20-F 1 a5115656.htm SKF 20-F
-As filed with the Securities and Exchange Commission on April 5, 2006

United States
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
___________

FORM 20-F

 
o REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) or 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended December 31, 2005.
 
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

OR
o SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    Date of event requiring this shell company report_______________________

 
Commission file number 0-13722

AKTIEBOLAGET SKF
(Exact name of registrant as specified in its charter)

SKF Incorporated
(Translation of Registrant's Name into English)

Kingdom of Sweden
(Jurisdiction of Incorporation or Organization)

SE-415 50
Gothenburg, Sweden
(Address and Principal Executive Offices)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
B Shares, par value SEK 2.50

SECURITIES FOR WHICH THERE IS A REPORTING OBLIGATION
PURSUANT TO SECTION 15(d) OF THE ACT:
None
 
Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report.

Class B Shares: 404,615,210
Class A Shares: 50,735,858

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 

Yes x
No o
 

 
If this report is an annual or transition report, indicate by check mark if the Registrant is required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes x
No o

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:
 
Yes x
No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer x
Accelerated Filer o Non-Accelerated Filer  o

If this is an annual report, indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o
No x

Indicate by check mark which financial statement item the Registrant has elected to follow

Item 17 x
Item 18 o
 
 
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TABLE OF CONTENTS
 
TABLE OF CONTENTS
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INTRODUCTION AND USE OF CERTAIN TERMS

We prepare our financial statements in Swedish kronor (“kronor” or “SEK”). Merely for convenience, this Annual Report on Form 20-F presents translations into United States dollars of certain kronor amounts. These translations should not be construed as representations that the amounts referred to actually represent such translated amounts or could be converted into the translated currency at the rate indicated. Unless otherwise stated, such translations have been made at 7.93706.6687 kronor per United States dollar, the noon buying rate (the “Noon Buying Rate”) in New York City on December 30, 2005 for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York. On March 15, 2006, the Noon Buying Rate was 7.7855 kronor per United States dollar. See also Item 3.A for certain historical exchange rate information.

Throughout this Annual Report on Form 20-F the term “MSEK” represents millions of Swedish kronor. The term MUSD represents millions of United States dollars. The term MEUR represents millions of Euros. Amounts in parentheses refer to comparable figures for 2004 and 2003, respectively.

When reference is made to a “Note” this consistently refers to a Note in the Consolidated Financial Statements, filed as part of this Form 20-F.

Unless the context otherwise requires, as used herein, the term “Company” refers to Aktiebolaget SKF and the terms “SKF”, the “SKF Group” and the “Group” refer to the Company and its subsidiaries.
 
5


FORWARD-LOOKING STATEMENTS 
 
This Form 20-F contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, relating to the Group's business and the sectors in which it operates. Certain forward-looking statements can be identified by the use of forward-looking terminology such as “believes”, “expects”, “may”, “are expected to”, “will”, “will continue”, “should”, “would be”, “seeks” or “anticipates” or similar expressions or the negative thereof or other variations thereof or comparable terminology, or by discussions of strategy, plans or intentions. Such statements include descriptions of the Group’s strategy including financial targets, competitive environment, the Group's investment and research and development programmes and anticipated expenditures in connection therewith, descriptions of new products expected to be introduced by the Group and anticipated customer demand for such products. Such statements reflect the current views of the Group with respect to future events and are subject to certain risks, uncertainties and assumptions. Many factors could cause the actual results, performance or achievements of the Group to be materially different from any future results, performances or achievements that may be expressed or implied by such forward-looking statements. Some of these factors are discussed in more detail herein, including under “Item 3.D. Risk Factors”, “Item 4. Information on the Company” and “Item 5. Operating and Financial Review and Prospects.” Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described in this Form 20-F as anticipated, believed, estimated or expected. The Group does not intend, and does not assume any obligation, to update any industry information or forward-looking statements set out in this Form 20-F.
 
6

 
 
Not applicable.
 
 
Not applicable.
 
7

 
 
The selected consolidated financial data in respect of the Group set forth below should be read in conjunction with, and are qualified in their entirety by reference to, the consolidated financial statements and Notes thereto filed as part of this Form 20-F. Commencing in 2005, SKF has prepared its financial statements in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union. The years 2004 and 2003 have been restated to conform to this presentation and selected financial data for earlier years have been omitted. See Note 32 to the consolidated financial statements filed as part of this Form 20-F.
 
       
   
For the years ended December 31
 
 
   
2005
($)* 
 
2005
(SEK) 
 
2004 (4)
(SEK)
 
2003 (4)
(SEK) 
 
   
(In millions of USD or SEK except per
share data and number of shares)
 
Amounts in accordance with IFRS. (1)                          
Income and dividend data:                          
Net sales
   
6,210
   
49,285
   
44,826
   
41,377
 
Operating profit
   
671
   
5,327
   
4,434
   
3,307
 
Profit before taxes
   
662
   
5,253
   
4,087
   
2,801
 
Taxes
   
(207
)
 
(1,646
)
 
(1,111
)
 
(703
)
Profit after taxes (2)
   
454
   
3,607
   
2,976
   
2,098
 
Net profit (2)
   
454
   
3,607
   
2,976
   
2,098
 
Basic earnings per share after tax (3)
   
0.97
   
7.73
   
6.42
   
4.48
 
Diluted earnings per share after tax (3)
   
0.97
   
7.70
   
6.42
   
4.48
 
Number of shares, thousands (3)
   
455,351
   
455,351
   
455,351
   
455,351
 
                           
Balance sheet data:
                         
Current financial assets
   
639
   
5,072
   
3,565
   
6,342
 
Total assets
   
5,084
   
40,349
   
35,014
   
36,552
 
Financial liabilities
   
31
   
249
   
212
   
372
 
Non-current loans
   
522
   
4,145
   
904
   
1,246
 
Share capital
   
143
   
1,138
   
1,423
   
1,423
 
Shareholders' equity
   
2,297
   
18,233
   
17,245
   
15,852
 

*
Solely for the convenience of the reader, Swedish kronor amounts have been translated into U.S. dollars at the noon buying rate on December 30, 2005, of SEK 7.9370 per $1.00.
(1)
The consolidated financial statements of the SKF Group were prepared in accordance with IFRS, as adopted by the European Union, which differ in certain significant respects from accounting principles generally accepted in the United States of America (“U.S. GAAP”). See Note 1 and the Reconciliation to U.S. GAAP in Note 3533 to the consolidated financial statements filed as part of this Form 20-F.
(2)
Includes minority owners' portion.
(3)
Figures 2003 - 2004 have been recalculated due to split and redemption in 2005.
(4)
As allowed under the transitional provisions of IFRS1, 2003 and 2004 have not been fully restated. See Note 1 to the consolidated financial statements filed as part of this Form 20-F and Item 5.A. Operating Results - Diluted earnings per share after tax.
 
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2005
($)
*
 
2005
(SEK)
 
2004
(SEK)
 
2003
(SEK)
 
2002
(SEK)
**
 
2001
(SEK)
**
 
Amounts in
accordance with
U.S. GAAP: (1)
 
(In millions of USD or SEK except per share data)
Net profit
   
452
   
3,589
   
2,750
   
2,478
   
2,428
   
1,947
 
Earnings per share after tax - basic (2)
   
0.99
   
7.88
   
6.04
   
5.44
   
5.33
   
4.28
 
Earnings per share after tax - diluted (2)
   
0.99
   
7.85
   
6.03
   
5.44
   
5.33
   
4.28
 
Total assets
   
5,075
   
40,284
   
35,850
   
37,267
   
38,982
   
40,740
 
Shareholders' equity
   
2,296
   
18,222
   
17,271
   
16,232
   
15,638
   
15,768
 

*
Solely for the convenience of the reader, Swedish kronor amounts have been translated into U.S. dollars at the noon buying rate on December 30, 2005, of SEK 7.9370 per $1.00.
**
Figures for 2001-2002 are not restated according to IFRS.
(1)
The consolidated financial statements of the SKF Group were prepared in accordance with IFRS, as adopted by the European Union, which differ in certain significant respects from accounting principles generally accepted in the United States of America (“U.S. GAAP”). See Note 1 and the Reconciliation to U.S. GAAP in Note 3533 to the consolidated financial statements filed as part of this Form 20-F.
(2)
As described in Note 33 to the consolidated financial statements, all U.S. GAAP earnings per share amounts have been restated to retroactively reflect the effects of a 5:1 share split, combined with a redemption procedure, in 2005. Through this procedure the shareholders received four new shares and a redemption share that was mandatorily redeemed for SEK 25.
 
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Cash Dividends per Share
The following table sets forth the total cash dividends per share with respect to each fiscal year. Because dividends are paid by the Group in Swedish kronor, exchange rate fluctuations will affect the U.S. dollar amounts received by holders of American Depositary Receipts (ADRs). Cash dividends are translated into U.S. dollars at the Noon Buying Rate on December 30, 2005.
 

               
 
 
 
Year(1)
 
Cash Dividends (in millions of SEK)
 
Total Dividend
per share
(SEK)
 
Total Dividend
per ADR(2)
($) 
 
               
2003 (3)
   
1,138
   
2.50
   
0.35
 
2004 (3) (5)
   
1,366
   
3.00
   
0.45
 
2005 (4)
   
1,821
   
4.00
   
0.50
 
 

(1)
Dividends are set forth in the above table under the year to which they are attributed to rather than the year in which they were declared and paid.
(2)
SKF has issued American Depositary Shares (“ADSs”). Each ADS represents one B Share. American Depositary Receipts (the “ADRs”) evidencing the ownership of the ADSs have been listed on the OTC Market.
(3)
Figures have been restated due to split and redemption in 2005
(4)
Dividend according to Board of Directors' proposed distribution of surplus for the year. The dividend is subject to approval by shareholders at the Annual General Meeting April 25, 2006, and has not been included as a liability in the financial statements.
(5)
The total transfer to the shareholders amounted to MSEK 4,212 whereof MSEK 2,846 pertained to the redemption and MSEK 1,366 to paid dividends.
 
10

 
Exchange Rates
The following table sets forth, for the periods indicated, the Noon Buying Rate for Swedish krona in terms of Swedish kronor per U.S. dollar for the periods shown:

Period
   
Period End
   
Average (1
)
 
High
   
Low
 
2001
   
10.4571
   
10.4328
   
11.0270
   
9.3250
 
2002
   
8.6950
   
9.6571
   
10.7290
   
8.6950
 
2003
   
7.1950
   
8.0351
   
8.7920
   
7.1950
 
2004
   
6.6687
   
7.3320
   
7.7725
   
6.5939
 
2005
   
7.9370
   
7.5170
   
8.2434
   
6.6855
 
October 2005
       
7.9695
   
7.6870
 
November 2005
       
8.2434
   
7.9749
 
December 2005
       
8.1162
   
6.6855
 
January 2006
       
7.8097
   
7.5385
 
February 2003
       
7.9656
   
7.6487
 

(1) Calculated by using the average of the Noon Buying Rates on the last day of each  full month during the period.

On March 15, 2006, the Noon Buying Rate was 7.7855 Swedish kronor per U.S. dollar.

The following exchange rates have been used when translating the financial statements of foreign subsidiaries operating in the countries shown below into SEK:

           
Average rate
 
Year-end rate
 
Country
 
Unit
 
Currency
 
2005
 
2004
 
2003
 
2005
 
2004
 
2003
 
Canada
 
1
 
CAD
 
6.16
 
5.65
 
5.76
 
6.84
 
5.46
 
5.55
 
China
 
1
 
CNY
 
0.91
 
0.89
 
0.97
 
0.99
 
0.80
 
0.88
 
EMU-countries
   
1
   
EUR
   
9.28
   
9.12
   
9.12
   
9.43
   
9.00
   
9.08
 
India
   
100
   
INR
   
16.90
   
16.21
   
17.30
   
17.65
   
15.11
   
15.95
 
Japan
   
100
   
JPY
   
6.76
   
6.82
   
6.97
   
6.78
   
6.36
   
6.80
 
United Kingdom
   
1
   
GBP
   
13.54
   
13.40
   
13.19
   
13.74
   
12.70
   
12.90
 
USA
   
1
   
USD
   
7.45
   
7.35
   
8.07
   
7.95
   
6.60
   
7.27
 
 
11

 
Not applicable.

 
Not applicable.


Risks and uncertainties in the business

The company operates in many different industrial and geographical segments that are at different stages of the economic cycles. A general economic downturn at the global level, or in one of the world’s leading economies, could reduce the demand for the Group's products, solutions and services for a period of time. The Group's wide geographical presence and its very broad customer base would normally mean that at any specific point in time the business climate is good in some of the geographical regions and some of the customer segments.

Global political environment

Terrorism and other hostilities as well as disturbances in worldwide financial markets could have a negative effect on the demand for the Group’s products, solutions and services.

Competition

In terms of sales, SKF is the world leader for bearings and the largest supplier to the European markets. In Western Europe, SKF is closely followed by the German Schaeffler Group, with its INA and FAG brands. SKF is number two in North America, with the US company, Timken (including Torrington) as the largest supplier there. SKF is the number-one supplier in the Asian markets outside Japan. The Japanese bearing market is dominated by the domestic manufacturers NSK Ltd, NTN Corp. and Koyo Seiko (renamed JTEKT following its merger with Toyoda Machine Works as of 1 January 2006).

The largest, and also the fastest growing of the emerging markets, is China. It is a very fragmented market with many local manufacturers. SKF is currently one of the leading bearing companies in China - both as an importer and a local manufacturer - but in recent years all the major international bearing companies have set up production in the country. China is expected to show significant growth over the next few years both as a market and as a global supply base.

The Central and Eastern European markets, where SKF is the leading bearing company in the region, are also characterized by a large number of local manufacturers serving more than 50% of the market. Their total size, however, accounts for only a few percentage points of the world market.

The rolling bearing world can also be divided up according to the different types of bearings. Ball bearings, of various designs, account for more than half the market, while different roller bearings make up the balance. The most popular of the ball bearing types is the deep groove ball bearing, which accounts for about one third of the total world bearing market. Other ball bearings are angular contact ball bearings, self-aligning ball bearings, thrust ball bearings and hub bearing units for automotive wheels. The roller bearings are named according to the shape of the rollers. They can be cylindrical, spherical, tapered, or needle shaped. The largest of the roller bearing families is the tapered roller bearing, with a share of less than one fifth of the total world bearing market. Sales of this type of bearing have declined over the last 15 years, however, as wheel hub units incorporating balls now replace tapered roller bearings to a large extent.
 
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Competitive factors, including changes in market penetration, increased price competition, the introduction of new products and technology by existing and new competitors as well as changes in customer demand on sales, product mix and prices could have a material adverse effect on SKF’s business and results of operations.

Foreign currency exchange rate risk

The Group is exposed to changes in exchange rates in the future flows of payments related to firm commitments and forecasted transactions and to loans and investments in foreign currency, i.e. transaction exposure. The Group’s accounts are also affected by the effect of translating the results and net assets of foreign subsidiaries to SEK, i.e. translation exposure.

A sensitivity analysis based on year-end figures and on the assumption that everything else is equal shows that a weakening of 10% of the SEK against the USD has an effect from net currency flows on profit before taxes of approximately MSEK 450, excluding any effects from hedging transactions. The Group’s exposure is primarily to the USD.

Transaction exposure

Transaction exposure mainly arises when manufacturing SKF companies sell their products to SKF companies situated in other countries to be sold to end-customers on that local market. Sales to end-customers are normally made in local currency. The Group’s principal commercial flows of foreign currencies pertain to exports from Europe to North America and Asia and to flows of currencies within Europe.

Currency rates and payment conditions to be applied for the internal trade between SKF companies are set by SKF Treasury Centre. Internal invoicing during a quarter is made at fixed forward rates based on external market rates. Currency exposure and risk is primarily and to a large extent reduced by netting internal transactions. In some countries transaction exposure may arise from sales to external customers in a currency different from local currency. The Group’s main transaction exposure in 2005 was reduced through netting to MSEK 5,400.

Translation exposure

Translation exposure is defined as the Group’s exposure to currency risk arising when translating the results and net assets of foreign subsidiaries to Swedish kronor. In accordance with Group policy, these translation effects on the Group’s accounts are not hedged.
 
13


Interest rate risk exposure

Liquidity and borrowing is concentrated to SKF Treasury Centre. By matching investments made by subsidiaries with borrowings of other subsidiaries, the interest rate exposure of the Group can be reduced.

The exposure to currency and interest rate risk in foreign borrowing has been managed by cross-currency interest rate swaps. EUR loans with fixed and floating interest rates have been swapped into SEK loans with floating 3 months’ interest rates. As of December 31, 2005, the hedged loans amounted to MEUR 350. The floating 3 months’ STIBOR rate was 1.965%.

The SKF Group policy states that the average interest period for investments must not exceed 12 months. As of December 31, 2005, the average interest period of the Group’s investments was 2 months and for loans 6 months, taking into account cross-currency and interest rate swaps. Interest rate swaps were also used for trading purposes in 2005.

As of December 31, the Group had net current financial assets (current financial assets less total loans) of MSEK 678 (2,449 and 4,724).

A change of one percentage point in interest rates influences profit before taxes by approximately MSEK 11.

Liquidity risk

Liquidity risk, also referred to as funding risk, is defined as the risk that the Group will encounter difficulties in raising funds to meet commitments.
Group policy states that in addition to current loan financing, the Group should have a payment capacity in form of available liquidity and/or long-term committed credit facilities not falling below MEUR 300. In addition to own liquidity the Group had committed credit facilities of MEUR 300 syndicated by 10 banks at December 31, 2005. These facilities, which are unutilized, will expire in 2012. Available liquidity as per December 31 amounted to MSEK 4,886 (3,565 and 6,342).

Credit risk

Credit risk is defined as the Group’s exposure to losses in the event that one party to a financial instrument fails to discharge an obligation. The Group deals only with well-established international financial institutions. The Group does not obtain collateral or other security to support financial derivative instruments subject to credit risk.

The Group’s policy states that only well established financial institutions are approved as counterparties. The major part of these financial institutions have signed an ISDA-agreement (International Swaps and Derivatives Association, Inc.). Transactions are made within fixed limits and exposure per counterparty is continuously monitored.

For financial derivative instruments and investments, the Group’s credit risk exposure related to the two counterparties with the largest concentration of risks was MSEK 852 and MSEK 632, respectively, at December 31, 2005.

14

 
The Group’s concentration of credit risk related to trade receivables is relatively limited primarily because of its many geographically and industrially diverse customers.

Trade receivables are subject to credit limit control and approval procedures in all subsidiaries.

Changes in manufacturing cost

Changes in cost associated with various levels of operations including, but not limited to, effects of unplanned work stoppages, cost of labour, and the cost and availability of materials and energy could have a material adverse effect on SKF’s business and results of operations. The primary raw material used by the Group is steel. SKF believes that adequate supplies of necessary raw materials are available for the Group's operations.

Changes in costs for raw material

The annual cost of the purchase of raw material and components is approximately SEK 11 billion. Of this amount, steel bars, tubes, components or oil-based products account for the major part. The price of bearing steel increased sharply during 2004 and remained at a high level during 2005. For the full-year 2005, these increases were compensated by price increases, higher efficiency, cost reductions and by alternative sourcing. An increase of 1% in the cost of raw material and components reduces profit before taxes by MSEK 111.

Environmental matters

As an industrial company, SKF is subject to numerous environmental laws and regulations governing, among other things, air emissions, waste water discharge and solid and hazardous waste disposal. SKF’s manufacturing operations are designed to prevent or minimize environmental pollution. However, like other long-established industrial companies, SKF is involved in some remediation projects, resulting from historical activities. SKF has made its best estimate of environmental provisions for a number of locations and several superfund sites designated by the U.S. Environmental Protection Agency and U.S. state agencies and the authorities in several other countries. A superfund site is an old landfill or plant site in the United States with soil or groundwater contamination, subject to a remediation programme according to federal law. Remediation funding is provided by those who contributed to the contamination. Although SKF believes that the ultimate resolution of these issues will not have a material impact on its financial position, it can give no assurance that it will not have a material adverse effect on its business and results of operations. In addition, stricter environmental laws and regulations, sometimes with retroactive effect, may lead to increased expenditures to comply with these laws and regulations. Furthermore, accidental environmental pollution may also expose the Group to substantial liability that could have a material adverse effect on SKF’s result of operations.
 
Environmental provisions

The Group has made its best estimate of expected environmental provisions for a number of locations and several superfund sites designated by the U.S. Environmental Protection Agency and U.S. state agencies and the authorities in several other countries. Management believes the ultimate resolution of these issues will not have a material impact on the financial position or results of operations of the Group, but no assurance can be given that actual costs may not exceed the estimates.
 
15


Unanticipated claims

Unanticipated claims including, but not limited to, claims or problems related to intellectual property, product warranty and product liability could have a material adverse effect on SKF’s business and results of operations.
 
16

 
 
Aktiebolaget SKF was incorporated under the laws of Sweden in 1907 and is headquartered in Göteborg, Sweden. SKF’s principal offices are located at Hornsgatan 1, SE-415 50 Göteborg, Sweden and its telephone number is +46-31-3371000.

In terms of sales, the SKF Group is the leading global supplier of products, solutions and services in the area comprising rolling bearings, seals, mechatronics, services and lubrication systems. The Group’s service offer also includes technical support, maintenance services, condition monitoring and training.

SKF has a history of innovation in bearing design. Since SKF was founded on the invention of the self-aligning ball bearing in 1907, almost all of the new types of bearings subsequently introduced in the market have been developed by SKF. SKF’s products continue to be further developed through the addition of new variants and new designs. SKF’s innovations include the development of prototypes of existing bearings, formulas designed to calculate the life of a bearing and “units” (bearings combined with related components, ready for installation, such as hub-bearing units with integrated sensors). Each innovation has represented an improvement in life, operating temperature, weight, energy consumption or other related indicia of bearing performance.

Capital Expenditures

The Group’s capital expenditures for tangible assets amounted to MSEK 1,623 (1,401 and 1,379) of which 68% was made in Europe (85% and 77%), 10% was made in North America (7% and 12%), 19% was made in Asia/Pacific (7% and 8%) and 6% was made in other areas (4% and 4%).

Of the Group's total capital expenditures during 2005, approximately MSEK 89 (72 and 70) was attributable to environmental investments, the aim of which is to improve both the external environment and the internal working conditions.

17

 
Strategy

The SKF Group announced its current target for growth and profitability in April 2003. The goal is to have an operating margin level of 10% and to increase sales by a growth rate of 6% annually, measured in local currency, by the end of 2006 and based on year 2002. In order to reach its target, SKF is continuing to implement its business strategy for long-term profitable growth, by developing new products, solutions and services with higher added value, by growing profitably both organically and through acquisitions, by improving the price quality and by reducing capital employed and fixed costs. This should be achieved despite fluctuations in market demand, raw material price increases and currency impact. The plan is for acquisitions to account for one third of the targeted sales growth.

SKF is currently focusing on five different technology areas, called platforms, which cover the company's technical capabilities. These platforms are: Bearings and units, Seals, Mechatronics, Services and Lubrication systems. SKF utilizes the capabilities of all the platforms in order to offer the customer a tailor-made proposition with selected capabilities from the different platforms. Some examples from 2005 where SKF gained customers with combinations of the value offerings from the different platforms:
 
-Bearings and components for erectors of a large European tunnel-boring project
-Special ceramic hybrid bearing solution that extends the product life cycle of fuel pumps for locomotives
-A combination of lubrication and bearing solutions for industrial washing machines
-An oscillating bearing unit solution for the printing industry, comprising capabilities of all five platforms
-SKF ConRo, a re-lubrication free roller solution including temperature sensors equipment for the steel industry
-Engineering and application services for Original Equipment Manufacturer (OEM) customers, thereby supporting them in their early design phase within a wide range of segments and applications
-Sales of actuation systems to the postal sorting market and food equipment market
-A table for a new lithoscope multifunctional urological system, designed and manufactured by SKF
-The X-TrackerTM bearing, an asymmetrical hub bearing unit where the two rows have different diameters and one row contains more balls than the other
-A washing machine drum bearing unit incorporating bearings, seals and housing in a single unit, supplying the customer with a function rather than a product
-Contract sales for Integrated Maintenance Solutions and predictive maintenance

Recent acquisitions and divestments

During 2005, SKF acquired Jaeger Industrial Ltd, a leading manufacturer of electromechanical actuators, electronic control units and complete actuation systems. It is headquartered in Taipei, Taiwan, and has manufacturing facilities in Taiwan and in China. The main segments for SKF's actuation solutions are the machine tool, medical, health care and factory automation segments.

SKF also acquired Sommers Industriteknik AB, a distributor of Vogel lubrication systems located in Linköping, Sweden in 2005.

18

 
At the beginning of 2005, SKF sold Ovako La Foulerie, its factory for hot rolled rings in Carignan, France, to the Italian steel company Fomas S.p.A.

During the year, SKF disposed of its shares in FlexLink.

Major events

In May 2005, AB SKF, Rautaruukki Corporation and Wärtsilä Corporation combined their long steel businesses by creating a jointly owned new company, Oy Ovako Ab. The operation consists of SKF’s subsidiary, Ovako Steel, Wärtsilä’s subsidiary, Imatra Steel, and Rautaruukki’s long products subsidiaries, Fundia Special Bar, Fundia Wire and Fundia Bar & Wire Processing. Rautaruukki, SKF and Wärtsilä own 47.0%, 26.5% and 26.5% respectively. Oy Ovako Ab became a leading European long steel producer of engineering steels to the rolling bearing, heavy vehicle, automotive and general engineering industries. The three merged businesses complement each other very well in terms of skills and expertise.
 
19


 
Business - General Description

SKF delivers a wide range of products and services to a large number of customers in a variety of industries and to all the geographical regions of the world. SKF service and product offerings are tailored to meet the specific requirements, conditions and needs of each customer.

Since 1907, SKF has built an extensive customer knowledge base through its work with different industries in many countries and has established its technical knowledge base through the continual development of its many different products, solutions and services.

SKF's technical knowledge and capabilities are within Bearings and units, Seals, Mechatronics, Services and Lubrication systems.

In terms of sales, the SKF Group is the leading global supplier of products, solutions and services in the area comprising rolling bearing, seals, mechatronics, services and lubrication systems. The Group’s service offer also includes technical support, maintenance services, condition monitoring and training.

SKF utilizes the capabilities of all the platforms to offer its customers tailor-made solutions that are designed to strengthen their offer to their customers or will make their production more effective. SKF also focuses on offering environmentally sound solutions that reduce energy consumption or the need for lubricants.

SKF's industrial customers manufacture products and equipment such as pumps, fans, compressors, motors, gearboxes, machine tools, paper machines, steel mills, printing presses and wind-mills. These customers impose rigorous demands on the Group’s ability to develop and deliver products and solutions that offer the highest possible performance and the most efficient asset utilization. This requires SKF to have a thorough knowledge not only of its customers’ products but also of their markets and of their customers, including the challenges that the latter, in their turn, could be facing. SKF focuses on continuously developing its products and solutions, which are often customized to meet demanding technical criteria. Original Equipment Manufacturer (OEM) customers in these segments number more than ten thousand. The needs of these OEM customers are primarily handled through SKF’s Industrial Division, which offers both a wide range of highly qualified products and advanced engineering services, including high-tech computer simulations and calculations.

The responsibility for the industrial aftermarket lies within the SKF Service Division, that provides replacement products and services for end-users. SKF and the largest network of authorized distributors in the bearing world have together developed a service organization that is unique. SKF and some 7,000 distributors are not only close to their customers wherever they are in the world, but their combined knowledge also ensures a thorough understanding of customers’ needs and requirements. With an efficient supply chain, technical and logistic services and e-business portals, SKF and its distributors have developed the right stock profile and availability to offer the right solutions to customers. Providing an end-user solution means supplying the right bearing, seal, lubricant or other products in a timely manner to keep the customer’s factory operating. A solution also helps the customer increase the productivity of a factory through maintenance and reliability services and systems. This offer of asset management includes a large number of different products, from hand-held computers for monitoring the condition of a piece of equipment to sophisticated software that enables the customer to make the right decisions to optimize the utilization of assets. The solution for the latter includes mechanical services, preventive maintenance, predictive maintenance, condition monitoring and systems for decision support in the maintenance work.

20

 
Furthermore, a few years ago, SKF introduced a new concept to the industrial aftermarket called Certified Maintenance Partners. Further to this concept, SKF’s partners, who have increased their skills and expertise with the help of SKF now offer end-users certain maintenance and reliability services that were previously only provided by SKF.

Over the last seven years, SKF has developed maintenance solutions, technology and asset management in order to provide solutions that optimize plant asset efficiency and maintenance. This has been achieved through acquisitions and internal business development. Managing knowledge and intellectual capital are the key components that are contributing to SKF’s success in the service business.

SKF’s Industrial and Service Divisions work closely together to identify customers’ needs and ensure that the Group’s capabilities are effectively utilized throughout the entire life cycle of the equipment they serve. 2005, they jointly represented more than half of the Group’s total net sales and more than two-thirds of the Group’s operating profit.

Another customer category comprises the manufacturers of a large series of products for which there are specific and exacting requirements in terms of technology, quality, logistics, environment, safety and price. These customers comprise the manufacturers of cars and trucks, household appliances, small electric motors, two-wheelers and similar products, and are serviced through the Automotive and Electrical Divisions.

In this context, using SKF's knowledge and long-term partnerships with world-leading manufacturers, a differentiated offer is proposed, switching from standard to customized bearings and to integrated solutions. For instance special support units for washing machine drums or mechatronic units suitable for motor control or tachometry allow customers to simplify their supply chain and obtain SKF quality in complex sub-assemblies.

The Automotive Division supplies automotive manufacturers and the vehicle service market. In this case, SKF deals with the automotive manufacturers and with their direct suppliers. Since the lead time for developing a new generation of cars or trucks is approximately four to six years, SKF’s dialogue and product development involvement with the customer starts several years before the start of production. Customer demands in terms of innovation, performance and quality are very high and almost all automotive products and solutions are specifically designed for each individual customer. The SKF knowledge that is acquired by managing automotive customers’ demands is often utilized by other units within the SKF Group, thereby creating positive synergies.

The SKF offerings to the automotive market have evolved over time from different types of bearing towards more unitized modules, integrating knowledge and the capabilities of bearings, sealing solutions, mechatronics and lubrication systems. SKF application engineers tailor integrated solutions to achieve the optimal and most beneficial design for each customer.

21

 
Another characteristic of the automotive business is that volumes are generally very high. The business scope normally covers a total vehicle life cycle, which naturally varies for different cars and trucks but usually extends to approximately six to eight years. High annual volumes, in combination with a vehicle life-cycle scope, form the basis of these large contracts. Ultimately, the volume will depend on how successful the automotive producers are in terms of sales of cars and trucks to end-customers.

To service the automotive aftermarket, SKF operates the vehicle service market business. For many years, this business has been based on SKF’s “kit” concept. The idea is to offer service station mechanics a convenient solution to help speed up and facilitate repair work. By putting together kits with all the components that are needed for a change of wheel bearings, water pumps, timing belts and so on, it is possible for the mechanic to pick the right kit for a repair. The specific kit for the car model is listed in both a catalogue and a computer-based system. SKF currently has approximately 6,000 variants on the market.

SKF Aerospace supplies the aerospace business, which includes both original equipment manufacturers and the aftermarket. SKF is a supplier of products and services to different levels in the supply chain, including manufacturers of engines and gearboxes, fixed wing aircraft, helicopters and maintenance, repair and overhaul organizations. The aerospace business is characterized by very long development and qualification lead times, followed by application life cycles that are often longer than 20 years. Production volumes are generally low compared with other industries. The products are custom-designed for each application. SKF works in close co-operation with its customers to develop innovative products and to devise solutions to meet very challenging demands. Aerospace applications have the most rigorous requirements for reliability and quality. The products need to have a very high strength-to-weight ratio and must be able to perform under extreme operating conditions. The knowledge acquired from the aerospace business is also used in other businesses with very challenging demands, such as applications for high-speed trains and racing cars.
 
22


Markets

The world bearing market
The size of the world bearing market is usually defined as global sales of rolling bearings, which comprise ball and roller bearings of various designs. SKF estimates that this market is worth more than SEK 220 billion a year, excluding various types of mounted bearing units. The Western-European and North-American markets each account for about 25% of this world bearing market, while China and Japan each account for approximately 15%. Other markets that have a sizeable local production of bearings and are recording interesting growth are the Republic of Korea, India and Thailand, as well as Central and Eastern Europe.

In terms of sales, SKF is the world leader for bearings and the largest supplier to the European markets. In Western Europe, SKF is closely followed by the German Schaeffler Group, with its INA and FAG brands. SKF is number two in North America, with the US company, Timken (including Torrington) as the largest supplier there. SKF is the number-one supplier in the Asian markets outside Japan. The Japanese bearing market is dominated by the domestic manufacturers NSK Ltd, NTN Corp. and Koyo Seiko (renamed JTEKT following its merger with Toyoda Machine Works as of 1 January 2006).

The largest, and also the fastest growing of the emerging markets, is China. It is a very fragmented market with many local manufacturers. SKF is one of the leading bearing companies in China - both as an importer and a local manufacturer. In recent years all the major international bearing companies have set up production in the country. China is expected to show significant growth over the next few years both as a market and as a global supply base.

The Central and Eastern European markets, where SKF is the leading bearing company in the region, are also characterized by a large number of local manufacturers serving more than 50% of the market. Their total size, however, accounts for only a few percentage points of the world market.

The rolling bearing world can also be divided up according to the different types of bearings. Ball bearings, of various designs, account for more than half the market, while different roller bearings make up the balance. The most popular of the ball bearing types is the deep groove ball bearing, which accounts for about one third of the total world bearing market. Other ball bearings are angular contact ball bearings, self-aligning ball bearings, thrust ball bearings and hub bearing units for automotive wheels. The roller bearings are named according to the shape of the rollers. They can be cylindrical, spherical, tapered, or needle shaped. The largest of the roller bearing families is the tapered roller bearing, with a share of less than one fifth of the total world bearing market. Sales of this type of bearing have declined over the last 15 years, as wheel hub units incorporating balls now replace tapered roller bearings to a large extent.

The polymer seals market
SKF is also a leading company within the polymer seals market and estimates that the world market for various automotive, industrial and aerospace applications is worth approximately SEK 60 billion per year. The Western-European and North-American markets each account for about one third of this, while the Asian market accounts for about one quarter. With a market share of below 10%, SKF is, nevertheless, one of the major suppliers to the fragmented polymer seals market. SKF has particularly strong positions in bearing seals and automotive seals. The German Freudenberg Group (including its partnerships with the Japanese company NOK) is the largest supplier on the world polymer seals market, followed by the US company Parker Hannifin and the Swedish company Trelleborg.

23

 
The lubrication systems market
The market for lubrication systems is mainly divided into two segments, oil- and grease-based systems. The lubrication world market for both segments totals approximately SEK 10 billion. SKF's acquisition in 2004, Willy Vogel AG, is the leader in the global oil-lubrication systems market and is also a strong player in grease lubrication. Vogel is the clear market leader in Europe for oil and grease lubrication. The largest competitor in lubrication systems is the US company Lincoln Industrial Corp. Lincoln focuses on grease-lubrication systems and is the largest company within this segment, as well as being the leader in the total US market. Vogel and Lincoln together cover more than one fifth of a very fragmented world market.

The linear motion market
The linear motion market comprises very many different products unified by the fact that they all provide linear movements. The industry consists of a very large number of companies, some of which have evolved from firms producing mechanical components, while others specialize in motors or controls. All the companies which provide linear-motion control combine mechanics, electric motors and controls. The value of the world motion-control market, including systems and components, is in the region of SEK 100 billion. SKF focuses primarily on the medical, healthcare, machine tool and factory automation segments, by providing products such as actuators, linear guides and ball and roller screws or complete subsystems. SKF's annual growth rate in this business is in the two-digit percentage area.

The asset efficiency market
In the asset efficiency market, SKF is successfully developing in the service business, selling reliability and asset efficiency with a full portfolio from maintenance consultancy to on-site maintenance and a complete range of reliability software and hardware. SKF is opening up a new market by offering customers support for their asset performance. In this way, SKF is creating a more secure and predictable demand for its core products, as well as generating new revenues. It is difficult to define the exact size of this asset efficiency market, but it is clearly growing rapidly. A larger percentage of the SKF Group’s sales will be service and software related in the future. Each year, these products are increasing their contribution to the Group. As a consequence SKF has extended its leadership in the reliability systems business among its traditional bearing competitors, and, by virtue of its specialist knowledge of friction management, SKF has developed a leading niche in prolonging the life cycle of rotating machinery assets.
 
24


SKF Markets

SKF operates in all its major markets through subsidiaries located in 21 European countries, the United States, Canada, 7 Latin American countries, 5 African countries, 16 Asian countries, Australia and New Zealand. In addition, SKF also operates through branch offices in a number of additional countries. SKF’s sales companies and independent distributors generally promote the full range of SKF’s products. Certain larger manufacturing subsidiaries are responsible for the production of specific product lines.

As of December 31, 2005, approximately 92% of SKF’s labour force was located outside Sweden. For the year ended December 31, 2005, 96% of SKF’s sales were outside Sweden.

SKF’s net sales by geographical area were as follows* (amounts in MSEK).
                   
Geographical area
   
2005
   
2004
   
2003
 
North America
   
9,930
   
9,152
   
9,244
 
Europe
   
27,671
   
25,717
   
23,401
 
Asia / Pacific
   
8,381
   
6,659
   
5,912
 
Other Countries
   
3,303
   
3,298
   
2,820
 
TOTAL
   
49,285
   
44,826
   
41,377
 
*Translations to SEK is done at the rate for the respective year.

SKF’s net sales by Division were as follows* (amounts in MSEK).
             
Division
 
2005
 
2004
 
2003
 
Industrial Division
   
12,773
   
10,785
   
9,665
 
Service Division
   
15,995
   
14,115
   
12,947
 
Automotive Division
   
15,146
   
14,054
   
13,344
 
Electrical Division
   
2,102
   
1,931
   
1,833
 
Aero and Steel Division
   
3,198
   
3,874
   
3,551
 
Other
   
71
   
67
   
37
 
TOTAL
   
49,285
   
44,826
   
41,377
 
*Translations to SEK is done at the rate for the respective year.

Two individual countries have net sales above 10% of the net sales for the Group.
The net sales for those two countries were as follows* (amounts in MSEK):
             
Country
 
2005
 
2004
 
2003
 
Germany
   
8,751
   
8,096
   
7,104
 
USA
   
9,074
   
8,235
   
8,296
 
*Translations to SEK from USD and EUR is done at the rate for the respective year.

25


Products and Services

In terms of sales, the SKF Group is the leading global supplier of products, solutions and services in the area comprising rolling bearings, seals, mechatronics, services and lubrication systems. The Group’s service offer also includes technical support, maintenance services, condition monitoring and training.

SKF Divisions

In 2005 the SKF Group was divided into five divisions, each one focusing on specific customer groups worldwide. SKF has rationalized its divisional structure and reduced the number of divisions within the Group. As from January 1, 2006 the Aero and Steel Division as well as the Electrical Division were integrated into the other divisions. See "New divisional structure in 2006".

·  
Industrial Division

The Industrial Division is responsible for sales to industrial OEM customers and for the product development and production of a wide range of bearings (including spherical and cylindrical roller bearings and angular contact ball bearings), lubrication systems, linear motion products and couplings. The division has four specialist business areas, Lubrication, Railways, Actuation & Motion Control (A&MC) and Couplings.
 
Through the ongoing integration of Willy Vogel AG, SKF offers a wide range of centralized lubrication solutions to improve the performance and productivity of its customers' applications. During the year, SKF started to implement Minimal Quantity Lubrication (MQL), which supplies an extremely small amount of lubricant to cutting tools, at its own and at external customer factories, to increase efficiency and reduce the use of cutting oil to sustain the environment.

During the year, SKF gained customers through its combined knowledge of bearings, seals and lubrication systems within a number of segments, including wind energy, pulp and paper and railways. New SKF Lubrication Centres of Excellence have been established in a number of countries.

SKF is the leading roller bearing, bearing-related products and service supplier to the global railway industry (freight cars, locomotives, multiple units and high-speed vehicles). 

A&MC was set up as a new unit in order to strengthen the focus on actuation and motion control solutions.

The couplings business area specializes in the production and sale of connectors and fitters for rotating high-torque applications, such as connectors for propeller shafts in marine applications, steam and gas turbines and main shafts for wind turbines.

During the year, Jaeger Industrial Ltd was acquired in order to support SKF’s objective of becoming the global leader within the rapidly expanding market for electromechanical actuators, linear drives and actuation systems. Jaeger is a leading Asian manufacturer of electromechanical actuators, control units and complete actuation systems. The company is based in Taipei, Taiwan, and has manufacturing facilities in Taiwan and in China.
 
26

 
·  
Service Division

The Service Division is responsible for sales to the industrial aftermarket, mainly via a network of some 7,000 distributors. The division also supports industrial customers with knowledge-based service solutions to optimize plant asset efficiency. The SKF Reliability Systems business area offers consulting and mechanical services, predictive and preventive maintenance, condition monitoring, decision-support systems and performance-based contracts. SKF Logistics Services deals with logistics and distribution for both the SKF Group and external customers.

In 2005, SKF established Centres of Excellence for its condition-monitoring products and consulting services. The hardware and software programmes have been integrated into SKF Condition Monitoring, while the consulting services have been aligned with SKF Asset Management Services. The focused industries are pulp and paper, hydrocarbon processing, power generation, food and beverage and metal-working segments. Contract sales for Integrated Maintenance Solutions (IMS) and Predictive Maintenance (PdM) were significantly higher than in 2004.

·  
Automotive Division

The Automotive Division is responsible for sales to the car, light truck, heavy truck, bus and vehicle component industries and the vehicle service market and also for the product development and production of bearings, seals and related products and service solutions. The products include wheel hub bearing units, taper roller bearings, seals, special automotive products and complete repair kits for the vehicle service market.

·  
Electrical Division

The Electrical Division is responsible for sales to manufacturers of electric motors, household appliances, electrical components for the automotive industry, power tools, office machinery and two-wheelers and also for the product development and production of deep groove ball bearings and bearing seals. Of the Division’s total sales, some 70% are made through other divisions.

·  
Aero and Steel Division

SKF Aerospace is responsible for sales, product development and the production of bearings, seals and components for aircraft engines, gearboxes and airframes and also for offering various services including the repair of bearings.

SKF Forgings and Rings is responsible for sales, product development and the production of forgings and rings, primarily for the bearing industry. The division results included results of the Ovako Steel operations through April 2005. Ovako Steel was responsible for product development and the production of special steels and steel components for the bearing industry and also for other industries with demanding applications.

27

 
Global air traffic experienced strong growth throughout the year, with higher volumes in 2005 than in 2004. The number of parked aircraft in the world declined for the second consecutive year. The production of fixed-wing aircraft, helicopters and jet engines was higher than in 2004, in both Europe and North America. Consequently, there was an increase in demand during the year for bearings and components for the aerospace industry. Sales measured in local currencies were significantly higher in 2005 than in 2004 in both Europe and North America.

In May 2005, AB SKF, Rautaruukki Corporation and Wärtsilä Corporation combined their long steel businesses by creating a jointly owned new company, Oy Ovako Ab. The operation consists of SKF’s subsidiary, Ovako Steel, Wärtsilä’s subsidiary, Imatra Steel, and Rautaruukki’s long products subsidiaries, Fundia Special Bar, Fundia Wire and Fundia Bar & Wire Processing. Rautaruukki, SKF and Wärtsilä own 47.0%, 26.5% and 26.5% respectively. Oy Ovako Ab became a leading European long steel producer of engineering steels to the rolling bearing, heavy vehicle, automotive and general engineering industries. The three merged businesses complement each other very well in terms of skills and expertise.

SKF Forgings and Rings produces rings that are of precise, circular shape and meet exacting demands with regard to tolerances and material quality. The main customer is SKF, but SKF intends to grow sales to external customers. The share of the business that represents external sales grew for the fifth consecutive year.

Raw material

The annual cost of the purchase of raw material and components is approximately SEK 11.1 billion. Of this amount, steel bars, tubes, components or oil-based products account for the major part. The price of bearing steel increased sharply during 2004 and remained at a high level during 2005. For the full-year 2005, these increases were compensated by price increases, higher efficiency, cost reductions and by alternative sourcing. An increase of 1% in the cost of raw material and components reduces profit before taxes by MSEK 111. SKF believes that adequate supplies of necessary raw materials are available for the Group's operations.

New divisional structure in 2006

SKF has rationalized its divisional structure and reduced the number of divisions within the Group. As from January 1, 2006 the Aero and Steel Division as well as the Electrical Division were integrated into the other divisions.

The development, manufacturing and sales of bearings, seals and airframe components for the aerospace industry, which are part of the Aero and Steel Division, were moved to the Industrial Division. The forging operations, that also are part of this division, were transferred to the Automotive Division.

The development, manufacturing and sales of small ball bearings and bearing seals, that are part of the Electrical Division, were transferred to the Automotive Division. The customers and the buying patterns are similar, few and large customers that buy large volumes on longer contracts. The development, manufacturing and sales of medium size ball bearings, that are mainly supplied to the industrial market, were transferred to the Industrial Division.

28

 
Environmental Regulation

SKF has a multi-site certificate ISO 14001, the international standard for environmental management. This certificate covers the Group’s manufacturing, logistics and technical facilities. The Group environmental certificate now includes 84 sites in 24 countries, and demonstrates SKF’s ambition to work to the highest standards in all the countries in which it operates. The SKF Group has environmental permits and consents for all operations in every country in which it has manufacturing facilities. The permits cover SKF’s production of bearings, seals, lubrication systems, and related products.

The environmental impact of the Group’s operations is mainly in the areas of waste disposal, emissions to air and water, and noise. All impacts are controlled to ensure compliance with national and local regulations.

SKF’s manufacturing operations are designed to prevent environmental pollution. However, like other long established industrial companies, SKF is involved in some remediation projects, resulting from historical activities. Many SKF factories have disposed of various wastes at approved landfills. Because of stricter laws and regulations - some with retroactive effect - concerning landfill disposal, a few SKF companies are currently involved in the clean-up of old landfills, most of which have not been used for many years. The majority of these cases concern so-called Superfund sites in the United States. In most of these cases SKF USA was one of many companies contributing to the waste disposal at the landfill in the past, and, in general, SKF’s share is very low - a few percent or less. The total estimated cost for SKF, including remediation at a few plant sites, is not significant, and appropriate provisions have been made in the consolidated financial statements.

Legal Proceedings

On March 31, 1988, Torrington, a bearing manufacturer based in the United States, filed a petition with the Department of Commerce (“DOC”) and the United States International Trade Commission (“ITC”) requesting the imposition of antidumping duties on certain types of bearings imported and sold in the United States from Germany, the United Kingdom, France, Italy, Sweden, Japan, Thailand, Singapore and Romania. Bearings manufactured by SKF were subject to the petition. In May 1989, the DOC found that bearings manufactured by SKF and other manufacturers under investigation were being sold in the United States at less than fair value, i.e. below the cost of production or the price at which the goods were sold in the country of manufacture, after adjustment for certain factors. The ITC also decided in May 1989 that domestic manufacturers had suffered material injury as a result of such pricing policies. As a result, SKF and the other manufacturers under investigation were required to pay antidumping duties to the United States Department of Treasury. These payments are equal to the difference between the prices each manufacturer charges for its goods in the United States and the prices that each manufacturer charges in the various countries of manufacture, after adjustment for certain factors. SKF expects that there will generally be an additional net payout for each period starting from May 1, 1993, averaging US$ 1 million per review period. Each review period lasts from May 1 to April 30 the following year. All expected payouts have been accrued for in the consolidated financial statements. SKF expects these review periods to continue for the foreseeable future, but with the limitation described in the next paragraph.

29

 
On June 28, 2000, the ITC forwarded to the DOC its final determination in the sunset review of the various bearing antidumping duty orders. The DOC then revoked these orders, for entries on or after January 1, 2000. The revoked orders for SKF were: ball bearings from Sweden, cylindrical roller bearings (CRB) from Germany and spherical plain bearings from Germany. For SKF, these represented half of the dumping volume and half of the antidumping duty in SKF’s latest review. The ITC decision regarding cylindrical roller bearings has been appealed by Torrington, which is now owned by SKF’s largest competitor in North America. Torrington was unsuccessful in the CRB appeal because both the Court of International Trade and the Court of Appeals for the Federal Circuit sustained the ITC no injury determination. As a result of the court decisions, the revocation of the CRB orders is final.

The Company believes that, except as described above, there are no material proceedings pending, to which any member of the Group is a party or of which any of its property is subject. However, the Group is involved with litigation that is incidental to the Group’s business.

 
AB SKF is the parent company of the SKF Group.

The following operating subsidiaries have assets that exceed 10% of SKF’s consolidated total assets or contribute more than 10% to the Group's income from continuing operations.
 
               
Company
   
Country
   
Holding (
%)
SKF USA Inc.
   
USA
   
99.9
 
SKF GmbH
   
Germany
   
100.0
 
SKF Industrie S.p.A
   
Italy
   
100.0
 
SKF France S.A.
   
France
   
100.0
 
SKF Sverige AB
   
Sweden
   
100.0
 
 
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The location of SKF’s production sites as of December 31, 2005, and the principal products produced at such sites are listed below.
 
       
Country
Location
Supporting Platform
No of factories
Argentina
Tortuguitas
Bearing/Units
1
Australia
Basewater (WA)
Bearing/Units
1
 
Williamstown (Vic)
Bearing/Units
1
 
Salysbury (Qld)
Bearing/Units
1
Austria
Steyr
Bearing/Units,Mechatronics
1
 
Steyr
Bearing/Units
2
 
Steyr
Bearing/Units, Services
1
Brazil
Cajamar
Bearing/Units
2
Bulgaria
Sopot
Bearing/Units
1
 
Kalofer
Bearing/Units
2
 
Karnare
Bearing/Units
1
 
Kalofer
Seals
1
Canada
Calgary
Mechatronics
1
China
Nankou*
Bearing/Units, Services
1
 
Wafangdiang*
Bearing/Units
1
 
Shanghai*
Bearing/Units
2
 
Wuhu
Seals
1
 
Dalian
Bearings/Units
1
 
Da Lang
Mechatronic
1
 
Pin Hu
Mechatronic
1
France
Chambery
Mechatronics
1
 
Avallon
Bearing/Units
1
 
Saumur
Lubrication systems
1
 
St Cyr
Bearing/Units
1
 
Fontenay
Bearing/Units
1
 
Saint-Cyr-sur-Loire
Mechatronics
1
 
Saint-Cyr-sur-Loire
Bearing/Units, Services
1
 
Saint-Vallier-sur-Rhone
Bearing/Units
1
 
Lons-le-Saunier
Bearing/Units
1
Germany
Schweinfurt
Bearing/Units
5
 
Schweinfurt
Services
1
 
Schweinfurt
Mechatronics
3
 
Maulburg
Mechatronics
1
 
Berlin
Lubrication systems
1
 
Hocheneim
Lubrication systems
1
 
Leverkusen
Seals
1
 
Luechow
Bearing/Units
2
 
Muehlheim
Bearing/Units
1
 
31

 
Great Britain
Luton
Bearing/Units
2
 
Luton
Services
1
 
Livingstone
Services
1
 
Clevedon
Bearing/Units
1
 
Stonehouse
Bearing/Units, Services
1
India
Pune*
Bearing/Units
5
 
Bangalore*
Bearing/Units
1
 
Bangalore*
Seals
1
Indonesia
Jakarta
Bearing/Units
1
Italy
Turin
Bearing/Units
1
 
Turin
Bearing/Units, Services
1
 
Massa
Bearing/Units
1
 
Villar Perosa
Bearing/Units
2
 
Airasca
Bearing/Units
1
 
Airasca
Mechatronics
1
 
Cassino
Bearing/Units
1
 
Bari
Bearing/Units
1
 
Villar Perosa
Bearing/Units, Services
2
 
Varese
Seals
1
 
Villanova
Seals
1
Japan
Nagano
Bearing/Units
1
Malaysia
Nilai
Bearing/Units, Services
1
Mexico
Puebla
Bearing/Units
1
 
Guadalajara
Seals
1
Poland
Poznan
Bearing/Units
1
South Africa
Uitenhage
Bearing/Units, Services
1
South Korea
Changwon
Bearing/Units
1
 
Taegu
Seals
1
Spain
Tudela
Bearing/Units
1
 
32

 
Sweden
Katrineholm
Bearing/Units
1
 
Goteborg
Mechatronics
1
 
Vasteras
Mechatronics
1
 
Goteborg
Services
1
 
Goteborg
Bearing/Units
7
 
Goteborg
Bearing/Units, Services
1
 
Lulea
Services
1
Switzerland
Liestal
Mechatronics
1
Taiwan
Taipei
Mechatronic
1
Ukraine
Lutsk
Bearing/Units
1
USA
Grafton
Mechatronics
1
 
Grafton
Mechatronics,Services
1
 
Detroit
Mechatronics
1
 
Hanover
Bearing/Units
2
 
Elizabethtown (KY)
Bearing/Units
1
 
San Diego
Services
1
 
Aiken
Bearing/Units
1
 
Elgin
Seals
2
 
Glasgow
Bearing/Units
1
 
Hobart
Seals
1
 
Seneca
Seals
1
 
Springfield
Seals
1
 
Gainesville
Bearing/Units, Services
1
 
Jamestown (NY)
Bearing/Units
1
 
Falconer (NY)
Bearing/Units, Services
1
 
Charleston (SC)
Services
1
 
Colebrook (CT)
Bearing/Units
1
 
Elgin (IL)
Seals
1
 
Franklin
Seals
1
 
* SKF is holding majority interest and has control.

At the beginning of 2005, SKF decided to strengthen its manufacturing capacity in China to respond to the growing demand from the domestic Chinese market and to support its markets outside China. SKF will build a completely new factory in the Dalian Economic & Technological Development Area in north-eastern China. This factory will manufacture and recondition large-sized bearings of different types. The first phase of the factory will be finished in 2006. At the same time, it was decided to increase the production capacity for the automotive industry, as well as the capacity for the production of deep groove ball bearings for the electrical industry, both in Shanghai. A new factory for the automotive industry is being built in Shanghai. It was also decided to build a new factory in Korea for products for the automotive industry and a factory in Indonesia for deep groove ball bearings. In India, it was decided to start the production of cylindrical roller bearings and to increase the present capacity for the production of other products. Finally, in Brazil, the capacity for the production of taper roller bearings was increased during the year. A new factory for the most recent acquisition in Asia, Jaeger, is being built in the Shanghai area.

33

 
Other facilities

SKF has a major distribution centre in Tongeren, Belgium, serving mainly Europe, the Middle East, Africa and Latin America. The distribution centre at Crossville, Tennessee, United States, serving North America, is run by CoLinx, LLC, an e-business company in the United States owned 25% by SKF. SKF also has a distribution centre in Singapore serving the Asia Pacific region and a distribution centre in Hebron, Kentucky, serving the seal and vehicle replacement markets in North America.

The SKF Group has a central research and development centre in Nieuwegein in The Netherlands for product development and a central research and development centre in Göteborg, Sweden for process development. The Group has many technical centres throughout the world, primarily focusing on engineering.

SKF believes that its sites are generally sufficiently modern and adequate for the purposes for which they are used.

As of December 31, 2005, total assets of MSEK 115 were pledged as collateral for outstanding indebtedness. These assets include real estate with a value of approximately MSEK 46. For a further description, see Note 25 to the consolidated financial statements filed as part of this Form 20-F. The net book value of all property, plant and equipment on that date was MSEK 11,119.
 
34

 
 
The following operating and financial review and prospects should be read in conjunction with the consolidated financial statements included in this Form 20-F.

The consolidated financial statements of the SKF Group are prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU), which differ, in certain significant respects from accounting principles generally accepted in the United States of America (“U.S. GAAP”) U.S. GAAP, as described below. Note 1 to the consolidated financial statements describes IFRS. Those portions of IFRS not adopted by the EU have no material effect on this report.

Critical accounting policies involving significant management judgment

The following accounting policies involve management judgments that are considered to have the most significant effect on the consolidated financial statements.

Income taxes
General
Taxes include current taxes on profits, deferred taxes and other taxes such as taxes on capital, actual or potential withholding on current and expected transfers of income from Group companies and tax adjustments relating to prior years. Income taxes are recognized in the income statement, except to the extent that they relate to items directly taken to equity, in which case they are recognized in equity.
Significant management judgment is required in determining current tax liabilities and assets as well as deferred tax liabilities and assets. The process involves estimating the current tax exposure together with assessing temporary differences arising from differing treatment of items for tax and accounting purposes. In particular, management must assess the likelihood that deferred tax assets will be recoverable from future taxable income.

Current taxes
All the companies within the Group compute current income taxes in accordance with the tax rules and regulations of the countries where the income is taxable. Provisions have been made in the consolidated financial statements for estimated taxes on earnings of subsidiaries expected to be remitted in the following year, but not for tax liabilities, which may arise on distribution of the remaining unrestricted earnings of foreign subsidiaries as they can be distributed free of tax or as SKF does not intend to internally distribute them in the foreseeable future.

Deferred taxes
The Group utilizes a balance sheet approach for measuring deferred taxes, which requires deferred tax assets and liabilities to be recorded based on enacted tax rates for the expected future tax consequences of existing differences between accounting and tax reporting bases of assets and liabilities, and tax loss and tax credit carry-forwards. Such tax loss and tax credit carry-forwards can be used to offset future income. Deferred tax assets are recorded to the extent that it is probable that sufficient future taxable income will be available to allow the recognition of such benefits.

35

 
Other taxes
Other taxes refer to taxes other than income taxes, which should not be included elsewhere in the income statement.

Financial instruments as from January 1, 2005

Financial assets and financial liabilities are recognized on the Group's balance sheet when the Group becomes a party to the contractual provisions of the instrument. Settlement day recognition is applied for financial assets and liabilities other than derivatives, which are recognized at trade date. Financial instruments are recorded initially at cost, which usually equals fair value at the time of acquisition. Transaction costs are included in the initial measurement of financial assets and liabilities that are not measured at fair value through profit and loss. Subsequent measurement depends on the designation of the instrument, as determined by management, as follows:

o Investments in equity securities (other than interests in jointly controlled and associated companies) are designated as available for sale. Changes in fair value of equity investments with a reliable fair value are recognized directly in equity, except for impairment losses, which are recognized in the income statement. When the investments are derecognized, the cumulative gain or loss recognized in equity is removed from equity and recognized in the income statement. If the fair value of an unquoted equity security cannot be reliably measured the investment is measured at cost;

o Deposits for which substantially all initial investment is expected to be recovered, comprising principally of funds held with landlords and other service providers, trade receivables, loans granted and funds held with banks are designated as loans and receivables and measured at amortized cost using the effective interest method. Impairment losses are recognized where there is objective evidence of impairment;

o Financial assets other than those designated as available for sale or loans and receivables are designated as financial assets at fair value through profit and loss;

o Loans and other financial liabilities are measured at amortized cost using the effective interest method. Liabilities that are hedged against changes in fair value, however, are recorded at fair value.

o Derivatives, comprising foreign exchange contracts, currency options, cross-currency and interest rate swaps and embedded derivatives are always recognized at fair value in the income statement unless they are designated and effective hedging instruments;

o Derivatives embedded in other financial instruments or other non-financial host contracts are treated as separate derivatives when their risks and characteristics are not closely related to those of the host contract and the host contract is not carried at fair value with unrealized gains or losses reported in profit or loss.

36

 
Financial assets are derecognized when the contractual rights to the cash flow have expired or been transferred together with substantially all risks and rewards. Financial liabilities are derecognized when they are extinguished.

Critical accounting policies involving key sources of estimation uncertainty

The following accounting policies involve key assumptions and/or estimates that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year.

Impairment of long-lived assets and assets with indefinite lives
Long-lived assets
Intangible assets and plant, property and equipment are tested for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The determination is performed at the cash generating unit (CGU) level. Factors that are considered important are:
o Underperformance relative to historical and forecasted operating results;
o Significant negative industry or economic trends;
o Significant changes relative to the asset including plans to discontinue or restructure the operation to which the asset belongs.
When there is an indication that the carrying value may not be recoverable based on the above indicators, the profitability of the product line to which the asset belongs is analyzed to further confirm the nature and extent of the indication. When an indication is confirmed an impairment loss is recognized to the extent that the carrying amount of the affected CGU exceeds its recoverable amount.

Assets with indefinite lives
Goodwill and other intangibles with indefinite lives are tested annually for impairment at the CGU level where an impairment loss is recognized if the carrying amount exceeds the recoverable amount.

Calculating the impairment loss
The recoverable amount is the greater of the estimated net selling price and value in use. For those CGU's acquired during the year, the net selling price, being the purchase price, is used as recoverable amount. Such net selling price has been developed with reference to discounted cash flows and observable market prices and therefore, without evidence to the contrary, it is assumed to be the greater value. For other CGUs the recoverable amount has been determined on the basis of value in use.
In assessing value in use, a discounted future cash flow model (DCF) is used. The DCF model involves a number of significant assumptions and estimates in the forecasting of future operating cash flows, including terminal values, the number of years on which to base the cash flow projections, market growth rates, revenue volumes, production costs, and working capital requirements. Forecasts of future operating cash flows are based on the best estimates of future revenues and operating expenses using historical trends, general market conditions, industry trends and forecasts and other available information. Terminal values are based on the Gordon Growth model, which includes a growth factor representing inflation expected in the country in which the assets operate.
Forecasts for operating cash flow are adjusted by an appropriate discount rate derived from the Group's costs of capital plus reasonable risk premiums, including market risk and small company premium, at the date of evaluation. Management determines the discount rate to be used based on the risk inherent in the related activity's current business model and industry comparisons.

37

 
Predicting these key variables involves uncertainty about future events and market conditions, and therefore actual outcomes may be significantly different. However, the assumptions, which have been reviewed by management, are consistent with the Group's internal forecasts.

Provisions
In general, a provision is recognized when there is a present obligation as a result of a past event, it is probable that an outflow of resources will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. As the estimates involve uncertainty about future events outside the control of the Group, the actual outcomes may be significantly different.

Restructuring provisions including termination benefits
Restructuring provisions for programs that materially change the manner in which the SKF Group operates, are recognized when a detailed formal plan has been established and a public announcement of the plan has occurred creating a valid expectation that the plan will be carried out. Restructuring provisions often include termination benefits, which can be either voluntary or involuntary. Termination benefits are recognized in accordance with the above, except where there is a service requirement in connection with the benefits, in which case the cost is spread over the service period.
Restructuring provisions involve estimates about the timing and cost of the planned future activities. The most significant estimates involve the costs necessary to settle employee severance or other employee separation obligations, as well as the costs involved in contract cancellations and other exit costs. Such estimates are based upon historical experience and the expected future cash outflows, based on the current status of negotiations with the affected parties and/or their representatives.

Provisions for litigation
Provisions for litigations are estimates of the future cash flows necessary to settle the obligations. Such estimates are based upon the nature of the litigation, the legal processes and potential level of damages in the jurisdiction in which the litigation has been brought, the progress of the cases, the opinions and view of internal and external legal counsel and other advisors regarding the outcome of the case, and experience with similar cases.

Warranty provisions
Warranty provisions involve estimates about the outcome of warranty claims resulting from defective products, which include estimates for potential liability for damages caused by such defects to the Group's customers or to the customers of the Group's customers and potential liability for consequential damages. Assumptions are required for both determining the likelihood of favourable outcomes of warranty disputes and the cost incurred when replacing the defective products and compensating customers for damages caused by the Group's products. Warranty provisions are estimated with consideration of historical claims statistics, expected costs to remedy and the average time lag between faults occurring and claims to the company.
 
38


Post-employment benefits

The post-employment provisions and assets arise from defined benefit obligations in plans which are either unfunded or externally funded. For the unfunded plans, benefits paid out under these plans come from the all-purpose assets of the company sponsoring the plan. The related provisions carried in the balance sheet represent the present value of the defined benefit obligation less the fair value of plan asset and adjusted for unrecognized actuarial gains and losses and past service costs.
Under externally funded defined benefit plans, the assets of the plans are held separately from those of the Group, in independently administered funds. The related balance sheet provision or asset represents the deficit or excess of the fair value of plan assets over the present value of the defined benefit obligation, taking into account any unrecognized actuarial gains or losses and past service cost. However, an asset is recognized only to the extent that it represents a future economic benefit which is actually available to the Group for example in the form of reductions in future contributions, or refunds from the plan. When such excess is not available it is not recognized, but is disclosed in the notes.
The projected credit method is used to determine the present value of all defined benefit obligations and the related current service cost and where applicable, past service cost. Valuations are carried out annually for the most significant plans and on a regular basis for other plans. External actuarial experts are used for these valuations.
Estimating the obligations and costs involves the use of assumptions. Such assumptions vary according to the economic conditions of the country in which the plan is located and are adjusted to reflect market conditions at every year-end. However, the actual costs and obligations that in fact arise under the plans may be materially different from the estimates based on the assumptions due to changing market and economic conditions. The most sensitive assumptions are related to the discount rate, expected return on assets, future compensation increases and health care cost rates. The selection of the discount rate is based on rates of return on high-quality, fixed-income investments (high quality corporate bonds, and in countries where there is no deep market for such bonds, government bonds) that, if invested at the valuation date, would provide the necessary future cash flows to pay the benefits when due. The expected return on assets is based on the market expectations (at the beginning of each period) for returns over the entire life of the related obligation. In developing the long term rate of return, management considers the historical returns and the future expected return based on current market developments for each asset class as well as the target allocations of the portfolio. The salary growth assumptions reflect the non-current actual experience, the near term outlook and assumed inflation. Health care cost trend rates are developed based on historical cost data, the near term outlook, and an assessment of likely non-current trends. Actuarial gains and losses arise mainly from changes in actuarial assumptions and differences between actuarial assumptions and what has actually occurred. They are recognized in the income statement, over the remaining service lives of the employees, only to the extent that their net cumulative amount exceeds 10% of the greater of the present value of the obligation or of the fair value of the plan assets at the end of the previous year.
For all defined benefits plans the actuarial cost charged to the income statement consists of current service cost, interest cost, expected return on plan assets (only funded plans) and past service cost as well as any amortized actuarial gains and losses. The past service cost for changes in pension benefits is recognized when such benefits vest, or amortized over the periods until vesting occurs.
 
39

 
Interest cost and the expected return on assets to the extent that it covers that plan's interest cost, is classified as financial expense. Other expense items as well as any remaining expected return on assets and all defined contribution expenses are allocated to the operations based on the employee's function as manufacturing, selling, or administrative.
The defined benefit accounting described above is applied only in the consolidated accounts. Subsidiaries, including the Parent Company, continue to use the local statutory pension calculations to determine pension costs, provisions and assets in the stand-alone statutory reporting.
Some post-employment benefits are also provided by defined contribution schemes, where the Group has no obligation to pay benefits after payment of an agreed-upon contribution to the third party responsible for the plan. Such contributions are recognized as expense when incurred.
A portion of the ITP pensions arrangements in Sweden is financed through insurance premiums to Alecta. This arrangement is considered to be a multi-employer plan where defined benefit accounting is required. Alecta is currently unable to provide the information needed to do such accounting. As a result, such insurance premiums paid are currently accounted for as a defined contribution expense.

New accounting principles adopted in 2005 for US GAAP

During 2005 the Group adopted SFAS 151 "Inventory costs - an amendment of ARB No.43, chapter 4". SFAS 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. The adoption of SFAS 151 did not have any material effect on the Group's consolidated financial position or results of operations reported in accordance with U.S. GAAP.
In March 2005, the FASB issued Interpretation No. 47, "Accounting for conditional asset retirement obligations - an interpretation of FASB Statement No. 143" (FIN47). This Interpretation clarifies that the term conditional asset retirement obligation as used in FASB Statement No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143), refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. An entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The adoption of FIN47 had no impact on the Group's consolidated financial position or results of operations reported in accordance with U.S. GAAP.

New accounting principles to be adopted in future periods for US GAAP

In December 2004, the FASB issued SFAS 123 (revised 2004), "Share-based payment." The revised standard eliminates the alternative used by the Group in accounting for share-based compensation using the intrinsic value method Accounting Principles Board (APB) Opinion No. 25. The revised standard generally requires the recognition of the cost of employee services based on the grant date fair value of equity or liability instruments issued. The effective date for the Group is January 1, 2006. Although the revised standard applies to new awards granted after the effective date, the revised standard also may, in certain instances, impact the accounting for awards granted before the effective date. The impact of the adoption of the revised standard on the Group's consolidated financial position and results of operations reported in accordance with U.S. GAAP has not been determined.

40

 
In December 2004, the FASB issued SFAS 153, "Exchanges of nonmonetary assets - an amendment of APB Opinion No. 29." APB Opinion No. 29 provided an exception to the basic fair value measurement principle for exchanges of similar productive assets. That exception required that some nonmonetary exchanges, although commercially substantive, be recorded on a carryover basis. SFAS 153 eliminates the exception to fair value measurement for exchanges of similar productive assets and replaces it with a general exception to fair value measurement for exchange transactions that do not have commercial substance - that is, transactions that are not expected to result in significant changes in the cash flows of the reporting entity. SFAS 153 is effective prospectively for the Group in accounting for nonmonetary asset exchanges under U.S. GAAP occurring after December 31, 2005.

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments. SFAS No. 155 amends SFAS No. 133 and SFAS No. 140, and allows financial instruments that have embedded derivatives that otherwise would require bifurcation from the host to be accounted for as a whole, if the holder irrevocably elects to account for the whole instrument on a fair value basis. Subsequent changes in the fair value of the instrument would be recognized in earnings. The standard also:
· Clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133;
· Establishes a requirement to evaluate interests in securitized financial assets to determine whether interests are freestanding derivatives or are hybrid financial instruments that contain an embedded derivative requiring bifurcation;
· Clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and
· Amends Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest ( that is itself a derivative financial instrument ).

SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity´s first fiscal year that begins after September 15, 2006. The Company is currently evaluating the impact adoption of SFAS No. 155 on its financial position and results of operations.

In June 2005, the EITF reached a consensus on Issue No.05-5, "Accounting for early retirement or post-employment programs with specific features (such as terms specified in Altersteilzeit early retirement arrangements)". This issue provides guidance on the accounting for the bonus feature in German Altersteilzeit (ATZ) early retirement programs and states that the bonus feature and the additional contributions into the German government pension scheme under a Type II ATZ arrangement should be accounted for as a post-employment benefit under FASB Statement 112, "Employers' Accounting for Post-employment Benefits-an amendment of FASB Statements No. 5 and 43". An entity should recognize the additional compensation over the period from the point at which the employee signs the ATZ contract until the end of the active service period. The issue also states that the employer should recognize the government subsidy when it meets the necessary criteria and is entitled to the subsidy. EITF No.05-5 should be applied to fiscal years beginning after December 15, 2005, and reported as a change in accounting estimate effected by a change in accounting principle as described in paragraph 19 of FASB Statement 154, "Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3". The impact of EITF Issue No 04-13 and 05-5 on the Group's consolidated financial position or results of operations reported in accordance with U.S. GAAP has not yet been assessed.
 
41


Currency exposure

Fluctuations in exchange rates between the Swedish krona and other currencies can significantly affect the Group's financial results. During 2005, approximately 96% of Group net sales were generated in currencies other than the Swedish krona. All assets and liabilities are translated into Swedish krona at the period-end exchange rate, whereas income and expense items are translated at average exchange rates for the period. See Note 1 to the consolidated financial statements filed as part of this Form 20-F. The Group regularly enters into forward foreign currency contracts, foreign currency swaps and foreign currency options designed to hedge against the impact of currency fluctuations.

Compared to year 2004, exchange rates for the full year 2005, including translation effects and flows from transactions had a negative effect on operating profit of approximately MSEK-150.

See also Item 11 - “Quantitative and Qualitative Disclosures About Market Risk” for details about the Group's financial risks and policies to monitor these risks.

European Monetary Union

As of December 31, 2005, the European Union consisted of 25 member countries. There are 12 member countries using the Euro.

Sweden is a member of the European Union and the European Monetary Union but has decided not to join the Currency Union for the time being. The introduction of a single currency in Europe has not brought about any change in the Group’s strategic direction. SKF has treated Europe as a single market for a number of years. The SKF companies operating in the Euro-zone gradually converted from local currencies to the Euro in 2001. The migration from local currencies to the Euro was completed before January 1, 2002.

Results of Consolidated Operations - 2003-2005

·  
Sales
 
Net sales in 2005 amounted to MSEK 49,285 (44,826). The 9.9% increase in net sales compared to 2004 was attributable to structure by -1.1%, to exchange rate effects by 2.6%, to price and mix by 3.4%, and to volume by 5.0%. Mix refers to volume shifts between regions, various customer segments and products with different price levels. Structure refers to acquisition and divestment of companies.

Qualifying hedging instruments affected net sales by MSEK -107.

Net sales in 2004 amounted to MSEK 44,826 (41,377). The 8.3% increase in net sales compared to 2003 was attributable to structure by 1.1%, to exchange rate effects by -3.5%, to price and mix by 2.4%, and to volume by 8.3%.

·  
Operating Profit

The operating profit in 2005 amounted to MSEK 5,327 (4,434), and included an income of MSEK 52 from the disposal of the shares in FlexLink AB. The restructuring plan to close two factories in the U.S.A was announced in June and caused an initial charge of MSEK 190 primarily due to impairments. Another charge of MSEK 200 for restructuring and impairment was taken in December, primarily due to rationalization in Fontenay, France.
42

 
The operating profit in 2004 amounted to MSEK 4,434 (3,307), and included a net effect of approximately MSEK -100 for implementing the restructuring programme announced 2003. As part of ongoing business activities in 2004, some MSEK 80 were carried as an expense due to impairment of fixed assets and measures to reduce future costs. A restructuring expense of MSEK 282 and impairment of MSEK 205 were charged to 2003. Additionally, a restructuring expense of approximately MSEK 250 was offset by certain non-recurring income as well as through a reassessment of existing provisions.

Compared to year 2004, exchange rates for the full year 2005, including translation effects and flows from transactions, had a negative effect on operating profit of approximately MSEK 150.

Compared to year 2003, exchange rates for the full year 2004, including translation effects and flows from transactions had a negative effect on operating profit of approximately 410.

Operating margin for 2005 amounted to 10.8% (9.9% and 8.0%).

In 2005, cost of goods sold, selling and administrative expenses amounted to MSEK 44,215 (40,461). The costs were divided into 34% salaries, wages and social charges, 4% depreciation, amortization and impairment and 62% mainly purchased goods and services.

In 2004, cost of goods sold, selling and administrative expenses amounted to 40,461 (38,189). The costs were divided into 36% salaries, wages and social charges, 4% depreciation, amortization and impairment and 60% mainly purchased goods and services.

In 2005, other operating income, of MSEK 388(305 and 367) and other operating expense, of MSEK -303(-233 and -267) include items such as foreign exchange gains and losses arising on operating assets and liabilities, gains and losses on sales of plant, property and equipment, gains and losses on sales of companies and operations as well as rental revenues.

The exchange gains and losses, net, 2005 amounted to MSEK 24 (25 and -42). In 2005, other operating income included the gain on sale of FlexLink AB and Ovako La Foulerie S.A. In 2004 other operating income included a gain on sale of the associated company Momentum Industrial Maintenance Supply AB. In 2003 other operating income included a gain on sale of the associated company NN Euroball ApS.

The improvement in the SKF Group's financial results in 2005 can be attributed to a continued focus on delivering value to its customers, higher sales, improved pricing, increased productivity and cost reduction despite higher raw material costs and a negative currency impact. The strong increase in raw material prices that started in 2004 and continued into 2005 was addressed at a very early stage by the Group, enabling it to offset the negative impact by cost reduction, increased productivity, improved sourcing and pricing.

43

 
·  
Profit before taxes

Profit before taxes 2005 amounted to MSEK 5,253 (4,087). The financial income and expense, net, amounted to MSEK -74 (-347) and was negatively affected by increased borrowings and positively affected by disposal of shares as well as revaluation of share swaps. Interest-bearing loans at year-end totalled MSEK 4,296 (1,116), while provisions for post-employment benefits amounted to MSEK 4,916 (4,655). Post-employment benefits have affected the financial net negatively with MSEK 235. The financial and foreign exchange gains and losses on financial assets and liabilities, net amounted to MSEK -31 and include a positive effect of MSEK 50 from qualifying hedging instruments.

Profit before taxes in 2004 amounted to MSEK 4,087 (2,801). The financial income and expense, net, amounted to MSEK -347 (-506) and was positively affected by decreased borrowings. Post-employment benefits have affected the financial net negatively with MSEK 290. The financial exchange gains and losses, net, on financial assets and liabilities amounted to MSEK -20 and includes a positive effect of MSEK 127 from hedging activities.

·  
Net profit

Profit after taxes in 2005 amounted to MSEK 3,607 (2 976). The actual tax rate in 2005 was 31% (27%). The tax rate in 2005 returned to a more normalized level as compared to 2004 which included favourable outcome of two tax disputes.

Net profit in 2004 amounted to MSEK 2,976 (2,098). The actual tax rate in 2004 was 27% (25%). The low tax rate was attributable to the favourable outcome of two tax disputes and to the reversal of valuation allowances on deferred tax assets because of changes in judgment of the realizability of the related deferred tax assets. 
 
·  
Dividend and mandate to repurchase the Company’s own shares

In view of the company's strong performance, cash generation capacity and outlook, the Board of Directors of AB SKF proposes an increase in the dividend of 33% giving a dividend of SEK 4 per share for the financial year 2005.

Furthermore, the Board proposes that the Annual General Meeting should resolve to authorize the Board, until the next Annual General Meeting, to decide upon the repurchase of the company’s own shares. The intention of this proposal is to be able to adapt the capital structure of the company to its capital needs, in order thereby to contribute to increased shareholder value. According to the proposal, the authorization will involve shares of Series A as well as Series B. The maximum number of shares to be repurchased, will be such that the company then holds a maximum of 5% of all shares issued by the company. The shares may be repurchased by operations on the OMX Stockholm Stock Exchange. No SKF shares are currently owned by the company.

The proposals are subject to resolutions by the Annual General Meeting in April 2006.

44


Reconciliation of IFRSs to US GAAP

The differences in net income and shareholders´equity between IRFSs and US GAAP result primarily from deferred income taxes, provision for restructuring and impairment of assets, post-employment benefits and capitalization of interest costs. See note 33 to the Consolidated Financial Statements, included elsewhere in this document, for a reconciliation of net income and shareholders´equity from IFRSs to US GAAP and a discussion of such differences.

Net income determined in accordance with US GAAP would have been SEK 3,589
(2,750 and 2,478) as compared to SEK 3,607 (2,976 and 2,098) of net income under IFRSs.

Shareholders equity determined in accordance with US GAAP would have been SEK 18,222 (17,271 and 16,232) compared to SEK18,233 (17,245 and 15,852) of Shareholders´equity under IFRS.

Diluted earnings per share after tax

Stock options allocated in 2001, 2002 and 2003 are as from 2005 accounted for as equity instruments and no liability is recorded for the difference in market price of the SKF B share and the exercise price of outstanding options. A diluted EPS is calculated considering the effects of dilutive potential ordinary shares, i.e. options that may entitle its holder to ordinary shares. Prior years have not been fully restated as allowed under the transitional provisions of IFRS 1, see Note 1 to the consolidated financial statements, filed as a part of this Form 20-F. Under Swedish GAAP applied in 2004 and 2003 for financial instruments, unrealized gains in derivatives offsetting the unrealized cost for options not yet exercised were kept off-balance sheet. For that reason no dilutive effect has been calculated for these years.

Basic earnings per share, both A and B shares included, is calculated by dividing the earnings attributable to holders of ordinary equity of the Parent Company by the weighted average number of ordinary shares outstanding during the period. The weighted average number of ordinary shares outstanding in 2005, 2004 and 2003 was 455 351 068. The number has been recalculated to reflect the split and redemption in 2005.

Diluted earnings per share, both A and B shares included, is calculated using the weighted average number of shares outstanding during the period adjusted for all dilutive potential ordinary shares. The average market price of the SKF B share for the reporting period is used.
 
45


Division overview for the years ended December 31, 2005, 2004 and 2003.

Previously published amounts have been reclassified to conform to the current Group structure in 2005 and IFRS. The following table provides information regarding the results of SKF’s divisions for 2005, 2004 and 2003 (Amounts in MSEK):
 
Industrial Division
 
2005
 
2004
 
2003
 
Net sales
   
12,773
   
10,785
   
9,665
 
Sales including intra-Group sales
   
19,183
   
16,640
   
15,139
 
Operating profit
   
1,933
   
1,585
   
1,456
 
Operating margin %
   
10.1
   
9.5
   
9.6
 
 
Service Division
                   
Net sales
   
15,995
   
14,115
   
12,947
 
Sales including intra-Group sales
   
17,533
   
15,554
   
14,307
 
Operating profit
   
2,078
   
1,688
   
1,414
 
Operating margin %
   
11.9
   
10.9
   
9.9
 
                     
Automotive Division
Net sales
   
15,146
   
14,054
   
13,344
 
Sales including intra-Group sales
   
17,021
   
15,679
   
14,804
 
Operating profit
   
452
   
612
   
471
 
Operating margin %
   
2.7
   
3.9
   
3.2
 
                     
Electrical Division
                   
Net sales
   
2,102
   
1,931
   
1,833
 
Sales including intra-Group sales
   
7,426
   
6,824
   
6,459
 
Operating profit
   
357
   
297
   
172
 
Operating margin %
   
4.8
   
4.4
   
2.7
 
                     
Aero and Steel Division
                   
Net sales
   
3,198
   
3,874
   
3,551
 
Sales including intra-Group sales
   
5,136
   
6,584
   
6,016
 
Operating profit/loss
   
463
   
206
   
-179
 
Operating margin %
   
9.0
   
3.1
   
-3.0
 
                     

Results for 2005 compared to 2004

·  
Industrial Division

Net sales in 2005 amounted to MSEK 12,773 (10,785). Sales including intra-Group sales in 2005 totaled MSEK 19,183 (16,640). The operating profit in 2005 was MSEK 1,933 (1,585), with an operating margin of 10.1% (9.5%)

Sales were significantly higher in Europe, North America and Asia, measured in local currencies and compared to last year.

46


·  
Service Division

Net sales in 2005 amounted to MSEK 15,995 (14,115). Sales including intra-Group sales in 2005 totalled MSEK 17,533 (15,554). The operating profit in 2005 was MSEK 2,078 (1,688), with an operating margin of 11.9% (10.9%).

Sales in Europe were slightly higher in 2005 compared to 2004, measured in local currencies, while they were significantly higher in Asia, North America and Latin America.
 
·  
Automotive Division

Net sales in 2005 amounted to MSEK 15,146 (14,054). Sales including intra-Group sales in 2005 totalled MSEK 17,021 (15,679). The operating profit in 2005 was MSEK 452 (612), with an operating margin of 2.7% (3.9%). The operating profit includes a charge for restructuring expenses of MSEK 190 during the second quarter.

Sales to the car and light truck industry in Europe were higher in 2005 than in 2004, measured in local currencies. Sales in North America were significantly lower. Sales to the heavy truck industry in Europe were higher in 2005 than in 2004 and they were significantly higher in North America. Sales to the vehicle service market were significantly higher in 2005 than in 2004.

·  
Electrical Division

Net sales in 2005 amounted to MSEK 2,102 (1,931). Sales including intra-Group sales in 2005 totalled MSEK 7,426 (6,824). The operating profit in 2005 was MSEK 357 (297) with an operating margin of 4.8% (4.4%).

Sales, measured in local currencies, were lower in Europe in 2005 compared with 2004. Sales in Asia were significantly higher than in 2004.

·  
Aero and Steel Division
 
Net sales in 2005 amounted to MSEK 3,198 (3,874). Sales including intra-Group in 2005 totalled MSEK 5,136 (6,584).

The operating profit in 2005 was MSEK 463 (206), with an operating margin of 9.0% (3.1%). The result for the aeroengine bearings business was affected by high steel prices and steel supply problems.
 
 
Results for 2004 compared to 2003

·  
Industrial Division
 
Net sales in 2004 amounted to MSEK 10,785 (9,665) Sales including intra-Group sales in 2004 were MSEK 16,640 (15,139). Sales were significantly higher in Europe, North America and Asia, measured in local currencies and compared to last year. The increased focus to develop and deliver added value products and the increased industrial activity enabled SKF to increase its sales.

The operating profit in 2004 was MSEK 1,585 (1,456) with an operating margin of 9.5 (9.6). The result for the division was a result of a better price/mix in the business and good cost control despite higher raw material costs and negative currency effect.

47


·  
Service Division

Net sales in 2004 amounted to MSEK 14,115 (12,947). Sales, including intra-Group sales in 2004, were MSEK 15,554 (14,307).

Sales in Europe, Asia and Latin America, measured in local currencies, were significantly higher in 2004 than in 2003 and higher than in 2003 in North America. The increase in sales was a result of improving the SKF offer to its distributors, the launch of new distributor development programmes and a good market demand situation in all regions in the world.

The operating profit in 2004 was MSEK 1,688 (1,414) with an operating margin of 10.9% (9.9%).

·  
Automotive Division

Net sales 2004 amounted to MSEK 14,054 (13,344). Sales including intra-Group sales in 2004 were MSEK 15,679 (14,804). Sales in Europe to the car and light truck industry were higher in 2004 than in 2003, measured in local currencies. Sales in North America were slightly lower. Sales to the heavy truck industry were significantly higher in 2004 than in 2003, both in Europe and in North America. Sales to the vehicle service market were significantly higher 2004 than in 2003.

The overall market for cars and light trucks in Europe was stable while SKF sales increased significantly due to the fact that SKF supplied models had a good sales development during the year. Sales to the heavy trucks industry were good in Europe as well as in North America, this because of the overall strong market demand for heavy trucks during the year.

The operating profit in 2004 was MSEK 612 (471) with an operating margin of 3.9% (3.2%). This was in spite of a negative currency impact and higher raw material costs.

·  
Electrical Division

Net sales in 2004 amounted to MSEK 1,931 (1,833). Sales including intra-Group sales in 2004 were MSEK 6,824 (6,459) Sales, measured in local currencies, were unchanged in Europe in 2004 compared to 2003. Sales in Asia were significantly higher than in 2003, mainly due to strong sales to the two-wheeler industry. Sales to household appliance manufacturers developed positively owing to the strength of the segment and to new business gained. For the two-wheeler segment, new products launched during 2003 such as crankshaft and camshaft bearings have contributed to the rise in sales and the gain of new customers in 2004.

The operating profit in 2004 was MSEK 297 (172) with an operating margin of 4.4% (2.7%). 
 
48

 
·  
Aero and Steel Division

Net sales in 2004 amounted to MSEK 3,874 (3,551). Sales, including intra-Group sales in 2004, were MSEK 6,584 (6,016). Global air traffic showed strong growth through-out the year with volume significantly higher. There was also a decline in the number of parked aircraft. Fixed-wing aircraft production was higher than in 2003, especially in Europe. Both helicopter and jet engine production were also higher in 2004. Consequently, the demand for bearings and components from the aerospace industry began to rise slowly. SKF sales in Europe in 2004 were slightly higher than in 2003, while they were unchanged in North America.

The operating profit in 2004 was MSEK 206 (-179) with an operating margin of 3.1% (-3.0%).

SKF Aerospace’s operating margin increased due to higher demand for bearings and components for the aerospace industry as a consequence of factors described in section above. Ovako Steel’s operating margin increased due to higher market demand combined with positive effects from the major restructuring programme implemented in 2002 and 2003.
 
49

 
 
Over the last few years, a comprehensive programme has been carried out to restructure underperforming activities and to improve the cost structure and operating margin. The importance of the efficient use of capital and a positive cash flow has been focused in the organization.

Financial targets

The current target for profitable growth was set in April 2003 and based on the year 2002. The goal is to have an operating margin level of 10% and to increase sales by 6% a year measured in local currencies, by the end of 2006.

The operating margins in 2003, 2004 and 2005 were 8.0%, 9.9% and 10.8% respectively. Sales growth, measured in local currency, from 2002 up to and including 2005 was 16.2%. Return on capital employed should be 20%. For the 12-month period ended 31 December 2005 the figure was 21.8%. SKF also has a target, set in 2005, to reach 18% inventories to sales by 2007, at the end of December 2005 the figure was 20.1%. Cash flow after investments before financing and structural investments should equal net profit over a number of years.

The financial targets are cascaded down to the divisions and business units through SKF’s financial performance management model.

Financial performance management model

SKF’s financial performance management model is a simplified, economic value-added model. This model, called Total Value Added (TVA), promotes improved operating profit, capital reduction and profitable growth. TVA is the operating profit, less the pre-tax cost of capital in the country in which the business is conducted. The TVA result trend for the Group correlates well with the trend for the share price over a longer period of time. Group Management’s variable salaries programme is based on this model.

Dividend policy

SKF’s dividend policy is based on the principle that the dividend should be adapted to the trend for earnings and cash flow, while taking account of the Group’s development potential and financial position. The Board of Directors' view is that the dividend should amount to approximately one half of SKF’s average net profit calculated over a business cycle.

Financing

It is SKF’s policy that the financing of the Group’s operations should be long-term. As of December 31, 2005, the average maturity of SKF’s loans was three and a half years. In 2005, SKF issued a 100 million euro three-year floating-rate note and a 250 million euro five-year bond in order to finance its share redemption programme.
 
50


As of December 31, 2005, the Group had an A minus (A-) rating for long-term credits from Standard and Poor’s and an A3 rating from Moody’s Investors Service, both with stable outlook.

Consolidated statements of cash flow

·  
Cash flow from operations

A continued good operating profit, which in 2005 amounted to 5,327 (4,434 and 3,307), contributed to the strong cash flow.

·  
Cash flow from investing activities

The target is to continuously generate a net cash flow after investments before financing and structural investments to a level equal to net profit. The Group’s capital expenditures for property, plant and equipment amounted to MSEK 1,623 (1,401 and 1,379). Of the Group’s total additions to property, plant and equipment approximately MSEK 89 (72 and 70) were invested in measures to improve the environment, both internally and externally. In 2005, the Group cash out flow from acquisitions was MSEK 419 (644 and 89), primarily related to Jaeger Group (see Note 2 to the consolidated financial statements). Cash flow from sales of businesses related to the divestment of Ovako La Foulerie S.A.

·  
Cash flow from financing activities

Interest-bearing loans totalled MSEK 4 394 at year-end (1,116 and 1,618). In June, SKF issued a 100 MEUR three-year floating-rate note and a 250 MEUR five-year bond in order to finance its share redemption programme. Interest payments amounted to MSEK 222 (196 and 313) and interest received to MSEK 201 (234 and 249). The change in cash and cash equivalents was MSEK -697 (100 and 943). In 2005, changes in exchange rates affected cash and cash equivalents by MSEK 219 (-78 and -129) owing mainly to USD and EUR. Other financial assets totalled MSEK 2,999 at year-end (937 and 3,814).

The company believe that, based on current levels of operating performance and anti-cipated market conditions, the Group's cash flow from operations, together with other available sources of funds will be adequate to make required payments of principal and interest on the Group's debt, to permit proposed capital expenditures and to fund anticipated working capital requirements.

Working Capital

While the Group has no present plans with respect to acquisitions involving the need for additional funding through debt or equity financing, any significant future acquisition may involve such external debt or equity financing.

On January 27, 2005, the Board of Directors of SKF announced a proposal of a 5:1 share split combined with a redemption of shares. The proposal was approved at the Annual General Meeting on April 19, 2005.
 
51


In 2005, the total transfer to the shareholders amounted to MSEK 4,212 whereof MSEK 2,846 pertained to the redemption and MSEK 1,366 to paid dividends.

SKF believes that the financial position will be sufficient to further finance and develop its operations. In the Group’s opinion, its working capital is sufficient for its present requirements.

SKF issued a 100 MEUR three-year floating-rate note and a 250 MEUR five-year bond in order to finance its share redemption program.

Restricted reserves

In accordance with statutory requirements in Sweden and certain other countries in which the Group operates, the Parent Company and its subsidiaries maintain restricted reserves which are not available for distribution as dividends.

In countries where legal revaluations of assets were made, an amount corresponding to the net revaluation was transferred to restricted reserves. Restatements from Group accounts to local accounts are considered restricted reserves.

Tax laws in Sweden and certain other countries permit allocations
to reserves that are deductible for tax purposes. To a certain extent, companies can thus allocate profit so that it remains in the companies without being taxed immediately. In the Group balance sheets the cumulative value of these allocations, less the related provisions for deferred taxes, is shown under restricted reserves. These restrictions are not expected to have any impact on the Group’s ability to meet its cash obligations.

Cash and cash equivalents
Cash and cash equivalents of the Group are mainly held in Swedish kronor, Euro and USD.

Financial risk

The SKF Group’s operations are exposed to various types of financial risks. The Group’s financial policy includes guidelines and definitions of currency, interest rate, credit and liquidity risks and establishes responsibility and authority for the management of these risks. The policy states that the objective is to eliminate or minimize risk and to contribute to a better return through the active management of risks. The management of the risks and the responsibility for all treasury operations are largely centralized in SKF Treasury Centre, the Group’s internal bank.

Currency risk

The SKF Group is exposed to both transaction and translation exposure. The Group’s principal commercial flows of foreign currencies pertain to exports from Europe to North America and Asia and to flows of currencies within Europe.

SKF’s hedging policy is to hedge forecasted currency flows in USD three to twelve months.

As of year-end, the lengths of the actual forward contracts conformed to the basic policy.

52

 
In accordance with Group policy, the translation effects on the Group’s accounts are not hedged.

Interest rate risk

Liquidity and borrowing is concentrated to SKF Treasury Centre. By matching investments made by subsidiaries with borrowings of other subsidiaries, the interest rate exposure of the Group can be reduced.

Credit risk

The Group’s policy states that only well-established financial institutions are approved as counterparties. The major part of these financial institutions have signed an ISDA-agreement (International Swaps and Derivatives Association, Inc.). Transactions are made within fixed limits and exposure per counterparty is continuously monitored.

Liquidity risk

In addition to own liquidity the Group had committed credit facilities of MEUR 300 syndicated by 10 banks at December 31, 2005.
More details about risk management and hedging activities can be found in Note 29 to the consolidated financial statements.

Commitments for capital expenditures

At December 31, 2005, the Group had approximately MSEK 482 (415) in commitments for capital expenditures.
 
53

 
SKF’s Research and Development (R&D) work is fundamental to its strategy. The primary areas for SKF's basic R&D are:
 
-Tribology - how to reduce friction and wear and select lubrication

-The selection of materials (steel, ceramics, plastics, polymers, etc.)

-Manufacturing processes to obtain the required material properties for the products

-Near net shape forming processes for improved efficiency and material utilization, enabling SKF to reduce waste in manufacturing

-Intelligent machining in order to have consistent and reliable manufacturing processes to produce to the right tolerance - first piece right

-Calculation models - knowledge implemented in SKF’s unique software products which help customers quickly to select the right bearings and to predict which bearing and seal performance is expected in a specific application

-Mechatronics - the synergistic integration of mechanical engineering with electronics and intelligent computer control in the design of industrial products and processes

-Artificial Intelligence (AI) - the use of AI tools (e.g. artificial neural networks, knowledge-based systems) for knowledge generation and management in industrial systems.

Research and development expenditures in 2005, 2004 and 2003 amounted to MSEK 837 (784 and 750), corresponding to 1.7%, (1.7% and 1.8%), of annual sales.

IT development costs and costs for product customization are not included. Basic research is conducted at the Group's Engineering & Research Centre in the Netherlands and SKF’s manufacturing process development centre in Gothenburg, Sweden. SKF intends to continue to invest in product development and increased productivity. SKF regularly patents new technologies. There are no patents or licenses that are material to the company's business or profitability.

 
The market demand for SKF's products and services in the first quarter of 2006, compared to the previous quarter, is expected to remain on a high level in Europe, to be slightly higher in North America, significantly higher in Asia and to remain on a high level in Latin America. This is in addition to normal seasonality.

The manufacturing level will be unchanged for the first quarter of 2006, compared to the fourth quarter of 2005, while higher in absolute terms due to normal seasonality.

54


 
The Group does not have any off-balance sheet arrangements as defined in the rules to this Item 5.E.

 
The following table sets forth the Group's contractual obligations at December 31, 2005 by maturity.

Payments due by period (amounts in MSEK):
                     
Contractual Obligations
 
Total
 
Less than 1
 year
 
1-3
years
 
4-5 years
 
After 5 years
 
Long-Term Debt Obligations
 
4,153
 
8
 
1,777
 
2,336
 
32
 
Capital Lease Obligations
 
3
 
1
 
2
 
-
 
-
 
Operating Leases
 
1,358
 
275
 
422
 
250
 
411
 
Purchase Obligations
 
1,844
 
945
 
722
 
168
 
9
 
Other Long-Term Obligations
   
97
   
16
   
52
   
20
   
9
 
TOTAL
   
7,455
   
1,245
   
2,975
   
2,774
   
461
 
 
55

 
 
The Articles of Association of the Company provide that the Board shall consist of not fewer than five and not more than ten members (not including employee representatives), with such numbers of deputy members (not more than five) as are elected by the shareholders at the Annual General Meeting. Board members and deputy members serve until the next Annual General Meeting. Under Swedish law, employees have the right to appoint additional members and their deputies.

Directors elected by the Annual General Meeting

The names of the members of the Board, their age and title, the year in which they joined the Company's Board and their principal business activities performed outside SKF as of December 31, 2005 are set forth below.

Anders Scharp
Born 1934. Chairman. Board member since 1992.
Chairman of Saab AB, Chairman of superior board of Alecta, Chairman of AB Ph. Nederman & Co, Deputy Chairman of Investor AB.

Tom Johnstone
Born 1955. President and Chief Executive Officer.
Board member since 2003.
Board member AB Electrolux.

Sören Gyll
Born 1940. Board member since 1997.
Board member Skanska AB, SCA Svenska Cellulosa Aktiebolaget, Medicover A.A., IVA, Fenix Holding AB and Gyttorp Cartridge AB.

Vito H Baumgartner
Born 1940. Board member since 1998.
Board member Partnerre Ltd, Northern Trust Global Services Ltd. and Scania AB.

Ulla Litzén
Born 1956. Board member since 1998.
Board member Atlas Copco AB, Boliden AB, Investor AB, Karo Bio AB and Posten AB

Clas Åke Hedström
Born 1939. Board member since 2000.
Chairman of the SKF Audit Committee.
Chairman of Sandvik AB.

56


Winnie Fok
Born 1956. Board member since 2004.
CEO Investor Asia Limited, Hong Kong
Board member Global Beauty International Limited and Memorex Holdings Ltd.

Leif Östling
Born 1945. Board member since 2005.
President and CEO Scania AB since 1994.
Board member Scania AB, The Confederation of Swedish Enterprise, The Association of Swedish Engineering Industries and ISS A/S.

Employee representatives

Göran Johansson
Born 1945. Board member since 1975.
Chairman Liseberg AB.

Lennart Larsson
Born 1948. Board member since 2004.
Chairman SIF (The Swedish Union of Clerical and Technical Employees in Industry), SKF, Gothenburg.

Kennet Carlsson
Born 1962. Deputy board member since 2001.
Chairman Metalworkers' Union, SKF, Gothenburg and SKF Workers World Council, Gothenburg.

Jeanette Stenborg
Born 1967. Deputy Board member since 2005.
Board member SIF (The Swedish Union of Clerical and Technical Employees in Industry), SKF, Gothenburg.

Honorary chairman

Lennart Johansson
Honorary Chairman of the
Board of Directors of AB SKF.

Auditor

Thomas Thiel
Authorized Public Accountant
KPMG Bohlins AB
 
57


Group Management

Set forth below are the names of the members of Group Management of SKF as of December 31, 2005, their age, length of employment with SKF, the year in which they were appointed to their respective offices, their areas of experience within the Group and their principal business activities performed outside SKF. 

Tom Johnstone
Born 1955.
Employed since 1977.
President and Chief Executive Officer from April 15, 2003
Executive Vice President AB SKF from 1999 to April 15, 2003, President SKF Automotive. Division from 1996 to April 15, 2003.
Board member AB Electrolux.
Previous positions within SKF:
Marketing Manager, International Marketing SKF (U.K.), Director Vehicle Aftermarket SKF Bearing Services, Executive Director, Automotive and Electrical Sales Division, President, Automotive & Electrical Division.

Christer Gyberg
Born 1947.
Employed since 1972.
Executive Vice President AB SKF since April 15, 2003.
President SKF GmbH and Group Supply Chain, IT and Purchasing.
Previous positions within SKF:
Marketing Director SKF Maintenance Products in Holland, Marketing Director Miniature Bearings in France, Sales Director SKF Sweden, Director Product Division Large Seize Bearings in Sweden, Director Product Division Tapered Bearings in Germany and Director, Product Division Deep Groove Ball Bearings in France, President, SKF Industrial Division.
Board member: Centaur Utveckling AB.

Giuseppe Donato
Born 1944.
Employed since 1979.
President, Electrical Division since 1996.
Previous positions within SKF:
Sales Manager RFT (SKF’s rubber components company), Managing Director and General Manager, RFT, Executive Director of SKF Sealing Systems, Executive Director of HBU Bearing Division.

Tore Bertilsson
Born 1951.
Employed since 1989.
Executive Vice President since 2005.
Chief Financial Officer since 1995.
Previous positions within SKF: Group Finance Director, Group Treasury Director.
Board member: Trygg-stiftelsen Ågrenska AB and Momentum Maintenance Supply AB.

58


Phil Knights
Born 1948.
Employed since 1987.
President, Service Division since 1999.
Previous positions within SKF:
Managing Director SKF (U.K.) Services Ltd, Chief Executive, SKF South East Asia & Pacific Ltd, Sales & Marketing Director, SKF South East Asia & Pacific Ltd.
Board member: Endorsia.com International AB and CoLinx, LLC.

Sten Malmström
Born 1943.
Employed since 1973.
President, SKF USA Inc. since 1999.
Previous positions within SKF:
President SKF Reinsurance, President SKF International, Vice President and SKF Group Treasurer, Vice President Finance, SKF France, President SKF Component Systems, Senior Vice President SKF Group Business Development.
Board member: The Swedish-American Chamber of Commerce and Manufacturers Alliance/MAPI.

Kaj Thorén
Born 1944.
Employed since 1975.
President, Aero and Steel Division since 2002.
Previous positions within SKF:
Senior Vice President, Group Business Development, Group Controller, Group Treasurer and Managing Director of SKF International AB, Chief Executive of Business Area SKF Tools, Group Finance & Information Systems Director.
Board member: Tradex Converting AB, The Association of Swedish Engineering Industries, Bille Tryckeri AB and Alecta.

Lars G Malmer
Born 1943.
Employed since 1974.
Senior Vice President, Group Communication since 1986.
Previous positions within SKF: Managing Director SKF Nicaragua, Head of Corporate Communications AB SKF.
Board member: West Sweden Chamber of Commerce and Industry, International Council of Swedish Industries and Chalmers Teknikpark.

Carina Bergfelt
Born 1960.
Employed since 1990.
General Counsel AB SKF and Secretary to the Board since 1996.
Previous positions within SKF: Legal Counsel, Group Legal.
Board member: The Association of Exchange-listed Companies.

59


Tryggve Sthen
Born 1952.
Employed since 2003.
President, Automotive Division since 2003.

Tommy G Klein
Born 1947.
Employed since 2005.
Senior Vice President, Group Business Development & Six Sigma since 2005.
Board member: Endorsia.com International AB.

Henrik Lange
Born 1961.
Employed 1988-2000 and since 2003.
President, Industrial Division since 2005.
Previous positions: Senior Vice President, Group Business Development,
President, SKF Polen, President SKF Austria.
Board member: Endorsia.com International AB.

Eva Hansdotter
Born 1962.
Employed since 1987.
Senior Vice President Group Human Resources and Sustainability.
Previous positions: Department Manager, Finance & HR Systems/Application Delivery, SKF Dataservice, Group IT Strategist and HR & OD of Group IT, Director Human Resources Industrial Division AB SKF.

Management as from 1 January, 2006:

Tom Johnstone*
President and Chief Executive Officer

Tore Bertilsson*
Executive Vice President, AB SKF and Chief Financial Officer

Christer Gyberg
Executive Vice President, AB SKF, President, SKF GmbH, Schweinfurt and Group Supply Chain, IT and Purchasing

Henrik Lange*
President, Industrial Division

Phil Knights*
President, Service Division

Tryggve Sthen*
President, Automotive Division

Giuseppe Donato
Senior Vice President
 
60


Kaj Thorén
Senior Vice President

Carina Bergfelt
General Counsel

Lars G Malmer
Senior Vice President, Group Communication

Eva Hansdotter
Senior Vice President, Group Human Resources and Sustainability

Tommy G Klein
Senior Vice President, Group Business Development and Six Sigma


* member of the Group Executive
Committee

 
Principles

In January 2005 the Board of Directors of AB SKF adopted a Remuneration Policy for the Group Management. The main principles of the policy were presented at the Annual General Meeting 2005. The policy applies in all respects to members of Group Management that have been appointed after the adoption of the policy, and, in other cases, to the extent existing agreements so permit.

The objective of the policy is to attract and retain the best people in order to support the SKF mission and business strategy. The remuneration shall be market-competitive, consistent with best practice and at the same time support the shareholders' best interest.

The total remuneration package for a member of Group Management consists primarily of: fixed salary, variable salary, company car, pension and severance pay. The components should create a well-balanced remuneration reflecting individual performance and responsibility as well as SKF's overall performance.

Board of Directors

The Chairman of the Board and the Board members are remunerated in accordance with the decision taken at the Annual General Meeting. At the Annual General Meeting held in 2005 it was decided that the Board be entitled to a fixed allotment of SEK 2,350,000, SEK 700,000 to be distributed to the Chairman of the Board and SEK 275,000 to each of the other Board members elected by the Annual General Meeting and not employed by the company. It was further decided that an allotment corresponding to the value of 800 SKF B shares be received by the Chairman, and an allotment corresponding to the value of 300 SKF B shares be received by each of the other Board members elected by the Annual General Meeting and not employed by the company (the references to 800 and 300 SKF B shares are before the share split decided by the Annual General Meeting 2005). When deciding upon the amount of the allotment, the value of an SKF B share shall be determined at the average latest payment rate according to the quotations on the OMX Stockholm Stock Exchange during the five trading days after publication of the company’s press release for the financial year 2005. Finally it was decided that an allotment of SEK 300,000 for committee work shall be divided according to the decision of the Board among the Board members that are part of a committee established by the Board.

61

 
Chief Executive Officer

Tom Johnstone, Chief Executive Officer and President of AB SKF received from the company in year 2005 as salary and other remunerations a total of SEK 9 092 640, of which SEK 3,000,000 was variable salary for 2004 performance. Tom Johnstone’s fixed annual salary 2006 will amount to SEK 6,000,000. The variable salary paid out in 2005 could amount to a maximum of 60% of the fixed annual salary for year 2004 and was based on the financial performance of the SKF Group established according to the SKF management model which is a simplified economic value-added model called Total Value Added; TVA (see Board of Directors report for description). The variable salary for year 2005 will be determined based on both the short and long term financial performance of the SKF Group. Tom Johnstone’s retirement age is 60 years. Tom Johnstone is entitled to a lifelong benefit-based pension amounting to 37% of SEK 3,001,356 corresponding to SEK 1,110,502 per year. The amount SEK 3,001,356 shall be adjusted in accordance with the Income Base amount (defined in accordance with Chapter 1 § 6 of the law (1998:674) on income based retirement pension). The benefit-based pension is gradually earned according to the principles generally applied within the company. The pension is thereafter not conditioned upon future employment. In addition thereto AB SKF shall pay a yearly premium corresponding to 30% of the difference between Tom Johnstone’s fixed annual salary and the amount on which Tom Johnstone’s benefit-based pension is calculated as described above. This part of Tom Johnstone’s pension benefit is fee based and vested. The cost for Tom Johnstone’s pension benefits was recorded in the amount of SEK 1,908,919. The remuneration to the Chief Executive Officer did not include any stock option entitlements. Tom Johnstone holds from earlier allocations according to the AB SKF Stock Option Programme described below stock options allowing him to acquire 110,969 existing SKF B shares (the increase of the number of shares Tom Johnstone may acquire compared to the number specified in the Annual Report 2004 is a result of the share split decided by the Annual General Meeting 2005). In the event of termination at the request of AB SKF, Tom Johnstone will receive severance payments amounting to maximum two years’ salary.

Group Management

SKF’s Group Management (exclusive of the Chief Executive Officer), at the end of the year, 12 people, received in 2005 salary and other remunerations amounting to a total of SEK 56,500,897, of which SEK 36,555,425 was fixed annual salary and SEK 14,824,743 was variable salary for 2004 performance (in relation to managers that have joined or left Group Management during the year, the fixed salary amounts are stated prorated to the period that each individual has been a member of Group Management). The variable salary parts could amount to a maximum percentage of the fixed annual salary and are determined primarily based on the financial performance of the SKF Group established according to the SKF management model TVA. The variable salary for year 2005 will be determined based on both the short and long term financial performance of the SKF Group. The remuneration to Group Management did not include any stock option entitlements. Group Management holds from earlier allocations according to the AB SKF Stock Option Programme stock options allowing them to acquire 349 875 existing SKF B shares (the increase of the number of shares Group Management may acquire compared to the number specified in the Annual Report 2004 is a result of the share split decided by the Annual General Meeting 2005). In the event of termination of employment at the request of AB SKF of a person in Group Management, that person will receive a severance payment amounting to a maximum of two years’ salary.
 
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The SKF Group’s Swedish defined-benefit pension plan for senior managers has a normal retirement age of 62 years. The Chief Executive Officer is not covered by this pension plan. The plan entitles the senior managers covered to receive an additional pension over and above the ordinary ITP-plan. This additional pension amounts to a yearly compensation from the retirement age of up to 32.5% of the pensionable salary above 20 basic amounts, provided the senior manager has been employed by the SKF Group for at least 30 years. The pension benefit is thereafter not conditioned upon future employment.

During 2003 the Board decided to introduce a premium based Swedish supplementary pension plan for senior managers of the Swedish companies within the SKF Group. The normal retirement age is 62 years. The Chief Executive Officer is not covered by this pension plan. The plan covers, at the end of 2005, five senior managers and entitles them to an additional pension over and above the pension covered by the ITP-plan. The senior managers in question are not covered by the defined-benefit pension plan described in the previous paragraph. The company pays for the senior managers covered by the premium based plan contributions based on each individual’s pensionable salary (i.e. the fixed monthly salary excluding holiday pay, converted to yearly salary) exceeding 30 Income Base amounts. This pension is fee-based and vested.

For additional pension benefits to SKF’s Group Management, over and above the pensions covered by the ITP-plan and other ordinary pension plans applied in relation to certain member’s not resident in Sweden, a provision was recorded in the amount of MSEK 54 as at December 31, 2005. The cost for these additional pension benefits in year 2005 amounted to MSEK 17.
 
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Activities of the Board of Directors of AB SKF in 2005:

The Annual General Meeting of AB SKF, held in the spring of 2005, elected eight Board members. In addition hereto, two members and two deputy members have been appointed by the employees. The Board held seven meetings in 2005. The Board adopted written rules of procedure for its internal work. These rules prescribe, inter alia:

• the number of Board meetings and when they are to be held;
• the items normally included in the Board agenda;
• the presentation to the Board of reports from the external auditors.

The Board also issued written instructions as to:

• when and how information required for the Board’s assessment of the Company’s and the Group’s financial position shall be collected and reported to the Board;
• the allocation of the tasks between the Board and the President;
• the order in which the deputy Presidents shall act in the President’s absence.

Remuneration Committee

The Board has established a Remuneration Committee consisting of the Chairman of the Board, Anders Scharp, and the Board members, Sören Gyll and Vito H Baumgartner. The Remuneration Committee prepares matters related to the principles for the remuneration, including incentive programmes and pension benefits, of the Group Management. All decisions related to such principles during 2005 were decided upon by the Board of Directors. Matters related to the CEO’s employment conditions, remuneration and other benefits were in 2005 prepared by the Remuneration Committee and decided upon by the Board of Directors. The Remuneration Committee held three meetings in 2005.

Audit Committee

The Audit Committee consists of Clas Åke Hedström as Chairman and the Board members Anders Scharp, Ulla Litzén and Winnie Fok. The tasks of the Audit Committee include preparations in relation to the nomination of external auditors, a review of the scope of the external audit, an evaluation of the performance of the external auditors, a review of financial information and a review of internal financial controls. The Audit Committee held four meetings in 2005.

Board issues

Issues dealt with by the Board during the year include market outlook, financial reporting, acquisitions and divestments of companies, the strategic direction and business plan of the SKF Group and management issues. The Board members assess the quality of the work of the Board through the completion of a questionnaire. The result is thereafter discussed at a Board meeting.

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Nomination of Board members

At the Annual General Meeting of AB SKF held in the spring 2005 it was resolved that the Company shall have a Nomination Committee formed by one representative of each of the four major shareholders with regard to the number of votes held as well as the Chairman of the Board. When constituting the Nomination Committee, the shareholdings in September 2005 would determine which shareholders are the largest with regard to the number of votes held. The names of the representatives of the four largest shareholders were announced in October 2005.

The Nomination Committee is to furnish proposals in the following matters to be presented to, and resolved by, the Annual General Meeting in 2006:
- proposal for Chairman of the Annual General Meeting
- proposal for Board of Directors
- proposal for Chairman of the Board of Directors
- proposal for fee for the Board of Directors
- proposal for fee for the auditors
- proposal for a Nomination Committee facing the Annual General Meeting of 2007

The proposals of the Nomination Committee were published in connection with the notice to the Annual General Meeting 2006.

Executive Committee

The Executive Committee comprises, besides the Chief Executive Officer, the president of each division and the Chief Financial Officer. The Executive Committee comprised in the end of 2005 the following seven members: Tom Johnstone, President and Chief Executive Officer; Tryggve Sthen, President Automotive Division; Henrik Lange, President Industrial Division ; Giuseppe Donato, President Electrical Division; Phil Knights, President Service Division; Kaj Thorén, President Aero and Steel Division and Tore Bertilsson, Chief Financial Officer.
 
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On December 31, 2005, the Group had 38,748 registered employees (39,867 and 38,700).

Temporary employees, if on the payroll of an SKF company, are included in the number of employees presented by the Group but are not significant in number. Temporary employees on subcontract from a temporary services firm are not included in the figures. Previously published amounts have been reclassified to conform to the 2005 current Group structure.

Geographic specification of average number of employees in subsidiaries abroad:
Year ended December 31:

               
   
2005
 
2004
 
2003
 
               
Sweden (1)
 
2,932
 
4,686
 
4,673
 
France
 
3,390
 
3,678
 
3,813
 
Italy
   
4,506
   
4,573
   
4,614
 
Germany
   
5,898
   
5,985
   
5,430
 
Other Western Europe excluding Sweden
   
3,338
   
3,336
   
3,334
 
Central/Eastern Europe
   
3,278
   
3,220
   
3,201
 
USA
   
4,451
   
4,708
   
4,725
 
Canada
   
193
   
188
   
190
 
Latin America
   
1,933
   
1,833
   
1,642
 
Asia
   
6,901
   
5,658
   
5,342
 
Middle East and Africa
   
634
   
637
   
668
 
     
37,454
   
38,502
   
37,632
 

(1) The reduction of employees in Sweden compared to 2004 and 2003 is due to the Ovako Steel transaction.
The transaction is reflected in Note 11 to the consolidated financial statements.
 
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Registered number of employees by division
Year ended December 31

               
   
2005
 
2004
 
2003
 
                     
Industrial Division
   
12,530
   
11,609
   
10,649
 
Service Division
   
4,804
   
4,617
   
4,469
 
Automotive Division Division
   
9,506
   
9,762
   
9,608
 
Electrical Division
   
7,648
   
7,517
   
7,615
 
Aero and Steel Division
   
2,839
   
4,993
   
4,978
 
Others
   
1,421
   
1,369
   
1,381
 
Total
   
38,748
   
39,867
   
38,700
 

Most of the Group's employees are unionized. Although the Group has occasionally experienced localized labor difficulties that may have had a temporary effect on particular operations, no major strike or other significant industrial action has occurred in the last ten years. The Group considers its relationship with its employees to be good.
 
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In the tables below the individual share ownership in SKF by the Directors and Group Management is summarized. None of these people own more than 1% of the shares of the Group. The Group Management table also discloses the remaining number of shares over which members of Group Management hold stock options to buy SKF B shares.

As of December 31, 2005, ownership of shares is as follows:
 
           
Directors at year end 2005
(excluding CEO)
 
Shares
 
Class
 
Anders Sharp
   
100,000
   
B
 
Sören Gyll
   
8,000
   
B
 
Vito H Baumgartner
   
2,400
   
B
 
Clas Åke Hedström
   
4,100
   
B
 
Ulla Litzén
   
28,400
   
B
 
Winnie Fok
   
2,000
   
A
 
Leif Östling
   
0
   
-
 
Göran Johansson
   
400
   
B
 
Lennart Larsson
   
0
   
-
 
Kenneth Carlsson
   
0
   
-
 
Jeanette Stenborg
   
0
   
-
 
Total (excluding CEO Tom Johnstone's shares, 15,068)
   
145,300
       
 
 

               
Group Management at
year end 2005
 
 
A Shares
 
 
B Shares
 
Remaining number of B Shares possible to acquire under stock options granted in year
 
           
2001
 
2002
 
2003
 
Tom Johnstone
 
0
 
15,068
 
26,128
 
41,295
 
43,546
 
Tryggve Sthen
 
0
 
0
 
0
 
0
 
0
 
Henrik Lange
 
0
 
0
 
0
 
0
 
0
 
Christer Gyberg
 
0
 
28,000
 
0
 
0
 
0
 
Giuseppe Donato
 
0
 
0
 
0
 
0
 
0
 
Tore Bertilsson
 
4,000
 
4,000
 
0
 
41,295
 
43,546
 
Phil Knights
   
0
   
8,400
   
0
   
41,295
   
43,546
 
Sten Malmström
   
4,108
   
2,000
   
0
   
0
   
0
 
Kaj Thorén
   
0
   
20,204
   
8,710
   
16,517
   
43,546
 
Lars G Malmer
   
4,800
   
5,468
   
17,419
   
16,517
   
17,419
 
Carina Bergfelt
   
0
   
0
   
17,419
   
16,517
   
17,419
 
Eva Hansdotter
   
0
   
0
   
0
   
0
   
8,710
 
Tommy G Klein
   
680
   
0
   
0
   
0