a n n u a l r e p o r t Contents

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2 a n n u a l r e p o r t Contents Financial Information Management Report for the Danfoss Group Danfoss Divisions Danfoss Refrigeration & Air Conditioning Division Danfoss Heating Division (including Danfoss Water Controls) Danfoss Motion Controls Division Group projects Danfoss Services Sauer-Danfoss Inc Management report for Danfoss A/S Financial and operational risk management Accounting policies Management statement & audit report Profit and loss account Balance sheet Statement of cash flow Capital and reserves Notes, table of contents Danfoss Group Companies Organisation Financial highlights (DKK) Financial highlights (EUR) Corporate Citizenship Introduction People and Values Social Responsibility (CSR) Environment Accounting principles Audit endorsement Danfoss A/S DK-6430 Nordborg, Denmark CVR No.: Tel.: Fax: danfoss@danfoss.com

3 2005 in brief Danfoss is one of Denmark s largest industrial companies. Danfoss is a global Group which plays a leading role within research, development, production, sales and service of mechanical and electronic components for a large range of sectors. Danfoss activities are divided into three main business areas: Danfoss Refrigeration & Air Conditioning Division: The division supplies products and services worldwide within refrigeration and air conditioning. Danfoss Heating Division including Danfoss Water Controls: The division supplies a number of components and services worldwide within heating and water. Danfoss Motion Controls Division: The division supplies products and services within frequency converters and gearmotors for industries globally. Danfoss strives to reach its goals with a minimum consumption of raw materials and energy, the least possible impact on the environment and efficient use of resources. Danfoss has a long-standing tradition for social responsibility towards employees and the external environment. Danfoss owns 38.4% of the shares in Sauer-Danfoss, which is one of the world s leading producers and suppliers of mobile hydraulics and electronic components for agricultural and entrepreneurial vehicles. Highlights in 2005 The positive development of the last four months of the year exceeded the Group s expectations announced at the half-year, fulfilling the original expectations for the entire year. The Group net sales, amounting to 16.4bn DKK, is approximately the same as in the previous year. The growth in net sales amounted to 5%, when calculated at last year s exchange rates and adjusted for acquisitions and divestments. The operating profit excluding other income and expenses was 910m DKK which is at level with the previous year. The operating profit (EBIT) amounted to 943m DKK, a decrease of 12%, which was primarily due to less non-recurrent income compared to the year before. The result before taxes amounted to 999m DKK, an increase of 7% compared to the previous year. The number of employees rose to 18,168 from 17,543, an increase of 4%. Acquisitions in 2005: AGH Warmte-units b.v., Holland; FWT Wärmetechnik AG, Germany; Thermia Värme AB, Sweden; Holip, China; and Senstronics Ltd., England. Divestments in 2005: Als Motor A/S, Denmark, Danfoss Analytical A/S, Denmark, and the Spring Factory, Denmark. Expectations for 2006 Net sales are expected to reach 17.0 to 17.5bn DKK. This equals a growth of between 4% and 7% compared to The operating profit (EBIT) is expected to be 1.0 to 1.1bn DKK. The EBIT margin is expected to be between 6.0% and 6.5%.

4 F i n a n c i a l I n f o r m a t i o n Management Report for the Danfoss Group The Group s net sales were 16.4bn DKK, approximately the same as in the previous year. Calculated at last year s exchange rate level and adjusted for acquisitions and divestments this equals a growth of 5%. Operating profit was 943m DKK. The result before tax was 999m DKK, 7% higher than in The positive development in the last four months of the year meant that the Group s expectations at the half-year were exceeded and the original expectations for the whole year were met. It must be noted that even in an extremely competitive and difficult market, Danfoss chose to continue with a high level of investment activity in various projects and activities all of which are aimed to ensure that the Group maintains long-term competitiveness and earning potential. In 2006, Danfoss expects net sales to reach 17.0 to 17.5bn DKK. This equals a growth of between 4% and 7% compared to The operating profit (EBIT) is expected to be 1.0 to 1.1bn DKK. Any effects of future acquisitions and divestments are not included in the expectations. Group sales Distributed by divisions mill DKK 20,000 15,000 10,000 5,000 % Danfoss Refrigeration & Air Conditioning Division Danfoss Heating Division (including Danfoss Water Controls) Danfoss Motion Controls Division Other activities Distributed by regions EU excl. DK Denmark Rest of Europe Latin America North America Africa & Middle East Asia Pacific Net sales in 2005 were bn DKK, which was about the same as in 2004 when they reached 16,345bn DKK. When calculated at last year s exchange rates and adjusted for acquisitions and divestments the growth was 5%, which is slightly lower than in 2004, when the similar growth was 9%. Danfoss entered 2005 expecting that the beginning of an upward global trend would affect the Group s markets and therefore maintained a corresponding level of activity. However, it was evident that by the end of the halfyear, that assumptions had not been met and despite several markets showing a growth in sales, the Danfoss Group did not meet its projected targets in its key markets. Lower net sales meant a reduction in capacity utilisation, which led to greater production costs. This, combined with the continued high cost of raw materials and fierce price competition had a negative affect on earnings. However, at the half-year end the decision was taken to proceed with a series of strategic Group projects, which in the long-term will help secure the Group s competitiveness and earnings. At the same time other projects were also brought forward. Consequently, expectations of net sales and earnings for the whole year were readjusted accordingly to bn DKK and m DKK. Original expectations were at bn DKK and 900-1,000m DKK. The development in the Group s largest core business area, Danfoss Refrigeration & Air Conditioning Division, was the cause of the downward adjustment of the figures. In the last four months of the year, several markets again began to show signs of improvement and throughout the whole year some markets, particularly in North and Latin America, showed decent growth. The main European market showed only moderate growth throughout the year but towards the end of the year there were signs of a rise in customer sales. The important German market also showed signs of improvement. Central and Eastern Europe, including the Russian market, showed steady double-digit growth. Asian markets, including China, were not quite able to live up to last year s growth rate.

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6 Group result mill DKK 1,200 1, Operating profit (EBIT) Operating profit excl. other income and expenses Profit before tax Raw material prices, index Jan 04 Jun 04 Dec 04 Jun 05 Dec 05 Mar 04 Sep 04 Mar 05 Sep 05 Copper Oil Brass Steel EBIT margin/rona % EBIT margin RONA The unexpected positive development in the latter four months of the year meant that the Group s expectations were exceeded so that original expectations for the whole year were met. Operating profit excluding other operating income and expenses were 910m DKK, and at the same level as the previous year. Despite sales remaining at the same level as 2004 and the cost level being relatively higher than expected, it was still possible to achieve an acceptable operating result. The effect of a lower capacity utilisation was significant. Earnings were further affected by bringing forward a series of strategic projects, which in the longterm will create the conditions for better earnings. Costs of the Group s strategic and operational projects reached 109m DKK in 2005 (89m DKK). Research and development costs were increased by 36m DKK to 594m DKK in order to build up innovation and support growth in coming years. Danfoss is currently going through a period of reorganisation and restructuring which will secure the Group s future profitability and competitiveness. The relocation of parts of the compressor production from Germany to Slovakia and of parts of the refrigerator thermostat production from Denmark to Slovakia were elements of the restructuring. The results of these projects are expected to appear in the next few years. Some of the already noticeable effects of the projects meant that Danfoss, in a difficult market, was able to show an acceptable operating profit excluding other operating income and expenses. It was also decided in 2005 that Danfoss should increase its sales in Japan through a working partnership with Saginomiya Seisakusho Inc. The local Danfoss sales organisation was therefore shut down. This incurred one-off payments and provisions of 42m DKK. Moreover, the result is negatively affected by a loss of 23m DKK from the sale of a plane. Operating profit (EBIT) ended at 943m DKK compared to 1,072m DKK which equals a decrease of 12%. The decrease is primarily due to less non-recurrent income than in Operating profit was therefore better than the Group expected following the downward adjustment at the half-year end and the Group s expectations at the start of 2005 were therefore met. In this light the result is considered satisfactory. The share of income from Sauer-Danfoss reached 114m DKK which is an increase of 13% in comparison to the same period of the previous year. In 2005 Sauer-Danfoss showed a growth in both net sales and earnings. Financial income and expenses were 22m DKK net which is an improvement of 213m DKK. The positive development in the financial items can primarily be ascribed to considerable exchange rate adjustments/gains in 2005 as a result of increasing rates in USD and USD related currencies. In accordance with IFRS 2 (Share-based Payment), financial items have also been affected by an addition of 32m DKK to the Group s share remuneration programme, compared to 114m DKK in The result before tax rose to 999m DKK from 931m DKK which equals a growth of 7% compared to The result for the year was 733m DKK compared to 699m DKK in This represents an increase of 5%. This is considered a satisfactory result when taking into account the increasing price of raw materials and falling growth rates which were particularly present in the first half of RONA measures the Group s ability to carry the interest of its net assets. In 2005 RONA was 12.1% compared to 15.5% in The decrease can be 6

7 Cash flows mill DKK 1,500 1, ,000 1,500 2, Cash flow from operating activities Cash flow from investing activities Free cash flow Net interest-bearing debt mill DKK 1,200 1, ascribed to a combination of lower results and an increased balance following goodwill in connection with the acquisition of companies and activities. Equity increased to 8,693m DKK from 7,787m DKK which meant a growth of 12% while the equity ratio was at 59.4% (59.1%). Statement of cash flows free cash flow The free cash flow, which is a combination of cash flows from operations of 1,192m DKK and cash flows from investments of 1,626m DKK totalled, 434m DKK compared to 281m DKK the previous year. The change compared to the previous year can mainly be ascribed to the acquisition of companies and fewer investments in fixed assets. Cash flows from operating activities totalled 1,192m DKK, a decrease of 40m DKK compared to Cash flows are affected by lower interest rates and less fluctuation in the working capital. Cash flows from investing activities amounted to 1,626m DKK, an increase of 675m DKK or 71%. In 2005 a series of acquisitions affected the level of investment. This meant that the collective cash flows following purchase and sale of companies totalled 504m DKK compared to 355m DKK in 2004 when there were major one off earnings from sales of activities. Financial resources Net interest-bearing debt rose to 825m DKK in 2005 from 167m DKK the previous year which represents an increase of 658m DKK, primarily due to loans in connection with acquisitions. This meant that the Group s leverage (net interest-bearing debt as percentage of Shareholders Equity) rose to 9.5% compared with 2.1% in Danfoss policy is to maintain considerable long-term financial resources. The Group had on December 31, 2005 unused long-term binding credit facilities of about 3.3bn DKK (3.4bn DKK). Changes to accounting policies Comparable figures for results and net capital for the Group have been subject to changes to accounting policies and appear differently to the 2004 Annual report. The most important change concerns calculation of warrants and options (the 2001 program) in the profit and loss and balance sheet. For 2005, impact of the change on the profit and loss (under financial expenses) is 32m DKK before tax. Accordingly, the comparable figures for 2004 have been affected by 114m DKK before taxes. There have also been several reclassifications. The most important concerns tax in associated companies and joint ventures. The share of profit from these companies is now calculated after tax in the profit and loss account, whereas previously, it was recognised before tax. The Group s result for the year has not been affected by this change. Please refer to Accounting Policies for further details. Research and development Research and development are essential criteria for the Group s future growth and such activities are primarily conducted within the individual business areas. At Group level 3.9% (3.5%) of net sales was used for research and development in 2005 excluding venture activities. This equals 646m DKK including capitalised development costs. This is a growth of 14% compared to the

8 previous year. The increase reflects Danfoss wish to strengthen its activities in research and development. Within the refrigeration field, Danfoss received in 2005 the prestigious American innovation prize AHR Innovation Award for its new Plug & Cool cooling system which has been designed in such a way that it can be integrated in, for example, soft drink vending machines. The flexibility of the concept enables new cooling technologies to be introduced to customers step by step, without having to replace the entire vending machine. A new development centre for turbo compressor technology is being set up in Nordborg, Denmark. The centre will be researching new ways to apply the technology. The new American environmental requirements for energy use in private air conditioning units have meant that the TR6 valve, which enables better management of air conditioning units, has been adapted accordingly and a high level of automation has made it profitable to set up a new product line in Nordborg, Denmark. As for the heating market, 2005 not only saw the launch of a new generation of wireless controls together with a complete range of components for installing water based floor heating, but also a design series of radiator thermostats. Danfoss Motions Controls Division presented several new features to the industrial market for the new frequency converter VLT AutomationDrive FC301 together with new hardware for the VLT 5000 series. In April the High Power frequency converter was presented to the global market at the Hanover Trade Fair in Germany. For further information on product development and market introductions, please refer to the Divisions individual reports. The Group files a number of patent applications each year for new inventions in order to safeguard research results. In 2005, 83 (71) new applications were filed and the Group obtained approvals of a total of 138 (222) patents. The total number of active patents at the end of 2005 was 962. Danfoss Ventures In 2004, a new strategy was launched for venture activities and in 2005 Danfoss Ventures has concentrated on being the focal point for both internal and external business ideas as well as on putting the parameters in place for venture activities. The Group s target is to spend between m DKK yearly on venture activities. This will be used to further the development of new business ideas which lie outside the core business areas but which have the potential to either strengthen or expand them. In 2005, as a result of a higher level of activity a total of 149m DKK was spent on venture activities compared with 127m DKK the previous year. Every venture has its own management team led by a senior Danfoss manager. All ventures follow business plans and must meet certain milestones to make financing available for further development. An important element in the implementation of the venture strategy is to have the right people involved in venture activities. Danfoss has therefore put into place a series of activities to attract employees who have an interest in business development and in expanding their skills in this field. More than 100 people are involved in the network Man on the Moon. The aim of the network is to educate members through seminars, workshops and, via competitions, to bring out and develop the best business ideas. The establishment of

9 proper training courses in intrapreneurship has also begun (i.e. how to behave as an entrepreneur within the company). Knowledge and the environment To ensure Danfoss is able to handle global competition in the future, it is important that employees have the necessary skills and competences. One of the most essential areas is therefore continued professional and personal employee development. Skills development does takes place through traditional course attendance but is also increasingly forming part of the day-to-day work schedule and via internal courses which aim to improve and optimise the daily processes within Danfoss. The shift from the more traditional courses to a more personal and direct job related training and strengthening of skill sets is supported by an increased use of e-learning. In 2005, an e-learning function was established across the Group with the aim of progressing and developing those activities which, for many years, have been used within, for example, product knowledge. In 2005, Danfoss spent approximately 112m DKK on employee training, which is in line with the previous year. All of the Group s factories must implement environmental management systems according to the international environmental management standard ISO The environmental management systems ensure that the environmental impact is reduced at source and that the environmental work is embedded in the entire organisation. The Group s preventive environmental work means that new environmental requirements are not expected to require major investments in any of the production plants. The introduction of two EU-Directives concerning the use of electronic products and the prohibition of certain substances within electronic products will only affect earnings slightly in the years to come. The directives are expected to incur additional costs of less than 10m DKK per annum. The directive concerning environmentally-friendly development of energy-consuming products, EuP, is expected to come into force in 2008 or 2009 and will only slightly affect costs for product development. In 2005, a pilot project was launched to introduce the certified working environment management system (OHSAS 18001) in the factories outside Denmark. The pilot project is expected to start in the spring of 2006 in 4-6 of the factories. Evaluation of the pilot project will determine whether working environment management should be implemented throughout the whole Group, as has already happened in Denmark. The section on Corporate Citizenship includes further information about employees and environmental matters. Employee Conditions At the end of 2005, Danfoss had a total of 18,168 employees which represents an increase of 625 employees compared with The number of employees has been reduced throughout 2005 with 221 as a result of the divestment of activities. The purchase of new businesses has meant an addition of 515 employees. Thus, the real growth in the number of employees is 2%. Employees are divided between regions with 14,460 in Europe (14,245), 1,536 in North America including Mexico (1,527), 1,688 in Asia Pacific including China (1,213) and 484 in other regions (558). At the end of 2005 Denmark

10 had 5,810 employees compared to 6,048 the previous year. The reduction in employees is mainly due to the sale of companies. The Executive Committee and Board At the Danfoss Annual General Meeting on April 15, 2005, Hans Michael Jebsen was elected as a new member of the Board, because Jørgen M. Clausen did not offer himself for re-election. The Board then elected Henrik E. Nyegaard as Chairman and Tom Kähler as Vice-Chairman. In May there was a reallocation of work tasks within the Executive Committee and this change resulted in the Executive Committee being composed as follows: Jørgen M. Clausen, President and Chief Executive Officer (CEO). Ole Steen Andersen, Executive Vice President and Chief Financial Officer (CFO). Niels B. Christiansen, Executive Vice President and Chief Operations Officer (COO). Hans Kirk, Executive Vice President and Chief Development Officer (CDO). In December there was an election of employee representatives to the Board. Niels Christian Jørgensen and Arno Knöpfli were re-elected and Jens Peter Nielsen was elected as a new employee representative replacing Henning Wendelboe, who chose not to run for re-election. Jens Peter Nielsen will become a member of the Board at the Danfoss A/S Annual General Meeting on April 4, The Group s organisation The Group is organised in three core business areas: Danfoss Refrigeration & Air Conditioning Division, Danfoss Heating Division (including Danfoss Water Controls) and Danfoss Motion Controls Division. Sales happen mainly via regional sales organisations within the individual divisions. The divisions also each include a number of Business Units, maintaining development and production within different product groups. The Group s venture activities are organisationally placed at Danfoss Ventures. Danfoss consists of a further series of shared corporate and service functions. In order to make personnel and HR conditions more uniform, the decentralised HR and personnel functions were reorganised in 2005 and assembled in a new Global HR organisation. Acquisition and sale of companies Acquisition of companies, business expansion and establishments in 2005 With effect from January 1, 2005, Danfoss took over the sales and development company AGH Warmte-units b.v in Nieuwegein (Uttrecht), Holland. The company s net sales for 2004 were approximately 37m DKK and it has three employees. In April, Danfoss acquired FWT Wärmetechnik AG in Hamburg, Germany. This company sells and develops small and large substations for district heating, hot water systems for houses, anti-legionella systems and heat exchangers. The company s net sales for 2004 were approximately 75m DKK and it has 28 employees. The acquisition of AGH Warmte-units b.v and FWT Wärmetechnik AG should be viewed as part of the Group s strategy to become the leading sup- 10

11 plier to the district heating industry. AGH Warmte-units b.v is included in the accounts as of January 1, 2005 and FWT Wärmetechnik AG is included as of April 1, In June, Danfoss took over the heat pump manufacturer Thermia Värme AB in Arvika, Sweden. In 2004 the company had net sales of approximately 330m DKK and it has 230 employees. The company is included in the accounts as from July 1, In June, the construction of the 15,000m 2 new factory in Wuqing, China, was completed. At the same time, the first sod was turned for a further extension of 10,000m 2. The construction budgeted at 39m DKK is expected to be completed during spring When the construction is complete, the Danfoss factories, administration offices and warehouse in Wuqing will measure a total of 50,000m 2. On August 23, Danfoss entered into an agreement for the acquisition of the products and Intellectual Property Rights from the German company Eucon. Eucon supplies system solutions, consultancy and project management for heating, light, ventilation, climate and energy-surveillance of supermarkets in Germany. In November, Danfoss acquired the Chinese producer of frequency converters Holip (Zhejiang Haili Electronic Technology Co. Ltd) with 200 employees and net sales of approximately 65m DKK. The company is included in the accounts from November 1, In December, Danfoss, together with Launchchange Ltd, a subsidiary of the Danaher Group, took over the English company Senstronics Ltd in a 50/50 joint venture. Senstronics, which is a producer of pressure transmitters, had a turnover of 30m DKK in 2004 and 69 employees. The company will be included in accounts as of December 31, Sale of companies, relocations and outsourcing in 2005 In May, the competition authorities approved the agreement on the sale of Danfoss Analytical A/S to the Danaher Group, entered into in December As a consequence of the fierce price competition within the refrigerator/ freezer market, Danfoss moved the production of refrigerator/freezer thermostats from Nordborg in Denmark to the Danfoss factory in Slovakia. The move was carried out at the end of the year and affected 77 employees in Nordborg, Denmark. It has been possible to secure employment for almost all the affected employees. In June, Danfoss sold 51% of its shares in Als Motor A/S Sønderborg, to Als Motor Holding A/S. The company had net sales of approximately 235m DKK in 2004 and has 93 employees. The company is included in the accounts until May 1, In 2006, Danfoss sold its remaining shares to Als Motor Holding A/S. In July, Danfoss entered an initial agreement with Capgemini about outsourcing part of the Group s finance and book-keeping transactions to Capgemini in Krakow, Poland. The agreement is expected to affect approximately 110 employees in Europe and South Africa. In August, Danfoss sold its Spring factory in Tinglev, Denmark, with 46 employees, to the Swedish spring manufacturer Lesjöfors AB. The company was included in accounts until September 30, In September, Danfoss entered into an agreement with the Japanese Group Saginomiya Seisakusho Inc. whereby, from January 1, 2006, the company will take over sales and service of Danfoss products on the Japanese market. The agreement meant that Danfoss Japanese subsidiary was closed on Decem- 11

12 ber 31, out of the company s 67 employees were offered jobs with Saginomiya. Risk factors Every business-related activity carries with it a risk which can affect future results. Danfoss is focusing on identifying the most important risks and is actively looking at how they can be managed. As part of ongoing risk management, Danfoss aims continuously at identifying the risks areas that could have a negative impact on the Group s activities, financial results or future growth. The identified, monitored risk areas include financial and operational areas, risks related to customers and market conditions as well as those related to the company s environmental and social responsibility. This list of risks is not exhaustive but covers those areas most likely to affect the Group in the future. Financial and operational risk management Danfoss central finance department deals with the financial and operational risk management in cooperation with the Group s business units. For further information, please refer to the section Financial and Operational Risks. Lawsuits Danfoss is a party to a few lawsuits. It is the view of the management that the outcome of the lawsuits will not have a considerable impact on the Group s financial position. Losses on customers The risk of losses on customers is primarily connected with customers nonpayment for products already supplied. The Group supplies many different products to customers worldwide and none of the customers are large enough to be a risk of critical business losses. Product Risk Even though the majority of Danfoss products do not incur any risk during use, they can be sub-components in end products that are possibly hazardous to the surroundings. Danfoss therefore invests time and money to ensure that the products are environmentally-friendly and safe for customers. Environment Danfoss environmental work is based on a number of internal rules and standards that are defined in the Group s Environmental Policy. In addition to these rules, all of the Group s factories must, of course, comply with the requirements set by the local authorities in the countries where the factories are located. In 2005, Danfoss acquired a range of companies. Prior to any acquisition, due diligence is carried out which includes environment, working environment and security relations. Examination of the company s registrations together with an inspection of the company itself and interviews with employees ensures that financial and environmental risks together with relations which can damage Danfoss reputation are all covered. Information on environmental relations is collected together with other information on the company prior to any acquisition negotiations. 12

13 The section on Corporate Citizenship contains further information on the Group s environmental matters. UN Global Compact In 2002, Danfoss joined UN s Global Compact which encourages businesses to contribute to the creation of sustainable development in the world. Global Compact was chosen as the framework for how Danfoss manages its social and environmental responsibility, both internally and externally. For further information about Danfoss management of the social and environmental responsibility, refer to the section on Corporate Citizenship. Events following the close of the financial year. Organisational change in the Danfoss Refrigeration & Air Conditioning Division As part of the process to make the Danfoss Refrigeration & Air Conditioning Division more customer and market orientated the Division was restructured. This took place on January 1, The Division will now have three business units: Danfoss Automatic Controls, Danfoss Compressors and Danfoss Electronic Controls & Sensors. The three business units will be supported by a global sales and marketing organisation. For further information regarding the new organisation please refer to the section on Danfoss Refrigeration & Air Conditioning Division. As of January 6, 2006, the New Zealand company Heatcraft NZ LTD has taken over the sales and support of Danfoss cooling and air-conditioning products on the New Zealand market. The 20 employees in the local Danfoss company will all be offered jobs with Heatcraft NZ LTD. Significant events that would affect the Group s financial position have not been recorded after the Balance Sheet date. Expectations for 2006 expects the following for 2006: Net sales are expected to reach 17.0 to 17.5bn DKK. This equals a growth of between 4% and 7% compared to The operating profit (EBIT) is expected to be 1.0 to 1.1 bn DKK. The EBIT margin is expected to be between 6.0% and 6.5%. Any impact from future acquisitions and divestments is not included in the expectations. Prerequisites In 2006, growth is primarily expected to come from the North and Latin American markets, Eastern and Central Europe and from the Chinese market, which again is expected to add to the collective growth. Markets in the rest of Asia and Europe are expected to show a moderate growth. A large part of Danfoss sales outside Europe are settled in dollars. A low dollar exchange rate could therefore mean a restricted growth in net sales when exchanged to Danish kroner. The expectations are based on a dollar exchange rate of 6.05 DKK/USD. The price of raw materials is expected to remain high for Development of copper, brass and aluminium is particularly uncertain and there is likewise a risk of increasing energy prices. Danfoss will try to hedge selected raw 13

14 materials and thereby try to even out some of the major fluctuations in raw material prices. If prices continue to rise at the same rate as in 2005, it will have a negative impact on results for The Group s projects, which have already been started and brought forward, will also have a negative impact on results for 2006, but the projects are important to secure the Group s long-term competitiveness. There are no immediate plans to start any new and larger Group projects. Strategy Danfoss strategy is based on the Danfoss Vision. The Vision was drawn up in 2001 and guides the organisation to reach future targets that are defined in the perspective plan. Danfoss will be a global leader within our core businesses, as a highly respected company, which improves quality of life by mastering advanced technologies in customer applications while creating value for all stakeholders perspective plan The perspective plan describes targets of the Group, including the projects and activities which will allow Danfoss to get closer to its strategic goal of being number one or two within all of the strategic core businesses by the end of the perspective period in In 2008 the target for net sales is 24bn DKK, which corresponds to an average yearly growth of 9% in the period 2004 to The increase in net sales is to be achieved through a combination of organic growth and acquisitions. Growth is primarily expected to come from the North and Latin American markets, Eastern Europe and Asia. Profitability will also be strengthened, in that earnings capacity measured in terms of an EBIT margin is to be 10%. In 2005 the EBIT margin stood at 5.7%. The goal for RONA (Return on Net Assets) in the perspective period is 20% at the end of In 2005, RONA was 12.1%. In particular, the Group has high expectations from the Chinese market and a new strategy was prepared in 2004 for this market, which will help to secure the Group s annual sales growth of 40% during the perspective period. In order to reach the targets of the Chinese market, it will be necessary to recruit a considerable number of employees in China. In 2005, approximately 1,230 (747) were employed in China which corresponds to a growth of 65% compared to Acquisitions are an important part of Danfoss efforts to become global leader within its strategic core business areas. Ongoing acquisitions will be made during the perspective period. Based on the Group s strategic core business areas, Danfoss evaluates potential acquisition candidates on an ongoing basis. Despite the business being focused on the Divisions core competencies, the company portfolio will be under an ongoing evaluation as to whether Danfoss continues to be the right owner or whether individual activities will be able to develop more successfully under new ownership. Danfoss Business System is an essential project to ensure the targets of the perspective plan are reached. For further information please refer to Danfoss Business System. 14

15 Geographic distribution of shareholders Others Asia/Pacific North & Latin America 1,500 1, Rest of Europe England Slovenia France Germany Denmark Fluctuation in market price of Danfoss shares DKK/aktie Relationships with shareholders Danfoss share capital is 1,022.98m DKK and is divided into two share classes: A and B. A-shares are 425.0m DKK and B-shares are m DKK. A-shares entitle ten votes for every 100 DKK share (nominal value) while B shares entitle one vote for every 100 DKK share (nominal value). Owners of A-shares also have pre-emptive rights to B-shares in the event of any increases in share capital. The Bitten and Mads Clausen Foundation and the Clausen family jointly own all A-shares and a number of B-shares equalling 99.4% of the votes. Danfoss has about 7,200 employee shareholders of whom about 25% are employed at companies outside Denmark. The employee shareholders and senior management together own about 3% of share capital and hold about 0.6% of the votes. All employee shares are B-shares. Shareholders with more than 5% share capital: Bitten and Mads Clausen Foundation, Nordborg Clausen Controls A/S, Sønderborg, Denmark Henrik Mads Clausen, Lake Forrest, USA Bente Skibsted, Lutry, Switzerland The Danfoss shares are not freely negotiable. The Bitten and Mads Clausen Foundation has the pre-emptive right to shares sold to individuals who are not descendants of Bitten and Mads Clausen. However, employee shares are excepted. Should the Foundation not exercise this pre-emption right, transfers can only take place with the consent of the Board of the Bitten and Mads Clausen Foundation. Employee shares In 2004, employees were offered the annual opportunity to buy or sell shares in a limited period only and in continuation of the Annual General Meeting at the fixed market price (2005:1,438 DKK). 51 employees took advantage of this offer and acquired a total of 1,146 shares. These shares will only be sellable following the Annual General Meeting in Fluctutations in market price for Danfoss shares Danske Bank fixes the market price of the Danfoss shares once a year before the Annual General Meeting in April. The first employee shares were issued in 2001 and this was also the first time the market price of the shares was fixed. In 2001 the market price was fixed at 749. The calculation of the market price is based upon Danfoss economic development, the Group s expectations for coming years, the ability to meet the stated expectations, the economic development for other similar companies and their future expectations together with the general development on the stock market. The 2005 price was 1,438. Dividends and Annual General Meeting The Board proposes that the dividend for the accounting year of 2005 is fixed at 18%, corresponding to 184m DKK (152m DKK). The dividend percentage was increased compared to 15% in The dividend will be paid in Danish kroner and 28% Danish dividend tax will be deducted from Danish shareholders. For shareholders outside Denmark, dividend tax will be deducted according to the joint taxation agreements that Denmark and the countries in question have entered into. 15

16 The Board Henrik E. Nyegaard Chairman (born 1940) Tom Kähler Vice-chairman (born 1943) Hans Michael Jebsen (born 1956) Peter J. M. Clausen Vice President (born 1949) Sven Murmann Managing Director (born 1967) Companies with major board activities: Chairman of: Gyldendal A/S Vice Chairman of: Rockwool A/S VELUX A/S VKR Holding A/S Board member of: The Bitten and Mads Clausen Foundation Lousiana Museum MAN B&W A/S Companies with major board activities: Chairman of: Rockwool International A/S A/S Saltbækvig Rockwool Fonden Vice Chairman of: The Bitten and Mads Clausen Foundation Board member of: A.P. Møller og Hustru Chastine Mc-Kinney Møllers Fond til almene Formaal Member of the Advisory Board of: Danske Bank Companies with major board activities: Chairman of: Jebsen & Co Ltd Board member of: A.P. Jessen Fonden Hysan Development Co Ltd Wharf (Holdings) Ltd Companies with major board activities: Chairman of: The Bitten and Mads Clausen Foundation Fabrikant Mads Clausens Fond Als Motor A/S Danfoss Educational Scholarship Board member of: The Mads Clausen s Institute Companies with major board activities: Chairman of Bibus Hydraulik AG, Schweiz Schleswig-Holstein Musik Festival Foundation Board Vice Chairman of: Sauer-Danfoss Inc., USA The ordinary Annual General Meeting will take place in Nordborg, Denmark, on April 4, Financial Calendar Financial reports in 2006 will be published on the following dates: May 15, First quarterly report 2006 September 4, Interim report 2006 November 13, Third quarterly report 2006 Corporate Governance The Danfoss Board is following the public debate surrounding Corporate Governance and will be considering if new proposals and advice should be integrated into the Group s Corporate Governance policy. Danfoss has a two-tier management system consisting of a Board and an Executive Committee. The Board has the overall responsibility for the company activities while the Executive Committee is responsible for day-to-day operations. Good corporate governance is based on key words such as responsibility, integrity and openness regarding the Group s activities. It is important that the individual leader knows how to act within his or her own powers and the framework of the law. The Articles of Association of the company and a large number of procedures for internal management and control are also included in Danfoss Corporate Governance. Annual General Meeting The Annual General Meeting has the ultimate authority in all company matters. The ordinary Annual General Meeting is held before the end of the fourth month after the end of the accounting year. All shareholders, who have requested an admission card, are allowed access to the Annual General Meeting and can ask questions of the Board and the Executive Committee. Shareholders can send proposals for the meeting s agenda, which must arrive at the Board no later than March 1 in order to be discussed at the Annual General Meeting. Danfoss has Class A and Class B shares, of which the A-shares are entitled to ten votes per share and the B-shares are entitled to one vote per share. Decisions are made by an ordinary majority at the Annual General Meeting, unless otherwise stated by law or by Danfoss Articles of Association. The Board The Board is elected at the Annual General Meeting and has the overall responsibility for company activities. The Board determines, among other things, the overall strategies and objectives and also defines the Executive Committee s guidelines for daily operations of the Group. The order of business contains a description of the allocation of tasks between the Board and the Executive Committee. Current issues are decided through simple majority at Board meetings and in case of equality of votes the Chairman holds the deciding vote. At least five Board meetings are held each year and one Board meeting is held in connection with a visit to one of the Group s locations. Each year, the strategy, target and perspective plan, among other items, are evaluated and updated. During 2006, the Board will decide as to how Danfoss will be ready to live up to the EU s 8th Directive concerning the setting up of an audit committee. 16

17 Bente Skibsted (born 1942) Niels Christian Jørgensen Employee Board Member (born 1950) Shop steward in Metal Deputy Senior Shop Steward Arno Knöpfli Employee Board Member, Senior Engineer (born 1959) Henning Wendelboe Employee Board Member (born 1945) Bitten Clausen Honorary Member Companies with major board activities: Board member of: The Bitten and Mads Clausen Foundation Companies with major board activities Board member of: The Bitten and Mads Clausen Foundation Sønderborg Lufthavn A.m.b.a. Member of: Nordborg Byråd Companies with major board activities: Chairman of: The Danfoss European Information and Consultation Forum, EICF Board member of: The Bitten and Mads Clausen Foundation Companies with major board activities: Chairman of Danfoss Employee Foundation Board member of: The Bitten and Mads Clausen Foundation The Danfoss Board consists of nine members: six elected at the Annual General Meeting, three employee-elected representatives and Bitten Clausen, who is a honorary member appointed by the Board. The members elected at the Annual General Meeting are elected for one year at a time so that all members elected at the Annual General Meeting are up for election at the ordinary Annual General Meeting. The employee-elected Board members are, according to Danish law, up for election every four years. In 2005 Niels Christian Jørgensen, Arno Knöpfli and Jens Peter Nielsen were elected. The next election will be held in Jens Peter Nielsen joins the Board in connection with the ordinary Annual General Meeting on April 4, On December 31, 2005, the Board consisted of: Elected at the Annual General Meeting: Henrik E. Nyegaard (Chairman), Tom Kähler (Vice-Chairman), Hans Michael Jebsen, Peter M. Clausen, Sven Murmann and Bente Skibsted. Employee-elected: Niels Christian Jørgensen, Arno Knöpfli and Henning Wendelboe. Honorary Member: Bitten Clausen The Board members are not required to be shareholders of Danfoss and the age limit of elected members is 70 years. Vice President of Corporate Communications & Reputation Management Ole M. Daugbjerg takes the minutes of Board Meetings. Executive Committee The Executive Committee, which can consist of between two and six members, holds the day-to-day responsibility for the Group s operation and is employed by the Board. The current age limit for members of the Executive Committee is 65 years. At the end of 2005, the Executive Committee consisted of four members: CEO and President Jørgen M. Clausen and Executive Vice Presidents Ole Steen Andersen, Niels B. Christiansen and Hans Kirk. The Executive Committee holds weekly meetings. According to the order of business, the Executive Committee must see to it that the following issues, among others, are discussed at least once a year at a Board meeting: Assessment of internal control functions, including IT security. Securing of capital resources, book-keeping and property management. Establishment of risk management systems, including insurance issues and currency management. Review and updating of the order of business, the Corporate Governance policy and internal sets of rules. Preparation of budget, three year plans and perspectives. Audit The audit safeguards the interests of shareholders and the public. At the ordinary Annual General Meeting, an independant auditor is elected to deal with the audit tasks until the next Annual General Meeting. 17

18 Executive Committee Jørgen M. Clausen President CEO (born 1948) Ole Steen Andersen Corporate Vice President CFO (born 1946) Companies with major board activities: Chairman of: Sauer-Danfoss Inc. Forskningscenter RISØ Højteknologifonden Junior Achievement, Young Enterprise (Europe) Board member of: The Bitten and Mads Clausen Foundation Member of the Advisory Board of: Danske Bank Companies with major board activities: Chairman of: Cowi A/S Board member of Danske Trælast Auriga A/S Sauer-Danfoss Inc. In 2003, an agreement was entered into with KPMG C.Jespersen to attend to all of Danfoss subsidiaries in Denmark and abroad, in addition to being the Group s corporate auditor. The agreement is renegotiated annually. At the last Annual General Meeting, the auditing firm KPMG C.Jespersen was appointed as Group auditor until the next ordinary Annual General Meeting. Reporting All of the Group s companies report figures to the monthly, quarterly and annual reports in one and the same reporting environment, securing complete transparency across all of the Group s units. The reporting is prepared according to the International Financial Reporting Standards (IFRS). The Group s Corporate Citizenship reporting takes place within the framework of UN s Global Compact. In order to minimise the Group s risks, the individual companies reporting is reviewed by centrally located accounting controllers. At least once a year the Board approaches the internal audit environment. Vice President Corporate Communications & Reputation Management Ole M. Daugbjerg and Vice President of Corporate Finance Per Have are responsible for the Danfoss Group s entire reporting. Risk Management See the section on Risk Factors. Niels Bjørn Christiansen Corporate Vice President COO (born 1966) Hans Kirk Corporate Vice President CDO (born 1943) Companies with major board activities: Board member of Axcel Companies with major board activities: Chairman of: NIRAS Gruppen Teknologisk Institut Board member of: The Bitten and Mads Clausen Foundation Sauer-Danfoss Inc. Remuneration of the Executive Committee and Board The Board members receive an annual fee set at the Annual General Meeting. In addition to the above mentioned fee, payment can be conferred on Board members who have performed special tasks. Additional payments have not been transferred in The total Board fee for 2005 was 3m DKK (2m DKK). Included in the fee, the Board was granted share options. The members of the Executive Committee have individual remuneration packages that are adjusted once a year by the Board. In addition to the regular remuneration, a bonus scheme is linked to financial development of Danfoss A/S. Apart from that warrants are also included, as described in detail in the section Warrants and Options. The Executive Committee receives gross pay, which includes a pension contribution paid by the company. Each member of the Executive Committee can choose to retire at the age of 63 and will then continue to be paid a sum that equals their gross pay until the age of 65. The members of the Executive Committee have a notice period of between one to three years, depending on the time they have been on the Executive Committee. The Executive Committee members are entitled to severance pay equalling 36 months remuneration, if the employment ends for other reasons than own resignation. All members of the Executive Committee are entitled to a redundancy scheme if Danfoss is taken over by another company and can, in such a case, also resign at short notice. Such an event does not mean that granted options can be used since obligations in connection with warrant agreements would be taken over by any other purchaser of the Group. The total Executive Committee fee for 2005 was 27m DKK (29m DKK). Included in the fee, the Executive Committee was also granted share options. 18

19 Warrants and Options Danfoss has introduced a range of incentive programmes based on shares for senior employees, the Executive Committee and the Board. Since 2001, the senior employees and the Executive Committee have been granted warrants in several turns and at the end of 2005, 81 senior employees and the four members of the Executive Committee had been granted a total of 333,261 warrants. The Board has also been granted options in several turns since As of December 31, 2005, the Board members have been granted a total of 18,000 options. At the 2004 Annual General Meeting a new option scheme for the Board and a new subscription scheme to the Executive Committee and senior employees was decided upon. The schemes allow the participants to be granted options and warrants from 2005 to The maximum number of warrants to be granted totals 9,600 and 242,064, respectively, of which about one third were granted in The conditions of being granted warrants or options are based on an annually fixed target for RONA. The participation in the incentive scheme is also conditional on the fact that the senior employees and the Executive Committee buy a number of shares at full market price (2005: 1,438 DKK each). 19

20 f i n a n c i a l i n f o r m a t i o n Danfoss Divisions Division profiles The Danfoss Refrigeration & Air Conditioning Division consists of three business units and four sales units. The three business units, Danfoss Automatic Controls, Danfoss Compressors and Danfoss Electronics & Sensors are, within their product areas, responsible for product development, production and key customers. The products are manufactured at 27 factories in 16 countries. The Division sells products on the global market through its own sales organisation which is dedicated towards customer groups within Air Conditioning Key Accounts, Food Retail and Industrial Automation. A fourth sales unit is dedicated to the major markets of Commercial Refrigeration, Industrial Refrigeration and, not least, the significant market on which sales takes place via the refrigeration wholesalers. Financial highlights Danfoss Refrigeration & Air Conditioning Division mill DKK Net sales Operating profit Intangible fixed assets Tangible fixed assets Total assets Non-interest-bearing debt Net assets Net investments (excl. goodwill) Net investments in goodwill Depreciation / amortisation Impairments Cash flow from operating activities (excl. paid tax and financial items) Cash flow from investing activities ,583 8, ,702 1,967 5,189 5,669 1,678 1,605 3,449 4, Number of employees EBIT margin RONA 9,006 9, % 5.4% 18.3% 12.0% Danfoss Heating Division offers a number of components and solutions for the generation, supply and control of heating to optimise comfort and save energy in private households and small commercial buildings. The Division is a leading company within the global industry with production facilities in more that 10 countries, and sales companies and agents on all heating markets worldwide. The constant improvement of products and services has enabled Danfoss Heating Division to build strong relationships with customers and business partners throughout the value chain. Danfoss Water Controls produces and offers components for the water industry in the form of valves and related products. The business unit s sales and service network covers all markets, which means that Danfoss can offer assistance to both global and local customers. Regional companies maintain marketing, sales and customer service with highly qualified staff close to the customers. Danfoss Heating Division (including Danfoss Water Controls) mill DKK Net sales Operating profit Intangible fixed assets Tangible fixed assets Total assets Non-interest-bearing debt Net assets Net investments (excl. goodwill) Net investments in goodwill Depreciation / amortisation Cash flow from operating activities (excl. paid tax and financial items) Cash flow from investing activities Number of employees EBIT margin RONA ,192 4, , ,884 3, ,109 3, ,143 4, % 10.9% 22.5% 19.7% 20

21 Danfoss Motion Controls Division is comprised of two business units: Danfoss Drives and Danfoss Gearmotors with factories in Denmark, China, Slovakia, Germany and the USA. Danfoss Drives and Danfoss Gearmotors operate as independent business areas, which cooperate to offer package solutions to the customers. The division has a global network of sales offices offering professional service to the customers. Danfoss Drives is the global market leader in the food, beverage, HVAC and water industries and has activities within the automobile, chemical, petrochemical, textile, steel and mining industries in selected markets. Danfoss Gearmotors delivers gearmotors for industrial applications and holds a strong position within the automobile, material handling and steel industry. Danfoss Motion Controls Division mill DKK Net sales Operating profit Intangible fixed assets Tangible fixed assets Total assets Non-interest-bearing debt Net assets Net investments (excl. goodwill) Net investments in goodwill Depreciation / amortisation Cash flow from operating activities (excl. paid tax and financial items) Cash flow from investing activities ,208 3, ,572 1, Number of employees EBIT margin RONA 2,816 3, % 7.9% 37.0% 27.1% 21

22 f i n a n c i a l i n f o r m a t i o n Danfoss Refrigeration & Air Conditioning Division The Danfoss Refrigeration & Air Conditioning Division achieved net sales in 2005 of 8,351m DKK compared to 8,583m DKK in 2004, a decrease of 3%. The operating profit was 449m DKK, which is a decrease of 27% compared to the year before. The result is not considered satisfactory. Refer to the division s profile and financial highlights on page 27 The net sales decreased to 8,351m DKK from 8,583m DKK, a decrease of 3%, primarily due to the divestment of the Elsmark Group in the autumn of The growth in net sales was 4% in 2005, when converted at last year s exchange rates and adjusted for acquisitions and divestments. The result is acceptable in the light of the very weak demand on the Division s main markets in the first half of the year. The first half year was characterised by considerable costs incurred through adjusting production levels to the poor demand which in turn resulted in a reduced capacity utilisation. At the end of the year, demand and capacity once again balanced which improved the profitability of the business. The difficult market conditions also meant that the increasing material prices could not fully be covered by increases in prices. Because of the result at the half year, strategic projects were initiated and brought forward to secure the Division s long-term competitiveness. The decision lead to a restructuring of selected parts of the divisional activities in Japan and Denmark, among other things, which resulted in non-recurrent expenses totalling 42m DKK. The operating profit was 449m DKK compared to 615m DKK the year before. This is a decrease of 27%, which is considered unsatisfactory. The return on the Divisions net assets (RONA) was 12%, compared to 18.3% the year before. The decline in the result and a 556m DKK increase in the net assets had an effect on RONA. The increase in the net assets was primarily due to the high activity level at the end of the year which increased the funds tied up in the form of increased amounts owed by the customers. In addition to this, the relocation of production to sites such as the one in Slovakia has had an impact on the net assets. The cash flow from operating activities amounted to 853m DKK, equalling an increase of 46m DKK. In spite of the decrease in operating profits, cash flows were not reduced correspondingly which was primarily due to a significant reduction of the working capital. The cash flow from investing activities amounted to 655m DKK, an increase of 203m DKK compared to However, income from the sale of the Elsmark Group was set off, affecting the cash flow amount in The relocation of the household compressor production from Danfoss factory in Flensburg, Germany, to the factory in Slovakia was initiated in The first compressor line was relocated in the autumn of 2005 and approximately 170 employees left at the end of the year. The relocation will ensure that the Group continues to be competitive in the field of household compressors. The 22

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24 factory in Flensburg, Germany, will remain a competence centre for the entire compressor production. The production of small-sized commercial compressors will continue to take place in Flensburg. The Division anticipates net sales and profit to increase in 2006, as a result of the implemented restructuring and the increasing growth in the Division s markets, among other things. Market development for the Danfoss Refrigeration & Air Conditioning Division The growth in the markets in North and Latin America continued, showing very satisfactory double-digit growth rates. All markets and business areas of the region improved significantly, especially sales to the major air conditioning OEMs (Original Equipment Manufacturers) had a major breakthrough in Because some of the large European customers adjusted their stocks, demand in the first half year was less than anticipated. The total sales to customers in the EU countries were, however, largely unchanged compared to 2004, as a result of a good fourth quarter. The year was characterised by a generally low financial activity level in many countries, including Italy that in previous years showed high growth rates. In spite of the generally difficult situation, the Division managed to realise decent growth rates on the markets in Germany, France and Sweden. Sales in the Asia-Pacific markets did not show the same growth rates as in previous years. One of the reasons was that sales stagnated on the mature markets in Australia, New Zealand and Japan. A decline in the number of publicly financed construction projects in China meant that the substantial increase in demand shown in previous years could not be maintained, because a large part of Danfoss sale to China is to air conditioning OEMs. Consequently, sales in China only grew moderately in On the markets in Korea, India and Taiwan double-digit growth rates were achieved. To support the Division s sale of integrated solutions for refrigeration control in supermarkets, an agreement was made in 2005 for the takeover of products and know-how from the German company Eucon. Danfoss entered a joint venture with a company of the Danaher group to take over the English company Senstronic Ltd. The purpose of the takeover was to strengthen the current pressure transmitter product range. As a result of the restructuring, the New Zealand company Heatcraft NZ LTD took over the sale and support of Danfoss refrigeration and air conditioning products on the market in New Zealand, after the end of the accounting year. Products and R&D The Plug & Cool refrigeration system was awarded the prestigious American innovation prize AHR Innovation Award for being the most innovative, new product in 2005 within its category. The system is a complete refrigeration system designed to be easily integrated in, for example, soft drink vending machines. In comparison with conventional systems, it is easier to replace and maintain the Plug & Cool system. In this way, significant savings can be obtained throughout the entire life span of the vending machine. Additionally, the concept makes it possible for customers to gradually introduce new refrigeration technologies, which are more energy-efficient or which are based on natural refrigerants such as CO 2, without having to replace the entire vending machine. 24

25 In order to meet the increasing demand for oil-free turbo compressors for commercial air conditioning the Danfoss Turbocor Compressors Inc. s headquarters and production will be moved from Montreal, Canada, to Tallahassee, Florida in A new development centre for turbo compressor technology is being established in Nordborg, Denmark. The purpose of the centre will be to research new opportunities to utilise the technology. As a consequence of new environmental requirements in the USA, (SEER13), concerning energy consumption of private air conditioning systems, the TR6 valve was made to comply with the new American requirements. The valve facilitates more accurate control of air conditioning systems. To comply with the demand, the Division decided to expand the existing valve production in Mexico. In addition, a new production line for TR6 valves was established in Nordborg, Denmark, in The project is a fine example of the fact that it is possible to establish new production in Denmark, when the potential for a high degree of automation exists. Organisational changes In order to sharpen focus on customers and markets and begin a gradual generational change, the organisational structure of the Danfoss Refrigeration & Air Conditioning Division was changed as of January 1, Three new development and production units were set up, based on three main technologies within refrigeration and air conditioning. At Danfoss Compressors, all of Danfoss compressor activities were joined together through a gradual integration of Danfoss Household Compressors, Danfoss Commercial Compressors and Danfoss Appliance Controls. Through the integration of Danfoss Refrigeration and Air Conditioning Controls and Danfoss Industrial Controls, activities relating to mechanical and electro-mechanical components for the control and regulation of refrigeration and air conditioning and other industrial systems will be grouped in Danfoss Automatic Controls. Danfoss Electronic Controls & Sensors will be the centre of activities relating to electronic and mechatronic products for the control and regulation of refrigeration, air conditioning and other industrial systems. Moreover, three new organisations will be established in relation to sale and marketing with focus on customer groups within Air Conditioning Key Accounts, Food Retail and Industrial Automation. A fourth sales organisation will be dedicated to the markets for Commercial Refrigeration, Industrial Refrigeration and refrigeration wholesalers. Perspective plan The Division expects to increase net sales in the period, through acquisitions and alliances with companies doing business within the existing activities and in areas that are similar to the current core business, in addition to organic growth. The cooperation with both Danaher Inc. and Saginomiya Seisakusho Inc. are concrete examples of how this strategy is being realised. Through an expanded cooperation with a number of international customers on the development and supply of new products and solutions, Danfoss is expected to strengthen its market position within refrigeration and air conditioning. Danfoss range of compressors will be modernised and significantly expanded in the perspective period. The Division s production flow will be adjusted in connection with the Group s productivity program, which means that an increasing number of compressors are being produced in countries with a competitive cost level, such as China, Slovakia and Slovenia. The 25

26 expansion of the range will be done partly through own development and the establishment of joint ventures, and partly through acquiring companies which can provide Danfoss with new compressor technologies. Today, the Danfoss Refrigeration & Air Conditioning Division is an important player in China. The target is to retain and expand this position, through, among other things, the expansion of the production capacity, the development of new products for the Chinese market and through the acquisition of companies. The ambition is for the market share in China to be comparable with Danfoss large market shares in the European market. 26

27 Division profile Danfoss Refrigeration & Air Conditioning Division consists of three business units and four sales units. The three business units, Danfoss Automatic Controls, Danfoss Compressors and Danfoss Electronics & Sensors are, within their product areas, responsible for product development, production and key customers. The products are manufactured at 27 factories in 16 countries. The Division sells products on the global market through its own sales organisation which is dedicated towards customer groups within Air Conditioning Key Accounts, Food Retail and Industrial Automation. A fourth sales unit is dedicated to the major markets of Commercial Refrigeration, Industrial Refrigeration and, not least, the significant market on which sales takes place via the refrigeration wholesalers. Financial highlights for Danfoss Refrigeration & Air Conditioning Division mill DKK Net sales Operating profit Intangible fixed assets Tangible fixed assets Total assets Non-interest-bearing debt Net assets Net investments (excl. goodwill) Net investments in goodwill Depreciation / amortisation Impairments Cash flow from operating activities (excl. paid tax and financial items) Cash flow from investing activities Number of employees EBIT margin RONA ,583 8, ,702 1,967 5,189 5,669 1,678 1,605 3,449 4, ,006 9, % 5.4% 18.3% 12.0% Division sales Distributed by regions % EU excl. DK Denmark Rest of Europe Latin America North America Africa & Middle East Asia Pacific

28 f i n a n c i a l i n f o r m a t i o n Danfoss Heating Division (including Danfoss Water Controls) The net sales of Danfoss Heating Division reached 4,640m DKK in 2005 compared to 4,192m DKK in This is an increase of 11%. The operating profit increased by 13% to 505m DKK. This result is considered satisfactory. The results from the business unit Danfoss Water Controls are included in the overall figures for Danfoss Heating Division. Refer to the division s profile and financial highlights on page 32 Net sales increased to 4,640m DKK in 2005 from 4,192m DKK in 2004, corresponding to a growth of 11%. When calculated at last year s exchange rates and adjusted for acquisitions and divestments the growth was 4%, which is considered satisfactory when the general market development is taken into consideration. The Division s various business areas generally displayed satisfactory growth in 2005, continuing the positive development. The markets in Eastern Europe and Russia developed particularly satisfactorily, while several Western European markets only displayed weak growth and in a few cases stagnation. In 2005 the Division participated in the continuous implementation of the cross-group project directed at production, sales and procurement (Danfoss Business System), and thereby achieved significant process improvements across the value chain. The Group s improvement projects have, however, tied up significant resources, which have had a negative effect on the result, but it is expected that the improvements will contribute positively to earnings in the future. The operating profit rose to 505m DKK from 449m DKK, a growth of 13%. The result was negatively affected by costs incurred with the integration of acquired companies. The Division s RONA (Return on Net Assets) reached 19.7% compared to 22.5% in 2004, primarily due to the fact that the division s net assets increased as a result of company acquisitions. Cash flows from operations amounted to 548m DKK, which is 96m DKK less than in The cash flows from investing activities amounted to 820m DKK, increased by 456m DKK due to acquisitions. In 2006 the Division will continue to focus on increasing sales by focusing even more on the customers and the sales process, and by keeping an eye on opportunities to develop business in new areas. The positive developments on most of the markets are expected to continue. Therefore, the business areas within Danfoss Heating Division are expected to develop positively in Market development in Danfoss Heating Division Constantly increasing energy costs and various political initiatives, e.g. the EU s directive regarding energy consumption in buildings, have increased interest in the Division s products. 28

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30 All business areas within Danfoss Heating Division achieved high growth rates in Eastern Europe and Russia, and seen as a whole the Division strengthened its market position in The Western European market was also characterised by difficult market conditions in 2005, but the launch of a number of sales-stimulating activities started to show results in several countries in the second half of Sales in China did not reach the same high level as in Developments in the district heating market followed the same trends as in previous years with limited growth in Scandinavia and Central Europe, while the markets in Eastern Europe, Russia and China continue to grow rapidly. In Western Europe there is a continued tendency towards installing complete district heating units rather than piecing them together from single components as was previously common. Danfoss Comfort Controls maintained its position in the Western European markets in 2005 and has strengthened its position in new markets such as Eastern Europe and the Middle East. Sales of radiator thermostats in the Russian market are going well and are expected to rise significantly in the years to come. Danfoss Floor Heating achieved a fine increase in sales that resulted in a generally strengthened market position. This growth will be supported in 2006 by a number of sales supporting activities and continuous expansion into new markets. Danfoss Burner Components experienced a drop in sales in 2005, partly due to the divestment of Danfoss Spring factory and a generally low activity level on the market for oil burners. The high oil prices have indirectly contributed to a shift to other forms of heating that are not dependent on oil prices, which affected the sales of oil burners. In spite of the difficult market conditions the business area has succeeded in strengthening its relative market position. In 2005 the Division continued its focus on sales growth and business development, which resulted in the acquisitions of the Swedish producer of oil pumps, Thermia, the Germany-based FWT Wärmetechnik, and the Dutch company AGH Wärmte-units as a continued expansion of the Division s district heating strategy. Additional focus on the Division s core businesses resulted in the divestment of the industrial metering business to the German company Metra Energie Messtechnik GmbH and the sale of Danfoss Spring factory to the Swedish company Lesjöfors. Products and R&D During 2005, a number of new products for the district heating business were introduced, including controls, heat exchangers and district heating stations. As a result of acquisitions, the product program has been expanded with container solutions and stations for water heating, combined district heating and cooling as well as small stations. Danfoss Comfort Controls introduced several new products in 2005 that focus on design in the segment for thermostats for bathroom radiators. This has strengthened the market position in the growing design segment. In 2005 Danfoss Floor Heating introduced a new generation of wireless controls and a complete range of components for the installation of waterbased floor heating. WebHome has also been developed further, so that the electric floor heating setup can be controlled via the internet, and also other features such as monitoring of electricity and water consumption. 30

31 Heat Pumps has introduced a new air-water heat pump, which makes operation possible in temperatures down to 20 C. The water-water range was also expanded with a capacity regulating heat pump. Perspective plan During the perspective period the Division will focus on growth within selected components and solutions for heating and climate applications for residential and commercial buildings. The underlying condition for the growth strategy is the continued development of the markets in Eastern Europe, Russia, China and selected business areas in North America. In order to secure its leading position Danfoss Heating Division will actively participate in the ongoing consolidation in the market. Innovative product development that focuses on user and installation friendliness will also contribute to strengthening the division s market position in established markets. Danfoss Heating Division will also focus on developing its business through company acquisitions within the division s focus areas. In the perspective period the Division will focus on profitability through process improvements across the entire value chain. It is therefore expected that Danfoss Heating Division can retain its current earnings while also focusing on continued growth. Danfoss Water Controls In 2005 Danfoss Water Controls experienced growth in its main markets, and the markets in Eastern Europe, Asia and North America in particular displayed good growth rates. In spite of difficult conditions in Western Europe the business area succeeded in winning market shares, partly following the introduction of the new series of industrial butterfly valves in The launches of a new type of large, industrial butterfly valves for the water segment and special industrial applications were well received by the market. At the end of the year a new type of sealed valve (Aquosus) was introduced and it is expected that the valve will win a significant share of the market in the future. In 2005 Danfoss Water Controls participated in the Group s productivity program, where the factory in Mery achieved improvements of more than 20%. 31

32 Division profile Danfoss Heating Division offers a number of components and solutions for the generation, supply and control of heating to optimise comfort and save energy in private households and small commercial buildings. The Division is a leading company within the global industry with production facilities in more that 10 countries, and sales companies and agents on all heating markets worldwide. The constant improvement of products and services has enabled Danfoss Heating Division to build strong relationships with customers and business partners throughout the value chain. Danfoss Water Controls produces and offers components for the water industry in the form of valves and related products. The business unit s sales and service network covers all markets, which means that Danfoss can offer assistance to both global and local customers. Regional companies maintain marketing, sales and customer service with highly qualified staff close to the customers. Financial highlights for Danfoss Heating & Water Division (including Danfoss Water Controls) (INCL. DANFOSS WATER CONTR mill DKK Net sales Operating profit Intangible fixed assets Tangible fixed assets Total assets Non-interest-bearing debt Net assets Net investments (excl. goodwill) Net investments in goodwill Depreciation / amortisation Cash flow from operating activities (excl. paid tax and financial items) Cash flow from investing activities Number of employees EBIT margin RONA ) ,192 4, , ,884 3, ,109 3, ,143 4, % 10.9% 22.5% 19.7% Division sales Distributed by regions % EU excl. DK Denmark Rest of Europe Latin America North America Africa & Middle East Asia Pacific

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34 f i n a n c i a l i n f o r m a t i o n Danfoss Motion Controls Division The Danfoss Motion Controls Division had net sales in 2005 of 3,211m DKK which was in line with the previous year. The operating profit amounted to 252m DKK which corresponds to a decrease of 29%. The result is considered to be very satisfactory considering the divestment of Danfoss Marine Systems in Refer to the division s profile and financial highlights on page 38 In 2005, the Danfoss Motion Controls Division obtained net sales of 3,211m DKK, which was in line with the previous year where it amounted to 3,208m DKK. When calculated at last year s exchange rates and adjusted for acquisitions and divestments the growth was 9%, which is considered satisfactory. Sales on the EU markets developed positively, in particular the important German market. The division experienced double-digit growth rates on the markets in Latin and North America and on the Asian market. This resulted in an increased market share and a stronger market position. Moreover, the development on the Chinese market was satisfactory. The total operating profit of Danfoss Motion Controls Division amounted to 252m DKK in 2005, compared to 354m DKK in 2004, corresponding to a decrease of 29%. The result is considered very satisfactory given the divestment of Danfoss Marine Systems in When adjusted for non-recurrent items in 2004 the profit increased by 20%. As a result of the reduced earnings, the RONA (Return on Net Assets) of the division was 27.1%, compared to 37.0% in the previous year. The cash flows from operating activities amounted to 411m DKK, which was an increase of 44m DKK compared to The cash flows from investment activities amounted to 228m DKK, compared to 150m DKK in 2004, which was affected by the earnings in connection with the divestment of Danfoss Marine Systems. The Danfoss Productivity Program continued in Three projects were launched at Danfoss Drives, two in Gråsten, Denmark, and one in Milwaukee, USA. Danfoss Gearmotors launched a project in Munich, Germany. So far, eight projects have been launched in Motion Controls. The projects resulted in productivity improvements of up to 25%. Danfoss Silicon Power participated in one of the first pilots in the Full Potential Purchasing Program, which is expected to reduce purchasing prices considerably in the next years. In 2006, Danfoss Motion Controls Division will participate in the Danfoss Sales Program. The program aims to support the sales organisation in increasing sales and earnings and by developing a strong culture of ongoing improvements. Danfoss Motion Controls Division expects earnings to increase in 2006, as a consequence of the completed restructuring of activities in Danfoss Gearmotors, the Group s Productivity Program and the improved market prospects. 34

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36 Market development for Danfoss Drives The growth of Danfoss Drives continued in 2005 where sales were 13% higher than last year and considerably higher than the market growth. Danfoss Drives maintained its position as one of the largest worldwide suppliers of frequency converters for motors from kw. In 2005, Danfoss Silicon Power strengthened its position in the automobile segment by entering into agreements with several car manufacturers on the supply of parts for electronic control of both conventional cars and the more environmentally friendly hybrid cars. In Europe, the three business areas, HVAC (Heating, Ventilation and Air Conditioning), Food & Beverage and Industry, grew considerably. The sale of the new product line, VLT AutomationDrive, exceeded expectations and Germany in particular experienced soaring sales. North America benefited from double-digit growth rates within the HVAC and Service business areas. In 2005, one of the leading American producers of air compressors chose frequency converters from Danfoss for their new compressors. The first frequency converters will be delivered in The sales activities in Latin America focused on getting new customers within the HVAC, Food and Beverage, and Water businesses and the efforts resulted in double-digit growth rates. Furthermore, the sales organisation received new orders for energy solutions for the beverage industry. The markets in Asia-Pacific had double-digit growth rates. Focus was on HVAC and Water and an international pump manufacturer, among others, placed a multi-million order for Danfoss frequency converters. In Australia, the sales company obtained new orders for the delivery of frequency converters for luggage handling systems. The activity level in India has increased during the year and new orders have, among other things, been received from Indian textile and plastic producers. Despite local, strong price competition, Danfoss managed to increase sales in China and Taiwan by approximately 15%. In order to support Danfoss Drives ambitions for growth in China, the Chinese company Holip (Zhejiang Haili Electronic Technology Co.) was acquired in Holip is one of the leading players on the market for lowprice frequency converters in China. Products and R&D 2005 saw the introduction of several functionalities through the launch of the new generation of frequency converters VLT AutomationDrive FC301 to the industrial market as well as new hardware for the VLT 5000 line. The VLT 2900 was launched to the big OEM customers in China, and at the Hanover Trade Fair in Germany the new High Power frequency converters were presented to the global market. In April, Danfoss Drives signed an agreement with the German company Pilz concerning the joint development of special solutions for VLT AutomationDrive. The systems are, among other things, used in the Food & Beverage industries. In the beginning of 2005, a new production line for Medium Power frequency converters was set up in Denmark. The Danish Society of Engineers (IDA) awarded the Elektro Prisen 2005 to Henrik Rosendahl Andersen. Elektro Prisen is presented once a year to a person who has shown high-level specialist skills by way of excellent technical and scientific results. He was awarded the prize for his PhD thesis on the reduction of refrigerators power consumption and his work in Danfoss Drives, where he helped develop frequency converters, e.g. for induction engines. 36

37 Market development at Danfoss Gearmotors In 2005, Danfoss Gearmotors reached its target of positive operating results and ended the year better than expected. The sale of gearmotors was well above last year s level and showed a strong development in almost all regions. In Europe sales increased by 6%. Germany is still Danfoss Gearmotors largest market. The sale of gearmotors in North America increased by 9% compared to last year. The Asia-Pacific region is a new and promising market for Danfoss Gearmotors. Sales in China increased by 33% and more salespeople will be engaged in China in 2006 to ensure the positive development. In 2005, Danfoss Gearmotors signed a license agreement on the production of the new BAUER 2000 line in India and in September, the first gearmotors were delivered to customers there. Danfoss Gearmotors has high expectations for the Indian market, which showed positive growth rates in Products and R&D Within the area of R&D, Danfoss Gearmotors concentrated on launching new products which live up to special serial requirements and completing the product range. The gearmotor product range, which is used in sterile environments in the food industry, among other things, was expanded with a new model as Danfoss Gearmotors aims to enhance its profile within this area. Perspective plan for In 2005, Danfoss Motion Controls Division reviewed their strategy to obtain a global market leader position. It was concluded that the Division may benefit from concentrating on its core businesses and thus utilise the growth and earnings potential as much as possible. Therefore, the sales organisation was restructured and the employees were allocated to either Danfoss Drives or Danfoss Gearmotors to be able to offer better service to their respective customers within the strategic business areas. 37

38 Division profile Danfoss Motion Controls Division is comprised of two business units: Danfoss Drives and Danfoss Gearmotors with factories in Denmark, China, Slovakia, Germany and the USA. Danfoss Drives and Danfoss Gearmotors operate as independent business areas, which cooperate to offer package solutions to the customers. The division has a global network of sales offices offering professional service to the customers. Danfoss Drives is the global market leader in the food, beverage, HVAC and water industries and has activities within the automobile, chemical, petrochemical, textile, steel and mining industries in selected markets. Danfoss Gearmotors delivers gearmotors for industrial applications and holds a strong position within the automobile, material handling and steel industry. Financial highlights for Danfoss Motion Controls Division mill DKK Net sales Operating profit Intangible fixed assets Tangible fixed assets Total assets Non-interest-bearing debt Net assets Net investments (excl. goodwill) Net investments in goodwill Depreciation / amortisation Cash flow from operating activities (excl. paid tax and financial items) Cash flow from investing activities Number of employees EBIT margin RONA ,208 3, ,572 1, ,816 3, % 7.9% 37.0% 27.1% Division sales Distributed by regions % EU excl. DK Denmark Rest of Europe Latin America North America Africa & Middle East Asia Pacific

39 f i n a n c i a l i n f o r m a t i o n Group projects Danfoss Business System Danfoss Business System is a Group initiative with the purpose of strengthening focus on the ability for continuous improvements throughout the value chain. This is achieved through a number of cross-group projects which will be completed during the next few years. So far programmes have run in production, sales and purchasing. Danfoss Productivity Program was launched at the end of 2003 and focuses on optimising the production areas. Using an approach built on Lean thinking all processes are analysed with the goal to increase the utilisation of the entire production system. The results of the production related projects that have been completed so far are satisfactory. Productivity in the areas covered by the project has increased by more than 20%, capacity has grown by 25% and work in progess has been reduced by more than 30%. In 2008 all production units will have completed the program. Delivery service and quality assurance of products are not covered by Danfoss Business System due to the fact that these are monitored in separate quality assurance systems. The Danfoss Sales Program was launched in This programme primarily aims at increasing sales by introducing best practise in all parts of the sales process. When the first test projects are completed, full scale implementation will commence in 2006 and will run until The programme will start in Europe and from there roll out to the rest of the world. In 2005 Danfoss also kicked off the Full Potential Purchasing Program, which focuses on securing Danfoss the optimal purchasing process in cooperation with the suppliers. The entire process, from component specification until the component is built into a Danfoss product, will be analysed in order to reduce the total costs. The programme is expected to run until the end of

40 f i n a n c i a l i n f o r m a t i o n Danfoss Services Danfoss Global Business Services Danfoss Global Business Services is an internal service organisation, whose purpose is to optimise the Group s internal administrative service functions to achieve economy of scale benefits, and thereby contribute to reducing the Group s total cost level. In 2005 Danfoss Global Business Services entered into an agreement with Capgemini regarding outsourcing parts of the Group s European finance and accounting transactions to Capgemini in Krakow, Poland. Within logistics the new European distribution structure with direct deliveries from Danfoss Distribution Center in Rødekro, Denmark, was almost finalised. In 2005 Danfoss implemented a shared sales and distribution system in Brazil as the first country in North and Latin America. Implementation will proceed in more countries in the region during In Asia the system was implemented in Singapore and India, while Malaysia and the Philippines are expected to be ready at the beginning of Danfoss Industrial Service Danfoss Industrial Service offers services internally in Danfoss and to companies outside the Group. The business area offers, among other things, services to laboratories, technology consultants, workshops, building administration, advertising, catering and cleaning services. The future focus of Danfoss Industrial Service will be directed at activities that improve competitiveness in addition to continuing to expand externally. Furthermore, in 2005 Danfoss Industrial Service opened the Mads Clausen Entrepreneur Park, which is an entrepreneur park where Danfoss through its competence centres helps entrepreneurs develop their ideas. 40

41 Danfoss IT Danfoss IT is responsible for projects, infrastructure, service, operation and purchasing in connection with the Group s use of information technology. The function employs approximately 400 IT professionals who support the Group s business areas and common services through implementation projects, operation of business systems and the underlying IT infrastructure. Significant activities during the period have included the design and implementation of a shared system to support sales and marketing efforts (CRM), the continued global expansion of a shared SAP platform, and the development and pilot testing of the Work smart project the optimal use of Danfoss global Microsoft Infrastructure. In order to support the global implementation of SAP systems Danfoss IT has entered into an agreement with a leading consultancy firm with employees on all continents. Danfoss IT uses consultants from these locations to help implement SAP R/3 in Asia and for ongoing system maintenance. Danfoss IT s services have been the centre of attention in a survey regarding price/quality and user satisfaction compared to other global companies. The result showed that Danfoss IT is ranked among the top 10% of the participating companies in the survey. 41

42 f i n a n c i a l i n f o r m a t i o n Sauer-Danfoss Inc. Sauer-Danfoss Inc. is one of the world s leading producers and suppliers of mobile hydraulic and electronic components for vehicles in the agriculture and construction sector. Sauer-Danfoss is listed on the New York Stock Exchange. Sauer-Danfoss was established in 2000 through a merger of the mobile hydraulics activities of Danfoss A/S and Sauer-Sundstrand Inc. Danfoss owns 38.4% of Sauer-Danfoss, and the market value of Danfoss ownership was approximately 2,17bn DKK at the end of 2005 (2,18bn DKK). Through the company Danfoss-Murmann Holding A/S, Danfoss A/S owns, jointly with the Murmann family, the majority of shares in Sauer-Danfoss Inc. Three members of the Danfoss A/S Executive Committee (Jørgen M. Clausen, Ole Steen Andersen and Hans Kirk) represent Danfoss on the Board of Sauer Danfoss Inc. and in 2004 Jørgen M. Clausen was elected Chairman of the Board. Sauer-Danfoss Inc. is included in the accounts as a joint venture. Accounts for 2005 Sauer-Danfoss net sales in 2005 increased to 1,548m USD from 1,404m USD, equalling an increase of approximately 10%. When calculated at last year s exchange rates and adjusted for acquisitions and divestments, net sales in 2005 increased by 10%. The operating profit (EBIT) amounted to 80.6m USD compared to 91.9m USD in 2004, while the result for the year after tax was 38.7m USD compared to 33.2m USD in The growth in net sales in 2005 applied to all business segments. The cash flows from operating activities in 2005 amounted to 116.3m USD compared to 124.8m USD the year before. The cash flows from investing activities rose to 93.3m USD in 2005 from 75.5m USD in The earnings per share (EPS) amounted to 0.81 USD in 2005 against 0.70 USD the year before. Sauer-Danfoss employed a total of people at the end of Expectations for 2006 Sauer-Danfoss expects that the U.S. markets will continue to grow, but at a more moderate rate compared to the strong growth experienced in 2005, while the European markets are showing signs of strengthening from 2005 levels. The company also expects the markets in Asia-Pacific to contribute to the growth again, in line with the stronger sales seen in the last two quarters. The earnings per share in 2006 are expected to reach USD. 42

43 f i n a n c i a l i n f o r m a t i o n Management report for Danfoss A/S Danfoss A/S is the Parent Company of the Danfoss Group. It is made up of a number of production facilities within Danfoss Refrigeration & Air Conditioning Division and Danfoss Heating Division. In addition, the Parent Company includes the major part of the Group s Corporate Functions, Danfoss IT and Danfoss Industry Services, among other things. As of January 1, 2005, the subsidiary Danfoss Industrial Refrigeration A/S merged with Danfoss A/S while the buildings in Nordborg, Denmark, at the same time were spun off to the Danfoss Ejendomsselskab A/S. More information about the major areas influencing the Parent Company is available in the Danfoss Group Management Report. Net sales rose to 4,554m DKK from 4,437m DKK in 2004, equalling growth of 3%. The operating profit (EBIT) fell by 26m DKK compared to 2004, to a deficit of 33m DKK in The result is affected by increased costs at Danfoss Services and in the venture business. The net financial income and expenses were 248m DKK, which was an increase of 201m DKK compared to the year before. The change is particularly due to exchange rate adjustments, write-down on loans to subsidiaries, and the fact that the financial items were affected by an allocation to share remuneration programs amounting to 23m DKK against 85m DKK in The result after tax was 201m DKK compared to 46m DKK. The equity increased to 6,126m DKK from 6,070m DKK, equalling a growth rate of 1%. As a consequence of changed accounting policies, the result and equity of the Parent Company Danfoss A/S are changed compared to the Annual Report For further details about the implemented changes please refer to the section on Accounting Policies. At the end of 2005, Danfoss A/S employed 4,191 people, which is at the same level as the year before. The 2006 net sales and operating profit are expected to be on a par with Events after the end of the year Significant events which would affect the Parent Company s financial position have not been recorded after the balance sheet date. 43

44 r e p o r t & a c c o u n t s Financial and operational risk management The Group s central financial department, in cooperation with the Group s business units, handle overall monitoring and control of the Group s financial and operational risk management. The control is based on policies established with the Danfoss Board and Executive Committee. Financial risks s international activities mean that profit, cash flow and equity are affected by developments in exchange rates and interest in a number of countries. It is therefore necessary to quantify and hedge the related risks. Currency exposure Today, the Danfoss Group operates with approximately 40 currencies, and variations in these exchange rates against DKK can have an effect on the Group s net sales, profit and equity. The Group accounts for the currency exposure of each company is allocated on commercial cash flows and financial positions in foreign currency in order to be able to respond to the development, limiting the movement in net sales, profit and equity. Furthermore, the risk is accounted for when translating and consolidating the Group s results. In addition, the expectations for the development of the currencies are used to control the Group s currency exposure. Danfoss most significant currencies are, in descending order, EUR, USD, GBP, SEK and AUD. In addition to the hedge that exists in form of selecting in which currency to borrow and buy, Group currency risk is covered through forward contracts and options. The financial instruments, which Danfoss uses for covering currency exposure prepared according to the Group s policies, are recognised in accordance with the»hedge accounting«rules in IAS 39. Interest rate risk The interest rate risk of the Group is primarily ascribable to interest-bearing debt and cash funds. The Group makes use of both fixed-rate loans and loans with floating interest rate. The choice between floating and fixed-rate interest is based on an evaluation of the expected future interest development. Cash flow risk The Group continuously calculates the Group s cash flow and financing requirements in the light of accounts, budget, and strategy plans, among other things. The control of the subsidiaries cash flow and financing is based on the largest possible reduction of the corporate net financing expenses. In that regard, cash pools have been established in EUR, DKK, GBP, USD, SEK and NOK. All of the Western European companies participate in a EUR cash pool set up at one of the Group s main banks. In order to be able to ensure satisfactory cash flows in proportion to Group activities, the Group has established longterm binding credit undertakings from different banks, of which approximately 3.3bn DKK are unused. Credit risk The Group s credit risks primarily apply to trade receivables and bank deposits. Trade receivables are allocated on a number of customers and geographic areas. A systematic credit rating is carried out on all customers and any write down carried out to meet a loss on trade receivables is made on the basis of this credit rating. The rating also serves as the basis for the terms of payment offered to the customers. The credit risk is insured when considered necessary. Historically, the Group has only had limited losses on bad debts. Other hedging Danfoss profit is affected by developments in global raw material prices. Supplementing the fixed-price contracts with suppliers, some business units of the Danfoss Group also hedge using financial instruments in relation to the Group s purchase of metals and electricity. Risk hedging using financial instruments always takes place on the basis of an expected future commercial need. Operational risks It is the Group s policy to primarily use insurance as a hedge towards large financial losses. In addition to all compulsory insurances, areas are also insured where control and administrative benefits are gained. With regards to major insurance risks, worldwide master programmes/group policies have been established. Participation is obligatory for all subsidiaries. The master programmes include, for example, All Risks Insurance (machines, equipment, buildings, stocks, loss on operations), Transport Insurance, Commercial and Product Liability Insurance and Executive Committee and Board Liability Insurance. Furthermore, the subsidiaries establish local insurance covers, including work-related injury insurance covers. 44

45 Risk Management In addition to attending to the control of insurable risks, Risk Management is responsible for initiating and developing risk management on a corporate level. This includes the development of Group tools to supports the entire process, ranging from initiation over risk mapping to the handling of the risks. As part of the Group s risk management system, an overall consolidation and risk mapping is made of all of the Group s major risks, primarily those that are insurable, strategic, operational and financial. It is the Group s goal to continuously identify risks that can have a significant impact on the Group s financial results and growth. To ensure that the consolidation gives a true and fair view of risks, a risk management function was established in 2005 with a risk manager appointed for each of the three Divisions. On the basis of reports from the risk managers and a risk report prepared by the corporate functions, the risk management function produces a total consolidated report every six month for the Board and the Executive Committee. 45

46 r e p o r t & a c c o u n t s Accounting policies The Report & Accounts 2005 for Danfoss A/S have been prepared in accordance with International Financial Reporting Standards (IFRS/IAS), the Danish Accounting Act (Accounting Class C Large companies) and EU approved accounting standards. International Financial Reporting Standards are issued by the International Accounting Standards Board (IASB) and interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC/SIC). In order to make the report and financial statements more understandable and readable, certain parts of the information required by IFRS/IAS has been included in the reports, instead of directly in the notes of the financial statement. Only accounting standards that became effective on December 31, 2005 apply. Changes in accounting principles As a consequence of new IFRS/IAS accounting standards that became effective certain changes have taken place both in respect to Group and the Parent Company. Comments to changes in accounting principles: 1) Share Based Schemes New (IFRS 2 Share Based Payments ): Share schemes established in 2004 and onwards: the value of share-based schemes is allowed for in the profit and loss account through the aggregate vesting period for the schemes that exist or are established after January 1, The corresponding entry is in the equity, which on the whole makes the equity unchanged. Comparative figures are changed correspondingly. The effect on comparative figures is as follows: (mill DKK): Group January 1, 2004 December 31, 2004 December 31, 2005 Accounting principles before changes Warrants and share options (new) Warrants and share options (old) Notes Assets Equity Net profit Assets Equity Net profit Assets Equity 13,081 5,814 7, ,158 5,223 7, ,520 5,736 8, Minority interest Goodwill Tax effect of changes Total adjustments New accounting principles 13,081 5,867 7, ,158 5,371 7, ,598 5,905 8,693 Parent Company January 1, 2004 December 31, 2004 December 31, 2005 Accounting principles before changes Warrants and share options (new) Warrants and share options (old) Shares in subsidiaries 5 Adjusted shares in subsidiaries Notes Assets Equity Net profit Assets Equity Net profit Assets Liabilities Liabilities Liabilities Liabilities Liabilities Liabilities Equity 10,081 2,814 7, ,259 2,324 7, ,565 2,781 8, , , , , , ,524 Dividend less impairments Tax effect of changes Total adjustments 1, , , , , ,658 New accounting principles 9,044 2,923 6, ,593 2,523 6, ,138 3,012 6,126 46

47 2) Share Based Schemes ( Old ) (IFRS 2 Share Based Payments ): Share schemes established in 2001: The vesting period of these schemes ended before 2005, but since these schemes can be demanded settled in cash, cf. the assumptions stated in note 23 of the Annual Report, the value of the total cash settlement liability is included in the annual accounts. The set-off item of the liability as of January 1, 2005, is the equity. The value of the cash settlement liability will be annually accounted for, and changes in value will be taken to the profit and loss account under Financial Items. In the Parent Company an additional asset is recorded, which comprises the expected contribution from subsidiaries in respect of the above share based liabilities. This amount adds up to 71 mill DKK at the end of 2005 and is recorded in the line item Financial assets. Comparative figures are changed correspondingly. 3) Minority interest (IFRS 1 Presentation of Financial Statements ): The minority interests share of the Group s equity will no longer be a separate item on the liabilities but be a part of the Group s equity as a separate item. This will also mean that the minority interests share of the profit after tax will not be deducted from the profit after tax. Comparative figures are changed correspondingly. 4) Goodwill amortisations (IFRS 3 Business Combinations ): Goodwill amortisations will cease in 2005, and amortisations will only be made if required by related impairment tests. Amortisations of goodwill in 2004 reached approximately 60 mill DKK. According to IFRS 3 comparative figures (2004) are not changed correspondingly. Accumulated amortizations January 1, 2005 are deducted in cost price of goodwill, which after that constitutes the new cost price of goodwill. 5) The Parent Company s recognition of capital shares in subsidiaries, associated companies and joint ventures (IAS 27 Consolidated Financial Statements and Accounting for Investments in Subsidiaries et al.): In 2005, capital shares in the companies referred to above are no longer recognised in the Parent Company by the equity method. Instead, capital shares are recognised at accumulated cost price deducted impairments, if any. Income in the form of dividends is recognised in the profit and loss account at the time of declaration. Comparative figures are changed correspondingly. 6) Deferred taxes caused by adjustments: Deferred tax is recorded based on the adjustments, primarily, in relations to Share based payments ( Old ) Changed joint taxation rules for the Parent Company As a consequence of new requirements in the changed joint taxation rules, Danfoss has changed its accounting method, from allocating all Danish taxes to the Parent Company to allocating taxes entirely to the Danish companies. According to this new method the current Danish corporation tax is allocated based on the taxable income in the different companies. Companies that are utilizing taxable losses in other companies are paying a fee to the Parent company, which equals the tax value of the losses, while companies which taxable losses are utilised by other companies are receiving a corresponding fee from the Parent Company. At the transition deferred taxes, which previously was recorded only in the Parent company, were allocated to the different companies. The impact of this allocation of deferred taxes, is recorded as dividend in the Parent company in case a deferred tax asset is transferred, and as a reduction in cost price of shares in subsidiaries in case a deferred tax liability is transferred. This change in principle has no impact on the comparative figures (2004). For 2005 the Parent Company has received 7 mill DKK in dividend, and reduced its shares in subsidiaries with 3 mill DKK as a result of the above mentioned rules. Reclassifications: 1) Taxes in joint ventures and associates: According to new practice, income from joint ventures and associates contains the proportionate share of earnings/losses after tax from joint ventures and associates. This means that the proportionate share of their taxes no longer is incorporated in the line item corporation taxes. 2) Provisions: Deferred taxes, pensions and provisions are no longer presented under a separate heading in the balance sheet (Provisions), but are instead divided into non-current and current liabilities. 3) Cash Flow Statement: Dividends are no longer presented under the heading Cash flow from investment activities, but are instead presented under the heading Cash flow from operating activities. The above reclassifications did not affect net profit, equity or free cash flow. Comparative figures are changed correspondingly. Key figures and ratios Comparative figures for are not restated as a consequence of changes in accounting principles. The impact on these figures are estimated not to be material. However, 47

48 changes made in connection with reclassifications, cf. above, resulted in restatements with regard to the above mentioned years. Accounting judgments and estimates When measuring certain assets and liabilities, estimates on how future events are affecting the value of these assets and liabilities, are required. Estimates that are significant for the accounting process are exercised when evaluating depreciations, impairments, inventories, pensions, provisions and contingent liabilities. The applied estimates are based on assumptions, which the management rate as reasonable, even though they contain uncertainties. The Group is subject to risk and uncertainties, which may cause those actual results, deviate from these estimates. The value of intangible assets may especially be impacted by significant changes in the estimates and assumptions that are the basis of such calculations. Description of accounting principles Group accounts The Group accounts include Danfoss A/S and subsidiaries of which Danfoss A/S directly or indirectly has more than 50% of the voting rights or in another way has the controlling interest. Companies where the Group has between 20% to 50% of the voting rights and exercises a considerable, but not controlling interest, are considered associated companies or jointly controlled entities (joint ventures), where the joint venture conditions of IAS 31 are complied with. The Group accounts are prepared by merging the Parent Company s and the individual subsidiaries audited annual accounts, which have all been accounted for in accordance with Danfoss A/S accounting policies. At consolidation, elimination of Group internal income and expenses, holding of shares, internal balances and dividends and realised and unrealised earnings and losses at transactions takes place between the consolidated companies. Business combinations Newly acquired or established companies are recognised in the Group accounts from the time of the takeover, and divested companies are recognised until the time of divestment. Comparative figures are not adjusted for companies integrated through acquisition or merger or for divested companies. When companies are acquired, identifiable assets and liabilities, including contingent liabilities, are stated at fair value at the time of acquisition. The tax effect of the performed revaluations is taken into consideration. Identifiable intangible assets are recognised, if they can be separated or stems from a legal contract, and the fair value can be reliably stated. Goodwill, representing the excess of cost of the acquisition over fair value of net identifiable assets, is capitalised and stated under intangible assets. Until the end of 2004, goodwill acquired before April 1, 2004 was systematically amortised by the straight-line method over the estimated useful life of the asset. Goodwill is no longer amortised, but is only subject to impairment evaluations, cf. the section Impairment. The carrying amount of goodwill is allocated to the Group s Cash Generating Units at the time of takeover. This allocation is the basis for subsequent impairment tests. Cash Generating Units are determined by the management and financial structures of the Group. If uncertainty exists at the time of the takeover as to the measuring of net identifiable assets and obligations, the first recognition takes place at preliminary stated fair value. Should it turn out later that the fair value of identifiable assets and obligations are different than assumed at the time of the takeover, goodwill is adjusted until 12 months after the acquisition. After that, goodwill is only adjusted as a result of changes in the estimates of conditional acquisition payments. The effect is recognised in the equity and comparative figures are restated if material. Besides the above, other adjustments after the 12 month period, are included in the profit and loss account, except for adjustments in deferred tax assets, which will affect the goodwill. Gains or losses are stated as the difference between the purchase price or disposal price and the carrying amount of net assets at the time of the sale, including goodwill, and expenses for sale or disposal. Profit and loss account Net sales Net sales of goods for resale and finished goods are recognised in the profit and loss account, providing delivery and risk transfer to the purchaser took place before the end of year, and if the income can be reliably measured and payment is expected to be received. Net sales are recorded exclusive of VAT, duties and discounts in relation to the sale. Related service income is recognised in the profit and loss account as the services are performed, whereby the recognised sale corresponds to the market value of the work performed during the year. The sale of services is recognised in the profit and loss account, when the aggregate income and expenses of the service contract can be reliably recorded, and it is probable that the Group will receive the financial benefits, including payments. Net sales Danfoss Services etc. Net sales Danfoss Services etc. cover the units Danfoss Industrial Service, Danfoss Distribution A/S and Danfoss IT s sale of services etc for joint ventures, associated companies and other external parties. Production costs Production costs include costs, including depreciations and salaries, which are paid in order to achieve the year s net sales. Production costs also include research and development expenses and amortisation of development costs. Distribution costs Distribution costs include expenses related to sales staff, advertising and exhibition costs etc., including depreciations. Administration costs Administration costs include expenses in relation to administrative staff, the management, offices, office costs etc., including depreciations. 48

49 Other operating income and expenses Other operating income and expenses comprise financial items of a secondary nature compared with the principal aim of the companies. Included are gain/losses on disposal of fixed assets and companies, impairments and retirement expenses. Income from associates and joint ventures In the Group, a proportionate share of the associates and the joint ventures earnings or losses after tax is taken to the profit and loss account after elimination of proportionate share of internal profit/loss and deduction of impairment of goodwill. Financial income and expenses Financial income and expenses comprise interest income and expenses as well as realised and unrealised currency gains and losses on securities, debt and foreign exchange transactions. Also included are the finance charges related to finance leases, and gains and losses on derivatives that are not classified as hedging transactions. In the Parent Company dividends from subsidiaries, associates and joint ventures is recognised in the profit and loss account at the time of declaration. In case declared dividends from a company is higher than the accumulated earnings after the time of takeover, dividends are not recognised in the profit and loss account, but are instead recognised as a write down of the cost price of the shares. Balance Sheet Intangible fixed assets Goodwill Goodwill is included in the balance sheet the first time at cost price, as described under Group accounts. Subsequently, goodwill is recorded at cost price with deducted accumulated impairments. Goodwill is no longer amortized. Development projects, software, patents and licenses Development projects for new products and processes, including software, with the intent to produce, market and use the developed systems within a few years, must be capitalised, if for example a clear connection between expenses and future income can be demonstrated. Expenses for the purchase and development of projects are recognised at cost price deducted accumulated impairments and depreciations. Cost price includes direct and indirect expenses, including salaries. Development costs, including software are generally amortised over 4 to 5 years. Patents and licenses are recognised at cost price deducted accumulated amortizations and impairments. Patents are amortised on a straight-line basis over the remaining patent period, and licenses are amortised over the agreement period, unless the useful life is shorter. Other intangible fixed assets, including those taken over in business combinations, are amortized over useful life. The intangible assets, customer relations and technology, are amortised over up to 12 and 10 years, respectively. Intangible assets with no definitive useful life are not amortised, but are tested annually for impairments. Profit and loss incurred at the disposal of intangible fixed assets are recorded as the difference between the sales price less sales expenses and the carrying amount at the time of the sale. Profit or loss is recognised in the profit and loss account under other operating income and expenses. Tangible fixed assets Land and buildings, plant and machinery and equipment are recorded at cost less accumulated impairments and depreciations. The cost price includes expenses for materials, components, subsuppliers, direct salary expenses and for own manufactured assets as well as indirect production costs. The cost price is added estimated costs in relation to dismantling and disposal of the assets and reestablishment if it can be provided for according to IFRS 38. The cost price is divided into separate assets if useful life is different for the individual assets. The assets are then depreciated accordingly. Interests and other lending expenses are not included in the cost price. Subsequent expenditure, ie. exchange of parts of tangible fixed assets, are included in the carrying amount of the asset, when it is probable that it may generate future economic benefits. Expenditure on repairs and maintenance are recognised in the profit and loss account when incurred. Depreciations are calculated by the straight-line method over the estimated useful life. The estimated useful life for tangible fixed assets is as follows: Buildings Machinery Equipment useful lives years 4-10 years 2-6 years The depreciable amount of an asset is determined after deducting the residual value of the assets and any impairment charges. The residual value is determined on the acquisition date and reassessed annually. If the residual value exceeds the carrying amount of the asset, depreciation will cease. Changes in useful lives or residual values that are affecting depreciations are recognised in the current and future periods. Profit and loss at the disposal of tangible fixed assets is stated as the difference between the sales price less sales expenses and the carrying amount at the time of the sale. Profit or loss is stated in the profit and loss account under other operating income and expenses. Assets that are finance leases are stated at inception of the lease in the balance sheet at an amount equal to the lower of its fair value or the present value of the future minimum lease payments. When calculating the current value, the leasing agreement s internal interest rate is used as a discount factor or its approximate value. Assets that are financial leases are depreciated and amortised as other tangible fixed assets. Leasing assets are systematically taken to the profit and loss account during the term of the contract. Impairments Goodwill and intangible fixed assets with in definitive life are annually tested for impairments. Development projects in progress are tested in the same way. The carrying amount of non-current assets, other than goodwill, intangible assets with 49

50 indefinitive life, development projects in progress, deferred tax assets and financial assets, are annually reviewed in order to determine whether there is any indication of impairment. If any such indication exists, the assets are tested for impairment. Impairment is tested by estimating the asset s recoverable amount. The recoverable amount is the greater of the net selling price and value in use. If the net selling or value in use cannot be decided on individual assets, the recoverable amount is evaluated on the cash generating unit (CGU) in which the asset belongs. An impairment loss is reversed if the there has been a change in the estimates used to determine the recoverable amount. An impairment loss in respect of goodwill is not reversed. An impairment loss is reversed only to the extent that the asset s carrying amount does not exceed the carrying amount that would have been determined, net of depreciations or amortisation, if no impairment loss had been recognised. Financial assets The share of total recognised gains and losses in associates and joint ventures are recognised in the consolidated financial statement on an equity basis. The gains and losses are adjusted for group internal unrealized earnings/losses. The Parent company s share of subsidiaries, associates and joint ventures are stated at cost price. If the cost price exceeds the recoverable amount, the cost price is impaired. The cost price is written down to the extent, received dividend exceeds the accumulated earnings after the date of takeover. Shares and bonds, that are part of the Group s trading holdings, are stated at cost price within current assets and are subsequently stated at fair value. Changes in the fair value are recognised in the profit & loss account within financial items. Shares and bonds, that are not part of the Group s trading holdings (available for sale), are recognised within non-current assets at cost price and subsequently recognised at fair value. If fair value cannot be estimated reliably the assets are stated at cost prices. Unrealised value adjustments are recognised in equity, except for impairment losses and reversals hereof. When the assets are realized the accumulated adjustments in equity are transferred to financial items in the profit & loss account. Inventories Inventories are stated at the lower of cost and net realisable value. Net realisable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and selling. Cost is stated on basis of the weighted average/fifo methods. The cost price, under manufacturing and manufactured finished goods, includes expenses for the cost price of raw materials and consumables, conversion costs and other costs, which directly or indirectly can be related to the goods. Indirect production costs include maintenance and depreciation of production facilities and plants as well as administration and management of factories. Interests and other borrowing costs are not included in the cost price. Accounts receivable Receivables are stated at cost/amortised cost less impairment losses. Equity Share capital Share capital includes the nominal portion of the amounts paid in accordance with the subscription of shares. Share capital can only be released according to the rules relating to capital reduction, after submitting a statutory notice. Proposed dividends Dividends are recognised as a liability at the time of the decision of the Annual General Meeting. Proposals for the dividends of the accounting year are included under the equity item proposed dividends. Revaluation reserve Refer to the section Derivatives. Translation reserve Variations in exchange rates, which have occurred at the translation of foreign subsidiaries equity at the beginning of the year into the exchange rates of the balance sheet day as well as translation of profit and loss accounts from average exchange rates into the exchange rates of the balance sheet day, are recorded directly on equity under the item exchange rate adjustments. Exchange rate adjustments of long-term accounts with foreign subsidiaries and associates, which are considered additions or deductions of the subsidiaries equity, are also recorded directly on equity. When disposing of capital shares of the foreign companies, the accumulated net effect is recorded at the profit and loss account. Reserve for own shares The acquisition price and disposal price of own shares are recorded directly on equity under reserves. The same applies to dividends of own shares. Reserve for Minority interests The minority interest s proportionate share of the subsidiaries earnings and equities are separately stated in the equity. Minority interests are recognised, at time of take over, based on the fair values of identifiable assets and liabilities. Remuneration based on shares The Board, Executive Committee and several senior employees are included in the option and warrant schemes based on the company s shares. The service benefit of options/warrants granted is based on the fair value op these options/warrants. For Equity based schemes the fair value is measured at grant date and recognised in the profit and loss account, as personnel costs, over the period during which the employees become unconditionally entitled to the options/warrants. The corresponding entry is an increase in equity. For equity schemes where the employees have the right to receive cash based payments, the fair value is measured at grant date and initially recognised in the profit and loss account, as personnel costs, over the period during which the employees become unconditionally entitled to the options/ warrants. The corresponding entry is an increase in liability. The liability is measured at the balance sheet date and at set- 50

51 tlement date. Changes in the fair value of the liability are recognised within financial item in the profit and loss account. At initial recognition of the options and warrants an estimate of the expected number of awarded options and warrants is made. The estimate is subsequently changed when the exact number of options and warrants awarded are known. The fair value of the schemes are measured based on the Black & Scholes formula, taking into account the terms and conditions upon which the instruments were granted. Subscription of employee shares As from January 1, 2005 the difference between the fair value of the shares and the subscription prices, is recognised as an expense in the profit & loss account. The corresponding entry is in equity. Until January 1, 2005, the employee shares where treated accounting wise as ordinary share subscriptions which means that the profit and loss account was not affected. Provisions A provision is recognised in the balance sheet when the Group has a legal or constructive obligation as a result of a past event in the financial year or previous years, and it is probable that a settlement of the obligation will lead to a consumption of the company s financial resources which can be fairly stated at the balance sheet date. The management s best estimate is considered when the provision is measured. Restructuring expenses are provided for when the Group has decided on a detailed and formal plan, and the Group has started the implementation, or it has published the principal features of the plan. Provisions for restructuring do not include costs for the ongoing operations during the restructuring phase. Defined benefit plans The Group has established defined benefit plans with some employees at some of the Group s foreign companies. The plans place the Group under an obligation to pay a certain consideration in connection with retirement (e.g. in the form of a fixed amount at retirement or a share of the employee s exit salary). The pension obligations are recorded via a discount of the pension obligations at current value. In order to calculate the current value, prerequisites of the future development of financial elements, such as interest level, inflation, expected time of death and disability probabilities, are determined. The stated obligation less the market value of assets covered by the scheme is recorded in the balance sheet cf. below. Differences between the expected development of pension assets and liabilities and the realised values are described as actuarial gains and losses. If the accumulated actuarial gains and losses exceed the greater of the nominal value of 10% of the pension assets or 10% of the pension liabilities, the excess amount is recorded in the profit and loss account and accrued over the service period of the remaining workforce in the company in question. Actuarial gains and losses that are below the above limits are not recorded in the profit and loss account ( 10% corridor rule ). Liabilities in the form of debt and finance leases Debt is initially recognised at cost. Subsequent measurement is at cost/amortised cost. Amortised cost price is the recognition of a constant, gross yield over the term. Amortised cost price is recorded as the original cost price less any repayments and additions/deductions of the accumulated amortisation of the difference between the cost price and the nominal amount. Any capitalised outstanding lease obligation for finance lease obligations are stated in the balance sheet as a liability. The part of the lease payments that relate to the interest charge is charged in the profit and loss account statement under financial items. Grants Grants, which are compensations for the incurrence of expenses eligible for grants, are recorded systematically in the profit and loss account concurrently with the taking to the profit and loss account of the expenses, which are compensated by the grants. Grants relating to investments (fixed assets) are deducted the acquisition price of the fixed assets in question. Corporation tax and deferred taxes Danfoss A/S companies are liable to pay tax in the countries where they are located. The current tax includes both Danish and foreign income tax. As a consequence of new joint taxation rules, Danfoss A/S is from 2005 only taxed jointly with its Danish subsidiaries. The current Danish corporation tax is now accounting wise fully allocated to the Danish companies. In 2004 Danfoss A/S was taxed jointly with both a number of wholly owned, Danish and foreign subsidiaries. In the 2004 number (comparative numbers) the current Danish corporation tax fully allocated to the parent company. The jointly taxed companies are included in the Tax Prepayment Scheme. Profit and loss account The current and deferred taxes of the year are taken to the profit and loss account, except from tax related to readjustments, which are recorded in the equity. Additions, deductions and compensations relating to tax payments are recognised in financial income and expenses. Tax at source relating to dividends from subsidiaries, associates and joint ventures is recorded in the profit and loss account in the year the dividend is declared. Balance sheet Tax payable and outstanding current tax is recognised in the balance sheet as calculated tax of the year s tax liable income, adjusted for prepaid tax. Deferred tax obligations and deferred tax assets are recognised in the balance sheet of all temporary differences between carrying amounts and tax amounts of assets and liabilities. Exempted is tax that would be incurred from any sale of shares of subsidiaries and tax relating to goodwill, which is not eligible for tax deduction. Deferred tax assets are recorded at the expected realisable value, either by an offset in deferred tax obligations or by settling with tax from future earnings within the same legal tax unit. Deferred tax is recognised on basis of the tax rules and at the rate of tax, which would be in force through the legislation of the balance sheet day, when the tax obligation 51

52 is expected generated as current tax. In Denmark, the tax rate was 28% in 2005 (30%). Foreign currency For each of the companies in the Group a functional currency is determined. The functional currency is the currency which is used in the primary economical environment, in which the different companies operates. Transactions in other currencies than the functional currency are transactions in foreign currencies. Transactions in foreign currencies are translated initially at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated to the foreign exchange rate at the balance sheet date. Currency gains and losses arising on translation are recognised in the profit and loss account statement under financial items. Non-monetary assets and liabilities denominated in foreign currencies are translated at foreign exchange rates ruling on the transaction date. The assets and liabilities of foreign operations are translated into Danish Kroner at foreign exchange rates ruling at the balance sheet date. The revenues and expenses of foreign operations are translated into Danish Kroner at rates approximating to the foreign exchange rates ruling at the dates of transactions. Foreign exchange differences arising on retranslation are recognised separately in equity. Exchange differences arising on an internal loan that in substance forms part of the net investment in a foreign operation is also recognised in equity accordingly. Derivatives Derivative financial instruments, such as foreign exchange contracts or options and raw material contracts, are recognised initially at cost in the balance sheet and subsequent at fair value in the profit and loss account statement. Provided that the restrictive conditions relating to documentation etc. are fulfilled, the instruments are reported as hedge accounting. By hedging future sales and purchase transactions (cash flow), changes in the market value are recorded in the equity, under revaluation reserves, until the time when the expected sale and purchase, respectively, is realised. At the realisation, the accumulated change is recorded in the same item in the profit and loss account as the sale and purchase transaction, respectively. If the criteria for hedge accounting are not fulfilled, changes in market value are recognised directly in the profit and loss account statement under financial items. Assets held for sale and discontinued operations Assets held for sale comprises non-current assets and disposal groups held for sale. Disposal groups are defined as a group of assets to be disposed of, by sale or otherwise, together as a group in a single transaction. Liabilities associated with assets held for sale are those liabilities directly associated with the assets that will be transferred in the transaction. Assets are classified as held for sale if the carrying amount will be recovered principally through a sale within 12 months in accordance with a formal plan rather than through continuing use. Assets or disposal groups held for sale are measured at the lower of carrying amount or fair value less costs to sell. Assets are not depreciated or amortised from the date when they are reclassified as held for sale. Impairment losses on initial recognition as held for sale and gains and losses on subsequent remeasurement at the lower of carrying amount and fair value less costs to sell are recognised in the income statement in the items to which they relate. Gains and losses are disclosed in the noted. Assets and liabilities are recognised separately in the balance sheet and main items are specified in the notes. Cash flow statement The cash flow statement shows the cash flows from operating, investing and financing activities for the year and cash equivalents at the beginning and end of the year. Cash generated from the acquisition and sale of companies is showed separately under cash flows from investing activities. In the cash flow statement cash flows are included relating to acquired companies at the time of the acquisition, and cash flows relating to divested companies are included until the time of the sale. Cash flows from operations Cash flows from operations are recognised by the indirect method on basis of the operating profit and adjusted for noncash operating items, changes in the working capital, paid financial items and paid corporation taxes. Cash flows from investing activities Cash flows from investing activities include payment in connection with the acquisition and sale of companies and activities, intangible and tangible fixed assets as well as securities related to investing activities. Cash flows from financing activities Cash flows from financing activities include payments diverted by changes in the size or composition of the share capital, paid dividends and raising of and instalment of longterm debt and short-term bank debt. Cash and cash equivalents Cash and cash equivalents include bank account deposits and cash balances. Segment information Segment information is given for business segments (primary) and geographical segments (secondary). The segment information is prepared in accordance with the Group s internal financial control and reporting. The segment information complies with the Group s accounting policies. The income, expenses, assets and liabilities of the segment include those, which can be allocated on a reasonable basis. Deferred tax (assets and liabilities), outstanding and payable tax, cash and interest-bearing liabilities are not allocated to the segments. Trading between segments generally takes place at market value. New IFRS standards that are effective from 2006 IASB and EU have approved the following standards, which are effective from 2006 and onwards: 52

53 IAS 19 (updated 2004) Post-employment services are effective from Danfoss A/S has not yet decided if the present method of recognizing actuarial losses/gains according to the 10% corridor rule will be continued or if actuarial losses/gains will be recognised in the consolidated statement of recognised income and expense immediately. If the new optional rule had been applied for 2005 the effect on total equity would have been around 150 to 200 million DKK and the net profit would have been improved by 3 mill DKK. IAS 39 Financial Instruments (update) are effective from Danfoss does not expect to use the option of recognizing financial assets and liabilities at fair value. IFRS 4 Insurance Contracts and IFRS 6 Exploration for and Evaluation of Mineral Resources and related changes of IFRS 1 are effective from Danfoss are not engaged in activities that are comprised by these standards. IFRS 7 Disclosure of Financial Instruments and changes to IAS 1 in regards to equity are effective from The new standard will have no impact on the recognition financial instruments. IASB and EU have approved the below IFRIC s. The IFRIC s have no effect on the financial report for 2005 IFRIC 4 Determining whether an Arrangement contains a Lease is effective from At the moment there are no indications that Danfoss has agreements that will be classified as leasing arrangement according to IFRIC 4. IFRIC 5 Rights to interests arising from Decommissioning, Restoration and Environmental Rehabilitation Funds are effective from Danfoss are not engaged in activities that are comprised by this IFRIC. IFRIC 6 Liabilities arising form participation in a Specific Market Waste Electrical an Electronic Equipment is effective from At the moment there are no indications that this IFRIC will have a material impact on the financial statements for IFRIC 7 Applying Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies is effective from Danfoss has no material foreign operations that are placed in hyperinflationary economies (not approved by EU as per December 31, 2005). 53

54 r e p o r t & a c c o u n t s Management statement & audit report Management statement The Board and Executive Committee have today considered and approved the Danfoss A/S. The Annual Report has been presented in accordance with the International Financial Reporting Standards (IFRS), which have been approved by the EU, and Danish disclosure requirements regarding presentation of the accounts. In our opinion, the accounting policies and estimates selected are appropriate and the Annual Report gives a true and fair view of the Group s and the Parent Company s assets, liabilities and financial position as of December 31, 2005, and of the result of the Group s and the Parent Company s activities and cash flows in The supplementary report on Corporate Citizenship at Danfoss A/S gives a true and fair view within the scope of common, recognised guidelines. We recommend that the Annual General Meeting adopt the Annual Report. Nordborg, March 5, 2006 Executive committee Jørgen M. Clausen Ole Steen Andersen Niels B. Christiansen Hans Kirk Board of directors Henrik E. Nyegaard Tom Kähler Peter J. M. Clausen Chairman Vice-chairman Hans Michael Jebsen Niels Christian Jørgensen Arno Knöpfli Sven Murmann Bente Skibsted Henning Wendelboe 54

55 Audit report To the shareholders of Danfoss A/S We have audited the Annual Report of Danfoss A/S for the financial year January 1-December 31, 2005, Financial Information section. The audit did not include the supplementary report on Corporate Citizenship. The company management has the responsibility for the Annual Report. Our responsibility is, on basis of our audit, to express an opinion on the Annual Report, which is presented according to International Financial Reporting Standards (IFRS), which have been approved by the EU, and the Danish disclosure requirements regarding presentation of the accounts. Basis of opinion We conduct our audit in accordance with Danish auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurance that the Annual Report is free of material misstatement, partly through random sampling of the information supporting the amounts and information stated in the Annual Report. An audit also includes assessing the accounting policies used and significant estimates made by the Board of Directors and Executive Committee, as well as evaluating the overall Annual Report presentation. We believe that our audit provides a reasonable basis for our opinion. Our audit has not resulted in any qualification. Opinion In our opinion, the Danfoss A/S Annual Report, the sections Financial Information, gives a true and fair view of the Group s and the Parent Company s assets, liabilities and financial position at December 31, 2005, and of the results of the Group s and the Parent Company s operations and consolidated cash flows for the financial year January 1- December 31, 2005, in accordance with the International Financial Reporting Standards (IFRS), which have been approved by the EU, and also the Danish disclosure requirements regarding presentation of the accounts. Sønderborg, March 5, 2006 KPMG C.Jespersen Statsautoriseret Revisionsinteressentskab Finn L. Meyer State Authorised Public Accountant Helge Kallesøe State Authorised Public Accountant 55

56

57 f i n a n c i a l i n f o r m a t i o n Profit and loss account 1 January to 31 December mill DKK Parent Company Group Note Net sales 1 4,437 4,554 16,345 16,416 Net sales Danfoss Services etc Cost of sales 2-4,128-4,419-11,643-11,865 Gross profit ,100 5,003 Distribution expenses ,492-3,443 Administration expenses Operating profit excl. other income and expenses Other operating income Other operating expenses Operating profit , Income from associates and joint ventures after tax Financial income Financial expenses Profit before tax Corporate tax expenses Net profit Net profit is distributed as follows: Minority interest 15 5 Transferred to the proposed dividends reserve Transferred to other reserves Earnings per share (share of nominel 100 DKK) Earnings per share, diluted (share of nominel 100 DKK)

58 f i n a n c i a l i n f o r m a t i o n Balance sheet BALANCE SHEET As per 31 December mill DKK Parent Company Group ASSETS Note Non-current assets Goodwill ,364 Other intangible fixed assets Intangible fixed assets ,090 1,772 Land and buildings ,519 1,695 Machinery ,596 1,709 Equipment Buildings and machinery under construction Tangible fixed assets 8 1, ,020 4,339 Non-current financial assets 3 Investments in subsidiaries 2,108 3,190 Receivables from subsidiaries Investments in associates and joint ventures 1,247 1, Other investments Defined benefit plans, net asset Deferred tax assets Financial assets 3,610 4,717 1,443 1,590 Total non-current assets 4,985 5,852 6,553 7,701 Current assets Raw materials and consumables Work in progress Finished goods and goods for resale ,246 1,211 Inventories ,411 2,396 Trade receivables ,716 3,060 Receivables from subsidiaries 10 2,375 2,350 Receivables from associates and joint ventures Receivable corporation tax Other receivables Accounts receivable 2,690 2,711 3,236 3,765 Cash and cash equivalents Total currrent assets 3,608 3,286 6,605 6,897 Total assets 8,593 9,138 13,158 14,598 58

59 BALANCE SHEET As per 31 December mill DKK Parent Company Group LIABILITIES AND SHAREHOLDERS EQUITY Note Shareholders' equity Share capital 11 1,023 1,023 1,023 1,023 Proposed dividends Other reserves 4,895 4,919 6,599 7,470 Danfoss A/S' share of equity 6,070 6,126 7,774 8,677 Minority interest Total shareholders equity 6,070 6,126 7,787 8,693 Liabilities Provisions for warranty and other provisions Provisions for stock options and warrants Deferred tax liabilities Defined benefit plans Bank loans, unsecured Bank loans, secured Non-current liabilities 813 1,106 1,877 2,172 Bank loans, unsecured Bank loans, secured Trade creditors ,324 1,358 Debt to subsidiaries ,084 Debt to associates and joint ventures Corporation taxes Provisions for warranty and other provisions Other debt ,211 1,328 Current liabilities 1,710 1,906 3,494 3,733 Total liabilities 2,523 3,012 5,371 5,905 Total liabilities and shareholders equity 8,593 9,138 13,158 14,598 Contingencies etc. 17 Related parties 21 Government grants 22 Events after the balance sheet date 25 59

60 f i n a n c i a l i n f o r m a t i o n Statement of cash flow STATEMENT OF CASH FLOW As per 31 December mill DKK Parent Company Group Note Operating profit , Adjustments for non-cash transactions Changes in working capital Cash flow generated from operations before interest ,596 1,518 Net financial items Dividends received Cash flow from operations before tax ,521 1,503 Paid tax Cash flow from operating activities ,232 1,192 Acquisition of intangible fixed assets Acquisition of tangible fixed assets ,240-1,043 Proceeds from sale of tangible assets Acquisition of subsidiaries etc Proceeds from disposal of subsidiaries etc Acquisition(-) and sale of other investments etc Cash flow from investing activities , ,626 Free cash flow Financing by non-shareholders: Financing by repayment of (-)/proceeds from interestbearing debt, including finance leases Financing by shareholders: Issuing of shares/sale of own shares Addition/disposal of minority interest Dividends paid Cash flow from financing activities Net change in cash and cash equivalents Cash and cash equivalents at 1 January , Foreign exchange adj. on cash and cash equivalents Cash and cash equivalents at 31 December The cash flow statement cannot be derived on the basis of the annual financial statements alone. As part of the Group's stand-by liquid funds there are unused long-term binding credit facilities of approximately 3.3 bn DKK (2004: 3.4 bn). 60

61 f i n a n c i a l i n f o r m a t i o n Capital and reserves mill DKK Group Share capital Share premium Reserve according to equity method Balance at 1 January , ,360 7,267 Change in accounting principle Balance at 1 January , ,315 7,214 Net profit Other Currency translation adjustments Total recognised income and expense Dividends to shareholders Shares issued/capital reduction Balance at 31 December , ,859 7,787 Proposed dividends Revaluation reserve Translation reserve Reserves own shares Minority interest Other reserves Total Net profit Other Currency translation adjustments Total recognised income and expense ,054 Dividends to shareholders Shares issued/capital reduction 7 7 Balance at 31 December 2005 P 1, ,509 8,693 In the line "Other" in the column "Other reserves" 22 mill DKK (2004: 11 mill) is recognised in relation to equity compensation benefits established in 2004, cf. note 23. Share capital and other shareholder information are described in note 11 and in "Management Report for the Danfoss Group" under shareholder information. Specification of revaluation reserve Revaluation reserve 1 January Transfered to the profit and loss account*) Additions and disposals Tax effect 6-25 Revaluation reserve 31 December *) Income in profit and loss account (-) 61

62 Capital and reserves (continued) mill DKK Parent Company Share capital Share premium Reserve according to equity method Balance at 1 January , ,290 7,267 Change in accounting principle ,145 Balance at 1 January , ,900 6,122 Net profit Other Total recognised income and expense Dividends to shareholders Shares issued Balance at 31 December , ,817 6,070 Proposed dividends Revaluation reserve Translation reserve Reserves own shares Minority interest Other reserves Total Net profit Other Total recognised income and expense Dividends to shareholders Shares issued 7 7 Balance at 31 December 2005 P 1, ,932 6,126 In the line "Other" in the column "Other reserves" 14 mill DKK (2004: 7 mill) is recognised in relation to equity compensation benefits established in 2004, cf. note 23. Specification of revaluation reserve 2005 Revaluation reserve 1 January 11 Transfered to the profit and loss account*) 7 Additions and disposals -24 Tax effect 5 Revaluation reserve 31 December -1 *) Income in profit and loss account (-) 62

63 f i n a n c i a l i n f o r m a t i o n Notes, table of contents 1. Segment reporting Expenses and other operating income Non-current financial assets Financial income Financial expenses Corporation tax expenses Intangible fixed assets Tangible fixed assets Inventories Trade receivables and receivables from subsidiaries Share capital Provisions Deferred tax assets and liabilities Defined benefit plans Financial instruments Current corporation tax Contingencies etc Adjustment for non-cash transactions Change in working capital Acquisition and sale of subsidiaries etc Related parties Government grants Equity compensation benefits Earnings per share Events after the balance sheet date

64 1. Segment reporting mill DKK Main business segments Division Controls) Division Venture eliminations Group Net sales, external 8,527 8,306 4,161 4,618 3,200 3, ,345 16,416 Net sales, internal Net sales 8,583 8,351 4,192 4,640 3,208 3, ,345 16,416 Net sales Danfoss Services etc Operating profit , Income from associates and joint ventures Financial income Financial expenses Profit before tax Tax expenses Net profit Other information Income from associates and joint ventures Investment in associates and joint ventures Intangible assets , ,090 1,772 Fixed assets 1,702 1, ,020 4,339 Total assets 5,189 5,669 2,884 3,821 1,572 1, ,366 3,113 13,158 14,598 Non-interest-bearing debt 1,678 1, ,056 1,066 4,247 4,343 Net investments (excluding goodwill) ,125 1,164 Net investments in goodwill Depreciation / amortisation Impairments *) Number of employees 9,006 9,093 4,143 4,437 2,816 3, ,346 1,292 17,543 18,168 *) Income (-) See definitions in "Financial highlights (DKK)". Danfoss Refrigeration & Air Conditioning Danfoss Heating Division (incl. Danfoss Water Danfoss Motion Controls Danfoss Corporate/ not allocated/ The three divisions, "Danfoss Refrigeration & Air Conditioning Division", "Danfoss Heating Division (including Danfoss Water Controls)" and "Danfoss Motion Controls Division" are further described in separate reports. As described in "Accounting policies" for segment information, the assets cash and cash equivalents, interest-bearing debt and deferred taxes are not allocated to the divisions. Instead they are recorded in the line "Total assets" in the column "Corporate/not allocated/eliminations". Information about cash flow is described in the separate division reports. In the column ''Corporate/not allocated/eliminations'' net costs for Corporate Functions are included and amount to 209 mill DKK. (2004: 206 mill). 64

65 1. Segment reporting (continued) Geographical segments (secondary segments) Group mill DKK 2004 EU Other Europe Asia North America Africa Pacific Latin America Middle East Net sales 10,401 1,603 1,637 1, ,345 Total assets *) 9, ,640 Net investments (excluding goodwill) ,125 Total Group 2005 EU Other Europe Asia North America Africa Pacific Latin America Middle East Net sales 10,032 1,658 1,588 1, ,416 Total assets *) 10, ,129 1, ,074 Net investments (excluding goodwill) ,164 *) Deferred tax assets are not included. "Net sales" are based on customer location, while "Total assets" and "Net investments" are based on the location of the production, service and sales facilities. Total 65

66 2. Expenses and other operating income mill DKK A. Personnel expenses Res.opg. Parent Company Group Remuneration to Board of Directors *) Remuneration to Executive Committee *) Other salaries and wages 1,421 1,486 4,636 4,472 Social security Pension expenses ,555 1,629 5,336 5,215 Average number of employees 4,156 4,297 17,399 18,258 Total number of employees 4,195 4,191 17,543 18,168 *) Including equity compensation benefits of 0.8 mill DKK (2004: 0.4 mill) to the Board of Directors and 6.8 mill DKK (2004: 3.4 mill) to the Executive Committee, cf. further information of equity compensation benefit in note 23. Expenses for defined benefit plans are described in note Personnel expenses divided into functions: Production 1,212 1,268 3,191 3,247 Distribution ,613 1,594 Administration Other operating income and expenses ,555 1,629 5,336 5,215 B. Depreciation/amortisation and impairment losses Parent Company Group Divided into categories: Amortisation of intangible fixed assets Depreciation of tangible fixed assets Impairment on tangible fixed assets Reversal of impairment losses on tangible fixed assets Divided into functions: Cost of sales Distribution expenses Administration expenses Other operating income -100 Other operating expenses C. Research and development expenses Parent Company Group Research and development costs Capitalised development costs Amortisation development costs 1 3 Research and development expenses are included in "Cost of sales". Parent Company Group D. Other operating income Parent Company Group Gain on disposal of activities Gain on disposal of tangible fixed assets Reversal of impairment losses on tangible fixed assets 100 Other Res.opg Reversal of impairments in 2004 is caused by the fact that a decided disposal of a business activity did not take place. Those estimates and assumptions that were present do no longer indicate a need for impairment on this activity. 66

67 2. Expenses and other operating income (continues) mill DKK E. Other operating expenses Parent Company Group Loss on disposal of tangible fixed assets Impairments Other Res.opg Impairments are based on expected net realisable values. In 2005, restructuring costs of approximately 45 mill DKK are included in the line "Other", which mainly relates to restructuring and close down concerning Global Business Services and the Japanese sales company. In 2004, restructuring costs of approximately 170 mill DKK are included, which mainly relates to restructuring of compressor activities. F. Fees to the Auditors appointed at the Annual General Meeting Parent Company Group Audit fee: KPMG Other fees: KPMG Total

68 3. Non-current financial assets mill DKK Parent Company Group Investments in subsidiaries Balance at 1 January 2, , Exchange rate adjustments etc. -4 Acquisitions Transfers Disposals Balance at 31 December 2, , Receivables from subsidiaries Investments in associates and joint ventures Other investments Investments in associates and joint ventures Other investments Balance at 1 January Exchange rate adjustments etc. 1 Transfers 1 Profit before tax and amortisation Tax expenses -44 Dividends -31 Disposals 2 Balance at 31 December Carrying amount at 31 December Aktiver 2, , "Other investments" are recorded at fair value, if a reasonable amount can be estimated. If this is not the case they are recorded at cost price deducted any impairments. Parent Company Group Investments in subsidiaries Balance at 1 January 2, , Exchange rate adjustments etc. 7 6 Acquisitions 1, Disposals Balance at 31 December 3, , Receivables from subsidiaries Investments in associates and joint ventures Other investments Investments in associates and joint ventures Other investments Balance at 1 January Exchange rate adjustments etc. 27 Profit before tax and amortisation s.o Tax expenses -35 Dividends -50 Balance at 31 December Carrying amount at 31 December Aktiver 3, , "Other investments" are recorded at fair value, if a reasonable amount can be estimated. If this is not the case they are recorded at cost price deducted any impairments. Further information about subsidiaries and joint ventures are described in the notes 4, 5, 15, and

69 4. Financial income mill DKK Parent Company Group Interest from subsidiaries Interest from associates and joint ventures 5 5 Interest from banks etc Foreign exchange gains, net Dividend from subsidiaries Dividend from associates and joint ventures Res.opg Financial expenses mill DKK Parent Company Group Interest to subsidiaries Interest to bank etc Foreign exchange losses, net Fair value adjustment for stock options and warrants *) Impairment/loss on loans Impairment/loss on disposal of shares in subsidiaries and associates Impairment, other investments *) cf. note Corporation tax expenses Res.opg mill DKK Parent Company Group Current tax expenses Change in deferred taxes Adjustments concerning previous years Res.opg Reconciliation of effective tax rate: Income tax using the domestic corporation tax rate 30.0% 28.0% 30.0% 28.0% Income from associates and joint ventures after tax -3.0% -4.6% Effect of tax rates in foreign jurisdictions 30/28% -0.8% 1.4% Tax exempt income/non-deductible expenses -17.8% 6.0% -5.6% 0.8% Adjustment concerning carry-forward of tax losses/joint taxation 100.0% 8.9% 3.6% 2.0% Net taxable profit in Danish companies included in joint taxation 29.3% Taxfree dividends % -28.0% Other adjustments *) 2.7% -8.4% 0.7% -1.0% Effective tax rates -15.7% 6.5% 24.9% 26.6% *) Including reduction in Danish company tax rate from 30% to 28%. Deferred tax recorded directly in Group's equity and relating to items recorded in equity, amounts to -25 mill DKK (2004: 6 mill). For the Parent Company the equivalent amount is 5 mill DKK in income (2004: -6 mill). 69

70 7. Intangible fixed assets mill DKK Group 2004 Patents, trademarks etc. Development costs Goodwill Software Balance at 1 January Foreign exchange effect etc Acquisitions, business combinations Transfers Acquisitions Disposals Balance at 31 December 1, Others total Balance at 1 January Foreign exchange effect etc Transfers Amortisation for the year Disposals Balance at 31 December Carrying amount at 31 December er Group 2005 Patents, trademarks etc. Development costs Goodwill Software Balance at 1 January *) Foreign exchange effect etc Acquisitions, business combinations Acquisitions Disposals Balance at 31 December 1, Balance at 1 January Foreign exchange effect etc Amortisation for the year Impairments for the year -1-1 Disposals Balance at 31 December Others total Carrying amount at 31 December er 1, *) Goodwill including accumulated amortisations end of At year end impairment tests of goodwill have been carried out. In this relation the carrying amount of goodwill is allocated to a number of Cash Generating Units (CGU s). When testing for impairment the present value of estimated net cash flows are compared with the carrying amounts of the net assets from the CGU s. The estimated cash flows are based on budgets/expectations for the years , approved by the management of the CGU s. The discount factor used lies within a level of 11-14% (before tax). The most significant variables/parameters are net sales, EBIT, working capital, net investments and taxes. Below the most significant goodwill allocations and related impairment tests are described: Electrical Floor Heating (Danfoss Heating Division) 33% of the Group s goodwill is allocated to Electrical Floor Heating (EFH). The earnings in this CGU have been satisfactory and are also expected to be so in the future. The CGU s RONA for 2005 is above the Group s minimum goal of 14%. The weighted average growth rate used to estimate the expected net cash inflow from 2015 and forward, is expected to be 2%. The EBIT margin in the terminal period is expected to be unchanged. The working capital in % of net sales is also expected to be at the same level during the period. Net investments are assumed to be equal to the depreciations and amortisations during the period. District Heating (Danfoss Heating Division) 20% of the Group s goodwill is allocated to District Heating (DH). The earnings in this CGU have been satisfactory and are also expected to be so in the future. The CGU s RONA for 2005 is above the Group s minimum goal of 14%. The weighted average growth rate used to estimate the expected net cash inflow from 2015 and forward, is expected to be 2%. The EBIT margin in the terminal period is expected to be unchanged. The working capital in % of net sales is also expected to be at the same level during the period. Net investments are assumed to be equal to the depreciations and amortisations during the period. 70

71 7. Intangible fixed assets (continued) Heating Pumps (Danfoss Heating Division) 29% of the Group s goodwill is allocated to Heating Pumps (HP). The earnings in this CGU unit have been satisfactory and with the expected future growth, the earnings will be significantly improved. The CGU s RONA for 2005 is below the Group s minimum goal of 14%, but is expected to exceed this goal within a reasonable period of time. The weighted average growth rate used to estimate the expected net cash inflow from 2015 and forward is expected to be 2%. The EBIT margin in the terminal period is expected to be unchanged. The working capital in % of net sales is also expected to be at the same level during the period. Net investments are assumed to be equal to the depreciations and amortisations during the period. Impairment tests of the remaining goodwill have also been carried out with similar assumptions as mentioned above. None of the above impairment tests indicated basis for impairments. Software in progress amounts to 22 mill DKK (2004: 30 mill). Development in progress amounts to 55 mill DKK (2004: 5 mill). Software and development in progress is mainly build up internal. The Group has in 2005 carried out impairment tests of the carrying amount for software and development in progress. The project development process related to the actual expenses and achieved milestones has been estimated according to the approved project and business plans. The recoverable amount is estimated to be above the carrying amount. mill DKK Parent Company 2004 Patents, trademarks etc. Development costs Goodwill Software Balance at 1 January Acquisitions Disposals Balance at 31 December Others total Balance at 1 January Amortisation for the year Disposals -7-7 Balance at 31 December Carrying amount at 31 December er Parent Company 2005 Patents, trademarks etc. Development costs Goodwill Software Balance at 1 January Acquisitions, business combinations Acquisitions Balance at 31 December Others total Balance at 1 January Acquisitions, business combinations Amortisation for the year Balance at 31 December Carrying amount at 31 December er *) Goodwill including accumulated amortisations end of

72 8. Tangible fixed assets mill DKK Group 2004 Land and buildings Machinery Equipment Work in progress Balance at 1 January 3,047 5,903 1, Foreign exchange effect Acquisitions, business combinations Transfers Acquisitions Disposals Balance at 31 December 3,133 6,299 1, Balance at 1 January 1,574 4, Foreign exchange effect Acquisitions, business combinations Transfers Depreciations for the year Impairments for the year/reversal of impairments (-) -96 Disposals Balance at 31 December 1,614 4, Carrying amount at 31 December Aktiver 1,519 1, Group 2005 Land and buildings Machinery Equipment Work in progress Balance at 1 January 3,133 6,299 1, Foreign exchange effect Acquisitions, business combinations Transfers Acquisitions Disposals Balance at 31 December 3,284 6,771 1, Balance at 1 January 1,614 4, Foreign exchange effect Transfers Depreciations for the year Impairments for the year/reversal of impairments (-) 3 Disposals Balance at 31 December 1,589 5, Carrying amount at 31 December Aktiver 1,695 1, The Group's carrying amount of financial leasing contracts, mainly equipment, amounts to 64 mill DKK (2004: 71 mill). 72

73 8. Tangible fixed assets (continued) mill DKK Parent Company 2004 Land and buildings Machinery Equipment Work in progress Balance at 1 January 1,115 2, Transfers Acquisitions 510 Disposals Balance at 31 December 1,178 2, Balance at 1 January 836 1, Depreciations for the year Impairments for the year 4 Disposals Balance at 31 December 838 1, Carrying amount at 31 December Aktiver Parent Company 2005 Land and buildings Machinery Equipment Work in progress Balance at 1 January 1,178 2, Acquisitions, business combinations Transfers Acquisitions 257 Disposals Balance at 31 December 249 2, Balance at 1 January 838 1, Acquisitions, business combinations Depreciations for the year Disposals Balance at 31 December 211 1, Carrying amount at 31 December Aktiver Publicly assessed market value on the Parent Company's land and buildings as per 31 December amounts to 178 mill DKK (2004: 584 mill). The Parent Company's carrying amount of financial leasing contracts, mainly equipment, amounts to 2 mill DKK (2004: 6 mill). 73

74 9. Inventories mill DKK Parent Company Group Inventories before obsolescence ,643 2,636 Obsolescence Inventories Aktiver ,411 2,396 Carrying amount of inventories written down to net realisable value Trade receivables and receivables from subsidiaries mill DKK Parent Company Group Trade receivables Aktiver ,716 3,060 Hereof trade receivables due after 1 year Trade receivables from subsidiaries Short-term borrowings to subsidiaries 1,856 1,720 Receivables from subsidiaries Aktiver 2,375 2,350 74

75 11. Share capital Shareholders holding more than 5% of the shares or 5% of the votes Bitten & Mads Clausen Foundation, Nordborg, Denmark; Henrik M. Clausen, Lake Forrest, USA; Clausen Controls A/S, Sønderborg, Denmark and Bente Skibsted, Lutry, Schweiz. Distribution of shares Group Group A-shares Pcs. Nominel value mill DKK Pcs. Nominel value mill DKK mill DKK mill DKK mill DKK mill DKK tdkk tdkk tdkk tdkk tdkk tdkk tdkk tdkk tdkk tdkk B-shares Pcs. Nominel value mill DKK Pcs. Nominel value mill DKK mill DKK mill DKK mill DKK mill DKK tdkk tdkk tdkk tdkk tdkk tdkk tdkk tdkk tdkk tdkk , DKK , DKK , , Total shares Passiver 226,109 1, ,389 1,023.0 Issue of shares During the last five years new shares have been issued in 2001, 2002, 2004 and 2005 with amounts of 11 mill DKK, 1 mill DKK, 11 mill DKK and 1 mill DKK, respectively. Dividend per share (DKK) Dividend per 100 DKK share The development in the Group's own shares (pcs.) is as follows (B-shares of 100 DKK) Stock at 1 January 15,509 15,572 Bought in the year by employees 63 Addition in relation to increase in share capital 3,000 Sold in the year to employees/bitten & Mads Clausen Foundation -3,043 Stock at 31 December 15,572 15,529 The primary purpose of holding own shares is to secure the share option programme for the Board of Directors in Danfoss A/S. Total cost price in 2005 for own shares amounts to 0 mill DKK (2004: 0.1 mill). Total sales price relating to own shares amounts to 4.4 mill DKK in 2005 (2004: 0 mill). Of the Group's share capital own shares make up 0.15% (2004: 0.15%). The value of own shares amounts to 22 mill DKK (2004: 20 mill). 75

76 12. Provisions mill DKK Group 2005 Warranty Restructuring Others Total Balance at 1 January Foreign exchange effect etc Acquisitions, business combinations Provisions used Provisions reversed Provisions made Disposals, business combinations -2-2 Balance at 31 December Passiver Estimated payable: Within 1 year Passiver Between 1 and 5 years rantilang After 5 years Passiver Parent Company 2005 Warranty Restructuring Others Total Balance at 1 January Provisions used Provisions reversed Provisions made Balance at 31 December Estimated payable: Within 1 year Passiver Between 1 and 5 years rantilang After 5 years Provisions for warranty comprise expected costs arising in the warranty period of the Group's products sold. The Group s provision for restructuring comprises mainly termination benefits. Other provisions comprise cost related to "earn-out agreements" in relation to acquisitions of companies and certain costs related to employees, including jubilee costs. 76

77 13. Deferred tax assets and liabilities mill DKK Changes in deferred taxes Parent Company Group Balance at 1 January, (net) *) Acquisitions, business combinations -48 Foreign exchange effect Changes in the year Disposals, business combinations 70 Balance at 31 December, (net) *) *) Liability (-) Deferred tax assets and liabilities attributed to accounting items Parent Company Group Deferred tax asset Deferred tax asset Deferred tax asset Deferred tax asset Intangible assets 27 3 Fixed assets and non-current financial assets Current assets Liabilities Gross tax value of loss carry-forwards Impairment of tax value Set-off of tax Deferred tax assets Aktiver Parent Company Group Deferred tax liability Deferred tax liability Deferred tax liability Deferred tax liability Intangible assets Fixed assets and non-current financial assets Current assets Liabilities Deferred tax regarding Danish joint taxation Set off of tax Deferred tax liabilities Passiver Of the tax asset, which stems from loss carry-forwards, 330 mill DKK (2004: 332 mill), a large part is related to subsidiaries that have suffered losses in 2004 and The part of the tax asset relating to carry-forward losses is expected to be utilised primarily by future taxable profits in the different subsidiaries. The tax value of unrecognised tax assets, which stems from carry-forward tax losses, amounts to 178 mill DKK (2004: 179 mill). The amount is not recognised as an asset, as the carry-forward tax losses are not expected to be utilised. Of the Parent Company's deferred tax liability of 205 mill DKK (2004: 288 mill), 208 mill DKK (2004: 256 mill) can be attributed to taxes relating to joint taxation with foreign subsidiaries in previous years. 77

78 14. Defined benefit plans The major part of the Group's pension obligations are defined contribution plans. However, a number of foreign subsidiaries have defined benefit plans, which are not funded or only partly funded. It is the Group s policy that pension plans within the Group should be arranged as defined contribution plans. However, in countries like, England, Japan, Germany, the Netherlands and Norway there is a tradition of defined benefit plans. Defined benefit plans that are unfunded are mainly located in the German subsidiaries, Danfoss Bauer GmbH and Danfoss Compressors GmbH. In these companies unfunded plans amount to approximately 325 mill DKK (2004: 290 mill). The obligations in these plans are slowly being reduced, as these plans are not offered to new employees. Funded and partly funded plans are mainly located in England, the Netherlands and Norway. All significant defined benefit plans are calculated by independent actuarial advisors. In 2005 a number of changes in the pension plans for England, the Netherlands and Norway took place. New employees in these countries are now part of defined benefit contribution plans instead of being part of defined benefit plans. Furthermore the defined benefit plans are being changed, so the risk of volatility in the net liabilities are reduced. mill DKK The Group's defined benefit plan obligations Group Present value of funded and unfunded obligations 992 1,174 Fair value of plan assets Unrecognised actuarial losses Above obligations are recorded as follows: Defined benefit plans, net asset Aktiver Defined benefit plans, liabilities Passiver Movements in the net liability recognised in the balance sheet Group Net liability at 1 January Foreign exchange effect etc. 1 Additions and disposals 2-1 Expense in the profit and loss account Contributions Net liability at 31 December Expenses recognised in the profit and loss account Group Current service costs Interest on obligation Expected return on plan assets Actuarial gains and losses, net 4 4 Losses on curtailments and settlements 3 Expense in profit and loss account Actual return on plan assets Principal actuarial assumptions at the balance sheet date Group Discount rates 4-5,5% 4-5,3% Future salary increases 1-4% 2-4% Expected return on plan assets 6-8% 5-8% Future pension increases 1-3% 2-3% So far, the major part of the plan assets have been invested in quoted equities. However the Group has changed its policy, so that in the future a larger part of the plan assets will be invested in less volatile assets, such as bonds. 78

79 15. Financial instruments mill DKK Cash and cash equivalents for the Group The major part of the Group's cash and cash equivalents of 736 mill DKK (2004: 958 mill) is placed on short term deposits, with an interest rate below 3% p.a. Term, debt repayment, effective interest rate and repricing schedule for the Group Group 2004 Repricing Repayment Carrying amount Average effective interest rate 0-1 year 1-5 years over 5 years 0-1 year 1-5 years over 5 years Non-current debt, unsecured % Non-current debt, secured % Finance leases: Gross payment % Reduced with interest part , Group 2005 Repricing Repayment Carrying amount Average effective interest rate Non-current debt, unsecured 1, % Non-current debt, secured % Finance leases: Gross payment % Reduced with interest part , year 1-5 years over 5 years 0-1 year 1-5 years over 5 years Group The above debt is recorded as follows: Current liabilities ver Non-current liabilities ver Passiver 1,125 1,561 Interest-bearing debt divided into major currencies for the Group DKK EUR USD Other ,125 1,561 The above is not to be seen as a measure of the Group's foreign exchange risk in connection with interest-bearing debt, as the major part of the Group's debt is established in the functional currency of the subsidiaries. 79

80 15. Financial instruments (continued) mill DKK Fair value of financial instruments for the Group Besides the items below, there are no significant differences between the carrying amounts and fair values of the assets and liabilities. Group Group Carrying amount Fair value Carrying amount Fair value Investments in associates and joint ventures *) 838 2, ,298 Interest-bearing debt 1,125 1,145 1,561 1,568 *) The difference between "Carrying amount" and "Fair value" is primarily due to Sauer-Danfoss Inc. where "Fair value" corresponds to the current market value of the shares. Derivatives as per 31 December for the Group Group Group Settlement value Gain/loss (-) when adjusting to market value Gain/loss (-) recorded in profit and loss accounts Derivatives, sale (-)/buy: USD sale USD buy CHF sale CHF buy GBP sale GBP buy Other currencies sale Other currencies buy Foreign exchange contracts Maturity Settlement value Gain/loss (-) when adjusting to market value Gain/loss (-) recorded in profit and loss accounts Maturity Rawmaterial contracts (buy) Other derivatives Derivatives end of year End of year 2005, unrealised gains on derivatives amounted to 174 mill DKK (2004: 78 mill). In the statement "Capital and reserves", specification of revaluation reserve, the unrealised amount, net of tax, of the Group's cash flow hedge transactions are stated. Further information regarding management of financial risk is available in the report "Financial and operationel risk management". 80

81 15. Financial instruments (continued) mill DKK Parent Company's non-current receivables from subsidiaries The interest rates concerning the above receivables have typically been at the level of 3.5% p.a. in 2005 (2004: 3%). Parent Company's cash and cash equivalents The major part of the Parent Company's cash and cash equivalents of 54 mill DKK (2004: 394 mio.) is placed on short term deposits, with an interest rate below 3% p.a. Term, debt repayment, effective interest rate and repricing schedule for the Parent Company Parent Company 2004 Repricing Repayment Carrying amount Average effective interest rate 0-1year 1-5 years over 5 years 0-1 year 1-5 years over 5 years Non-current debt, unsecured 1, % 1, Non-current debt, secured % Finance leases Gross payment 7 6.5% ,197 1, Parent Company 2005 Repricing Repayment Carrying amount Average effective interest rate Non-current debt, unsecured 1, % 1, , Non-current debt, secured 1 4.0% 1 1 Finance leases: Gross payment 4 7.0% ,632 1, , year 1-5 years over 5 years 0-1 year 1-5 years over 5 years Parent Company The above debt is recorded as follows: Current liabilities Non-current liabilities Debt to subsidiaries Passiver 1,197 1,632 Besides interest-bearing debt of 967 mill DKK (2004: 823 mill) the line ''Debt to subsidiaries'' contains accounts payables etc. of 117 mill DKK (2004: 70 mill). In total 1,084 mill DKK (2004: 893 mill). Fair value of financial instruments for the Parent Company Besides the items below, there are no significant differences between the carrying amounts and fair values of the assets and liabilities. Parent Company Parent Company Carrying amount Fair value Carrying amount Fair value Investments in associates and joint ventures *) 1,247 2,235 1,226 2,282 Interest-bearing debt 1,197 1,215 1,632 1,623 *) The difference between "Carrying amount" and "Fair value" is primarily due to Sauer-Danfoss Inc. where "Fair value" corresponds to the current market value of the shares. 81

82 15. Financial instruments (continued) mill DKK Derivatives as per 31 December for the Parent Company Parent Company Parent Company Settlement value Gain/loss (-) when adjusting to market value Gain/loss (-) recorded in profit and loss accounts Derivatives, sale/buy: USD sale USD buy CHF sale CHF buy GBP sale GBP buy Other currencies sale Other currencies buy Foreign exchange contracts Maturity Settlement value Gain/loss (-) when adjusting to market value Gain/loss (-) recorded in profit and loss accounts Maturity Other derivatives Derivatives end of year End of year 2005, unrealised gains on derivatives amounted to -1 mill DKK (2004: 16 mill). 82

83 16. Current corporation tax mill DKK Parent Company Group Corporation tax payable/receivable ( ) 1 January Foreign exchange effect on corporate tax expenses -1 Acquisitions, business combinations 3 Paid during the year Tax adjustments previous years Disposals, business combinations -6 Current tax expenses Corporation tax payable/receivable ( ) 31 December The above corporation tax is recorded as follows: Assets Aktiver Liabilities assiver

84 17. Contingencies etc. mill DKK Security Parent Company Group Carrying amount of land and buildings are subject to a registered debenture to secure bank loans/mortgages with Leasing assets are subject to a registered debenture to secure bank loans/mortgages with a carrying amount of In connection with disposal of activities, ordinary representations and warranties have been issued. Contingent liabilities A number of claims have been raised against the Group. The opinion of the management is that the outcome of these will not materially change the financial position of the Group. No significant asbestos-related claims have been identified. The claims that have been raised at present are not material and assessed to be unfounded. The Group does not believe that the cost of resolving current and possible asbestos-related claims will have a material impact on its consolidated financial position, liquidity and results of operations. Operating leases (lease expenses) Operating lease rentals are payable as follows: Parent Company Group Buildings: Less than 1 year Between 1 and 5 years More than 5 years Machinery etc.: Less than 1 year Between 1 and 5 years The Group has expensed 337 mill DKK in operating lease rentals in 2005 (2004: 255 mill). Expensed lease rentals relate mainly to buildings and machinery. Operating leases (lease income) Operating lease rentals are receivable as follows: Parent Company Group Less than 1 year Between 1 and 5 years More than 5 years

85 18. Adjustment for non-cash transactions mill DKK Parent Company Group Depreciations/amortisations and impairments Gain on disposal of land and buildings, machinery etc Others, including provisions Pengestrøm Change in working capital mill DKK Parent Company Group Change in inventories Change in receivables Change in payables Pengestrøm

86 20. Acquisition and sale of subsidiaries etc. mill DKK Group Acquisitions Acquisitions Disposals Disposals Intangible fixed assets, except goodwill Tangible fixed assets Inventories Receivables Cash and cash equivalents Interest-bearing debts Provisions including deferred taxes Payables Goodwill(-)/gain on disposal Consideration paid( )/received Cash and cash equivalents Net consideration paid( )/received Acquisitions Acquisitions Disposals Disposals Net consideration paid( )/received is paid as follows: Cash and cash equivalents Pengestrøm Receivable, 31 December -49 Payable, 1 January Shares Group In the "Management Report for the Danfoss Group" and the division reports further information about time and type of acquisitions and disposals of companies/activities is provided. Acquisitions and disposals 2005 Danfoss Heating Division acquired Thermia Värme AB, Sweden and some minor sales activities in Germany and the Netherlands. The acquisition amount was approximately 539 mill DKK. The acquisition amount was paid in cash and as "earn-out agreements". In relation to the acquisitions assets and liabilities are identified and valued to fair values, cf. the table below. After recognition of identifiable assets and liabilities to fair values, goodwill (residual) was stated to approximately 411 mill DKK. Goodwill primarily represents the value of the staff, know-how and not least the expected synergies going forward. The acquisitions have impacted the Group s net profit with approximately 3 mill DKK. Had the companies been acquired as of January 1, 2005, under the same assumptions, the Group s net profit would have been impacted by estimated 4 mill DKK and net sales with 495 mill DKK. The information regarding Thermia and the sales activities are aggregated, as from a materiality point of view, it is not necessary to disclose the information per transaction. Danfoss Motion Controls Division acquired Zheijang Holip Electronic Technology Co. Ltd (Holip) in November The acquisition amount was paid in cash and as an "earn-out agreement". In relation to the acquisition assets and liabilities are identified and valued to fair values, cf. the table below. After recognition of identifiable assets and liabilities to fair values, goodwill (residual) was stated to approximately 48 mill DKK. Goodwill primarily represents the value of the staff, know-how and not least the expected synergies going forward. Holip has had an impact on the Group s net profit with 0 mill DKK. Had the company been acquired as of January 1, 2005, under the same assumptions, the Group s net profit would have been impacted by estimated 7 mill DKK and net sales with 63 mill DKK. Adjustments in relation to IFRS 3 (mill DKK) Holip Thermia etc. The most significant adjustments are: Technology Customer relations/contracts 7 64 Land and buildings 5 Inventories 2 6 Others 14 3 Deferred tax on adjustments Total The Group s divestments in 2005 are Danfoss Analytical, the automobile business Als Motor A/S and the Spring Factory. The Analytical business and Als Motor A/S were disposed in spring. The Spring Factory was disposed in the autumn. The impact on the Group s net profit in 2005 was insignificant, 86

87 20. Acquisition and sale of subsidiaries etc. (continued) Acquisitions and disposals 2004 Acquisitions in 2004 are primarily related to Gemina Termix Production A/S. In accordance with the accounting policies fair value adjustments of assets and liabilities have been made in connection with the acquisition. The fair value adjustments however, have not exceeded 5 mill DKK. The remaining amount, goodwill, reflects non-identifiable assets such as know-how etc. The activities in Gemina Termix in 2004 contributed to the Group result with less than 10 mill DKK net after tax. Disposals in 2004 are primarily related to the sold activities in The Elsmark Group and Danfoss Marine Systems. The disposals took place in the 4th quarter of 2004, and the Group result in 2004 is therefore only affected by the profit related hereto. Parent company mill DKK Parent Company Acquisitions Acquisitions Disposals Disposals Intangible fixed assets, except goodwill -8 Tangible fixed assets Investments in subsidiaries , Inventories Receivables -23 Cash and cash equivalents 1 Interest-bearing debts Provisions including deferred taxes -60 Payables , Goodwill(-)/gain on disposal Consideration paid( )/received , Cash and cash equivalents -1 Net consideration paid( )/received , Acquisitions Acquisitions Disposals Disposals Net consideration paid( )/received is paid as follows: Cash and cash equivalents Pengestrøm Receivable, 31 December -39 Investments in subsidiaries , The Parent Company's issuing of shares/acquisitions of companies and activities of -1,237 mill DKK (2004: 925 mill) are mainly issuing of shares and Group internal transfers. The Parent Company's divestments of companies and activities of 386 mill DKK are mainly internal disposals. In 2004 the amount was 864 mill DKK which mainly was related to Group internal transfers. 87

88 21. Related parties 21. Related parties Danfoss A/S related parties include the Bitten & Mads Clausen Foundation, other shareholders, subsidiaries, associates, joint ventures, the Board of Directors, the Executive Committee and senior managers. Further related parties include companies, in which, the above-mentioned persons have significant interests. Bitten & Mads Clausen Foundation and other shareholders Bitten & Mads Clausen Foundation holds 48.9% of the shares in Danfoss A/S and controls 85.5% of the voting power. In the financial year a limited number of transactions have taken place between the Bitten & Mads Clausen Foundation, its other subsidiaries including Danfoss Universe and certain shareholders of the Clausen Family. The transactions comprise service and financial transactions and they have been made according to the arm's length principle. The total payment does not exceed 15 mill DKK (2004: 10 mill). Around 97% of Danfoss A/S' dividend payments is related to Bitten & Mads Clausen Foundation and shareholders of the Clausen Family. Board of Directors, Executive Committee and senior managers In the financial year, no transactions took place with the Board of Directors or the Executive Committee, other than transactions as a result of conditions of employment. The only exception is a rental agreement in Italy with CEO Jørgen M. Clausen. The rental agreement runs until The rent payment amounted to 3 mill DKK in 2005 (2004: 3 mill). The rent is set on basis of arm's length. Besides that companies, in which CEO Jørgen M. Clausen has significant influence, have sold goods and services below 10 mill DKK (2004: 10 mill) to the Danfoss Group. Joint ventures and associated companies Share of joint ventures: The following items representing the Group s share of joint ventures (in all materiality according to Danfoss accounting policies): mill DKK Parent Company Group Share of: Non-current assets 1,283 1,451 1,283 1,452 Current assets 1,154 1,303 1,154 1,308 Total assets 2,437 2,754 2,437 2,760 Non-current liabilities Current liabilities 1,073 1,031 1,073 1,033 Total debt 1,630 1,852 1,630 1,854 Net assets Net sales 3,308 3,690 3,308 3,699 Expenses 3,216 3,602 3,216 3,613 Net profit The major part of the above stems from Sauer-Danfoss Inc. A separate description of Sauer-Danfoss Inc. can be found in "Sauer-Danfoss Inc.". Besides the cooperation with Sauer-Danfoss Inc. Danfoss has joint venture cooperation with different manufacturing companies. For further information on joint ventures refer to the page "Danfoss Group Companies". Share of associated companies: The following items representing the Group s share of associated companies (in all materiality according to Danfoss accounting policies): mill DKK Parent Company Group Share of: Total assets Total debt Net assets Net sales Expenses Net profit The major part of the above stems from Damcos Holding A/S, where the investment is a financial investment. Besides this, a number of minor investments in venture companies are included in the above numbers. Refer to the page "Danfoss Group Companies" for further information on associated companies. 88

89 21. Related parties (continued) Transactions with joint ventures and associated companies: mill DKK Parent Company Group Net sales of goods and related services Net sales Danfoss Services etc Purchase of goods and services Loans, trade receivables and liabilities in relation to joint ventures and associated companies are stated separately in the balance sheet of the Parent Company and the Group. Besides the above transactions between the Parent Company and subsidiaries are described in the notes 3, 4, 5 and 15. Transactions etc. with subsidiaries: Transactions between the Parent Company and the subsidiaries: mill DKK Parent Company Net sales of goods and related services 3,242 3,440 Net sales Danfoss Services etc Purchase of goods and services 1,008 1,276 Purchase of intangible and tangible assets 1 60 Disposal of intangible and tangible assets Besides the above, transactions between the Parent Company and subsidiaries are described in the notes 3, 4, 5 and Government grants The Group received government grants amounting to 8 mill DKK in 2005 (2004: 9 mill). The grants are primarily related to research and development projects as well as grants for the establishment of workplaces. 89

90 23. Equity compensation benefits Equity compensation benefits established in 2001 In 2001 at the annual shareholders meeting, members of the Board, executives and senior managers received the right to be awarded shares. The programs are limited to the period 2001 to Under existing share plans the total awards of options/warrants are limited to 16,500 and 358,500 (in number), respectively. In order to participate in the program, the executives and senior managers had to buy a number of shares at market value before the annual general assembly in Approximately 1/3 of the options and warrants were awarded in The principal criterion for receiving options/warrants was a RONA for a given year being above a certain minimum target. Based on this, options/ warrants were awarded in 2003 and The awarded options and warrants grant the right to buy and subscribe to, respectively, B-shares (of 100 DKK) in the year Danfoss is quoted on the stock exchange, at certain exercise prices, cf. below. If Danfoss is not quoted on the stock exchange, the calculated value of the options and warrants can be cashed in by the holders from April 6, The value of an option/a warrant will as such be calculated as the share price at the time of utilisation less the exercise price. The options/warrants must be cashed in/utilised no later than the date of annual shareholders meeting in Awards/disposals etc. of options/warrants in relation to the above program are specified below: Movements since 2001: The Board Executives Other Exercise (number) (number) (number) price Outstanding 1 January Awarded in ,000 33,333 78, Outstanding 31 December ,000 33,333 78,055 Awarded in Outstanding 31 December ,000 33,333 78,055 Awarded in ,000 33,333 78, Outstanding 31 December ,000 66, ,110 Awarded in ,000 33,333 77, Disposal in , /752 Outstanding 31 December , , ,228 Awarded in Disposal in , /752 Outstanding 31 December , , ,628 Holdings 31 December 2004: The Board Executives Other Fair value Fair value (number) (number) (number) (number) (mill DKK) Options/warrants - exercise price at 749 5,000 33,333 76, Options/warrants - exercise price at ,000 66, , , , , Holdings 31 December 2005: The Board Executives Other Fair value Fair value (number) (number) (number) (number) (mill DKK) Options/warrants - exercise price at 749 5,000 33,333 74, Options/warrants - exercise price at ,000 66, , , , , Disposals in 2004 and 2005 are related to pension retirements. In addition to the above program, a phantom share program was established for a few senior managers abroad. This program follows the same principles as the above program. As of 31 December 2005 there are awarded 9,000 pcs. with a fair value of 7 mill DKK (2004: 6 mill). 90

91 23. Equity compensation benefits (continued) Equity compensation benefits established in 2004 In 2004 at the annual shareholder s meeting members of the Board, executives and senior managers received the right to be awarded shares in a new equity compensation program. This program is limited to the period 2005 to Under this share plan the total awards of options/warrants are limited to 9,600 and 242,064 (in number), respectively. In order to participate in the program, the executives and senior managers have to buy a total of 7,028 shares at market value /1438. Approximately 1/3 of these options/warrants were awarded in 2005 (1. tranche). The principal criterion for receiving options/warrants is, like the old program that the RONA for a given year is above a certain minimum target. The awarded options and warrants grant the right to buy and subscribe to, respectively, B-shares (of 100 DKK) not earlier than 3 years after the options or warrants are granted to certain exercise prices. The exercise prices are determined as the latest published share price less 15%. The latest date for utilisation of the options/warrants awarded in 2005 (1. tranche) is 21 May Are the options or warrants granted for the last tranche (3. tranche), the latest date for utilisation of this part will be 21 May The options and warrants can only be exercised in return of Danfoss shares. Awards/disposals etc. of options/warrants in relation to the above program are specified below: Movements in 2005: The Board Executives Other Exercise (number) (number) (number) price Outstanding 1 January Awarded in 2005 (1. tranche) 3,000 26,000 53, Outstanding 31 December ,000 26,000 53,539 Holdings 31 December 2005: The Board Executives Other Fair value Fair value (number) (number) (number) (number) (mill DKK) Options/warrants - exercise price ,000 26,000 53, ,000 26,000 53, In 2006 it is expected that 84,575 options and warrants are granted, as the adjusted RONA requirements for 2005 were fulfilled. The exercise price and the fair values will be determined at the annual shareholders meeting on 4 April Based on the fair value of 1. tranche, a preliminary fair value can be estimated to 48 mill DKK. Recognition of equity compensation programs Recognised liabilities in relation to the 2001 program, including phantom shares, as per 31 December, are 264 mill DKK (2004: 236 mill). Net profit for 2005 is impacted by -32 mill DKK (2004: -114 mill), which primarily stems from the fair value adjustment of the liability from 1 January For the Parent Company the liability amounts to, as per 31 December, net 192 mill DKK (2004: -169 mill) and the net profit is impacted by -23 mill DKK (2004: -85 mill). The Group s net profit for 2005 is furthermore impacted by -22 mill DKK (2004: -11 mill) which stems from 1. tranche and 2. tranche of the 2004 program. The fair value at grant date of 1. tranche and 2. tranche of 95 mill DKK, is recognised and accrued in the profit and loss account from 1 January 2004 until April The corresponding entry is the equity. No liability is recognised for this program, as the related options/warrants cannot be terminated by cash payments from the Danfoss Group. The Parent Company s net profit is impacted by -14 mill DKK (2004: 7 mill). The fair value of the options/warrants as per balance sheet date for the Group is stated in the tables above. The calculated fair values used for stating the values at the balance sheet dates and when computing the value of the 2004 program on the grant date, are based on the Black & Scholes model. The assumptions used in the Black & Scholes model are: Share price Expected volatility 23.0% 21.0% Expected dividends 1.0% 1.0% Risk-free interest rate 3.9% 3.7% Exercise prices cf. tables above Expected life of options/warrants: 2001 programme programme As Danfoss is not quoted on a stock exchange, the foundation for calculating the above values are based on a number of quoted comparable companies in Denmark and abroad. 91

92 24. Earnings per share mill DKK Group Net profit Minority interest The Group's share of net profit Nominel value (mill DKK) Weighted average number of ordinary shares 1, ,022.8 Average number of own shares Average number of shares issued 1, ,021.1 Effect of share options/warrants on issue 6.2 Diluted average number of ordinary shares issued 1, ,027.3 Earnings per share (share of nominel 100 DKK) Res.opg Earnings per share, diluted (share of nominel 100 DKK) Res.opg Events after the balance sheet date 25. Events after the balance sheet date No significant changes affecting the 2005 Annual Accounts have occured after the balance sheet date. 92

93

94 f i n a n c i a l i n f o r m a t i o n Danfoss Group Companies December 31, 2005 The companies are owned 100 percent by Danfoss unless otherwise stated after the company address. EUROPA Austria Danfoss Gesellschaft m.b.h, Guntramsdorf DEVI Austria GmbH, Salzburg Belgium Danfoss Socla Benelux S.P.R.L., Brussels N.V. Danfoss S.A., Groot-Bijgaarden Bulgaria Danfoss EOOD, Sofia DEVI EOOD, Sofia Croatia Danfoss d.o.o., Zagreb Czech Republic Danfoss s.r.o., Prague DEVI s.r.o., Breclav Denmark Als Motor A/S, Sønderborg 49 Damcos Holding A/S, Næstved 25% (associated company) Danfoss A/S, Nordborg (Parent Company) Danfoss Bionics A/S, Nordborg Danfoss Compressor Holding A/S, Nordborg Danfoss Distribution Services A/S, Rødekro Danfoss Drives A/S, Gråsten Danfoss Ejendomsselskab A/S, Nordborg Danfoss Innovation A/S, Nordborg Danfoss International A/S, Nordborg Danfoss Issab Holding ApS, Nordborg Danfoss Murmann Holding A/S, Nordborg Danfoss Redan A/S, Risskov Danfoss Solutions A/S, Kolding DEVI A/S, Vejle Gemina Ejendomsselskab A/S, Sunds Gemina Termix Production A/S, Sunds Piflex GP Company Aps, Løgumkloster 50% (Joint Venture) Piflex P/S, Løgumkloster 50% (Joint Venture) Powerlynx A/S, Sønderborg 2.4% (associated company) Estonia Danfoss AS, Tallinn DEVI Eesti AS, Tallinn LPM Balti AS, Tallinn Proekspert AS, Tallinn 55% Finland Danfoss Bauer Oy, Vantaa DEVI OY, Nummela Oy Danfoss Ab, Leppävirta 94

95 France Danfoss Commercial Compressors S.A., Trevoux Danfoss Desbordes, Villeurbanne Danfoss S.a.r.l., Trappes Danfoss Socla S.A.S., Virey Le Grand Deléage S.A. Saint-Malo SCI Deléage Immo, Saint-Malo Germany Danfoss Bauer GmbH, Esslingen Danfoss Compressors GmbH, Flensburg Danfoss GmbH, Offenbach/Main Danfoss Silicon Power GmbH, Schleswig Danfoss Socla GmbH, Rheinbach Danfoss Werk Offenbach GmbH, Offenbach/Main DEVI Deutschland GmbH, Flensburg FWT Wärmetechnik AG, Hamburg Nanotron GmbH, Berlin 30.2% (associated company) Ossacur A.G., Oberstenfeld Great Britain Conduit Ventures Fund, London 18.1% (associated company) Danfoss Holding UK Limited, Denham Danfoss Limited, Denham Danfoss Randall Limited, Bedford DEVI Electroheat Ltd., Bury St. Edmunds Senstronics Holding Ltd., London 50% (Joint Venture) Viking FC Motors Ltd, Huddersfield 50% (Joint Venture) Greece Danfoss E.P.E., Moschato Hungary Danfoss Kft., Budapest Iceland Danfoss hf., Reykjavik Irland Danfoss Ireland Ltd., Dublin DEVI Heat Ltd., Dublin Italy Danfoss Socla Italia S.r.l., Milan Danfoss S.r.l., Turin Latvia DEVI SIA, Riga SIA Danfoss, Riga Lithuania Danfoss UAB, Vilnius Netherlands AGH warmte-units B.V., Utrecht Danfoss B.V., Schiedam Danfoss Holding B.V., Schiedam Norway Danfoss AS, Skui, Oslo 95

96 Danfoss Esco AS, Kongsberg DEVI Elektrovarme A/S, Oslo Poland Danfoss LPM Sp. z o.o., Chwaszczyno Danfoss Saginomiya Sp. z o.o., Grodzisk Mazowiecki 50% (Joint Venture) Danfoss Sp. z o.o., Grodzisk Mazowiecki Elektronika S.A., Gdynia 50% (Joint Venture) Portugal Danfoss (Portugal), Lda., Carnaxide Romania Danfoss s.r.l., Bucharest Russia LTM Teplo, Moscow 39% (associated company) O.o.o. Danfoss Istra, Istra O.o.o. Gruppa LPM, St. Petersburg ZAO Danfoss, Moscow Serbia & Montenegro Danfoss d.o.o., Belgrade Slovak Republic Danfoss Compressors spol. s.r.o., Zlaté Moravce Danfoss spol. s.r.o., Zlaté Moravce DEVI s.r.o., Kúty Slovenia Biterm d.o.o., Bistrica ob Sotli 25% (associated company) Danfoss Compressors d.o.o., Crnomelj Danfoss d.o.o., Ljubljana Danfoss Trata d.o.o., Ljubljana Spain Danfoss S.A., Madrid Danfoss Socla Iberica S.A., Madrid Sweden Danfoss AB, Linköbing Danfoss District Heating AB, Gothenburg DEVI AB, Vällingby DEVI Sverige AB, Vällingby Singeln Invest KB, Vällingby Thermia Värme AB, Arvika Switzerland Danfoss AG, Frenkendorf Turkey Danfoss Otomasyon ve Urunleri Tic Ltd., Istanbul Ukraine Danfoss T.o.v., Kiev DE-VI TOV, Kiev NORth AMERIcA Canada Danfoss Inc., Mississauga, Ontario Danfoss Turbocor Compressors Inc., Dorval, Québec 50% (Joint Venture) Mexico Danfoss Industries S.A. de C.V., Apodaca, Monterrey Danfoss S.A. de C.V., Monterrey USA Danfoss Inc., Baltimore, Maryland Danfoss Commercial Compressors Ltd., Lawrenceville, Georgia Danfoss Flomatic Corporation, Glenn Falls, New York Sauer-Danfoss Inc., Lincolnshire, IL 38.4% (Companies in the Sauer-Danfoss Group) 96

97 South america Argentina Danfoss S.A., Buenos Aires Brazil Danfoss do Brasil Indústria e Comércio Ltda., São Paulo Chile Danfoss Industrias Ltda., Santiago Colombia Danfoss S.A., Santiago de Cali Peru Danfoss S.R.L., Lima Venezuela Danfoss S.A., Valencia AFRIcA Namibia Reco Namibia (Pty) Ltd, Windhoek South Africa Danfoss (Pty) Ltd., Rivonia, Johannesburg Refrigeration Equipment Company (Pty.) Limited, Johannesburg Refrigeration Investment Company (Pty.) Limited, Johannesburg ASIa China Anshan Danish-China Controls Co. Ltd., Anshan 75% Danfoss (Shanghai) Automatic Controls Co, Ltd., Shanghai Danfoss (Tianjin) Limited, Tianjin Danfoss Industries Limited, Hong Kong Zheijang Holip Electronic Technology Co. Ltd., Zheijang India Danfoss Industries Pvt. Limited, Chennai Japan Danfoss K.K., Gotemba Kazakhstan Danfoss LLP, Almaty Malaysia Danfoss Industries Sdn Bhd, Selangor Philippinerne Danfoss Inc., Manila Singapore Danfoss Industries Pte. Ltd., Singapore South Korea Danfoss Ltd., Seoul Taiwan Danfoss Co. Ltd., Tapei Thailand Danfoss (Thailand) Co. Ltd., Bangkok 49% United Arab Emirats Danfoss FZCO, Dubai 60% AUSTRALIa Australien Danfoss (Australia) Pty. Ltd., Melbourne New Zealand Danfoss (New Zealand) Ltd., Auckland 97

98 f i n a n c i a l i n f o r m a t i o n Organisation Executive Committee Hans Kirk Executive Vice President & CDO Niels B. Christiansen Executive Vice President & COO Jørgen M. Clausen President & CEO Ole Steen Andersen Executive Vice President & CFO Corporate Functions Danfoss Ventures Danfoss Refrigeration & Air Conditioning Division Vagn Helberg President Danfoss Heating Division Nis Storgaard President Danfoss Motion Controls Division Sven Ruder President Danfoss Automatic Controls Danfoss Comfort Controls Danfoss Drives Danfoss Compressors Danfoss Electronic Controls & Sensors Danfoss District Heating Danfoss Burner Components Danfoss Floor Heating Danfoss Gearmotors Owner share 38.4% Danfoss Heat Pumps Danfoss Water Controls Danfoss Services 98

99 f i n a n c i a l i n f o r m a t i o n Financial highlights (DKK) mill DKK PROFIT AND LOSS ACCOUNT Net sales 14,384 14,923 15,434 16,345 16,416 Operating profit added depreciations, amortisations and impairments (EBITDA) 1,439 1,571 1,994 1,746 1,695 Operating profit ,109 1, Income from associates and joint ventures Financial items Profit before tax , Net profit BALANCE SHEET Total assets 11,945 12,272 13,081 13,158 14,598 Net investments (excl. goodwill) 1, ,125 1,164 Net investments in goodwill Equity 6,653 6,859 7,295 7,787 8,693 Interest-bearing debt 2,070 2,022 1,766 1,125 1,561 Net interest-bearing debt 1, CASH FLOW STATEMENT Cash flow from operating activities 969 1,500 1,284 1,232 1,192 Cash flow from investing activities -1, , ,626 Free cash flow Cash flow from financing activities Cash and cash equivalents at 31 December 948 1,693 1, Number of employees (headcount) 16,544 16,972 17,449 17,543 18,168 KEY FIGURES RONA 8.9% 10.7% 16.7% 15.5% 12.1% EBIT margin 4.2% 4.8% 7.2% 6.6% 5.7% EBITDA margin 10.0% 10.5% 12.9% 10.7% 10.3% Net investment ratio 8.0% 4.8% 10.5% 7.4% 9.9% Return on sales 3.3% 5.0% 6.7% 5.7% 6.1% Return on equity 5.1% 7.6% 10.5% 9.3% 8.9% Equity ratio 55.6% 55.8% 55.5% 59.1% 59.4% Leverage ratio 16.9% 4.8% 5.2% 2.1% 9.5% In the case where the Danish Association of Financial Analyst defines the above ratios, the ratios are computed according to these definitions. DEFINITIONS RONA (Return On Net Assets) Operating Profit as percentage of average Net Assets. Net Assets is Total Assets deducted Investments in joint ventures and associates, Cash and cash equivalents, Provisions and Noninterest bearing debt. EBIT margin Operating Profit as percentage of Net Sales. EBITDA margin Operating Profit added Depreciations, Amortisations and Impairments as percentage of Net Sales. Net investment ratio Net Investments as percentage of Net Sales. Net Investments is total acquisitions and disposals of tangible and intangible assets (including acquisitions and disposals related to business combinations), except goodwill. Return on sales Profit before Tax as percentage of Net Sales. Return on Equity Net Profit as percentage of average Shareholders Equity. Equity ratio Shareholders Equity as percentage of Total Liabilities and Shareholders Equity end of year. Leverage ratio Net interest-bearing debt as percentage of Shareholders Equity end of year. 99

100 f i n a n c i a l i n f o r m a t i o n Financial highlights (EUR) mill EUR PROFIT AND LOSS ACCOUNT Net sales 1,930 2,008 2,077 2,197 2,203 Operating profit added depreciations, amortisations and impairments (EBITDA) Operating profit Income from associates and joint ventures Financial items Profit before tax Net profit BALANCE SHEET Total assets 1,606 1,653 1,757 1,769 1,957 Net investments (excl. goodwill) Net investments in goodwill Equity ,047 1,165 Interest-bearing debt Net interest-bearing debt CASH FLOW STATEMENT Cash flow from operating activities Cash flow from investing activities Free cash flow Cash flow from financing activities Cash and cash equivalents at 31 December Number of employees (headcount) 16,544 16,972 17,449 17,543 18,168 CONVERSION FACTOR BETWEEN DKK AND EUR Profit and loss account and cash flow statement (average exchange rate 100 EUR) Balance sheet (exchange rate at 31 December, 100 EUR) KEY FIGURES RONA 8.9% 10.7% 16.7% 15.5% 12.1% EBIT margin 4.2% 4.8% 7.2% 6.6% 5.7% EBITDA margin 10.0% 10.5% 12.9% 10.7% 10.3% Net investment ratio 8.0% 4.8% 10.5% 7.4% 9.9% Return on sales 3.3% 5.0% 6.7% 5.7% 6.1% Return on equity 5.1% 7.6% 10.5% 9.3% 8.9% Equity ratio 55.6% 55.8% 55.5% 59.1% 59.4% Leverage ratio 16.9% 4.8% 5.2% 2.1% 9.5% In the case where the Danish Association of Financial Analyst defines the above ratios, the ratios are computed according to these definitions. 100

101 C o r p o r a t e C i t i z e n s h i p Introduction Danfoss is aware of the role played by the company in society, and knows that the Group s reputation is founded on daily actions and behaviour. Globalisation brings with it increasing demands on companies to act responsibly when ethical challenges arise. This especially applies to companies like Danfoss that operate globally, and therefore encounter many diverse ethical questions. As a family-owned company with strong values, the Group always has environmental issues and social responsibility in mind, and we are convinced that a responsible approach to people and the environment creates added value for all stakeholders. The triple bottom line, where finance, the environment and social responsibility form the three pillars of the company s total results, is a principle that has been adopted by many companies and investors. Since 2003, Danfoss has produced a Corporate Citizenship report as part of the Group annual report, and it describes how the Group has shown responsibility as a member of society with regard to its employees, the environment and social responsibility in a broader perspective. In several regions of the world, Danfoss is a visible constituent in local society and is correspondingly important to the people who live and work in its neighbourhood. Danfoss wishes therefore to make a difference to local communities by acting in harmony with the company s five Core Values, one of which cover being an environmentally and socially responsible company. As a major Danish company, Danfoss is also responsible for contributing to the development of the concept of company ethics. Consequently, Danfoss has taken an active role in NVIR, a network for business ethics and nonfinancial reporting, in the discussion of how good company ethics influence the bottom line. Additionally, Danfoss has tested part of the Human Rights Compliance Assessment, during 2005, which was developed by the Danish Institute for Human Rights. Danfoss overall goal within environmental and social responsibility is to keep our own house in order. This applies with regard to employees, so that they have an attractive workplace. It applies to the environment, where Danfoss products contribute to energy savings, and the environmental impact of their manufacture is constantly being reduced. And it applies to social responsibility in a wider sense (CSR). The result is a positive effect on the bottom line where employee satisfaction is high, consumption of resources is as low as possible, and the company s ethics and reputation are good. The Corporate Citizenship report is divided into three sections: People and Values, Social Responsibility (CSR) and Environment. 101

102 C o r p o r a t e C i t i z e n s h i p People and Values Number of employees world-wide 20,000 15,000 10,000 5, Employees by region Number of employees 10,000 8,000 6,000 4,000 2,000 Denmark EMA (excl. DK) North America (incl. MX) Latin America Age distribution by region % Globally Denmark years EMA (excl. DK) North America (incl. MX) Latin America China China Asia-Pacific (excl. CN) Asia-Pacific (excl. CN) years years years years > 66 years Danfoss has a strong foundation in the company s core values, which to a large extent come from the employees themselves, and in the mutual trust that has been built up through many years between company and employees, customers, suppliers and partners. Danfoss knows that satisfied and committed employees who do their utmost to reach the targets that have been laid out are an important factor for continued growth and earnings. In order to succeed in the competition to be leaders within the Group s businesses, Danfoss must to an even greater degree have the will to win both on the individual and collective level. The efforts of Human Resources in Danfoss are directed at developing employees, management and the organisation in order to achieve constant improvements. This enables managers to create results through their employees, thus creating value for the business. HR activities focus on a variety of common strategic goals that define the overall focus areas. Each goal is defined by indicators which mark out the status in each of the chosen focus areas and enables even better measurement of the effect of HR initiatives Good leadership at Danfoss In 2004, a global employee perception survey showed that the Group had many good managers, but that some managers needed to improve their ability to communicate and participate actively in the development of employees. The ability to motivate staff and to set and maintain targets must be strengthened, and six fundamental leadership competences have been specifically defined as the characteristics of good leadership at Danfoss. These leadership skills are supported by a new incentive structure, in which part of the managers bonus and subsequent career progress depend on an assessment of their qualities as leaders. At the same time participation in development programmes such as training or coaching is considered a mandatory element in a career as manager at Danfoss. Besides a continual evaluation of the managers general conduct and results, development and evaluation tools are used to assess individual managers with regard to the leadership competences. The assessment is made by their direct reports, colleagues in management and immediate superiors. These measures and the individual plans of action that were made out for each manager after the latest perception survey are to ensure that the general standard of management in Danfoss is enhanced, so that it is reflected in business results and in the employees assessment of the leadership in the Group. In 2006 Danfoss will intensify its efforts to train the Group s managers. The internal range of management training programmes is being revised, and will be structured to provide both basic competence development and more specific business oriented training for individual managers. Attention will be centred on ensuring learning, so that a real change in behaviour takes place, and this will later be followed up with measurements of the changes in managers knowledge, attitudes and conduct. 102

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104 Age distribution, globally Whitecollar employees % Managers Temporary Trainees employees Educational basis % Primary education (less than 6 years) Managers Secondary education (6 to 9 years) Higher secondary education (10-14 years) White-collar employees Blue-collar employees Bachelor or equivalent Bluecollar employees Master and Ph.D Completed Employee Development Dialogues (EDDs) Distributed by regions Globally Denmark EMA (excl. DK) North America (incl. MX) Latin America China Accomplished EDDs Distributed by categories of employees Asia-Pacific (excl. CN) White-collar Blue-collar Managers employees employees 45,2% 73,0% 70,7% Case: Management in Danfoss China The increasing globalisation of Danfoss activities also influences the way in which the Group practises management. The Danfoss Core Values and the leadership competences form the foundation, but a crucial factor in the success of the business is that the management of the regional Danfoss companies are adapted to local conditions, allowing for different cultures. A specific example is Danfoss in China, which should run as a Danfoss company in China (and not as a Danish or a Chinese company). Put simply, it is a question of creating a Chinese Danfoss culture based on the best of both cultures. In this regard, it is important to understand that the typical Chinese working culture, which is based on a very different cultural heritage than in western Europe is at present undergoing considerable changes. Less willingness to take risks and greater power distance are strong elements in a conventional image of Chinese working culture, which does not immediately support the ideal of individual employees taking initiative or acting independently in the course of their work. Danfoss has seen, however, that the Chinese have a great deal of self respect and an increasing desire to make progress and create results that acts as a powerful driving force behind activities in China. Precisely this wish to take the initiative is indispensable for Danfoss in China with high annual growth rates, and where it is important that every employee makes a strong contribution. To support the development and the cultural changes in Danfoss in China, specific efforts are being made to reduce the number of employees stationed in China from abroad, and to train the Chinese managers to take charge of daily operations. In addition, responsibility is being delegated to managers and employees in key positions and others in order to build up a mature culture around responsibility and initiative. By means of a simple, but target-oriented technique, by which a manager always asks for the employee s advice, and in some cases actually demands advice from the employees, a strong feeling of responsibility has been created among the employees. It is now the general rule that employees no longer simply draw attention to a problem when it arises, but also suggest a solution on their own initiative. An essential factor is that many employees have been employed by the company for many years. A large proportion of the present managers have been employed at Danfoss in China since it was first established, and they were able to celebrate their tenyear anniversaries in In the effort to make China a second home market for Danfoss it is vital to build a bridge between the Danish and Chinese cultures and create mutual understanding. Danfoss will continue to expand its activities in China in the coming years, and the experiences and considerations described here will help to ensure that Danfoss in China can maintain its employees satisfaction and pride in their work while increasing the financial results of their activities. Training and enhancement of competencies Professional and personal development is another of the most important areas for development, pointed out by the employee perception survey mentioned earlier. Employees development at Danfoss is increasingly aimed at building up and securing the necessary skills for individual employees or in teams, so that they will subsequently be able to perform their tasks in the immediate future as well as here and now. Competence building may still take place through participation in conventional courses, but it is gradually becoming just as frequently acquired through daily work or internal programmes such as 104

105 the Danfoss Business System, which is designed to improve and optimise daily processes at Danfoss. Case: Danfoss Business System Occupational satisfaction in connection with improvement programmes Danfoss has achieved considerable production improvements through Danfoss Productivity Program. Until now more than 900 employees have been involved, and on average productivity has increased by 21%. Improvement programs have also been initiated in sales and purchasing. All these programs are part of the Danfoss Business System a global initiative designed to help to increase growth and profitability in Danfoss, to improve its success on a competitive global market. Achieving these goals calls for hard work, and employees often need to learn new ways of working, while constantly concentrating on doing their work better than before. It can be both frustrating and stressful. Several initiatives have been introduced to help employees through the changes. As of June 2005 employees in Denmark have taken courses in stress prevention before starting on Danfoss Productivity Program projects. The supervisors in production, whose job can be particularly stressful, have been given new job descriptions that clearly specify what they are to spend time on and what tasks they can pass on to others. The project managers who are responsible for implementing the improvement projects undergo training, so that they are better able to identify with the employees situation, listen to them and involve them in the process. In order to constantly monitor how the employees feel about their work, perception studies have become a regular element in all projects. These perception studies enable managers to identify danger signals and react to them before the situation becomes serious. The new working methods are defined and improvements created by the area managers and employees with the support of the Danfoss Business System organisation. Case: Skills development for production supervisors The Danfoss Business System, which was introduced in 2005, has especially involved employees in production and to some extent those in group sales functions. As a result of implementing the Danfoss Productivity Program and the general development of production management, new areas of responsibility and new tasks appeared for the Danfoss production supervisors. They have a crucial role to play in ensuring that Danfoss achieves the improvements in production and the changes in the working culture with regard to performance and continuous improvements, which are the actual target. The role of the production supervisors is essential in achieving the goals, both during and after the implementation of Danfoss Productivity Program. At the same time the production supervisors are responsible for initiating and completing improvement projects. Experience from Danfoss Productivity Program shows that great pressure can build up around production supervisors and employees, and there have been cases of stress-related sickness and candidates rejecting the offer of positions as production supervisors. As a consequence, a working group drew up a new job description and skills profile for Danfoss production supervisors. In the future, active leadership, development and care for employees are to take up more of the production supervisors normal working day. At least 50% of their time at work must therefore be spent among the employees in the 105

106 production. On the basis of the new competence profile, a special course of supplementary training has been designed for production supervisors, concentrating on improving the skills needed if the production supervisors are to meet the demands of their leadership role. This production supervisor course are carried out for the first time at the beginning of 2006, and according to plan it will become an integrated part of the Danfoss Productivity Program activities at Danfoss. The transition from conventional course activities to a more direct and individual work-related form of training and competence development is increasingly supplemented by e-learning, and a common Group e-learning function was established in Danfoss wants to take advantage of the possibilities opened up by e-learning, for instance to extend the knowledge of administrative tools that are to be used globally within the Group. E-learning is regarded as a cost-effective supplement to the more conventional ways of building up skills and competences, which can be carried out locally or through training programmes. Another purpose behind the continuing focus on enhancement of competencies for Danfoss employees is to improve their chances of getting a new job either within the Group or externally, if the employment situation at Danfoss changes. This development of skills provides a solid foundation for employees if they lose their jobs due to cutbacks. Danfoss has particularly good experience of how a coordinated, purposeful effort produced positive results when it was necessary to find other work for the employees affected. Again in 2005 there have been examples of business units at Danfoss that have decided to relocate production from Denmark or Germany, because the considerably lower costs of production in other parts of the world have been critical for maintaining or expanding the Group s position on the market. Case: Redundancies at Danfoss in Flensborg, Germany Globally, the competitive situation within household compressors is dominated by the fact that production is chiefly carried out in countries where the level of costs is low (such as Brazil, Korea, Eastern Europe, Malaysia, and to some extent China). Due to unprofitable production of smaller-sized household compressors in Flensburg, Germany, the employees were informed in 2004 that plans would be made to relocate that type of production. As a result of the specific plans for relocation, production of small household compressors is being relocated to Slovakia in the course of Subsequently, the plans for relocation were discussed with employee representatives, who have accepted that the move was an economic necessity. The cuts in personnel at the Flensburg factory will result in a reduction of the staff by nearly 700 employees over about two and a half years, and the selection of those to be dismissed is based on social criteria. Redundancy payments have been negotiated between the employee representatives and the management. At the same time a new job-training company (Transfergesellschaft Küste) has been established, which also operates as a job exchange. This company is based on financial support from Danfoss, and develops the employment skills of the employees affected by the dismissal round, and also negotiates new employment contracts. In parallel, the employee representatives and the factory management have also started further activities that aim to create new forms of employment for workers both north and south of the border between Denmark and Germany. 106

107 The purpose of the relocation is to restore cost-effectiveness in production, and at the same time to secure the remaining production of smaller commercial compressors and future work at the Flensburg factory, which will also continue to be the competence centre for the entire compressor production. The restructuring process during 2005 has been characterised by the employees acceptance of the need to relocate production. Case: Partnership for women as entrepreneurs in China Danfoss is committed to developing society and creating workplaces. In China Danfoss, UNDP and the Beijing Women s Federation have entered into a partnership to train unemployed women as entrepreneurs. The project exploits a combination of Danfoss expertise on starting enterprises, UNDP s expert knowledge of conditions in China, and the Beijing Women s Federations network to identify suitable candidates, together with the unemployed women s need to find themselves jobs. The project centres on self-help, and the first 66 women completed their training in In the future the unemployed women who are trained as entrepreneurs will be expected to train new entrepreneurs. This project is being assessed together with other UNDP partnerships as part of a PhD study at the University of Aarhus in Denmark. The project was started because unemployed women are marginalised in China, where there is an unwritten rule: jobs are difficult to find for men aged over 50 and for women aged over 40. Case: Women as managers in China During recent years Danfoss has seen an increase in the number of female managers. In % of the managers in the Group were women, while the number of women managers in China was twice as high. A total of 26% of Chinese managers are women. The apparent reason is that gender equality is more widespread in China than in other societies, and that the one-child policy combined with grandparents looking after the children makes it easier for women to have a career. Talent management at Danfoss One of the most vital areas for HR work at Danfoss is the ability to attract and retain employees with talents at all levels, in various types of work. Danfoss endeavours to strengthen the company s position as one of the preferred workplaces on a labour market strongly affected by competition. In recent years recruitment activities at Danfoss have taken on an increasingly international dimension with sharpened focus on readiness for change and cultural understanding. This tendency is expected to continue and become stronger in the next few years, and consequently Danfoss extended its resources in recruitment to key positions in The globalisation of the recruitment function will continue in In connection with this strengthening of the recruitment function Danfoss has drawn up a strategy for strengthening talent development at middle management level. The new initiatives will be based on experience gathered from the group s highly successful Postgraduate Rotational Program(see the case below). In addition, a general fostering of talents processes concerned with identifying, managing and developing talents will become more systematic at all levels within Danfoss and will be a result of coordinated action and follow-up right across the business areas and companies in the Group. 107

108 International experience Employees who have been stationed outside their countries for 2 years or longer Distributed by region % Length of service % % Globally Globally Denmark 0-4 years years Absence Globally Denmark Denmark EMA (excl. DK) EMA (excl. DK) EMA (excl. DK) North America (incl. MX) North America (incl. MX) Latin America 5-14 years year > 35 years North America (incl. MX) Latin America Latin America China China China Asia-Pacific (excl. CN) Asien-Pacific (ekskl. CN) Asien-Pacific (ekskl. CN) Case: Postgraduate Rotational Program More than 30 years ago Danfoss developed a two-year development and rotation program for newly trained engineers and economists. Today this program the Postgraduate Rotational Program (PRP) has spread globally and covers all types of Master s degrees relevant to Danfoss. Many talented people have been developed through the program, and today many of them hold key positions at Danfoss. In employees went through the program, representing ten different nations: Denmark, China, India, Japan, Indonesia, Malaysia, USA, Poland, Germany and France. The participants work both in their own home countries and in Danfoss locations throughout the world. They carry out or contribute to value-creating projects, typically taking on four to six tasks of up to six months duration in the course of the two-year program. Outside Denmark, focus is sharpest on the Asian growth markets, and the target group consists of the best graduates at Master s degree level from the appropriate universities. In China, Danfoss collaborates with nine universities, and this collaboration will be extended to include fifteen with the best reputations in core areas. As a result, Danfoss has received more than 1,000 written enquiries, and from these six candidates will be chosen to take part in the program in Danfoss needs far more new employees in China, and many of the enquiries about the Postgraduate Rotational Program lead to other forms of permanent employment in the company in China. It is Danfoss ambition to continue to develop the program with a view to becoming a qualified player in the contest to attract the best talents. Cross-cultural understanding Since an increasing number of Danfoss activities are carried on outside Denmark or across international borders, there is an increasing need to develop cross-cultural skills and understanding among the company s employees. The rotation program described above supports this development, and additionally the understanding of cultural differences is increased when employees are exchanged or stationed to different companies in the Danfoss Group. Experience shows that personal experience is necessary in order to understand other cultures, and real international experience is only gained through carrying out long-term assignments abroad preferably lasting more than six months, and optimally involving actual stationing abroad, with a duration of at least two years. At the end of 2005 a total of 72 Danfoss employees were stationed outside their respective countries for at least a year. Since Danfoss started stationing employees abroad in 1991, 915 employees have been stationed abroad for at least a year of which 229 have spent more than two years abroad. Employee satisfaction The global survey of employee satisfaction in 2004 showed a largely satisfactory picture of overall satisfaction and motivation among employees. At the beginning of 2005 individual managers drew up and presented plans of action, defining the measures they would take to improve weak points or maintain the best in each department. The employees in the various departments have been involved in taking general action, while other measures have been more concerned with personal development for the managers. In both cases resources have been made available to implement the measures taken. At the same time each manager s immediate superior has been responsible for following up on the progress of the action plans. 108

109 Employee turnover Excl. sale of companies % Reasons for leaving Distributed by regions % Globally Denmark EMA (excl. DK) North America (incl. MX) Latin America China Reasons Retirement for and leaving illness Distributed by categories of employees % Globally Denmark Managers White-collar employees Managers EMA (excl. DK) North America (incl. MX) White-collar employees Latin America Blue-collar employees Total (excl.) Blue-collar employees China Asien-Pacific (ekskl. CN) Total employee turnover including company divestments was 17%. Without divestments employee turnover was 16% Asien-Pacific (ekskl. CN) Case: Improving employee satisfaction at Danfoss in Turkey The Danfoss sales company in Turkey was one of the units in the organisation that did not show good results in the employee satisfaction survey in The assessment of the management and the employees general satisfaction was not acceptable, and a process was started to bring about many different changes that would lead to considerable improvements. Efforts were concentrated on four problem areas, where employees have been involved in drawing up suggestions for improvements: confidence, communication, teamwork and time spent together socially. Additionally, training was provided for the company s management team. The specific results of the changes made and the action taken at Danfoss Turkey were measured in the middle of This analysis showed improvements in all areas compared with the results from The employees feel twice as motivated as before, and the assessment of the company management also shows considerable improvements. Workplace of the Year in Denmark At the end of 2005 Danfoss was voted Workplace of the Year 2005 in Denmark by 3F, (United Federation of Danish Workers) and the magazine Fagbladet. This is a title awarded on the basis of votes from the Union s own members. The award committee singled out the Danfoss company culture and the ability to propagate that culture when new companies are established round the world. It also mentioned employee influence and the individual s experience of being able to make a difference as factors that contributed to the nomination of Danfoss as one of the best workplaces in Denmark. The human factor and company acquisitions In the next few years, part of Danfoss growth will come from acquisitions of new companies. The Group has gradually accumulated valuable knowledge and experience of the financial and business-oriented processes in assessing potential companies for acquisition and the subsequent integration. Up to now, however, Danfoss has not focused sharply on exploiting the experience of personnel and management factors in connection with the process of acquisition and integration. In 2005, a number of initiatives were implemented centrally to ensure that in the future HR will play an important role in connection with company acquisitions by Danfoss. From a human resource point of view, the acquisition of another company can be seen as a kind of recruitment of new employees where, in addition to gaining access to new customers, products and technology, Danfoss also acquires new skills, professional knowledge and experience. The human factor, as in the new employees and managers motivation, is in most cases vitally important to the success of the company takeover. To bring about integration, links must be forged and a we attitude built up with the new company. Specialists from the HR function must support the management in the processes of adaptation and integration that are necessary in order to achieve the expected gains from the acquisition. From the beginning of 2006 Danfoss will be even better equipped to carry out effective integration processes. A checklist has been made out covering the aspects of human resources and management to be investigated when a company is being evaluated for acquisition ( HR due diligence ), and which of these aspects should be given particular attention in the integration process. Retirement and illness Employee action Danfoss action 109

110 Optimising HR processes In order to create continuous improvements in the area of human resources, the entire Group section of the Danfoss HR organisation has been fundamentally restructured during The central and regional functions have been merged in a single global HR organisation, and initiatives have been implemented that will extend and strengthen the global network of HR staff. The decentralised responsibility for day-to-day personnel work in the company units and local Danfoss companies will be maintained. Nevertheless, greater efforts are being made to create aligned, Group-oriented coordination in HR work at Danfoss globally, with the primary aim of contributing to Danfoss ability to achieve satisfactory business results. In relation to this, a web portal has been created with global coverage, to make it easier for Danfoss managers to gain an overview and carry out HR activities more effectively. This web portal will make it possible for individual company units and managers to ensure more alignment in their focus and actions in all units across national borders. The new HR platform provides access to relevant employee data among other things and to the tools to be used by managers in connection with interviews and employee development. Access to the portal and administration of the data comply with local legislation. At the end of 2005, 77% of the managers have access to the portal, and this number will increase during 2006, while new tools are added. 110

111 Danfoss Employee Foundation, allocation of grants Change of address Continuation 12% school 1% Funeral aid 4% Other 4% Health treatment 4% Financial problems 26% Confirmation 4% Abuse 1% Donations from the Fabrikant Mads Clausens Foundation Outside Denmark 18% Art & culture 13% Spare time & sports 10% Psychologist 27% Divorce, dissolved partnerships 14% Illness, dentist, etc. 3% Research & training 28% Hospitals, institutions, health 31% Foundations Danfoss Employee Foundation The Danfoss Employee Foundation is a social foundation that offers advisory and financial support to employees in Danfoss A/S and associates, including Sauer-Danfoss ApS. In 2005, the Foundation attended to about 300 cases. The cases included problems in connection with divorce, illness and death as well as psychological and financial problems. The Foundation made donations totalling about DKK 3.6m in 2005, which is an increase of 24% compared to The legal consultancy services of the Employee Foundation dealt with about 400 inquiries, primarily in relation to inheritances and wills, divorce/ estate divisions, debt relief and insurance issues. The Foundation carried out a campaign promoting estate planning in 2004 to encourage as many employees as possible to make a will. Since the campaign was very successful, it has been made permanent. The Fabrikant Mads Clausen Foundation The Fabrikant Mads Clausen Foundation was established in 1960 with the aim of making donations for charitable purposes. The Foundation has granted considerable funds for many purposes, historically primarily in the local area around the Nordborg plant. As Danfoss expanded and became global, the support has now expanded to include areas around Danfoss locations in Denmark and abroad. The Foundation generally supports training and research, the promotion of Danish cultural enterprise in Denmark and abroad, charitable associations or institutions and other charitable purposes judged suitable by the Board. In 2005, the Fabrikant Mads Clausen Foundation donated 7.3m DKK. The Foundation has once again supported a wide range of associations and institutions in Danfoss vicinity in Denmark, including sports clubs, scouts groups, pensioners associations and disabled persons institutions. To support art and culture, donations have been made for local museums, choirs and orchestras. Within research and training, the Foundation has supported different projects to fight diseases, for instance the research in cancer and resistant bacteria. Several hospitals have received support allowing them to purchase diagnostic and treatment equipment. Among them is Sønderborg hospital which has purchased laser equipment for the treatment of enlarged prostate as well as equipment for the monitoring of ill, newborn and premature babies. In 2005, the Foundation donated approx. 1.3m DKK outside Denmark. During the past year, the world has witnessed a number of major natural disasters, which have had a bearing on the Foundation s donations. The foundation donated, for example, 1m DKK to the victims of the tsunami in Southeast Asia, This initiative began with collections among the Group s employees globally, who raised 0.5m DKK. The Foundation doubled the amount. Additionally, funds have been donated for relief aid and the reconstruction work following the hurricane Katrina in the southern part of the USA and the earthquake in Pakistan. 111

112 C o r p o r a t e C i t i z e n s h i p Social Responsibility (CSR) Social responsibility applies to companies, both internally and externally. Internal social responsibility concerns the way the company treats the employees, their opportunities and challenges and how they are supported (refer to People and Values). Externally, it is a matter of company ethics and social responsibility in a wider sense of the word. Danfoss has joined UN s Global Compact Initiative which comprises ten principles for good company ethics. Global Compact covers human rights, labour rights, environment and corruption. In the interest of the reader, the three environmental principles are dealt with in the latter part of the report, whereas the other principles relating to CSR are described in this section. In the following ten items, the Global Compact principles are reviewed, explaining how Danfoss approaches them and which initiatives the Group has taken in this field in In order to ensure that the organisation lives up to the expectations for a company like Danfoss, an internal survey of the Group s social responsibility has been conducted for three consecutive years (CSR questionnaire). The survey focuses on the handling of, for instance, discrimination, children s work, labour rights, business ethics, corruption and bribery, working environment, relationship with the local community, and the implementation of policies. Some of the questions in Danfoss CSR surveys concern internal procedures and good business ethics, while others relate to UN s Global Compact. Principle 1. We will support and respect the internationally declared human rights within our spheres of influence A prerequisite of supporting and respecting human rights is that the organisation is familiar with the human rights and local conditions in the countries where the Group has its activities. Consequently, Danfoss has initiated country analyses of all the countries in which the Group has factories. The country analyses are used in connection with the acquisition of companies outside Denmark and when visiting factories, in which cases social responsibility is a parameter. The analyses are also available to all purchasers. Danfoss outlined a Code of Conduct in 2004 for suppliers. It was updated in 2005 which means that the tenth principle in Global Compact on fighting corruption and bribery is now included. More than 100 purchasers worldwide have received training in the tenth principle and in the use of a new database containing information of suppliers CSR and environmental conditions. The database was designed on request of the purchasers who were trained in Global Compact in Danfoss Code of Conduct has been incorporated into the Group s standard contract and is part of the purchasing terms. 112

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114 Principle 2. We will ensure we are not complicit in human rights abuses The principle deals with the respect towards human rights at Danfoss companies. A basic prerequisite of not violating the human rights is that these are known by management. Danfoss internal CSR questionnaire examines different aspects of human rights and labour rights, and if areas are found not to be satisfactory, this monitoring is used to improve conditions. In some of the 21 countries where Danfoss has production, violations of human rights are not unusual. Therefore, social responsibility has been an integral part of the Basic Management Programme since The programme involves management training for young managers. The purpose of the programme is to enable the managers to deal with the challenges they come across in different countries and sharpen their awareness on social responsibility. Visits to the factories take place regularly in order to keep our own house in order. The visits typically relate to environmental and social responsibility issues. The communication with the factories is based on the analysis of the country in question. Conditions are adjusted to meet the conventions of ILO, International Labour Organisation, if areas are found not to fully comply. Information is also gathered on how local sites act in different circumstances to use as best practice for the benefit of the rest of the Group. Cases: China Expansion of factory in China Danfoss opened a new factory in China in 2005 and plans to expand the factory area with another 10,000 square meters in March In order to prevent difficulties for the local inhabitants when the need for new land arises, Danfoss has made an agreement with local authorities concerning housing. According to the agreement, all of the affected residents will be offered another home free of charge of the same size as he/she has today in a different location. If the number of square meters of the new home exceeds the size of the previous home, the amount charged for the extra square meters will be equivalent to half the market price. The new apartments are based on ownership, not rental. In addition, the authorities will offer the local residents up to three jobs and training if required. Residents above the age of 55 will receive pension, irrespective of having earned it or not. This settlement has been well received by the local people. Medical examination in China It is common practice for many countries to use agencies for the recruitment of employees or health examinations for potential employees. Usually, companies should take a cautious approach when examining employees health, because this implies a risk of discrimination. Danfoss China employs an agency to examine whether a pulmonary disease has been passed on to the applicants. The examination is partly required by the authorities but also by the employees at Danfoss China who have requested an annual health examination. Applicants will be informed of the result of the examination. If the pulmonary disease has been passed to an employee, he or she will be asked to receive treatment. Danfoss will only be informed if job applicants have been infected with the disease in question. 114

115 Principle 3: We aim to maintain employees rights to unionise and recognise employees rights to collective bargaining Danfoss respects the employees right to unionise and participate in collective bargaining, and the top managements of all the companies state in the survey that the employees have the right to do so. In countries where the employees do not have the right to be members of trade unions of their own choice or where trade unions are banned, the Group has established alternative forums at several locations, giving the employees the opportunity to discuss work conditions with the local management. Examples are China, the USA and the United Arab Emirates. Principle 4: We aim to actively fight all kinds of forced labour does not tolerate forced labour. Danfoss social responsibility policy requires that all employees have employment contracts or are subject to agreements, which specify the employment terms, stating the voluntary aspect of the employment. Employees at 92% of the companies included in Danfoss survey have written employment contracts. The remaining 8% of companies define the employees salary and working conditions on the basis of other agreements. These companies are located in Argentina, the USA, Finland, England and Iceland. Principle 5: We aim to actively fight child labour Danfoss respects children s and young people s right to development and education. As a global company with activities in many markets there are several sets of rules regarding when young people are considered part of the work force. Danfoss has consulted Save the Children in Denmark and thus the rules governing child labour are made plain in the revised CSR policy from Danfoss complies with ILO s rules, specifying that young people between 15 and 18 years of age can be part of the work force, if they are beyond the school age and if they are under special protection. Young people are not allowed to work night shifts or have hazardous work, and they are entitled to more breaks than adults. A total of nine factories employ young people between 15 and 18 years of age: Six Danfoss companies in Denmark, one in Germany, one in Finland and one in England. A total of 40 young people are employed at Danfoss, of which only six are employed full-time. Some are apprentices while others are weary of going to school and do not have the motivation to continue school. They are being offered ad-hoc service work and are trained in being independent and having responsibilities. The purpose is to prepare them for training later or an apprenticeship in business life. A number of the factories employ young people during the summer holiday, which is the case in Germany and Finland. The remaining number of young people only work four to eight hours a week. The factories comply with local law regarding child labour and the ILO requirements are also complied with, such as offering the young people sufficient breaks. At one factory, DEVI in Vejle, Denmark, six young people under the age of 15 are employed. DEVI has introduced a scheme allowing the children of employees to work a couple of hours a week with ad hoc service work, such as tidying up, shredding paper or assembling a few and small-sized components in their own home. Of the six young people, five do not work in the factory, but are given a small number of components, which one of their parents brings home. The work is organised so that the children are not prevented 115

116 from attending school and every aspect of Danish law relating to children s labour is complied with (refer to CSR declaration). But the scheme is contrary to Danfoss own CSR policy. Consequently, in the future only young people over the age of 15 will be employed under the scheme. The young people presently employed under the scheme will continue to be employed, however, because they will soon be 15. Principle 6: We aim to eliminate discrimination in the work place The Group aims to promote a work place culture of dignity and respect towards employees, where discrimination is not tolerated. Abolishing discrimination is a point in Danfoss social responsibility policy. In addition to the social responsibility policy, 54% of the Group s companies have local policies or procedures to counteract discrimination, according to Danfoss CSR survey. This is an increase of 13 percentage points, compared to the 2004 figure. The policies or procedures often cover equal treatment at the work place (77%). The chart shows the percentage distribution. A long range of the companies which do not have written procedures to counteract discrimination have decided how to handle cases of discrimination, if required. Distribution of policies Issue (among those companies that have policies) Gender 81 Nationality/ethnicity 69 Religion 71 Age 71 Sexual harassment 71 Bullying 67 Disabilities 62 HIV/AIDS 40 Principle 10: We will work against corruption, including extortion and bribery Corruption and bribery are some of the most substantial obstacles to free trade and is also the biggest obstacle to eliminating poverty in the world. It is therefore important that companies approach the tenth principle on the fighting of corruption and bribery. In the revised CSR policy from 2005, Danfoss has defined its view on corruption and bribery: Taking part in corruption or bribery is incompatible with being employed at Danfoss and employees must be careful not to participate in situations which involve corruption or bribery, for example when entering into agreements with business partners. Corruption and bribery are illegal in a range of countries, but is seldom enforced. They are covert actions, so one of the companies most important tools is to introduce transparent business procedures and increase the employees awareness on the issue so that they know how to respond. The CSR policy, which applies throughout the Group, establishes that any gifts worth more than a certain amount must be reported to the immediate manager. The manager can decide to set a different lower limit locally. Other CSR issues at the Danfoss Group Ethics and decent behaviour are important parameters for Danfoss. Inquiries have therefore been made at every Danfoss company to establish whether employees had been dismissed due to unethical behaviour or the violation 116

117 of Danfoss guidelines (abuse of company property, theft, violation of security rules or fraud). 92% of all of the Group s companies have never had reason to dismiss an employee on grounds of unethical behaviour or violation of company guidelines, however 8% of the companies have dismissed employees or have accepted the employee s resignation. A total of 20 employees have left Danfoss in Denmark, South Africa, China, Ireland, Mexico, France, Vietnam, the Philippines and the USA. The reasons for leaving Danfoss were theft of company property, violation of the law, or disloyal/unethical behaviour towards the colleagues or Danfoss. 117

118 C o r p o r a t e c i t i z e n s h i p Environment Principle 7: We will support a precautionary approach to environmental challenges Over many years, a principal element in Danfoss environment policy has been that the Group aims to be among the most environmentally conscious companies within its branch of industries. Among other things, this means restricting the use of substances and processes, which may pose a risk to humans and the environment. Danfoss uses potentially harmful substances, which cannot directly be dispensed with. The challenge is to replace them with other, less harmful substances, to use them as efficiently as possible and to protect employees and the environment in the best possible way. Danfoss strives to prevent the occurrence of environmental problems in all situations. Consequently the Group carries out environmental assessments of all potential acquisitions before a decision is taken on whether the company shall be included in the Group. This environmental due diligence ensures that Danfoss has a deep knowledge of the environmental impact of new companies and that purchase of new companies takes place with environment al considerations. has joined The Business Charter for Sustainable Development issued by the International Chamber of Commerce. Danfoss use of refrigerants Danfoss has successfully phased out the environmentally harmful gasses CFC and HCFC. The switchover to the less harmful HFC gas has been a gain for the environment and it will be of further benefit when it becomes technically viable to use natural alternatives in those applications where HFC is the only technically sustainable option. The refrigerants CFC, HCFC and HFC are chemicals containing Chlorine (C), Fluorine (F), Carbon (C) and Hydrogen (H). CFCs and HCFCs have an ozonedepleting effect because they contain Chlorine. However, HFCs do not contain Chlorine, so they do not have a harmful impact on the ozone layer. All three of them contribute to global warming, but HFCs are depleted faster in the atmosphere, contributing less to global warming than the others. Danfoss sees objective, reasonable reasons for developing alternatives to the HFC gasses. HFCs are contributing to global warming but only if the refrigerants are released into the atmosphere. Danfoss collects the refrigerants to prevent release into the atmosphere. Danfoss has over recent years invested substantially in research and development of these alternatives. The energy consumption in stationary cooling and air conditioning installations is a much larger contributor to global warming than refrigerants. An increase in the energy efficiency of installations has consequently a much higher positive effect on the global climate than the choice of refrigerant. Today the most energy effective cooling and air conditioning installations are based on HFC. 118

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120 Especially within air conditioning, not very many components for alternative refrigerants have been developed yet. Danfoss fundamentally believes that maximum consideration for the environment is part of sustainable development which means that the company will continue to research in and develop alternatives to existing solutions. Case: Environmentally friendly cooling technology A desire to cool food by means of environmental friendly technology is behind the installation of the first commercial CO 2 cooling system in Great Britain, which is installed in a supermarket in Clapham. The cooling system is the result of a cooperation between a number of suppliers and the supermarket giant Sainsbury s. Danfoss supplied an ADAP-KOOL system which consists of electronic control units, frequency converters and expansion valves all developed for use in CO 2 -installations. Danfoss Industrial Refrigeration s ICM Electronic Motorised Control Valve was awarded the prestigious prize as This year s environmental friendly product at the distribution of Great Britain s 2005 Cooling Industry Awards held on the 22nd September. The valve is the result of the work over several years at Danfoss Industrial Refrigeration and represents a major leap forward. With the hermetically closed and magnetically actuator, the valve overcomes the problems with poor closing and leakage in connection with traditional industrial cooling valves. In this way, the loss of refrigerant is very much minimised. At the same time the design of the valves makes it possible to use it with all forms of refrigerants including high-pressure carbon dioxide, ammonia, HCFC and HFC. The performance of the valve goes far beyond its limited size. It is a product with a significant future both concerning industry and environment. The award ceremony, which took place for the second time, is an event for the entire industry where the best and most recent methods for more environment friendly cooling is rewarded and celebrated. ISO at the Danfoss factories Certified environmental management (ISO 14001) in place 84% Environmental management initiated 11% Assembly factories which are not yet to be certified 5% Principle 8: We will undertake initiatives to promote greater environmental responsibility. Industrial production cannot take place without an impact on the environment. It is crucial to minimise the impact, which is why environmental responsibility must be high. Danfoss most important means towards this end is the implementation of environmental management systems according to the international environmental management standard ISO and the introduction of a common global environment target as of The environmental management systems ensure that the environmental work pervades the entire organisation and that the environmental impact is reduced at the source. A network has been established between the environmental coordinators of the factories to spread best practice and to avoid double work. Through the anchoring of Danfoss vision and values with all the employees, the ownership of environmental work at all levels in the Group is ensured and the local societies are positively affected. 84% of the 57 factories included in the environment part of the Corporate Citizenship Report are environmentally certified, and 11% are in the process of becoming certified. The last 5% are assembly plants which are too small to introduce environmental management. 120

121 Environmental management systems in Danfoss Danfoss aims to drive continuous environmental improvements through environmental management systems. Local engagement and ownership is the basis for success ensured through focus on planning, operation, monitoring and corrections by using the Plan-Do-Check-Act method as a foundation for the management systems. When a factory introduces environmental management, all environmental conditions are assessed to create an overview of where to take action, both on basis of what are considerable environmental impacts, the environmental policy and the local national legislation and environmental agreements. Danfoss environmental policy is implemented and, if necessary, complemented by local formulations, and environmental objectives and action plans are agreed upon, initiating environmental improvements projects. Procedures and instructions describe the environmental work, making it a part of the daily operation. Continuous monitoring of the environmental conditions ensures that irregularities or errors are corrected and that preventive action is initiated to prevent recurrence. The executive management monitor the environmental management system by means of internal audits and annual reviews of all system elements to ensure that the environmental management system is functioning properly. All parts of the management system are examined by an external assessor who evaluates whether certification can be upheld. Organising the environmental work The responsibility for environment, working environment and safety lies to the broadest extent with the factories in the Group. Corporate policies and standards are maintained by Corporate Environment & CSR which also maintains a network of environmental coordinators at each factory. The coordinators are local resources within environment and also contribute data for the Corporate Citizenship Report. It is the responsibility of each factory to maintain its own procedures and management systems and to observe local legislation during operation of the facility. All environmental aspects are considered when designing new products or processes. The use of chemical substances, atmospheric emissions, machine safety, waste management and ergonomics are among the topics dealt with when assessing Danfoss environmental impact. Ongoing education and training of employees at all factories throughout the Group ensure that they have the required knowledge and skills to enable continuous improvement of safety and environmental impact. The education and training is planned according to local needs and constituted 32,300 hours in Environmental conditions of suppliers Danfoss is conscious of the importance of selecting suppliers who meet our stringent requirements. Thus Danfoss launched a global concept for selection and approval of suppliers. The concept is implemented through the global purchasing organisation and includes quality, logistics, production, technology, management, employees, environment as well as the principles of Global Compact. A standardised evaluation tool and scoring system is used, to be able to register and compare the performance of the suppliers. 121

122 Environmental indicators EII Energy EII Water EII Waste EII CRAN materials EII HCFC Montreal Protocol Bad Good Ethical guidelines (Code of Conduct) for suppliers and Danfoss own lists of banned and undesired substances and materials supplement the evaluation tool. Danfoss negative list describes the chemical substances and materials which must not be used in products or processes and substances of which the use must be limited as much as possible. The list must be used in connection with all contacts with suppliers and is updated in the end of The list ensures that purchasers everywhere in the organisation know the requirements of Danfoss to the supplier s use of chemical substances and that only substances for which the environmental effects are known and accepted are purchased and used. Global environmental targets and indicators To further a continued positive development of the Group s environmental impacts, environmental targets have been set up across all organisational units with effective in Danfoss finds it important to set measurable targets for the Group s total consumption of CRAN substances, organic solvents, energy, water and HFC as well as waste and accidents. All factories have been asked to contribute to fulfilling the targets and focus has been set on those with large consumption, which have developed ambitious action plans. The aim is, over a period of three years, to reduce the total relative environmental impact (EII, Environmental Impact Index) of the Group on each of the areas mentioned by at least 5-10% annually. The aim is that the annual increase in CRAN substances, organic solvents, energy, water, HFC and waste does not exceed 20-50% of the annual increase in the Group s raw material consumption. The number of accidents must decrease by at least 5% annually. The Danfoss Management can monitor the environmental targets through the Danfoss Performance Management System. Danfoss expects that this system will be used by the factories in the future, to monitor their own results. Environmental reporting All Group factories are required to report environmental data for the Corporate Citizenship report. Every year, the factories must report on 90 different parameters which are processed and subjected to thorough internal audit. Finally an external audit is carried out on the whole environmental section of the Corporate Citizenship report. A week long seminar is held annually for all employees responsible for reporting, to provide training and updated knowledge required for the reporting task. In 2005, 45 of approximately 60 coordinators from 14 countries participated in a seminar in Slovakia. Some factories prepare their own environmental statement or green account depending on whether they are subject to legislation or are registered according to the European EMAS regulation. The factories in Nordborg issue a joint green account whereas the magnet valve factory in Kolding and the compressor factory in Flensborg issue EMAS-statements. Danfoss Drives in Graasten is obliged by Danish legislation to issue a green account. Case: Visualising environmental performance The radiator thermostat factory in Silkeborg, Denmark, was awarded an environmental diploma for their preparation of a reader friendly environmental statement to all employees. The diploma is awarded by the local environmental network Miljøforum Østjylland in recognition of Danfoss contribution to the improvement of environmental consciousness in the local society. 122

123 Danfoss Compressors in Slovenia experienced that increasing production resulted in less consideration of clean and organised work places. This situation called for a campaign which would re-create order and tidiness. Posters were set up to supplement a thorough education of employees. Subsequent follow-up each week quickly lead to the desired result. The local chamber of commerce in Slovenia recognised the efforts and awarded the compressor factory for its hard work. The factory received an award as the cleanest and best organised factory in the region. Only one other company in Slovenia has previously received this award. Since mid-2004 Danfoss Industries S.A. de C.V. in Mexico has participated in PROFEPA s (the Mexican Environmental Protection Agency) Clean Industry Certification. This certification program, supported by Mexico s environmental minister, led to certification of the company on areas as emissions and handling of waste and environmental risks in September For customers and the local society the certification means that the factory is recognised as an environmentally responsible company which acts in a sustainable way. The certification also means that the company can use an official Clean Industry mark in the marketing and that inspection from the authorities is suspended as long as the certificate is upheld. The certification is extended with participation in the local state program Ecology Award by Recycling, which focuses on a sustainable development and the exchange of knowledge and experience about recycling with other companies. Danfoss LPM in Finland participated for the fourth year in a row in an event with local industry companies and the university in Kuopio. The aim was to inform adults and children about industry processes and products and how everybody in society can participate to improve the environment. In an amusing and inspiring way families learned how LPM s district heating stations are manufactured and how they contribute to saving energy. Principle 9: We will encourage the development and diffusion of environmentally friendly technologies. Danfoss defines development and diffusion of environment-friendly technology as developing and producing more environmentally friendly products but also as using cleaner technology in production. Most of Danfoss products are characterised by the fact that they contribute to energy savings when used by the customers. Many Danfoss products have a positive environmental impact as the energy consumption is a parameter which weighs heavily in the environmental impact of a product from cradle to grave. Continued focus on the environmental impact of electronics In 2005 Danfoss worked on implementing the requirements from EU s WEEE directive on recycling of electrical and electronic products and the RoHS directive which prohibits the use of a number of substances in electronics. The WEEE directive is only expected to cover a limited portion of Danfoss products by the end of New interpretations of fixed installation and installed by professional has moved the responsibility for registration and recycling of most products from Danfoss to those customers building our components and products into their products before selling it to the end user. Following this, Danfoss only bears the responsibility for ensuring recycling for a limited number of products. Danfoss labels a number of products with a crossed-over wheeled bin and issues product declarations describing the major material fractions and princi- 123

124 ples for separation and reuse. The declarations are made available to customers and recycling companies. The RoHS directive bans the use of lead, cadmium, hexavalent chromium, mercury and the flame retardants PBB and PBDE and is already implemented in a number of business areas. The directive has a major impact on Danfoss Drives, for example, which is the biggest electronics manufacturer in the Group. Drives is very advanced in introducing alternatives to soldering materials with lead and by the end of 2005 the first products were delivered, which meet the requirements in the RoHS directive. The introduction of lead-free soldering has been an easier task technically than expected and the quality of the new soldering is increased to the advantage of the customers. The RoHS directive has also influenced many other business areas. Hexavalent chromium, which is used for surface treatment of e.g. screws, is one of the unwanted substances. Danfoss Household Compressors has, through successful co-operation with its suppliers, developed a durable corrosion protection for screws and other metal parts in the compressors. Since mid-2005, Household Compressors has been capable of delivering compressors which meet the requirements of the customers. All other products are expected to be marketed according to the directives of RoHS by mid Case: Development of environmental-friendly products Danfoss Drives in Loves Park, USA, has reduced the size of the largest frequency converters so they weigh less and have fewer parts than the previous generation. In this way the organisation has succeeded in saving 4,333 parts in a 200 kw converter which equals 45% of the parts. At the same time, the weight was reduced by 60% and the size by 38%. Lower weight, smaller size and fewer parts mean lower costs for materials and transportation and is an example of how environmental advantages go hand-in-hand with business advantages. In June 2005 this example was chosen as This year s environmental story at Danfoss at the environmental coordinators annual seminar. Bacteria have many hiding places in a brewery that leads to possible damage to the soft drinks tapped into bottles. Danfoss Gearmotors has found a solution by developing a gear motor without the cooling fins and ventilator that normally collects dirt on a motor. The concept is called Aseptic Drive. The need for cleaning-friendly motors has its origin within the brewery industry which needs motors which can be cleaned with strong chemicals and at the same time are sealed to prevent particles from being whirled into the air. It is especially important in modern bacteria free bottling lines. The concept reduces the number of bacteria around the bottling machine before caps are put on. The Gerolsteiner brewery, which is Germany s largest producer of mineral water in bottles has implemented Danfoss concept as their standard system. 124

125 Possible environmental effects Energy and water Raw and auxiliary materals Noise Waste water and waste Emission to air CO 2, SO 2, NO x Finished products Old ground contaminations Production affects the environment The many Danfoss production sites have an impact on the environment in terms of use of resources, emissions to air, discharges to water and ground, and generation of waste. Danfoss aim is to reduce the relative environmental impact so that a rise in production is not followed by a corresponding rise in environmental impact. For most parameters, there is a relative decreasing environmental impact compared to previous years. In 2005 Danfoss sold the Spring factory in Tinglev, Denmark, and Danfoss Analytical in Sønderborg, Denmark. The sale has no major influence on the environmental accounts as the environmental impact of the two factories makes up less than 1% of the overall effect of the Group. Danfoss still purchases from the Spring Factory and as of 2005 the raw materials will be included in the reporting from each business area. Danfoss acquired Thermia Värme AB in Arvika, Sweden, in Thermia s amount of raw materials equals 1% of the total amount of the Group whereas the amount of HFC is 39%. The EEI graph for HFC has therefore changed accordingly in In the following, each parameter is explained and evaluated with an overall objective, actual development and cases. The total raw material consumption of the Group decreased almost 10% in 2005 compared to This will affect the EEI graphs which for many parameters will not decrease as much as expected. Some of the environmental impacts are not fully proportional to the activity level in the factories. For example, the energy used for heating remains almost unchanged even though activities are going down. Significant environmental impacts Energy consumption TJ 2,000 1,500 1, TJ EII Natural gas 32.7% Distribution of energy consumption District heating 6.2% Gas oil 2.1% Heavy fuel 2.7% Waste oil 0.2% EII 100 Electricity 56% Resource consumption: Energy Objective: To reduce the relative consumption of energy Danfoss wants to reduce the energy consumption per unit produced, so many factories implement energy-saving projects, either by optimising production equipment, or by making other saving procedures. Danfoss is a growing company, which involves a rise in the absolute energy consumption, all other things equal. The decisive factor is the best possible reduction of consumption, and especially that the relative consumption falls every year. The absolute energy consumption has increased 3.7% since 2004, whereas the relative consumption has increased by 12% due to the lower consumption of raw materials. The electricity comsumption in 2005 was 56% of Danfoss comsumption of energy which is the same as in The share of natural gas is increasing over time. The most polluting fuels (e.g. gas oil and heavy fuel oil) have at some factories been substituted by natural gas or other environmentally friendlier energy sources. The consumption of gas oil and heavy fuel oil has decreased by 18%. Case: Energy savings and alternative sources of energy Refrigeration & Air Conditioning in Nordborg, Denmark, has replaced 448 old light sources with 220 new ones controlled by the incoming daylight. The business area saves kwh per year, equivalent to the annual energy consumption in more than 100 private homes. It has furthermore been possible to reduce the lighting, which benefits the working environment. 125