24th Feb 2005 07:03
GKN PLC24 February 2005 For immediate release 24 February 2005 GKN Preliminary Results 2004 Financial Results 2004 2003 Increase/--------------------------- -------- -------- (decrease) --------Sales £4,447m £4,585m (3%)--------------------------- -------- -------- --------Results before goodwill amortisation andexceptional items Operating profit £268m £302m (11%)Profit before tax £221m £246m (10%)Earnings per share 21.3p 22.8p (7%)--------------------------- -------- -------- --------Operating exceptional items £(250)m £(91)m n/a--------------------------- -------- -------- --------Operating (loss)/profit £(11)m £174m n/a--------------------------- -------- -------- --------Exceptional profits on businesses sold £687m £55m n/a--------------------------- -------- -------- --------Profit before tax £629m £173m n/a--------------------------- -------- -------- --------Earnings per share 78.8p 13.8p n/a--------------------------- -------- -------- --------Net funds/(borrowings) £65m £(793)m £858m--------------------------- -------- -------- --------Dividend per share 11.9p 11.6p 2.6%--------------------------- -------- -------- --------Note: 2004 profit includes £11 million benefit from changing the method ofcharging depreciation from reducing balance to straight line. Results beforegoodwill amortisation and exceptional items are presented in the above table toshow the underlying performance of the Group. Business highlights • A year of significant transition o Disposal of 50% shareholding in AgustaWestland transforms balance sheet o Control of TFS secures leading torque technology position o Driveline deployment to low cost, high growth regions begins • Group profit before tax, goodwill amortisation and exceptional items down 10% in line with expectations o Impact of global raw material and energy cost increases o Negative currency and pension impact. Positive depreciation change. o Continuing operations operating profit was level with 2003 before increase in charge for UK pension deficit. • Increased Automotive revenues despite flat major markets • Good second half Aerospace recovery and margin improvement •Technology-led wins on new US and European aerospace programmes Kevin Smith, Chief Executive of GKN plc, commented: "The strategic development of GKN gathered pace in 2004. "The most significant event of the year was the disposal of our shareholding inAgustaWestland at the end of November which generated cash consideration in theyear of £1,028.5 million and a profit on the sale of £652 million. Thetransaction has transformed the Group's balance sheet and enhanced our abilityto pursue the strategic growth and development of GKN in automotive andaerospace. "Taking control of Tochigi Fuji Sangyo of Japan, a specialist torque managementsupplier, was a further step in our move into higher value automotive systems. Anumber of new vehicles launched during 2004 were equipped with completedriveline systems from GKN underpinning our strategic ambitions for torquetechnology. "In Aerospace, a parallel focus on the technology of composite aircraftstructures and their production processes secured positions on the world's majornew civil and military aircraft programmes. We are also deeply involved in thedevelopment of greater use of composites within jet engines. "We initiated the restructuring measures in Automotive announced in March 2004and, although costs in the year were somewhat lower than originally estimated,the programme to transition more of our automotive driveline production assetsto high growth, low cost economies remains on track to deliver the benefitsoriginally identified. "Our Automotive revenues in the year increased in mainly flat markets and we sawa strong, second half improvement in Aerospace margins. "Raw material prices, particularly steel, provided a major challenge in 2004 andwhile this will continue to be a difficult issue we have actions in place whichmake it manageable. As anticipated, the charge for the UK pension deficit was£15 million higher than in 2003 and the strength of sterling also affectedreported profits. There was some offset from an £11 million benefit as a resultof a modification to our treatment of depreciation. "In these circumstances, the 10% reduction in profit before tax, goodwill andexceptional items to £221 million was a sound performance. "At the year end we had net funds of £65 million compared with net borrowings of£793 million at the end of 2003 and are well positioned for future development." 2005 Outlook In Automotive the major European and North American markets are forecast toremain relatively static in 2005. Growth in the developing markets is expected to continue, although at a slightlylower level than 2004. Overall, global automotive demand is anticipated tomaintain its steady 2-3% annual growth. In Aerospace prospects are improving, with rising civil aircraft production anda robust US military market. Our OffHighway markets overall look set to show modest growth with steady USdemand and a slight increase in Europe. Against this background we expect our Automotive businesses to improveunderlying sales and operating performance although high worldwide raw materialprices, particularly for steel, present a challenge to 2005 Automotiveprofitability. Renegotiated annual supply contracts will add some £30m to costsin 2005. In addition we are exposed to fluctuations in the scrap steel pricewhich is surcharged in the industry. In the first quarter this surcharge willhave some impact on costs, although if scrap were to stay at the currentsomewhat reduced price levels, little further impact would be felt in the restof the year. We continue to negotiate for recovery of this cost increase with our customersand are having some success, although the full quantum of recovery will not beknown for several months. Our focus on productivity improvement will continue. In Aerospace trading is expected to continue to improve in 2005 and OffHighway'sperformance should also show progress. The benefits of our leading technology, new products and strong presence inemerging markets, combined with the benefits of the restructuring activitiesunderway, leave the Group's Continuing businesses well positioned for growth. In addition, the transformation of the Group which started in 2004 will continuein 2005. The £1 billion sale proceeds from AgustaWestland have significantlystrengthened the balance sheet and provide a solid platform for acceleratedgrowth in profits and earnings from their new, re-based levels. The Group iswell placed to take advantage of opportunities in all its markets and looks tothe future with confidence. Further enquiries: GKN Corporate CommunicationsTel: 020 7463 2354 The full text of the Operating and Financial Review which will appear in theAnnual Report & Accounts together with Financial Statements and selected notesextracted from the audited accounts is attached to this press release which maybe downloaded from www.gkn.com. GROUP ACTIVITIES GKN is a global engineering business serving the automotive and aerospacemarkets.Automotive activities comprise GKN Driveline, Powder Metallurgy, AutoComponents,Emitec and OffHighway Systems. Aerospace activities are concentrated on structural components, propulsionsystems and special components for both military and civil aerospace markets.For eleven months of the year the Group had a 50% shareholding inAgustaWestland, the European helicopter manufacturer. This was sold on 30November 2004. STRATEGY GKN is committed to providing long-term shareholder value by supplyingoutstanding products and services to our global automotive and aerospacecustomers to produce growth in sales and sustained profitability. This will beachieved largely through a combination of organic development of our businessesand selective acquisitions which add to our technological capabilities,geographical presence or are in support of customer outsourcing programmes. CHANGES IN THE COMPOSITION OF THE GROUP With effect from 1 April 2004 the Group increased its shareholding in TochigiFuji Sangyo (TFS) from 33% to 84% with the result that is accounted for as asubsidiary, rather than an associated company, from that date. Because TFS is apublicly quoted company with a March year end its results as an associate wereincluded six months in arrears. The 2004 accounts therefore include a 33% shareof its results for the six months 1 October 2003 to 31 March 2004 and 100% ofits results for the 9 months 1 April 2004 to 31 December 2004, with appropriateadjustment to earnings for the remaining 16% minority interest. The company isbeing integrated into the Driveline division and forms the nucleus of its TorqueSystems Group. For strategic reasons, the 50% shareholdings in AgustaWestland and AerosystemsInternational were sold on 30 November and 13 August, respectively. The resultsof these businesses have been incorporated in the consolidated results to thedates of disposal and are separately shown as "discontinued operations" in theprofit and loss account. Comparative figures for 2003 for discontinuedactivities comprise these two companies together with the Group's share of Alvisplc which was sold in September 2003. On 1 September 2004 the Group soldWalterscheid Rohrverbindungstechnik GmbH, its German OffHighway hydraulicfittings operation. CHANGES IN ACCOUNTING POLICY There were no changes in accounting policy in the year. However, following areview by the directors and in order to bring the Group into line withcomparable engineering companies, the method of charging depreciation ontangible fixed assets was changed with effect from 1 January 2004 from reducingbalance to straight line and this increased the year's profit by £11 millioncompared with the previous basis. REVIEW OF OPERATIONS In this review and elsewhere in the annual report, in addition to the statutorymeasures of earnings, we have included references to profit before goodwillamortisation and exceptional items since we believe this shows most clearly theunderlying trend in performance. Where appropriate, reference is made to resultsexcluding the impact of both 2003 and 2004 acquisitions and divestments as wellas the impact of currency translation. As in 2003, in the segmental analysis thecost of the UK pension deficit, which is material and cannot readily beattributed to the current Automotive or Aerospace businesses, is shownseparately. Group performanceSalesTotal sales, including our share of joint ventures and associates, were £4,447million compared with £4,585 million in 2003, a decrease of £138 million (3.0%),which was more than accounted for by the reduction of £235 million in sales ofdiscontinued businesses. In continuing businesses, sales increased by 2.7% from £3,595 million in 2003 to£3,692 million in 2004. Excluding the impact of currency translation,acquisitions and divestments, the underlying increase in sales was similar at£131 million (3.8%). Automotive sales of £3,123 million were £87 million (2.9%) above last year withan underlying increase of £118 million. 2004 was a year of relatively staticmarket conditions in both Western Europe and North America which werecompensated to some extent by continuing strong growth in emerging markets,albeit at somewhat lower rates than in 2003. Aerospace Services sales of £569 million were £10 million (1.8%) higher than2003. Excluding the impact of currency translation and acquisitions, theincrease was 2.5%. Sales in discontinued businesses were £755 million compared with £990 million in2003. Most of this reduction reflected the absence of the Group's share of Alvisplc, which was sold in 2003 and the shorter period for which results wereincluded for AgustaWestland and Aerosystems International. AgustaWestland,however, also experienced underlying sales reductions following completion ofmajor UK military contracts in the first half of the year. Operating profit (before goodwill amortisation and exceptional items)Total Group operating profit before goodwill amortisation and exceptional itemsof £268 million was £34 million (11.3%) lower than 2003. Operating profit in continuing operations was £181 million, a reduction of £14million (7.2%) from the previous year. Movements in currency exchange rates hada negative impact on both translation of results and transactions of £11 millionand £14 million, respectively. The impact of higher raw material costs, mainlyon steel and steel-based products, was significant and although some recoverywas made from customers, the net impact on the operating profit for the year isestimated at around £40 million. Net acquisitions and divestments contributed£15 million. Total operating profit was also impacted by an increase of £15million in the charge for the UK pension deficit. Automotive operating profit decreased by £11 million (5.6%) to £184 million.Excluding translational currency effects, acquisitions, divestments and thebenefit of the changed depreciation methodology the decrease was £18 million(9.7%). Aerospace Services profits improved from £23 million to £35 million. Adjustingfor translational currency impacts, acquisitions, divestments and the benefit ofthe changed depreciation methodology, underlying profit increased by £4 million(20.0%). Profits in discontinued operations fell by £20 million to £87 million reflectingthe lower sales noted above. As noted previously, the charge to operating profit in respect of the UK pensionscheme deficit rose to £38 million from £23 million in 2003 and this is shownseparately in the segmental analysis. The increase was due to the higher annualcharge commencing mid-way through 2003. Operating exceptional items (including goodwill impairment)There was a charge in the period of £250 million (2003 - £91 million) whichcomprised two elements: £€99 million in respect of the restructuring measures announced in March 2004 to move some 20% of Driveline production capacity from high cost, low growth economies to the low cost emerging markets of Eastern Europe, South America and Asia Pacific, together with costs associated with the recovery programme in US Powder Metallurgy and overhead cost reductions elsewhere in the Group; and £€151 million from a review of asset carrying values relating to the accelerated write down of goodwill and tangible assets in Powder Metallurgy where planned recovery in the US has been delayed by higher raw material prices and weak markets for the business's major customers. The 2003 total goodwill impairment of £91 million arose in Powder Metallurgy (£83 million) and Aerospace Services (£8 million). The £99 million charged in respect of restructuring measures was somewhat lowerthan had been estimated earlier in the year as discussions about plant closureswith customers and employees identified some potential alternative,cost-effective actions. It comprised £62 million in respect of asset write-downsin specific plants where definitive plans and intent existed or actions had beentaken, and £37 million in respect of redundancy and other reorganisation costswhere external announcements or commitments had been made by the end of theyear, mainly in Driveline and Powder Metallurgy. Cash outflow in the year inrespect of these totalled £16 million. Looking forward, the original estimates of total charges of approximately £210million, cash costs of £140 million and full year benefits of £60 million by2007 remain valid. Goodwill amortisationAmortisation of goodwill was £29 million (2003 - £37 million). In continuingoperations the charge was £24 million compared with £31 million in 2003. Statutory operating loss/profitThere was an £11 million loss after goodwill amortisation and exceptional items(2003 - profit £174 million). Exceptional items arising on sale of businessesExceptional profits arising on the sale of businesses totalled £687 million(2003 - £55 million). £652 million related to profit on the disposal of theGroup's 50% shareholding in AgustaWestland, together with related property, fora cash consideration received in the year of £1,028.5 million and was aftercharging £100 million of goodwill previously charged directly to reserves on theoriginal acquisition of Westland Group plc. No account has yet been taken of afurther £35 million of consideration which remains in escrow pending the awardby the UK Ministry of Defence of certain contracts relating to its fleet of Lynxhelicopters. The balance of the exceptional profit of £35 million related mainlyto the disposal of the Group's 50% shareholding in Aerosystems International andthe wholly owned subsidiary Walterscheid Rohrverbindungstechnik GmbH. InterestNet interest payable by subsidiaries was £46 million (2003 - £56 million). Thereduction was due mainly to a combination of lower average borrowings in thefirst 11 months of the year and interest for one month on the proceeds of saleof AgustaWestland and the effect of interest rate movements in our dollar andeuro balance sheet hedges. The Group's share of net interest payable by jointventures was £1 million (2003 - nil), all of which was in discontinuedbusinesses. Interest costs were covered 5.7 times (2003- 5.4 times) by operating profitbefore goodwill amortisation and exceptional items. Looking ahead to 2005, in the light of the Group's strategic intent to pursueselective business acquisitions, it is currently intended to leave the Group'slong-term fixed borrowings in place. Profit before taxTotal profit before tax, goodwill amortisation and exceptional items was £221million compared with £246 million in 2003, a decrease of 10.2%. Statutory profit before tax was £629 million compared with the 2003 figure of£173 million. TaxationThe total tax charge decreased to £49 million from £70 million in 2003. The tax rate, expressed as a percentage of profit before goodwill amortisationand exceptional items, for the year was 28.1% compared with a 2003 figure of31.3%. The 3.2 percentage point decrease is largely attributable to an increasein credits arising from the settlement of prior year tax liabilities, thisbenefit being partially offset by an increased deferred tax charge resultingfrom the non-recognition of deferred tax assets in respect of current year taxlosses and the revision of prior year capital allowance claims in the UK. The tax rate for 2005 is expected to show a modest reduction following thedisposal of the AgustaWestland business. In addition, there may be a favourableimpact from the future resolution of outstanding tax issues. The tax credit on exceptional items was £13 million (2003 - £7 million). The total effective tax rate based on profits after goodwill amortisation andexceptional items was 7.8% (2003 - 40.5%). EarningsEarnings per share before goodwill amortisation and exceptional items were 21.3pcompared with 22.8p in 2003, a reduction of 6.6%. After these items the figurewas 78.8p (2003 - 13.8p). The effect of the 13.3 million shares bought intotreasury in the final quarter of the year was negligible. DividendA final dividend of 8.0p per share is proposed, payable on 10 May 2005 toshareholders on the register at 15 April 2005. Shareholders may choose to reinvest this dividend under the DividendReinvestment Plan ('DRIP'). The closing date for DRIP mandates is 25 April 2005. Together with the interim dividend of 3.9p, the total dividend for the year willbe 11.9p, an increase of 2.6% over the equivalent figure for last year. Thetotal dividend is covered 1.8 times by earnings before goodwill amortisation andexceptional items (2003 - 2.0 times). Cash flowOperating cash flow, which GKN defines as cash inflow from operating activities(£179 million) adjusted for capital expenditure (£184 million) and proceeds fromthe disposal of fixed assets (£8 million), was £3 million compared with £138million in 2003 but was after a £100 million advance payment into the UK pensionscheme and £21 million (2003 - £13 million) expenditure on exceptional items ofboth current and prior years. Excluding the advance pension payment and the impact of exceptional provisionsthere was a £22 million outflow on working capital, largely reflecting higherstocks resulting from the increase in raw material prices and the increase inunderlying sales. Capital expenditure was £184 million (2003 - £162 million). This represented115% of depreciation and is in line with our previous expectations that capitalexpenditure is likely to be in a range of 110% - 120% of depreciation in anormal year. Net interest paid was £46 million compared with £53 million in2003. Dividends from joint ventures and associates were £10 million (2003 - £68million), most of the reduction reflecting the absence of a dividend fromAgustaWestland. Tax paid totalled £47 million compared with £63 million in 2003, the latterfigure including the settlement of certain prior year tax issues. The figure for2005 is expected to be broadly similar to 2004. The net impact of acquisitions and divestments was an inflow of £1,045 million(2003 - £29 million) leaving a net cash inflow for the year, before dividendpayments, of £963 million (2003 - £118 million). Proceeds from divestments inthe year totalled £1,068 million in respect of the 50% stakes in AgustaWestlandand Aerosystems International and the wholly-owned hydraulic fittings business,Walterscheid Rohrverbindungstechnik. Acquisitions mainly comprised an additional51% of TFS for £34 million together with an additional 10% of Shanghai GKN DriveShaft for £8 million. In addition, there were cash and bank balances onacquisition of £17 million. Share buybackIn October 2004 the Company announced its intention to commence a share buybackprogramme up to a value of £100 million. By the end of November, the start ofthe 'close period', 13.3 million shares had been purchased into treasury at acost of £30 million. It is intended to recommence the programme in 2005. Net funds/borrowingsAt the end of the year the Group had net funds of £65 million (2003 - netborrowings £793 million). These included the benefit of customer advances of £53million in the Aerospace businesses (2003 - £48 million), which are shown inshort-term creditors in the balance sheet. There were net borrowings in jointventures of £2 million. GoodwillAt the year-end the balance sheet showed goodwill of £197 million (2003 - £340million) in relation to subsidiaries and a further £7 million (2003 - £114million) within the equity value of joint ventures and associates. Thesignificant decrease in value of goodwill in subsidiaries reflects the £100million impairment charge made in the year. The reduction in joint ventures andassociates follows the divestment of AgustaWestland and the re-classification ofTFS as a subsidiary. Shareholders' equityShareholders' equity was £1,460 million at the end of the year compared with£926 million at the end of 2003. Retained profit for the year was £491 millionafter charging £100 million of goodwill previously written off to reserves. Theshares purchased into treasury reduced shareholders' funds by £30 million whilethere was a small (£2 million) increase from shares issued. The currency impactarising on translation was £31 million negative and there were other positivemovements of £2 million. Divisional Developments and PerformanceAutomotive ManagementDuring the course of 2004 a small management team was created, led by IanGriffiths, to take overall responsibility for the management of our Automotivebusinesses. The structure recognises the global nature of the automotive marketand the requirements of our global customers. The objective is to createadditional and accelerated value from the portfolio through a cohesiveintegrated strategy and to ensure the adoption of best in class practices andprocesses across the portfolio. MarketsBy comparison with 2003 car and light vehicle production was relatively stablein both North America, which was down 0.6%, and Western Europe, which was levelwith last year. There was, however, continued growth in the emerging markets ofAsia Pacific where production in China and India rose by some 14% to 5.7 millionunits. Notwithstanding these generally static markets, sales revenue of £3,123 millionwas £87 million higher than 2003. The impact of currency translation was £136million negative while the full year impact of 2003 and 2004 acquisitions andchanges in status added £114 million. The impact of divestments was small at £9million so that on a like-for-like basis sales were £118 million (4.1%) higherthan in 2003. Operating profit was £184 million, £11 million (5.6%) below 2003. The impact ofcurrency translation was £8 million adverse which was exactly offset by thebenefit arising from the change in depreciation methodology. The net effect ofacquisitions and divestments added £7 million and excluding all these factorsprofits fell by £18 million (9.7%). The major factor behind this reduction wassignificantly higher raw material costs, mainly steel and steel-based products.Some but not all of this cost was passed on to customers and the net effect isestimated to have reduced profits by some £40 million by comparison with 2003.The adverse transactional impact of currency was some £14 million, mainly onsales out of continental Europe. GKN DrivelineProducts and marketsGKN Driveline specialises in the manufacture of components for light vehicledrivelines (defined as the components that transfer torque between a vehicle'stransmission and its driven wheels). These include geared components (transfercases, power transfer units and final drive units), torque management devicesand driveshafts (propshafts for longitudinal power transmission and sideshaftsfor lateral transmission). Since the acquisition of the majority shareholding inTFS, the division comprises GKN Driveline Driveshafts (GKN Driveshafts) and GKNDriveline Torque Systems Group. GKN Driveshafts is the global leader in the production of constant velocityjointed (CVJ) products for use in light vehicle drivelines. The majority of CVJsare used in sideshafts for front wheel drive, rear wheel drive and four wheeldrive vehicles; CVJ sideshafts are required for every driven axle withindependent suspension. Some but not all longitudinal propshafts are also fittedwith CVJs. In 2004, based on internal estimates, GKN Driveshafts businesses, including itsjoint ventures, produced around 42% of CVJs for the global light vehicle market.The market share of the next largest producer is estimated at 16%. Nearly 25% ofCVJs are produced by vehicle manufacturers (VMs) for their own use through'in-house' operations. Orders won during the year confirm that there is unlikelyto be any major change in the division's market share in the period up to 2006/7, the latest date for which reliable data is available. GKN Driveshafts manufactures CVJs and related products in 21 countries acrossall major vehicle producing regions of the world and has enjoyed considerablesuccess in developing markets, with strong market shares of some 84% in SouthAmerica and 51% in the Asia Pacific region (excluding Japan and South Korea). GKN Driveshafts is also one of the largest suppliers of premium propshafts,which we define as those propshafts with sophisticated joints, materials orother features. We estimate that in 2004 premium propshafts representedapproximately 33% of global light vehicle propshaft demand, or some 10 millionpropshaft assemblies. GKN Driveshafts' share of this segment was in the regionof 19%. GKN Driveline Torque Systems Group comprises Torque Technology Group (TTG),Industrial and Distribution Services and Specialty Vehicles. TTG produces a wide range of driveline components aimed at actively managing theflow of torque to the driven wheels based on road conditions, vehicle situationand driver intent. Torque management devices (TMDs) are mechanical orelectro-mechanical devices that improve vehicle performance and handling bycontrolling the flow of torque throughout the driveline. GKN offers the most complete range of TMD solutions as both stand-alone andintegrated devices to VMs and to certain Tier One suppliers. In 2004, weestimate that on an annualised basis, GKN supplied approximately 18% of TMDs forlight vehicle applications on a global basis. We expect to increase this sharebased on market acceptance of our electronically controlled coupling, ETM,during 2005. Geared component sales by TTG are currently approximately £100 million perannum, realised through installation on many successful all wheel drive/fourwheel drive vehicles. Increasingly, we are also involved in many activedevelopment projects on future vehicle programmes. We expect above market growthin power transfer units and final drive units as VMs continue to introduce new'crossover' vehicles that combine four wheel drive with car-like dynamics andcomfort, and our products are well positioned for success in these areas. Industrial and Distribution Services operates an aftermarket business, primarilyin Western Europe, that serves distributors and service outlets with a range ofnew and remanufactured driveline and other components, while Specialty Vehiclesservices non-automotive markets, such as marine and all-terrain, with drivelinecomponents. The GKN Driveline business is managed globally to ensure effective use ofresources and capital. Customers are served by global account teams that arestructured to reflect customer organisations, and all manufacturing and sourcingdecisions are reviewed from the perspective of global capacity and strategy. 2004 highlightsSales in 2004 were £2,057 million (2003 - £1,938 million). The change in statusof TFS from associate to subsidiary, the additional 10% stake in our jointventure Shanghai GKN Drive Shaft and the impact of prior year acquisitionsaccounted for £111 million of the increase. The effect of translational currencywas £82 million adverse, leaving the underlying increase at £90 million (4.8%).This overall increase was encouraging as it was achieved in the face of staticvehicle production and continued pricing pressure in major markets. Productivity gains were made from continuous improvement which offset some ofthe annual selling price reductions. However, the adverse effect of higher rawmaterial prices, which in most cases could not be fully recovered fromcustomers, was significant and overall there was a slight reduction in operatingmargins from 2003. There were also some productivity improvements from therestructuring announced in March but, as expected, these did not providesignificant benefits in the year.As part of the division's global strategy of increasing its manufacturingfootprint in low cost regions, agreement was reached during the year for theacquisition of the remaining 51% of the shares not currently owned in Velcon, aMexican manufacturer of CVJs. Completion took place on 1 February 2005 for acash consideration of US$ 83 million (£44 million). There continued to be a high degree of focus on research and development, andduring the year the division invested some £74 million including expendituresfor product and process improvement, cost reduction and innovation. All thesecosts were charged to operating profit during the year. Powder MetallurgyProducts and marketsGKN's Powder Metallurgy division produces metal powder and sintered productswhich are largely iron-based, although growth is currently seen in the use ofaluminium and other alloys. GKN estimates that it has in the region of 16%global market share, with sales to major automotive and industrial originalequipment manufacturers and first tier players. At four times the size of the nearest competitor our advantage lies in technicaldevelopment, manufacturing capability and global reach. Work continues to ensurethat this advantage is fully leveraged. GKN's sintered component production takes place in North America, Western Europeand the emerging markets (Asia Pacific and South America) with the percentagesof sales in those regions being 52%, 42% and 6% respectively.Hoeganaes is the largest producer of powder in North America with a greater than50% market share and has also continued its development outside the US,particularly through growth in Europe due to increased usage by GKN's ownsintering companies in this region. Hoeganaes' sales to external customersaccounted for some 50% of its shipments and just over 10% of the PowderMetallurgy division's sales. Growth of the Romanian powder producer, which wasacquired in 2003, continued as planned. Powder technology was historically seen as essentially substitutional for castor forged components but an increasing trend towards parts designed to takeadvantage of powder metal differentiation potential can be seen. 2004 highlights2004 sales of £589 million were £19 million (3.1%) lower than 2003 due to thetranslational impact of currency. On a like-for-like basis there was an increaseof £21 million (3.7%), with higher sales in Europe and strong growth in theemerging markets of India and Brazil offsetting the impact of reduced productionby General Motors, Ford and Chrysler in North America. 2004 was also marked by a Letter of Intent with Shanghai Automotive IndustryCorporation to review the feasibility of forming a joint venture in China toposition GKN Powder Metallurgy in this rapidly developing market. The division was particularly badly affected by the substantial increase in thecost of scrap steel, its primary raw material, which rose from an average of$158 per ton in 2003 to $302 per ton in 2004 and resulted in a significantreversal of profitability, leading to a small loss in the year and delaying theplanned return to acceptable margins. As noted in the financial section of thisreview, as a result of this and further reductions in the market share of majorcustomers it was considered appropriate to make an impairment charge of £151million in respect of capitalised goodwill and fixed assets of the division. Operational improvements continued as the manufacturing footprint wasprogressively restructured and rationalised. This ongoing achievement isunderpinned by the launch of the GKN Group Lean Enterprise programme providingthe tools to drive operational excellence in a robust, disciplined fashion. During the year new business intake continued positively, with an annualisedpeak sales value of approximately £100 million won in all three operatingregions including strong growth in new customers and applications. Theseprogramme wins, which comprise both new and replacement business, will largelyphase into production in 2006/7. Further impetus for future growth is expectedto be provided by developments at the new European Technical Centre which wasofficially opened in the summer. Customer relationships continued to strengthen,marked notably by a supplier of the year award from General Motors amongstothers. AutoComponents, Emitec and OffHighway Systems Products and marketsAutoComponents, which is predominantly UK-based, manufactures structuralcomponents and engine cylinder liners for passenger car, light vehicle and heavycommercial vehicle markets in Western Europe and the US. Early in 2005 thedivision entered into an agreement to establish a 59% owned subsidiary in Chinawith a view to establishing a new low cost production base to serve existing andemerging markets. Emitec, our 50:50 joint venture with Siemens, produces metalsubstrates for catalytic converters used in cars and light vehicles. OffHighway Systems (OHS) designs and manufactures steel wheels and drive-linesystems for the global agricultural and construction industries. Approximately80% of its sales are to the agricultural market. The European agricultural machinery market declined by 3% compared with 2003,but this was less than expected. By contrast, US agricultural machinery salesincreased by 23% as a result of record net farming income in 2003. Overall, USproduction increased by 28% as field inventories were also rebuilt fromhistorically low levels. Led by China and the recovering US economy, globally the construction marketenjoyed a record year. Production and sales were up by 24% in both of thesemarkets. Europe also returned to growth after the stagnation of the previous twoyears with production up 13% over 2003. 2004 also saw production of both agricultural and construction machineryincrease in other regions and China, India, Japan and Brazil now account forapproximately 33% of global production. OHS sales in these areas will increasein 2005 as new local facilities come on stream. 2004 highlightsAutoComponents sales were £143 million compared with £157 million in 2003.Despite this reduction, driven largely by customer platform changes, operatingprofit was broadly flat inclusive of new programme start up costs and the netimpact of the significant contract and platform changes on the major programmes.Underlying operating conditions remain difficult within this business. Emitec suffered from the cessation of US contracts at the end of 2003. TheGroup's share of sales fell from £55 million in 2003 to £42 million, reflectingan underlying decrease of 20.8%. Profit on the same basis fell by more than 50%.OffHighway Systems sales rose from £278 million to £292 million. Excluding theimpact of currency and divestments the increase was £31 million (11.9%)reflecting both the strength of demand, noted above, and the full recovery ofsteel price increases. Profits also improved significantly from a combination ofvolume increases and productivity gains.Aerospace Services Products and marketsGKN Aerospace Services operates in two main product sectors, Aerostructures andPropulsion Systems & Special Products. We also have an Engineering DesignServices business. As a leader in the design and manufacture of advanced composites, transparenciesand complex metal structures at the component and assembly level we serve allthe major airframe and engine OEMs. Products and services are provided to bothfixed wing and rotary wing manufacturers, with 60% of sales in the US. Currentannual sales are approximately 65% to military and 35% to civil customers. The overall aerospace market improved in 2004, with initial signs of recovery inthe civil sector expected to continue into 2005. Airbus and Boeing areanticipating an increase in the number of aircraft deliveries from 605 in 2004(up from 586 in 2003) to around 670 in 2005 and industry forecasts of thecompound annual growth rate (CAGR) for the civil sector are around 6% for therest of the decade. In the military market a CAGR of 4% from 2004 to 2010 isforecast, with the US being the dominant force. Although we are cautiouslyoptimistic about the recovery in the aerospace sector it does remain fragilewith some major airlines in the US in difficulty and the defence sector havingto balance conflicting priorities. Beyond these market trends we also see significant growth opportunities for GKNdriven by increased use of composite materials on new platforms and engines,focused acquisitions which arise from outsourcing opportunities or provideaccess to complementary technologies or products, and further industryconsolidation. 2004 highlightsSales of £569 million compared with £559 million in 2003. The effect of currencyon translation of sales revenue was £37 million negative, while 2003acquisitions and disposals added a net £34 million. Eliminating these factors,underlying sales were £13 million (2.5%) higher than 2003. Profits for the year of £35 million compared with £23 million in 2003. £3million of the improvement came from the change in depreciation methodology butthis was entirely offset by £3 million from currency translation as the USdollar showed further weakness in the year. The full year impact of theaerospace business acquired from Pilkington in October 2003 was £8 million sothat the underlying increase in the year was £4 million (20%). This reflected amarked improvement in the second half of the year, following a first half whichhad been impacted by tooling and other asset write-downs and US programme delayswhich have now been rectified. The military side of the business continued to perform steadily and there wasalso some improvement in civil in the second half as a consequence of uplift indemand which is expected to continue into 2005. Discontinued Operations AgustaWestland The Group completed the sale of its 50% shareholding in AgustaWestland on 30November 2004. Figures for 2004 therefore reflect our share for the elevenmonths ended on that date and are based on accounts which reflect the contractmargin and provision reviews which normally take place as part of the year endprocedures. GKN's share of sales revenue in 2004 of £740 million was £136 million below the2003 figure, reflecting the loss of one month's revenue, together with lowerunderlying sales largely as a consequence of the completion of the EH101contract for the UK Ministry of Defence during the early part of 2003 anddelivery of the final six Apaches for the British Army in 2004. As a consequence, GKN's share of operating profit of £86 million was £16 millionbelow last year. As noted earlier, the Group also booked an exceptional profit of £652 million ondisposal of the business. Other discontinued operations During the year the Group also sold its 50% shareholding in AerosystemsInternational to its joint venture partner BAE Systems plc. This businesscontributed £15 million (2003 - £26 million) to Group sales and £1 million (2003- £1 million) to operating profit in the year. OTHER FINANCIAL MATTERS Treasury managementGKN co-ordinates all treasury activities through a central function whosepurpose is to manage the financial risks of the Group as described below and tosecure short and long-term funding at the minimum cost to the Group. The centraltreasury function operates within a framework of clearly defined Board approvedpolicies and procedures, including permissible funding and hedging instruments,exposure limits and a system of authorities for the approval and execution oftransactions. It operates on a cost centre basis and is not permitted to makeuse of financial instruments or other derivatives other than to hedge identifiedexposures of the Group. Speculative use of such instruments or derivatives isnot permitted, and none has occurred during the year. The central treasury function prepares a formal twice yearly report to theBoard, and prepares formal monthly reports for the Finance Director and othersenior executives of the Group. In addition, the gross and net indebtedness ofthe Group is reported on a weekly basis to the Chief Executive and the FinanceDirector, whilst liquidity, interest rate, currency and other financial riskexposures are monitored daily. The central treasury function is subject toannual internal and external reviews of controls. Funding and liquidityThe Group funds its operations through a mixture of retained earnings andborrowing facilities, including bank and capital markets borrowings and leasing.The relative proportions of equity and borrowings are governed by specific Boardapproved parameters. These are designed to preserve prudent financial ratios,including interest, dividend and cash flow cover, whilst also minimising theoverall weighted average cost of capital to the Group. All the Group's borrowing facilities are arranged by the central treasuryfunction and the funds raised are then lent to operating subsidiaries oncommercial arm's-length terms. In some cases operating subsidiaries haveexternal borrowings, but these are supervised and controlled centrally. TheGroup's objective is to maintain a balance between continuity of funding andflexibility through borrowing at a range of maturities from both capital marketsand bank sources. Bank borrowings are principally in the form of three year committedmulti-currency bilateral revolving credit facilities with a group ofrelationship banks. There were no borrowings against these facilities as at 31December 2004. Capital markets borrowing of £705 million includes unsecured issues of £350million 6.75% bonds maturing in 2019 and £325 million 7% bonds maturing in 2012,together with £30m debenture stock of Westland Group plc, which is secured onassets of that company and certain of its subsidiaries. At the year-end the Group had committed borrowing facilities of £1,319 million,of which £737 million was drawn. The weighted average maturity profile of theGroup's committed borrowings was 10.8 years. This leaves the Group well placedto fund its strategic growth plans and to withstand any sudden changes inliquidity in the financial markets. The Group also has access to significant lines of uncommitted funds which areused principally to manage day-to-day liquidity. Wherever practicable, pooling,netting or concentration techniques are employed to minimise gross debt. At the year-end the Group had £752 million pounds on deposit as a result of thereceipt of the AgustaWestland sales proceeds at end November. The deposits weremainly held in money market funds or with banks at maturities of 3 months orless. Risk managementThe Group is exposed to a variety of market risks, including the effects ofchanges in foreign currency exchange rates and interest rates. In the normalcourse of business, the Group also faces risks that are either non-financial ornon-quantifiable, including country and credit risk. The Group uses interest rate swaps, swaptions, forward rate agreements, nettingtechniques and forward exchange contracts to manage the primary market exposuresassociated with its underlying assets, liabilities and anticipated transactions. Counterparty credit riskThe Group is exposed to credit-related losses in the event of non-performance bycounterparties to financial instruments. Credit risk is mitigated by the Group'spolicy of only selecting counterparties with a strong investment gradedlong-term credit rating, normally at least AA- or equivalent, and assigningfinancial limits to individual counterparties. Interest rate riskThe Group operates an interest rate policy designed to optimise interest costand reduce volatility in reported earnings. This policy is achieved bymaintaining a target range of fixed and floating rate debt for discrete annualperiods, over a defined time horizon. This is achieved partly through the fixedrate character of the underlying debt instrument, and partly through the use ofstraightforward derivatives (forward rate agreements, interest rate swaps andswaptions). The Group's normal policy is to require interest rates to be fixedfor 30% to 70% of the level of underlying borrowings forecast to arise over a 12month horizon. However, this policy was suspended in December as it was deemedinappropriate given the absence of floating rate bank debt following the receiptof the sale proceeds of GKN's share in AgustaWestland. Consequently, as at 31stDecember 2004, 89% of the Group's gross financial liabilities were at fixedrates of interest, whilst the weighted average period in respect of whichinterest has been fixed was 10.9 years. Currency riskThe Group has transactional currency exposures arising from sales or purchasesby operating subsidiaries in currencies other than the subsidiaries' functionalcurrency. Under the Group's foreign exchange policy, such transaction exposuresare hedged once they are known, mainly through the use of forward foreignexchange contracts. The level of hedges may be varied from time to time as thevolume of underlying trading also varies. Differences arising on such variationsare taken to the profit and loss account either as a credit or a charge. The Group has a significant investment in overseas operations, particularly incontinental Europe and the Americas. As a result, the sterling value of theGroup's balance sheet can be affected by movements in exchange rates. The Grouptherefore seeks to mitigate the effect of these translational currency exposuresby matching the net investment in overseas operations with borrowingsdenominated in their functional currencies, except where significant adverseinterest differentials or other factors would render the cost of such hedgingactivity uneconomic. This is achieved by borrowing either directly (in eitherthe local domestic or euro-currency markets), or indirectly through the use ofrolling annual forward foreign exchange contracts. Borrowings created throughthe use of such contracts amounted to £775 million at 31 December 2004 and weredenominated in US dollars (44%), euro (46%) and Japanese yen (10%). Pensions and post-retirement benefitsPension costs in these accounts have been accounted for on an SSAP 24 basis. Thetotal charge to Group operating profit before goodwill and exceptional items was£90 million (2003 - £74 million). The increase, which was predicted in last year's annual report, arose largely asa consequence of the triennial valuation of the UK scheme which took placeduring the course of the 2003 and which is discussed in more detail below.Because the valuation applied for only part of that year there was a consequentadditional increase in 2004 of £15 million. Pending the move to International Financial Reporting Standards in 2005, theGroup has not adopted FRS 17 in the 2004 accounts, but is disclosing fully theeffects had it done so. These are shown in the appendix to this press releaseand cover both the balance sheet and profit and loss account impacts. UK pensionsMuch of the external focus is on the Group's UK pension scheme which hasapproximately 58,000 members of whom only 10% are currently in service with theremainder either deferred or current pensioners. As a UK defined benefit scheme,this is run on a funded basis with funds set aside in trust to cover futureliabilities to members. An actuarial valuation of the scheme was carried out in2003 which showed that the aggregate funding on an ongoing basis was 69%. As aconsequence, the Group raised its regular annual cash payment to the fund to £54million in both 2003 and 2004. This figure is expected to apply at least untilthe next valuation. Employees have also increased their contributions to reflectthe higher cost of providing future benefits. In addition, £100 million advancepayment to the scheme was made by the Company in December 2004. Under SSAP 24 the charge to profit for the UK scheme was £48 million (2003 - £33million), analysed as £9 million in respect of current service, £38 million inrespect of the deficit and £1 million in respect of other costs. Because of themateriality of the deficit and since it relates in large part to employees ofcompanies which are no longer part of the Group, as in 2003 it is shownseparately in the segmental analysis to enable underlying performance to beunderstood better. Overseas pensionsThe charge for overseas post-retirement benefits under SSAP 24 was £42 million(2003 - £39 million), including an additional £1 million in companies acquired. FRS 17 also values post-retirement benefits outside the UK, including thosecountries where schemes are unfunded and it is already the practice to providefor the liability in the balance sheet. The principal regions involved are theAmericas, continental Europe and the Rest of the World. The detailed assumptionsunderlying the FRS 17 additional net liabilities in those territories of £36million, £35 million and an asset of £17 million respectively, are explainedfurther in note 6 in the appendix to this press release. SummaryIn total, at 31 December 2004 on the FRS 17 basis, there was a net additionalliability on all pension/post-retirement obligations of £580 million (2003 -£563 million) in addition to the net £68 million (2003 - £138 million) alreadyincluded in long-term liabilities/prepayments on the balance sheet. This netliability arises after a deferred tax credit of £181 million (2003 - £203million) which, it should be noted, is restricted by the forecast availabilityof UK taxable profits. Joint venturesFollowing the divestments made in 2004 there would be no significant impact onthe equity of joint ventures from the application of FRS 17. International Financial Reporting StandardsThe European Union requires all listed companies to report under InternationalFinancial Reporting Standards (IFRS) for accounting periods commencing on orafter 1 January 2005 with prior year comparatives on the same basis. We gave details in our 2003 Annual Report of the programme of work the Group hadestablished to enable it to report under IFRS for the first time when itannounces its 2005 interim results. That work continued during the year and, inDecember 2004, we advised that in addition to generally introducing morevolatility, the key areas of impact on the profit and loss account and balancesheet will be in accounting for financial instruments, post-retirement benefits,development expenditure and share-based payments. There will also be otherchanges of less significance. It is our intention to re-state the 2004 results on an IFRS basis at the end ofApril, prior to the publication of the interim results, to allow the impact tobe interpreted and understood. Financial resources and going concernAt 31 December 2004 the Group had net funds of £65 million. In addition it hadavailable, but undrawn, committed borrowing facilities totalling £582 million. Having assessed the future funding requirements of the Group, the Directors areof the opinion that it is appropriate for the accounts to be prepared on a goingconcern basis. Cautionary statementThis press announcement contains forward looking statements that are subject torisk factors associated with, amongst other things, the economic and businesscircumstances occurring from time to time in the countries and sectors in whichthe Group operates. It is believed that the expectations reflected in thesestatements are reasonable but they may be affected by a wide range of variableswhich could cause actual results to differ materially from those currentlyanticipated. APPENDIX This appendix does not form the statutory accounts of the Group. The statutoryaccounts for the year ended 31 December 2003 have been filed with the Registrarof Companies and contained an unqualified audit report. The audited results for2004 were approved by the Board on 23 February 2005 and have been agreed withthe auditors. Page numberGKN Consolidated financial informationConsolidated profit and loss account for the year ended 31 December2004 20 Consolidated balance sheet at 31 December 2004 21 Statement of total recognised gains and losses 22 Reconciliation of movement in shareholders' equity 22 Movement in net funds/(debt) 22 Consolidated cash flow statement for the year ended 31 December 2004 23-24 Segmental analysis 25 Notes 26-32 Consolidated Profit and Loss AccountFor the year ended 31 December 2004 --- ---------------------- ----- -------- -------- ------ -------- -------- ------ 2004 2003 Before goodwill Goodwill Total Before goodwill Goodwill Total amortisation amortisation amortisation amortisation and exceptional and exceptional and exceptional and exceptional items items items items Notes £m £m £m £m £m £m--- ---------------------- ----- -------- -------- ------ -------- -------- ------SalesContinuing operations Subsidiaries 3,484 - 3,484 3,334 - 3,334 Share of joint 161 - 161 162 - 162 ventures Share of associate 47 - 47 99 - 99--- ---------------------- ----- -------- -------- ------ -------- -------- ------ 3,692 - 3,692 3,595 - 3,595Discontinued operations Share of joint 755 - 755 902 - 902 ventures Share of associate - - - 88 - 88--- ---------------------- ----- -------- -------- ------ -------- -------- ------ 4,447 - 4,447 4,585 - 4,585--- ---------------------- ----- -------- -------- ------ -------- -------- ------Operating profit/(loss)Subsidiaries:Continuing operations Before goodwill amortisation and exceptional items 162 - 162 168 - 168 Goodwill amortisation - (23) (23) - (31) (31) Exceptional items including goodwill impairment 3 - (250) (250) - (91) (91) -------- -------- ------ -------- -------- ------ Total subsidiaries 162 (273) (111) 168 (122) 46 -------- -------- ------ -------- -------- ------Share of joint ventures:Continuing operations Before goodwillRelated Shares:
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