Report of the Foundation Administratiekantoor ERIKS 92. Declarations of independence 93. Ten year record 94

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2 Contents Page Profile 4 Organization chart as of January 1, Key data ERIKS, an innovative distributor 10 ERIKS stocks 11 Corporate governance 15 Information on the organization and market position 18 Mission, objectives, SWOT analysis and strategy 20 Risks and risk management 25 Directors 30 Report of the Supervisory Board 32 Report of the Executive Board 34 Developments per cluster 54 Financial statements 66 Accounting policies 66 Consolidated statement of income 69 Consolidated balance sheet 70 Consolidated statement of movements in stockholders equity 71 Consolidated cash flow statement 72 Notes to the consolidated accounts 73 Corporate statement of income 84 Corporate balance sheet 84 Notes to the corporate accounts 85 Other information 90 Auditors report 90 Foundation ERIKS Group 90 Articles of Incorporation provisions concerning profit appropriation 90 Profit appropriation and proposed dividend for Events after balance sheet date 91 Report of the Foundation Administratiekantoor ERIKS 92 Declarations of independence 93 Ten year record 94 Clusters / group companies / International Product Managers (IPMs) 96 1

3 Sealing Technology

4 Profile Organization chart as of January 1, 2004 Key data 2003

5 Profile ERIKS group nv is the Dutch holding company of a group of technical trading companies, and has been listed on the Official Market of the Euronext Amsterdam stock exchange (Euronext N.V.) since Sales of EUR million were realized in 2003, with an average workforce of 1,942. The net result for 2003 was EUR 12.0 million. The ERIKS group is an innovative distributor, which performs the dual role of specialist and supplier. Offering added value through a wide and in-depth product range, know-how, processing facilities and logistics services, as well as maintaining close proximity to our customers, is our central concern in all our activities. The group's activities consist of the purchasing, storage, processing, sale and distribution of an extensive range of high-quality mechanical engineering components. We supply all branches of industry with highly developed technical and logistics services, as well as product and application know-how. The group supplies more than 50,000 industrial customers (business to business), boasts a range of more than 500,000 items and acquires its products from a large number of qualified suppliers/manufacturers. The ERIKS group currently consists of almost fifty group companies, with operations in eight countries. Western Europe forms the geographical focus of the group s activities (the Netherlands, Belgium, Luxembourg, Germany and France.) It also has operations in the United States and South-east Asia (Singapore and Malaysia). The aim of the ERIKS group is to establish a leading market position in Western and Central Europe and to become a truly "European player", while maintaining a presence, directly or indirectly, in the United States and South-east Asia, insofar as this contributes to its position in Europe. Our current range is divided into six core activities and their associated product groups: Sealing Technology - dynamic sealing elements - O-rings and rubber technology - flange gaskets Power Transmissions - hydraulics - pneumatics - mechanical power transmissions - bearings - electrical power transmissions Flow Technology - valves and instrumentation - plastic piping - hoses and accessories Tools and Maintenance Products Industrial Plastics Technical and Logistics Services (Always related to the above product groups) PARTS ARE JUST PART OF OUR SERVICE 4

6 Organization chart as of January 1, 2004 ERIKS group nv Executive Board MIS and organization Treasury and taxes Human Resources ICT Investor Relations International Product Management ERIKS Netherlands ERIKS Belgium ERIKS Germany ERIKS France ERIKS USA ERIKS South-east Asia Sales (EUR millions) As % of total sales Average number of employees An average workforce of 15 staff was employed at ERIKS group nv in

7 Key data 2003* In EUR thousands Statement of income Net sales 381, , ,583 Percentage change Operating result (incl. amortization of goodwill) 21,984 19,255 21,321 Operating result before amortization of goodwill (EBITA) 24,501 21,345 22,631 Percentage change Result from ordinary activities after taxes and before amortization of goodwill 14,577 12,832 14,672 Percentage change Result from ordinary activities after taxes 12,060 10,742 13,362 Percentage change Extraordinary result after taxes Net result 11,984 10,706 17,750 Cash flow Depreciation 5,191 5,473 5,095 Cash flow from ordinary activities 19,692 18,269 19,753 Cash flow from operational activities 23,822 21,208 28,058 Cash flow from investing activities -21,498-23,809-20,520 Cash flow from financing activities 6,694-2,661-8,672 Cash flow on balance 9,018-5,262-1,134 Balance sheet Working capital 1) 89,836 90,697 85,065 Stockholders equity (before profit appropriation) 91,760 83,249 76,949 Total capital 2) 153, , ,492 Net capital invested 3) 107, ,574 95,635 Ratios EBITA as a percentage of sales EBITA as a percentage of average net capital invested Interest coverage ratio Net result as a percentage of stockholders' equity (before profit appropriation) For dividend wholly in cash: - group equity -/- intangible fixed assets / total capital (solvency ratio) 35% 34% 38% For dividend wholly in stocks: - group equity -/- intangible fixed assets / total equity (solvency ratio) 39% 38% 43% Other key data Salaries, social security and pension charges 88,407 82,751 72,792 Average number of employees 1,942 1,879 1,694 Average salary costs per employee *See also 10-year record on pages 94 and 95. The balance sheet before profit appropriation was taken as a basis. 1) Working capital = inventories + accounts receivable trade -/- suppliers. 2) Total capital = balance sheet total -/- intangible fixed assets -/- liquid resources. 3) Net capital invested = balance sheet total -/- intangible fixed assets -/- financial fixed assets -/- liquid resources -/- suppliers -/- other short-term liabilities. 6

8 Net sales Operating result (EBITA) Result from ordinary activities after taxes and before amortization of goodwill Cash flow from ordinary activities EBITA as a percentage of average net capital invested Average number of employees 7

9 Power Transmissions

10 ERIKS, an innovative distributor ERIKS stocks Corporate governance

11 ERIKS, an innovative distributor For three years in succession, we have witnessed a decline in industrial activity in Western Europe and the United States, causing the whole market for mechanical engineering components in these regions to contract. In this environment, many manufacturers and distributors have suffered heavy annual percentage falls in sales and profits. The ERIKS group has not fallen prey to this general state of affairs, and has improved both the level of its sales, and its profitability. Our strategy, which is based on entrepreneurship, broadening our market, expanding our services and improving productivity, is paying dividends. In financial terms, this has resulted in a tenth successive year of sales growth (up 6.6 percent on 2002) and an increase in profitability in terms of both operating result (EBITA: percent) and as a percentage of average net capital invested (2003: 23.7 percent). The autonomous growth in sales was 1.2 percent, which is considerably better than the market average. Thus we also strengthened our market position. It is now down to us to continue in this positive vein. In today s uncertain market, this is no easy task: on the contrary, it will be a real challenge. Over the next few years we will continue to pursue our strategy, which is explained in detail elsewhere in this report, in what remains a fragmented market. Our objective is, and will remain, to strengthen and expand our market positions, so that we can be a strong European player in our field. The ERIKS group presents itself as a distribution company driven by know-how and added value, which occupies an important and indispensable position in the industrial column between manufacturers and customers. Our customers needs are the guiding force behind the way we run our business. The resulting marketing mix is constantly adapted to reflect the changing needs of our customers different buying profiles. This approach to the market calls for our employees to be pro-active and flexible in their attitude, and willing to cooperate with colleagues both within and outside their own company. This explains our preoccupation with internal communication about the objectives and strategy of the ERIKS group. We can attest to a strong and thriving group spirit among our employees, and to the wide support throughout the organization for the ERIKS group s chosen course. This attitude enables us - to expand our product range and the associated technical and logistics services - to fulfill the role of "specialist" and "total supplier" - to achieve forward integration, by expanding our local presence - to improve the effectiveness of primary operational processes at the various companies. Our innovative strength enables us to improve our market positions and maintain the profitability of our business at a reasonable level. We would like to express to our employees our appreciation for their efforts and we have every faith in the future of the ERIKS group. Although there are signs that the level of industrial output is no longer declining, and is in fact beginning to pick up a little in some sectors, it would be premature to assume that total industrial output will improve in This means we cannot make any concrete predictions for 2004 as a whole. Nevertheless, we are confident that the ERIKS group will profit to the full from the revival of industrial activity when it occurs. The Executive Board of ERIKS group nv H. Kreuger, Chairman 10

12 ERIKS stocks The depositary receipts for stocks of ERIKS group nv are quoted on Euronext N.V. in Amsterdam. The par value of 1 common stock (depositary receipt) is EUR 1.=. The bearer depositary receipts for common stocks are embodied in a global bearer depositary receipt held by Necigef. ERIKS group nv is listed in the NextPrime segment of Euronext N.V. At the end of 2003, the average number of stocks issued was 3,751,743, an increase of 122,456 compared with the end of The results and cash flow per stock are calculated on the basis of the average number of stocks issued. This average has risen from 3,581,334 for 2002, to 3,700,720 for 2003, which equates to 119,386 or 3.33 percent. Starting from 2002, stockholders will be given the option of electing to receive a stock dividend when the dividend is paid out. Of the 3,751,743 stocks subscribed and issued as of the end of the year under review, 3,727,871, or 99.4 percent, can be traded as depositary receipts via the Foundation Administratiekantoor ERIKS. The company has not paid out or issued any stock options. The members of the Executive Board and Supervisory Board hold a total of 7,614 depositary receipts for stocks as at the end of Dividend policy and dividend 2003 It is our policy to pay out a dividend of approximately 50 percent of the result from ordinary activities, circumstances permitting. The profit appropriation and dividend proposal for 2003 can be found on page 91 of this report. We propose to set a dividend of EUR 1.60 per stock of EUR 1.= for 2003, giving a payout percentage of 50.1 percent. Stockholders may elect to receive the dividend in cash or in stocks, charged to the reserves. The value of the proposed stock dividend will be 2 to 4 percent higher than that of the cash dividend. The stock dividend will be declared one day after the option period ends, based on the average price of the stock during the last five trading days of this option period. To support the financing of the planned growth (see chapter on "Mission, objectives SWOT analysis and strategy"), the company calls on stockholders to opt to receive a pay out in stocks, i.e. a stock dividend, charged to the reserves. During the year under review, as regards the dividend for the year 2002, 44.3 percent was paid out in cash and 55.7 percent in the form of a stock dividend. The value of the stock dividend was 3.27 percent higher than that of the cash dividend. Overview of movements in the stock (x 1,000 units) Subscribed at start of year 3,629 3,514 3,514 3,514 3,514 Stock dividend Subscribed at year-end 3,752 3,629 3,514 3,514 3,514 Average subscribed 3,701 3,581 3,514 3,514 3,514 11

13 Key data per stock (of EUR 1.= par value) x EUR 1.= Net result Net result before amortization of goodwill Result from ordinary activities Cash flow from ordinary activities Dividend Pay-out as a percentage of result from ordinary activities Stockholders' equity (2001 to 2003 incl. before profit appropriation) Stock exchange quotation at year-end Highest quotation Lowest quotation Market value at year-end (x EUR millions) Movements in ERIKS stock versus AEX index 140 (Index 01/01/1999 = 100) AEX ERIKS stock

14 Investor Relations The ERIKS group attaches great importance to good communication with financial and other interested parties, such as investors, financiers and analysts, with a view to providing a good insight into the group's position in the ever-changing market. Information that is liable to influence the stock price is always released in general reports. Strategy, financial results and the latest developments are explained in greater depth at meetings with investors, analysts and the financial press. Quarterly financial statements are published and explained to financial analysts and journalists during a conference call. This transparency and openness is aimed at supporting optimal stock price formation and broadening the spread of ownership of our stocks. The ERIKS website provides comprehensive information, including press releases, financial reports and strategic news. The website will be revised and extended during the course of 2004, to reflect the requirements of the new Netherlands Corporate Governance Code which came into force on 1 January Market maker (Liquidity Provider) The number of transactions in depositary receipts for ERIKS group nv stock is restricted. In order to nevertheless maintain a continuous listing and optimize our relationship with our depositary receipt holders, SNS Securities N.V. in Amsterdam has been appointed to fulfill the role of a market maker. Market makers ensure that there is steady supply and demand in the trading system at all times. They also help to ensure that relationships are maintained with existing and potential investors and that analysts' reports are published. The activities and results are evaluated on an annual basis. In the year under review, in which there were 219 days of trading, 1,104 transactions were executed in ERIKS depositary receipts. During this period, 894,000 depositary receipts were traded, with a total market value of EUR 22.7 million. The progressive Investor Relations policy implemented by the ERIKS group and the transparency of the information provided on the policy pursued are evident from, amongst other things, our admission to the NextPrime segment of Euronext N.V. The requirements accompanying admission to this segment including the following: - the publication of quarterly reports - as of 2005, financial statements based on the international accounting standards (IFRS) - holding at least two analysts' meetings per year - the possibility of continuous trading, possibly through a market maker - a website containing comprehensive financial information. 13

15 Holdings exceeding 5 percent 99.4 percent of the stock capital has been issued as depositary receipts for stocks. Pursuant to the Dutch Disclosure of Major Holdings in Listed Companies Act, the following notifications had been received by the end of December 2003: Caravelle Holding AG 20.10% Darlin nv 5.15% Delta Lloyd Nuts Ohra N.V. 5.50% H.L.B. Holding B.V % Internationale Nederlanden Groep nv 10.26% Orange Deelnemingen Fund N.V. 5.15% Internal regulations on insider trading ERIKS complies with the rules on notifying transactions as contained in the Dutch Securities Transactions (Supervision) Act (Wte 1995). A wide circle of employees and advisors are formally obliged, by signing a declaration, to observe the regulations as set forth in section 46d Wte In 2002, the internal regulations for the members of the Executive Board and Supervisory Board of ERIKS group nv were also extended to comply with the Dutch Disclosure of Major Holdings in Listed Companies Act 1996 (WMZ 1996), as amended as of September 1, The Authority for the Financial Markets (AFM) supervises compliance with the WMZ Over the coming year, the internal regulations will be subjected to a detailed assessment, and adapted to reflect the provisions of the Netherlands Corporate Governance Code. Financial diary 13 May 2004 General Meeting of Stockholders in Alkmaar. Publication of first-quarter results for 2004*. 17 May st ex-dividend listing. 17 May to 2 June 2004 incl. Option period. 3 June 2004 Determination of the number of dividend rights giving entitlement to 1 new stock (i.e. depositary receipt). 8 June 2004 Dividend payable and delivery of stock (i.e. depositary receipt). 25 August 2004 Publication of first-half results for 2004*. 11 November 2004 Publication of first nine months' results for 2004*. 24 February 2005 Publication of annual results for 2004*. 12 May 2005 General Meeting of Stockholders in Alkmaar. Publication of first-quarter results for 2005*. *Published during stock exchange, followed by conference call. 14

16 Corporate governance The members of the Executive Board and Supervisory Board of ERIKS group nv attach great importance to good corporate governance. For many years now, on both a formal and an informal level, there has been clear separation between the responsibilities of the Executive Board and those of the Supervisory Board. We also constantly endeavor to report as openly as possible to stockholders and other stakeholders. We always welcome suggestions made by stockholders and holders of depositary receipts, which receive due consideration and are followed up, provided they foster the continuity of the business and account is taken of the interests of all stakeholders. Since 1996, therefore, the ERIKS group has, to the greatest extent possible, complied in a positive manner with the 40 recommendations formulated by the Committee on Corporate Governance in 1996 (the Peters Committee). For no other reason than that the ERIKS group s status as a smaller listed company might, in certain circumstances, make it vulnerable, we continue to maintain two "anti-takeover constructions": - the issuance of depositary receipts for stocks; natural persons may reclaim up to 1 percent of the issued common stock capital - the possibility of placing protective preference stocks with a Foundation, having independent directors. ERIKS group nv has granted the Foundation a call option on preference stocks. The sole purpose of these anti-takeover constructions is to allow sufficient time to assess, in the event of any hostile action by third parties, whether the action in question is in the interests of all the stakeholders in the ERIKS group and whether the intentions of those parties tie in with our strategy. It is unfortunate that negative developments at a few large, international listed companies have necessitated the tighter standardization of relations between members of Executive and Supervisory Boards, stockholders and employees. This only increases the amount of administration and red tape involved, particularly for small and medium-sized listed companies. The Executive Board of ERIKS group nv has closely followed the reports on the activities of the Tabaksblat Committee, established in 2003, and has read the Committee s report entitled "The Netherlands Corporate Governance Code". The Executive Board supports the Committee s efforts to define principles for sound business management. For many years, the ERIKS group has adhered, be it on a formal or informal basis, to many of the best practice provisions contained in the Netherlands Corporate Governance Code. The members of the Executive and Supervisory Boards will comply with these provisions over the coming year in a constructive spirit. We do not expect the implementation of the code to create any major problems. Naturally, account will be taken of the status of ERIKS group nv as a relatively small listed company, the fact that its current procedures work well, and the existing contracts and agreements. With regard to the influence of stockholders, we will follow social developments and changes to company law. We are debating the voluntary application of the statutory two-tier rules and the issuance of depositary receipts for shares that are subject to convertibility restrictions. Over the next few months, the Executive Board will prepare the general outlines of the new statutory organization and present them to stockholders and holders of depositary receipts at the General Meeting of Stockholders scheduled for May 13, ERIKS group nv will not relinquish its option to retain one or more anti-takeover constructions. Various "best practice provisions" have already been incorporated in this annual report. At the General Meeting of Stockholders scheduled for May 2005, the Executive Board will present the corporate governance policy in its entirety to stockholders and holders of depositary receipts. 15

17 Flow Technology

18 Information on the organization and market position Mission, objectives, SWOT analysis and strategy Risks and risk management

19 Information on the organization and market position ERIKS group nv The holding company acts as a strategic parent company. Its role is that of provider of capital, initiator, motivator, implementer, supervisor and coordinator of the strategy developed for the ERIKS group. It ensures that the group has added value as compared to independent companies. Consequently, the Executive Board of ERIKS group nv devotes a great deal of time and attention to defining and interpreting the strategy at the various clusters/companies. A decentralized organizational structure affords the companies the necessary flexibility, inventiveness and quality to serve their customers properly and to establish partnerships with their suppliers. In order to maintain a firm grasp of plans for autonomous growth and growth through acquisitions, the ERIKS group is divided into clusters. Cluster A cluster, one company or a group of companies, serves a specific geographical market area. A cluster engages in one or more core activities and has all the disciplines needed to carry out complete operational management on its own. The ERIKS group comprises six clusters. Taking the agreed strategy and the operational plan as a basis, mandates are given to the cluster managers to further develop market position in their sphere of influence. Depending on the developmental stage of the cluster, managers in each cluster are responsible for the further development of the separate core activities and the product groups they encompass. They work from a central operation (Competence Center) for the relevant cluster and generally keep in direct contact with OEM's and other major customers. They also hold responsibilities for developing market position in a specific region. This can be done via ERIKS' own operations and/or dealers, with the operations primarily keeping in direct contact with the maintenance market. Core activities The range of more than 500,000 mechanical engineering components and the associated services are divided into six core activities, each with their own product groups, as described in the "Profile" chapter of this report. The ERIKS group not only functions as an intermediary for technical products, but also provides services and know-how. The ERIKS group is a distributor, and its operational management is spearheaded by a desire to develop and offer added value. In all of the core activities and their product groups, an extensive range of technical and logistics services is provided. Customers The ERIKS group serves more than 50,000 customers across all branches of industry, such as the chemical industry, the food industry, mechanical engineering, semiconductors, oil refineries, construction, offshore and metals. The group separates its customers or buying profiles into the following categories: Maintenance market (MRO - Maintenance Repair Overhaul) ERIKS products and services are used directly for the maintenance of plant and machinery. OEM (Original Equipment Manufacturers) ERIKS products and services are used for the production of finished products by the customer. Projects ERIKS products and services are used for large-scale maintenance projects or construction. Distribution Dealers: ERIKS products and services are supplied via dealers, in order to be close to customers within the existing local markets. Export: ERIKS products are exported, mainly in order to attain the necessary volume in market areas in which the ERIKS group does not have its own operations. In these areas, we deal with both national distributors and OEM s. 18

20 Installation companies and engineering contractors are classified under "maintenance market" or "projects", depending on the type of purchase they make. The ERIKS group offers its customers quality, fast delivery, a wide range, reliability, expertise in materials, technical know-how, processing facilities, logistics services and the ability to supply services and products as a complete package. The combination of these factors has allowed ERIKS to develop into an important market player. Suppliers On the basis of a partnership, while maintaining its independent position, the ERIKS group enters in principle into long-term relationships with manufacturers around the globe. The group's size offers many manufacturers the prospect of substantial sales and a large market share. Market position Customers and suppliers alike are seeing a further internationalization and concentration of activities. It is important for the ERIKS group to expand its geographical coverage with regard to the various core activities and to be in a position to offer its suppliers adequate volume and market share. The table below demonstrates that the ERIKS group does not have a dominant position in any of its core activities, which means there are possibilities for growth on all sides. In some regions, particularly Germany, the United States and South-east Asia, the markets are still very fragmented. This means that an important position can be acquired with just a small market share. For more information, see the chapters entitled "Mission, objectives, SWOT analysis and strategy" and "Developments by cluster". Our market shares in the various regions, by core activity, are as follows: Country The Netherlands Core activity Sealing technology ++ Power transmissions ++ Flow technology + Tools and Maintenance Products + Industrial plastics + Belgium Germany (the western and southern parts) n/a France (the north-west part) USA (in the region of the companies) + n/a n/a n/a - South-east Asia n/a - ++ = >25% + = 10 25% - = <10% n/a = core activity not part of the cluster s range 19

21 Mission, objectives, SWOT analysis and strategy Mission The mission of the ERIKS group is to be a leading, international distribution company, serving all sectors of industry with an extensive range of high-quality mechanical engineering components and related technical and logistics services, as well as know-how regarding its products and applications. The ERIKS group presents itself as a distribution company driven by know-how and added value. Objectives ( ) Commercial Based on its mission statement, the ERIKS group wants to be the innovative, reliable and flexible supplier to its customers. To its suppliers, the ERIKS group wants to be the reliable partner with sufficient market share and volume, serving the entire industrial market based on extensive technical and logistics know-how. Driven by a highly developed group identity, the ERIKS group is striving to achieve the following objectives: - to build a leading market position in Western and Central Europe, in order to become a truly "European player" - to take a strong market share (in the top 3) for all core activities in its range, in all regions where the group has its own operations - to offer an extensive range of high-quality mechanical engineering components - to have a balanced distribution of sales across the main customer types (buying profiles) "Maintenance" and "Original Equipment Manufacturers" (OEM) to keep control over its risk profile - to have a direct or indirect presence in the markets of the United States and South-east Asia, insofar as this contributes to establishing the position of the ERIKS group in Europe. Financial Based on independent, autonomous development and normal growth in economic activity, the financial objectives for the next three years are: - average sales growth of 10 to 15 percent, roughly 5 to 7 percent of which is achieved through autonomous growth and the remainder through acquisitions (2003: 6.6 percent). This will result in sales of EUR 500 to 550 million in an operating result (EBITA) of at least 20 percent of the average net capital invested (2003: 23.7 percent) - a solvency ratio of at least 30 percent (end 2003: 39.0 percent before profit appropriation) - an average rise in earnings per stock of 5 to 10 percent (2003: 8.4 percent) - a dividend payout, circumstances permitting, of approximately 50 percent of the result from ordinary activities (2003: 50.1 percent). Achieving these objectives will foster a lasting relationship with our customers and suppliers, increase development opportunities for our employees and should create added stockholder value. SWOT analysis External analysis - Market size There is no accurate information on the size of the market in which the ERIKS group operates. It is estimated that the total size of the European market is approximately EUR 20 billion. The market in the countries in which the ERIKS group operates is worth in excess of EUR 10 billion. Due in part to the decline in economic activity over the past three years, but also due to the shift in manufacturing away from Western Europe to lowwage countries in Eastern Europe and the Far East, the market as a whole has contracted. The only way for existing manufacturers and distributors to maintain and grow their sales in the Western markets is to pursue an innovative policy and develop new market segments. 20

22 - Suppliers Dictated in part by capital-intensive investments in business assets and the high costs of research and product development, there is still a very pronounced trend towards concentration among manufacturers. They are able to offer the market an increasingly wide and in-depth range and are seeking, either directly or indirectly, to be more closely involved in distribution to the end industrial consumer. This trend towards forward integration among manufacturers, allied with the constant evolution of internet technology, can influence the market positions of distributors. In this environment, a distributor s future can depend on having partnerships with suppliers, having volume and market share and offering a wide range of high-quality technical and logistics services. - Customers Customers expect distributors of mechanical engineering components (technical trade) to deliver added value. It is essential that the distributor has sound product and application knowledge, good processing facilities and logistics services. Only then can both parties do business with each other in an efficient manner. For many customers, reducing the number of suppliers and having just one point of contact for various national and international operations is a primary aspect of their policy. For all parties involved in the industrial column, reducing transaction costs and working capital are of paramount importance in their operations. Distributors are expected to offer a wide and in-depth range, and be able to provide technical know-how and offer logistics services. - Competitors The European market for the distribution of mechanical engineering components remains highly fragmented. A few, larger parties of equivalent size to the ERIKS group are operating in various countries and have an international expansion strategy. However, the combined market share of these international distributors is still limited. As well as these distributors, there are many small and medium-sized family businesses, which serve the market with one or more product groups on a national or regional scale. Internal analysis As explained in greater depth in the chapter "Information on the organization and market position", the activities of the ERIKS group are divided in organizational terms into six clusters (geographical market areas). Each cluster is at a specific developmental stage. The ERIKS Netherlands and ERIKS Belgium clusters have included all the core activities in their range. In the Netherlands, the ERIKS group occupies a top 3 position in all its activities. The cluster masters all the necessary technical disciplines and attaches particular importance to cooperation between the various units, building upon its local presence and further expanding its logistics services. In Belgium, not all the core activities occupy a top-3 position in the market as yet. Cooperation between the various units features prominently in this cluster, too. The policy is spearheaded by the continual development of technical and logistics services. Not all the units have the required level of internal efficiency at present. The ERIKS Germany cluster is working constantly to expand and deepen the range and integration of the companies taken over in recent years, and is investing in good, professional management and the modernization of the infrastructure. The technical trade market remains highly fragmented and the cluster does not rank among the top 3 in any of its product groups. However, in Germany ERIKS is one of the larger distributors of mechanical engineering components. The ERIKS France cluster must undergo many more developmental stages over the coming years. There is still a long way to go in terms of the expansion of the core activities and associated services, as well as with regard to the modernization of the infrastructure. 21

23 The ERIKS USA cluster now operates only in the highly fragmented market for dynamic sealing elements and industrial plastics, but has the resources to achieve further growth. The market position of the ERIKS South-east Asia cluster remains fragile. The marketing mix is being adapted to the requirements of the market through the rationalization of the range and the enhancement of product and application know-how. Financing ( ) and the creation of value Assuming that industrial activity, rather than continuing to decline, will in fact experience something of a revival, a longe-range growth model has been drawn up based on realistic assumptions. The model suggests that the ERIKS group is able to finance its growth targets, while maintaining its financial ratios within the limits set and increasing the value of the company. The financing plan based on the growth model provides for recourse to external financiers and stockholders (by means of setting aside stock dividends). Nevertheless, this does not rule out the ERIKS group being prepared, under certain conditions, to cooperate with other independent industrial suppliers or financial institutions. However, it is essential that any cooperation with third parties will offer long-term benefits for all stakeholders of the ERIKS group and enable objectives to be achieved more quickly. Strategy Various measures were taken, and projects started and/or completed, in the year under review, as mentioned in the 2002 Annual Report under the chapter entitled "Basic assumptions for the year 2003". The Executive Board's report considers these in greater detail. Despite the tough economic environment the ERIKS group further consolidated its position in 2003, in line with the stated objectives and strategy. To realize the objectives, and based on the conclusions drawn from the external and internal analysis, the spearheads of the strategy are as follows: Autonomous growth This can only be achieved if customer demands are central to operational management, if the ERIKS group differentiates itself from its competitors ("a distribution company driven by know-how and added value") and if the group has well-trained, motivated employees. An extremely important part of operational management is paying permanent attention to maintaining and further developing the marketing mix, attuned to each customer group and to market developments. Important aspects in this respect are the following: - Entrepreneurship The ERIKS group will grow first and foremost thanks to employees with a strong sense of entrepreneurship. This aspect is continually borne in mind in our organizational structure and recruitment procedures. - Management development It is essential to future growth that we have good, experienced managers. An appropriate Management Development program has been implemented with this in mind. - Well-trained employees (KNOWLEDGE) ERIKS employees have up-to-date and in-depth knowledge of products and their applications, as well as knowledge of both physical and administrative logistics services. This enables them to work permanently on renewing 22

24 the services package, to correctly interpret the needs of customers and to translate these into appropriate advice and services. In addition, they help to develop new products in close consultation with suppliers. - Wide and in-depth range of products and services The ERIKS group has a wide and in-depth range of products and services, which sets it apart from many of its competitors. The quality of product management should be high at all companies. Only then is the group in a position to serve all market segments and customer groups in industry. - Engineering and processing The ERIKS group has production facilities for all its product groups, so that it can adapt products to customer demands. - Logistics services Managing order flows, reducing transaction costs and controlling the costs of maintaining stocks (i.e. Supply Chain Management) are important to all of the parties involved in the industrial column (manufacturers, distributors, customers). In direct response to this, the ERIKS group has a package of logistics services (EASY ORDER SYSTEM ), which it keeps under development. ERIKS is able to offer logistics concepts tailored to customer groups. - "Couleur locale" It is essential that customer service in all regions has "couleur locale". With this in mind, the ERIKS group has its own operations in the major industrial centers. Where necessary, the ERIKS group has its own branches or works closely with local technical distribution companies. Growth through expansion The ERIKS group will employ a rollout strategy over the next few years, to further enlarge its market area. The main areas for further expansion will be Germany, Central Europe and Northern France. This will create an uninterrupted market area of sufficient size, in which the ERIKS group can offer its customers and suppliers an equivalent package of products and services. In the longer run, as the industrial market in Eastern Europe continues to develop, we will push ahead with our rollout to the East. In addition to this, there will be acquisitions within existing market areas to strengthen the market positions for current activities. As stated in the chapter "Risks and risk management", acquisition candidates are carefully analyzed and must contribute right away to the group's profits. Distribution concept in the Netherlands and Belgium The wheels are in motion for the revised distribution concept in the Netherlands and Belgium. Originally, in most product groups the market was served from central operations. To strengthen the basis for achieving healthy autonomous growth, besides its central operations the ERIKS group will have its own local operations in industrial centers for all its products (forward integration). This will strengthen ERIKS' relationship with the maintenance market. The product range has also been expanded with the core activity "Tools and Maintenance Products". This will bring about particular improvements in access to the maintenance customers. 23

25 Employees A good relationship with our nigh on 2,000 employees is naturally of great importance to the ERIKS group. Offering good opportunities for self-development is part of this. ERIKS offers its employees an attractive package of terms of employment and fringe benefits. We expect our employees to actively contribute to achieving the necessary growth and to demonstrate a high degree of independent responsibility. Efficient operational management For efficient operational management, both administrative and physical logistics share center stage in the eyes of our management. We are investing, and will continue to invest, in advanced operational management systems. - Advanced business information system. The optimization of the business information system SAP R/3, as employed at ERIKS Netherlands, ERIKS Belgium and Flexion bv, has been completed. In line with the distribution concept that was defined for the Dutch and Belgian clusters, this system will, if found to be operationally efficient, be implemented at the other operations in Benelux as well over the next few years. This will enable us to serve a great many of our customers and suppliers using one, common database. The policy for the other clusters is to have one and the same business information system in operation within one cluster, in principle. - E-commerce. All business information systems have functionalities to enable communication with customers and suppliers with the aid of worldwide web technologies. Applications are being developed for the further management of administrative flows (see page 23, logistics services). - Physical logistics. In physical logistics, a distinction is made between bulk (for all clusters), cluster and operation warehousing. The optimum division of these three areas will always reflect developments in the distribution channel. We are investing at various branch operations in premises and logistics tools that are better suited to operational management. Synergy Where there are opportunities for synergy, the group companies work together. Specially appointed employees, the International Product Managers (IPM's), coordinate the composition of the product range, the choice of suppliers, purchasing, transfer of know-how, the development and performance of logistics services, documentation and physical logistics. The central Corporate Information Management department manages the SAP R/3 business information system and defines ICT policy and standards for the group. The progress made with the implementation of the strategy is considered in the chapter "Report of the Executive Board". The chapter "Developments by cluster" expands further upon the objectives, strategy and implementation for each cluster. 24

26 Risks and risk management The risks for the ERIKS group can be divided into financial risks, and market and operational risks. This chapter also considers the internal risk management and control system. Financial risks The financial risks for our distribution company are relatively small. They include, inter alia, access to financial resources, sensitivity to exchange rate fluctuations, etc. From the anticipated development of sales and results, cash flow is generated that enables the ERIKS group to finance some of its growth from its own funds. Backed up by the banking facilities, part of which have not yet been used, and satisfactory solvency, the group is able to fund its intended 10 to 15 percent average growth from an autonomous position in the coming years and has developed a financing plan to this end. When important, major steps, in excess of 10 to 15 percent growth, have to be taken in order to become a truly "European player", the ERIKS group will have to attract alternative funding. Although the ERIKS group purchases its trade goods from all over the world, the risk from exchange rate fluctuations remains limited and manageable. Usually, such fluctuations are translated into an adjustment of sales prices, albeit often with some delay. If this is not possible, important risk positions in the transaction sphere are hedged. Currency translation risks associated with investment in foreign participations are, in principle, not hedged. Market and operational risks As a result of a broad approach to the market, a presence in all branches and contacts with different customer groups, sales are spread widely over many customers. A large proportion of sales is generated in the maintenance market, whose sensitivity to fluctuations in the economy at large is limited. The OEM market for our products is more sensitive to cyclical movements. The increase in the number of our own operations in the Netherlands and Belgium and the rapid development and expansion of the core activities Tools and Maintenance Products and Technical and Logistics Services have significantly strengthened our access to the maintenance market, thereby lowering the risk profile as regards our sales. There is an adequate spread over various suppliers on the purchasing side. The growth that the ERIKS group wants to achieve relies among other things on acquisitions. In general, these involve more uncertainty and risk than autonomous growth. The ERIKS group is endeavoring to limit these risks as far as possible by selecting candidates carefully and through detailed analysis and evaluation during the acquisition process. Whether an acquisition goes ahead is also determined by the availability of adequate management capacity to be able to subsequently steer the integration of the acquired company in a professional manner. Acquisition candidates that would require a "turnaround" are not considered. Major points of interest in the analysis are the presence of a skilled management, a solid, market-oriented corporate culture, sufficient size and a good spread of sales over the customers, a range that complements the ERIKS group and reliable, high-quality suppliers. 25

27 The following important operational risks have been identified: Continuity of data processing For the larger group companies in the Netherlands and Belgium which are linked to the SAP R/3 system, the task of technical management has been handed over in its entirety to a professional service provider. Measures have been taken there to safeguard the continuity of data processing and the transportation of the data. For the other companies, agreements have been concluded with hardware suppliers. Should there be any disasters, we have emergency procedures in place to bridge a particular period. Product liability The risks of malfunctioning products supplied and ensuing claims for consequential loss are sufficiently covered by arrangements and agreements with the suppliers, but also through our own group product liability insurance. Fire damage and loss of profits The group has taken out insurance against fire damage and loss of profits. Internal procedures and preventative measures at, and the physical status of, the various companies are assessed annually, and corrective measures are taken where necessary. Another important risk-limiting aspect is quality control, which is part and parcel of our working methods. At almost all group companies, processes are certified to NEN ISO-9000 standards. Internal risk management and control system The internal risk management and control system and the associated planning and budgeting system of the ERIKS group are organized in such a way that - for each cluster and company, the strategy and target financial results are clear - reliable and timely information is obtained about the situation in the various clusters and companies and their different core activities - the company s assets and resources are managed well - enough guidance information (performance indicators) is obtained to assess the effectiveness and efficiency of the primary operational processes and to improve them. For financial reporting, the budgeting and planning process and for risk management, group manuals have been produced describing the reporting structures and the procedures to be followed. These manuals are evaluated and adapted annually. Within the framework laid down at group level, the operational managers are responsible for the set-up and operation of the internal management and control systems at their own companies. Each year, external auditors assess the most important aspects of the set-up and operation of the administrative organization and the internal control mechanisms it incorporates. They report on this to the local management as well as the Executive Board of the ERIKS group and the Supervisory Board. 26