset by increased input prices from our suppliers following the strengthening of the euro against the U.S. dollar and price reductions on certain of our products. In 2003, the gross profit margin remained flat in the Manufacturing Automation business area, as operational improvements were offset by an increase in material costs. For the businesses now constituting the Process Automation and Automation Products business areas, gross profit margin declined following cost increases related to systems projects, despite the declining percentage of revenue represented by such projects.
Selling, general and administrative expenses
Selling, general and administration expenses increased by $258 million, or 14 percent (5 percent in local currencies), to $2,147 million in 2004 from $1,889 million in 2003 Expressed as a percentage of revenues, selling, general and administration expenses decreased to 19 percent in 2004 from 20 percent in 2003, reflecting cost reductions primarily from the Step change program.
Selling, general and administration expenses increased by $103 million, or 6 percent (decreased 8 percent in local currencies), to $1,889 million in 2003 compared to $1,786 million in 2002. Expressed as a percentage of revenues, selling, general and administration expenses decreased to 20 percent in 2003 from 22 percent in 2002, reflecting the impact of the various restructuring and efficiency improvement programs.
Earnings before interest and taxes
EBIT grew $289 million, or 39 percent (30 percent in local currencies) to $1,027 million in 2004. EBIT margin increased to 9.3 percent in 2004 from 7.7 percent in 2003. EBIT margin increased in all business areas reflecting productivity improvements, benefits from operational excellence initiatives and a decrease in restructuring costs in 2004 to $72 million from $139 million in 2003.
EBIT increased by $243 million, or 49 percent (30 percent in local currencies), to $738 million in 2003 compared to $495 million in 2002. All business areas improved in operating income in 2003, mainly due to productivity improvements and our cost savings programs. The increase in operating income was partially offset by higher restructuring costs in 2003, at $139 million, as compared to $126 million during 2002. As a result, the EBIT margin increased to 7.7 percent in 2003 compared to 6.0 percent in 2002.
77
Orders
Orders received by Non-core activities were as follows:
|
Year ended December 31, |
||||||||
---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||||
|
(U.S. dollars in millions) |
||||||||
Oil, Gas and Petrochemicals | $ | 1,216 | $ | 1,156 | $ | 2,123 | |||
Building Systems | 388 | 1,616 | 2,351 | ||||||
New Ventures | 41 | 45 | 70 | ||||||
Equity Ventures | 7 | 26 | 19 | ||||||
Structured Finance | 6 | 48 | 77 | ||||||
Other Non-core activities | 36 | 469 | 960 | ||||||
Total Non-core activities | $ | 1,694 | $ | 3,360 | $ | 5,600 |
Orders received declined by 50 percent and 40 percent (53 percent and 43 percent in local currencies) in 2004 and 2003, respectively. The reductions in orders over these periods were primarily due to ongoing divestments, declining orders in the Building Systems business area, the discontinuation and reduction of activities in the Group Processes business area and a shift in our Oil, Gas and Petrochemicals business away from entering into long-term fixed price contracts toward reimbursable contracts. Non-core activities orders from other divisions amounted to $36 million in 2004 (representing 2 percent of the division orders in 2004), $445 million in 2003 (representing 13 percent of the division orders in 2003) and $980 million in 2002 (representing 17 percent of the division orders in 2002). The orders received by the Group Processes business area, which only received internal orders from other divisions, constituted $413 million and $755 million of Non-core activities orders received in 2003 and 2002, respectively.
In 2004, orders for Oil, Gas and Petrochemicals business area increased mainly through base orders (orders below $15 million). Large orders in 2004, 2 percent below 2003, included major projects in Sweden, Russia, China, Poland and Middle East. Orders increased in all regions during 2004 compared to 2003.
Within the Building Systems business area, 91 percent of the orders in 2004 were received by our German business and 6 percent by the now-sold Swiss business.
In 2004, Non-core activities orders predominantly came from Europe, with approximately 50 percent of our orders from Western Europe and approximately 20 percent from Eastern Europe. The remaining orders were received in roughly equal proportions from the Americas (principally from the United States), Asia (principally from China) and the MEA.
In 2003, orders decreased by $2,240 million, or 40 percent (43 percent in local currencies), to $3,360 million. This reduction in orders is partially due to the divestment of businesses, the performance of the remaining businesses in the Building Systems business area and the discontinuation and reduction of activities in the Group Processes business area. Additionally, this reduction resulted in part from a decrease in large orders in our Oil, Gas and Petrochemical business, mainly attributable to our strategic decision to de-emphasize fixed priced EPC contracts in favor of lower-risk reimbursable contracts (which generally have lower order values) and to more selectively tender for project work.
78
Order backlog
Order backlog in Non-core activities was as follows:
|
Year ended December 31, |
||||||||
---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||||
|
(U.S. dollars in millions) |
||||||||
Oil, Gas and Petrochemicals | $ | 1,251 | $ | 1,264 | $ | 2,143 | |||
Building Systems | 255 | 554 | 1,263 | ||||||
New Ventures | 8 | 14 | 79 | ||||||
Equity Ventures | | | | ||||||
Structured Finance | | 2 | 3 | ||||||
Other Non-core activities | 19 | 31 | 91 | ||||||
Total Non-core activities | $ | 1,533 | $ | 1,865 | $ | 3,579 |
Revenues
Revenues from Non-core activities were as follows:
|
Year ended December 31, |
||||||||
---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
||||||
|
(U.S. dollars in millions) |
||||||||
Oil, Gas and Petrochemicals | $ | 1,079 | $ | 1,895 | $ | 2,321 | |||
Building Systems | 508 | 1,829 | 2,375 | ||||||
New Ventures | 49 | 53 | 50 | ||||||
Equity Ventures | 7 | 26 | 19 | ||||||
Structured Finance | 6 | 48 | 66 | ||||||
Other Non-core activities | 44 | 471 | 783 | ||||||
Total Non-core activities | $ | 1,693 | $ | 4,322 | $ | 5,614 |
Revenues decreased by 61 percent and 23 percent (63 percent and 36 percent in local currencies) in 2004 and 2003, respectively. Revenues from other divisions amounted to $52 million, $476 million and $882 million (representing 3 percent, 11 percent and 15 percent of Non-core activities revenues) in 2004, 2003 and 2002, respectively.
Oil, Gas and Petrochemicals revenues in 2004 were 43 percent (46 percent in local currencies) lower than 2003, primarily due to the winding down and reduced scope of large projects. Revenues from the licensing of process technologies significantly increased, led by revenues from the licensing of ethylene and novolen technologies. Revenues decreased by 18 percent (28 percent in local currencies) in 2003 compared to 2002, primarily due to the lower volume of order backlog going into 2003 as a consequence of our focus in pursuing reimbursable EPC projects. In an effort to reduce our exposure to risks associated with long-term fixed price contracts, particularly in our Oil, Gas and Petrochemicals business, we have been pursuing instead long-term reimbursable contracts in which we charge our customers the sum of our materials, production, logistics, administrative and financial costs, together with a negotiated operating profit. We believe that long-term reimbursable contracts, while not eliminating the risk of loss completely, should generally enable us to recover from the customer costs relating to contract delays or cost increases more easily than we can with fixed price contracts, where we generally must demonstrate that the delays and increased costs were a direct result of the customer's action or omission. Despite our strategy of focusing on reimbursable contracts, we may continue to experience losses on our contracts.
79
Building Systems revenues decreased by 72 percent and 23 percent (74 percent and 34 percent in local currencies) in 2004 and 2003, respectively, primarily resulting from the sale of businesses. Building Systems revenues in 2004 were primarily generated in Germany, with 79 percent of 2004 business area revenues, the United States (which we plan to close) with 10 percent, and Switzerland (sold in February 2004) with 6 percent.
New Ventures revenues came from distributed energy operations in Europe.
Equity Ventures includes mainly equity accounted companies, the income from which, are recorded in other income (expense), net.
Structured Finance revenues decreased in each of 2004 and 2003 due to the ongoing portfolio reduction.
Other Non-core activities include Group Processes, Customer Service Workshops and Logistic Systems business areas. Group Processes revenues decreased by $421 million, or 100 percent, to $0 million in 2004. In 2003, Group Processes revenues decreased by $183 million, or 30 percent (37 percent in local currencies), to $421 million in 2003 from $604 million in 2002. This business area does not generate revenue from third-party sales, with all the revenues of this business area resulting from internal charges to other divisions. These decreases were due principally to the transfer of activities to the other business areas or cessation of activities. Of the remaining businesses, revenues decreased by $6 million and $129 million in 2004 and 2003, respectively, due to the ongoing divestment and related closing processes in our Customer Service Workshop and Logistic Systems business areas.
Earnings before interest and taxes
EBIT for Non-core activities was as follows:
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Oil, Gas and Petrochemicals | $ | (4 | ) | $ | (296 | ) | $ | (142 | ) | |
Building Systems | (70 | ) | (104 | ) | (113 | ) | ||||
New Ventures | (5 | ) | (21 | ) | (37 | ) | ||||
Equity Ventures | 69 | 76 | 43 | |||||||
Structured Finance | (14 | ) | (65 | ) | 96 | |||||
Other Non-core activities | (22 | ) | (57 | ) | (157 | ) | ||||
Total Non-core activities | $ | (46 | ) | $ | (467 | ) | $ | (310 | ) |
The Oil, Gas and Petrochemicals business area in 2004 improved as compared to 2003, reflecting better project execution capabilities across the organization as well as a significant reduction in project-related write-offs in 2004. Stronger performance following the winding down or culmination of unprofitable long-term, fixed price EPC projects and increased revenue related to the licensing of process technologies was partially offset by under absorption of operating costs by the Floating Production Systems business. EBIT in 2004 was also negatively impacted by a charge to depreciation and amortization of $26 million for the years 2003 and 2004. This charge was required in 2004 following the reclassification of this business area from discontinued operations to continuing operations (see the section entitled "Discontinued operations" below).
EBIT losses generated by the Oil, Gas and Petrochemicals business area increased in 2003 compared to 2002, primarily due to charges in 2003 of approximately $399 million relating to four large, long-term fixed price projects booked prior to the implementation of our current bidding strategy that focuses on reimbursable contracts. The customers and countries in which these four projects were located are unrelated. The charges are related to delays, project cost overruns and write-downs of assets that we no longer considered recoverable.
EBIT losses generated by the Building Systems business area decreased by $34 million in 2004 as compared to 2003, primarily due to operational improvements and a reduction in restructuring
80
expenses, primarily in Germany, partially offset by losses in the United States and the loss of income from the profitable Nordic businesses sold in 2003 and the Swiss business sold in February, 2004. In 2003, EBIT losses decreased by $9 million as compared to 2002. EBIT for 2003 included the gain on sale of the Nordic businesses for approximately $124 million, partially offset by a loss on sale of businesses located in several other countries, principally Belgium, the Netherlands, Austria and the UK, of approximately $41 million.
EBIT losses in the New Ventures business area decreased by $16 million in 2004 compared to 2003. This improvement resulted partly because in 2004 this area no longer included the income from our investment in Turbec AB, which generated negative earnings recognized in 2003. Turbec was sold in the fourth quarter of 2003. The 2004 operating loss also includes a $20 million gain on the divestment of our equity interest in IXYS Corporation. In 2003, EBIT losses decreased by $16 million as compared to 2002, largely due to restructuring activities leading to a significant reduction in selling, general and administrative expenses and lower asset write-downs, offset in part by negative earnings from equity accounted companies related to our investment in Turbec AB.
EBIT generated by the Equity Ventures business area decreased by $7 million in 2004 as compared to 2003. The decline from the EBIT generated in 2003, which included a $28 million gain on the sale of investments in Australia, was offset in part by an increase in EBIT from savings in sales, general and administrative expenses following the cessation of development activities and from a gain on the sale of an investment in Oman. In 2003, EBIT increased by $33 million as compared to 2002, due to the gain realized from divestments in Australia and savings in sales, general and administrative expenses.
EBIT losses in the Structured Finance business area decreased by $51 million in 2004 as compared to 2003, principally because 2003 included a loss of $80 million on the disposal of our investment in the Swedish Export Credit Corporation (which was offset in part in 2003 by income from Swedish Export Credit Corporation of $13 million recognized in other income (expense), net). In 2003, EBIT decreased by $161 million as compared to 2002 due to the loss on disposal of our investment in the Swedish Export Credit Corporation and a reduction in income from the Swedish Export Credit Corporation of $112 million.
EBIT generated by the businesses in Other Non-core activities increased by $35 million in 2004 as compared to 2003. This improvement was due to the dissolution of the Group Processes business area, which represented $0 million and $42 million of the losses in 2004 and 2003, respectively. EBIT generated by the Customer Service Workshops business area improved in 2004 due to a reduction in restructuring expenses and improved operational performance by the few remaining units. The Logistic Systems business area recognized an operating loss of $24 million in 2004 due to issues relating to the Harare airport project completed in 2001. In 2003, EBIT losses in Other Non-core activities decreased by $100 million as compared to 2002. Group Processes represented approximately $42 million and $105 million of the losses in 2003 and 2002, respectively.
Corporate/Other
Corporate and other activities comprise headquarters and stewardship, research and development and other activities. EBIT for Corporate and other activities are as follows:
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Headquarters and stewardship | $ | (421 | ) | $ | (352 | ) | $ | (202 | ) | |
Research & Development | (91 | ) | (92 | ) | (93 | ) | ||||
Other | 5 | (65 | ) | (142 | ) | |||||
Total | $ | (507 | ) | $ | (509 | ) | $ | (437 | ) |
Headquarters and stewardship operating costs increased by $69 million and $150 million in 2004 and 2003, respectively. The 2004 expense included a $14 million write-down in 2004 of an e-business
81
investment. The increase in 2003 as compared to 2002 was mainly due to events in 2002, such as the recovery of payments from two former chief executive officers, that did not recur in 2003.
Other operating costs (including Real Estate, Group Treasury Operations and consolidation) decreased by $70 million and $77 million in 2004 and 2003, respectively. The improvement in 2004 occurred in each of Real Estate, Group Treasury Operations and consolidation. Real estate improved in 2004 as compared to 2003 due to reduced restructuring expenses. Group Treasury Operations improved in 2004 due to a reduction in the level of general and administrative expenses.
Other operating costs improved in 2003 mainly due to lower costs following the cessation of proprietary trading in 2002 and the consequent reduction in employees in Group Treasury Operations, as well as a reduction in earnings from certain intra-company transactions as compared to 2002.
Loss from discontinued operations, net of tax, in our Consolidated Income Statement reflects primarily the following.
Loss from discontinued operations, net of tax, was $483 million, $408 million and $693 million in 2004, 2003 and 2002, respectively. The loss from discontinued operations, net of tax, and including operational results, accumulated foreign currency translation adjustments, allocation of interest in accordance with Emerging Issues Task Force No. 87-24 (EITF 87-24), Allocation of Interest to Discontinued Operations, capital gains and losses on sale, impairment charges, goodwill write-offs and
82
other costs for businesses classified in discontinued operations for the years ended December 31, 2004, 2003 and 2002 are as set forth below.
|
Year ended December 31, |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Discontinued operations |
|||||||||||
2004 |
2003 |
2002 |
|||||||||
|
(U.S. dollars in millions) |
||||||||||
Combustion Engineering (Asbestos) | $ | (262 | ) | $ | (142 | ) | $ | (395 | ) | ||
Powerlines | (75 | ) | (10 | ) | (17 | ) | |||||
Upstream Oil, Gas and Petrochemicals | (70 | ) | (44 | ) | 14 | ||||||
Reinsurance | (41 | ) | (97 | ) | 22 | ||||||
Wind Energy | (25 | ) | (42 | ) | (1 | ) | |||||
Foundry | (17 | ) | | | |||||||
MDCV Cables | | (24 | ) | (1 | ) | ||||||
Export Bank | | (9 | ) | 10 | |||||||
Metering | 12 | (3 | ) | (54 | ) | ||||||
Structured Finance | 14 | (29 | ) | (183 | ) | ||||||
Other abandoned or sold businesses | (19 | ) | (8 | ) | (88 | ) | |||||
Income (loss) from discontinued operations, net of tax | $ | (483 | ) | $ | (408 | ) | $ | (693 | ) |
In addition to the businesses already classified in discontinued operations, we may from time to time dispose of or close businesses that are not integral to our core divisions. If such a business meets the criteria of SFAS 144, we will reflect the results of operations from the business as discontinued operations in our Consolidated Income Statement and as assets and liabilities held for sale and in discontinued operations in our Consolidated Balance Sheet. We will reclassify the prior years' presentation to reflect any disposals or closures on a comparable basis.
Asbestos
Loss from discontinued operations, net of tax, includes costs and provisions related to asbestos-related claims, including those against our U.S. subsidiary, Combustion Engineering Inc., of approximately $262 million, $142 million and $395 million in 2004, 2003 and 2002, respectively.
An overview of our potential asbestos-related obligations is included separately in "Contingencies and retained liabilities."
Powerlines
Our Powerlines business is a construction business that operates in a market with very low barriers to entry. This has resulted in increasing price-based competition with local competitors in the various countries in which we operate. The business has consequently experienced declining revenues, and net losses.
At the time we decided to exit the Powerlines business, this business operated in Austria, Germany, Italy, Saudi Arabia, Brazil, Venezuela, South Africa and Nigeria. The Nigerian and Italian businesses were sold in January 2005 and February 2005, respectively. The Brazilian business was abandoned in the fourth quarter of 2004. We expect the German business to be sold during 2005. In the fourth quarter of 2004, we reclassified the Nigerian, Italian, Brazilian and German businesses to discontinued operations. This reclassification has been reflected in the financial statements for 2004, 2003 and 2002 and the results of the reclassified businesses are discussed below. We intend to exit our remaining Powerlines businesses, although we have not classified them in discontinued operations.
Revenues were $117 million, $187 million and $254 million in 2004, 2003 and 2002, respectively. We recorded net losses of $75 million, $10 million and $17 million in 2004, 2003 and 2002, respectively. The increase in losses in 2004 relates to reducing the book value of net assets to fair value less costs to sell the operations in Italy, Germany and Nigeria, costs related to the abandonment in Brazil and operational losses.
83
Upstream Oil, Gas and Petrochemicals
In July 2004 we closed the sale of the Upstream Oil, Gas and Petrochemicals business to a consortium of private equity investors, Candover Partners, JP Morgan Partners and 3i Group, for an initial sale price of $925 million. We received net cash proceeds from the sale of approximately $800 million after adjustments for approximately $85 million of unfunded pension liabilities and changes in net working capital.
The Upstream Oil, Gas and Petrochemicals business generated revenues of $855 million (up to the date of sale), $1,499 million and $1,535 million in 2004, 2003 and 2002, respectively.
Revenues declined in 2004 as compared to 2003 due to the sale of the business in July 2004. Revenues decreased in 2003 as compared to 2002 due to a large project in the Floating Production Systems unit nearing completion and the smaller value of new orders due to our pursuit of long-term reimbursable contracts, rather than long-term fixed price contracts.
We recorded net losses for the Upstream Oil, Gas and Petrochemicals business of $70 million and $44 million in 2004 and 2003, respectively, and a net income of $14 million in 2002. The 2004 net loss of $70 million includes a loss on disposal of approximately $26 million and compliance costs relating to violations of the Foreign Corrupt Practices Act, including aggregate fines of $10.5 million and a $5.9 million payment to the United States Securities and Exchange Commission as a disgorgement of unlawful profits and in resolution of civil charges, as well as other related costs.
In 2003, this business generated a net loss of $44 million, a $58 million decline from net income in 2002 of $14 million. This decline was primarily due to certain loss order provisions in Brazil and the settlement of a project-related dispute that resulted in an asset write-down in 2003.
Reinsurance business
In April 2004 we sold our Reinsurance business to White Mountains Insurance Group Limited of Bermuda for gross cash proceeds of $415 million.
Reinsurance revenues were $139 million, $782 million and $644 million in 2004, 2003 and 2002, respectively. Reinsurance revenues decreased in 2004 due to the sale of the business in April 2004. The increase in revenues in 2003 as compared to 2002 was primarily due to higher premium income from increased volumes and higher insurance premium rates compared to the rates for comparable products and risks in 2002.
We recorded net losses for our Reinsurance business of $41 million and $97 million in 2004 and 2003, respectively, and a net income of $22 million in 2002. The 2004 net loss was primarily a result of currency translation effects (as explained in Note 2 "Significant accounting policiesTranslation of foreign currencies and foreign exchange transactions" to our Consolidated Financial Statements) of $32 million, transaction costs, and price adjustments (as part of the sales agreement all operational risks and results in 2004 were transferred to the purchaser). The 2003 net loss includes a $154 million impairment charge, income from operations of approximately $72 million (resulting from higher technical insurance results and improved investment income) in the major operating units and an allocation of interest of $15 million in accordance with EITF 87-24. The impairment charge of $154 million recorded in 2003 related to the anticipated disposal of the Reinsurance business and principally consisted of impairment charges to assets of $48 million, to goodwill and other intangible assets of $89 million and to deferred tax assets of approximately $16 million, and selling costs of $25 million, offset in part by an accumulated foreign currency translation gain of $24 million. The 2002 net income of $22 million reflects the normal operating results of the Reinsurance business.
Wind Energy
Our Wind Energy business primarily focused on the development and operation of wind parks located mainly in Europe. While this business purchased equity interests in a number of established wind park companies, its main focus remained general wind park construction contracting.
84
In December 2003, we sold most of our Wind Energy business to GI Ventures AG of Munich, including the majority of our investment in Windpark Dahme. As part of this sale, GI Ventures also took over most of the projects under development in our German Wind Energy business and all the employees. The wind energy business has, since that time, been non-operative. We also sold one of our equity participations in Greece as part of a management buy-out in February 2004 and we intend to sell the remaining Greek equity participation during 2005. Once this sale is complete there will be no other projects or participations in respect of our Wind Energy business remaining.
Revenues were $0 million, $16 million and $48 million in 2004, 2003 and 2002, respectively.
We recorded net losses of $25 million, $42 million and $1 million in 2004, 2003 and 2002, respectively. The 2004 net loss of $25 million was principally caused by asset impairment charges relating to the remaining windpark in Rhodes. The 2003 net loss of $42 million was comprised principally of a $25 million loss from disposal (net of a tax benefit of $10 million), impairment charges to assets of $9 million and loss from operations of $8 million.
Foundry
Our Foundry business provides furnace systems, pouring systems, forging systems and related services in Germany, Sweden, the United States, Brazil and Thailand. We expect to sell this business in 2005.
Revenues were $41 million, $45 million and $49 million in 2004, 2003 and 2002, respectively. We recorded net losses of $17 million, $0 million and $0 million in 2004, 2003 and 2002, respectively. The 2004 net loss includes an anticipated capital loss on divestment and the operational results, which included restructuring costs.
MDCV Cable business
In January 2004, we sold our MDCV (Mitsubishi-Dainichi Continuous Vulcanization) cable business. This business was located in Germany and manufactured medium and high-voltage cables, cable-systems and accessories for power suppliers and network operators.
Revenues were $0 million, $74 million and $78 million in 2004, 2003 and 2002, respectively. MDCV Cable business revenues were $0 million in 2004 due to the sale of the business. The decrease in 2003 was mainly due to the loss of important projects. We recorded net losses of $0 million, $24 million and $1 million in 2004, 2003 and 2002, respectively. The net loss was $0 million in 2004 due to the sale of the business. The 2003 net loss of $24 million was comprised principally of impairment charges to assets of $10 million and a loss from operations of $14 million.
ABB Export Bank
In December 2003, we completed the sale of ABB Export Bank, which was part of our Structured Finance business area and arranged export, trade and project financing. Revenues were $0 million, $9 million and $17 million in 2004, 2003 and 2002, respectively. Revenues declined in 2003 due to lower business volumes, the sale of assets following our decision to divest the business and lower interest rates.
We recorded a net loss of $0 million and $9 million in 2004 and 2003, respectively, and a net income of $10 million in 2002. The 2003 net loss of $9 million includes a $12 million loss on disposal, income from operations of $6 million and the allocation of interest expense of $3 million in accordance with EITF 87-24. The loss on disposal of $12 million for the sold business was principally comprised of an asset write-down of $20 million, transaction costs of $1 million, capital tax expense associated with the disposal of $4 million and an accumulated foreign currency translation gain of approximately $13 million. The 2002 net income of $10 million consisted of normal operational income and the release of approximately $8 million of excess bad debt provisions.
85
Metering
In December 2002, we sold our Metering business. This business produced electricity, water, energy and gas meters, metering systems and load control systems.
We recorded net income of $12 million in 2004 and net losses of $3 million and $54 million in 2003 and 2002, respectively. The 2004 net income of $12 million resulted from the release of provisions originally made at the date of sale for certain price and net equity adjustments. The 2003 net loss of $3 million relates to transaction costs and price adjustments relating to the divestment in 2002. The 2002 net loss of $54 million included a $48 million loss on disposal, loss from operations of $3 million and the allocation of interest expense of $3 million in accordance with EITF 87-24. The loss on disposal of $48 million principally consisted of impairment charges in respect of goodwill and other intangibles of $65 million, transaction costs and other provisions of $46 million, tax expense associated with the disposal of $21 million and an accumulated currency translation loss of $35 million, offset in part by a gain of $119 million recognized in disposal of the business.
Structured Finance
Our Structured Finance business provided debt capital for projects and equipment, and asset-based financing such as leasing. In November 2002, we completed the sale of most of our Structured Finance business to General Electric Capital Corporation (GE) and received cash proceeds of approximately $2.0 billion. The divestment included a put right in favor of GE regarding certain designated assets which was exercised in January 2004 for $28 million as well as some letters of credit for certain performance related obligations retained by us, of which approximately $63 million were outstanding at December 31, 2004.
We recorded net income of $14 million in 2004 and net losses of $29 million and $183 million in 2003 and 2002, respectively. The 2004 net income of $14 million relates to the settlement of some outstanding matters with GE and resulted from the release of excess provisions. The 2003 net loss of $29 million primarily relates to a provision taken with respect to these outstanding matters that were finalized in 2004. The 2002 net loss of $183 million included a $146 million loss on disposal, loss from operations of $22 million and the allocation of interest expense of $15 million in accordance with EITF 87-24. The loss on disposal of $146 million for the sold business was principally comprised of an asset write-down of $15 million, goodwill and other intangible write-offs of $2 million, transaction costs of $27 million, the fair value for GE's right to require us to repurchase certain designated assets for $38 million, capital tax expense associated with the disposal of $10 million and an accumulated foreign currency translation loss of $54 million.
LIQUIDITY AND CAPITAL RESOURCES
Principal sources of funding
In 2004, 2003 and 2002, we met our liquidity needs using cash from operations, bank borrowings, the proceeds from the issuance of debt securities, divestment proceeds, as well as the sales of receivables under our securitization programs. The reductions in our credit rating during 2002 (see "Credit ratings") restricted our access to the capital markets during 2002 and the first half of 2003. As a result, we relied increasingly on proceeds from divestments, bank borrowings, cash from operations and, cash raised from our capital strengthening program in 2003. Also, in the first quarter of 2003, we raised approximately $156 million from the sale of 80 million treasury shares in two transactions.
During the second half of 2003, we completed a number of steps to strengthen our Consolidated Balance Sheet and to improve our liquidity. In September 2003, we issued convertible unsubordinated bonds of an aggregate principal amount of CHF 1,000 million, due 2010. See "Bonds and notes." In October 2003, we announced a three-component capital strengthening program, consisting of a rights issue providing net proceeds of approximately $2.5 billion, a new $1 billion unsecured revolving credit facility to replace our $1.5 billion credit facility and a bond offering of 650 million euro (equivalent to
86
approximately $769 million at the date of issuance). This program has provided a stronger financial base for the growth of our core operations, has deleveraged our balance sheet by reducing our gearing (defined as total debt divided by the sum of total debt and the stockholders' equity including minority interest) from 87 percent at December 31, 2002 to 71 percent at December 31, 2003 (see "Financial position") and has given us more financial flexibility.
During 2004, our financial position was further strengthened by the positive cash flow from operating activities of $962 million and the proceeds from sales of businesses (net of cash disposed) of $1,182 million. The cash generated allowed us to repay maturing debt, repurchase debt (see "Bond repurchases") and further reduce gearing to 64 percent at December 31, 2004 (see "Financial position").
We believe that our ability to obtain funding from the sources described above will continue to provide the cash flows necessary to satisfy our working capital and capital expenditure requirements, as well as meet our debt repayments and other financial commitments for the next twelve months. Due to the nature of our operations, our cash flow from operations generally tends to be weaker in the first half of the year than in the second half of the year.
Rights issue
On November 20, 2003, our shareholders approved the issuance of 840,006,602 new shares pursuant to a fully underwritten rights issue. For each share that they owned, holders of existing shares were allocated one right to purchase the offered shares. For every 10 rights, holders of existing shares were entitled to purchase seven offered shares. The banks agreed to underwrite 840,006,602 shares at an issue price of CHF 4.00 per share, representing an approximate 50 percent discount on the share price at the time and providing for net proceeds of $2,487 million. The rights issue was completed on December 12, 2003 when the cash was received together with the net proceeds of the bonds of 650 million euro aggregate principal amount (see "Bonds and Notes"). Of these funds, approximately $1.2 billion was used to repay debt maturing in December 2003 and repurchase bonds with a face value of $94 million, while the remainder was placed on deposit with banks to be used to repay debt maturing in 2004.
Interest rates
We have obtained financing in a range of currencies and maturities and on various interest rate terms. We use derivatives to reduce the interest rate and/or foreign exchange exposures arising on our debt. For example, to reduce our exposure to interest rates, we use interest rate swaps to effectively convert fixed rate borrowings into floating rate liabilities and we use cross currency swaps to effectively convert foreign currency denominated bonds into U.S. dollar liabilities. At December 31, 2004, after considering the effects of interest rate swaps, the effective average interest rate on our floating rate long-term borrowings (including current maturities) of $1,950 million and our fixed rate long-term borrowings (including current maturities) of $1,625 million was 5.8 percent and 5.5 percent, respectively. This compares with an effective rate of 3.2 percent for floating rate long-term borrowings and 5.8 percent for fixed-rate long-term borrowings as of December 31, 2003. A discussion of our use of derivatives to modify the characteristics of our long-term borrowings is contained in Note 15 to our Consolidated Financial Statements.
Bond repurchases
During the first six months of 2004, through open market repurchases, we repurchased a portion of our public bonds with a total equivalent face value of $458 million. These repurchases included 107 million euro (approximately $131 million) of the 475 million euro 5.125 percent bonds due 2006, and 26,500 million Japanese yen (approximately $243 million) of 50,000 million Japanese yen 0.5 percent bonds due 2005. The 26,500 million Japanese yen bonds and the 107 million euro bonds were subsequently cancelled at the end of July and mid-September 2004, respectively. During the second half of 2004, a further 6,075 million Japanese yen 0.5 percent bonds (approximately $55 million)
87
were repurchased on the open market and were not cancelled. The open market repurchases resulted in a gain on extinguishments of debt of approximately $6 million. During 2003, we repurchased outstanding bonds with a face value of $94 million and recorded an insignificant gain on extinguishments of debt in connection with the repurchases.
On July 29, 2004, we announced tender offers to repurchase all of the outstanding 300 million euro 5.375 percent bonds due 2005 and 475 million euro 5.125 percent bonds due 2006, being approximately 275 million euro and approximately 368 million euro, respectively. In conjunction with the tender offers, we convened bondholders' meetings to vote on amendments to these bonds to allow us to call and redeem those bonds that were not tendered under the respective tender offer. Bonds validly tendered and accepted under the tender offers were settled on September 14, 2004. On September 9, 2004, bondholders approved the resolutions, which gave us the option to redeem the outstanding instruments. We exercised our option to redeem early the remaining outstanding 2005 and 2006 bonds that were not tendered and set the redemption date as September 29, 2004. The open market repurchases, combined with the tender offers and calls, resulted in a decrease in total borrowings during 2004 of $1,330 million.
Bonds and notes
In 2004, we did not issue any bonds.
In 2003, we completed two note issuances, including the issuance of bonds convertible into our shares, as sources of funding.
In September 2003, we issued convertible unsubordinated bonds of an aggregate principal amount of CHF 1,000 million (approximately $722 million at the date of issuance), due 2010. This transaction lengthened the maturity profile of our debt, thereby reducing our dependence on short-term funding. We used the proceeds, net of expenses and fees, to reduce our drawing under our $1.5 billion credit facility (see "Credit Facilities"). The convertible bonds pay interest annually in arrears at a fixed annual rate of 3.5 percent. On issuance, each CHF 5,000 principal amount of bonds was convertible into 418.41004 fully paid ABB ordinary shares at an initial conversion price of CHF 11.95. The conversion price is subject to adjustment provisions to protect against dilution or change in control. As a result of the rights issue discussed above, the conversion price and conversion ratio of the bonds were adjusted to CHF 9.53 and 524.65897 shares, respectively, effective December 12, 2003, representing 104,931,794 fully paid ordinary ABB shares if the bonds are fully converted.
The bonds are convertible at the option of the bondholder at any time from October 21, 2003 up to and including the tenth business day prior to September 10, 2010. We may at any time on or after September 10, 2007 redeem the outstanding bonds at par plus accrued interest if, for a certain number of days during a specified period of time, the official closing price of our ordinary shares on the relevant exchange has been at least 150 percent of the conversion price. In addition, at any time prior to maturity, we can redeem the outstanding bonds at par plus accrued interest, if at least 85 percent in aggregate of the principal amount of bonds originally issued have been redeemed, converted or purchased and cancelled. We have the option to redeem the bonds when due in cash, ordinary shares or any combination thereof.
In November 2003, as part of our three-component capital strengthening program, we issued bonds of an aggregate principal amount of 650 million euro (approximately $769 million at the time of issuance), due 2011. These bonds pay interest semi-annually in arrears at a fixed annual rate of 6.5 percent. In the event of a change of control of ABB Ltd, the terms of the bonds require us to offer to repurchase the bonds at 101 percent of the principal amount thereof, plus any accrued interest.
In May 2002, we issued $968 million aggregate principal amount of convertible unsubordinated bonds due 2007. The bonds pay interest semi-annually in arrears at a fixed annual rate of 4.625 percent. On issuance each $1,000 principal amount of bonds was convertible into 87.7489 fully paid ABB ordinary shares at an initial conversion price of CHF 18.48 (converted into U.S. dollars at a fixed conversion rate of CHF 1.6216 per U.S. dollar). The conversion price is subject to adjustment
88
provisions to protect against dilution or change in control. As a result of the rights issue and resulting increase in our share capital discussed above, the conversion price of the bonds was adjusted, effective November 21, 2003, to CHF 14.64 (converted into U.S. dollars at the fixed exchange rate of CHF 1.6216 per U.S. dollar), representing a total of 107,220,546 shares if the bonds were fully converted. As a result of the amendment to the bonds in May 2004, described below, the conversion price of the bonds was amended to $9.03, representing 107,198,228 shares if the bonds are fully converted.
The $968 million bonds are convertible at the option of the bondholder at any time from June 26, 2002 up to and including May 2, 2007. We may, at any time on or after May 16, 2005, redeem the outstanding bonds at par plus accrued interest if (1) for a certain number of days during a specified period of time, the official closing price of our American Depositary Shares on the New York Stock Exchange exceeds 170 percent of the conversion price or (2) at least 85 percent in aggregate principal amount of bonds originally issued have been exchanged, redeemed or purchased and cancelled. We have the option to redeem the bonds when due, in cash, American Depositary Shares or any combination thereof.
Under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, a component of the convertible bonds due 2007 had to be accounted for as an embedded derivative as the shares to be issued upon conversion were denominated in Swiss francs, while the bonds are denominated in U.S. dollars. A portion of the issuance proceeds was deemed to relate to the value of the derivative on issuance and subsequent changes in value of the derivative were recorded through earnings and as an adjustment to the carrying value of the bonds. The allocation of a portion of the proceeds to the derivative created a discount on issuance that was being amortized to earnings over the life of the bonds. On May 28, 2004, bondholders voted in favor of our proposed amendment to the terms of the bonds whereby, if the bonds are converted, we will deliver U.S. dollar-denominated American Depositary Shares rather than Swiss franc-denominated ordinary shares. The conversion price was set at $9.03. As a result of the amendment, we are no longer required to account for a portion of the bonds as a derivative. Consequently, on May 28, 2004, the value of the derivative was fixed and the amount previously accounted for separately as an embedded derivative was considered to be a component of the carrying value of the bonds. This carrying value is being accreted to the $968 million par value of the bonds as an expense in interest and other finance expense over the remaining life of the bonds. The amortization of the discount on the bonds will be between $7 million and $9 million per quarter until the bonds mature in May 2007.
Also in May 2002, we issued 200 million pounds sterling (approximately $292 million at the time of issuance) aggregate principal amount of bonds due 2009 (sterling-denominated bonds), which were issued under our medium term note program and pay interest semi-annually in arrears at 10 percent per annum. We also issued in May 2002, 500 million euro (approximately $466 million at the time of issuance) aggregate principal amount of bonds due 2008 (euro-denominated bonds), which were also issued under our medium term note program and pay interest annually in arrears at 9.5 percent per annum.
The sterling-denominated bonds and the euro-denominated bonds contain certain clauses linking the interest paid on the bonds to the credit rating assigned to the bonds. If the rating assigned to these bonds by both Moody's and Standard & Poor's remains at or above Baa3 and BBB-, respectively, then the interest rate on the bonds remains at the level at issuance, that is 10 percent and 9.5 percent, for the sterling-denominated and euro-denominated bonds, respectively. If the rating assigned by either Moody's or Standard & Poor's decreases below Baa3 or BBB-, respectively, then the annual interest rate on the bonds increases by 1.5 percent per annum to 11.5 percent and 11 percent, for the sterling-denominated and euro-denominated bonds, respectively. If after such a rating decrease, the rating assigned by both Moody's and Standard & Poor's returns to a level at or above Baa3 and BBB-, respectively, then the interest rates on the bonds return to their original levels. As a result of the downgrade of our long-term credit rating by Moody's to Ba2 on October 31, 2002, this step-up clause
89
in interest was triggered on both bonds. The increase in interest costs is effective for interest periods beginning after the payment of the coupon accruing at the date of the downgrade. This increase in interest rates had no significant impact on 2002 interest expense. The total impact on 2004 and 2003 was an increase in interest expense of approximately $15 million and $13 million, respectively. Future years will also be affected if our credit ratings do not return to at least both Baa3 and BBB- from Moody's and Standard & Poor's, respectively.
A cross-currency swap has been used to modify the characteristics of the sterling-denominated bonds and an interest rate swap has been used to modify the euro-denominated bonds. After considering the impact of the cross-currency and interest rate swaps, the sterling-denominated bonds effectively became a floating rate U.S. dollar obligation, while the euro-denominated bonds became a floating rate euro obligation. In both cases, the floating rate resets every three months. See Note 15 to our Consolidated Financial Statements.
Almost all of our publicly traded bonds contain cross-default clauses which would allow the bondholders to demand repayment if we were to default on certain borrowings at or above a specified threshold amount.
Credit facilities
On November 17, 2003, as part of our three-component capital strengthening program, we entered into a unsecured syndicated $1 billion three-year revolving credit facility which became available in December 2003 after the fulfillment of certain conditions including the repayment and cancellation of the previous $1.5 billion facility and the raising of specified minimum levels of gross proceeds from the rights issue (see "Rights Issue") and from the bonds denominated in euros which were issued in November 2003 (see "Bonds and Notes"). The $1 billion facility is for general corporate purposes. At December 31, 2004 and 2003, nothing was outstanding under the facility and although we currently do not intend to draw on it, it provides us with additional financial flexibility.
In November 2004, the facility was amended. The amendments included a reduction in the level of commitment fees and the removal of restrictions on us to redeem early capital market instruments, such as bonds, having a maturity date beyond that of the facility.
The facility contains certain financial covenants in respect of minimum interest coverage, maximum net leverage and a minimum level of consolidated net worth. We are required to meet these covenants on a quarterly basis. Should our unsecured long-term debt ratings reach certain defined levels (basically investment grade), these covenants will only have to be calculated as of June and December of each year. The facility also contains provisions for the mandatory prepayment and cancellation of the facility upon a change of control of ABB Ltd.
The facility imposes restrictions on the amount of third party indebtedness in subsidiaries other than in the obligors under the facility, subject to certain exceptions. The facility also contains certain other undertakings including certain limitations on disposals of assets, certain restrictions on mergers and acquisitions and negative pledges.
The facility contains cross-default clauses whereby an event of default would occur if we were to default on indebtedness, as defined in the facility, at or above a specified threshold.
The facility replaced a $1.5 billion 364-day revolving facility entered into in December 2002 and secured by a package of assets with a net carrying value of $3.5 billion at December 31, 2002 and by certain intra-group loans.
90
The $1.5 billion facility contained certain stringent financial covenants in respect of minimum interest coverage, total gross debt, a maximum level of debt in subsidiaries other than those specified as borrowers under that facility, a minimum level of consolidated net worth, as well as specific negative pledges. We were required to meet these financial covenants at each quarter-end commencing December 31, 2002. In addition, in order to ensure the continued availability of the $1.5 billion facility until its cancellation in December 2003, we were required to obtain minimum levels of proceeds from the disposal of specified assets and businesses and/or equity issuances during 2003.
Securitization programs
In addition to the aforementioned primary sources of liquidity and capital resources, we also sell certain trade receivables to Qualifying Special Purpose Entities ("QSPEs"), unrelated to us, primarily through two revolving-period securitization programs. Solely for the purpose of credit enhancement from the perspective of the QSPEs, we retain an interest in the sold receivables. Retained interests at December 31, 2004 and 2003 amounted to $373 million and $390 million, respectively. The fair value of the retained interests at December 31, 2004 and 2003 was approximately $349 million and $367 million, respectively.
The net cash received from (paid to) QSPEs during 2004, 2003 and 2002 was $130 million, $(119) million and $(384) million, respectively, as follows:
|
At December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
Gross trade receivables sold to QSPEs ($25, $505 and $832)(1) | $ | 5,846 | $ | 5,661 | $ | 5,972 | ||||
Collections made on behalf of and paid to QSPEs ($(23), $(696) and $(753))(1) | (5,713 | ) | (5,883 | ) | (6,074 | ) | ||||
Purchaser, liquidity and program fees ($0, $(2) and $(5))(1) | (20 | ) | (21 | ) | (37 | ) | ||||
Decrease (increase) in retained interests ($0, $117 and $(87))(1) | 17 | 124 | (245 | ) | ||||||
Net cash received from (paid to) QSPEs during the year ($2, $(76) and $(13))(1) | $ | 130 | $ | (119 | ) | $ | (384 | ) |
At December 31, 2004 and 2003, of the gross trade receivables sold, the total trade receivables for which cash has not been collected at those dates amounted to $1,083 million and $898 million, respectively. Of these amounts, $54 million and $34 million at December 31, 2004 and 2003, respectively, was more than 90 days past due.
In addition, we transfer receivables outside of the above described securitization programs. These transfers were sales, made without recourse, directly to banks or pursuant to factoring or similar type arrangements. Total sold receivables included in these transactions during 2004 and 2003 were approximately $902 million and $1,400 million, respectively, of which, sales of $159 million and $594 million, respectively, related to assets held for sale and in discontinued operations. During 2004 and 2003, the related costs, including the associated gains and losses, were $10 million and $12 million, respectively, of which, costs of $1 million and $3 million, respectively, related to assets held for sale and in discontinued operations.
For further discussion of our securitization programs, see the section entitled "Off-balance sheet arrangements" below and Notes 2 and 7 to our Consolidated Financial Statements.
91
Credit ratings
Debt ratings are an assessment by the rating agencies of the credit risk associated with our company and are based on information provided by us or other sources that the rating agencies consider reliable. Lower ratings generally result in higher borrowing costs and reduced access to capital markets.
At December 31, 2002, after a series of rating downgrades during 2002, our long-term company ratings were Ba3 and BBB- (our long-term unsecured debt was rated B1 and BB+) from Moody's and Standard & Poor's, respectively. On January 13, 2003, Standard & Poor's further lowered our long-term company rating to BB+ and our long-term unsecured debt to BB-. In late October 2003, both rating agencies changed the outlook on these ratings to positive from negative. On May 18, 2004, Moody's increased our long-term company rating from Ba3 to Ba2 and our long-term unsecured debt from B1 to Ba2, both with stable outlook. On December 6, 2004, Standard & Poor's changed the outlook on these ratings from positive to stable. Our ratings are currently below "investment grade" that would be represented by Baa3 (or above) and BBB- (or above) from Moody's and Standard & Poor's, respectively. A rating below investment grade is reflected in higher interest costs on borrowings. Until our credit rating has returned to investment grade, we do not anticipate having the ability to access the commercial paper markets.
Restrictions on transfers of funds
We face restrictions on the transfer of funds in various countries due to local regulations and foreign exchange restrictions. Funds, other than regular dividends, fees or loan repayments, cannot be transferred offshore from these countries and are therefore deposited locally. As a consequence, these funds are not available within our Group Treasury Operations to meet short-term cash obligations. These funds are reported as cash on our Consolidated Balance Sheet, but we do not consider these funds as available for the repayment of debt outside the respective countries where the cash is situated, including those described below.
Currency and other local regulatory restrictions exist in a number of countries where we operate, including: Brazil, China, Egypt, India, Korea, Malaysia, Russia, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey and Venezuela.
Furthermore, restricted cash amounting to $452 million and $433 million at December 31, 2004 and 2003, respectively, is not included in cash and equivalents but is reflected in long-term assets on our Consolidated Balance Sheet.
Balance sheet
During 2004 and 2003, the divestments and discontinuations of certain businesses were recorded as discontinued operations pursuant to SFAS 144, as discussed in detail under "Application of Critical Accounting PoliciesAccounting for discontinued operations" above. Accordingly, the balance sheet data for all periods presented have been restated to present the financial position and results of operations of the businesses meeting the criteria of SFAS 144 as assets and liabilities held for sale and in discontinued operations.
92
Current assets
|
At December 31, |
|||||
---|---|---|---|---|---|---|
|
2004 |
2003 |
||||
|
(U.S. dollars in millions) |
|||||
Cash and equivalents | $ | 3,676 | $ | 4,783 | ||
Marketable securities and short-term investments | 524 | 473 | ||||
Receivables, net | 6,330 | 6,049 | ||||
Inventories, net | 2,977 | 2,671 | ||||
Prepaid expenses and other | 1,688 | 1,794 | ||||
Assets held for sale and in discontinued operations | 155 | 4,981 | ||||
Total current assets | $ | 15,350 | $ | 20,751 |
Our total current assets, at December 31, 2004, decreased by 26 percent, compared to December 31, 2003. See "Cash Flows" for a detailed discussion on changes in cash and equivalents.
Our Group Treasury Operations invest the surplus cash available from time to time in time deposits and marketable securities, with varied maturities based on defined investment guidelines and the liquidity requirements of the business. Investments which are less than three months in duration are classified as part of cash equivalents, and those of more than three months in duration are classified as part of marketable securities and short term investments. Receivables, net, as at the end of 2004 increased from the end of 2003, primarily as a result of a decline in the value of the U.S. dollar, which we use for reporting purposes, against local currencies. A reduction in receivables, particularly from Non-core activities is primarily due to collections from the contracts completed over the same period, was more than offset by increases in receivables in the core divisions resulting from higher volume of revenues. Inventories, net, increased by 5 percent in local currencies reflecting a higher order backlog at the end of 2004 compared to the end of 2003.
Current liabilities
|
At December 31, |
|||||
---|---|---|---|---|---|---|
|
2004 |
2003 |
||||
|
(U.S. dollars in millions) |
|||||
Accounts payable, trade | $ | 4,272 | $ | 4,034 | ||
Accounts payable, other | 1,437 | 1,395 | ||||
Short-term borrowings and current maturities of long-term borrowings | 633 | 1,644 | ||||
Accrued liabilities and other | 6,436 | 5,957 | ||||
Liabilities held for sale and in discontinued operations | 290 | 3,990 | ||||
Total current liabilities | $ | 13,068 | $ | 17,020 |
Total current liabilities as at the end of December 2004 decreased by 23 percent compared to December 31, 2003. Operating liabilities, excluding liabilities held for sale and in discontinued operations, include accounts payable, short-term borrowings including current maturities of long-term borrowings and accrued liabilities and other.
Total accounts payable increased at December 31, 2004 compared to December 31, 2003, as increases in this account from the core divisions were partially offset by reductions, primarily from the Oil, Gas and Petrochemicals business.
Our short-term debt was lower at the end of 2004 than at the end of 2003, reflecting our debt repayments during the year (see "Liquidity and capital resources").
93
Accrued liabilities and other increased primarily as a result of higher volume of advances received from customers and additional provisions in respect of asbestos-related liabilities, recorded at December 31, 2004 (see "Asbestos liability").
Non-current assets
|
At December 31, |
|||||
---|---|---|---|---|---|---|
|
2004 |
2003 |
||||
|
(U.S. dollars in millions) |
|||||
Financing receivables, non-current | $ | 1,233 | $ | 1,372 | ||
Property, plant and equipment, net | 2,981 | 2,858 | ||||
Goodwill | 2,602 | 2,528 | ||||
Other intangible assets, net | 493 | 601 | ||||
Prepaid pension and other related benefits | 549 | 564 | ||||
Investments and other | 1,469 | 1,727 | ||||
Total Non-current assets | $ | 9,327 | $ | 9,650 |
Financing receivables at December 31, 2004, which include receivables from leases and loans receivable, decreased compared to December 31, 2003, as we continue to terminate our lease portfolios and loan receivables within our Structured Finance business area.
The increase in the value of property, plant and equipment, net, at December 31, 2004, mainly reflects the decline in the value of the U.S. dollar, which we use for reporting purposes, against local currencies. Expressed in local currency terms, property, plant and equipment decreased by 3 percent primarily as a result of the sale of real estate properties, mainly in Switzerland, and normal levels of depreciation. Capital expenditure during 2004 increased, with major investments in the core divisions in machinery and equipments in Germany, Italy, Finland and Sweden partially offset by reduced investments in Non-core activities, particularly in the Equity Ventures business area.
The reduction in other intangible assets, net mainly reflects amortization on capitalized software and other intangible assets.
During 2004, goodwill increased principally due to a decline in the value of the U.S. dollar, which we use for reporting purposes, partly offset by a write-off of $21 million goodwill related to the sale of businesses.
Investments and other decreased, mainly due to write-down of certain deferred tax assets created in the previous years as we did not believe the tax assets were more likely than not to be realized and to a lesser extent due to the sale of our ownership interests in investments during 2004.
Non-current liabilities
|
At December 31, |
|||||
---|---|---|---|---|---|---|
|
2004 |
2003 |
||||
|
(U.S. dollars in millions) |
|||||
Long-term borrowings | $ | 4,901 | $ | 6,290 | ||
Pension and other related benefits | 1,551 | 1,790 | ||||
Deferred taxes | 953 | 1,022 | ||||
Other liabilities | 1,083 | 1,077 | ||||
Total Non-current liabilities | $ | 8,488 | $ | 10,179 |
During 2004, long-term borrowings were significantly reduced through the repayment of maturing bonds, open market repurchases of public bonds, the tender offer for certain of our bonds and the call
94
of those bonds not tendered. Our gearing ratio (defined as total borrowings divided by the sum of total borrowings and the stockholders equity including minority interest), excluding the borrowings in the discontinued operations, was 64 percent at December 31, 2004, compared to 71 percent at December 31, 2003, reflecting the reduction of our total debt. The reduction in the value of pension and other employee benefits at December 31, 2004, was mainly due to our contribution of $549 million of available-for-sale debt securities to certain of our pension plans in Germany, offset in part by an increase in liabilities related to the decline in value of the U.S. dollar, our use of a lower discount rate compared to 2003 and lower performance of existing plan assets, along with the normal increase in the pension liabilities during the year.
Other liabilities include non-current provisions of $439 million and $441 million, deferred income of $143 million and $158 million, and non-current derivative liabilities of $53 million and $40 million at December 31, 2004 and 2003, respectively. Included in non-current provisions are amounts accrued for the estimated environmental remediation costs related to our former Nuclear Technology business (see Note 18 to our Consolidated Financial Statements) of $266 million and $276 million at December 31, 2004 and 2003, respectively.
We entered into certain leasing transactions with U.S. investors prior to 1999. Prepaid rents that have been received on these transactions are $314 million and $312 million at December 31, 2004 and 2003, respectively, and have been recorded as deposit liabilities. Net gains on these transactions are being recognized over the lease terms.
Cash flows
In the Consolidated Statements of Cash Flows, the effects of the discontinued operations are not segregated, as permitted by Statement of Financial Accounting Standards No. 95 (SFAS 95), Statement of Cash Flows. The Consolidated Statements of Cash Flows can be summarized into main activities as follows:
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Cash flows provided by (used in) operating activities | $ | 962 | $ | (173 | ) | $ | 0 | |||
Cash flows provided by investing activities | 354 | 754 | 2,651 | |||||||
Cash flows provided by (used in) financing activities | (2,805 | ) | 1,603 | (2,793 | ) | |||||
Effects of exchange rate changes | 74 | 150 | 141 | |||||||
Adjustment for the net change in cash and equivalents in assets held for sale and in discontinued operations | 308 | (80 | ) | 60 | ||||||
Net change in cash and equivalents continuing operations | $ | (1,107 | ) | $ | 2,254 | $ | 59 |
Cash flows provided by (used in) operating activities
Operating assets and liabilities include marketable securities held for trading purposes, trade receivables, inventories, payables and other assets and liabilities. Debt and equity securities that are purchased and held principally for the purpose of sale in the near term are classified as trading securities. Cash flows from marketable securities classified as available-for-sale are reflected in investing
95
activities. Cash flows from discontinued operations are included in the table below in the respective divisions in which these businesses were formerly classified.
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Net loss, net of adjustments for non-cash items | $ | 942 | $ | (431 | ) | $ | (419 | ) | ||
Changes in operating assets and liabilities | 20 | $ | 258 | $ | 419 | |||||
Sub-total: Cash flows provided by (used in) operating activities | $ | 962 | $ | (173 | ) | $ | 0 | |||
Consisting of: | ||||||||||
Power Technologies | $ | 499 | $ | 639 | $ | 337 | ||||
Automation Technologies | 1,090 | 814 | 503 | |||||||
Non-core activities* | (69 | ) | (754 | ) | (27 | ) | ||||
Corporate and Other | $ | (558 | ) | $ | (872 | ) | $ | (813 | ) |
In 2004, as compared to 2003, cash from operations from the Power Technologies division decreased, primarily influenced by lower advances from customers and increased volume of project receivables. Over the same period, cash from operations provided by the Automation Technologies division increased, mainly through higher earnings, higher advances from customers and the increase of trade payables. Cash used in Non-core activities was lower compared to 2003 primarily from the improvements in our Oil, Gas and Petrochemicals business due to a stronger focus on cash management and improved collection of receivables from customers as a result of completion of several large projects. These factors more than offset the cash outflows from the Upstream Oil, Gas and Petrochemicals business due to the cancellation of securitization programs and other activities involved in the preparation for the sale of this business. Other cash inflows in Non-core activities mainly represented the dividend received from Jorf Lasfar by our Equity Ventures business area in 2004. Cash used in corporate was lower in 2004 compared to 2003, influenced primarily by lower cash payments to the Combustion Engineering settlement trust. The cash payments in 2004 relating to the settlement of asbestos-related issues were $45 million. Cash inflows from operating activities improved by $1,135 million over 2003.
During 2003, higher earnings and working capital improvements contributed to increased cash in 2003 as compared to 2002 from the operating activities of the Power Technologies and Automation Technologies divisions. These cash flows were more than offset by cash used in corporate, which included cash payments of $388 million towards the settlement of asbestos-related issues as well as cash used in corporate overheads and interest payments. In addition, losses from Building Systems and New Ventures business areas mainly contributed to cash outflows in Non-core activities during 2003. The net cash used in operating activities during 2003 was $173 million, compared to a break even level of cash during the year 2002.
During 2002, net cash provided by operating activities of the Power Technologies and Automation Technologies divisions primarily resulted from improved earnings and a reduction of net working capital. Net cash provided by Non-core activities, excluding the Oil, Gas and Petrochemicals businesses, mainly consisted of net cash proceeds from the sale of marketable securities (trading) of $498 million. The Oil, Gas and Petrochemicals businesses had an operating cash outflow due to project losses and higher working capital levels. Corporate cash outflows were influenced by increased costs in respect of the credit facility and other financing arrangements, and included cash payments related to asbestos-related claims of $246 million. These resulted in a break-even level of cash from operations for 2002.
96
Cash flows provided by (used in) investing activities
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Acquisitions, investments, divestitures, net | $ | 1,158 | $ | 488 | $ | 2,365 | ||||
Asset purchases, net of disposals | (420 | ) | (392 | ) | (126 | ) | ||||
Other investing activities | (384 | ) | 658 | 412 | ||||||
Sub-total: Cash flows provided by investing activities | $ | 354 | $ | 754 | $ | 2,651 |
Investing activities include: accounts receivable from leases and third party loans (financing receivables); net investments in marketable securities that are not held for trading purposes; purchases of property, plant and equipment, net of disposals; and acquisitions of, investments in and divestitures of businesses. Net cash provided by investing activities was $354 million during 2004, a decrease of $400 million from $754 million during 2003.
We continued our program of divesting non-core businesses and other assets during 2004. For 2004, cash inflows from acquisitions, investments and divestitures, net, were higher by $670 million compared to 2003. Significant divestitures during 2004 were the sale of our Upstream Oil, Gas and Petrochemicals business ($800 million), the sale of our Re-insurance business (approximately $280 million) and the sale of our participations in IXYS Corporation ($42 million).
During 2003, we received cash proceeds of approximately $149 million from the sale of our 35 percent stake in Swedish Export Credit Corporation and approximately $90 million from the sale of our investments in two projects in Equity Ventures business area in Australia. Cash proceeds of approximately $213 million were received through the sale of our Building Systems businesses in Sweden, Norway, Denmark, Finland and Russia. In addition, the sale of the ABB Export Bank for approximately $50 million, and the sale of part of our Wind Energy business, part of the New Ventures business in Non-core activities, were completed during the fourth quarter of 2003. As a result of these significant divestitures and net cash outflows of $24 million for certain smaller investments and disposals, net cash inflows from purchases of, investments in and divestitures of businesses was $488 million during 2003.
The net cash outflows from the purchase and sale of property, plant and equipment was higher in 2004 as compared to 2003, reflecting fewer properties sold in 2004. Cash outflow for capital investment in property, plant and equipment remained at the same level for 2004 compared to 2003. Major capital expenditures on investment in machinery and equipment during 2004 occurred in Germany, Italy, Finland and Sweden. For 2004, proceeds of $123 million were received on the sale of property, plant and equipment compared to $155 million in 2003. Significant asset sales during 2004 included the sale of real estate properties in Switzerland, Germany and Italy.
Cash used for purchases of property, plant and equipment, net of disposals, was $392 million during 2003, an increase of $266 million compared to $126 million during 2002. While investment in property plant and equipment remained at nearly the same level in both 2003 and 2002, proceeds of approximately $300 million from the sale of our real estate properties in Sweden in 2002, substantially offset the outflows of investment in property, plant and equipment.
During 2004, we made a non-cash contribution of $549 million in available-for-sale debt securities to certain of our pension plans in Germany. Prior to the non-cash contribution, a significant portion of these securities was purchased during 2004, which significantly increased net cash used in other investing activities. Additionally, cash outflows in investing activities for 2004 represents the net investment of cash in marketable securities by Group Treasury Operations and our Group captive
97
insurance companies, partly offset by cash inflows from the termination of lease portfolios and loan receivables from our remaining Structured Finance business.
Cash provided by other investing activities increased to $658 million in 2003 from $412 million in 2002. The cash provided by other investing activities largely resulted from cash proceeds of $390 million from the sale of financing receivables related to our Structured Finance business and net cash proceeds of $268 million from the sale of marketable securities that were not held for trading purposes, primarily relating to the Reinsurance business which we sold in April 2004 and the sale of our shares in the China National Petrochemical Corporation (Sinopec Corp.) for approximately $80 million. The increase in cash provided by other activities in 2002 was primarily due to a reduction in investments in financing receivables.
Cash flows provided by (used in) financing activities
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Change in borrowings, net of repayments | $ | (2,752 | ) | $ | (1,016 | ) | $ | (2,796 | ) | |
Treasury and capital stock transactions | (36 | ) | 2,675 | 0 | ||||||
Other financing activities | (17 | ) | (56 | ) | 3 | |||||
Sub-total: Cash flows provided by financing activities | $ | (2,805 | ) | $ | 1,603 | $ | (2,793 | ) |
Our financing activities primarily include borrowings, both from the issuance of debt securities and directly from banks, treasury and capital stock transactions.
Significant cash outflow from financing activities during the year 2004 included the repayment of maturing bonds, open market repurchases of public bonds, the tender offer for certain of our bonds and the call of those bonds not tendered. See "Liquidity and Capital Resources" for a detailed discussion on the nature of borrowings. The cash outflow for the treasury and capital stock transactions represented payments made in 2004 in respect of certain tax and other liabilities incurred in connection with the rights issue carried out during the fourth quarter of 2003.
During 2003, as part of our strategy to lengthen our debt maturity profile, we replaced maturing short-term borrowings with long-term borrowings. Cash outflows in connection with borrowings reflected the repayment of short-term (including current portion of long-term) borrowings as they fell due, partially offset by cash inflows from the proceeds of the CHF 1,000 million convertible bonds and 650 million euro aggregate principal of bonds issued in September and November 2003, respectively. The net proceeds of the rights issuance of $2.5 billion, completed in December 2003 and the proceeds from the sale of treasury shares during the first quarter of 2003 for $156 million, contributed to the overall net cash inflow of $2,675 million during 2003.
During 2002, net cash outflows from borrowings reflected our strategy to reduce our overall level of borrowings, particularly in respect of borrowings with maturities of 90 days or less. There were no treasury and capital stock transactions or dividends paid in 2002.
98
DISCLOSURES ABOUT CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Contractual obligations
The following table summarizes certain of our contractual obligations and principal payments under our debt instruments and leases at December 31, 2004:
Payments due by period |
Total |
Less than 1 year |
13 years |
35 years |
After 5 years |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(U.S. dollars in millions) |
||||||||||||||
Long-term debt obligations | $ | 5,350 | $ | 449 | $ | 1,040 | $ | 1,854 | $ | 2,007 | |||||
Operating lease obligations | 1,924 | 347 | 536 | 389 | 652 | ||||||||||
Purchase obligations | $ | 3,013 | $ | 2,003 | $ | 651 | $ | 186 | $ | 173 |
OFF-BALANCE SHEET ARRANGEMENTS
Commercial commitments
Certain guarantees issued or modified after December 31, 2002 are accounted for in accordance with Financial Accounting Standards Board Interpretation No. 45 (FIN 45), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. Upon issuance of certain guarantees, a liability, equal to the fair value of the guarantee, is recorded.
FIN 45 requires that we disclose the "maximum potential exposure" of certain guarantees, as well as possible recourse provisions that may allow us to recover from third parties amounts paid out under such guarantees. The "maximum potential exposure" as defined by FIN 45 does not allow any discounting of our assessment of actual exposure under the guarantees. The information below reflects our maximum potential exposure under the guarantees, which is higher than our assessment of the expected exposure.
Guarantees
The following table provides quantitative data regarding our third-party guarantees. The maximum potential payments represent a "worst-case scenario," and do not reflect our expected results.
The carrying amount of liabilities recorded in the Consolidated Balance Sheets reflects our best estimate of future payments we may incur as part of fulfilling our guarantee obligations.
99
|
At December 31, |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
||||||||||
|
Maximum potential payments |
Carrying amount of liabilities |
Maximum potential payments |
Carrying amount of liabilities |
||||||||
|
(U.S. dollars in millions) |
|||||||||||
Third-party performance guarantees | $ | 1,525 | $ | 2 | $ | 1,200 | $ | | ||||
Financial guarantees | 253 | 1 | 207 | | ||||||||
Indemnification guarantees | 198 | 16 | | | ||||||||
Total | $ | 1,976 | $ | 19 | $ | 1,407 | $ | |
Guarantees related to third-party performance
Performance guarantees represent obligations where we guarantee the performance of a third party's product or service according to the terms of a contract. Such guarantees may include guarantees that a project will be completed within a specified time. If the third party does not fulfill the obligation, we will compensate the guaranteed party in cash or in kind.
We retained obligations for guarantees related to the Power Generation business contributed in mid-1999 to the former ABB ALSTOM POWER NV joint venture. The guarantees primarily consist of performance guarantees, advance payment guarantees and other miscellaneous guarantees under certain contracts such as indemnification for personal injuries and property damages, taxes, and compliance with labor laws, environmental laws and patents. The guarantees are related to projects that are expected to be completed by 2015, but in some cases the guarantees have no definite expiration. In May 2000, we sold our interest in the ABB ALSTOM POWER NV joint venture to ALSTOM SA (ALSTOM). As a result, ALSTOM and its subsidiaries have primary responsibility for performing the obligations that are the subject of the guarantees. Further, ALSTOM, the parent company, and ALSTOM POWER NV, formerly ABB ALSTOM POWER NV, have undertaken jointly and severally to fully indemnify and hold us harmless against any claims arising under such guarantees. Our best estimate of the total maximum potential exposure of quantifiable guarantees issued by us on behalf of the Power Generation business is approximately $875 million and $1,200 million at December 31, 2004 and 2003, respectively. We have not experienced any losses related to guarantees issued on behalf of the Power Generation business.
We have retained obligations for guarantees related to the Upstream Oil, Gas and Petrochemicals business sold in July 2004. The guarantees primarily consist of third-party performance guarantees, advance payment guarantees and other miscellaneous guarantees. The guarantees have maturity dates ranging from one to five years. The maximum amount payable under the guarantees is approximately $650 million at December 31, 2004. We have the ability to recover potential payments under these guarantees through certain backstop guarantees. The maximum potential recovery under these backstop guarantees is approximately $146 million at December 31, 2004.
Guarantees relating to financial obligations
Financial guarantees represent irrevocable assurances that we will make payment to a beneficiary in the event that a third party fails to fulfill its financial obligations and the beneficiary under the guarantee incurs a loss due to that failure.
At December 31, 2004 and 2003, we had $253 million and $207 million, respectively, of financial guarantees outstanding. Of those amounts, $123 million and $189 million, respectively, were issued on behalf of companies in which we currently have or formerly had an equity interest. The guarantees have original maturity dates ranging from one to thirteen years. Also included in the $253 million are financial guarantees we retained related to the Upstream Oil, Gas and Petrochemicals business sold in July 2004. The maximum amount payable under these guarantees is approximately $101 million and the
100
guarantees have original maturity dates ranging from one to six years and in some cases have no time-related expiry as they are contingent on future events.
Guarantees relating to indemnification
We delivered to the purchasers of the Upstream Oil, Gas and Petrochemicals business and Reinsurance business guarantees related to assets and liabilities divested in 2004. The maximum liability at December 31, 2004, of approximately $49 million and $149 million, relating to the Upstream Oil, Gas and Petrochemicals business and Reinsurance business, respectively, will reduce over time, pursuant to the agreements. The fair value of these guarantees is not material.
We have indemnified certain purchasers of divested businesses for potential claims arising from the operations of the divested businesses, including for asbestos-related claims arising from the operations of Combustion Engineering and its predecessors and affiliates. Such indemnifications have not been fair valued to the extent they were issued prior to the effective date of FIN 45. Additionally, in cases where we could not calculate the maximum loss related to such indemnifications, no amounts have been included under maximum potential payments in the table above. Indemnifications for which maximum losses could not be calculated include indemnifications for legal claims.
Other commitments
We have granted lines of credit and have committed to provide additional capital for certain equity accounted companies. At December 31, 2004, the total unused lines of credit amounted to $78 million and capital commitments amounted to $24 million.
Securitization programs
In addition to the primary sources of liquidity and capital resources described in the section entitled "Liquidity and Capital Resources", we also sell certain trade receivables to Qualifying Special Purpose Entities ("QSPEs"), unrelated to us, primarily through two revolving-period securitization programs. Under the two securitization programs, neither QSPE commits to purchase our trade receivables, and the QSPEs may at any time refuse to continue purchasing our trade receivables. If both QSPEs simultaneously refuse to purchase additional receivables, then we would experience a temporary loss of cash flow from the sale of trade receivables over a period of several weeks until new trade receivables generated by us began to convert to cash in the normal course of our business.
Solely for the purpose of credit enhancement from the perspective of the QSPEs, we retain an interest in the sold receivables. Pursuant to the requirements of the revolving-period securitizations, we effectively bear the risk of potential delinquency or default associated with trade receivables sold or interests retained. Retained interests included in other receivables at December 31, 2004 and 2003 amounted to $373 million and $390 million, respectively. The decrease in the retained interest during 2004 of $17 million was mainly due to a change in terms of one program, resulting in a reduction in the level of reserves required. In the normal course of servicing the assets sold, we evaluate potential collection losses and delinquencies and update the estimated fair value of our retained interest. Pursuant to the terms of the securitization programs, receivables more than 90 days overdue are considered delinquent. An increase in delinquency rates compared to historic levels will cause an increase in retained interests, while a decrease in delinquency rates compared to historic levels will cause a corresponding decrease in retained interests. Ultimately, if the customer defaults, we will be responsible for the uncollected amount up to the amount of our retained interest relating to the relevant securitization program. The fair value of the retained interests at December 31, 2004 and 2003 was approximately $349 million and $367 million, respectively.
We retain servicing responsibility relating to the sold receivables. Net cash settlements on both programs take place twice per month. However, in one of the programs there is, in addition, the daily
101
transfer of collections of sold receivables. Under the terms of the latter program, if our rating falls below BB+ (Standard & Poor's) or Ba3 (Moody's) then we may be required to relinquish the right to collect the sold receivables on behalf of the QSPE, and instead the cash collection of such sold receivables would be made directly to the accounts of the QSPE rather than via us.
The net cash received from (paid to) QSPEs during 2004, 2003 and 2002 was $130 million, $(119) million and $(384) million, respectively, as follows:
|
Year ended December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2004 |
2003 |
2002 |
|||||||
|
(U.S. dollars in millions) |
|||||||||
Gross trade receivables sold to QSPEs ($25, $505 and $832)(1) | $ | 5,846 | $ | 5,661 | $ | 5,972 | ||||
Collections made on behalf of and paid to QSPEs ($(23), $(696) and $(753))(1) |
(5,713 | ) | (5,883 | ) | (6,074 | ) | ||||
Purchasers, liquidity and program fees ($0, $(2) and $(5))(1) | (20 | ) | (21 | ) | (37 | ) | ||||
Decrease (increase) in retained interests ($0, $117 and $(87))(1) | 17 | 124 | (245 | ) | ||||||
Net cash received from (paid to) QSPEs ($2, $(76) and $(13))(1) | $ | 130 | $ | (119 | ) | $ | (384 | ) |
The increase in gross receivables sold in 2004 compared to 2003, is due primarily to an increase in the programs' size, a change in the definition of receivables eligible to be sold in one program and the addition of new sellers to one of the programs. The decrease in gross receivables sold in 2003, as compared to 2002, is due primarily to the fact that businesses which were either classified as discontinued operations or which we sold were phased out of the securitization programs during 2003.
We pay purchaser, liquidity and program fees on our securitization programs. Purchaser and program fees are based on the amount of funding that we receive, while liquidity fees are based on the programs' size. These costs of $20 million, $21 million and $37 million in 2004, 2003 and 2002, respectively, are included in interest and other finance expense.
At December 31, 2004 and 2003, of the gross trade receivables sold, the total trade receivables for which cash has not been collected at those dates amounted to $1,083 million and $898 million, respectively. Of these amounts, $54 million and $34 million at December 31, 2004 and 2003, respectively, was more than 90 days past due.
In addition, we transfer receivables outside of the above described securitization programs. These transfers were sales, made without recourse, directly to banks and/or sales pursuant to factoring or similar type arrangements. Total sold receivables included in these transactions during 2004 and 2003 were approximately $902 million and $1,400 million, respectively, of which, sales of $159 million and $594 million, respectively, related to assets held for sale and in discontinued operations. During 2004 and 2003, the related costs, including the associated gains and losses, were $10 million and $12 million, respectively, of which, costs of $1 million and $3 million, respectively, related to assets held for sale and in discontinued operations. The reduction in the amount of receivables transferred outside of the securitization programs in 2004 compared to 2003 was mainly the result of the sale of a business classified in discontinued operations that had in 2003 generated significant sales of receivables.
For a further discussion of our securitization programs, see Notes 2 and 7 to our Consolidated Financial Statements.
Pension and other post-retirement obligations
At December 31, 2004 and 2003, our pension liabilities exceeded plan assets by $1,451 million and $1,680 million, respectively. Our other post-retirement plan liabilities exceeded plan assets by $369 million and $397 million at December 31, 2004 and 2003, respectively. This underfunding is not a
102
short-term obligation for us as the settlement of the pension liability will take place as the covered employees draw benefits from the plans in the future. At the end of April 2005, we announced that we anticipate contributing a total of $187 million and $29 million to our pension plans and our postretirement benefit plans, respectively, in 2005.
Variable interests
We are a party to certain off-balance sheet arrangements including variable interests in unconsolidated entities. See Note 8 to the Consolidated Financial Statements for additional information on variable interests.
All of our operations, but particularly our manufacturing operations, are subject to comprehensive environmental laws and regulations. Violations of these laws could result in fines, injunctions (including orders to cease the violating operations) or other penalties (including orders to improve the condition of the environment in the affected area or to pay for such improvements). In addition, environmental permits are required for our manufacturing facilities (for example, with respect to air emissions and wastewater discharges). In most countries in which we operate, environmental permits must be renewed on a regular basis and we must submit reports to environmental authorities. These permits may be revoked, renewed or modified by the issuing authorities at their discretion and in compliance with applicable laws. We have implemented formal environmental management systems at nearly all of our manufacturing sites in accordance with the international environmental management standard ISO 14001, and we believe that we are in substantial compliance with environmental laws, regulations and permit requirements in the various jurisdictions in which we operate, except for such instances of non-compliance that, in the aggregate, are not reasonably likely to be material.
In a number of jurisdictions, including the United States, we may be liable for environmental contamination at our present or former facilities, or at other sites where wastes generated from our present or former facilities were disposed. In the United States, the Environmental Protection Agency and various state agencies are responsible for regulating environmental matters. These agencies have identified certain of our current and former U.S. based companies as potentially responsible parties in respect to a number of such sites under the Comprehensive Environmental Response, Compensation, and Liability Act, the Resource Conservation and Recovery Act and other federal and state environmental laws. As a potentially responsible party, we may be liable for a share of the costs associated with cleaning up these sites. As of December 31, 2004, there were approximately 25 sites, at which, our companies have, or may be potentially responsible for, environmental clean up costs. These 25 sites include several of our current or former facilities where we have undertaken voluntary corrective actions. The clean up of these sites involves primarily soil and groundwater contamination. We do not believe that our aggregate liability in connection with these sites will have a material adverse impact on our consolidated financial position, results of operations and cash flows.
Generally, our liability with regard to any specific site will depend on the number of potentially responsible parties, their relative contributions of hazardous substances or wastes to the site and their financial resources, as well as on the nature and extent of the contamination. Nevertheless, such laws commonly impose strict liability jointly and severally on the parties involved, so that any one party may be liable for the entire cost of cleaning up a contaminated site.
In addition, we retained liability for certain specific environmental remediation costs at two sites in the United States that were operated by our Nuclear technology business, which has been sold to British Nuclear Fuels PLC (BNFL) in April 2000. Pursuant to the purchase agreement with BNFL, we have retained all of the environmental liabilities associated with our subsidiary Combustion Engineering Inc.'s (Combustion Engineering) Windsor, Connecticut facility and a portion of the environmental liabilities associated with our ABB C-E Nuclear Power Inc. subsidiary's Hematite,
103
Missouri facility. The primary environmental liabilities associated with these sites relate to the costs of remediating radiological and chemical contamination at these facilities. Such costs are not payable until a facility is taken out of use and generally are incurred over a number of years. Although it is difficult to predict with accuracy the amount of time it may take to remediate radiological contamination upon decommissioning, based on information that BNFL has made publicly available, we believe that it may take until 2013 to remediate the Hematite site. With respect to the Windsor site, we believe the remediation may take until 2008. At the Windsor site, a significant portion of the contamination is related to activities that were formerly conducted by or for the United States government. We believe that a significant portion of the remediation costs for this facility will be covered by the United States government under the government's Formerly Utilized Sites Remedial Action Program. As a result of the sale of the Nuclear Technology business, in 2000 we established in other liabilities a reserve of $300 million in connection with our estimated remediation costs related to both facilities. We have estimated the total contingent liability in a range of loss from $266 million to $447 million. As such, at December 31, 2004, we have recorded in other liabilities a reserve of $266 million, net of payments since inception of $34 million. Expenditures charged to the remediation reserve were $10 million, $6 million and $12 million during 2004, 2003 and 2002, respectively. In connection with the Chapter 11 filing by Combustion Engineering discussed below, we will assume any and retain all remaining environmental liabilities of Combustion Engineering in respect to the Windsor and Hematite sites.
Estimates of the future costs of environmental compliance and liabilities are imprecise due to numerous uncertainties. Such costs are affected by the enactment of new laws and regulations, the development and application of new technologies, the identification of new sites for which we may have remediation responsibility and the apportionment of remediation costs among, and the financial viability of, responsible parties. In particular, the exact amount of the responsibility of the United States government for the Windsor site cannot be precisely estimated. It is possible that final resolution of environmental matters may require us to make expenditures in excess of our expectations, over an extended period of time and in a range of amounts that cannot be reasonably estimated. Although final resolution of such matters could have a material effect on our Consolidated Income Statement in a particular reporting period in which the expenditure is incurred, we believe that these expenditures will not have a material adverse impact on our consolidated financial position, results of operations and cash flows.
Summary
Our Combustion Engineering subsidiary has been a co-defendant in a large number of lawsuits claiming damage for personal injury resulting from exposure to asbestos. A smaller number of claims have also been brought against two other subsidiaries, ABB Lummus Global Inc. ("Lummus") (which is part of our Oil, Gas and Petrochemicals business and was formerly a subsidiary of Combustion Engineering) and Basic Incorporated ("Basic") (which was a subsidiary of Combustion Engineering and of Asea Brown Boveri Inc. ("Asea Brown Boveri") and is now a subsidiary of ABB Holdings Inc. ("Holdings") following the merger in December 2004 of Asea Brown Boveri into Holdings), as well as against other ABB group entities. In late 2002, taking into consideration the growing number and cost of asbestos-related claims, Combustion Engineering and we determined that Combustion Engineering's asbestos-related liability should be resolved through a comprehensive settlement that included a plan of reorganization for Combustion Engineering under Chapter 11 of the U.S. Bankruptcy Code.
In November 2002, Combustion Engineering and the representatives of various asbestos claimants entered into a Master Settlement Agreement which settled the value of approximately 154,000 open asbestos-related claims against Combustion Engineering. Under that agreement, Combustion Engineering established and funded a trust (the "CE Settlement Trust") to provide for partial payment on such settled claims.
104
In January 2003, Combustion Engineering reached agreement with various creditors (including representatives of the asbestos claimants who participated in the Master Settlement Agreement and a representative of future claimants) on the terms of a proposed "Pre-Packaged Plan of Reorganization for Combustion Engineering" under Chapter 11 of the U.S. Bankruptcy Code (as amended through June 4, 2003, the "CE Plan"). The CE Plan provided for a "channeling injunction" to be issued, under which asbestos-related claims related to the operations of Combustion Engineering, Lummus and Basic could only be brought against a trust (separate from the CE Settlement Trust established under the Master Settlement Agreement) to be established and funded by Combustion Engineering, ABB Ltd and other ABB group companies. This channeling injunction was intended to free Combustion Engineering, ABB Ltd and affiliates, as well as certain former direct or indirect owners, joint venture partners and affiliates of Combustion Engineering, including ALSTOM and ABB ALSTOM POWER NV, from further liability for such claims.
The CE Plan was filed with the U.S. Bankruptcy Court on February 17, 2003, and confirmed by the District Court on August 8, 2003. However, on December 2, 2004, the Court of Appeals for the Third Circuit effectively reversed the District Court's confirmation order. The Court of Appeals remanded the CE Plan to the District Court for a determination of whether, in light of the pre-petition payments made by Combustion Engineering to the CE Settlement Trust under the Master Settlement Agreement and the fact that claimants who received partial payments of their claims under the Master Settlement Agreement participated in the approval of the plan, the treatment of asbestos-related personal injury claims against Combustion Engineering under the CE Plan was consistent with the requirements of the Bankruptcy Code. Combustion Engineering and we have been reviewing the Court of Appeals' decision and considering various options to resolve the asbestos-related liability of Combustion Engineering, Lummus and Basic.
In March 2005, following extensive discussions with certain representatives of various parties, including the Creditors Committee and the Future Claimants Representative appointed in the Combustion Engineering case, we reached an agreement on certain "settlement points" for modifying the CE Plan with a view to bringing it into conformity with the Court of Appeals' decision and for providing a mechanism for resolving finally Lummus' potential asbestos liability. The settlement points contemplate that the modified plan will continue to reflect the CE Plan's fundamental approach of channeling asbestos-related claims against Combustion Engineering to a trust funded in part by other entities of the ABB group of companies. The settlement points provide for us to make an additional contribution of approximately $232 million to pay present and future asbestos claimants of Combustion Engineering and Lummus. In addition, the settlement points provide that we will pay directly or indirectly up to $8 million in respect of certain approved legal fees in the Chapter 11 case of Combustion Engineering. The settlement points contemplate that the modified CE Plan will become effective under the Bankruptcy Code concurrently with a separate Chapter 11 plan of reorganization for Lummus. The parties are now working to reach agreement on other issues relating to, and details of, the proposed modified plan and related proceedings involving Lummus and to prepare the related documentation. Each of the proposed plans will require approval of creditors and be subject to court review.
One of the holdings of the Court of Appeals was that the asbestos-related claims against Basic that are not related to Combustion Engineering's operations could not be "channeled" to the proposed trust under the CE Plan. The proposed plans do not address Basic, and we expect that Basic's asbestos-related liabilities will have to be resolved through its own bankruptcy or similar U.S. state court liquidation proceeding, or through the tort system.
Background
When we sold our 50 percent interest in the former ABB ALSTOM POWER NV joint venture to ALSTOM in May 2000, we retained ownership of Combustion Engineering, a subsidiary that had conducted part of our former power generation business and that now owns commercial real estate that
105
it leases to third parties. Combustion Engineering is a co-defendant, together with other third parties, in numerous lawsuits in the United States in which the plaintiffs claim damages for personal injury arising from exposure to asbestos in equipment or materials that Combustion Engineering allegedly supplied or was responsible for, primarily during the early 1970s and before.
From 1989 through February 17, 2003 (the date that Combustion Engineering filed for Chapter 11 as described below), approximately 438,000 asbestos-related claims were filed against Combustion Engineering. On February 17, 2003, there were approximately 164,000 asbestos related personal injury claims pending against Combustion Engineering. There were approximately 138,000 such claims pending against Combustion Engineering on December 31, 2002, and approximately 94,000 such claims were pending on December 31, 2001. Of the approximately 164,000 claims that were pending on February 17, 2003, approximately 154,000 are claims by asbestos claimants who participated in the Master Settlement Agreement. Approximately 29,000 new claims were made in the period from January 1, 2003, to February 17, 2003 (all but 111 of which agreed to participate in the Master Settlement Agreement). Approximately 34,500 claims were resolved in 2002 and approximately 27,000 claims were resolved in 2001.
Other entities of ours have sometimes been named as defendants in asbestos-related claims, including Lummus and Basic. At December 31, 2004 and 2003, there were approximately 11,000 claims pending against Lummus and 4,300 and 4,200 claims, respectively, pending against Basic.
Additionally, at December 31, 2004 and 2003, there were approximately 12,400 and 8,700 asbestos-related claims pending against our entities other than Combustion Engineering, Lummus and Basic. These claims are unrelated to Combustion Engineering and will not be resolved in the Combustion Engineering bankruptcy case. Of the 12,400 claims outstanding at December 31, 2004, approximately 3,660 are claims that were brought in the state of Mississippi in the United States, in 7 cases that include multiple plaintiffs and hundreds of co-defendants and make no specific allegations of any relationship between any entity of ours and the plaintiffs. Approximately 4,240 of such claims have been brought in the state of Ohio in the United States by claimants represented by a single law firm in cases that typically name 50 to 60 co-defendants and do not allege any specific linkage between the plaintiffs and any entity of ours. Approximately 2,700 such claims are pending in the state of West Virginia in the United States. The remaining such claims are pending in various jurisdictions. We generally seek dismissals from claims where there is no apparent linkage between the plaintiffs and any entity of ours. To date, resolving claims against our entities other than Combustion Engineering, Lummus and Basic has not had a material impact on our consolidated financial position, results of operations or cash flows.
Negotiations with representatives of asbestos claimants and pre-packaged Chapter 11 filing
During 2001 and 2002, Combustion Engineering experienced a significant increase in the level of new claims and higher total and per-claim settlement costs as compared to prior years. In October 2002, Combustion Engineering and we determined that it was likely that the expected asbestos-related costs of Combustion Engineering would exceed the value of its assets ($812 million at September 30, 2002 and $828 million at December 31, 2002) if its historical settlement patterns continued into the future. In October 2002, Combustion Engineering and we determined to resolve the asbestos-related liability of Combustion Engineering and its affiliates by reorganizing Combustion Engineering under Chapter 11, the principal business reorganization chapter of the U.S. Bankruptcy Code. Combustion Engineering and we determined to structure the Chapter 11 reorganization as a "pre-packaged plan," in which Combustion Engineering would solicit votes from asbestos claimants to approve the plan before the Chapter 11 case was filed with the Bankruptcy Court.
Beginning in October 2002, Combustion Engineering and we conducted extensive negotiations with representatives of certain asbestos claimants with respect to a pre-packaged plan. On November 22, 2002, Combustion Engineering and the asbestos claimants' representatives entered into a Master
106
Settlement Agreement for settling open asbestos-related personal injury claims that had been filed against Combustion Engineering prior to November 15, 2002. Combustion Engineering also agreed, pursuant to the Master Settlement Agreement, to form and fund the CE Settlement Trust to administer and pay the asbestos-related personal injury claims settled under the Master Settlement Agreement. Under the terms of the Master Settlement Agreement, eligible claimants who met all criteria to qualify for payment were entitled to receive a percentage of the value of their claim from the CE Settlement Trust and retain a claim against Combustion Engineering for the unpaid balance (the "stub claim"). The Master Settlement Agreement divides claims into three categories based on the status of the claim at November 14, 2002, the status of the documentation relating to the claim and whether or not the documentation establishes a valid claim eligible for settlement and payment by Combustion Engineering. The Master Settlement Agreement was supplemented in January 2003 to clarify the rights of certain claimants whose right to participate in a particular payment category was disputed. The Master Settlement Agreement, as supplemented, settles the value of and provides for the partial payment on approximately 154,000 open asbestos-related personal injury claims that had been lodged against Combustion Engineering.
The Master Settlement Agreement, as supplemented, provided that the CE Settlement Trust was to be funded by:
Approximately 154,000 eligible claimants have entered into the Master Settlement Agreement or adoption agreements with Combustion Engineering and the CE Settlement Trust and have received partial payment on their claims.
Pre-packaged plan of reorganization
On January 17, 2003, we announced that Combustion Engineering and we had reached an agreement on a proposed Pre-Packaged Plan of Reorganization for Combustion Engineering under Chapter 11 of the U.S. Bankruptcy Code. The agreement was reached with representatives of certain asbestos claimants with existing asbestos-related personal injury claims against Combustion Engineering (encompassing both claimants who had lodged claims prior to November 15, 2002, and claimants who had filed claims on or after that date and were not eligible to participate in the Master Settlement Agreement) and with the proposed representative of persons who may be entitled to bring asbestos-related personal injury claims in the future.
As proposed, the CE Plan provided for the creation of the Asbestos PI Trust, an independent trust separate and distinct from the CE Settlement Trust, and addressed Asbestos PI Trust Claims, which consist of present and future asbestos-related personal injury claims (including the stub claims of claimants who previously settled pursuant to the Master Settlement Agreement) that arise directly or indirectly from any act, omission, products, or operations of Combustion Engineering, Lummus or Basic. The CE Plan provided that, if it were to become effective, a channeling injunction would be issued under Section 105 of the U.S. Bankruptcy Code pursuant to which the Asbestos PI Trust Claims against ABB Ltd and certain of its affiliates (including Combustion Engineering, Lummus and Basic) would be channeled to the Asbestos PI Trust. The effect of the channeling injunction contemplated by the CE Plan would be that the sole recourse of a holder of an Asbestos PI Trust Claim would be to the Asbestos PI Trust and such holder would be barred from asserting such a claim against ABB Ltd and
107
the affiliates covered by the injunction (including Combustion Engineering and, under the CE Plan as proposed, Lummus and Basic).
As proposed, the CE Plan provided that on its effective date, the Asbestos PI Trust would be funded with the following:
In addition, the CE Plan as proposed provided that if Lummus were sold within 18 months after the CE Plan's effective date, ABB Inc. would contribute $5 million to the CE Settlement Trust and $5 million to the Asbestos PI Trust (together, these payments are referred to as the "Lummus Sale Payments"). If the CE Settlement Trust has ceased to exist at that time, both $5 million payments would be made to the Asbestos PI Trust, but in no event would this contribution exceed the net proceeds from the sale of Lummus.
Upon the effective date under the CE Plan, ABB Inc. would indemnify the Combustion Engineering estate against up to $5 million of liability on account of certain contingent claims held by certain indemnified insurers. Further, on the effective date, Asea Brown Boveri (now merged into Holdings) would provide for the benefit of Combustion Engineering a nuclear and environmental indemnity with regard to obligations arising out of Combustion Engineering's Windsor, Connecticut, site. The two indemnities described in this paragraph are referred to as the "Related Indemnities".
108
Judicial review process
The solicitation of votes to approve the CE Plan began on January 19, 2003. Combustion Engineering filed for Chapter 11 in the U.S. Bankruptcy Court in Delaware on February 17, 2003, based on the terms previously negotiated in connection with the CE Plan. On June 23, 2003, the Bankruptcy Court issued its Order Approving the Disclosure Statement but Recommending Withholding of Confirmation of the Plan of Reorganization for Combustion Engineering for Ten Days (the "Initial Ruling") and related findings of fact. The Initial Ruling approved the disclosure statement that was the document used as the basis for soliciting approval of the CE Plan from asbestos claimants and verified the voting results that approved the CE Plan and indicated that the Bankruptcy Court would recommend that the CE Plan be confirmed if Combustion Engineering and we could establish to the court's satisfaction certain specified information. We then submitted the additional information for the court's consideration.
On July 10, 2003, the Bankruptcy Court issued a Supplemental and Amendatory Order Making Additional Findings and Recommending Confirmation of Plan of Reorganization (the "Supplemental Ruling"). The Supplemental Ruling recommended to the U.S. District Court, among other things, that the CE Plan be confirmed.
Following the issuance of the Supplemental Ruling, interested parties had a period during which they could appeal the Initial Ruling and the Supplemental Ruling. This appeal period expired on July 24, 2003. A number of interested parties, including a small number of asbestos claimants and certain insurance companies which historically have provided insurance coverage to Combustion Engineering, Lummus and Basic filed appeals based on various objections to the CE Plan. The District Court held a hearing on July 31, 2003, with respect to the appeals and entered its confirmation order on August 8, 2003.
Various parties appealed the District Court's confirmation order to The United States Court of Appeals for the Third Circuit, which granted a motion for expedition of appeals and ordered that all briefs were to be filed by October 7, 2003. On June 3, 2004, the Court of Appeals held a hearing with respect to the appeals of the confirmation order of the District Court. On December 2, 2004, the Court of Appeals issued its decision (the "Third Circuit Decision").
The effect of the Third Circuit Decision was to reverse the District Court's confirmation order in respect of the CE Plan. The Third Circuit Decision focused on three issues raised by the appealing parties which relate to the ultimate terms of the CE Plan: (i) whether the Bankruptcy Court had "related to" jurisdiction over the claims against the non-debtors, Lummus and Basic, that do not arise from any products or operations of Combustion Engineering (the "non-derivative claims"); (ii) whether the non-debtors, Lummus and Basic, could avail themselves of the protection of the channeling injunction by invoking Section 105 of the Bankruptcy Code and contributing assets to the Asbestos PI Trust; and (iii) whether the two-trust structure and use of stub claims in the voting process comply with the Bankruptcy Code. The Court of Appeals held that there were insufficient factual findings to support "related-to" jurisdiction and that Section 105 of the Bankruptcy Code could not be employed to extend the channeling injunction to the non-derivative claims against nondebtors, such as Lummus and Basic. With regard to the two-trust structure, the Court of Appeals remanded the CE Plan to the District Court to determine whether creditors received fair treatment in light of the pre-petition payments made to the CE Settlement Trust participants and the use of stub claims in the voting process. Among other things, the Court of Appeals instructed the lower courts to consider whether payments under the CE Settlement Trust constituted voidable preferences that were inconsistent with the fair distribution scheme of the Bankruptcy Code.
On December 15, 2004, Combustion Engineering filed a petition seeking a rehearing en banc by the Court of Appeals. Specifically, Combustion Engineering and its immediate parent, Asea Brown Boveri, now merged into Holdings, challenged the holding in the Third Circuit Decision that the Bankruptcy and District Courts did not have "related to" jurisdiction over the non-derivative claims against Lummus and Basic and that Section 105 of the Bankruptcy Code could not be used to extend the channeling injunction to such claims. On January 19, 2005, the Court of Appeals denied the petition for rehearing en banc.
109
Notwithstanding the Third Circuit Decision, the Master Settlement Agreement, which settles the amount of and provides for partial payment on approximately 154,000 asbestos-related claims, remains effective. Early in the Combustion Engineering bankruptcy case, an asbestos claimant commenced an action against the trustee of the CE Settlement Trust and individuals who had received distributions from such trust, asserting that further distributions by the CE Settlement Trust should be enjoined because the transaction that created the CE Settlement Trust was a voidable preference. The Bankruptcy Court ruled that it would not dismiss that action for lack of standing. On October 22, 2004, the trustee of the CE Settlement Trust moved to dismiss the complaint in that action. This matter is pending and no decision has been rendered by the Court.
Following the Third Circuit Decision, the lower courts assumed jurisdiction over further confirmation proceedings in respect of the CE Plan. On January 27, 2005, the Bankruptcy Court authorized the Future Claimants Representative and the Creditors Committee to file any available bankruptcy-related and similar claims against third parties, including preference claims against certain claimants that did not participate in the CE Settlement Trust, and any potential bankruptcy related claims against us. The Bankruptcy Court further stated that if Combustion Engineering and we cannot agree on modifications to the CE Plan with the Future Claimants Representatives and Creditors Committee, and the representative of Combustion Engineering claimants who opposed the confirmation order, the Bankruptcy Court would appoint an independent representative to prosecute all of the foregoing preference claims and bankruptcy related claims asserted against us. We also entered into a tolling agreement to extend the time period within which bankruptcy related claims against us could be brought.
Since February 17, 2003, a stay and preliminary injunction have barred the commencement and prosecution of certain asbestos-related claims against Combustion Engineering, Lummus, Basic, certain other ABB group entities and certain other parties, including parties indemnified by us. The barred claims include, among others, claims arising from asbestos exposure caused by Combustion Engineering, Lummus or Basic and claims alleging fraudulent conveyance, successor liability and veil piercing. We do not know the number or nature of claims that would now be pending against the protected entities if those legal measures had not been in place.
Modified CE Plan
In March 2005, following extensive discussions with certain representatives of various claimants, the Creditors Committee and the Future Claimants Representative, we reached an agreement on certain "settlement points" for modifying the CE Plan with a view to bringing it into conformity with the Third Circuit Decision and for providing a mechanism for resolving finally Lummus' potential asbestos liability.
The settlement points contemplate the following elements for finally resolving both Combustion Engineering's and Lummus' potential asbestos liability:
110
In a status conference on April 5, 2005, the Bankruptcy Court instructed the Company to submit the documentation relating to the Modified CE Plan and the Lummus Plan to the Bankruptcy Court within approximately 60 days. We and various other interested parties are now working to reach agreement on open issues, details relating to the Modified CE Plan and the Lummus Plan and the form and substance of the operative documents and related Bankruptcy Court motions and other pleadings. We cannot be certain when those negotiations will be concluded or whether or on what terms the parties will resolve outstanding issues. The Modified CE Plan and the Lummus Plan will become effective only if different classes of their respective creditors vote in favor of the respective plans. The Modified CE Plan and the Lummus Plan will be subject to the approval of the Bankruptcy and District Courts, as well as to further judicial review if appeals are made. While we believe that the Modified CE Plan and the Lummus Plan are consistent with the Third Circuit Decision and other applicable laws and precedents, we cannot be certain whether the courts will approve the plans, nor can we predict whether the plans will receive the needed creditor votes.
We do not know whether any plan of reorganization for Combustion Engineering or Lummus will ultimately be confirmed or whether asbestos-related liabilities of any other ABB group entities would be resolved by any such plan. If for any reason a Chapter 11 plan relating to Combustion Engineering is not eventually confirmed, Combustion Engineering could be required to enter a Chapter 7
111
proceeding. If for any reason a Chapter 11 plan relating to Lummus is not eventually confirmed, we expect that Lummus' asbestos-related liabilities will have to be resolved through the tort system.
Because the Third Circuit Decision held that non-derivative claims cannot be subject to the CE Plan's proposed channeling injunction, Basic will not be included in the Modified CE Plan. We expect that Basic's asbestos-related liabilities will have to be resolved through its own bankruptcy or similar U.S. state court liquidation proceeding or through the tort system.
If any ABB group entities are not included in the protection offered by the channeling injunction entered pursuant to any Combustion Engineering plan that is confirmed, such entities could be required to resolve in the tort system, or otherwise, current and future asbestos-related claims that are asserted against such entities. Such events would be subject to numerous uncertainties, risk and expense.
If U.S. federal legislation addressing asbestos personal injury claims is passed, which is speculative at this time, such legislation may affect the amount that will be required to resolve the asbestos-related claims against ABB group entities.
Effect on our financial position
Expenses. We recorded expenses related to asbestos of $262 million, $142 million and $395 million in loss from discontinued operations, net of tax, and $1 million, $3 million and $25 million in income from continuing operations, net of tax, for 2004, 2003 and 2002, respectively. Loss from discontinued operations, net of tax, for 2004 reflects a charge of $232 million taken in connection with the agreement we reached in March 2005 on the basic terms of the Modified CE Plan, $17 million resulting from the mark-to-market adjustment relating to the CE Settlement Shares, a credit of $6 million resulting from adjustment of the provision for the estimated liability of Basic as described below, and other costs of $19 million. Loss from discontinued operations, net of tax, for 2003 includes a charge of $68 million, net of tax, resulting from the mark-to-market adjustment relating to the CE Settlement Shares, a provision of $41 million, representing the present value of the first two $25 million payments under the ABB Promissory Note, which were previously considered contingent, as well as $33 million of other costs. The 2002 amount reflected our estimate of incremental total costs to be incurred based upon the terms of the CE Plan.
Cash Payments. Cash payments, before insurance recoveries, related to Combustion Engineering's asbestos-related claims were $56 million (including $49 million contributed to the CE Settlement Trust, described above), $391 million (including $365 million contributed to the CE Settlement Trust), and $236 million (including $30 million contributed into the CE Settlement Trust), in 2004, 2003 and 2002, respectively. Administration and defense costs were $10 million, $36 million and $32 million in 2004, 2003 and 2002, respectively.
Cash payments related to asbestos-related claims against Lummus and Basic made through December 31, 2004 were approximately $3 million and $3 million, respectively. Cash payments to resolve asbestos-related claims against entities other than Combustion Engineering, Lummus and Basic have been immaterial to date, totaling less than $1 million in the aggregate. We have not maintained a reserve for the claims pending against entities other than Combustion Engineering, Lummus and Basic.
Provisions. At December 31, 2004, 2003 and 2002, we recorded total provisions on a consolidated basis of $1,023 million, $815 million and $1,095 million in respect of asbestos-related claims and defense costs related to Combustion Engineering, Lummus and Basic. Our provisions in continuing operations for asbestos-related liabilities at December 31, 2003 and 2002, now include $2 million and $4 million, respectively, previously classified in liabilities held for sale and in discontinued operations. Based upon the expected implementation of the Modified CE Plan and the Lummus Plan, we recorded provisions of $985 million and $33 million, respectively, at December 31, 2004, in accrued liabilities and
112
other. If the Modified CE Plan and Lummus Plan become effective, certain amounts will be reclassified as of the effective date to other long-term liabilities based on the timing of the future cash payments to the Asbestos PI Trust or any similar trust created under the Lummus Plan. Future earnings will be affected by mark-to-market adjustments relating to the CE Settlement Shares through the effective date of the Plan, as well as contingent payments when they become probable of payment. The provisions as of December 31, 2003 and 2002, were based on our obligations under the CE Plan and assumed that the CE Plan would be confirmed and become effective as proposed.
In light of the decision of the Court of Appeals, we have made a separate provision as of December 31, 2004 with respect to Basic in accordance with Financial Accounting Standard Board Statement No. 5, Accounting for Contingencies, and Financial Accounting Standards Board Interpretation No. 14, Reasonable Estimation of the Amount of a Loss: an interpretation of FASB Statement No. 5. With respect to Basic, we have established a provision of $5 million relating to its asbestos-related liabilities based on analysis of historical claims statistics and related settlement costs and a projection of such claims activity over the next several years.
Management believes that it is probable that the full amount of the relevant provisions will be required to settle the respective asbestos-related liabilities of Combustion Engineering, Lummus and Basic. We may incur liability greater than the existing provisions, whether in connection with a modified plan of bankruptcy or otherwise, but management does not believe that the amount of any such incremental liability can be reasonably estimated or that there is a better estimate of these liabilities than the amounts that are provided for.
Our provisions in respect of asbestos-related claims include, as stated above, amounts for each of Combustion Engineering, Lummus and Basic. The assets of Combustion Engineering include amounts receivable of approximately $221 million, $232 million and $241 million at December 31, 2004, 2003 and 2002, respectively, for probable insurance recoveries, which were established with respect to asbestos-related claims.
The ultimate outcome of our efforts to resolve the asbestos-related personal injury claims against Combustion Engineering and other entities of ours (including any such claims against third parties indemnified by entities of ours) remains uncertain. The related costs may be higher than our provisions reflect and could have a material adverse impact on our consolidated financial position, results of operations and cash flows. In the event the Modified CE Plan or Lummus Plan do not become effective, the ultimate cost for the resolution of asbestos-related personal injury claims against Combustion Engineering and Lummus may be significantly higher and could have a material adverse impact on our consolidated financial position, results of operations and cash flows.
113
Item 6. Directors, Senior Management and Employees
Our board of directors defines the ultimate direction of the business of ABB and issues the necessary instructions. It determines the organization of the ABB Group and appoints, removes and supervises the persons entrusted with the management and representation of ABB. The internal organizational structure and the definition of the areas of responsibility of our board of directors, as well as the information and control instruments vis-à-vis the executive committee, are set forth in the regulations of the board of directors. We have been granted an exception by the Federal Office of Justice of Switzerland (Bundesamt für Justiz) to the rule that a majority of the members of the board of directors of ABB must be citizens of Switzerland with residence in Switzerland according to Article 708 para 1 of the Swiss Code of Obligations.
Our articles of incorporation stipulate that the board of directors must consist of not fewer than seven and no more than 13 members at any time. Swiss law and our articles of incorporation also provide that each director must be a shareholder of ABB Ltd. Directors are elected for terms of one year by the shareholders in a shareholders' meeting. Members of the board of directors whose terms of office have expired are immediately eligible for re-election. Our articles of incorporation do not provide for the retirement or non-retirement of directors under an age-limit requirement. Our internal regulations provide that a director shall resign at the annual general meeting of shareholders taking place in the year of his 70th birthday.
The board of directors appoints its Chairman and one or more Vice Chairmen, as well as the persons entrusted with our management and representation, whom the board of directors is also responsible for removing. At present, the position of Vice Chairman is vacant.
The following table sets forth the names and the years of birth of our directors and their current positions with ABB.
Name |
Born |
Current Position |
||
---|---|---|---|---|
Jürgen Dormann | 1940 | Chairman of the Board | ||
Roger Agnelli | 1958 | Director | ||
Louis R. Hughes | 1949 | Director | ||
Hans Ulrich Märki | 1946 | Director | ||
Michel de Rosen | 1951 | Director | ||
Michael Treschow | 1943 | Director | ||
Bernd W. Voss | 1939 | Director | ||
Jacob Wallenberg | 1956 | Director |
ABB Ltd became the ultimate holding company of the ABB Group on June 28, 1999. The biographies of Messrs. Dormann and Wallenberg also note the years of service they provided to ABB Asea Brown Boveri Ltd, the former parent company of the ABB Group.
Jürgen Dormann has been the Chairman of ABB's board of directors since November 2001 and served as ABB's President and Chief Executive Officer from September 5, 2002 until December 31, 2004. He has been a member of ABB's board of directors since June 28, 1999. From 1998 to 1999, he served as a member of the board of directors of ABB Asea Brown Boveri Ltd. He is the vice-chairman of the board of directors of sanofi aventis (France). He is a member of the boards of directors of Adecco (Switzerland), IBM (U.S.) and BG Group (U.K., as from June 1, 2005). Mr. Dormann is a German citizen.
Roger Agnelli was elected to ABB's board of directors at the annual general meeting of shareholders on March 12, 2002. He is the President and Chief Executive Officer of Companhia Vale do Rio Doce (Brazil). He is also a member of the board of directors of Duke Energy (U.S.) and Suzano Petroquimica (Brazil, as of April 2005). Mr Agnelli is a full member of the Economic and Social Development Council (CDGS), an advisory council to the President of Brazil, and member of
114
the International Investments Council, which advises the President of the Republic of South Africa. He is also President of the Chinese-Brazilian Business Council. Mr. Agnelli is a Brazilian citizen.
Louis R. Hughes was elected to ABB's board of directors at the annual general meeting of shareholders on May 16, 2003. Mr. Hughes is the chairman of the board of directors of Maxager Technology and appointed Chief Executive Officer of GBS Laboratories (both U.S.). He is also a member of the boards of directors of BT Group (U.K.), Sulzer (Switzerland) and Electrolux (Sweden). Mr. Hughes was the president and chief operating officer of Lockheed Martin Corp. in 2000 and was an executive vice president of General Motors from 1992 to 2000. He was also the acting chief executive officer of Wavecrest Laboratories from 2002 to 2003. Mr. Hughes is a United States citizen. As announced on October 28, 2004, Louis R. Hughes has taken a temporary leave of absence from ABB's board of directors to serve the United States government as chief of staff of the Afghanistan Reconstruction Group.
Hans Ulrich Märki was elected to ABB's board of directors at the annual general meeting of shareholders on March 12, 2002. He is chairman of IBM Europe, Middle East and Africa (France) and a member of the board of directors of Mettler-Toledo International (Switzerland). Mr. Märki is a Swiss citizen.
Michel de Rosen was elected to ABB's board of directors at the annual general meeting of shareholders on March 12, 2002. He is the chairman, president and chief executive officer of ViroPharma (U.S.). He is a member of the boards of directors of Ursinus College and Pennsylvania Biotech (both U.S.). He is also a member of the advisory boards of Paul Capital Partners Royalty Fund and the Global Business Coalition on HIV/AIDS (both U.S.). Mr. de Rosen is a French citizen.
Michael Treschow was elected to ABB's board of directors at the annual general meeting of shareholders on May 16, 2003. He is the chairman of the boards of directors of Ericsson, Electrolux and the Confederation of Swedish Enterprise (all Sweden). From 1997 to 2002, he was the president and chief executive officer of Electrolux (Sweden). Prior to 1997, he was the president and chief executive officer of Atlas Copco. Mr. Treschow is a Swedish citizen.
Bernd W. Voss was elected to ABB's board of directors at the annual general meeting of shareholders on March 12, 2002. He is a member of the supervisory board of Dresdner Bank (Germany). He is also a member of the boards of directors of Allianz Leben, Continental, Quelle, Hapag-Lloyd, Wacker Chemie and Osram (all Germany). Mr. Voss is a German citizen.
Jacob Wallenberg has been a member of ABB's board of directors since June 28, 1999. From March 1999 to June 1999, he served as a member of the board of directors of ABB Asea Brown Boveri Ltd. He is the chairman of the board of directors of Investor and W Capital Management (both Sweden). He is vice-chairman of Skandinaviska Enskilda Banken, Atlas Copco and SAS (all Sweden). He is also a member of the boards of directors of the Knut and Alice Wallenberg Foundation, the Nobel Foundation (both Sweden) and the Wharton European Advisory Board (U.S.). Mr. Wallenberg is a Swedish citizen.
Our board of directors has delegated the executive management of ABB to the chief executive officer and the other members of the executive committee. The chief executive officer, and under his direction the other members of the executive committee, are responsible for our overall business and affairs and day-to-day management. The chief executive officer reports to the board regularly, and whenever extraordinary circumstances so require, on the course of our business and financial performance and on all organizational and personnel matters, transactions and other issues relevant to the group.
Upon proposal by the nomination and compensation committee, the executive committee is appointed and discharged by the board and consists of the chief executive officer, the chief financial officer and the other executive vice presidents.
115
The following table sets forth the names and the years of birth of the members of the executive committee, their current positions with us and the dates of their initial appointment to their current positions.
Name |
Born |
Current Position |
Year of Appointment |
|||
---|---|---|---|---|---|---|
Fred Kindle | 1959 | President and Chief Executive Officer | 2005 | |||
Michel Demaré | 1956 | Chief Financial Officer | 2005 | |||
Dinesh C. Paliwal | 1957 | Head of Automation Technologies Division | 2003 | |||
Peter Smits | 1951 | Head of Power Technologies Division | 2003 | |||
Gary Steel | 1952 | Head of Human Resources | 2003 |
Fred Kindle has been our Chief Executive Officer since January 2005, after joining ABB on September 1, 2004. Mr. Kindle is a member of the board of directors of VZ Holding Ltd. (Switzerland). Before joining ABB he has been the chief executive officer of Sulzer (Switzerland). Mr. Kindle has been with the Sulzer Group since 1992. In 1999, he became responsible for Sulzer Industries. In 2001, he became chief executive officer of Sulzer. From 2003 to 2004 he has also been a member of Sulzer's board of directors. Mr. Kindle has dual Liechtenstein and Swiss citizenship.
Michel Demaré joined ABB as Chief Financial Officer on January 1, 2005. He succeeded Peter Voser, who left ABB on September 30, 2004 to become chief financial officer of Royal Dutch/Shell (Netherlands/U.K.). From 2002 until 2004 Mr. Demaré has been vice president and chief financial officer Europe of Baxter International. From 1984 until 2002 he held various positions within Dow Chemical (U.S.), including group finance director for the global polyolefins and elastomers business from 1997 to 2002. Mr. Demaré is a Belgian citizen.
Dinesh C. Paliwal has been the Head of our Automation Technologies division since January 2003. From April 2002 to January 2003, he was our Executive Vice President responsible for our Industries Division. Between January 1, 2001 and March 2002, he was our Executive Vice President responsible for our Process Industries division. From 1999 to 2001, he was responsible for our worldwide activities in the Automation Segment for the paper, printing, metals, mining and cement industries. From 1998 to 1999, he was responsible for our worldwide activities in the Automation Segment for the pulp, paper and printing industries. From 1994 to 1998, he was Vice President responsible for our automation activities in process industries in China and Northeast Asia. From 1990 to 1994, he was Director of Marketing and Sales for our automation activities for the paper industry in Asia. Prior to 1990, he held several positions in sales and project management. Mr. Paliwal has dual Indian and U.S citizenship.
Peter Smits has been the Head of our Power Technologies division since January 2003. From 2001 to January 2003, he was Executive Vice President responsible for the Power Technology Products division. From 1998 to 2001, he was Senior Vice President, Business Area Manager Distribution Transformers, at ABB T&D Ltd. From 1994 to 1998, he was President and Country Manager at Asea Brown Boveri SA, Belgium. From 1990 to 1994, he served as President at Pfleiderer Verkehrstechnik GmbH. From 1988 to 1990, he held the position of Vice-President at ABB Schaltanlagen GmbH and was Business Unit Manager within our High-Voltage Switchgear business area. From 1980 to 1988, he held several positions at Asea Lepper GmbH. Mr. Smits is a German citizen.
Gary Steel was appointed our Head of Human Resources in January 2003. In 2002, he was the Human Resources Director, Group Finance at Shell. Between 1976 and 2002, he held several human resources and employee relations positions at Shell. Mr. Steel is a British citizen.
We are committed to the highest international standards of corporate governance, and we support the general principles as set forth in the Swiss Code of Best Practice for Corporate Governance as well as those of the capital markets where ABB shares are listed: the SWX Swiss Exchange, the Stockholm Exchange, the London Stock Exchange, the Frankfurt Stock Exchange and the New York Stock Exchange (where our shares are traded in the form of ADSs).
116
In addition to the provisions of the Swiss Code of Obligations, our principles and rules on corporate governance are laid down in our articles of incorporation, our board regulations, our standards for corporate governance, the charters of our board committees, the board membership guidelines, several internal directives (such as the directive on insider information) and the code on business ethics. It is the duty of our board of directors to review and amend or propose amendments to those documents from time to time to reflect the most recent developments and practices as well as to ensure compliance with applicable laws and regulations.
In November 2003, the Securities and Exchange Commission approved changes to the New York Stock Exchange's listing standards related to the corporate governance practices of listed companies. Under these rules, listed foreign private issuers, such as ABB, must disclose any significant ways in which their corporate governance practices differ from those followed by U.S. domestic companies under the New York Stock Exchange listing standards. This disclosure can be found on our web site under www.abb.com/about.
Duties of Directors and Officers
The directors and officers of a Swiss corporation are bound, as specified in the Swiss Code of Obligations, to perform their duties with all due care, to safeguard the interests of the corporation in good faith and to extend equal treatment to shareholders in like circumstances.
The Swiss Code of Obligations does not specify what standard of due care is required of the directors of a corporate board. However, it is generally held in Swiss doctrine and jurisprudence that the directors must have the requisite capability and skill to fulfill their function, and must devote the necessary time to the discharge of their duties. Moreover, the directors must exercise all due care that a prudent and diligent director would have taken in like circumstances. Finally, the directors may not take any actions that may be harmful to the corporation.
Exercise of Powers
Directors as well as other persons authorized to act on behalf of a Swiss corporation may perform all legal acts on behalf of the corporation which the business purpose as set forth in the articles of incorporation of the corporation, may entail. Pursuant to court practice, such directors and officers can take any action that is not explicitly excluded by the business purpose of the corporation. In so doing, however, the directors and officers must still pursue the duty of due care and the duty of loyalty described above and must extend equal treatment to the corporation's shareholders in like circumstances. Our articles of incorporation do not contain provisions concerning a director's power, in the absence of an independent quorum, to vote on the compensation to themselves or any members of their body.
Conflicts of Interest
Swiss law does not have a general provision on conflicts of interest and our articles of incorporation do not limit our directors' power to vote on a proposal, arrangement or contract in which the director or officer is materially interested. However, the Swiss Code of Obligations requires directors and officers to safeguard the interests of the corporation and, in this connection, imposes a duty of care and loyalty on directors and officers. This rule is generally understood and so recommended by the Swiss Code of Best Practice for Corporate Governance as disqualifying directors and officers from participating in decisions, other than in the shareholders' meeting, that directly affect them.
Confidentiality
Confidential information obtained by directors and officers of a Swiss corporation acting in such capacity must be kept confidential during and after their term of office.
117
Sanctions
If directors and officers transact on behalf of the corporation with bona fide third parties in violation of their statutory duties, the transaction is nevertheless valid as long as it is not explicitly excluded by the corporation's business purpose as set forth in its articles of incorporation. Directors and officers acting in violation of their statutory dutieswhether transacting with bona fide third parties or performing any other acts on behalf of the companymay, however, become liable to the corporation, its shareholders and its creditors for damages. The liability is joint and several, but the courts may apportion the liability among the directors and officers in accordance with their degree of culpability.
In addition, Swiss law contains a provision under which payments made to a shareholder or a director or any person(s) associated therewith other than at arm's length must be repaid to the company if the shareholder or director or any person associated therewith was acting in bad faith.
If the board of directors has lawfully delegated the power to carry out day-to-day management to a different corporate body, e.g., the executive committee, it is not liable for the acts of the members of that different corporate body. Instead, the directors can only be held liable for their failure to properly select, instruct and supervise the members of that different corporate body.
Board Practices
Board meetings are convened by the chairman or upon request by a director or the chief executive officer. During 2004, five board meetings were held. Written documentation covering the various items of the agenda for each board meeting is sent out in advance to each board member in order to allow the member time to study the covered matters prior to the meetings. Decisions made at the board meetings are recorded in written minutes of the meetings. Our board membership guidelines require that the board of directors be comprised of a substantial majority of independent directors. Currently all board members, with the exception of Jürgen Dormann are independent, non-executive directors. The board of directors has made this determination in accordance with the Swiss Code of Best Practice and the independence criteria set forth in the corporate governance rules of the New York Stock Exchange. Mr. Dormann held also the position of president and chief executive officer from September 5, 2002 until December 31, 2004 in addition to his ongoing role as chairman.
In order to address potential conflict of interests, which Jürgen Dormann in his dual role could have experienced, the board created in 2003 the new position of lead director. The additional tasks of Jacob Wallenberg, who was appointed as lead director, were to act as counselor to the chairman and facilitate the dialogue between the members of the board and the chairman. He held special sessions without the chairman's presence where the chairman's role and performance was discussed. The position of lead director ceased to exist as of January 1, 2005, when Fred Kindle took over the position of president and chief executive officer from Jürgen Dormann, who remains chairman of the board of directors.
Our board of directors has appointed from among its members three board committees, the finance and audit committee, the nomination and compensation committee and the strategy committee, which has recently been dissolved. The duties and objectives of the board committees (except for the strategy committee, which was created in July 2003 and was only a temporary committee) are set forth in charters issued or approved by the board of directors. These committees assist the board in its tasks and report regularly to the board.
The finance and audit committee oversees the financial reporting processes and accounting practices, evaluates the independence, objectivity and effectiveness of external and internal auditors, reviews audit results, monitors compliance with the laws and regulations governing the preparation of our financial statements and assesses the processes relating to our risk management and internal control systems. The finance and audit committee is required to be composed of three or more independent directors who have a thorough understanding of finance and accounting. The chief
118
financial officer and, as determined by the committee's chairman for matters related to their respective functions, the head of internal audit, as well as the external auditors may participate in the finance and audit committee meetings. Mr. Voss is the chairman of the finance and audit committee, and Messrs. Agnelli and Wallenberg are members. The committee met six times in 2004.
The nomination and compensation committee determines the selection of candidates for the board of directors and its committees, plans for the succession of directors and ensures that newly elected directors receive the appropriate introduction and orientation and that all directors receive adequate continuing education and training to fulfill their obligations. The nomination and compensation committee proposes the remuneration of the members of the executive committee. The nomination and compensation committee is required to be composed of three or more independent directors. Upon invitation by the committee's chairman, the chief executive officer or other members of the group executive committee may participate in the committee meetings, provided that any potential conflict of interest is avoided and confidentiality of the discussions is maintained. Mr. Märki is the chairman of the nomination and compensation committee, and Messrs. de Rosen and Wallenberg are members. The committee met seven times in 2004.
During a review of the group's medium-term strategy in 2003 and 2004, the board's strategy committee worked in cooperation with the ABB Group executive committee to discuss proposals for the group's future focus and direction. The committee completed its work in 2004 and was then dissolved. Mr. Hughes was the chairman of the strategy committee, and Messrs. Märki and Treschow were members. Most meetings of the strategy committee were also attended by all of the members of the group executive committee. The committee met four times in 2004.
Board of Directors
For the period from the annual general meeting of shareholders in 2004 to the annual general meeting of shareholders in 2005, the compensation of the board of directors was kept at the previous year's level, which is:
Payments to board members are made in May and November in advance of each term.
Board members receive at least 50 percent (and may elect to receive a higher ratio) of their net compensation (i.e., after deduction of social security costs and withholding tax, where applicable), in ABB shares, which they are entitled to receive at a discount of 10 percent of the average share trading price during a 30-day reference period. During the term of board membership, the ABB shares are kept in a blocked account and may be disposed of only after the respective person has left the board of directors. The gross compensation paid to board members in shares and cash with respect to 2004 amounted to CHF 2,870,000 ($2,514,897 at December 31, 2004).
119
Our current board members received the following compensation with respect to 2004 (the calculation of the number of shares and the cash amount varies depending on whether the person is subject to taxation at source):
|
Total Annual Compensation (gross) |
Amount received in cash (net) |
Number of shares received |
|||
---|---|---|---|---|---|---|
|
CHF |
|
|
|||
Jürgen Dormann(1) | 1,000,000 | | 93,382 | |||
Roger Agnelli | 270,000 | | 27,630 | |||
Louis R. Hughes(2) | 150,000 | 52,202 | 7,848 | |||
Hans Ulrich Märki | 320,000 | | 44,922 | |||
Michel de Rosen | 270,000 | 93,901 | 13,815 | |||
Michael Treschow | 270,000 | 93,901 | 13,815 | |||
Bernd W. Voss | 300,000 | | 30,832 | |||
Jacob Wallenberg | 290,000 | | 29,688 | |||
Total | 2,870,000 | 240,004 | 261,932 |
With the exception of Jürgen Dormann for the period during which he served as both chairman of the board and chief executive officer, board members do not receive pension benefits and are not eligible to participate in any of our incentive programs.
No payments were made to former board members in 2004.
Executive Committee
Members of the group executive committee receive annual base compensation. They are further eligible for annual bonus compensation, determined in accordance with the principles explained below.
In addition to receiving annual base and bonus compensation, members of the group executive committee may participate in the newly created employee share acquisition plan and performance incentive share plan. Some members of the group executive committee have participated in the earlier launches of our management incentive plan (MIP). Group executive committee members receive customary additional benefits such as a company car and health insurance compensation and contributions to children education in some cases (see table below).
The table below shows the gross payments (i.e. compensation before deduction of employee social insurance and pension contributions) that were made to the members of the group executive committee with respect to 2004, as well as the employer's part of the ordinary pension contributions. All members of the group executive committee are insured in the ABB Pension Fund, the ABB Supplementary Insurance Plan and the Tödi Foundation (the regulations are available under www.abbvorsorge.ch), with the exception of Dinesh Paliwal, who is insured under the U.S. pension plan. The table also shows the numbers of conditionally granted shares under the performance incentive share plan (see "Performance Incentive Share Plan"). The exact number of shares to be received will be known in March 2006. In addition to the figures provided in the table below, Peter Smits and Gary Steel, but none of the other members of the group executive committee, participate in the employee share acquisition plan (see
120
details of the plan further below) with the maximum annual savings amount of CHF 9,000 ($7,886 at December 31, 2004).
|
Currency |
Salary |
Bonus(1) |
Additional compensation |
Total annual compensation(8) |
Employer's pension contributions |
No. of shares granted(2) |
Costs of company car |
Costs of health insurance |
Costs of Children education |
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Jürgen Dormann(3) | CHF | 3,372,508 | 1,046,250 | 0 | 4,418,758 | 1,352,544 | 0 | 31,440 | 3,926 | 0 | ||||||||||
Fred Kindle(4) | CHF | 433,336 | 400,000 | 200,000 | 1,033,336 | 99,607 | 130,480 | 5,814 | 1,787 | 0 | ||||||||||
Dinesh Paliwal(5) | USD | 654,167 | 557,125 | 800,000 | 2,011,292 | 370,970 | 110,475 | 24,000 | 22,365 | 114,905 | ||||||||||
Peter Smits | CHF | 862,500 | 743,850 | 0 | 1,606,350 | 237,407 | 113,282 | 41,738 | 7,925 | 0 | ||||||||||
Gary Steel | CHF | 670,840 | 585,675 | 0 | 1,256,515 | 170,134 | 89,193 | 31,475 | 8,093 | 64,700 | ||||||||||
Peter Voser(6) | CHF | 600,837 | 498,000 | 0 | 1,098,837 | 132,997 | 0 | 30,740 | 5,269 | 0 | ||||||||||
Total(7) | CHF | 6,686,556 | 3,909,566 | 1,112,960 | 11,709,082 | 2,416,039 | 443,430 | 168,596 | 52,523 | 195,830 |
Bonus determination
In 2003, ABB introduced a structure for aligning the performance expectations of its senior managers.
Group executive committee members, corporate staff and country managers of the 19 largest countries receive targets and are measured on ABB Group results, rather than on the basis of individual businesses. Business area managers and local country divisional managers receive targets and are measured on ABB Group results (60 percent) and on their business area or divisional results (40 percent). At least 20 percent of this "scorecard" must be made up of qualitative measurements relating, for example, to customers, employees or an issue of focus for the ABB Group.
In addition to this group of senior managers, all other participating managers are measured with a minimum of 30 percent on ABB Group results. Resulting bonuses are paid in March each year after full-year results are announced. In applying the scorecard principles, group executive committee members have a maximum bonus opportunity of 100 percent of their base salary.
Employee participation programs
In order to align its employees' interests with the business goals and financial results of the company, we operate a number of participation programs, linked to ABB's shares, which are described below.
Employee share acquisition plan (ESAP)
To incentivize employees, we granted stock options under an Employee Share Acquisition Plan (ESAP Plan) in November 2004. In the initial launch of the ESAP Plan, employees in eleven countries, including the United States, were invited to participate. The ESAP Plan is an employee stock option plan with a savings feature. Employees save over a twelve-month savings period, by way of monthly salary deductions. The maximum monthly savings amount is the lower of 10 percent of gross monthly salary or the local currency equivalent of CHF 750. At the end of the savings period, employees choose whether to exercise their stock options using their savings plus interest to buy ABB Ltd shares (American Depositary Shares (ADS) in the case of employees in the United Stateseach ADS
121
representing one registered share of the Company) at the exercise price set at the grant date, or have their savings returned with interest. The savings are accumulated in a bank account held by a third party trustee on behalf of the participants and earn interest.
The maximum number of shares that each employee can purchase has been determined based on the exercise price and the aggregate savings for the twelve-month period, increased by 10 percent to allow for currency fluctuations. If, at the exercise date, the balance of savings plus interest exceeds the maximum amount of cash the employee must pay to fully exercise his stock options, the excess funds will be returned to the employee. If the balance of savings and interest is insufficient to permit the employee to fully exercise his stock options, the employee has the choice but not the obligation, to make an additional payment so that the employee may fully exercise his stock options.
If an employee ceases to be employed by us, the accumulated savings as of the date of cessation of employment will be returned to the employee and the employee's right to exercise his stock options will be forfeited. Employees can withdraw from the ESAP Plan at any time during the savings period and will be entitled to a refund of their accumulated savings.
The exercise price per share and ADS of CHF 6.95 and $5.90, respectively, was determined using the respective closing price of the ABB Ltd share on SWX Swiss Exchange (virt-x) and ADS on the New York Stock Exchange on November 9, 2004, the grant date. We granted stock options, such that, if fully exercised, we would issue 7,548,360 registered shares (including shares represented by ADS). The aggregate fair value of the awards at the date of grant was $5 million, assuming zero percent dividend yield, expected volatility of 28.25 percent, a risk-free interest rate of 0.97 percent and a life of one year from the grant date. Forfeitures since the date of the grant have been insignificant. See Note 22 to the Consolidated Financial Statements for additional information regarding the Employee Share Acquisition Plan.
Management Incentive Plan (MIP)
We have a management incentive plan under which approximately 1,200 key employees received warrants and warrant appreciation rights for no consideration over the course of eight launches from 1998 to 2004. The warrants are exercisable for shares at a predetermined price, not less than the fair market value as of the date of grant. Participants may also sell the warrants rather than exercise the right to purchase shares. Equivalent warrants are listed on the SWX Swiss Exchange, which facilitates valuation and transferability of warrants granted under the management incentive plan.
Each warrant appreciation right entitles the holder to an amount in cash equal to the market price of one equivalent warrant on the SWX Swiss Exchange on the date of exercise of the warrant appreciation right. Warrant appreciation rights are not transferable. Participants may exercise or sell warrants or exercise warrant appreciation rights only during the 30 days immediately following publication of our interim or annual results. No exercise or sale is permitted until after the vesting period, which is three years from date of grant, although vesting restrictions can be waived in certain circumstances such as death or disability. All warrants and warrant appreciation rights expire six years from the date of grant.
As of March 31, 2005, the warrants outstanding represented the rights to acquire 21,894,263 of our shares (representing less than 2 percent of our total outstanding shares), including the right of the current members of our executive committee to acquire an aggregate of 740,330 shares. Also on that date, the warrant appreciation rights represented the rights to receive the cash equivalent to the market price of 131,030,020 warrants, including the right of the current members of our executive committee to receive the cash equivalent to the market price of 2,350,000 warrants. Our obligations under the management incentive plan are covered by contingent share capital. See Note 22 to the Consolidated Financial Statements for additional information regarding the management incentive plan.
The amounts of warrants outstanding include those instruments held by employees of the former ABB ALSTOM POWER joint venture, a discontinued operation. Under the terms and conditions of the management incentive program, employees of the former ABB ALSTOM POWER joint venture retain their entitlements in the management incentive plan.
As of March 31, 2005, 55,230,560 warrants representing the right to purchase 13,923,413 shares (representing less than 1 percent of our total outstanding shares) were exercisable and 80,540,520 warrant appreciation rights were exercisable.
122
The following table sets forth the number of warrants outstanding under the management incentive plan as of March 31, 2005.
Launch (Year) |
Warrants Outstanding |
Exercise Ratio (Warrants: Shares) |
Number of Shares Underlying Warrants |
Exercise Price (CHF) |
Expiration Date |
|||||
---|---|---|---|---|---|---|---|---|---|---|
3 (1999) | 4,648,060(1) | 1:0.2521 | 1,171,758(1) | 29.75 | 06/10/05 | |||||
4 (1999) | 14,565,000(1) | 1:0.2521 | 3,671,781(1) | 32.73 | 11/11/05 | |||||
5 (2000) | 19,630,000(1) | 1:0.2521 | 4,948,648(1) | 42.05 | 06/13/06 | |||||
6 (2001) | 16,387,500(1) | 1:0.2521 | 4,131,226(1) | 13.49 | 12/10/07 | |||||
7 (2003) | 25,379,250 | 1:0.2000 | 5,075,850 | 7.00 | 12/08/09 | |||||
8 (2004) | 14,475,000 | 1:0.2000 | 2,895,000 | 7.50 | 12/13/10 |
The following table sets forth the number of warrant appreciation rights outstanding under the management incentive plan as of March 31, 2005.
Launch (Year) |
Warrant Appreciation Rights Outstanding(1) |
Expiration Date |
||
---|---|---|---|---|
3 (1999) | 345,520 | 06/09/05 | ||
4 (1999) | 16,700,000 | 11/10/05 | ||
5 (2000) | 30,335,000 | 06/12/06 | ||
6 (2001) | 33,160,000 | 12/09/07 | ||
7 (2003) | 19,999,500 | 12/07/09 | ||
8 (2004) | 30,490,000 | 12/13/10 |
Performance incentive share plan
In December 2004, we introduced a performance incentive share plan (Performance Plan) for members of our Group executive committee (EC Members). EC Members did not participate in the management incentive plan in 2004.
The Performance Plan involves annual conditional grants of ABB Ltd shares (or ADSs where deemed appropriate by the Nomination and Compensation Committee). The number of shares conditionally granted is dependent upon the base salary of the EC Member. The actual number of shares that the participants will receive free of charge at a future date is dependent on 1) the performance of ABB Ltd shares during a defined period (Evaluation Period) compared to those of a selected peer group of publicly-listed multinational companies and 2) the term of service of the respective EC Member in that capacity during the Evaluation Period. The actual number of shares received after the Evaluation Period cannot exceed 100 percent of the conditional grant.
The Evaluation Period of the initial launch was defined as the period from March 15, 2004, to March 15, 2006. The reference price of CHF 7.68 for the purpose of comparison with the peers was calculated as the average of the closing prices of the ABB Ltd share on SWX Swiss Exchange (virt-x) over the 20 trading days preceding March 15, 2004.
Our performance compared to our peers over the Evaluation Period will be measured as the sum, in percentage terms, of the average percentage price development of the ABB share price over the Evaluation Period and an average annual dividend yield percentage (Our Performance).
In order for shares to vest, Our Performance over the Evaluation Period must be positive and equal to or better than half of the defined peers. The actual number of shares to be delivered will be
123
dependent on our ranking in comparison with the defined peers. The full amount of the conditional grant will vest when Our Performance is better than three-quarters of the defined peers.
If an EC Member gives notice of resignation or, under certain circumstances is given notice of termination, and the vesting period has not expired, then the right to shares is forfeited. In the event of death or disability during the vesting period, the conditional grant size for that participant is reduced pro rata based on the remaining vesting period. An evaluation of the Company's Performance for the Evaluation Period up to the date of death or disability is made to establish the number of shares that vest. If a Performance Plan participant ceases to be an EC Member for reasons other than described above, the conditional grant size is reduced pro rata based on the portion of the vesting period remaining when the participant ceases to be an EC Member. In respect of a Performance Plan grant for which the vesting period has not expired, the Nomination and Compensation Committee can invite a new EC Member to receive a conditional grant, adjusted to reflect the shorter service period.
In 2004, 443,430 shares were conditionally granted to EC Members. In January 2005, a further 59,001 shares were conditionally granted under the 2004 launch to Michel Demaré as a new EC Member. See Note 22 to the Consolidated Financial Statements for additional information regarding the Performance Incentive Share Plan.
Compensation to former members of the group executive committee
In 2004, we made a total payment of CHF 1,454,722 ($1,274,730 at December 31, 2004) gross to two former members of the group executive committee who departed before the calendar year 2004, in fulfillment of contractual pension commitments (whereof CHF 589,592 ($516,642 at December 31, 2004) was made in January 2004, as already reported in the 2003 annual report on Form 20-F).
Employment Contracts
None of our board members or executive committee members benefits from a "golden parachute" clause which would become effective upon a change of control. Employment contracts normally contain notice periods of 12 months for executive committee members, during which they are entitled to salaries and bonuses. No director has a contract with us providing for further benefits upon termination of his board membership, other than pursuant to applicable employment agreements in case of simultaneous termination of their employment.
Additional fees and remuneration
Other than as disclosed herein, none of the members of our board of directors, our group executive committee, or persons closely linked to any of them received any additional fees and remunerations for services rendered to us. A closely linked person includes a spouse, children below the age of eighteen, legal or natural person acting as a fiduciary and legal entities controlled by a member of the board of directors or the executive committee.
Loans and guarantees granted to the board of directors or group executive committee.
We have not granted any loans or guarantees to our board members or members of our group executive committee.
Under our management incentive plan, certain members of the executive committee have received warrants and warrant appreciation rights in the years 1998 to 2003, although there were no grants to members of the executive committee in 2002 and 2004. For details of the various warrant launches please see "Item 6. Directors, Senior Management and Employees Management Incentive Plan."
124
As of March 31, 2005 the current members of the board of directors and executive committee held the following numbers of shares (or ADSs representing such shares), warrants and warrant appreciation rights:
|
|
|
Number of Warrants and Warrant Appreciation Rights Granted under Management Incentive Plan |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Number of Shares |
Number of Shares granted(2) |
Launch Year 1999 |
Launch Year 2000 |
Launch Year 2001 |
Launch Year 2003 |
||||||
Jürgen Dormann | 673,797 | | | | | 1,000,000 | ||||||
Roger Agnelli | 98,243 | | | | | | ||||||
Louis R. Hughes | 44,504 | | | | | | ||||||
Hans Ulrich Märki | 240,499 | | | | | | ||||||
Michel de Rosen | 68,843 | | | | | | ||||||
Michael Treschow | 51,898 | | | | | | ||||||
Bernd W. Voss | 136,970 | | | | | | ||||||
Jacob Wallenberg | 124,017 | | | | | | ||||||
Fred Kindle | 2,500 | 130,480 | ||||||||||
Dinesh Paliwal(1) | 110,000 | 110,475 | 100,000 | 250,000 | 1,000,000 | 1,000,000 | ||||||
Peter Smits | 51,000 | 113,282 | 100,000 | 250,000 | 1,000,000 | 1,000,000 | ||||||
Gary Steel | | 89,193 | | | | 1,000,000 | ||||||
Michel Demaré(1) | 500 | 59,001 | | | | | ||||||
Total | 1,602,771 | 502,431 | 200,000 | 500,000 | 2,000,000 | 4,000,000 |
The current members of our board of directors and executive committee owned less than 1 percent of our total shares outstanding as of March 31, 2005.
Other than as stated in the table above, no person closely linked to any member of the executive committee holds any shares of ABB or options in ABB shares. A closely linked person includes a spouse, children below the age of eighteen, legal or natural person acting as a fiduciary and legal entities controlled by a member of the board of directors or the executive committee.
Share amounts provided in this section do not include the shares beneficially owned by Investor AB, of which Mr. Wallenberg is chairman. See "Item 7. Major Shareholders and Related Party TransactionsMajor Shareholders."
As of April 30, 2005, we employed approximately 102,100 people. A breakdown of our employees by geographic region for the years ended December 31, 2004, 2003 and 2002, is as follows:
|
At December 31, |
|||||
---|---|---|---|---|---|---|
Region |
||||||
2004 |
2003 |
2002 |
||||
Europe | 60,200 | 70,500 | 89,200 | |||
The Americas | 16,300 | 19,000 | 23,700 | |||
Asia | 16,500 | 15,700 | 15,900 | |||
Middle East and Africa | 9,500 | 11,300 | 10,300 | |||
Total | 102,500 | 116,500 | 139,100 |
The proportion of our employees that are represented by labor unions or are the subject of collective bargaining agreements varies based on the labor practices of each country in which we operate. We estimate that approximately 63 percent of all ABB Group employees are covered by collective bargaining agreements. We believe that our employee relations are good.
125
Item 7. Major Shareholders and Related Party Transactions
To the best of our knowledge, as of May 23, 2005, the following persons held 5 percent or more of our total current issued share capital:
Name |
Number of Shares Owned |
Total Percentage of Share Capital |
|||
---|---|---|---|---|---|
Investor AB(1)(2) | 181,975,142 | 8.8 | % | ||
FMR Corp.(3) | 152,535,942 | 7.4 | % |
On March 19, 2003, pursuant to the rules of the Federal Act on Stock Exchanges and Securities Trading (the "Swiss Stock Exchange Act"), the Capital Group International, Inc. and certain of its affiliates announced that, as at March 11, 2003, it held a total of 64,043,388 of our registered shares, which at that time constituted 5.33 percent of our total share capital. On July 30, 2003, Capital Group International, Inc. reported pursuant to the rules of the Swiss Stock Exchange Act that as at July 22, 2003, it held a total of 59,978,124 of our registered shares, which at the time constituted less than 5 percent of our total share capital. On December 1, 2003, Capital Group International, Inc. and certain of its affiliates filed a Schedule 13D with the U.S. Securities and Exchange Commission, stating that as at November 21, 2003, these shareholders beneficially owned 84,099,190 of our registered shares, which at the time constituted 6.8 percent of our total share capital. On February 13, 2004, these shareholders amended their Schedule 13D, stating that as at December 31, 2003, Capital Group International, Inc. and certain of its affiliates held 133,888,830 of our registered shares, which at the time constituted 6.5 percent of our total share capital. On April 30, 2004, pursuant to the rules of the Swiss Stock Exchange Act, these shareholders announced that as at April 23, 2004, they owned less than five percent of our registered shares. On February 14, 2005, Capital Group International, Inc. and certain of its affiliates amended their Schedule 13D, stating that at December 31, 2004, these shareholders beneficially owned 184,350 registered shares, which at the time constituted less than 1 percent of our total share capital.
Under our articles of incorporation, each registered share represents one vote. Major shareholders do not have different voting rights.
126
To our knowledge, we are not directly or indirectly owned or controlled by any government or by any other corporation or person.
Under the Swiss Stock Exchange Act, shareholders and groups of shareholders acting in concert who reach, exceed or fall below the thresholds of 5 percent, 10 percent, 20 percent, 331/3 percent, 50 percent or 662/3 percent of the voting rights of a Swiss listed corporation must notify the corporation and the exchange(s) in Switzerland on which such shares are listed of such holdings in writing within four trading days, whether or not the voting rights can be exercised. Following receipt of such a notification, the corporation must inform the public within two trading days.
An additional disclosure requirement exists under the Swiss Federal Code of Obligations, according to which we must disclose individual shareholders and groups of shareholders and their shareholdings if they hold more than 5 percent of all voting rights and we know or have reason to know of such major shareholders. Such disclosures must be made once a year in the notes to the financial statements as published in our annual report.
At April 14, 2005, we had approximately 288,000 shareholders. Approximately 30,000 were U.S. holders, of which approximately 700 were record holders. Based on the share register, U.S. holders (including holders of ADSs) held approximately 6 percent of the total number of shares issued, including treasury shares, at that date.
In the normal course of our industrial activities, we sell products and derive certain other revenues from companies in which we hold an equity interest. The revenues derived from these transactions are not material for ABB Ltd. In addition, in the normal course of our industrial activities, we purchase products from companies in which we hold an equity interest. The amounts involved in these transactions are not material for ABB Ltd. Also, in the normal course of our industrial activities, we engage in transactions with businesses that we have divested. We believe that the terms of the transactions we conduct with these companies are negotiated on an arm's length basis.
We have participations in joint ventures and affiliated companies, which are accounted for using the equity method. Many of these entities have been established to perform specific functions, such as constructing, operating and maintaining a power plant. In addition to our investments, we may provide products to specific projects, may act as contractor of such projects or may operate the finished products. We may also grant lines of credit to these entities or for specific projects and guarantee their obligations, as discussed under the section entitled "Off-balance sheet arrangements" above. These joint ventures, affiliated companies or project-specific entities generally receive revenues either from the sale of the final product or from selling the output generated by the product. The revenue usually is defined by a long-term contract with the end user of the output.
Our risk with respect to these entities is substantially limited to the carrying value of the companies on our Consolidated Balance Sheets. The carrying value for the equity accounted companies at December 31, 2004 and 2003, was $596 million and $642 million, respectively.
Our 2004 and 2003 Consolidated Financial Statements include the following aggregate amounts related to transactions with equity accounted investees and other related parties, including related party transactions, that are recorded in loss from discontinued operations, net of tax, and assets and liabilities held for sale and in discontinued operations:
|
Year ended December 31, |
|||||
---|---|---|---|---|---|---|
|
2004 |
2003 |
||||
|
(U.S. dollars in millions) |
|||||
Revenues | $ | 57 | $ | 99 | ||
Receivables |
11 |
105 |
||||
Other current assets | 13 | 23 | ||||
Financing receivables (non-current) | 45 | 22 | ||||
Payables |
1 |
6 |
||||
Other current liabilities | 1 | 4 | ||||
Short-term borrowings | 18 | 32 | ||||
Non-current liabilities | 4 | 2 | ||||
Long-term borrowings | $ | | $ | 48 |
127
In December 2001, we entered into, and, in April 2002, we amended and restated, a $3 billion 364 day revolving credit facility. Skandinaviska Enskilda Banken ("SEB") was one of the lenders under the credit facility with a $155 million commitment representing approximately 5 percent of the total commitment available to us under the credit facility. In December 2002, we replaced that credit facility with a $1.5 billion 364 day revolving credit facility. SEB was also a lender under this credit facility, with a $145 million commitment, representing approximately 9.6 percent of the total commitment available to us. In addition, Dresdner Bank Luxembourg S.A. was a lender under the $1.5 billion credit facility, with a $97 million commitment, representing approximately 6.5 percent of the total commitment available to us. We repaid and cancelled the $1.5 billion bank facility in December 2003. On November 17, 2003, we entered into a new unsecured syndicated $1 billion three year revolving credit facility, which became available in December 2003 after the fulfillment of certain conditions including the repayment and cancellation of the former $1.5 billion facility. Each of SEB and Dresdner Bank Luxembourg S.A. has committed to $70.8 million out of the $1 billion total. Jacob Wallenberg, a member of our board of directors, is the vice-chairman of SEB and Bernd W. Voss, a member of our board of directors, is a member of the supervisory board of Dresdner Bank AG.
We consider our relationships with SEB and Dresdner Bank to be among our primary banking relationships. In addition to participating in the credit facilities described above, each of these banks has from time to time provided commercial banking, lending, investment banking and financial advisory services to us and our affiliates in the ordinary course of business. They have received customary fees and/or commissions for such services. We expect to continue to conduct transactions with them in the future on an arm's length basis.
In June 2003, we entered into a 10 year global framework agreement with International Business Machines Corporation ("IBM") to outsource our information systems infrastructure services to IBM. This global framework agreement forms the basis for country agreements entered into with IBM in 15 countries (status as of December 31, 2004) in Europe, North America and our headquarters representing a significant portion of our information systems infrastructure. The agreement involved the transfer to IBM of 800 of our employees, in addition to the 380 employees transferred under pilot programs prior to 2003. Our total expenditure in respect of the agreement will amount to approximately $1.7 billion over 10 years, based on the current level of usage of the services. While the agreement was negotiated and transacted at arm's length with IBM, it should be noted that Jürgen Dormann, our chairman (who at the time also served as our president and chief executive officer), was a member of the board of directors of IBM until April 29, 2003, and has again been appointed member of IBM's board of directors as of February 22, 2005. Hans Ulrich Märki, a member of our board of directors, is chairman of IBM Europe, Middle East and Africa.
During 2004 and during the first four months of 2005, we were party to several contracts with Companhia Vale do Rio Doce (CVRD), a Brazilian company with operations in mining, logistics (railways and ports) and power generation, and its subsidiaries. The largest contracts were for engineering services and the supply of electrical equipment for CVRD's pellets plant in the North of Brazil with a value of approximately $4.6 million. There are also various purchase orders for spare parts and machinery in general. The total value of such contracts is approximately $17 million. Roger Agnelli, a member of our board of directors, is president and chief executive officer of CVRD.
We are a supplier of transmission and distribution equipment to Duke Power. In 2004, we supplied turnkey installation support for both capital improvements and operation and maintenance projects. We recognized revenues in 2004 from Duke Power of $10 million, with a turnkey circuit breaker replacement order representing $3 million of that total. Roger Agnelli, a member of our board of directors, is a member of the board of directors of Duke Energy, the parent corporation of Duke Power.
In February 2004, we completed the sale of Etavis AG, our Building Systems business located in Switzerland, but retained a 10 percent ownership interest. In connection with this transaction, Etavis AG and our wholly owned subsidiary ABB Switzerland Ltd entered into a loan agreement, pursuant to
128
which we have extended a loan in the amount of CHF 1,858,974 to Etavis AG. This loan bears an interest at an annual rate of 3.5 percent. The largest amount of this loan outstanding during the period covered by this report was CHF 1,909,941 (or $1,673,625) as at December 31, 2004. As of April 27, 2005, the outstanding amount of this loan was CHF 1,909,941. Additionally, under the terms of the sale agreement, ABB Switzerland Ltd and our other affiliates in Switzerland are obligated to continue using Etavis AG as their preferred installations service provider until September 2005. In addition, we have agreed to use our best efforts to grant Etavis AG "most-favored nation" treatment for our new building technology products in Switzerland until March 2006.
There are no cross-shareholdings in excess of 5 percent of the share capital or the voting rights between ABB and another company.
129
CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
See "Item 18. Financial Statements" for a list of financial statements contained in this report.
We are involved in legal proceedings from time to time incidental to the ordinary conduct of our business. These proceedings principally involve matters relating to warranties, personal injury, damage to property, environmental liabilities and intellectual property rights.
ABB Barranquilla Inc. ("ABB Barranquilla"), a subsidiary of our ABB Equity Ventures Inc. ("ABB Equity Ventures") subsidiary, is an equity investor in Termobarranquilla S.A., Empresa de Servicios Publicos ("TEBSA"), which owns a Colombian independent power generation project known as Termobarranquilla. One of the other shareholders of TEBSA is Corporación Electrica de la Costa Atlántica ("CORELCA"), a government-owned Colombian electric utility. CORELCA also purchases the electricity produced from the Termobarranquilla project. In addition to our equity investment, our former power generation business was EPC contractor for Termobarranquilla. The project was awarded to us and another company, as joint bidders, after a competitive bidding process in 1994. The co-bidder manages the operation and maintenance of the facility. We entered into certain side agreements with the co-bidder for a sharing and reallocation of a portion of the amounts paid to us and to the co-bidder under the EPC contracts and the operation and maintenance contract. These side agreements were not disclosed at the time they were entered into to TEBSA or CORELCA. They also were not disclosed to the lenders who provided financing to TEBSA for the project, including U.S. Overseas Private Investment Corporation and U.S. Export Import Bank, at the time of the closing of such financing, as required pursuant to the lending documents.
On June 28, 2002, ABB Barranquilla, ABB Equity Ventures, the co-bidder, TEBSA and CORELCA settled all claims and potential claims by TEBSA and CORELCA arising out of the entry into or performance of the side agreements. CORELCA and TEBSA released and discharged ABB and its affiliates from any claims that TEBSA and CORELCA had, may have or may thereafter claim to have, arising on or before June 28, 2002 (the effective date of the settlement) and whether or not previously asserted, which in any way may arise out of or relate to the entry into or the performance of any of the side agreements. As consideration, we terminated the side agreements, paid $13 million to CORELCA, and reimbursed CORELCA for its legal expenses. We also agreed to indemnify (i) TEBSA for any and all penalties, fines and interest, if any, incurred by TEBSA arising out of or in connection with the entry into or performance of the side agreements and (ii) CORELCA for liabilities, costs or expenses related to certain taxes payable by CORELCA as a result of the settlement. On June 28, 2002, TEBSA's project lenders consented to the terms of the settlement and waived all defaults under the project lending documents arising out of the entry into or performance of the side agreements. As consideration for the lenders' consent and waiver, ABB Switzerland Holding Ltd. and the co-bidder agreed to indemnify the project lenders from and against (i) any investigation, litigation or proceeding related to the entry into or performance of the side agreements and (ii) any other exposure as a consequence of, or which might be asserted against any of the project lenders by virtue of, the failure of ABB or the co-bidder to disclose the side agreements. The indemnification obligation is joint but not several and is limited to the credit exposure of the project lenders. On December 31, 2004, the outstanding balance owed by TEBSA to the project lenders was approximately $160.5 million.
On February 3, 2003, ABB Ltd, ABB Holdings Inc. and ABB Equity Ventures entered into a compliance agreement with U.S. Export-Import Bank. The compliance agreement, among other things, requires us to adopt and maintain additional compliance procedures and allow U.S. Export-Import Bank to audit our compliance.
130
In response to information provided by our employees, during 2002 and 2003 we undertook an investigation of potentially improper business conduct within our Oil, Gas and Petrochemical division. In such internal investigations, we uncovered a limited number of improper payments by some of our employees and agents in the upstream business in Africa, Central Asia, and South America, which we have voluntarily disclosed to the U.S. Department of Justice and the U.S. Securities and Exchange Commission. The payments, which violated our internal policies on business ethics, were made in order to obtain from local officials confidential information and commercial advantages, including with respect to contracts on which we were bidding. For further information on the sale of the upstream part of the Oil, Gas and Petrochemicals business, see "Item 5. Operating and Financial Review and ProspectsAcquisitions, Investments and DivestituresDivestitures of businesses, joint ventures and affiliated companiesDivestitures in 2004" and "Item 10. Additional InformationMaterial ContractsSale Agreement for Part of the Oil, Gas and Petrochemicals Business."
Subsequently, ABB Vetco Gray Inc. and ABB Vetco Gray UK Ltd., two of our subsidiaries that were sold as part of the Oil, Gas and Petrochemicals upstream business in July 2004, pleaded guilty on July 6, 2004, to two counts of conduct in violation of the U.S. Foreign Corrupt Practices Act of 1977 (FCPA), relating to the payment of bribes to officials of NAPIMS, a Nigerian government agency that evaluates and approves potential bidders for contract work on oil exploration projects in Nigeria, including bidders seeking subcontracts with foreign oil and gas companies. According to the stipulated statement of facts, the two former subsidiaries paid more than $1 million in exchange for obtaining confidential bid information and favorable recommendations from Nigerian government agencies in connection with seven oil and gas construction contracts in Nigeria from which the companies expected to realize profits of almost $12 million. As part of the plea agreement, we paid a criminal fine of $10.5 million to the Department of Justice.
In a separate, but related, action, the U.S. Securities and Exchange Commission filed a complaint against us. The complaint alleges violations of anti-bribery, books and records, and internal control provisions of the FCPA, arising from alleged payments in Nigeria, Kazakhstan and Angola. ABB Ltd has agreed to a civil settlement that includes (i) the hiring of an independent consultant to review our policies and procedures as they relate to compliance with the books and records, internal accounting controls and anti-bribery provisions of the FCPA, (ii) the disgorgement of profits and pre-judgment interest of $5.9 million, and (iii) a civil penalty payment of $10.5 million, which is to be deemed satisfied by payment of the criminal fine to the Department of Justice discussed above.
In May 2004, we announced that we had undertaken an internal investigation which uncovered that certain of our employeestogether with employees of other companies active in the gas insulated switchgear businesswere involved in anti-competitive practices. We have reported promptly such practices to the appropriate authorities including the European Commission. We have received an amnesty decision from the European Commission and are cooperating with it in the investigation that it has launched.
In June 2004, we disclosed to the U.S. Securities and Exchange Commission and the Italian authorities the preliminary results of our inquiry conducted with the assistance of outside counsel and forensic accountants. Those results showed that from the first quarter of 1998 through the first quarter of 2004, the PT-MV BAU overstated its earnings before interest and taxes (operating income) and net income through the early recognition of certain revenue from incomplete projects, improper capitalization of costs on certain projects, unrecorded liabilities and borrowings, and other improper journal entries. As a result, the financial statements and certain financial data set forth in our Consolidated Financial Statements as of December 31, 2003 and 2002 and for each of the years in the three year period ended December 31, 2003 were restated in September 2004. The inquiry also uncovered improper payments to an employee of an Italian power generation company. The investigation by the Italian authorities is ongoing and we are not currently in a position to predict the outcome.
131
On April 19, 2005, we announced that we had made a voluntary disclosure to the U.S. Department of Justice and the U.S. Securities and Exchange Commission of certain suspect payments made by employees of ABB network management, a specialized U.S.-based business unit. The suspect payments became apparent during an internal investigation following the dismissal of two managers from the company in mid-2004. The payments were made to intermediaries in Latin America and in the Middle East in connection with the company's business, which is control software for utility customers. We are continuing our investigation and compliance review of this business.
If these payments are found to have been illegal, we could be subject to civil and criminal penalties. There can be no assurance that any governmental investigation or our investigation of these matters will not conclude that violations of applicable laws have occurred or that the results of these investigations will not have a material adverse effect on our business and results of operations.
For a description of our involvement in asbestos litigation, see "Item 3. Risk FactorsWe are subject to ongoing litigation and potentially substantial liabilities arising out of asbestos claims" and "Item 5. Operating and Financial Review and ProspectsAsbestos Liabilities."
See "Item 3. Key InformationDividends and Dividend Policy."
Except as otherwise described in this report, there has been no significant change in our financial position since December 31, 2004.
132
Item 9. The Offer and Listing
The shares of ABB Ltd are principally traded on virt-x (under the symbol "ABBN") and on the Stockholm Exchange (under the symbol "ABB"). The shares are also traded on the Frankfurt Exchange and the London Stock Exchange.
ADSs of ABB Ltd have been traded on the New York Stock Exchange under the symbol "ABB" since April 6, 2001. ABB Ltd's ADSs are issued under the Amended and Restated Deposit Agreement, dated May 7, 2001, with Citibank, N.A. as depositary. Each ADS represents one share.
In connection with the sale of our structured finance business, on September 4, 2002, trading in our shares was suspended for approximately two hours on virt-x, but not on any other exchange on which our shares trade. No other suspension in the trading of our shares occurred in the years ended December 31, 2002, 2003 and 2004.
The table below sets forth, for the periods indicated, the reported high and low closing sale prices for the shares on virt-x and the Stockholm Exchange and for the ADSs on the New York Stock Exchange. All share prices have been adjusted to reflect the share capital increase completed in December 2003.
|
|
virt-x(1) |
Stockholm Exchange |
New York Stock Exchange |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
High |
Low |
High |
Low |
High |
Low |
||||||||
|
|
(CHF) |
(SEK) |
($) |
|||||||||||
Annual highs and lows | |||||||||||||||
2000 | 43.24 | 30.10 | 232.43 | 173.22 | |||||||||||
2001 | 35.20 | 7.93 | 208.66 | 52.77 | 18.95 | (2) | 6.49 | (2) | |||||||
2002 | 14.52 | 1.29 | 91.44 | 8.30 | 11.11 | 1.14 | |||||||||
2003 | 6.66 | 2.02 | 39.88 | 12.81 | 6.24 | 1.95 | |||||||||
2004 | 8.18 | 6.20 | 48.00 | 36.10 | 6.70 | 4.93 | |||||||||
Quarterly highs and lows |
|||||||||||||||
2002 |
First Quarter |
14.52 |
8.73 |
91.44 |
54.78 |
11.11 |
6.60 |
||||||||
Second Quarter | 12.50 | 9.64 | 79.36 | 60.83 | 9.77 | 7.84 | |||||||||
Third Quarter | 10.87 | 3.86 | 68.48 | 24.57 | 9.07 | 3.40 | |||||||||
Fourth Quarter | 4.26 | 1.29 | 26.59 | 8.30 | 3.54 | 1.14 | |||||||||
2003 |
First Quarter |
3.74 |
2.02 |
24.09 |
12.81 |
3.51 |
1.95 |
||||||||
Second Quarter | 4.05 | 2.56 | 24.01 | 16.27 | 3.95 | 2.43 | |||||||||
Third Quarter | 6.66 | 3.29 | 39.88 | 20.14 | 6.12 | 3.01 | |||||||||
Fourth Quarter | 6.53 | 5.39 | 37.95 | 32.07 | 6.24 | 4.79 | |||||||||
2004 |
First Quarter |
8.01 |
6.26 |
46.70 |
36.10 |
6.44 |
5.08 |
||||||||
Second Quarter | 8.18 | 6.51 | 48.00 | 38.90 | 6.34 | 5.10 | |||||||||
Third Quarter | 7.75 | 6.20 | 45.40 | 37.20 | 6.20 | 4.93 | |||||||||
Fourth Quarter | 8.00 | 6.20 | 46.70 | 36.10 | 6.70 | 5.43 | |||||||||
2005 |
First Quarter |
7.64 |
6.35 |
44.70 |
37.30 |
6.52 |
5.42 |
||||||||
133
Monthly highs and lows |
|||||||||||||||
2004 |
November |
7.14 |
6.65 |
42.10 |
39.60 |
6.24 |
5.69 |
||||||||
December | 7.04 | 6.20 | 41.40 | 36.10 | 6.17 | 5.43 | |||||||||
2005 |
January |
6.93 |
6.35 |
40.50 |
37.30 |
5.91 |
5.42 |
||||||||
February | 7.18 | 6.69 | 42.30 | 39.10 | 6.12 | 5.59 | |||||||||
March | 7.64 | 7.12 | 44.70 | 42.10 | 6.52 | 6.15 | |||||||||
April | 7.80 | 7.22 | 45.90 | 42.70 | 6.53 | 6.10 |
THE SWX SWISS EXCHANGE AND VIRT-X
ABB Ltd's shares are listed on the main board of the SWX Swiss Exchange and are included in the Swiss Market Index, a capitalization-weighted index of the shares of 27 large Swiss corporations currently traded on virt-x. ABB Ltd is subject to the regulations and listing rules of the SWX Swiss Exchange.
The SWX Swiss Exchange was founded in 1993 as the successor to the local stock exchanges of Zurich, Basel and Geneva. Trading in foreign equities and derivatives began in December 1995. In August 1996, the SWX Swiss Exchange introduced full electronic trading in Swiss equities, derivatives and bonds. The aggregate value of trading activity of Swiss shares, investment funds, warrants, and bonds as well as other non-Swiss shares, warrants and bonds on the SWX Swiss Exchange and on virt-x was in excess of CHF 1,200 billion in 2004. As of December 31, 2004, the equity securities of 409 corporations, including 120 foreign corporations, were listed and traded on the SWX Swiss Exchange.
&nbs