“In these challenging and uncertain times, our strategic and tactical priorities are clear:
We will remain focused on protecting the financial fundamentals – generating cash and maintaining a strong balance sheet.
We will protect our existing operations by being vigilant to the ever-changing business environment and reacting quickly and decisively. We will also continue to drive down expenses and focus our efforts on executing Projects Eagle and Cheetah.”
John ZimmermanFinance Director
Operating results
2008 compared with 2007
Group Overview The Group changed its presentation currency from sterling to the US dollar with effect from the beginning of 2008. Comparative figures for 2007 and 2006 that were originally presented in sterling have been re-presented in US dollars on the basis set out in note 2 to the consolidated financial statements.
Amortisation of intangible assets arising on acquisitions
(10.6)
(7.2)
Restructuring costs
(26.0)
(27.6)
Net gain on disposals and the exit of businesses
43.0
91.4
Impairments
(342.4)
(0.8)
Adjusted operating profit
403.4
530.5
Adjusted operating margin
7.3%
9.0%
(Loss)/profit before tax
(7.6)
525.4
Tax
(38.4)
(139.9)
(Loss)/profit after tax
(46.0)
385.5
Diluted (loss)/earnings per share
(7.29)c
40.91c
Adjusted diluted earnings per share
26.02c
37.14c
An explanation of the key performance measures referred to in the Operating and Financial Review is provided in the section entitled "Performance measures".
Sales in 2008 were $5,515.9 million (2007: $5,886.1 million). Sales were reduced by $268.8 million due to disposals of businesses (principally the disposal of Stant and Standard-Thomson in 2008 and Dearborn Mid-West in late 2007), but this was partially offset by the net currency translation gain of $157.9 million. Underlying sales fell by $322.8 million, principally due to reduced demand in most of the Group’s end markets.
Adjusted operating profit was $403.4 million (2007: $530.5 million). The adjusted operating margin was 7.3% (2007: 9.0%). Reduced volumes and initiatives to lower inventory levels led to lower fixed cost absorption that, combined with higher raw material prices that were not fully offset by price increases, led to lower profitability. The benefits of the restructuring initiatives mitigated to some extent the impact of lower sales.
Group sales bridge $ million
Group adjusted operating profit bridge $ million
Impairment In June 2008, as a result of the continued deterioration in North American automotive OE and US residential construction markets, the Group recognised a non-cash impairment amounting to $175.1 million. Management subsequently reviewed the recoverability of assets of the Group’s businesses in light of the continued weakness in the Group’s end markets, which was compounded by an increase in the discount rates that are required to be used for the purpose of the impairment tests. Additional fixed asset impairments were taken as part of the decision to implement Project Cheetah to restructure the manufacturing footprint of the Group. As a consequence of these developments, a further non-cash impairment of $167.3 million was recognised in the second half of 2008.
As a result, the total impairment recognised during 2008 was $342.4 million, of which $228.6 million related to goodwill and $113.8 million to property, plant and equipment. Goodwill allocated to Stackpole ($157.2 million) and to Gates Mectrol ($37.4 million) was written-off in its entirety and goodwill allocated to Selkirk was written down by $34.0 million to $38.3 million. Stackpole’s property, plant and equipment was written down by $65.9 million. Of the remaining $47.9 million impairment of property, plant and equipment, $36.9 million related to other Industrial & Automotive businesses and $11.0 million to Building Products businesses.
Impairments recognised during the year are analysed in notes 19 and 21 to the consolidated financial statements.
Restructuring costs Restructuring costs arise from major projects undertaken to rationalise the Group’s operations and to improve our cost competitiveness.
In 2008, restructuring costs were $26.0 million and principally related to the closure of Power Transmission’s facility at Moncks Corner, South Carolina, further rationalisation of the Lasco Bathware business in the US, the closure of Hart & Cooley’s production facility at Tucson, Arizona, and further costs associated with the outsourcing of IT services that began in 2007.
In 2007, restructuring costs were $27.6 million and principally related to the rationalisation of production facilities within the Lasco Bathware and Philips Products businesses in the US, the outsourcing of IT services and the initiatives within Fluid Power and Air Systems Components that began in 2006.
Net gain on disposals and on the exit of businesses During 2008, the Group recognised a gain of $43.2 million on the disposal of Stant and Standard-Thomson.
During 2007, the Group recognised a gain of $65.2 million on the disposal of Lasco Fittings, a gain of $13.4 million on the disposal of Dearborn Mid-West and a loss of $2.6 million on the disposal of Tridon’s indicator and side object detection businesses. Also during 2007, the Group recognised a gain of $15.4 million on the disposal of corporate property.
Share of (loss)/profit of associates In 2008, the Group’s share of the loss after taxation of its associates was $2.1 million (2007: profit of $0.8 million).
Net finance costs Net finance costs attributable to continuing operations were $75.0 million (2007: $60.9 million).
Net interest payable on net borrowings was lower at $47.1 million (2007: $52.8 million) due to lower average net debt and lower average interest rates during 2008 compared with 2007.
Net finance costs in relation to post-employment benefits were $2.9 million (2007: $1.3 million) as follows:
2008
$m
2007
$m
Interest cost on benefit obligation
78.4
76.3
Expected return on plan assets
(75.5)
(75.0)
Net finance costs on post-employment benefits
2.9
1.3
In 2007, net finance costs included $1.2 million in relation to dividends payable on the convertible preference shares that were redeemed in July 2007.
Other finance expense was $25.0 million (2007: $5.6 million), which principally related to financial instruments held by the Group to hedge its currency translation exposures that either did not qualify for hedge accounting or in respect of which there was hedge ineffectiveness.
Income tax expense In 2008, the income tax expense was $38.4 million (2007: $139.9 million). The loss before tax of $7.6 million (2007: profit before tax of $525.4 million) includes certain gains and losses on the disposal of subsidiaries and impairments for which no income tax is recognised. Excluding these gains, losses and impairments, the Group’s effective tax rate would have been 24.0% (2007: 25.4%).
The Group’s effective tax rate for 2009 is expected to be approximately 25%.
Minority interests In 2008, the profit after tax attributable to minority shareholders in subsidiaries not wholly-owned by the Group was $18.1 million (2007: $25.0 million).
(Loss)/earnings per share In 2008, there was a loss attributable to equity shareholders of $64.1 million (2007: profit of $293.8 million) and the diluted loss per share from continuing operations was 7.29 cents (2007: diluted earnings per share of 40.91 cents).
Adjusted earnings for calculating adjusted diluted earnings per share were $229.5 million (2007: $328.3 million). Adjusted diluted earnings per share were 26.02 cents (2007: 37.14 cents).
Dividend Following the re-denomination of the Company’s ordinary shares, which took effect in May 2008, dividends are now declared in US dollars.
Dividends in respect of 2007 and prior years were declared and paid in sterling. For comparative purposes, those dividends have been translated from sterling into US dollars at the exchange rate on their respective payment dates.
The Board has proposed a final dividend for 2008 of 2.00 cents per share, which is expected to absorb $17.6 million. When taken together with the interim dividend of 11.02 cents per share that was paid in November 2008, the total dividend per share for 2008 is 13.02 cents (2007: 27.68 cents).
Foreign currency translation Currency translation differences affect the Group’s results and cash flows on the translation of the results and cash flows of the Group’s operations from their functional currencies into US dollars. In 2008 compared with 2007, adjusted operating profit benefited by $20.4 million due to the effects of currency translation, principally because of the strengthening of the average euro and Korean won exchange rates against the US dollar during 2008.
Effect of inflation General price inflation in countries where the Group has its most significant operations remained at a low level during 2008 and the impact was not material to the Group’s results.
Industrial & Automotive Overview Sales in 2008 were $4,060.8 million (2007: $4,312.7 million).
Adjusted operating profit was $359.7 million (2007: $477.4 million). The adjusted operating margin was 8.9% (2007: 11.1%).
$ million, unless stated otherwise
2008
2007
Sales
- Power Transmission
2,106.4
2,063.2
- Fluid Power
832.3
769.1
- Fluid Systems
501.2
583.8
- Other Industrial & Automotive
620.9
896.6
Total sales
4,060.8
4,312.7
Adjusted operating profit
359.7
477.4
Adjusted operating margin
8.9%
11.1%
Net capital expenditure : depreciation
0.9 times
1.0 times
Average number of employees
20,994
21,296
Market background The US Industrial Production Index (as reported by the US Federal Reserve) showed an accelerating decline in US industrial production over 2008, falling by 8% over the year. Europe showed a steady decline in industrial production, with India and China also softening.
Our automotive aftermarket remained broadly flat in the developed regions, but saw continued strong growth in the developing regions of China and South America, in line with the growing number of vehicles in these markets.
The North American automotive OE market worsened throughout 2008, with North American automotive production in 2008 down 16% year on year (Source: CSM, light vehicle production volumes). Automotive OE markets outside North America were most noticeably affected towards the end of 2008, with declines in Europe and emerging economies.
Key markets trends:
Industrial OE and aftermarket
US industrial production declined by 8% in 2008
European industrial production declined by 10% in 2008
Industrial production in India and China softened in 2008
Automotive OE
Continued decline in North American auto production
Detroit Three on the brink of bankruptcy/accessing government funds
European auto production declined by 5%
Slowdown in emerging economies
Automotive aftermarket
Low consumer confidence causing deferral of discretionary spend
Continued decline in miles driven
Lack of credit threatening the smaller distributors
Destocking by distributors causing challenges in working capital management
Power Transmission Sales in 2008 were $2,106.4 million (2007: $2,063.2 million).
Adjusted operating profit was $229.6 million (2007: $266.8 million). The adjusted operating margin was 10.9% (2007: 12.9%).
Sales increased principally due to net foreign exchange translation gains and price increases, which more than offset lower volumes from global weakening end market conditions. The automotive aftermarket business, where sales were up marginally over the course of the year, continued to demonstrate its resilience.
Adjusted operating profit was impacted by lower fixed cost absorption from reduced sales volumes and initiatives to reduce inventory levels, the negative impact of transactional foreign exchange and raw material price increases. However, these factors were partially offset by price increases and the benefit of cost reduction initiatives.
Gates expanded its electro-mechanical drive system, which achieves approximately 3-8% fuel savings, and now has 18 systems in production and development with customers such as PSA, Chery and Hyundai. In Europe, Gates further expanded sales of its variable vane oil pumps, which contribute approximately 2-3% fuel savings, winning new contracts with Audi and PSA. Annualised new business awards in the automotive OE market totalling $233 million were won – a record for Gates – with 74% outside North America. Gates expanded its applications in the leisure market, supplying Trek and Giant with belts for bicycles.
Fluid Power Sales in 2008 were $832.3 million (2007: $769.1 million).
Adjusted operating profit was $46.2 million (2007: $71.0 million). The adjusted operating margin was 5.6% (2007: 9.2%).
Sales were higher due to the impact of price increases, foreign exchange translation gains and the acquisition of A.E. Hydraulic, which more than offset volume declines from weakening end markets, particularly in Europe. Gates Fleximak, which contributed $20.8 million of sales in 2007, was reclassified from Other I&A to the Fluid Power segment in 2008.
Adjusted operating profit decreased principally due to lower fixed cost absorption from reduced volumes, and initiatives to reduce inventory levels, coupled with the impact of higher raw material costs.
Gates E&S continued to expand, with the opening of the Kuwait service centre in late 2008 and the Turkey service centre on schedule to open in early 2009. Sales more than doubled during the year, assisted by the acquisition of A.E. Hydraulic early in 2008.
Fluid Systems Sales in 2008 were $501.2 million (2007: $583.8 million).
Adjusted operating profit was $39.9 million (2007: $55.0 million). The adjusted operating margin was 8.0% (2007: 9.4%).
Sales and adjusted operating profit decreased principally due to the deteriorating automotive OE market in the US, combined with the sale of Stant and Standard-Thompson during the year, offset to some extent by price increases and new contract wins.
Sales growth at Schrader Electronics slowed due to the weakness of the automotive OE market. This was partially offset by new contract wins at Mahindra & Mahindra and Ford, coupled with the increased replacement business from the greater number of vehicles fitted with RTPMS. European legislation mandating the application of RTPMS in European vehicles is currently expected and should drive continued growth in RTPMS.
Schrader Electronics is also working with other Group companies to develop innovative pressure and flow monitoring technologies.
Stant and Standard-Thomson were sold on 19 June 2008. Prior to their disposal, these businesses contributed $80.0 million to the Group’s sales in the first half of 2008, compared to $170.3 million in 2007.
Industrial & Automotive
Sales bridge $ million
Adjusted operating profit bridge $ million
Other Industrial & Automotive Sales in 2008 were $620.9 million (2007: $896.6 million).
Adjusted operating profit was $44.0 million (2007: $84.6 million). The adjusted operating margin was 7.1% (2007: 9.4%).
Other Industrial & Automotive includes the Dexter, Ideal, Plews and Gates Winhere businesses.
Other Industrial & Automotive sales decreased principally due to the weakening recreational vehicle and utility trailer end markets and general industrial market. Operating profit decreased principally due to lower volumes and, to some extent, by higher raw materials prices which were not fully offset by price increases.
Dearborn Mid-West was sold on 23 November 2007. Prior to its disposal, it contributed $163.7 million to sales and $9.9 million to adjusted operating profit in 2007, with no contribution in 2008.
Building Products Overview Sales in 2008 were $1,455.1 million (2007: $1,573.4 million).
Adjusted operating profit was $80.2 million (2007: $106.5 million). The adjusted operating margin was 5.5% (2007: 6.8%).
$ million, unless stated otherwise
2008
2007
Sales
- Air Systems Components
1,112.3
1,083.6
- Other Building Products
342.8
489.8
Total sales
1,455.1
1,573.4
Adjusted operating profit
80.2
106.5
Adjusted operating margin
5.5%
6.8%
Net capital expenditure : depreciation
0.8 times
0.8 times
Average number of employees
11,272
12,444
Market background Non-residential construction in the US, as measured by Dodge, contracted on a square foot basis by 19% in 2008, but remained broadly flat on a value basis. Building Products’ key markets of offices, warehousing, retail, education and hospitals were flat or declined. The US Architectural Billings Index, which is regarded as a leading indicator of future commercial construction activity, fell to historically low levels in 2008.
Residential construction in the US, measured by housing starts, declined by 33% in 2008 (according to the NAHB), the third straight year of decline, and 56% below the peak in 2005. Despite the reduction in housing construction, the number of months’ supply of unsold homes remained high throughout 2008 and, at the end of the year, stood at approximately nine months.
Key markets trends:
Non-residential construction
Significant declines in construction measured on square foot basis
Lack of credit affecting market
Vacancy rates rising
ABI suggesting significant decline in 2009
Increasing focus on ‘green’ buildings through demand for LEED-certified buildings
Residential construction
Seasonally adjusted annual housing starts declined to 560,000 units in December 2008
Significant lack of credit availability restricting purchasing power
Increasing inventory of unsold homes
Declining property values
Rising foreclosures
Manufactured housing
Continued decline in manufactured housing
Air Systems Components Sales in 2008 were $1,112.3 million (2007: $1,083.6 million).
Adjusted operating profit was $104.2 million (2007: $102.5 million). The adjusted operating margin was 9.4% (2007: 9.5%).
Sales into the non-residential construction markets remained broadly unaffected by the worsening economic environment, with the order backlog substantially maintained throughout the year. The combination of our new, ‘green’, energy-efficient products, geographic expansion into higher growth markets, and acquisitions completed during the year enabled us to outperform the market. Our acquisition of Trion, an indoor air quality business, was integrated successfully. Ruskin introduced its range of energy recovery ventilators, an energy-saving product that recycles conditioned air and reduces energy usage in HVAC systems. An additional facility was opened in India, expanding the geographic reach of our Indian businesses.
Sales and profits were adversely affected by the continued downturn in residential construction, mainly affecting our Hart & Cooley and Selkirk businesses. Adjusted operating profit increased in 2008 as a result of strong performance in our non-residential construction business. The adverse effect of higher raw materials costs, coupled with decreases in volumes, was offset by price increases, the contribution of acquisitions and the positive impact of restructuring initiatives.
Other Building Products Sales in 2008 were $342.8 million (2007: $489.8 million).
An adjusted operating loss of $24.0 million was recognised in 2008 (2007: profit of $4.0 million). The adjusted operating margin was (7.0)% (2007: 0.8%).
Other Building Products includes Lasco Bathware and Philips Products doors and windows business. Both businesses experienced further declines in sales in 2008 due to the continued weakening of residential construction, manufactured housing and remodelling markets. Adjusted operating profit decreased due to lower volumes combined with increased raw material and freight costs associated with higher diesel costs. Performance in the second half of 2008 improved as a result of continued restructuring initiatives in these businesses.
