Summary of Halma p.l.c. Annual report and accounts 2006
Accounting Policies and Notes
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Kevin Thompson Finance Director
| £ million | Revenue | % change |
|---|---|---|
| United States of America | 94.0 | 19.4% |
| United Kingdom | 82.9 | 18.0% |
| Mainland Europe | 77.2 | 6.2% |
| Asia Pacific and Australasia | 33.3 | 10.2% |
| Africa, Near and Middle East | 14.8 | 49.5% |
| Other | 8.6 | 23.6% |
| 310.8 | 15.7% |
Revenue from continuing operations increased by £42.0 million (15.7%) to £310.8 million of which £13.1 million (4.9%) came from acquisitions made this year and from the extra months’ benefit of acquisitions made last year. Underlying organic revenue growth* was therefore 10.8%. Profit before tax from continuing operations before amortisation of acquired intangibles grew by 20.3% to the record figure of £58.1 million and after adjusting for acquisitions, organic profit growth* was 14.9%. Statutory profit before tax was 17.9% higher at £56.6 million. Currency translation contributed a modest 1% to revenue and profit growth.
We disposed of eight businesses in the year. The table below shows the results both excluding and including those businesses.
| Continuing operations | Including discontinued operations | |||||
|---|---|---|---|---|---|---|
| £ million | 2006 | 2005 | % change | 2006 | 2005 | % change |
| Revenue | 310.8 | 268.7 | 15.7% | 337.3 | 299.1 | 12.8% |
| Profit before tax* | 58.1 | 48.3 | 20.3% | 59.6 | 49.9 | 19.4% |
| Return on sales | 18.7% | 18.0% | 17.7% | 16.7% | ||
* Excludes amortisation of acquired intangibles and profit on disposal of operations.
Comparatives have been restated on an IFRS basis. See Financial highlights.
In overview, revenue growth was strong in the year and gross margins held firm. Overheads were increased, in particular in the Infrastructure Sensors sector, to accelerate future opportunity across the world. The net result of our operational activity, acquisitions and disposals was to grow the return on sales to 18.7% and increase profit on continuing operations before amortisation of acquired intangibles and tax by £9.8 million.
During the year under review we increased revenues in all territories, with 73% of sales being made outside the UK. Indeed, sales outside of our traditional primary markets in the UK, mainland Europe and the USA grew by 20%.
Revenue from continuing operations increased to all of our geographic destinations and is shown on the table above.
The biggest absolute revenue growth came in our largest geographic sectors of the USA and UK where organic growth was strong. There was double-digit organic growth in Africa, Near and Middle East, in addition to the extra revenue in that region coming from the acquisition of our security sensor business, Texecom, which has a substantial branch network in South Africa. Mainland Europe showed a lower rate of growth and although Asia Pacific and Australasia grew by more than 10%, we see the opportunity for higher rates of growth here in the future.
All three of our sectors increased revenue by more than 10%, with the Infrastructure Sensors sector benefiting from the acquisition of Texecom. The Industrial Safety sector grew revenues by 16.8% and the Health and Analysis sector increased by the highest rate at 20.0%, with the growth in these two sectors predominantly organic. All three sectors increased profits.
Revenue, profit and returns are discussed on a sector basis in the Sector reviews.
Adjusted earnings per share* (which we consider gives a more consistent measure of underlying performance) and statutory earnings per share on continuing operations increased by 20% and 18% respectively, very good rates of growth. A reconciliation of adjusted earnings figures to statutory figures is given in note 2 to the accounts.
We paid out cash of £36 million on acquisitions and received £15 million for disposals in 2005/06, a net outflow of £21 million. The acquisition payments included £8 million in deferred consideration, mainly in relation to Ocean Optics which we acquired in 2004/05 and which achieved its maximum targets. These acquisitions and disposals were an important part of reallocating Group resources and positioning us for higher rates of growth.
The largest acquisition in the year was that of Texecom Limited (UK) in November 2005. We paid a total cash consideration of £26 million with the last audited accounts showing revenues of £19.2 million and earnings before interest and tax of £3.9 million. Prior to this we acquired Netherlocks Safety Systems B.V. (The Netherlands) in July 2005 for 13 million (£2.1 million) and Radio-Tech Limited (UK) in August 2005 for £2 million, these two businesses having a combined annual profit of £0.7 million on revenue of £3.2 million in their last audited accounts. There is no deferred consideration for Texecom but there is the potential to pay a further £7.3 million of consideration for the other two businesses conditional on substantial profit growth. The performance of each business has exceeded our expectations with all achieving very good growth and all delivering a return well in excess of the Group weighted average cost of capital which is calculated as being 8%.
In April 2006, early in the new financial year, we purchased Mikropack GmbH Aufbautechnik in der Sensorik ("Mikropack") for 12.3 million (£1.5 million) with up to a further 12.3 million (£1.5 million) payable depending on performance. Mikropack manufactures light sources and photonic accessories and joins our Ocean Optics business.
Disposal of the eight businesses converted assets, which were performing below acceptable Group levels, into cash. In aggregate the businesses sold contributed operating profit of £1.5 million to total Group profit in 2005/06 and £1.6 million in the prior year. The largest element of the disposal proceeds came from the sale of our group of five high power Resistor businesses, sold for £14 million in February 2006. The Consolidated income statement shows a profit from discontinued operations of £1.3 million. This comprises a pre-tax gain on disposal of £5.9 million, tax on disposal of £0.1 million, operating profit less tax of £0.9 million and is after writing off goodwill of £5.4 million attributable to these businesses.
Expenditure on Research & Development ("R&D") in our continuing operations increased by 20% to £13.5 million, representing 4.3% of revenue - a little higher than the prior year. R&D expenditure as a percentage of revenue in each of our three sectors was consistent with last year, with Health and analysis the highest at 4.9% of sales and Infrastructure sensors at a similar rate. Under IFRS we are required to capitalise certain development expenditure and include it as an asset on the Consolidated balance sheet and also to amortise expenditure from prior years. In the year we capitalised £2.5 million of such expenditure and amortised £1.4 million, resulting in an asset of £3.8 million on the closing balance sheet. All of these figures are at higher levels than in the prior year, demonstrating the increase in the amount of development work which we believe will have a future benefit. The net impact is that the Consolidated income statement was charged with an 11% higher cost than last year.
Expenditure on property, plant, equipment and computer software was 34% (£3.2 million) higher than 2004/05 at £12.6 million. There was less expenditure on property this year but more investment in operating assets to improve the performance of our businesses. The year’s expenditure was 150% of depreciation/amortisation, a higher ratio than typical but indicative of our continued intention to invest for future growth.
Cash flow was once again very good. Cash generated from operations was £70 million, including a small cash outflow (£0.7 million, 2005: £2.5 million inflow) into working capital despite high rates of growth in the business overall. We started and finished the year ungeared. The table on the next page summarises the change in net cash, the main elements of which are discussed in this financial review.
During the year we started to purchase Halma shares to be held in Treasury to fund the new performance share plan. In the coming year we would expect to purchase £1 million to £2 million of Halma shares for this purpose and this is likely to be an ongoing activity. We also expect to increase the amount of cash paid into the Halma pension schemes following the anticipated outcome of the main scheme valuation now in progress. The additional cash contributions in 2006/07 are expected to be in the order of £4 million. These additional demands on our cash will have some impact on our financial position but we do not believe they will significantly affect our investment or growth potential.
| £ million | 2006 | 2005 |
|---|---|---|
| Cash generated from operations | 70.2 | 61.4 |
| Acquisition of businesses | (36.2) | (24.6) |
| Disposal of businesses | 14.6 | (1.7) |
| Development costs capitalised | (2.5) | (1.1) |
| Net capital expenditure | (11.6) | (9.0) |
| Dividends paid | (24.5) | (23.3) |
| Taxation paid | (16.8) | (14.5) |
| Issue of shares | 0.6 | 2.5 |
| Net finance (expense)/income | (0.4) | 0.2 |
| Exchange adjustments | (1.9) | 0.6 |
| (8.5) | (9.5) | |
| Net cash brought forward | 12.0 | 21.5 |
| Net cash carried forward | 3.5 | 12.0 |
The Group finances its operations from retained earnings and third party borrowings when needed. There are no material funds outside the UK where repatriation is restricted. The Group’s Treasury policies seek to minimise financial risks and ensure sufficient liquidity for foreseeable needs. No speculative transactions are undertaken. Day to day implementation of the policy is largely delegated to the operating companies, overseen by Halma Head Office and co-ordinated in areas where we feel value will be added. Purchase and sale transactions are hedged into the functional currency of the relevant operating company and balance sheet net currency assets are hedged but foreign currency profits are not hedged.
Whilst we were again ungeared at the year end we seek to maintain financial flexibility so that short and long-term funding needs can be met and to allow opportunities to be taken as they arise. The Group is able to borrow at competitive rates and therefore consider this the most effective means of funding increased investment in the immediate future. During the year we secured a £60 million five-year debt facility from our well-established banking partners, improving our ability to fund our medium-term growth plans.
High margins and strong returns underpin the resilience and strength of Halma. We have benefited from the improvement in returns resulting from the sale of lower return businesses and this is demonstrated by the fact that return on sales for the total Group, including discontinued operations, would have increased from 16.7% to 17.7% in the year. Return on sales* on continuing operations increased from 18% to 18.7% this year with Health and Analysis growing sharply from 16.1% to 21.0%, in part benefiting from the recovery in our Water business but across the Group we achieved a widespread improvement.
We do not specifically target improvement in return on sales however we have found that as our businesses grow, many of them generate higher returns and higher margins due to significant operational leverage – we have high-margin businesses which benefit greatly from sales growth.
Return on Capital Employed (“ROCE”) is our measure of operating performance (see the calculation in note 3 to the accounts) and it increased to 56.9% (2004/05: 48.8%), a high rate but not untypical for Halma. ROCE measures our stewardship of the assets we use and the efficiency with which we run our businesses to generate the Group's strong cash flows.
Return on Total Invested Capital (“ROTIC”) increased to 12.8% (2004/05: 12.1%). The calculation basis is described in note 3 to the accounts – it is a post-tax measure and includes in the denominator all historic goodwill but excludes the pension deficit and also excludes the creditor relating to the pension obligations for companies sold. We feel that a basis where an increased pension deficit improved ROTIC would not be appropriate. The increased ROTIC arises because we have grown earnings faster than the underlying capital base and we continue to exceed our weighted average cost of capital (“WACC”) by a large margin, sustaining the generation of significant value for shareholders. Together with Total Shareholder Return, ROTIC is the key measure of performance which we employ in our performance share plan, aligning our senior executives with shareholders.
We have a progressive dividend policy; growing our dividend but with the objective of increasing cover towards a figure of around 2 over time, a level we feel is appropriate for our business. With the high level of earnings growth this year we have taken a good step towards this objective. The Board has recommended a 5% increase in the final dividend to 4.12p which together with the interim dividend (which was also 5% higher than last year) will give a total dividend of 6.83p per share, assuming the final dividend is approved. The total cost of the final dividend is expected to be £15.2 million, giving a total cost of £25.2 million for the dividends paid in respect of the year ended 1 April 2006. We believe we have adequate distributable reserves for the foreseeable future after taking into account the impact of inclusion of the pension deficit discussed below. Dividend cover, based on continuing operations before amortisation of acquired intangibles, is 1.6 times (2004/05: 1.5 times).
During 2005/06 the Group adopted International Financial Reporting Standards ("IFRS") in common with other listed companies in the European Union. This has required restatement of the 2004/05 results reported previously under UK GAAP. The financial information in respect of the Company, Halma p.l.c., is not required to be reported under IFRS and has therefore been prepared under UK GAAP and is included from page 74 to 80, at the end of the financial section of this Annual report.
There was little overall impact on Halma’s reported financial results from the adoption of IFRS. The Group’s underlying business economics are unchanged.
Profit before taxation and amortisation of acquired intangibles/goodwill under IFRS was £0.1 million higher than under the accounting policies used in 2004/05. The two main elements of these IFRS adjustments are as follows:
Under IFRS an expense is now included in the Consolidated income statement in relation to employee share related schemes operated by the Group. A performance share plan ("PSP") was introduced in 2005 and phasing it in has caused the major element of the year on year increase in the share-based payment expense. There would have been an extra element of cost for this and future years under the old share option plans which the PSP replaces. The total cost of all share-based payments is expected to have an annual run rate of approximately £2 million by March 2008, depending on performance.
Certain development costs are capitalised and amortised although the majority of R&D continues to be expensed as incurred. Capitalisation of development costs exceeded amortisation by £1.1 million in the year.
The main IFRS changes on the Consolidated balance sheet are as follows:
Now only accrued when the dividend is approved.
The net pension liability on the Group’s two defined benefit schemes, which are closed to new members, is now included in the Consolidated balance sheet. At 1 April 2006 the liability amounts to £46.0 million with £13.8 million deferred tax asset (2 April 2005: £40.8 million with £12.3 million deferred tax asset). In addition to the Consolidated balance sheet includes a creditor of £4.8 million relating to the pension obligations for the businesses sold during the year. The total pensions related liability at 1 April 2006 was £50.8 million (2005: £41.4 million). Although the value of scheme assets has grown over the year, the deficit has increased as a result of the decrease in the discount rate being applied to the scheme liabilities and by longer life expectancy. The net charge included in the Consolidated income statement is now split between an operating charge and a finance charge.
An unaudited summary of the restatement to IFRS was issued by the Group on 2 September 2005. There are a number of disclosure changes throughout these financial statements and note 29 below gives the restatement of opening figures in further detail.
The effective rate of tax on profit from continuing operations, before amortisation of acquired intangibles, is 30.1% (2004/05: 30.2%). This year’s tax rate is expected to be representative of the tax rate in the near future, depending on the actual mix of profits made across the world.
The Group has both translational and transactional currency exposures. Translational exposures arise on the consolidation of overseas company results into Sterling. Transactional exposures arise where the currency of sale or purchase differs from the functional currency in which each company prepares its local accounts and these exposures are the responsibility of local management. The largest translational exposures are to the US Dollar and to a lesser extent the Euro.
Translational impacts on the 2005/06 results were modest and increased revenue and profit by approximately 1%. US Dollar results were translated into Sterling at a rate of 1.78 (2004/05: 1.84) and Euros were translated at 1.47 (2004/05: 1.47). Around one-third of Halma’s revenue and profit is generated in US Dollars and so a 1% weakening of the US Dollar relative to Sterling would reduce revenue and profit by approximately 0.33% which represents £1 million in terms of revenue and £0.2 million of profit.
On 28 November 2005 we announced the change to reporting the Group’s financial performance under three new sectors, defined by markets rather than product type. A restatement of the last three years’ financial results under the new sector headings was given at that time together with growth drivers and market characteristics by sector.
Each new sector, Infrastructure Sensors, Health and Analysis and Industrial Safety, includes businesses with similar operating and market characteristics. This makes the Group more simple to understand, helps us further develop our market driven strategies and enables more proactive collaboration across the Group.
Halma has recently disposed of a number of non-core businesses including its high power Resistors businesses and over the past two years acquired significant new electronics based businesses so that now over 60% of Group revenues are generated from electronics based businesses. As a result Halma has been reclassified into the Electronic and Electrical Equipment Sector of the FTSE.
The main risks and uncertainties facing Halma are discussed above. The structure of the Group, with a number of relatively small autonomous companies, is designed to spread risk. High quality local teams manage each business, including a finance professional, so that they can respond quickly and effectively to risks as they emerge.
Our internal control processes have been strengthened even further during the year. There has been a widespread positive response to the use of financial "warning signs" in each business which highlight potential risks at an early stage for corrective action. The actions taken have actively reduced risk across the Group. However, we must never be complacent and our internal control processes, discussed in more detail on pages 93 and 94 remain under constant review.
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