Notes to the condensed financial statements

General information

Akzo Nobel N.V. is a public limited liability company headquartered in Amsterdam, the Netherlands. The interim condensed consolidated financial statements include the financial statements of Akzo Nobel N.V. and its consolidated subsidiaries (in this document referred to as “AkzoNobel”, “Group” or “the company”).

The company was incorporated under the laws of the Netherlands and is listed on Euronext Amsterdam.

Basis of preparation

All quarterly figures are unaudited. The interim condensed consolidated financial statements have been prepared in accordance with IAS 34 “Interim financial reporting”. The interim condensed consolidated financial statements were discussed and approved by the Board of Management and Supervisory Board. These condensed financial statements have been autorized for issue. The full-year 2019 numbers included in the condensed consolidated financial statements are derived from the consolidated financial statements 2019. The consolidated financial statements have not yet been published by law and still have to be adopted by the Annual General Meeting of shareholders. In accordance with Article 393 of Book 2 of the Dutch Civil Code, PricewaterhouseCoopers Accountants N.V. has issued an unqualified auditor's opinion on these financial statements, which will be published on March 10, 2020.

Invested capital

Invested capital at December 31, 2019, totaled €7.0 billion, up €0.8 billion from year-end 2018, mainly due to higher operating working capital, the impact of the adoption of IFRS 16 and increased goodwill and other intangible assets due to acquisitions.

Operating working capital (Trade)

Operating working capital as percentage of revenue increased to 11.9% in Q4 of 2019, compared with 9.7% in Q4 of 2018, mainly due to lower trade payables, including an adverse impact from acquisitions.

Operating working capital (Trade)

In % of revenue

Pension

The net balance sheet position (according to IAS19) of the pension plans at the end of 2019 was a surplus of €0.8 billion (year-end 2018: surplus of €0.4 billion). The development during 2019 was the result of the net effect of:

• Top-up payments into defined benefit pension plans
• Higher asset returns in key countries
• Net demographic assumption gains

Offset by:

• Lower discount rates in key countries

In February 2019, negotiations on the triennial review of the main UK defined benefit pension schemes were concluded, leading to a total of €640 million of cash payments:

• An amount of £290 million (€333 million) of top-up payments have been made in relation to deficit recovery plans for the ICI Pension Fund and Akzo Nobel (CPS) Pension Scheme
• Top-up payments of £129 million (€146 million) were paid in accordance with the previously agreed recovery plans
• An amount of £142 million (€161 million) of pre-funding was paid into an escrow account for the Akzo Nobel (CPS) Pension Scheme

Other top-up payments amounted to €2 million.

Workforce

At December 31, 2019, the number of people employed was 33,800 (December 31, 2018: 34,500). Acquisitions in 2019 added around 150 people.

Free cash flows

The cash generation in Q4 2019 improved compared to Q4 2018, mainly due to higher EBITDA and lower interest paid, partly offset by lower Other changes in provisions.

EBITDA was impacted by the adoption of IFRS 16 as per January 1, 2019. As a result, in 2019, some €113 million of lease expenses were recognized as depreciation of Right-of-use assets (€105 million) and as interest expense (€8 million). The 2018 comparative figures have not been restated.

Accounting policies and restatements

The significant accounting policies applied in the condensed consolidated interim financial statements are consistent with those applied in AkzoNobel’s consolidated financial statements for the year ended December 31, 2018, except for the following changes in accounting policies and disclosures:

IFRS 16 "Leases" is the most important change. IFRS 16 replaces the previous standard on lessee accounting for leases. It requires lessees to bring most leases on balance sheet in a single lease accounting model, recognizing a Right-of-use asset and a Lease liability. Compared with the previous standard for operating leases, it also impacts the classification and timing of expenses and consequently the classification between net cash from operating activities and net cash from financing activities. AkzoNobel has adopted IFRS 16 as per January 1, 2019, applying the modified retrospective approach. All Right-of-use assets are measured at the amount of the lease liability at transition, adjusted for any prepaid or accrued lease expenses. Short-term and low-value leases are exempted. AkzoNobel has not restated its 2018 comparative figures. The adoption did not have an impact on group equity.

IFRS 16 requires the Right-of-use asset and the Lease liability to be recognized at discounted value and assumptions with regards to termination and renewal options should be taken into consideration.

The blended incremental borrowing rate applied to the lease liabilities at January 1, 2019, was 2.2%. The table below reflects the reconciliation of the operating lease commitments as at December 31, 2018, and the lease liabilities recognized as at January 1, 2019.

The adoption of IFRS 16 as per January 1,2019, has resulted in the recognition of Right-of-use assets of €367 million, and additional lease liabilities of €363 million. In addition, assets with a book value of €65 million have been reclassified to Right-of-use assets, including among others finance leases. In the Consolidated statement of income, the Operating lease expenses (€113 million), previously recorded in Operating income, are replaced by the depreciation charge on Right-of-use assets (€105 million; remains recorded in Operating income) and by Interest expenses for the lease liability (€8 million; recorded in Net financing expenses). In addition we recorded a non-cash impairment charge of Right-of-use assets of €5 million, presented as identified item. On a net basis, the adoption of IFRS 16 has led to an increase of operating income by €3 million and an increase of Net financing expenses by €8 million; Profit before tax was €5 million lower and Profit for the period was €3 million lower. The payments for the Operating leases (€108 million), previously included in the net cash from operating activities, are now included in the net cash from financing activities.

AkzoNobel’s activities as a lessor are not truly material and hence the impact on the financial statements is not significant.

Several other new accounting standards were issued. These include, among others, IFRIC 23 ‘‘Uncertainty over income tax treatments” and ‘‘Plan Amendment, Curtailment and Settlement” (Amendments to IAS 19), both effective as from January 1, 2019. These changes do not have a material effect on AkzoNobel’s Consolidated financial statements, as to a large extent we already complied with these clarifications on IFRS.

Application of IAS 29 “Financial Reporting in Hyperinflationary economies”

IAS 29, "Financial Reporting in Hyperinflationary Economies" is applied to the financial statements for entities whose functional currency is the currency of a hyperinflationary economy. Since July 1, 2018, Argentina qualifies as a so-called hyperinflationary country under IFRS. As a consequence, special accounting procedures have been applied to eliminate hyperinflation effects from the accounts of the Argentinian operations, starting on January 1, 2018. The revaluation effect on the non-monetary assets at January 1, 2018, was a gain of €23 million after taxes, recorded as an adjustment to opening shareholders’ equity. Effects during the subsequent periods were not significant.

Seasonality

Revenue and results in Decorative Paints are impacted by seasonal influences. Revenue and profitability tend to be higher in the second and third quarter of the year as weather conditions determine whether paints and coatings can be applied. In Performance Coatings, revenue and profitability vary with building patterns from original equipment manufacturers.

Other activities

In Other activities, we report activities which are not allocated to a particular segment.

Revenue disaggregation

The table below reflects the disaggregation of revenue. Additional disaggregation of revenue is included on the respective pages of Decorative Paints and Performance Coatings.

Related parties

We purchased and sold goods and services to various related parties n which we hold a 50% or less equity interest (associates and joint ventures). Such transactions were conducted at arm’s length with terms comparable with transactions with third parties. We consider the members of the Executive Committee and the Supervisory Board to be the key management personnel as defined in IAS 24 “Related parties”. In the ordinary course of business, we have transactions with various organizations with which certain of the members of the Supervisory Board and Executive Committee are associated. All related party transactions were conducted at arm's length.

Alternative performance measures

In presenting and discussing AkzoNobel’s operating results, management uses certain alternative performance measures (APM) not defined by IFRS, which exclude the so-called identified items that are generated outside the normal course of business. These alternative performance measures should not be viewed in isolation as alternatives to the equivalent IFRS measures and should be used as supplementary information in conjunction with the most directly comparable IFRS measures. Alternative performance measures do not have a standardized meaning under IFRS and therefore may not be comparable to similar measures presented by other companies. Where a non-financial measure is used to calculate an operational or statistical ratio, this is also considered an APM.

AkzoNobel uses APM adjustments to the IFRS measures to provide supplementary information on the reporting of the underlying developments of the business. These APM adjustments may affect the IFRS measures operating income, net profit and earnings per share. A reconciliation of the alternative performance measures to the most directly comparable IFRS measures can be found in the tables for adjusted operating income and adjusted earnings from continuing operations further below.

OPI margin, ROS% and ROS% excluding unallocated costs are used as performance measures. OPI margin is operating income as percentage of revenue. ROS% is adjusted operating income as percentage of revenue. ROS% excluding unallocated costs is adjusted operating income as percentage of revenue for Decorative Paints and Performance Coatings; it excludes unallocated corporate center costs consistent with our 2020 guidance. The calculations are based on the Revenue as disclosed in the revenue table in Financial highlights.

ROI is adjusted operating income of the last 12 months as percentage of average invested capital. ROI excluding unallocated cost is adjusted operating income of the last 12 months as percentage of average invested capital, for Decorative Paints and Performance Coatings; it excludes unallocated corporate center costs and invested capital, consistent with our 2020 ambition.