Final Results

26th Feb 2008 07:01

Bodycote International PLC26 February 2008 BODYCOTE INTERNATIONAL PLC PRELIMINARY RESULTS FOR THE YEAR ENDED 31 DECEMBER 2007 Financial highlights • Revenue from continuing operations increased by 15% to £640.5 million (2006: £558.6 million) • Headline operating profit 1 rose 15% to £91.3 million (2006: £79.7 million) • Operating profit ahead 34% at £78.8m (2006: £58.8m) • Headline profit before tax 2 up 16% to £81.0 million (2006: £70.0 million) • Profit before tax improved by 47% to £68.5m (2006: £46.6m) • Basic headline earnings per share 3 increased 17% to 20.3p (2006: 17.3p) • Basic earnings per share increased 24% to 16.6 (2006: 13.4p) • Return on capital employed improved to 11.3% (2006: 10.8%) • Full year total proposed dividend 8.0 pence per share (2006: 7.0p), up 14.3% Operational highlights • Robust demand in key markets - aerospace, power generation and oil and gas sectors • Organic sales growth 10% in Testing and 9% in Thermal Processing • Emerging market sales increased to £58.6m (2006: £25.9m) • Revenue from Strategic Partnerships and Long Term Agreements increased 17% to £123 million (2006: £105 million) Commenting on the results, John Hubbard, Chief Executive said: "Bodycote delivered record sales and headline operating profits in 2007 andfurther increased return on capital employed. The geographic spread of ouroperations, range of services we provide and diversity of end markets we servehelped to ensure another robust performance despite weakness in some areas.Demand in several of our key markets - aerospace, power generation and oil andgas - remained strong as manufacturers continued to fulfill orders fromsignificant committed order books. Our customers are forecasting positivegrowth in 2008 and we enter the year confident that Bodycote will deliveranother successful performance." 1 a detailed reconciliation is provided in the Group Business Review Financial Results 2007 section 2 a detailed reconciliation is provided in the Group Business Review Financial Review section 3 a detailed reconciliation is provided in Note 4 to the Accounts. CHAIRMAN'S STATEMENT - 2007 Dear Shareholder, After an eventful and successful year, Bodycote produced record sales andheadline operating profits building on five years of annual improvement. Salesincreased 14.7% to £640.5m (2006: £558.6m) and operating profit was up 34.0% to£78.8m (2006: £58.8m). Despite the recent general and specific concerns of thestock market, I am confident that with the increased financial rigour anddiscipline we have demonstrated in recent years, coupled with the high level ofentrepreneurial flair across the Group, Bodycote will continue to prosper andthat financial markets will, in due course, reflect the value our customers andstaff already recognise in the business. The board is recommending a final dividend of 5.25p per share (2006: 4.5p), anincrease of 16.7%, to be paid on 4 July 2008 to all shareholders on the registerat the close of business on 6 June 2008. The total proposed dividend in respectof 2007 is therefore up by 14.3% to 8.0p per share (2006: 7.0p) of which 2.75pper share (2006: 2.5p) has already been paid as an interim dividend. The 2007total dividend is covered 2.1 times (2006: 1.9 times) by basic earnings pershare. Thermal processing, the major part of our business, has shown significantimprovement in 2007 and we expect that it will continue to do so. Europe,accounting for approximately 70% of sales, performed particularly well in 2007with good growth from all sectors and return on capital employed of 13.0%. Weexpect to see further improvement in 2008. In North America there have beenareas of strength, primarily related to the aerospace, power generation and oil& gas sectors and areas of softness related to general engineering andautomotive but overall our business continues to grow. In the developingeconomies of Latin America, Eastern Europe, the Middle East and Asia ourfootprint is expanding successfully. These long term initiatives are beingfinanced with an inevitable impact on short term performance. We have grown significantly our Testing businesses over the last three yearsincreasing our range of services across a wider geographical network. This isan exciting and attractive area of our overall business but the results to date,although satisfactory, are below where we expect to be in future. When I became Chairman in 2002 Bodycote was overstretched and market conditionsunderwent a severe downturn. Return on capital employed had fallen below thecost of capital. Under the leadership of Chief Executive John Hubbard and withthe mantra of restoring our return on capital, we have spent the last six yearsreshaping and improving the business. We have come a long way in that time andnow have a pre-tax return on capital of over 11% and a strategy and commitmentto achieve much more. Bodycote today is a far stronger and more resilientbusiness and we have a track record of successfully meeting the challenges thatinevitably face any business. We are committed to a long term approach which implies that we will beprofessional, ethical and rigorous in all that we do. Being disciplined withoutbeing bureaucratic, Bodycote will continue to foster the right entrepreneurialand safe working environment for all our staff. We continue to review allaspects of the business and strategy to ensure that we respond to and takeadvantage of opportunities as they arise. In February 2007 Sulzer AG made a takeover approach for the company buteventually withdrew when it was clear that a majority of shareholders and thedirectors believed that the company was worth more than Sulzer indicated. Early trading results suggest that 2008 will be another record year forBodycote. We continue to invest in the business, but we are vigilant inensuring that Bodycote is in a position to respond to any significant change ineconomic conditions. I have served Bodycote as a director since 1994 and am privileged to have beenChairman for the last six years. There have been significant changes andprogress during this time with much more to come. The process of refreshing theBoard has already commenced. John Biles has joined us as Chairman of the AuditCommittee and the Chairman's baton will pass on at the AGM to be held on 30April 2008. I wish my successor Alan Thomson, who was appointed to the board inDecember 2007, and everyone at Bodycote continued success. Finally, I would like to thank everyone at Bodycote for their commitment anddedication and for the support they have given me personally and to the Company. James WallaceChairman26 February 2008 2007 GROUP BUSINESS REVIEW Operations Bodycote provides thermal processing and testing services to manufacturers invirtually every sector of the world economy. From over 300 locations in 35countries, more than 11,000 employees provide high quality services to over60,000 customers. The Thermal Processing Strategic Business Unit (SBU)delivered 73% of Group sales compared to 74% in 2006 and saw its sales increaseby 12.4%. This SBU is organised into two divisions: Heat Treatment and HotIsostatic Pressing (HIP). The expansion of this SBU into emerging marketscontinued through both acquisitions and greenfield start-ups. In line with ourstrategy to grow rapidly the Testing SBU, sales increased by 21.1% and this SBUnow makes up 27% of Group sales compared to 26% in 2006. The Testing SBU isorganised into two divisions: Materials Testing, Engineering & Technology andMeasurement Technology (MEM) and Health Sciences & Environmental (HSE). Competitive Environment In the western hemisphere we are the clear leader in thermal processing and havea unique multi-disciplinary presence in the testing market. In both thermalprocessing and testing, Bodycote mainly competes with local, privately ownedcompanies and manufacturers' captive facilities. Both supply and demand arevery fragmented with hundreds of providers servicing thousands of customers. Wehave developed a sustainable advantage over local entrepreneurs through thesuperior quality of our systems, our extensive knowledge base, our breadth oftechnology, our flexible capacity and our broad range of services. Our proventrack record of supplying thermal processing and testing services to many of theworld's most respected manufacturers is a testament to our success inoutsourcing and subcontracting for manufacturers who need to reduce costs,whilst at the same time being confident that their critical components areprocessed to specification. Our HIP business operates in a much smaller market. We have more than 60% of the total capacity in the western hemisphere and fewmanufacturers invest in this technology because of the high capital cost whichrepresents a significant barrier to entry. Competitors we have vary fromsmaller private companies to a small number of large corporations. Regulatory environment As a service provider to virtually all market sectors and as a businessoperating in many countries, we are subject to a multitude of quality, safety,environmental and regulatory requirements. We continuously monitor changes inlaws, regulations and standards by adopting systems and policies to retainbest-in-class compliance. Although this effort is costly in the short term,being a good corporate citizen clearly differentiates us in the market place.Customers have confidence in our quality and the sustainability of our services. Macro-economic environment Generally, the countries in which we operate continue to experience positivemanufacturing economic conditions with inflation largely under control, althoughthere is some uncertainty about the near term outlook especially with regard tothe USA. Energy prices have remained near record highs during 2007 withdifferent countries experiencing varying levels of movement in unit costs, but,overall, we have marginally reduced energy costs as a percentage of sales.Materials such as nickel, chrome and molybdenum, used in the baskets andfixtures in our thermal processing plants, have significantly increased inprice, but we have successfully managed these costs. As a service provider weare ultimately subject to the cyclicality of our customers' requirements.Aerospace, power generation and oil & gas demand continues to be robust. Theonly significant sector that we serve which has exhibited softness is automotivein North America. However, we continue to offset this softer demand by winningnew business in our traditional territories, principally through outsourcing andby expanding into new geographies. In total, automotive sales increased by£14.7m (10.6% growth) in the year. Long term strategy and business objectives After a thorough review in early 2005, we have articulated a strategy whichincorporates four key initiatives, each aimed at enhancing shareholder value andaccelerating growth: • expand the Group into developing manufacturing geographies;• increase Testing to about half of Group's sales;• develop our high added value technologies; and• intensify outsourcing initiatives. We measure our performance against the delivery of this strategy using thefinancial and non-financial indicators shown in the table below. Our mostimportant indicator is the return on capital employed (ROCE) and furtherprogress has been made in 2007 towards our 5 year target. Key performance indicators 2007 2006 Five Year Target Financial Return on capital employed (1) 11.3% 10.8% Mid teens % Return on sales (2) 14.3% 14.3% Mid to high teens % Organic sales growth % (3) 8.8% 5.5% Mid to high single digit % People costs as a percentage of sales (4) Thermal Processing 39.5% 40.7% 40% Testing 53.3% 51.8% 50% Capital expenditure/depreciation ratio (5) 1.3x 1.2x 0.8 - 1.3x Non financial Capacity utilisation (Heat Treatment only)(6) 74% 72% >80% Capacity utilisation HIP (6) 71% 75% >80% ISO 14001/17025 compliant facilities (7) 233 184 All facilities Accident frequency (8) 1.6 2.2 Zero Definitions (1) Headline operating profit* as a percentage of average capital employed. Capital employed includes tangible and intangible assets including all previously amortised/impaired goodwill and all non-interest bearing assets and liabilities. (2) Headline operating profit* as a percentage of revenue from continuing operations. (3) Year on year increase in revenue, at constant currencies, from continuing operations excluding revenue from acquisitions made within the prior twelve months. (4) The salary and benefit costs of all employees as a percentage of revenue from continuing operations. (5) Net capital expenditure divided by depreciation. (6) Actual revenues expressed as a percentage of theoretical maximum revenue assuming that heat treatment facilities operate 24 hours per day, 365 days per year. (7) The number of facilities holding registrations for ISO 14001 or ISO 17025. (8) Accident frequency - the number of accidents x 200,000 (approximating 100 man years), divided by the total hours worked. * Headline operating profit, as referred to in this Group Business Review, isdefined and reconciled in the Financial Results for 2007 section. Overall return on sales was unchanged, with both Heat Treatment (+1%) and HIP(+3%) increasing while, as anticipated, greenfield investments, mix changes,additional infrastructure costs and difficult trading conditions in our Food andEnvironmental Testing businesses have resulted in a reduction of margins in theTesting SBU (-3%). Group organic sales growth (9%) was again within our targetrange. People costs are the Group's largest expense. Thermal Processing saw areduction in these costs to 39.5% of sales thus achieving our target of 40%.People costs in Testing however, increased slightly due to the impact of addedresources needed to support our acquisition programme. Capital expenditure was within our target range and was above the level ofdepreciation, reflecting the Group's establishment of new facilities in emergingmarkets and also the support of new outsourcing contracts. Additional capitalexpenditure also reinforces our commitment to additional HIP capacity with theaim of supporting growing demand in aerospace, power generation and oil & gas.We expect to benefit from these investments beginning in 2008 but particularlyin 2009 and 2010. Capacity utilisation is the key factor in improving profitability in ThermalProcessing. In 2007 we saw further progress towards our goal of >80% withcurrent utilisation in heat treatment at 74% (2006: 72%). HIP utilisation hastemporarily decreased following the installation of a new large unit at ourWashington facility to 71% (2006: 75%). We have largely achieved our target of having all the Group's facilities meetthe environmental standard ISO 14001 or the laboratory management standard ISO17025. Significant improvements in our work related accident rates have beenachieved over the past four years by a combination of training, systems andcultural change. We remain committed to achieving the highest standards ofsafety for our people and having zero accidents remains our goal. Acquisitions completed since the interim announcement Since the interim announcement and in line with our strategy, the Group hascompleted seven bolt-on acquisitions aimed at increasing expansion into emergingmarkets, enhancing market position in developed economies and increasing thescale of the Testing SBU, at a cost of £29.8m as follows:. Further expansion into emerging markets Thailand - Thai Inductions Services Co Ltd (TISCO) On 8 January 2008, Bodycote acquired the assets of TISCO, one of Thailand'slargest metallurgical services providers, offering heat treatment, induction andnitriding technologies to western and Japanese manufacturers. As part of theplanned expansion a greenfield production facility with a wide range of heattreatment capabilities will be added in Bangpoo, east of Bangkok, in the thirdquarter of 2008 to support the rapid expansion of Thailand's engineeringmanufacturing sector. Enhancing market position in developed economies: Texas, USA - Metroplex Heat Treat Inc Bodycote completed the acquisition of Metroplex Heat Treat Inc., based inArlington, Texas on 12 December 2007. Metroplex specialises in heat treatment,induction hardening, brazing and plasma nitriding. The Texas/Oklahoma region isan important and growing market for Bodycote focused on oil & gas, aerospace andpower generation. Metroplex's outstanding customer base secures a marketleading position for the Group. Germany - Nitrion GmbH On 18 December 2007, Bodycote announced the acquisition of nitriding specialist,Nitrion GmbH. Nitrion was founded in 1988 and is one of the largest nitriding serviceproviders in Germany. The company has three plants in the Munich area,specialising in plasma nitriding for a wide range of applications and has anexcellent customer base throughout southern Europe. It also operates astate-of-the art metallurgical laboratory, as well as salt spray test chambersfor corrosion testing which complement the development of the Testing SBU inthis region. France -Traitements Compression Services SAS (TCS) On 21 December 2007, Bodycote acquired the remaining 51% of the equity of TCS,the only provider of HIP services in France. TCS was formed ten years ago as ajoint venture between Bodycote France (49%) and Aubert & Duval (51%), the Frenchspecialist steel manufacturer. TCS, located in Magny-Cours, deals with powdermetallurgy applications and precision castings particularly for the aerospaceand power generation markets. TCS will now be able to focus not only on thegrowing requirements of Aubert & Duval but also on servicing the needs of thewider subcontract market in southern Europe, better utilising its capacity. Increasing the scale of the Testing SBU: Australia - Warrington Fire Research (Aust) Pty Ltd On 28 November 2007, Bodycote acquired the remaining stake in Warrington FireResearch (Aus) Pty Ltd in support of the strategic growth plans in the region.This provides the business with a much greater ability to facilitate growth inits local and surrounding markets. The business has fire safety engineeringoffices in Melbourne, Sydney and Brisbane with a fire testing laboratory also inMelbourne. The business has been renamed Bodycote Warringtonfire (Aust) PtyLtd. Accutest Laboratories Limited, Canada On 25 January 2008, Bodycote completed its nationwide coverage of Canadiananalytical facilities through the acquisition of Ottawa based AccutestLaboratories Limited. Metlab (Int.) Limited, Eire On 8 February 2008 we established our first metallurgical laboratory in Eirethrough the acquisition of Metlab (Int.) Limited. Metlab provides bothmaterials testing and non-destructive testing to the engineering andconstruction industries. Financial Results for 2007 Revenue 1 Headline operating profit Margin 2007 2006 2007 2006 2007 2006 £m £m £m £m % %Heat Treatment 421.7 375.0 61.6 50.3 14.6 13.4HIP 43.5 38.9 15.4 12.8 35.4 32.9Thermal Processing 465.2 413.9 77.0 63.1 16.6 15.2 Testing 175.3 144.7 21.0 21.3 12.0 14.7Head office costs - - (6.7) (4.7) - -Group Total 640.5 558.6 91.3 79.7 14.3 14.3 1 Revenue from continuing operations after deducting inter-segment sales Headline operating profit is defined as follows: 2007 2006 £m £mHeadline operating profit 91.3 79.7Share of associates' interest and tax - (0.6)Amortisation/impairment of acquired intangible fixed assets (1.9) (1.0)Impairment of goodwill (7.2) (6.0)Impairment of investment in associate - (8.3)Change to pension scheme rules 4.1 -)Major facility closure costs (5.4) (5.0)Bid response costs (2.1) -)Operating profit from continuing operations per financial statements 78.8 58.8 In 2007 Bodycote has again shown strong growth with sales increasing by 14.7% to£640.5m (2006: 18.6% growth to £558.6m). Organic sales accounted for 8.8%(2006: 5.5%) of this improvement before the impact of closed sites andacquisitions for 9.6% (2006: 13.1%). The impact of the movement in exchangerates on translation of sales was adverse by 2.6% (2006: nil). We have seen increasing demand in several key markets, most notably aerospace,power generation and oil & gas. Outsourcing (Strategic Partnerships and LongTerm Agreements) provided £18m of additional sales (17% growth), resulting in atotal of £123m in 2007 (2006: £105m). Some notable outsourcing agreementsconcluded in the year were with Sandvik, Dubai Light Railway, Rolls-Royce,General Motors, AM General, Nokia and Faurecia. Outsourcing sales continue toaccount for approximately 20% of Group sales and we expect further growth bothin absolute terms and as a share of Group activity. Headline operating profit increased by 14.6% to £91.3m in 2007 (2006: up 17.6%to £79.7m). The impact of exchange rates on the translation of overseas profitswas adverse 2.8% (£2.2m) this year (2006: -0.1%). Operating profit improved by £20.0m due to improved trading and as favourablechanges to the rules of the UK final salary pension scheme (£4.1m) more thanoffset bid response costs (£2.1m) and there was no impairment of investments inassociates in 2007 (2006: £8.3m). Overall, our headline operating margin remained consistent at 14.3% in both 2007and 2006. Whilst the Heat Treatment business saw its headline margin* increaseto 14.6% (2006: 13.4%) and HIP to 35.4% (2006: 32.9%), Testing saw its marginfall to 12.0% (2006: 14.7%). This is largely attributable to increasedinfrastructure costs to support a larger business, greenfield start-up lossesand weak performance in the food consumer products and environmental businesseswithin the Health Science and Environmental division of the Testing SBU in bothCanada and the UK. A charge of £1.7m (2006: £1.0m) has been accrued in head office costs for ashare-based long term incentive plan (LTIP) for senior managers which isdesigned to incentivise growth in profit and ROCE. The LTIP was approved byshareholders at the 2006 AGM. The amount charged reflects the expected fairvalue, spread over the three year vesting period, adjusted for current progresstowards planned targets. As part of our plans to increase activity in Asia, we have continued to investin equipment, real estate and in business development. We now have two heattreatment facilities in India, a further two in China and a joint Testing andThermal Spray location in Singapore. The total operating loss associated withthese developments was £1.8m (2006: £0.5m). During the year we acquired ten new businesses and the outstanding equity, notalready owned by Bodycote, in two others at a net cost of £32.7m. Only oneacquisition and the purchase of the remainder of Warrington Fire Research (Aus)Pty Ltd were in Testing as we have been concentrating on the integration of thetwelve businesses (38 laboratories) acquired in 2006. We expect significantlymore activity in 2008 and by February 26th three businesses at a cost of £10.4mhave joined the Group. Of the ten businesses acquired by the Thermal ProcessingSBU during the year, four are in emerging markets (China, India, Brazil andArgentina), five are focused on high added value specialist technologies inGermany and France and one gives Bodycote the market leading position in theTexas/Oklahoma aerospace and oil & gas market. Review by Strategic Business Unit (SBU) Thermal Processing SBU Thermal Processing reported sales of £465.2m, an increase of 12.4% on 2006.This was split 8.6% organic, 7.8% acquired and a reduction of 2.3% (£9.5m) inrespect of adverse foreign exchange translation impact. ROCE improved to 12.0%(2006: 9.9%) and margins increased to 16.6% (2006: 15.2%). The ten businessesacquired represent fourteen facilities at a net cost of £30.9m. Energy costincreases have been less in 2007 than 2006. Taking the last two years together,all energy cost increases have now been recovered. As part of our continuousreview of operations, we closed three heat treatment facilities: Lexington(USA), Charvonnex (France) and Koping (Sweden) with a proportion of the work andsome of the equipment transferred to other locations. All of the associatedcost has been charged to headline operating profit. However, the costsassociated with closing five sites previously treated as exceptional have risenand the associated provision has been increased by £3.4m. Heat Treatment Division The division delivered 12.5% (2006: 7.4%) growth with sales of £421.7m, whichaccounts for 66% of the Group revenues (2006: 67%). Margins rose to 14.6%(2006: 13.4%). The UK continued to see strong demand from power generation, aerospace and oil &gas customers resulting in 7.7% organic growth with demand for thermal spray andK-Tech coatings being particularly robust. Our Nordic group continued toperform very well and organic sales growth was an excellent 13.6% (at constantexchange rates) on the back of several additional outsourcing contracts with avariety of blue-chip engineering customers. Demand in Germany and theNetherlands was solid with good automotive growth resulting in an organic salesincrease of 9.6% (at constant exchange rates). The acquisition of Nitrion GmbHimmediately before the year-end significantly enhances the Group's position innitriding technologies. Our Eastern European facilities continue to growstrongly with organic growth of 28.8% and a further 31.8% (at constant exchangerates) from the first full year of Bodycote ISTAS in Turkey, in which the Grouphas a 60% interest. Margins in Eastern Europe are generally good but theresults in Turkey have been marginally impacted by costs associated withbringing safety, quality and business systems up to the standard expected by theGroup. France and Belgium made further excellent progress and margins now matchother parts of our European business. Organic growth was 7.1% (at constantexchange rates), with increasing demand from both aerospace and automotivecustomers. The business was also strengthened by the acquisition of Techmeta(electron beam welding) in February and Nitruvid SAS (a nitriding specialist,which Nitrion will complement) in July. Southern Europe had a reasonable yearwith very strong growth in Austria and Liechtenstein partly offset by softnessin Italy and Switzerland. North America saw organic sales grow 2.0% (at constant exchange rates) in thecontinuing business, although overall sales dropped by £4.8m (at constantexchange rates). Margins remained consistent with last year at 10.0%. Demandcontinues to be strong in the aerospace, oil & gas and power generation marketsbut automotive and general engineering demand is subdued. We continue to reviewour various locations in the light of our strategy to provide value addedservices with growth potential. Our investment in low pressure carburizingcapability (used for new generation automotive transmission gears in particular)in Silao, Mexico, will begin production in Q3 2008 to complement our Livonia,Michigan, facility which has been operating for 15 months. We are alsocontinuing to look for ways to consolidate the industry in key regions of theUSA and the acquisition in December of Metroplex Heat Treat Inc based inArlington, Texas, secures a leading market position for the Group in Texas/Oklahoma. 2007 was the first full year for the Group in Brazil following theacquisition of Brasimet. Market conditions were reasonable during the year andthe business had a satisfactory performance. Brasimet has a long standingphysical vapour deposition (PVD) capability and to enhance our offering in themarket place Bodycote acquired the small PVD activities of our associatecompany, SSCP Coatings Sarl, in both Brazil and Argentina. Our activities in Asia made significant progress with acquisitions in both Chinaand India adding to the start-ups in Singapore, Ranjangaon (India) and Wuxi(China) and we absorbed losses in the greenfield locations of £0.7m. HIP Division The division achieved an impressive 17.0% (at constant exchange rates) organicgrowth rate on the back of strong demand from aerospace, power generation andoil & gas customers and a widening use of the technology. especially for powder based near net shapes. Sales were £43.5m which amountedto 7% of total Group revenues (2006: 7%). Margins were 35.4% (2006: 32.9%).The strong performance balances the disappointing results experienced when endmarkets were at a cyclical low in 2002/2003. Aerospace and power generation ledthe growth in North America while power generation and oil & gas demand were thekey drivers of European growth. In late December, we purchased the remaining51% of the equity of Traitements Compression Services SAS, (TCS), the onlyprovider of HIP services in France. Testing SBU Testing recorded sales of £175.3m, an increase of 21.1%. This was split 9.5%organic, 14.9% acquisition and a reduction of £4.8m (3.3%) due to foreignexchange translation impact. ROCE declined to 13.1% and margins slipped to12.0% (2006: 14.7%) due to the costs associated with the greenfield laboratory(£1.2m), start-ups (Singapore, Bahrain, Croatia, Saudi Arabia, Kuwait, Dubai,Canada, USA and Mexico), additional infrastructure to support the growingbusiness and difficult trading conditions in our environmental and foodbusinesses in both Canada and the UK. We acquired only one Testing business and the outstanding minority in WarringtonFire Research (Aus) Pty Ltd in 2007 while we concentrated on the integration ofthe twelve businesses with 38 laboratories that we purchased in 2006. In linewith our strategy to grow Testing relative to the size of Thermal Processing,this SBU now represents 27% of the Group's increased revenue (2006: 26%). Materials Testing, Engineering & Technology and Measurement Technologies MEM) The division delivered 24.9% sales growth of which 13.0% was organic. Saleswere £124.4m, which accounts for 19% of group sales (2006: 18%). Margins were13.6% (2006: 14.4%). Oil & gas, aerospace and construction demand was robustacross all regions, with the Middle East particularly strong. Sales in AsiaPacific were £1.9m (2006: £1.2m). We continued to progress the expansion of the network into emerging markets,with full service laboratories opened in Croatia, Bahrain, Singapore and Brazil.Outsourcing remains a central plank of the organic growth strategy with asignificant number of deals concluded, including aerospace contracts for ourlaboratories in Plzen, Czech Republic and Monterrey, Mexico; automotive enginedevelopment agreements at Mississauga, Canada; civil engineering/constructioncontracts in Dubai and control systems at Rockford, Illinois USA. In response to a tough trading environment in the North American automotivemarket, a major consolidation project has been undertaken, reducing four sitesto one automotive centre of excellence in Warren, Michigan, USA. Know-howcontinues to be transferred around the Group with a number of areas benefiting,particularly in the emerging economies, as Group expertise is established inthese new operations, e.g. Bahrain, Singapore and Mexico. A technicaldevelopment laboratory has been established in the UK to formalise the roll-outof specialist energy/aerospace related testing activities. Health Sciences/Environmental (HSE) Division The division delivered 12.9% sales growth, with sales of £50.9m, which accountsfor 8% of Group revenues (2006: 8%). Margins were 8.1% (2006: 15.5%), havingbeen impacted by a combination of pricing pressures, wage inflation and poorweather conditions in the first half in the Environmental business in westernCanada and by price pressure in both the Environmental and Food business in theUK. We have been actively addressing these issues and we are continuing toincrease our emphasis on added value services. For example, our UK Food &Advisory division successfully tendered for a number of contracts from majorretailers which improves our order book visibility for 2008. And to enhance ourCanadian Environmental performance, we have added three further laboratoriesthrough a combination of greenfield, outsourcing and acquisition activity inHinton and Drayton Valley, both in Alberta and Accutest Laboratories in Ontario. Following the major acquisition activity in 2006 we have improved operationalefficiencies with laboratories closed in Windsor, UK, and in Quebec and Alberta,Canada. We continue to penetrate the fledgling environmental market in the Gulfregion with long-term contracts secured in Bahrain, Oman and the UAE.Significant investment is being made in our IS systems to allow clients todownload results and sample data from our laboratory information managementsystems via a client portal over the internet. Associated Company - SSCP Coatings Sarl (SSCP) SSCP provides high quality PVD coatings to the same market sectors as Bodycote.Trading in 2006 was disappointing and at the beginning of 2007, as part of therefinancing of SSCP, its shareholders agreed that share warrants would beattached to £10.4m of new funding. Bodycote decided that it was in the Group'sinterest to maintain its shareholding in SSCP and therefore subscribed to a prorata portion of the new funding for £3.4m. During 2007, trading performance hasimproved and is expected to continue to do so in 2008. The Group currently owns24.4% of the share capital of SSCP. Financial Review Revenue Group revenue from continuing operations was £640.5m, an increase of £81.9m (up14.7%) on 2006 (£558.6m). Revenue growth for Heat Treatment was £46.7m (up12.5%), for HIP £4.6m (up 11.8%) and for Testing £30.6m (up 21.1%). Organicgrowth accounted for £49.4m of total sales growth before the impact of closedsites which had annualised sales amounting to £7.1m and acquisitions for £53.9m,while foreign currency movements had an adverse impact on revenues of £14.3mmostly resulting from the weakening of the US Dollar. Operating Profit and Margins Demand was robust in most of our markets in 2007 with the notable exception ofNorth America. This had a particularly significant effect on our Testingbusinesses. Increases in energy and commodity prices have eased and we havemanaged to recover these increases through price increases. Consequently,operating profit increased by 34.0% from £58.8m to £78.8m and the marginincreased from 10.5% to 12.3% Heat Treatment benefited from strong growth in all of our European markets.Operating profit increased by 61.6% despite the adverse impact of foreigncurrency movements of 1.6%. Margins increased from 9.2% to 13.3%. HIP continued to benefit from robust aerospace and power generation demand andshowed an increase in operating profit of 21.9%. As the US business forms agreater proportion of the HIP SBU, foreign currency movements have had a muchgreater impact on its results, decreasing operating profit by 5.7%. Despite thismargins increased from 32.9% to 35.9%. Despite difficulties in its North American markets Testing has also continued toinvest in building its infrastructure to support its growth plans. Headlineoperating profit grew by 1.7% before the adverse impact of foreign currencymovements of 3.2%, which ultimately resulted in a fall of 1.5% in headlineoperating profit. Further costs for amortisation/impairment of acquiredintangible assets and goodwill (£4.8m), major facility closure costs (£2.0m)less gains on changes to pension scheme rules (£1.5m) totaled £5.3m (2006:£4.6m) and this resulted in operating profit falling by 6%. Finance Charge The net finance charge for the Group was £10.3m compared to £9.1m in, 2006,excluding the make whole for the early termination of the US Private Placementsenior notes (£3.1m). Profit before tax Headline profit before tax was £81.0m compared to £70.0m in 2006. Profit beforetax was £68.5m compared to £46.6m in 2006. Headline Profit Before tax is defined as follows: 2007 2006 £m £mHeadline Operating Profit* 91.3 79.7Net Finance Charge after the deduction of the early settlementof US Private Placement (10.3) (9.1)Share of associates' interest - (0.6)Headline Profit Before Tax 81.0 70.0Amortisation/impairment of intangible fixed assets (1.9) (1.0)Impairment of goodwill (7.2) (6.0)Impairment of investment in associate - (8.3)Change to pension scheme rules 4.1 -Major facility closure costs (5.4) (5.0)Bid response costs (2.1) -Early settlement of US Private Placement - (3.1)Profit Before Tax 68.5 46.6 Taxation Taxation was £14.7m for the year, £12m higher than the 2006 charge which hadbenefited from tax settlements of £11.2m. The effective tax rate for the Groupwas 21.5% (2006: 5.8%). The Group's underlying rate of tax which represents the tax rate beforeimpairment of goodwill and amortisation of acquired intangibles (both of whichare generally not allowable for tax purposes) and before non-recurring items was19.0% (2006: 7.7%). The 2006 underlying rate is stated after the impact ofspecific settlements with tax authorities that reduced the tax liability by£11.2m. The effective tax rates reflect a blend of rates in the numerous worldwidelocations in which Bodycote is present, and many of these have a lower tax ratethan the UK standard rate of 30%. Additionally, a number of jurisdictions havereduced their tax rates or have announced tax rate reductions, which have had afavourable impact on the Group's effective rate. Earnings per share Basic headline earnings per share (as defined in note 4) increased by 17.3% to20.3p from 17.3p. Basic and diluted earnings per share for the year were 16.6p(2006: 13.4p), an increase of 23.9% Dividend The Board has recommended a final dividend of 5.25p bringing the total dividendin 2007 to 8.0p (2006: 7.0p) an increase of 14.3%. The dividend is covered 2.5times (2006: 2.5 times) by headline earnings per share (as defined in note 4)and 2.1 times (2006: 1.9 times) by basic earnings per share. Capital Structure Our balance sheet at 31 December 2007 can be summarised as set out in the tablebelow: Assets Liabilities Net Assets £m £m £m Property, plant & equipment 508.9 508.9Goodwill and intangibles 227.3 227.3Current assets and liabilities 181.3 (157.2) 24.1Other non-current assets and liabilities 15.0 (12.0) 3.0Retirement benefit obligations (23.9) (23.9)Deferred tax 29.7 (74.3) (44.6)Total before net debt 962.2 (267.4) 694.8 Net debt 37.7 (235.9) (198.2) Total as at 31 December 2007 999.9 (503.3) 496.6 Total as at 31 December 2006 889.4 (435.5) 453.9 Net assets increased by 9.4% to £496.6m (2006: £453.9m) and net assets per shareby 9% to £1.56 (2006:£1.41). The main increases in the assets on the balancesheet were due to an increase in property, plant and equipment of £60.5m and anincrease in goodwill and intangible assets of £15.0m, which arose from theacquisitions completed during the year. The increases in assets were partiallyoffset by an increase in net debt of £37.3m. Net Debt Group net debt was £198.2m (2006: £160.9m). During the year, additional loansof £36.0m were drawn down under committed facilities. The Group continues to beable to borrow at competitive rates and therefore currently deems this to be themost effective means of funding. In 2007, a three year committed loan facilityof $20m was completed. Cash Flow Cash flow from operating activities was £108.0m compared to £109.2m in 2006, adecrease of 1.1%. After allowing for net capital expenditure of £66.9m (2006:£55.4m), the Group generated operating cash flow of £41.1m compared to £53.8m in2006. There has been continued focus on cash collection and debtor days havedecreased by 2 days to 68 days. Net interest payments in the year were £9.1m(2006: £12.8m) and tax payments were £16.0m (2006: £8.4m). Acquisitions anddisposals resulted in net cash outgoings of £32.9m (2006: £86.2m). Capital Expenditure Net capital expenditure for the year was £66.9m compared to £55.4m in 2006. Themultiple of net capital expenditure to depreciation was 1.3 times as the Groupexpands into emerging markets and continues to take advantage of outsourcingopportunities. With buoyant demand continuing in most markets, the Groupanticipates a ratio of 1.3 times again in the current year. During the year workcontinued on 21 greenfield investments started since 2006 such as the greenfieldheat treatment plant in Mexico, various testing facilities in the Middle East,the new testing facility in Mexico and the construction of our Indian heattreatment facility. Expansion projects with expenditure in 2007 included a newheat treatment plant in Finland, the completion of a large HIP unit in the USand the commencement of work on a new large HIP unit in Sweden. Borrowing Facilities At 31 December 2007, Bodycote had three committed bank facilities of £225m(2006: £225m), expiring July 2010; €125m (2006: €125m), expiring July 2013; and$20m (2006: nil) expiring July 2010 totalling £326.9m (2006: £309.2m). At thesame date, the three facilities were drawn £175.3m (2006: £140.3m), £44.1m(2006: £43.1m) and £4.6m (2006: nil) respectively, totalling £224.0m (2006:£183.4m). Financial Risk Management The Group's treasury function provides a centralised service to the Group forfunding, foreign exchange, interest rate management and counterparty risk.Treasury activities have the objective of minimising risk. Treasury operationsare conducted within a framework of policies and guidelines authorised andreviewed by the Company's Board of directors, most recently on 13 December 2007. The Group uses a number of derivative instruments that are transacted, for riskmanagement purposes only, by specialist treasury personnel. The use offinancial instruments including derivatives is permitted when approved by theBoard, where the effect is to minimise risk for the Group. Speculative tradingof derivatives or other financial instruments is not permitted. There has beenno significant change during the financial year, or since the end of the year,to the types or scope of financial risks faced by the Group or the Group'sapproach to the management of those risks. Capital Management The Group manages its capital to ensure that entities in the Group will be ableto continue as a going concerns while maximising the return to shareholders.The capital structure of the Group consists of debt, which includes borrowings,cash and cash equivalents and equity attributable to equity holders of theparent, comprising capital, reserves and retained earnings. The capital structure is reviewed regularly by the Company's Board of Directors.The Group's policy is to maintain gearing, determined as the proportion of netdebt to total capital within defined parameters, allowing movement in thecapital structure appropriate to the business cycle and corporate activity. Thegearing ratio at 31 December 2007 was 28% (2006: 26%). The Group's debt funding policy is to borrow centrally, using a mixture ofshort-term borrowings, longer-term loans and finance leases. These borrowings,together with cash generated from operations, are lent or contributed as equityto certain subsidiaries. The aim of the Group's funding policy is to ensurecontinuity of finance at reasonable cost, based on committed facilities fromseveral sources, arranged for a spread of maturities. Liquidity Risk Liquidity risk is defined as the risk that the Group might not be able to settleor meet its obligations on time or at a reasonable price. Liquidity risk arisesas a result of mismatches between cash inflows and outflows from the business.This risk is monitored on a centralised basis through regular cash flowforecasting: A 5 year rolling Strategic Plan, an annual budget agreed by theBoard each December and a quarterly re-forecast undertaken during the financialyear. The resulting forecast net debt is measured against a liquidity headroompolicy which, at the current net debt levels, requires committed facilities(plus term loans in excess of one year) to exceed net debt by 50%. As at 31 December 2007, the Group had committed facilities of £326.9m (2006:£309.2m) which exceed net debt of £198.2m (2006: £160.9m) by 65% (2006: 92%).The Group also uses uncommitted short term bank facilities to manage short termliquidity but these facilities are excluded from the liquidity headroom policy.The Group manages long term liquidity through long term committed bankfacilities and will, if appropriate, raise funds on capital markets. TheGroup's principal committed bank facility of £225m has a maturity of 2.6 years.The €125m committed bank facility has a maturity of 5.6 years. In addition cashmanagement pooling, netting and concentration techniques are used to minimiseborrowings. Market Risk Interest rate risk Interest rate risk arises on borrowings and cash balances (and derivativeliabilities and assets) being at floating interest rates. Changes in interestrates could have the effect of either increasing or decreasing the Group's netresult. Under the Group's interest rate management policy, the interest rateson each of the Group's major currency monetary assets and liabilities aremanaged to achieve the desired mix of fixed and variable rates for each majornet currency exposure. These major currencies currently include the US Dollar,Euro, Sterling, Swedish Krona and Canadian Dollar. Measurement of this interestrate risk and its potential volatility to the group's reported financialperformance is undertaken on a monthly basis. As at 31 December 2007, 6% of net borrowings were at fixed rates for an averageperiod of 3.0 years. Currency risk Bodycote has operations in 35 countries and is therefore exposed to foreignexchange translation risk when the profits and net assets of these entities areconsolidated into the Group accounts. Assets are hedged, where appropriate bymatching the currency of borrowings to the net assets. The Group principallyborrows in the US Dollar, Euro, Swedish Krona and Canadian Dollar, consistentwith the location of the Group's non-sterling assets. The Group also createsfurther currency financial liabilities and assets using cross currency swaps inorder to match currency assets with currency liabilities better. The Grouprecognises foreign exchange movements in equity for the translation of these netinvestment hedging instruments and balances. As at 31 December 2007, £231.7m ofgross debt and £148.8m of FX and cross currency swap liabilities were incurrencies other than sterling and net cash of £33.3m and cross currency swapassets of £140.2m were in sterling. It is Group policy not to hedge exposure for the translation of reportedprofits. Transaction foreign exchange exposures arise when entities within the Groupenter into contracts to pay or receive funds in a currency different from thefunctional currency of the entity concerned. It is Group policy to hedgeexposure to cash transactions in foreign currencies when a commitment arises,usually through the use of foreign exchange forward contracts. However thenature of the business is such that cross border sales and purchases are limitedand, other than currency and interest, such exposures are immaterial for theGroup. Market Risk sensitivity analysis The group has measured the estimated charge to the income statement and equityof either an instantaneous increase or decrease of 1% (100 basis points) inmarket interest rates or a 10% strengthening or weakening in sterling againstall other currencies from the applicable rates as at 31 December 2007, for allfinancial instruments with all other variables remaining constant. Thisanalysis is for illustrative purposes only, as in practice market rates rarelychange in such a manner. The sensitivity analysis excludes the impact of marketrisks on net post employment benefit obligations. Interest rate sensitivity The interest rate sensitivity analysis is based on the following assumptions: • changes in market interest rates affect the interest income or expense of variable interest financial instruments; • changes in market interest rates only affect the income statement in relation to financial instruments with fixed interest if these are recognised at their fair value; and • changes in market interest rates affect the fair value of derivative financial instruments designated as hedging instruments. Under these assumptions, a one percentage point fall or rise in market interestrates for all currencies in which the Group has variable net cash (andderivative assets) or net borrowings (and derivative liabilities) at 31 December2007 would reduce or increase profit before tax by approximately £1.9m. Thereis no material impact on equity. Currency sensitivity The currency risk sensitivity analysis is based on the assumption that changesin exchange rates affect the non sterling financial assets and liabilities andthe interest relating to those financial assets and liabilities. Under this assumption, a 10% strengthening or weakening of sterling against allexchange rates at 31 December 2007 would have reduced or increased profit beforetax and equity (before tax effects) as follows: £m CAD Euro SEK USD Other Total Impact on equity + / - 2.3 17.5 3.8 9.3 0.8 33.7Impact on profit before tax + / - 0.1 0.7 0.1 0.5 0.1 1.5 Non-sterling financial liabilities offset the exchange rate impact on non-sterling net assets. Counterparty risk Counterparty risk encompasses settlement risk on derivative financialinstruments and money market contracts and credit risk on cash and timedeposits. The Group monitors its credit exposure to its counterparties viatheir credit ratings (where applicable) and through its policy, thereby limitingits exposure to any one party to ensure there is no significant concentration ofcredit risk. Group policy is to enter into such transactions only withcounterparties with a long term credit rating of A-/A3 or better. However,acquired businesses occasionally have dealings with banks with lower creditratings. Business with such banks is moved as soon as practicable. Thecounterparties to the financial instruments transacted by the group are majorinternational financial institutions and whilst these counterparties may exposethe Group to credit losses in the event of non-performance, it considers therisk of material loss, given our policy, to be acceptable.. The notionalamounts of financial instruments used in interest rate and foreign exchangemanagement do not represent the credit risk arising through the use of theseinstruments. The immediate credit risk of these instruments is generallyestimated by the fair value of contracts with a positive value. The maximumexposure to credit risk for time deposits and other financial assets isrepresented by their carrying amount. Credit risk Credit risk arises from the possibility that customers may not be able to settletheir obligations as agreed. To manage this risk the Group periodicallyassesses the financial reliability of customers. The majority of the Group'strade receivables are due for maturity within 60 days. Concentrations of credit risk with respect to trade receivables are limited.The Group has a diverse customer base of over 60,000 customers and is notreliant on any one business sector, end market, or client. The largest customerrepresents c. 3% of total Group revenue and the top ten customers account for c.9%. Bodycote's diverse client base provides the Group with balanced demand froma number of sectors as seen below. Management therefore believes there is nofurther credit risk provision required in excess of the normal provision for badand doubtful receivables. Defined Benefit Pension Arrangements The Group has defined benefit pension obligations in the UK, Germany, Sweden,USA and Brazil and cash lump sum obligations in France, Italy and Turkey, whichare all reflected in the Group balance sheet. In the UK, the Group has a finalsalary scheme, which was closed to new members in April 2001, but continues toaccrue benefits for the 260 current employee members. The deficit as calculatedby the scheme actuary at 31 December 2007 using the principles of IAS 19 is£13.4m. The Group's heat treatment business in Germany has inherited severaldefined benefit arrangements. They are all unfunded and are closed to newmembers but existing members continue to accrue benefits. The IAS 19 liabilityat 31 December 2007 was £2.6m. In Sweden, the Group has two defined benefitarrangements. One is funded and one is unfunded and each is open to newemployees. The IAS 19 liability at 31 December 2007 was £2.0m. The companysponsors five defined benefit pension arrangements in the USA which wereinherited with the acquisition of Lindberg and had a total IAS 19 deficit at 31December 2007 of £0.2m. There are no further accruals on any of these plans.Brasimet operates a defined benefit plan for three senior members of staff. Itis fully funded and the members continue to accrue benefits. At 31 December2007 it had a surplus of £0.1m. In France we operate a plan which pays a cashlump sum on retirement and also for long service. The plan is open to newemployees but by its nature is not mortality dependent. It is unfunded and theIAS 19 liability at 31 December 2007 was £4.9 m. Italy and Turkey also havecash lump sum obligations which are open to new members. The IAS 19 liabilityis £0.7m for Italy and £0.1m for Turkey. Post balance sheet events After the year end the Group purchased Accutest Laboratories Limited, a Canadiananalytical testing business, Metlab (Int.) Ltd in Eire which provides materialstesting and non-destructive testing services and Thai Induction Services Co.Limited, Thailand's largest metallurgical services provider. The totalconsideration for these transactions was £10.4m. Change in accounting policies During the year there were no material changes to accounting policies. Going concern After making enquiries, the directors have formed the opinion that at the timeof approving the financial statements, there is a reasonable expectation thatthe Group has adequate resources to continue in operational existence for theforeseeable future. For this reason the directors continue to adopt the goingconcern basis in preparing the financial statements. Principal Risks and Uncertainties Markets The key risk we face is a reduction in end market demand, but with the exceptionof the automotive sector in western markets, forecast demand in the near termappears robust. Commercial relationships The Group benefits from many long term and partnership arrangements with keycustomers. Damage to or loss of any of these relationships may be detrimentalto Group results although we believe this is highly unlikely. Given that ourtop ten customers account for only c. 9% of sales, with the balance made up bymany thousands of customers, we have low revenue concentration risk. The Grouphas no significant supplier dependency. Competitors With the exception of HIP, our markets are fragmented and this means that theactions of competitors are typically felt locally rather than across the Group.The small market and concentrated supply of HIP means that there is a greaterrisk of material impact on this division should competitors add significantcapacity. Human Resources People are the Group's greatest asset and also form its largest cost. We workhard at maintaining a respectful and trusting relationship with all employees.However, we are mindful that there must be strong control on these costs, whichcan be flexed more easily in North America, the UK and emerging economies, butmuch less so in Western Europe where we strive to keep about 15% of ourworkforce flexible against a background of more restrictive employment laws. Safety and Health Our work environment has numerous and varied risks which we strive to mitigateby providing systems, equipment, training and supervision. Risk is evaluated byinternal and external resources so that it is continuously managed andmitigated. Brand and Reputation Bodycote is a valuable and well-known business to business brand. Any damage tothe brand because of the breakdown of commercial relationships, non-compliancewith laws and regulations, misuse of human or other resources in breach of ourcorporate ethos could have an adverse impact on the Group as a whole. For thesereasons Bodycote has instituted an effective programme under which employees canand do use the Group's open door policy to report legitimate concerns aboutbusiness conduct to the most senior executives and non-executive directors. Energy An increase in energy cost is a risk which we have been able to mitigate so far,although with some time lag, through price adjustments or surcharges and weexpect to be able to continue this practice. Operations Our stringent quality systems, our internal and external auditing as well as ourcustomers verification of our results, minimise the risk of releasing faultyparts or test results into use, which could arise as a result of system or humanfailure. Environmental Some of our heat treatment plants use solvents and other hazardous chemicals insmall quantities. There is therefore the potential for ground contamination atour facilities. Past exposures are remediated as and when required. Thelikelihood of future problems is mitigated by our procedures, typically underthe requirement of ISO 14001 environmental systems. Foreign exchange Although the Group has all but 17% of its sales generated outside the UK, theoverwhelming majority of those sales are supplied locally to customers buying inthe currency of our input costs. Consequently transaction risk is low. We are,however, exposed to fluctuation in exchange rates in respect of the translationof non-sterling denominated results. In common with the majority of UK listedcompanies we do not hedge this exposure. However, we do partially hedge ourbalance sheet assets and liabilities through a mixture of local currency loansand cross currency swaps. Resources The Group has key resources which are critical to its continued success: People,Technology, Approvals and Systems. People The strength of our Group primarily rests in our people and one of the keychallenges for management is to ensure availability of appropriately qualifiedpeople to support our continued growth. We are fortunate to have a competentand committed international team that is well respected in technical andbusiness circles. Most of our acquisitions are based on historicalrelationships with Bodycote personnel which is a testament to the integrity ofour people. The Board has established a remuneration policy which rewardsperformance while offering competitive base packages. In line with our policyof continuous improvement we have established a leadership development programmeto improve the succession pipeline for our future business leadership. With theopportunity for career development we believe we can continue to sustain andgrow the Group into the future. Technology The technology we apply in delivering our services is mostly generic. Thedifferentiator is in our know-how in applying that technology, the qualitystandards we adhere to, the depth of technical knowledge we are able to deliverand the consistency of service. In those instances where we have uniquetechnology, we have principally relied upon confidentiality with patentprotection for niche areas. Approvals We have 56 facilities registered to Nadcap, the international aerospace qualitystandard. All thermal processing facilities are certified to at least onequality standard (e.g. ISO 9001, TS 16949, Nadcap) and by the end of 2007 theyear 131 out of 194 thermal processing facilities were certified to ISO 14001environmental standards. Testing has 102 of its 115 facilities accredited tothe laboratory management standard ISO 17025. Our reputation for strongcompliance differentiates us in the market place and assures customers of ourability to deliver consistent quality. This makes our customers' decision tooutsource critical components easier. Systems Information Systems provide the systems that allow us to operate successfullyoperate a large distributed network. It is critical that we continue to developour systems so we can have the most efficient information processes forourselves, our customers and so we have the ability to identify and controlcosts across the whole of the Group. We use computer and internet technology toprovide secure real-time job status as well as technical support to ourcustomers. Corporate ethos In achieving Bodycote's aim to be recognised globally as the leading provider ofthermal processing and in testing services, the Board has over time developedseveral principles which will apply in its dealings with stakeholders and thewider community. Safety, health and the environment Bodycote has a proactive approach to safety, health and the environment and iscommitted to the highest practicable standards of safety and health managementand to the minimisation of adverse environmental impacts. Human Resources Bodycote's employment policies are non-discriminatory, complying with allcurrent legislation to engender equal opportunity irrespective of race, gender,religion, disability, sexual orientation or nationality. Harassment is nottolerated. Ethical Standards All Bodycote personnel are expected to apply a high ethical standard, consistentwith an international UK-listed company. Compliance with laws Bodycote has systems in place designed to ensure compliance with all applicablelaws and regulations and conformity with all relevant codes of businesspractice. Competition Bodycote aims to win business in a differentiated high value manner: We do notemploy unfair trading methods and we compete vigorously but fairly within therequirements of the applicable laws. Employees are prohibited from eithergiving or receiving any inducements. Conflicts of interest Employees are expected to ensure that their personal interests do not at anytime conflict with those of Bodycote. Shareholder employees are advised of andcomply with share trading codes. Politics Bodycote does not make political donations. As a result of these principles, some key areas of focus have emerged, namely inrespect of people, safety, health and the environment. Key areas of focus Training and Education The Group sponsors The Bodycote Educational Foundation, a registered charity,whose aim is to fund relevant educational and training opportunities. Theseaims are fulfilled by supporting short term student placements at Bodycotefacilities to work on specific projects of benefit to the Group. Since 1996,the Foundation has sponsored over 265 students from 10 countries. TheFoundation also supports the annual Prize Paper Competition. In its twelfthyear, the competition has become one of the most highly regarded in its field.Numerous entries from universities and materials science institutes worldwidefollow a rigorous selection process, with five entrants reaching the finalpresentation judged by management and engineering academics. Winners receive acash prize, publication in a peer reviewed journal and potential for careerdevelopment within the Group. Safety & Health Appropriate safety and health policies and procedures are in force in both SBUs.In 2004 the Group commenced reporting its performance internally in terms oflost time, frequency and severity of accidents in a uniform manner. As aresult, each SBU is now able to benchmark its safety and health performance andformulate criteria for improvements. Bonus payments to Directors and seniorexecutives are in part dependent on achievement of these targets. Environment Bodycote has for many years contributed to the reduction of the environmentalimpact of industry. By adopting the latest technologies as they have becomeavailable, Bodycote has provided its customers with environmentally friendlysolutions to their heat treatment requirements. The replacement, where possible,of harmful materials has reduced the need for disposal of waste products. At thesame time the adoption of high efficiency heating systems has reduced energyconsumption and reduced emissions. The success of Bodycote's processes in addressing these issues is key to ourenvironmental credentials. We do not simply aim to minimise our own energyconsumption, but also to effect substantial reductions in our customers' energyuse. Bodycote operates modern, efficient heat treatment furnaces around the clock.We aggregate demand from a wide range of customers to maximise efficiency andminimise energy costs. By replacing under-utilised, in-house thermal processingoperations with Bodycote's state of the art equipment, the overall amount ofenergy used can be dramatically reduced. The range of services offered across the Group is designed to enhance thesuitability and operational lifetime of components and for recycling at the endof their working lives. This increase in the working life of components has amajor effect on the amount of raw materials that are processed. Moderntreatments also allow new technologies, such as common rail diesel systems, tobe introduced within acceptable financial constraints. This, in turn, reducesthe environmental impact of motor vehicles by improving fuel consumption andreducing emissions. At every stage where Bodycote is involved in themanufacturing cycle, our operations aim to lessen the overall impact on theenvironment. Current Trading and Prospects Our customers in aerospace, oil & gas, power generation and health sciences areforecasting positive growth through 2008 despite widespread predictions ofeconomic slowdown. Many of the markets that Bodycote serves notably aerospace,power generation and oil & gas, operate on long cycles, with significantcommitted order books. North American automotive (4.9% of our Group sales) isforecast to build 1% fewer cars and light trucks in 2008, compared to 2007. Outsourcing by western manufacturers continues to grow with sales reaching £123min 2007, an increase of 17% (2006: £105m) and this trend is set to continue. Ourfocus on maximising capacity utilisation will allow us to provide manufacturerswith lower overall costs for their thermal processing and testing needs. Theincreased outsourcing growth has partially been absorbed into existing plant andequipment and in some cases additional equipment has been installed. We expectthis pattern to be repeated in 2008. Our strategy to increase our presence in developing economies, including thosein Asia, Latin America, Eastern Europe and the Middle East, is progressing.Sales now account for 9.1% of Group sales (2006: 4.6%). The early demand forhigh quality subcontracting is somewhat lower than anticipated in Asia but weremain confident of the long term opportunity. In total our greenfield sites inthe emerging markets recorded operating losses of £2.4m in 2007. We enter 2008 with market conditions for heat treatment remaining favourable inall territories and market sectors with the exception of the Great Lakes area ofNorth America, where much of the work comes from the automotive industry. Giventhe strength of the order books amongst our aerospace, power generation and oil& gas customer base and, given our market share gains in the automotive sector,we are confident about the Group's prospects not withstanding the uncertaintyabout the level of consumer demand in 2008, particularly in North America. HIP continues to experience increasing demand from its key aerospace, powergeneration and oil & gas markets. A new large HIP vessel went into productionin September in the USA and is ramping up sales as forecast. We have expandedour Swedish facility to improve the efficiency of fabricating containers used inpowder HIPped near-net-shape components and in preparation for a new large HIPvessel which will go into production in Q1 2010. The acquisition of theremaining 51% of the equity of Traitements Compression Services SAS (TCS) inMagny-Cours, France gives us control over this facility enabling us to utilisethis capacity in Southern Europe more effectively. After another good performance in 2007, the MEM division of testing is expectedto continue its success in 2008. The weakness in the North American automotivemarket has been addressed by restructuring our laboratory facilities inMichigan. In HSE a major cost reduction exercise has been undertaken which hasseen us exit several locations in Canada and management has been reorganisedaccordingly across the whole of North America. Similarly in the UK, a number ofenvironmental facilities have been closed to reduce the cost base and the FoodGroup have increased their focus on high added value advisory services. Weexpect a significant improvement in the performance of the HSE division in 2008. Since the end of 2007 we have acquired three businesses (two Testing, oneThermal Processing) for a total consideration of £10.4m. We have a strongpipeline of acquisition candidates for both Thermal Processing and Testing. Onaverage we expect to continue investing about £60m per annum on acquisitions. Capital expenditure for 2008 are expected to be at 1.3 times depreciation (2007:1.3 times) reflecting the continuing investment in greenfield locations indeveloping economies, expanding our HIP capacity and supporting our continuingoutsourcing growth. Ongoing operations require around 0.8 times depreciation tosustain their businesses. Since the start of the current financial year, trading has been above the levelsfor the same period in 2007 in both SBUs and in all geographies. We enter 2008with renewed confidence that we will deliver another successful performance. Finally, the employees and the Board of Bodycote would like to thank ouroutgoing Chairman, James Wallace, for his dedicated service to the company.Under James' leadership, Bodycote has been strengthened while growing ourbusinesses in line with our strategy. We all wish James continued success andpersonal happiness in the future. J D Hubbard D F Landless26 February 2008 26 February 2008 Consolidated Income Statementfor the year ended 31 December 2007 2007 2006 £m £mRevenueExisting operations 631.4 510.3Acquisitions 19.1 48.3 640.5 558.6 Operating profitExisting operations 77.5 51.3Acquisitions 1.2 7.2Share of results of associates 0.1 0.3 78.8 58.8 Operating profit prior to exceptional items 91.3 79.1Amortisation/impairment of acquired intangible fixed assets (1.9) (1.0)Impairment of goodwill (7.2) (6.0)Major facility closure costs (5.4) (5.0)Impairment of investment in associate - (8.3)Change to pension scheme rules 4.1 - Bid response costs (2.1) - Operating profit 78.8 58.8 Investment revenue 3.3 3.4Finance costs (13.6) (15.6)Profit before taxation 68.5 46.6 Taxation (14.7) (2.7) Profit for the year 53.8 43.9 Attributable to: Equity holders of the parent 52.8 43.1Minority interests 1.0 0.8 53.8 43.9 Earnings per share Pence PenceFrom continuing operations:Basic 16.6 13.4Diluted 16.6 13.4 Consolidated Statement of Recognised Income and Expensefor the year ended 31 December 2007 2007 2006 £m £m Exchange differences on translation of foreign operations 12.5 (6.7)Actuarial gains/ (losses) on defined benefit pension schemes 4.7 (3.7)Tax on items taken directly to equity (3.1) 1.6Net income/(loss) recognised directly in equity 14.1 (8.8) Profit for the year 53.8 43.9 Recognised income for the year 67.9 35.1 Attributable to:Equity holders of the parent 66.9 34.3Minority interests 1.0 0.8 67.9 35.1All activity arose from continuing operations. Consolidated Balance Sheetat 31 December 2007 2007 2006 £m £mNon-current assetsGoodwill 213.0 201.9Other intangible assets 14.3 10.4Property, plant and equipment 508.9 448.4Interests in associates 0.6 1.2Finance lease receivables 1.0 1.4Deferred tax asset 29.7 23.2Derivative financial instruments 0.1 0.6Trade and other receivables 13.3 11.3 780.9 698.4 Current assetsInventories 19.8 13.7Finance lease receivables 0.4 0.3Derivative financial instruments - 1.9Trade and other receivables 159.3 138.1Cash and cash equivalents 37.7 34.7Assets classified as held for sale 1.8 2.3 219.0 191.0Total assets 999.9 889.4Current liabilitiesTrade and other payables 124.5 111.1Dividends payable 8.8 8.0Current tax liabilities 13.0 6.7Obligations under finance leases 1.7 1.4Bank overdrafts and loans 9.0 4.4Derivative financial instruments 5.2 0.2Provisions 5.7 2.5 167.9 134.3 Net current assets 51.1 56.7 Non-current liabilitiesBank loans 221.8 186.5Retirement benefit obligation 23.9 32.8Deferred tax liabilities 74.3 68.7Obligations under finance leases 3.4 3.3Derivative financial instruments 3.0 0.1Provisions 2.2 4.1Other payables 6.8 5.7 335.4 301.2Total liabilities 503.3 435.5 Net assets 496.6 453.9 Consolidated Balance Sheet (continued)at 31 December 2007 2007 2006 £m £mEquityShare capital 32.4 32.2Share premium account 305.0 302.1Own shares (11.0) (2.4)Other reserves 6.0 3.8Hedging and translation reserves 16.9 4.4Retained earnings 140.7 109.4 Equity attributable to equity holders of the parent 490.0 449.5 Minority interest 6.6 4.4 Total equity 496.6 453.9 Consolidated Cash Flow Statementfor the year ended 31 December 2007 2007 2006 £m £m Net cash from operating activities 108.0 109.2 Investing activitiesPurchases of property, plant and equipment (72.5) (59.5)Proceeds on disposal of property, plant and equipment and intangible 6.6 4.8assets Purchases of intangible fixed assets (1.0) (0.7)Acquisition of investment in an associate (0.2) -Acquisition of subsidiaries (32.7) (86.3)Disposal of subsidiaries - 0.1 Net cash used in investing activities (99.8) (141.6) Financing activitiesInterest received 3.4 2.9Interest paid (12.5) (15.7)Dividends paid (22.6) (20.5)Dividends paid to a minority shareholder (0.1) (0.1)Repayments of bank loans (187.1) (65.5)Payments of obligations under finance leases (1.9) (1.8)New bank loans raised 216.4 46.0New obligations under finance leases 0.6 0.5Proceeds on issue of ordinary share capital 3.1 1.9Own shares purchased/settlement of share options (8.6) 0.1 Net cash used in financing activities (9.3) (52.2) Net decrease in cash and cash equivalents (1.1) (84.6) Cash and cash equivalents at beginning of year 33.4 120.7 Effect of foreign exchange rate changes 2.0 (2.7) Cash and cash equivalents at end of year 34.3 33.4 Reconciliation of operating profit to net cash from operating activities 2007 2006 £m £m Operating profit 78.8 58.8 Share of associates' interest and tax - 0.6 Depreciation of property, plant and equipment 49.3 44.8 Amortisation/impairment of intangible assets 2.7 1.6 Impairment of goodwill 7.2 6.0 Major facility closure costs 5.4 5.0Impairment of investment in associate - 8.3 Change to pension scheme rules (4.1) -Bid response costs 2.1 - EBITDA1 141.4 125.1 (Gain)/loss on disposal of property, plant and equipment (0.1) 0.3 Income from associates (0.1) (0.9)Share-based payments 2.5 2.1 Operating cash flows before movements in working capital 143.7 126.6 Increase in inventories (3.7) (0.4)Increase in receivables (8.4) (15.5)(Decrease)/increase in payables (2.9) 9.5 Decrease in provisions (5.4) (2.6) Cash generated by operations 123.3 117.6Cash inflow from settlement of derivative financial instruments 0.7 -Income taxes paid (16.0) (8.4) Net cash from operating activities 108.0 109.2 1 Earnings before interest, tax, depreciation and amortisation and other exceptional items Cash and cash equivalents (which are presented as a single class of assets onthe face of the balance sheet) comprise cash at bank and other short-term highlyliquid investments with a maturity of three months or less. 1. Operating profit 2007 2006 Existing Acquisitions Continuing Existing Acquisitions Continuing operations operations operations operations £m £m £m £m £m £m Revenue 631.4 9.1 640.5 510.3 48.3 558.6 Cost of sales (412.5) (5.6) (418.1) (334.7) (31.3) (366.0) Gross profit 218.9 3.5 222.4 175.6 17.0 192.6 Other operating income 5.0 0.2 5.2 2.8 - 2.8 Distribution costs (22.9) (0.7) (23.6) (16.5) (2.1) (18.6) Other administration (111.0) (1.8) (112.8) (90.7) (7.1) (97.8) expenses* Other operating expenses - - - (0.2) - (0.2) Amortisation/impairment (1.9) - (1.9) (0.4) (0.6) (1.0) of acquired intangible fixed assets* Impairment of goodwill* (7.2) - (7.2) (6.0) - (6.0) Major facility closure (5.4) - (5.4) (5.0) - (5.0) costs* Impairment of investment - - - (8.3) - (8.3) in associate* Change to pension scheme 4.1 - 4.1 - - - rules Bid response costs (2.1) - (2.1) - - - Operating profit before 77.5 1.2 78.7 51.3 7.2 58.5 income from associates Income from associates 0.1 0.3 after interest and tax Operating profit 78.8 58.8 * Administration expenses (total £125.3m, 2006: £118.1m) Exceptional items comprise amortisation/impairment of acquired intangible fixedassets, impairment of goodwill, major facility closure costs, impairment ofinvestment in associate, change to pension scheme rules and bid response costs. 2. Business and geographical segments Heat Treatment Hot Isostatic Testing - Testing - Head Office and Continuing Pressing MEM* HSE* eliminations operations 2007 2007 2007 2007 2007 2007 £m £m £m £m £m £mRevenueExternal sales 421.7 43.5 124.4 50.9 - 640.5 Inter-segment - - 0.8 - (0.8) - sales Total revenue 421.7 43.5 125.2 50.9 (0.8) 640.5 Inter-segment sales are charged at prevailingmarket prices. ResultSegment result 61.6 15.3 16.9 4.1 - 97.9 prior toexceptionalitems and shareof associates'profit after taxShare of - 0.1 - - - 0.1 associates'operating profitUnallocated - - - - (6.7) (6.7)corporateexpensesHeadline 61.6 15.4 16.9 4.1 (6.7) 91.3 operating profitAmortisation / (4.3) - (0.3) (4.5) - (9.1)impairment ofacquiredintangibleassets andimpairment ofgoodwillMajor facility (3.4) - (0.4) (1.6) - (5.4)closure costsChange to 2.0 0.2 1.3 0.2 0.4 4.1 pension schemerulesBid response - - - - (2.1) (2.1)costs Segment result 55.9 15.6 17.5 (1.8) (8.4) 78.8 Share of - - associates'interest and tax Operating profit 78.8 Investment 3.3 revenuesFinance costs (13.6) 68.5 Profit beforetaxTax (14.7) Profit for year 53.8 * Testing comprises MEM (Materials Testing/Engineering and Technology/Measurement Technology) and HSE(Health Sciences and Environmental). These divisions have been presented as separate segments in the current year in line with the Group'sinternal reporting structure. 2. Business and geographical segments (continued) Heat Treatment Hot Testing - Testing - Head Office and Continuing Isostatic eliminations operations Pressing MEM HSE 2006 2006 2006 2006 2006 2006 £m £m £m £m £m £mRevenueExternal sales 375.0 38.9 99.6 45.1 - 558.6 Inter-segment sales - - 0.6 - (0.6) - Total revenue 375.0 38.9 100.2 45.1 (0.6) 558.6 Inter-segment sales are charged at prevailingmarket prices. ResultSegment result prior 49.5 12.7 14.3 7.0 - 83.5 to exceptional itemsand share ofassociates' profitafter taxShare of associates' 0.8 0.1 - - - 0.9operating profit Unallocated corporate - - - - (4.7) (4.7)expenses 50.3 12.8 14.3 7.0 (4.7) 79.7 Amortisation/ (10.7) - (4.0) (0.6) - (15.3)impairment of acquiredintangible assets andimpairment of goodwilland investment inassociateMajor facility closure (5.0) - - - - (5.0)costs Segment result 34.6 12.8 10.3 6.4 (4.7) 59.4 Share of associates'interest and tax (0.6) (0.6) Operating profit 58.8 Investment revenues 3.4 Finance costs (15.6) Profit before tax 46.6Tax (2.7) Profit for year 43.9 2. Business and geographical segments (continued) Other information Heat Hot Testing Testing Head office and Consolidated Treatment Isostatic - - eliminations Pressing MEM HSE 2007 2007 2007 2007 2007 2007 £m £m £m £m £m £m Capital additions 44.2 12.6 13.1 3.1 0.5 73.5Depreciation and amortisation 36.0 4.3 7.9 3.2 0.2 51.6Impairment losses recognised 3.8 - 0.4 4.1 - 8.3in income Balance sheetAssets:Segment assets 941.4 100.2 152.9 82.4 (277.6) 999.3Interests in associates 0.6 - - - - 0.6 Consolidated total assets 942.0 100.2 152.9 82.4 (277.6) 999.9 Liabilities:Segment liabilities 522.9 48.2 107.5 57.9 (233.2) 503.3 Segment net assets 419.1 52.0 45.4 24.5 (44.4) 496.6 Heat Hot Testing Testing Head office and Consolidated Treatment Isostatic - - eliminations Pressing MEM HSE 2006 2006 2006 2006 2006 2006 £m £m £m £m £m £m Capital additions 38.8 6.6 10.6 3.9 0.3 60.2Depreciation and amortisation 33.1 4.3 5.9 2.7 0.2 46.2Impairment losses recognised 13.9 - 3.7 0.2 - 17.8in incomeBalance sheetAssets:Segment assets 772.6 87.2 126.0 70.5 (168.1) 888.2 Interests in associates 1.2 - - - - 1.2 Consolidated total assets 773.8 87.2 126.0 70.5 (168.1) 889.4 Liabilities:Segment liabilities 445.7 36.1 107.7 60.3 (214.3) 435.5 Segment net assets 328.1 51.1 18.3 10.2 46.2 453.9 2. Business and geographical segments (continued) By geographicalmarket Revenue 2007 2006 £m £mEurope, Middle East and Africa 422.0 356.8Americas 215.4 200.6Asia Pacific 3.1 1.2 640.5 558.6 Carrying amount of segment Additions to property, plant and assets equipment and intangible assets 2007 2006 2007 2006 £m £m £m £mEurope, Middle 395.1 321.5 45.4 37.3East and AfricaAmericas 101.0 129.8 24.0 19.6Asia Pacific 0.5 2.6 4.1 3.3 496.6 453.9 73.5 60.2 3. Taxation 2007 2006 £m £m Current taxation - charge for the year 17.0 10.5Current taxation - adjustment in respect of previous years 3.4 1.6Deferred tax (5.7) (9.4) 14.7 2.7 UK corporation tax is calculated at 30% (2006: 30%) of the estimated assessable profit for the year. Taxation for otherjurisdictions is calculated at the rates prevailing in the respective jurisdictions. Reductions in tax rates have been announced in a number of jurisdictions in which Bodycote operates. The impact ofthese reductions has been included within deferred tax balances and going forward will be reflected in current taxrates. 4. Earnings per share The calculation of the basic and diluted earnings per share is based on thefollowing data: 2007 2006 £m £mEarningsEarnings for the purposes of basic earnings per share 52.8 43.1being net profit attributable to equity holders of theparent Number of shares Number NumberWeighted average number of ordinary shares for the 317,934,910 320,462,772purposes of basic earnings per share Effect of dilutive potential ordinary shares:Share options 732,862 880,065 Weighted average number of ordinary shares for the 318,667,772 321,342,837purposes of diluted earnings per share Pence PenceBasic 16.6 13.4 Diluted 16.6 13.4 Headline earnings 2007 2006 £m £mNet profit attributable to equity holders of the parent 52.8 43.1 Add back:Impairment of goodwill 7.2 6.0 Amortisation/impairment of acquired intangible fixed 1.9 1.0 assetsImpairment of investment in associate - 8.3 Major facility closure costs 3.6 5.0 Change to pension scheme rules (3.0) - Bid response costs 2.1 - Cost of early settlement of US Dollar private placement - 3.1 debtTax settlements in respect of prior years - (11.2) Headline earnings 64.6 55.3 Earnings per share from headline earnings: Pence Pence Basic 20.3 17.3 Diluted 20.3 17.2 5. Basis of preparation The financial information has been prepared in accordance with InternationalFinancial Reporting Standards (IFRS) as adopted for use in the EU. Whilst the financial information contained in this preliminary announcement hasbeen computed in accordance with International Financial Reporting Standards,this announcement does not itself contain sufficient information to comply withIFRS. The Company expects to publish full financial statements that comply withIFRS in April 2008. The financial information has been prepared under the same accounting policiesas the 2006 financial statements. 6. Non-statutory financial statements The financial information set out above does not constitute the Group'sstatutory financial statements for the year ended 31 December 2007 or 2006 butis derived from those financial statements. Statutory financial statements for2006 have been delivered to the Register of Companies. Those for 2007 will bedelivered following the company's annual general meeting, which will be convenedon 30 April 2008. The auditors have reported on those accounts: their reportwas unqualified and did not contain any statement under Section 237(2) or (3) ofthe Companies Act 1985. This report was approved by the Board of Directors on 26 February 2008. This information is provided by RNS The company news service from the London Stock Exchange

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