Notes to the consolidated financial statements

Sulzer Ltd (the “companyˮ) is a company domiciled in Switzerland. The address of the company’s registered office is Neuwiesenstrasse 15 in Winterthur, Switzerland. The unaudited consolidated interim financial statements for the six months ended June 30, 2019, comprise the company and its subsidiaries (together referred to as the “groupˮ and individually as the “subsidiariesˮ) and the group’s interest in associates and joint ventures. The group specializes in pumping solutions, service solutions for rotating equipment, separation and mixing, and applicator technology. Sulzer was founded in 1834 in Winterthur, Switzerland, and employs around 16’300 people. The company serves clients in over 180 production and service sites around the world. Sulzer Ltd is listed on the SIX Swiss Exchange in Zurich, Switzerland (symbol: SUN).

The interim financial statements have been prepared in accordance with the requirements of IAS 34 “Interim financial reportingˮ. This is the first set of consolidated financial statements where IFRS 16 “Leasesˮ has been applied. Details and changes of the group’s accounting policies are described in note 13.

The financial position and performance of the group was particularly affected by the following events and transactions during the reporting period:

For a detailed discussion about the group’s performance and financial position please refer to the Business review.

Segment information by divisions

Segment information by divisions

Information about reportable segments

Operating segments are determined based on the reports reviewed by the Chief Executive Officer that are used to measure performance, make strategic decisions and allocate resources to the segments. The business is managed on a divisional basis and the reported segments have been identified as follows:

Pumps Equipment — Pump technology and solutions

This division provides a wide range of pumping solutions, compressors and mixers, including spare parts and service. The focus is on:

Rotating Equipment Services — Service solutions for rotating equipment

This division offers technology-based service solutions for complex rotating equipment maintenance, including gas and steam turbines, pumps, compressors, motors, generators and other adjacent equipment – be it Sulzer or third-party equipment. The focus is on:

Chemtech — Separation and mixing technology and associated services

This division offers separation and mixing technology, process solutions and field services for the oil and gas, hydrocarbon and chemical processing industries. The focus is on:

Applicator Systems — Systems for liquid applications

The division offers products and services for liquid application and mixing technology. The focus is on:

Others

Certain expenses related to the Corporate Center are not attributable to a particular segment and are reviewed as a whole across the group. Also included are the eliminations for operating assets and liabilities.

The Chief Executive Officer primarily uses a measure of adjusted earnings before interest, tax and amortization (operational EBITA) to assess the performance of the operating segments. However, the Chief Executive Officer also receives information about the segments’ order intake and backlog, revenue, and operating assets and liabilities on a monthly basis.

Operational EBITA (opEBITA) excludes amortization, restructuring expenses and impairments when the impairment is the result of an isolated, non-recurring event. It also excludes certain non-operational items that are non-recurring or do not regularly occur in similar magnitude such as acquisition-related expenses, gains and losses from sale of businesses or real estate, expenses related to the Sulzer Full Potential program, or amendments to the pension plans.

Sales from external customers reported to the Chief Executive Officer is measured in a manner consistent with that in the income statement. There are no significant sales between the segments. No individual customer represents a significant portion of the group’s revenue.

Operating assets and liabilities are assets or liabilities related to the operating activities of an entity and contributing to the operating income.

Segment information by region

The allocation of sales from external customers is based on the location of the customer.

Sales by region

Segment information by market segment

The following tables show the allocation of sales from external customers by market segments:

Sales by market segment

Acquisitions in 2019

The following table summarizes the recognized amounts of assets acquired and liabilities assumed at the date of acquisition, including the resulting goodwill and the total consideration paid. If new information obtained within one year of the date of acquisition about facts and circumstances that existed at the date of acquisition identifies adjustments to the amounts recognized below, then the accounting for the acquisition will be revised. 

Net assets acquired

GTC Technology US, LLC

On April 30, 2019, Sulzer acquired a 100% controlling interest of GTC Technology US, LLC (“GTCˮ) for CHF 43.2 million, of which CHF 39.9 million was paid in cash and CHF 3.3 million arose from a contingent consideration agreement. The headquarters of GTC are located in Houston, Texas, USA. GTC employs 200 people and is a technology company offering proprietary processes and systems for the production of aromatics and other petrochemicals. This acquisition strengthens Sulzer Chemtech’s leadership in petrochemical processes and expands its revenue base to process licensing and associated proprietary equipment and chemicals. The goodwill is attributable to synergies by leveraging cross-selling opportunities. None of the goodwill is expected to be deductible for tax purposes. Transaction costs recognized in the income statement amount to CHF 0.2 million. Since the acquisition date, GTC contributed order intake of CHF 7.8 million, sales of CHF 3.8 million and net income of CHF 0.0 million to the group.

Contingent consideration

The contingent consideration is dependent on patents, technology and licensing, as well as order intake from the company’s product portfolio. The total liability is limited at CHF 3.3 million. The calculation of the contingent consideration is based on management assessments that the criteria will be achieved at a probability of 100%.

Acquired receivables

The fair value of acquired trade accounts receivable is CHF 9.8 million. The gross contractual amount for trade account receivables due is CHF 12.1 million, of which CHF 2.3 million is expected to be uncollectible at the date of acquisition.

Pro forma sales and profit contribution

Had the acquisition above occurred on January 1, 2019, management estimates that total net sales of the group would amount to CHF 1’790.9 million, and the consolidated net income would be CHF 67.5 million.

Cash flow from acquisitions of subsidiaries

Contingent consideration

The following tables present the carrying amounts and fair values of financial assets and liabilities as of June 30, 2019, and December 31, 2018, including their levels in the fair value hierarchy. For financial assets and financial liabilities not measured at fair value in the balance sheet, fair value information is not provided if the carrying amount is a reasonable approximation of fair value.

Fair values are categorized into three different levels in a fair value hierarchy based on the inputs used in the valuation techniques as follows:

The fair value of financial instruments traded in active markets, including the outstanding bonds, is based on quoted market prices at the balance sheet date. Such instruments are included in level 1.

The fair values included in level 2 are based on valuation techniques using observable market input data. This may include discounted cash flow analysis, option pricing models or reference to other instruments that are substantially the same, while always making maximum use of market inputs and relying as little as possible on entity-specific inputs. The fair values of forward contracts are measured based on broker quotes for foreign exchange rates and interest rates.

Fair values measured using unobservable inputs are categorized within level 3 of the fair value hierarchy. This applies particularly to contingent considerations in business combinations.

Contingent considerations are linked to the fulfillment of certain parameters, mainly related to earn-out clauses and technology transfer. For more information please refer to note 4.

Fair value table

Fair value table

During 2019, the group reassessed the achievement of the earn-out targets related to contingent consideration arrangements. The reassessment did not result in a change of contingent considerations (half year 2018: income of CHF 1.4 million).

Other operating income includes income from litigation cases, government grants and incentives, and recharges to third parties not qualifying as sales from customers.

Sulzer has continued to adapt its global manufacturing footprint and streamline the organizational setup. For the half year 2019, the group recognized restructuring costs of CHF 16.2 million (half year 2018: CHF 5.9 million). Restructuring costs are mainly associated with measures in Germany. The group further performed impairment tests on the related production machines and facilities leading to impairments of CHF 0.5 million (half year 2018: CHF 0.7 million).

The functional allocation of the total restructuring expenses and impairments is as follows: cost of goods sold CHF –12.0 million (half year 2018: CHF –1.2 million), selling and distribution expenses CHF 0.0 million (half year 2018: CHF –0.1 million), general and administrative expenses CHF –4.8 million (half year 2018: CHF –5.1 million) and research and development expenses CHF 0.0 million (half year 2018: CHF –0.2 million).

“Interest expensesˮ increased from CHF 7.8 million in the first half year 2018 to CHF 10.0 million for the same period 2019. This is mainly due to the interest expenses on bonds issued in the second half of 2018 and interest expenses on lease liabilities resulting from the first time application of IFRS 16 “Leases”.

Comparing the first half of 2019 with the same period of 2018, total financial expenses increased from CHF –4.9 million to CHF –12.0 million because of negative currency effects on financial instruments and the first time application of IFRS 16 “Leases”.

Income tax expenses comprise current and deferred tax. Income tax expenses are recognized based on the estimated income tax rate for the full financial year. The estimated average annual tax rate used for the year 2019 is 22.8%, compared with 22.9% for the six months ended June 30, 2018.

The share capital amounts to CHF 342’623.70, made up of 34’262’370 shares with dividend entitlement and a par value of CHF 0.01. All shares are fully paid in and registered.

Treasury shares

The total number of shares held by Sulzer Ltd as of June 30, 2019, amounted to 205’999 treasury shares (December 31, 2018: 311’871 shares).

The treasury shares are mainly held for the purpose of issuing shares under the management share-based payment programs.

Dividends

On April 3, 2019, the Annual General Meeting approved an ordinary dividend of CHF 3.50 (2018: ordinary dividend of CHF 3.50) per share to be paid out of reserves. The dividend was paid to shareholders on April 9, 2019. The total amount of the dividend is CHF 119.2 million (2018: CHF 119.1 million), thereof paid dividends of CHF 77.5 million (2018: CHF 43.1 million) and unpaid dividends of CHF 41.7 million (2018: CHF 76.0 million). The unpaid dividends are reflected in the balance sheet position “other current and accrued liabilitiesˮ (see note 12).

The borrowings have been adjusted as of January 1, 2019, due to the first time application of IFRS 16 “Leasesˮ. Further details are provided in note 13.

As of June 30, 2019, and December 31, 2018, the syndicated facility was not used.

Outstanding bonds

As of June 30, 2019, the group has six outstanding bonds all traded at the SIX Swiss Exchange.

The category “Other employee benefitsˮ includes provisions for jubilee gifts, early retirement of senior managers and other obligations to employees. The additions and utilizations in “Other employee benefitsˮ provision are mainly related to medical insurances of employees of the US entities.

The category “Warranties/liabilitiesˮ includes provisions for warranties, customer claims, penalties, litigation and legal cases relating to goods delivered or services rendered.

Sulzer has continued to adapt its global manufacturing footprint and streamline the organizational setup. In the first half of 2019, restructuring expenses were mainly associated with measures taken in Germany. The group recognized restructuring provisions of CHF 16.7 million. The remaining provision as of June 30, 2019, is CHF 19.8 million, of which CHF 16.6 million is expected to be utilized within one year.

“Environmentalˮ mainly consists of expected costs related to inherited liabilities.

“Otherˮ includes provisions that do not fit into the aforementioned categories. A large number of these provisions refer to indemnities, in particular related from divestitures. In addition, provisions for ongoing asbestos lawsuits and other legal claims are included. Based on the currently known facts, Sulzer is of the opinion that the resolution of the open cases will have no material effects on its liquidity or financial condition. Although Sulzer expects a large part of the category “Otherˮ to be realized in one year, by their nature the amounts and timing of any cash outflows are difficult to predict.

13.1 Basis of preparation

The interim financial statements have been prepared in accordance with the requirements of IAS 34 Interim Financial Reporting. The accounting policies applied are consistent with those applied in the consolidated financial statements for the year 2018 and corresponding interim reporting period, except for the adoption of new and amended standards as set out below.

These interim financial statements do not include all the notes of the type normally included in an annual financial report. Accordingly, these financial statements are to be read in conjunction with the financial statements for the year ended December 31, 2018, and any public announcements made by Sulzer during the interim reporting period.

13.2 Change in accounting policies

a) Standards, amendments and interpretations which are effective for 2019

IFRS 16 “Leasesˮ

The group has initially adopted IFRS 16 “Leasesˮ as of January 1, 2019.

IFRS 16 introduced a single, on-balance-sheet accounting model for lessees. As a result, the group has recognized lease assets representing its rights to use the underlying assets and lease liabilities representing its obligation to make lease payments.

The group does not act as a lessor.

The group has applied IFRS 16 using the modified retrospective approach. Accordingly, the comparative information presented for 2018 has not been restated. The changes of the accounting policies are disclosed below. 

Definition of a lease

Previously the group determined at contract inception whether an arrangement was or contained a lease under IFRIC 4 “Determining whether an arrangement contains a leaseˮ. The group now assesses whether a contract is or contains a lease based on the new definition of a lease. Under IFRS 16, a contract is, or contains, a lease if the contract conveys a right to control the use of an identified asset for a period in exchange for consideration.

Accounting policies for leases

The group leases many assets, including properties, production equipment and other non-current assets. 

The group previously classified leases as operating or finance leases based on its assessment of whether the lease transferred substantially all of the risk and rewards of ownership. Under IFRS 16, the group recognizes lease assets and lease liabilities for most leases (these leases are on-balance-sheet). 

However, the group has elected not to recognize lease assets and lease liabilities for some leases of low value assets and short-term leases. The group recognizes the lease payments associated with these leases as an expense on a straight-line basis over the lease term.

The group presents lease assets and lease liabilities as separate line items in the balance sheet.

The group recognizes lease assets and lease liabilities at the lease commencement date. The asset is initially measured at cost and subsequently at cost less any accumulated depreciation and impairment losses and adjusted for certain remeasurements. The lease liability is initially measured at the present value of the lease payments that are not paid on commencement date, discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, the group’s incremental borrowing rate. In most cases, the group uses its incremental borrowing rate as the discount rate.

The lease liability is subsequently increased by the interest cost on the lease liability and decreased by lease payments made. It is remeasured when there is a change in future lease payments arising from a change in an index rate, a change in the estimate of the amount expected to be payable under a residual value guarantee, changes in the assessment of whether a purchase or extension option is reasonably certain to be exercised or a termination option is reasonably certain not to be exercised.

Significant accounting estimates

The group has applied judgment to determine the lease term for lease contracts that include renewal options. The assessment of whether the group is reasonably certain to exercise such options impacts the lease term, which significantly affects the amount of lease liabilities and lease assets recognized.

Transition

For finance leases, the carrying amount of the lease assets and the lease liability at January 1, 2019, were determined at the carrying amount of the lease assets and lease liability under IAS 17 immediately before that date.

For operating leases, lease liabilities were measured at the present value of the remaining lease payments, discounted at the group’s incremental borrowing rate as of January 1, 2019. Lease assets were measured at the amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments.

Impacts on transition

The following table summarizes the impact of IFRS 16 on the consolidated balance sheet as of January 1, 2019.

Consolidated balance sheet

When measuring lease liabilities that were classified as operating leases, the group discounted lease payments using its incremental borrowing rate at January 1, 2019. The weighted-average rate applied is 2.3%.

Impacts for the period

Consolidated balance sheet

As a result of initially applying IFRS 16, the group recognized CHF 99.8 million of lease assets and CHF 98.5 million of lease liabilities as of June 30, 2019, previously classified as operating leases.

Consolidated income statement

As a result of initially applying IFRS 16, the group has recognized depreciation and interest expenses, instead of operating lease expenses, related to leases under IFRS 16. During the six months ended on June 30, 2019, the group recognized CHF 15.6 million of depreciation charges and CHF 1.5 million of interest expenses. Due to the recognition of the depreciation and interest expenses compared to the operating lease expenses, the application of IFRS 16 had a positive impact of CHF 1.3 million on the group’s net income.

Consolidated statement of cash flows