Strong cash flow, increased market shares and much stronger corporate     development activities Business conditions Financial statements for 2005 Outlook for the future General meeting

Strong cash flow, increased market shares and much stronger corporate development activities
Again in 2005, the William Demant Holding Group expanded its market position. Unit sales of Group-manufactured hearing aids rose by 18%, among other factors driven by Oticon Syncro and the successful mid-priced products Tego og Tego Pro from Oticon and SwissEar from Bernafon. The improvement is to be viewed in the light of an estimated market growth rate in 2005 of 4-6%. In other words, the Group gained market shares also in 2005. Developments in 2005 suggest that our business is in a stronger position than ever before.

The highlights of the year summarised in a few facts and figures:

	In 2005, the Group realised revenues of DKK 4,716 million, or 9.6% growth. In local currencies, growth was 8.4%.
	Operating profits (EBIT) totalled DKK 1,103 million, corresponding to 10% growth or a profit margin of 23.4%.
	Net profits rose 10% to DKK 791 million, and earnings per share (EPS) improved by 14% to DKK 12.2.
	Corporate cash flows from operating activities amounted to DKK 892 million, or 24% growth.
	Based on the year’s substantial cash flows, the Company bought back shares worth DKK 695 million.

Realised revenues and operating profits (EBIT) matched the forecasts announced in our stock exchange announcement on 10 November 2005 on the quarterly review for the third quarter.

In many areas, the Group continued its strong focus on innovation and product development in 2005 in an effort to expand corporate growth potential on the long term:

	2005 was another year of fruitful response to our research and development endeavours, which enabled us to launch a number of new, innovative products with considerable commercial potential. The five product launches in the spring, including Oticon’s Tego and Tego Pro, were followed up in the autumn by the introductions of the thin-tube concept, Oticon Corda, the Oticon SAM envirometer and Bernafon’s high-end instrument, ICOS.
	The autumn inauguration of our new head office and development centre at Smørum was a milestone in the Group’s dedicated effort to always have the very best setting for innovation. Our vision was to create the leading and most exciting development facility in the hearing-aid industry. The move of 450 staff proceeded as planned.
	2005 was also a year in which the development effort received a tremendous boost from an already very high platform. This was done to gear our business for the development of products with improved features and user benefits also in the future and involved an increase in R&D costs of 18% in 2005.

 

 

 

 

 

 

 

 

 

 

 

 

In 2006, revenues are forecast at DKK 5.2-5.3 billion corresponding to a growth in the underlying business of about 10%. Operating profits (EBIT) are estimated at DKK 1,225-1,275 million. Generally, we plan to increase the buy-back of shares substantially in 2006. We forecast a buy-back of shares of up to DKK 1 billion in 2006. With full utilisation of this frame, it will be an increase of over 40% on 2005. The growth in earnings per share (EPS) is estimated at 15-17% in 2006.

Business conditions
Hearing Aids
Growth in the global market for hearing aids continues in line with our long-term forecasts of 3-5%, with the underlying growth factors being more or less unchanged. Growth is, among other factors, underpinned by the continued 1.5-2.0% increase in the over sixties population in the OECD countries. Moreover, the number of hearing impaired fitted with hearing aids on both ears (binaural fitting) is growing. This growth will, however, decrease gradually in the future. Also, we see a somewhat higher growth rate in some developing countries, albeit from a low level.

In Europe, growth seems overall to match our forecasts. In some countries such as Norway and Holland, growth is higher, whereas other countries, e.g. Switzerland, lag somewhat behind.

For the year as a whole, growth on the US market also matched our expectations, but trends in the US embrace 4% growth in the private market and a drop of 6% in the public segment (Veterans Affairs). Since the fourth quarter of 2004, the William Demant Holding Group has only supplied very few hearing aids under the Veterans Affairs scheme.

Although mix changes between the various price segments are increasingly frequent, which may lead to periodic movements in average selling prices, we are of the opinion that also on the longer term the development in prices will contribute to market growth by 1-2 percentage points. The positive price effect is the result of new innovative products, which typically sell at 5-10% higher prices than the hearing aids they replace.

As forecast in the Annual Report 2004, tougher competition in the high-end market segment has been a distinguishing feature in 2005, because – as expected – many competitors launched hearing aids in this segment in 2005.

One of the major market trends in 2005 was that recent years’ substantial growth in the sale of behind-the-ear (BTE) instruments compared with the sale of in-the-ear (ITE) instruments continued. A trend that was particularly conspicuous in the USA, where the proportion of BTE instruments rose from some 26% to 37% from the first quarter of 2004 to the fourth quarter of 2005. Compared with the first quarter of 2003, the increase was as high as 13 percentage points. The reason being solid growth in the sale of cosmetically attractive BTE instruments, which are typically based on thin tubes and open fittings.

The Group estimates that the market for cosmetically attractive thin-tube solutions now accounts for more than 10% of the total market. Almost all manufacturers have now introduced thin-tube instruments, and we are therefore convinced that in the next few years, the BTE market will outgrow the ITE market. Even though we were absent from the fastest growing market segment from 2003 to 2005, it is worth noting that during this period, the Group managed to capture market shares on a current basis. In summer 2005, Bernafon introduced SwissEar in this segment, and Oticon launched its universal thin-tube concept Oticon Corda, in late 2005. Over the next few years, we expect the two hearing-aid businesses together to achieve the same share of the thin-tube market as the Group’s share of the hearing-aid market in general.

The first quarter of 2006 saw the launch of the Group’s new, ground-breaking high-end hearing aid, Oticon Delta, which belongs to a new generation of communication solutions in the RITE (Receiver-In-The-Ear) category. Oticon Delta stands out from all the traditional ITE and BTE instruments on the market with its ultra-thin, almost invisible copper wire connecting a newly developed loudspeaker placed in the ear canal with a tiny, triangular, digital amplifier concealed behind the ear. Transferring the electronics to behind the ear makes space for an entirely open fitting without compromising the cosmetic and auditory benefits of ITE instruments. For example, the potential of the loudspeaker is fully utilised by the location close to the ear drum while preserving the robustness and functionality of the BTE instrument. Designed for people with mild or high-frequency hearing losses, Oticon Delta offers all the functions characteristic of the best and most sophisticated products on the market. Delta has been designed to accommodate the functional and design preferences of the rapidly growing group of 50-65-year olds. So far, the so-called baby boomers have been reluctant to use hearing aids, but the Group sees Oticon Delta as the industry’s most determined effort to overcome this generation’s reservations about using hearing aids.

2005 was another year with many vital product launches from the Group’s hearing-aid companies. Apart from the launch of Corda, Oticon in the spring introduced the second generation of its Syncro concept, which made a positive contribution in 2005. Syncro2 has several new functionalities including Syncro Memory (data logging) and an automatic Adaptation Manager for gradual increase of the amplification of the instrument to the desired level. In spring 2005, Oticon also introduced the Tego product brand including two complete product families, Tego and Tego Pro, which in terms of prices and functionalities together cover the entire mid-priced segment. Tego has had considerable success since its launch and has, in an extremely short time span, achieved a status as one of the world’s best-selling hearing aids. This summer, Oticon launched Sumo DM, which is a very compact and sophisticated digital Super Power instrument for users with very profound hearing losses. Towards year-end, Oticon presented its new Syncro SAM (Sound Activity Meter), a so-called EnvirometerTM. Syncro SAM, which is pinned to the user’s clothes, collects essential information on an ongoing basis about the hearing impaired’s listening environment prior to a fitting session. Based on the recorded information, the fitter creates an EnvirogramTM, which provides a detailed picture of the most frequent listening environments of the particular hearing-impaired person. This enables the fitter to match the choice of instrument, functionalities and settings precisely to the user’s needs.

Apart from SwissEar, Bernafon in spring 2005 launched the Win product family designed for the volume market. Win has contributed to Bernafon’s continued growth in sales of less expensive hearing aids. In the autumn, Bernafon unveiled ICOS, a new high-end product. ICOS is a highly adaptive hearing aid with sophisticated fitting tools and a data logging system called ICOS Tracker. ICOS was released for sale in the first quarter of 2006.

In 2005, the sale of self-manufactured hearing aids rose by 18% against a market growth rate of about 4-6%. In other words, recent years’ increase of market shares continued in 2005. Syncro, Tego Pro, Tego and GO, in particular, made a favourable contribution to unit growth in the Oticon business, and in Bernafon, the major growth drivers were SwissEar, Neo and Win.

All the above instruments were launched in the past two years; a fact that emphasises the importance of being able to introduce new, ground-breaking products at the right prices. In 2005, products launched in the past two years accounted for over half of the units sold and manufactured by Group enterprises. Outside the commercial market, Oticon’s sales to the British National Health Service also contributed considerably to unit growth.

In addition to being competitive as regards user benefits and product concepts, the Group’s hearing-aid companies are also met with a demand for high flexibility in the distribution link. In some cases, for instance, manufacturers must be willing to participate as a finance source in connection with business succession plans or an expansion of the business. In 2005, the Group took over a few minor distribution businesses and in some cases provided financing for new or existing customers.

The corporate effort to implement the so-called SLA technology (stereolithography) for the production of ITE instruments is progressing as planned. SLA technology is based on 3D scanning of the ear impression, which is modelled on a PC. The individually modelled shells are then manufactured automatically by means of a 3D printer. In 2005, Oticon and Bernafon implemented the new technology at another two production sites so that the Group now has seven SLA units. Moreover, scanners and modelling units have been installed locally in a large number of other Group enterprises. Via electronic data transfer, these scanners make it possible to have shells produced at one of the seven major ITE production sites. Further scanners and modelling units are scheduled for installation locally in 2006. At year-end, over three fourths of Group ITE instruments were made using the new SLA technology.

In the short term, SLA technology will not appreciably improve corporate profitability because initial investments are high and so are running-in costs and costs for IT systems, which are necessary to support joint production across national borders. However, in the long term, ITE instruments designed specially for the new technology will result in lower unit costs. SLA technology will also enable the production of more precise, individualised hearing aids; a feature that has already in selected markets reduced the proportion of hearing aids needing correction due to faulty shaping.

The move at the end of October 2005 to new corporate headquarters at Smørum, 25 km north-west of Copenhagen, marked the beginning of a new era for corporate hearing-aid activities. While solving immediate space requirements, the move also paved the way for the world’s leading and most exciting development facility for hearing aids. We are convinced that the new ultramodern facilities with sound studios, measuring equipment and laboratories will promote innovation and productivity in corporate development activities. The move will thus support the Group’s ability to also in future launch innovative hearing aids based on the most sophisticated functionalities in all segments of the market. The move of our 450 staff proceeded as planned. In connection with the move from the rented premises in central Copenhagen, the Group sold off furniture and fixtures in the amount of DKK 10 million.

In 2005, corporate retail activities saw a slightly weaker trend than the Group as a whole.

Diagnostic Instruments
In 2005, Diagnostic Instruments that include the two audiometer enterprises, Maico and Interacoustics, generated nice two-digit growth rates in a market with an underlying 3-5% rate of growth. This business area continued its positive trend by capturing sizeable market shares.

Growth was broadly founded with progress in all product categories, albeit with equipment for hearing-aid fitting and brain cell audiometry developing particularly favourably. Especially Interacoustics’ launch in the second quarter of 2004 of Affinity, a PC-based audiometer and fitting system, contributed positively to growth in this business area in 2005, and so did a targeted sales and marketing effort.

The diagnostic instruments industry continued its consolidation in 2005, now with four major players accounting for about 70% of revenues and with William Demant Holding’s diagnostic business as the third-largest in the industry. However, the industry still has a fairly large number of small local manufacturers and many small, niche-oriented manufacturers.

The favourable sales and earnings trends in the Diagnostic Instruments business area are expected to continue in 2006.

Personal Communication
Personal Communication comprising Phonic Ear and the joint venture, Sennheiser Communications, saw a slight improvement in 2005, with flat development in Phonic Ear and fair growth in Sennheiser Communications.

In the future, Phonic Ear will comprise three business areas:
Active Learning Systems, Assistive Listening Devices and Assistive Listening Systems.

In 2005, Phonic Ear bolstered its position within Active Learning Systems with the introduction of FrontRow (previously Soundfield) that encompasses school systems consisting of a wireless micro-phone worn by the teacher and a loudspeaker with a built-in wireless receiver. The FrontRow system is used in classrooms to maintain students’ attention in noisy environments with poor acoustics. So far, Active Learning Systems have been particularly popular in North America, UK, Australia and New Zealand. In 2006, Phonic Ear will continue to highlight this area, also on a number of other markets.

Personal FM equipment was previously a focus area for Phonic Ear. In conjunction with the development within the area of Personal FM equipment (PFM), Phonic Ear’s activities in this area are however being transferred to Oticon’s paediatric business. PFM are wireless systems primarily used in classrooms with the teacher wearing a microphone with a wireless transmitter and the hearing-impaired student wearing a receiver. The transfer of PFM from Phonic Ear to Oticon mirrors Oticon’s growing interest in the paediatric market, which is currently experiencing healthy growth driven among other things by the introduction of infant screening programmes in several countries. The FM receivers worn by students are undergoing particularly rapid development. In the past, receivers used to be separate, body-worn instruments, whereas today they are tiny units clicked directly onto the hearing aid. The trend towards integrating FM receivers into the hearing aid is another reason for transferring the activities.

Sennheiser Communications, a corporate joint venture in the headset area, is owned and operated in collaboration with German Sennheiser electronic GmbH & Co. KG. In 2005, Sennheiser Communications saw fair growth in all product areas and thus continued the upward trend in the sale of headsets for telecommunications and PC users. It presented its first wireless Bluetooth headset, BW-900, in 2005. BW-900 is designed for the so-called SOHO segment (Small Office/Home Office). Two of its distinguishing features are long range and outstanding sound quality. The launch has been slightly delayed compared to previous communications, but it is expected to be released for sale in 2006. In 2005, Sennheiser Communications furthermore complemented its product range in the multi-media and mobile segments. The business expects the positive trends to continue in 2006.

Financial statements for 2005
Revenues and foreign exchange conditions
Revenues for 2005 amounted to DKK 4,716 million, or 9.6% growth. Realised revenues matched our most recent forecasts. In terms of local currencies, growth amounted to 8.4%. Realised growth in 2005 should be viewed in the light of the fact that the comparative year 2004 was characterised by significant growth owing to the success of the high-end product Oticon Syncro. Overall, acquisitions contributed 0.6% to annual growth reflecting the fact that we did not carry through any major acquisitions in 2004 and 2005.

97% of consolidated revenues are generated outside Denmark. The revenue-related impact of movements in the Group’s trading currencies is therefore substantial. The graph below shows the indexed development in the Group’s trading currencies calculated on the basis of revenues generated in the various currencies in 2005 based on average exchange rates realised month by month.




As the US market accounts for a significant slice of sales, revenues are particularly sensitive to movements in the USD rate. In 2005, the realised exchange rate of USD was 600, which is unchanged compared with 2004. At year-end 2005 and in the first few months of 2006, the USD rate has seen a strengthening compared with the rate realised in 2005. The USD will therefore have a positive effect on consolidated revenues in 2006, provided the current exchange rate remains unchanged throughout the year.

Foreign-exchange rates	USD	EUR	GBP	AUD	CAD	JPY
31 December 2003	596	744	1058	445	454	5.57
Realised rate 2004	599	744	1097	441	460	5.54
31 December 2005	547	744	1049	424	451	5.27
Realised rate 2005	600	745	1090	457	495	5.45
31 December 2005	632	746	1089	463	544	5.37
Realised rate January 2006	617	746	1088	462	532	5.34

Revenue by business area  (DKK million)
	2004*	2004**	2005**
Hearing Aids	3,817	3,861	4,187
Diagnostic Instruments	242	243	271
Personal Communication	244	247	258
Total	4,303	4,351	4,716
*Computed at 2004 exchange rates    **Computed at 2005 exchange rates

The Group’s hearing-aid business generated 10% growth in 2005. The development is satisfactory, in particular because the loss of the Veterans Affairs contract in 2004 had full impact on the revenues generated in 2005, and because the comparative year, 2004, saw significant growth driven by the successful launch of the high-end product, Syncro. The total unit sales of self-manufactured hearing aids rose 18% in 2005, which is to be viewed in the light of a market growth rate of about 4-6% in 2005. The product mix in the hearing-aid business in 2005 showed that growth in the mid-priced segment, led by Tego and Tego Pro, and rising sales to the NHS in the UK exceeded the growth in other business segments. In 2005, the Group’s average selling prices in the various price segments were either unchanged or rising. Thus, a change in product mix was responsible for the reduction in the Group’s average selling price in 2005.

Corporate retail sales, which now constitute about 20% of consolidated revenues, are included in the hearing-aid business. The Group’s retail activities developed flatly in 2005.

Revenues from Diagnostic Instruments rose 12% in 2005. This business area continued its positive trend with progress in all product categories, increased market shares and continuous improvement of profitability, which was already at a satisfactory level.

In 2005, Personal Communication saw a minor 6% improvement in revenues with a flat trend for Phonic Ear and fair growth for Sennheiser Communications.





Gross profits
The Group generated gross profits of DKK 3,133 million in 2005, or an increase of 10%, resulting in a gross profit ratio of 66.4%, which is at the same level as last year. Sales of low-end and mid-priced products grew considerably in 2005, which had a negative impact on the gross profit ratio due to a lower gross contribution per product. However, continuous productivity improvements related to fewer working hours per instrument, better utilisation of existing capacity and a higher degree of processing of externally purchased components are on the positive side.

Capacity costs
The table below reflects the year’s increase in capacity costs of 9.5%, which matches the improvement in revenues for the period.

			Percentage change
Capacity costs (DKK million)	2004	2005	DKK	Local currency
R&D costs	324.2	382.5	18.0%	18.1%
Distribution costs	1,263.5	1,354.1	7.2%	6.0%
Admin. expenses	270.5	297.5	10.0%	8.2%
Total	1,858.2	2,034.1	9.5%	8.4%

Research & Development costs
In the Group’s opinion, a continuous focus on innovation and product development is vital to ensure the Group’s long-term growth potential. Substantial resources are therefore allocated to R&D activities to bring products on the market with improved user benefits. In pursuit hereof, R&D costs in 2005 rose 18%, which represents a higher increase than the development in sales and the underlying market. In 2005, R&D costs accounted for 8.1% of revenues against 7.5% in 2004. The fairly large increase in R&D costs mirrors the successful progress of several corporate development projects, most recently exemplified by the introduction of Oticon Delta and ICOS from Bernafon.

The development functions in the William Demant Holding Group collaborate across business areas and continents for maximum exploitation of know-how and knowledge. This policy ensures that basic technologies and special competencies developed for specific purposes in one part of the Group are being put to use in other corporate contexts for optimal exploitation of development resources. The purchase of our new domicile and development centre at Smørum, 25 kilometres north-west of Copenhagen, should be seen as part of our focused strategy to currently expand corporate development activities and create the very best setting for a strengthening of the Group’s innovative force and competi-tiveness on the long term. In addition to state-of-the-art facilities in Denmark, the Group has major development centres in Switzerland, Germany and the USA. Furthermore, the Group is a member of research networks and institutions all over the world.




Distribution costs
Distribution costs, which accounted for two thirds of capacity costs, rose 7%. Distribution costs for 2004 included costs in connection with customer-related activities on the occasion of Oticon’s centenary celebrations, which explains the fairly modest increase in 2005. Fairly low growth in corporate retail activities in 2005, which involve relatively high distribution costs, also contributed to dampened growth at corporate level.

Administrative expenses
Administrative expenses rose 10% in 2005, matching the year’s improvement in revenues. Growth was higher in the second half-year. The explanation is that to some degree other operating income included in the calculation of consolidated administrative expenses positively impacted the restated comparative figure for the second half of 2004.

The year’s profit
Operating profits (EBIT) amounted to DKK 1,103 million, matching the most recent forecasts. Operating profits amounted to 10% in 2005. Last year, operating profits (EBIT) rose as much as 17% driven by the successful launch of the high-end product, Oticon Syncro, which must be taken into account when considering operating profits for 2005. The consolidated profit margin in 2005 was 23.4%, which is similar to that of 2004.




Changes in exchange rates are hedged in two ways: by matching cash flows in major currencies as far as possible and by entering into forward-exchange contracts. With the Group’s current use of forward-exchange contracts, budgeted cash flows are hedged with a horizon of 6-24 months. Thus, movements in exchange rates affect revenues immediately whereas the effect on earnings is somewhat delayed. Realised forward-exchange contracts are recognised in the profit and loss account together with the items hedged by such contracts.

The underlying development in earnings in 2005 matched reported profits with a modest exchange-rate impact for the year as a whole. The development was negative in the first half and positive in the second half-year.

At year-end 2005, the Group had entered into forward-exchange contracts at a nominal value of DKK 843 million (DKK 982 million at 31 December 2004) with a market value of DKK -2 million (DKK 35 million at 31 December 2004). The major contracts hedged the following currencies:

Currency	Hedging period	Hedging rate
USD	8 months	604
JPY	6 months	5.76
EUR	10 months	746
CAD	7 months	519

Share of profits after tax from associated undertakings totalled DKK 4 million, including income from HIMSA, the association through which the hearing-aid industry collaborates on a common software platform, NOAH.

Net financials amounted to DKK -37 million against DKK -39 million in 2004 despite an increase of well over DKK 200 million in consolidated interest-bearing net debt. The rise in net debt primarily consists of a long-term mortgage loan for financing of the purchase of the Group’s new domicile. The explanation for net financials nevertheless showing a minor improvement on 2004 is that interest paid on the mortgage loan was capitalised until occupancy of the building in the fourth quarter of 2005.

Pre-tax profits were DKK 1,066 million, or a 10% increase. Tax on the year’s profits amounted to DKK 275 million, corresponding to an effective tax rate of 25.8%, which is at the same level as in 2004. The Group maintains its previous forecasts of a slightly increasing tax rate, which on the long term is expected to stabilise at a level matching the corporation tax rate in Denmark (28%). Convergence towards 28% will however stretch over a slightly longer period than previously assumed.

The year’s profit amounted to DKK 791 million, which is an increase of 10% on 2004. Earnings per share (EPS) were DKK 12.2 against DKK 10.7 in 2004, or a 14% rise. The reason for the relatively higher growth in earnings per share compared with the rise in profits is the Group’s current buy-back of shares, which in 2005 reduced the average number of shares by 2.0 million compared with 2004. For further details about the buy-back programme, we refer to the Capital section.

At the general meeting, the Directors will propose that all the year’s profit be retained and transferred to the Company’s reserves.

Shareholders’ equity and capital
At 31 December 2005, shareholders’ equity was DKK 756 million, an equity ratio of 26%.

On the transition to IFRS financial reporting standards, shareholders’ equity at 1 January 2004 was negatively impacted with DKK 6 million, see Accounting policies.

Consolidated shareholders' equity (DKK million)	2004	2005
Shareholders' equity at 1.1.	522	646
Changes in accounting policies	-6	-
Adjusted shareholders' equity	516	646
Exchange adjustments of subsidiary undertakings	-14	-26
Value adjustment of hedging instruments	17	-49
Buy-back of shares	-611	-695
Proceeds from sales of own shares to employees	15	0
Profit for the period	717	791
Reversal of reserve recognised in goodwill for prior years	0	89
Other adjustments	6	0
Shareholders' equity at 31.12.	646	756

At year-end 2005, we found that the recognition of a liability of USD 14 million relating to an acquisition in 2001 was no longer required. This liability was reversed in 2005 in the amount of DKK 89 million, which had a positive impact on shareholders’ equity.

At 31 December 2005, shareholders’ equity in the parent company was DKK 754 million.




Consolidated cash flows, financing and cash position
Cash flows from operating activities amounted to DKK 892 million in 2005, which is 24% above the level of 2004. The Group’s overall inventories, payables and receivables are at the same level as in early 2005. Paid corporation tax went up by 13% which should be viewed in the light of an improvement in pre-tax profits of 10%.

Cash flows by main items (DKK million)	2004	2005
Year's profit	717	791
CFFO	720	892
CFFI, excl. acquisitions and investments in new head office	-195	-237
Free cash flow, excl. special investments	525	655
Acquisitions	-30	-12
Investments in new head office and special investments	-171	-185
Buyback of own shares	-611	-695
Other financing activities	-62	-241
Year's net effect	-349	4