“We maintained healthy margins, strong returns and good cash flow, but we aim for greater improvement.”

Kevin Thompson, Finance Director

Group turnover was 2% higher than last year at £299 million (2003/04: £293 million) and ongoing turnover grew by 5% on a constant currency basis, excluding the turnover of new businesses at the time of acquisition. Profit before tax* at £50.4 million (2003/04: £50.3 million) was the highest ever made by the Group, by a small amount. On a statutory basis profit before taxation increased to £44.9 million (2003/04: £36.9 million). These results were achieved in 52 weeks rather than 53 weeks last year. We maintained healthy margins, strong returns and good cash flow, but we aim for greater improvement.

Around one-third of Halma’s turnover and profits are made in US Dollars and US Dollar-related currencies, with around 15% in Euros. The average rate at which we translate US Dollars has deteriorated by 9% in the year and even though the Euro translation rate was reasonably stable, the total currency impact reduced turnover by £10 million (3.7%) and profits by £1.6 million (3.2%). The commercial effects of currency movements on transactions, which show themselves for example in the advantage gained by US competitors, are difficult to quantify, but have a notable adverse impact on our business.

Measured at constant exchange rates, four of our sectors moved ahead in sales and profits, the exceptions being Resistors and Water – these are discussed in the Chief Executive’s Review.

Whilst the adverse currency effect was not as bad as we feared at the Interim stage, it impeded our progress.

In May 2004 we acquired Diba Industries, Inc. for £8 million and in June 2004 we paid an initial consideration of £14 million for Ocean Optics, Inc. In both cases the purchase price was approximately equal to their turnover at the time of acquisition, and pro-rata they would have added £17 million to our 2004/05 turnover. Up to a further £14 million is payable for Ocean Optics, with the maximum reached if it doubles its profit in the two years post acquisition. In the first year, it met its target.

Both are high-return businesses and have developed well since acquisition, contributing to the ongoing development of our Optics and Specialist sector which started with the disposal of three non-core businesses last year. Within the Optics and Specialist sector we also report holding company costs which increased this year, in part due to the cost of management changes.

Return on sales* at 16.8% was slightly below last year’s figure of 17.2%. High and consistent margins are a feature of the Group and all sectors except Resistors and Water maintained their return on sales. The benefit to Group margins from the disposals mentioned above was eliminated this year by the impact of those two sector performances. One important factor which affected the Resistors sector in particular, was the increase in stainless steel prices this year taking £0.9 million from Group profit.

A key indicator used internally in managing our businesses is Return on Capital Employed (ROCE*) and we have therefore published its progress over many years. It demonstrates the effectiveness of our managers in utilising the tangible assets under their direct control. At 62% for the Group this year, ROCE* is high even for Halma reflecting the good management of resource at operating company level.

We recognise the value to shareholders in reporting Return on Total Invested Capital (ROTIC*) and so this year we are also reporting that figure. We are reporting a post-tax ROTIC* which includes goodwill going back over the years. ROTIC* recognises that businesses must use both retained earnings and debt wisely to give shareholders good returns. As the graph on page three of this Annual Report shows, this year’s ROTIC* of 13.1% is far in excess of our weighted average cost of capital, continuing the trend established over many years.

Halma has a history of good cash generation and this year was no exception. Operating cash flow net of capital expenditure as a percentage of operating profit was 101%. We finished the year with net cash of £12 million. As noted below we do carry loans to hedge our currency assets but overall we are currently ungeared.

These strong cash flows will finance another record dividend. The Board recommends a final dividend of 3.92p per share, giving a dividend for the full year of 6.5p, 5% up on last year. We have continued our progressive dividend policy, dividends having increased every year for more than 25 years.

As the dividend increase is above the earnings increase, dividend cover has reduced a little. Our task is to deliver the earnings growth in the coming years so that we can raise that cover again. If approved, this final dividend will be paid on 24 August 2005 to shareholders on the register at the close of business on 22 July 2005.

Our operating companies hedge their trading transactions back into their local reporting currency. Our policy is to hedge our US Dollar and Euro net investment in overseas operations through currency denominated loans, but not to hedge the effects of currency movements on the translation of overseas earnings into Sterling. The philosophy behind our treasury activities is one of risk management and control; no speculative transactions are undertaken. As anticipated, the effective tax rate on profits* was in line with last year at 31.2%. Depending on the precise mix of profits earned in various tax jurisdictions, we expect the effective rate going forward to be broadly similar but perhaps a little higher. Pending the introduction of International Financial Reporting Standards (IFRS) next year, we have continued to adopt the transitional provisions of FRS 17 (Retirement Benefits) and these disclosures are given in Note 26. Under FRS 17, the net pension deficit has remained at £29 million net of the related deferred tax. The increase in the market value of scheme assets has been offset by higher calculated liabilities in part due to lower discount rates. New cash going into the main (defined benefit) pension scheme is being invested in fixed interest securities so that over time the profile of assets is more closely matched with the scheme’s liabilities, the scheme having been closed to new members several years ago.

A critical feature of Halma is the entrepreneurial and autonomous nature of our operating companies. To underpin that approach we install high-quality finance executives in each business to monitor and assist development.

Responsibility and accountability of local management has always been paramount but this has been further emphasised over the past year with strengthened local accounts sign-off and by widespread use of relevant financial warning signs across the Group.

We have further enhanced our internal review procedures this year, continuing to use senior finance staff to review other operating businesses but adding more rigorous feedback and follow-up. Together with the independent reporting route to the Audit Committee introduced in 2003/04, I can now confirm that our internal audit function is fully established.

For 2005/06 the Group is required to prepare its consolidated accounts in accordance with International Financial Reporting Standards (IFRS). Halma’s Interim Report and Annual Report and Accounts for 2005/06 will therefore contain financial statements for 2005/06 and comparatives for 2004/05 prepared under IFRS. There will be some presentational differences, but in summary the impact on trading results is not expected to be material and net assets will be reduced mainly by the inclusion in the Balance Sheet of the pension deficit noted above. Cash flows and the underlying economics of the business remain unchanged.

In a little more detail, the main effects of IFRS on Halma are as follows: since Research and Development is an important part of our business (we spend 4% of sales on R&D) we will recognise this asset by capitalising appropriate costs, although we anticipate expensing most of the cost as we go; share-based payments will add a new charge against our profits, starting off low but expected to increase as each new year falls under these rules and as we transition away from share options to our proposed performance share plan; goodwill on acquisitions will be frozen, goodwill amortisation no longer appearing in the Profit and Loss Account; pension costs are likely to be a little more volatile and as mentioned above, the pension deficit will come onto the Balance Sheet. The new rules on financial instruments will have a negligible effect on us.

In late summer, ahead of our half year end, we will publish a full quantification, reconciliation and explanation of the impacts on Halma of IFRS.

This year has seen a fair amount of change, with some repositioning and a lot of investment – there has been associated cost. Our pursuit of positive change and improvement will continue. Our key objective is to continue creating wealth for our shareholders through investment in high performance businesses and the generation of strong cash flows.