Group Performance

Group	2007 £m	2006 £m
Sales
Subsidiaries	3,869	3,634
Share of joint ventures	253	208
Total	4,122	3,842
Trading profit
Subsidiaries	277	251
Share of joint ventures	32	21
Total	309	272
Return on sales	7.5%	7.1%

Management sales (subsidiaries and joint ventures) £4,122 million

(2006 – £3,842 million)

Combined sales of subsidiaries and share of joint ventures totalled £4,122 million compared with £3,842 million in 2006. Excluding the impact of currency, the increase was £395 million (11%). Excluding acquisitions and divestments as well as currency, the increase was £277 million (7%) with benefits from solid demand in emerging markets and Europe for Driveline, new programmes in Powder Metallurgy and Aerospace, and good growth in the Emitec joint venture.

Sales of subsidiaries £3,869 million

(2006 – £3,634 million)

Sales of subsidiaries were £3,869 million compared with £3,634 million in 2006, an increase of £235 million (6%). Excluding the impact of currency translation, acquisitions and divestments, there was an increase of £226 million (6%).

In Automotive businesses, subsidiaries’ sales of £2,031 million compared with £2,004 million a year earlier. Currency was £48 million adverse, and excluding this and a £5 million negative impact for 2006 divestments, the underlying increase was £80 million (4%). On a management basis, including our share of joint ventures, sales were £2,281 million (2006 – £2,209 million) and the underlying increase was £131 million (6%).

Powder Metallurgy sales were £602 million compared with £582 million in 2006. Currency was £22 million adverse so that the underlying increase was £42 million (8%) as new programmes commenced towards the end of the year.

In OffHighway, subsidiaries’ sales improved to £416 million from £353 million in 2006. The full year impact of 2006 acquisitions was £27 million and, excluding these and the adverse impact of currency (£6 million), sales increased by £42 million (12%) with good market conditions in both Europe and North America for agricultural and heavy construction equipment.

Aerospace sales increased to £820 million from £695 million in 2006. The impact of both 2006 and 2007 acquisitions was £96 million and, excluding this and currency (£33 million negative), the improvement was £62 million (9%) reflecting strong demand in both civil and military markets and a number of new programmes coming on stream.

Management trading profit (subsidiaries and joint ventures) £309 million

(2006 restated – £272 million)

The aggregated trading profit of subsidiaries and our share of joint ventures was £309 million, an increase of £37 million (14%). The net positive impact of currency, acquisitions and divestments was £11 million and excluding these factors, the increase was £26 million (10%) reflecting the impact of higher sales in Driveline and Aerospace, essentially level underlying results in Powder Metallurgy and OffHighway as well as growth in Other Automotive joint ventures. Margin improved to 7.5% (2006 – 7.1%).

Trading profit of subsidiaries £277 million

(2006 restated – £251 million)

Group trading profit was £277 million compared with £251 million in 2006, an increase of £26 million (10%). The currency impact on the translation of overseas profits was £4 million negative. There was a net benefit of £15 million from 2006 and 2007 acquisitions and divestments and excluding these factors the increase was £15 million (6%).

Automotive subsidiaries’ trading profit totalled £146 million compared with £137 million (restated) in 2006. There was no impact of currency and the net effect of divestments was £1 million negative. Excluding this, profits rose by £10 million (7%). Driveline benefited from higher sales and fixed cost reductions which were partially offset by the impact of raw material costs and shortages of speciality steels. In Other Automotive weakening demand, cost pressures and an asset impairment charge, which was related to a reorganisation, led to an increased loss. For Automotive as a whole, subsidiaries’ margin of trading profit to sales was 7.2% (2006 – 6.8%). On a management basis, including our share of joint ventures, trading profit was £178 million (2006 restated – £158 million) with the underlying increase £21 million (13%). Return on sales was 7.8% (2006 – 7.2%).

Powder Metallurgy profits of £29 million were £2 million lower than 2006. £1 million of the reduction was due to currency, with the remainder largely a consequence of higher raw material costs, the absence of some favourable copper and nickel commodity contracts in the powder business which had benefited 2006 and operational inefficiencies in the second half of the year associated with the final restructuring and plant closure actions. Return on sales was 4.8% compared with 5.3% in 2006.

OffHighway profit improved to £29 million from £25 million in 2006 with the increase coming from acquisitions. The benefit from higher underlying sales was offset by capacity related inefficiencies in the Wheels business, some under recovery of material price increases due to timing and, in Driveline Systems, additional costs caused by supply chain disruption, all of which intensified in the second half of the year. Margin was 7.0% compared with 7.1% in 2006.

Aerospace profit rose to £83 million from £70 million in 2006. Currency was £3 million negative while there was a £12 million benefit from 2006 and 2007 acquisitions leaving an underlying improvement of £4 million (6%). Margin remained level with 2006 at 10.1% reflecting, in part, the impact of new programmes in the early stages of production.

Corporate and unallocated costs of £10 million (2006 – £12 million) represent stewardship, legacy, governance and compliance costs relating to the overall Group rather than individual businesses, with the reduction primarily arising from a non-recurring credit of £3 million relating to a legacy business.

The overall margin of subsidiaries was 7.2% compared with 6.9% in 2006.

Restructuring and impairment costs £31 million

(2006 – £74 million)

Net charges in the year relating to the strategic restructuring programme totalled £33 million (2006 – £63 million) with £19 million (2006 – £37 million) in Driveline and £14 million (2006 – £24 million) in Powder Metallurgy. Within the total figure, there was a charge of £39 million in respect of redundancy and other reorganisation costs which was partially offset by a net £6 million credit from the reversal of charges taken in earlier years on assets brought back into use on profitable activities.

The charge for 2007 is within the total anticipated at the start of the year and costs of some £4 million which under accounting rules cannot be accrued in 2007 will be charged in 2008. Benefits also remain in line with earlier expectations.

In addition to the costs of strategic restructuring, there was a £2 million credit (2006 – £11 million charge) from the reversal of an impairment charge taken in prior years in respect of Other Automotive assets.

Amortisation of non-operating intangible assets arising on business combinations £8 million

(2006 – £3 million)

In accordance with IFRS 3, the Group has recognised intangible assets arising on businesses acquired in 2006 and 2007. The amortisation of non-operating intangible assets (e.g. customer contracts and relationships, trademarks, non-compete agreements and intellectual property rights) increased during the year as a result of the full year impact of the 2006 acquisitions of Stellex and Rockford and the acquisition of Teleflex in June 2007.

Profits and losses on sale or closures of businesses £7 million charge

(2006 – £4 million charge)

The loss on closure of businesses of £7 million arose at the UK cylinder liner business (Sheepbridge) which ceased trading in September. The 2006 net charge of £4 million consisted of a charge in respect of Sheepbridge trading losses of £9 million, partially offset by a profit on the disposal of the Group’s controlling interest in Fujiwa.

Changes in the fair value of derivative financial instruments £10 million charge

(2006 – £33 million credit)

The Group enters into foreign exchange contracts to hedge much of its transactional exposure. At 1 January 2007 the net fair value of such instruments was an asset of £27 million and at the end of 2007 the figure was an asset of £18 million.

Transactional hedge accounting has been applied to a small proportion of these transactions. Where transactional hedging has not been applied, the difference of £9 million has been charged (2006 – £39 million credited) separately as a component of operating profit. In addition, there was a £1 million charge in respect of commodity hedges in Powder Metallurgy (2006 – £1 million charge) with no overall change in the value of embedded derivatives (2006 – £5 million charge) leaving a net charge of £10 million (2006 – £33 million credit).

Operating profit £221 million

(2006 – £203 million)

Operating profit of £221 million compared with £203 million in 2006, reflecting the movements discussed above.

Post-tax earnings of joint ventures £24 million

(2006 – £17 million)

There was an increase of £7 million in the Group’s share of post-tax earnings of joint ventures. Within this figure, trading profit rose to £32 million from £21 million in 2006, an increase of 52%. There was a small negative impact from currency and the underlying improvement was 57% with improved profitability at Driveline’s Chinese joint ventures, at Chassis Systems which benefited from both slightly higher sales and a one off benefit from the finalisation of contractual pricing arrangements, and at Emitec, where sales again improved as a consequence of the 2006 legislation in Germany requiring the retrofitting of particulate filters to diesel powered vehicles.

Net financing costs £46 million

(2006 – £38 million)

Interest payable totalled £62 million (2006 – £57 million) and arose mainly on the £675 million of bonds and £30 million debenture in issue. This was partially offset by interest receivable of £19 million (2006 – £23 million) which arose on short term deposits, together with the benefits of lower borrowing costs on foreign currency debt instruments used to hedge the Group’s overseas investments. The year on year movement mainly reflected the full year effect of acquisitions made in 2006 together with the second half impact of the Teleflex acquisition made on 29 June 2007.

Other net financing costs were £3 million (2006 – £4 million) and related to post-employment obligations. The reduction of £1 million is the net benefit arising from higher scheme asset values which increased the expected return on scheme assets by £10 million, offset by a £9 million increase in interest on post-employment obligations from the higher discount rate assumption. Details of the assumptions used in calculating post-employment costs and income are provided in note 27 to the financial statements.

Profit before tax

Profit before tax on a statutory basis was £199 million (2006 – £182 million). On a management basis (i.e. excluding restructuring and impairment charges, amortisation of non-operating intangible assets arising on business combinations, profits and losses on the sale or closures of businesses and changes in the fair value of derivative financial instruments), the figure of £255 million was £25 million higher than the £230 million (as restated) in 2006. The post-tax share of joint ventures contributed £24 million (2006 – £17 million) and subsidiaries £231 million (2006 restated – £213 million).

Taxation

The tax charge on management profits of subsidiaries of £231 million (2006 – £213 million as restated) was £6 million (2006 – £17 million), representing a 2.6% rate (2006 restated – 8.0%).

The significant reduction in rate is due principally to deferred tax credits arising on the recognition of certain previously unrecognised deferred tax assets (mainly tax losses), the utilisation of other previously unrecognised deferred tax assets and changes in the statutory rate of tax affecting both current and deferred tax in certain of the jurisdictions in which we operate. The impact of these beneficial factors was partly offset by an increase in provisions for uncertain tax positions.

GKN’s tax strategy is aimed at creating a sustainable ‘cash tax’ charge (which excludes deferred taxes, movements in provisions for uncertain tax positions and tax relating to those non-trading elements of operating profit separately identified in the income statement) that balances the shareholders’ interest of minimising tax payments with the need to comply with the tax laws for each country in which we operate. In 2007 the cash tax charge was 17% and we expect cash tax to average 20% or less for the near term as we continue to make use of prior years’ tax losses, allowances and deductions in the various countries in which we operate.

For 2008, we now anticipate that the reported rate is again likely to be somewhat lower than the cash tax rate of 17%. For 2009 and beyond, the overall reported tax rate is likely to continue to be volatile, being influenced by the possible further recognition of currently unrecognised deferred tax assets and the settlement of prior year tax disputes. These unrecognised, potential deferred tax assets principally relate to brought forward tax losses in the UK and US which, due to the structure of the Group and the geographic mix of profitability, have so far not been seen as realisable for tax purposes.

The total effective tax rate of subsidiaries was 0.6% (2006 – 3.0%).

Tax charge analysis	2007 %	2006 %
Weighted average tax rates of major countries in which GKN operates	33	33
Benefits of GKN tax profile (tax losses and other factors)	(16)	(15)
2007 ‘cash tax’ rate	17	18
Movement in provisions (2007 and prior years — net)	2	(7)
Deferred tax credit (net)	(16)	(3)
Tax charge as % of subsidiaries’ underlying profit before tax	3	8

Computation of ‘cash tax’ rate	2007 £m	2006 £m
Current tax — total	36	18
Remove:   net movement for provisions for uncertain tax positions	(4)	15
Add back:   current tax on restructuring and impairment charges	7	6
‘Cash tax’ charge	39	39
Profit before taxation of subsidiaries (management basis)	231	213
‘Cash tax’ rate	17%	18%

Discontinued operations

There were no discontinued operations in the period.

Minority interests

The share of profit relating to minority interests was £2 million compared with £nil in 2006 and arose as businesses in emerging markets moved into profit.

Earnings per share

Earnings per share were 27.9p (2006 – 25.0p). Before restructuring and impairment charges, amortisation of non-operating intangible assets arising on business combinations, profits and losses on the sale or closures of businesses and changes in the fair value of derivative financial instruments, the figure was 35.1p (2006 restated – 30.1p), an increase of 17%.

Cash flow

Operating cash flow, which GKN defines as cash generated from operations (£299 million; 2006 – £117 million) adjusted for capital expenditure (£192 million; 2006 – £230 million) and proceeds from the disposal of fixed assets (£21 million; 2006 – £13 million), was an inflow of £128 million compared with a £100 million outflow in 2006. Included within the 2006 figure is the £200 million contribution to the UK pension scheme made in April of that year.

The outflow on working capital and provisions totalled £49 million (2006 – £3 million) largely reflecting inventory increases in support of higher sales in the year and, in Aerospace, projected sales in 2008. The figure also included a £9 million outflow in respect of a legacy environmental obligation (2006 – £5 million) where a further £6 million is expected to be spent in 2008. 

Capital expenditure (on tangible and intangible assets) totalled £192 million (2006 – £230 million). Of this, £172million (2006 – £197 million) was on tangible assets representing property, plant and equipment and was 1.2 times (2006 – 1.4 times) the charge for depreciation. The ratio of capital expenditure to depreciation is expected to reduce slightly in 2008.

Expenditure on intangible assets totalled £20 million (2006 – £33 million) and mainly reflected initial non-recurring costs on Aerospace programmes which will underpin future performance.

Net interest paid totalled £44 million compared with £33 million in 2006 with the increase largely due to a combination of the cash outflow relating to businesses acquired during the second half of 2006 and in 2007.

Tax paid in the year was £28 million (2006 – £31 million).

Dividends received from joint ventures totalled £13 million (2006 – £7 million).

Free cash flow

Free cash flow, which is cash flow excluding acquisitions, share buybacks and currency translation but including capital expenditure and dividends paid, is a key performance indicator of the Group. Free cash flow for the year was an outflow of £23 million (2006 – £246 million) after £40 million (2006 – £57 million) of expenditure on strategic restructurings. The Group’s balance sheet remains strong and with profit improvement, lower restructuring spend and reduced capital expenditure it is anticipated that, from 2008 onwards, cash generation should improve markedly.

Acquisitions and divestments

The net expenditure on acquisitions and divestments in the year was £71 million (2006 – £113 million). £68 million was in respect of Teleflex with further payments of £3 million in respect of 2006 acquisitions.

Net borrowings

At the end of the year the Group had net debt of £506 million (2006 – £426 million). This included the benefit of £42 million (2006 – £33 million) from customer advances in the Aerospace businesses which are shown in creditors in the balance sheet. The Group’s share of net funds in joint ventures was £14 million (2006 – £3 million).

Pensions and post-employment obligations

GKN operates a number of defined benefit and defined contribution pension schemes together with retiree medical arrangements across the Group. The total charge to trading profit in respect of current and past service costs of defined benefit schemes and retiree medical arrangements was £19 million (2006 – £40 million), whilst other net financing charges included in net financing costs were £3 million (2006 – £4 million).

The decrease in the charge to trading profit mainly reflects a total of £14 million past service and curtailment credit (largely related to changes to retiree medical arrangements in the US) and a £6 million reduction in the current service cost (mainly due to the increases in discount rates in the US and Europe together with lower salary growth assumptions in the UK). The ongoing annual benefit of these changes is £2 million to trading profit with a further £1 million benefit to financing charges. Further information including asset, liability and mortality assumptions used is provided in note 27 to the financial statements.

UK pensions

The UK defined benefit scheme is considered to be relatively mature since fewer than 4,400 of its 53,400 members are currently in service. As a UK defined benefit scheme, this is run on a funded basis with funds set aside in trust to cover future liabilities to members. A scheme specific funding valuation as at April 2007 was completed during the year and included an agreement with the Trustees to a deficit recovery plan and a revised schedule of contributions. The schedule of contributions does not call for any deficit funding.

Following a consultation period, a number of changes to future service benefits were introduced in the year and included a move away from a final salary based pension to that of a pension based on each year’s earnings (Career Average Revalued Earnings). In addition, the financial impact of changes in longevity assumptions for active members is to be shared between the Company and employees.

The charge relating to the UK defined benefit scheme reflected in trading profit in respect of current and past service costs/curtailments was £17 million (2006 – £20 million), whilst other net financing credits included in net financing costs were £13 million (2006 – £12 million).

The deficit at 31 December 2007 of £3 million (2006 – £174 million) was significantly lower than that at the end of 2006 as a result of a beneficial impact from higher yields on long dated corporate bonds which are used to determine the net present value of future liabilities, partly offset by changes in other assumptions including mortality. Because of the size and profile of the scheme, longevity is reviewed annually against actual experience. During the year mortality assumptions were strengthened, the age rating to PA92 (year of birth) tables was improved by 0.5 of a year to 2.5 years, whilst the rate of future improvement in longevity was strengthened to medium cohort.

Overseas pensions

The principal countries involved are the US, Germany and Japan.

The net charge to trading profit in respect of current and past service costs/curtailments was £13 million (2006 – £19 million), whilst other net financing charges included in net financing costs were £12 million (2006 – £12 million).

The reduction in the deficit of £30 million to £281 million (2006 – £311 million) was largely a result of the lower net present value of liabilities from increases in discount rates partly offset by the translational impact of currency.

Retiree medical

GKN operates retiree medical arrangements in the Americas and has a closed scheme in the UK.

The credit to trading profit of £11 million (2006 – £1 million charge) arose largely as a result of a past service credit of £12 million from changes in retiree medical arrangements in the US, whilst other net financing charges included in net financing costs were £4 million (2006 – £4 million).

Largely as a result of these changes, the obligation in respect of all schemes at the end of the year was £47 million compared with £76 million at the end of 2006.

Summary

At 31 December 2007 the post-employment obligations of the Group totalled £331 million (2006 – £561 million).

Shareholders’ equity

Shareholders’ equity at the end of 2007 was £1,177 million compared with £892 million at the end of 2006.

Proposed dividend

A final dividend of 9.2p per share is proposed, payable on 14 May 2008 to shareholders on the register on 25 April 2008. Together with the interim dividend of 4.3p, the total dividend for the year will be 13.5p, an increase of 5.5% over the equivalent figure for last year. The cash cost to the Group is some £95 million. The dividend is covered 2.6 times (2006 – 2.4 times) by management earnings (i.e. before the impact of restructuring and impairment charges, amortisation of non-operating intangible assets arising on business combinations, profits and losses on the sale or closures of businesses and changes in the fair value of derivative financial instruments). Using the cash tax rate for the year of 17%, the dividend would have been covered 2.3 times by earnings (2006 on the same basis – 2.1 times).