Financial Review

Review of Results

In the year to 31st March 2002 turnover fell by 18% to £4.8 billion reflecting significantly lower average platinum and palladium prices. The average platinum price fell by 13% while palladium was 39% lower. Sales excluding the value of precious metals rose by 12% to £1.1 billion. Operating profit before exceptional items and goodwill amortisation rose by 10% to £193.3 million.

Divisional results are discussed in the Chief Executive’s Statement on pages 4 to 7, and in the individual divisional reports on pages 12 to 19.

Profit before tax, exceptional items and goodwill amortisation for the group rose by 4% to £187.2 million. Earnings per share, before exceptional items and goodwill amortisation rose by 6% to 60.4 pence. The board is recommending to shareholders a final dividend of 17.1 pence, making a total dividend for the year of 24.6 pence, an increase of 6%. The dividend would be covered 2.5 times by earnings.

Sales and Margins
Johnson Matthey’s turnover is heavily impacted by the high value of precious metals sold by the group particularly in the Precious Metals Division (PMD). The total value of sales each year varies according to the mix of metals sold and level of trading activity. The value of the precious metals included in sales is generally separately invoiced and payment made within a few days. Consequently, although return on sales (operating profit / total external sales) for the precious metals businesses is low, profit growth has been relatively stable and return on investment is high.

To provide a more useful measure of return on sales, the adjacent table shows sales by division excluding the value of precious metals. Total sales excluding precious metals were £1,093 million which was 12% up on last year and return on sales averaged 17.7% compared with 17.9% in 2000/01. The group’s target for each of its divisions is to achieve a return on sales excluding precious metals in excess of 10%. All four divisions were ahead of that target in 2001/02.

Catalysts & Chemicals achieved 11% growth in sales excluding precious metals and improved margins despite additional research and development expenditure on fuel cells. PMD’s sales excluding precious metals fell, partly reflecting the impact of lower metal prices on commissions, and partly following the exit from low margin product manufacturing in Canada which improved return on sales. Colours & Coatings’ sales were slightly up but margins fell, particularly in the Tableware sector. Urgent action has been taken to reduce costs. Pharmaceutical Materials’ sales and margins show the impact of the acquisitions made in the year.

Sales excluding Precious Metals Return on Sales   2001 £ million 2002 £ million 2001 % 2002 %   Catalysts & Chemicals 535 597 15.1 15.9 Precious Metals 162 143 35.5 39.1 Colours & Coatings 246 251 13.1 10.2 Pharmaceutical Materials 30 101 60.2 30.9 Discontinued 4 1 n/m n/m     977 1,093 17.9 17.7

Return on Investment
We set a target of 20% for the pre-tax return on assets (ROA) for all our businesses. For the group as a whole ROA was 22.2% (see pages 66 and 67) compared with 26.4% in 2000/01. The decline in the overall return reflects the more difficult trading conditions experienced in the year and the impact of the acquisitions made which are expected to take a few years to meet the group’s target.

On a post-tax basis the return on invested capital was 15.6% which was well above the estimated weighted average cost of capital (WACC) for the group of 9%. The margin above the cost of capital for the year was 6.6%, which was below last year’s figure of 8.5% but still very healthy.

Exceptional Items and Goodwill Amortisation
Exceptional items included in operating profit gave rise to a net charge of £18.1 million. They comprised the cost of rationalising production in the Tableware sector of Colours & Coatings (£24.0 million); the cost of eliminating board and other related costs at Meconic plc following its acquisition (£1.3 million); partly offset by a gain on disposal of some of the group’s holding of unhedged palladium stock (£7.2 million).

In addition, in early September 2001 we sold our loss-making French ceramic print business (part of Tableware). This sale gave rise to an exceptional book loss of £5.5 million shown in sale of discontinued operations.

Goodwill amortisation increased to £6.8 million following the acquisitions of Meconic plc, Pharm-Eco Laboratories, Inc., and Avocado Research Chemicals Limited.

Interest and Exchange Rates
The group had a net interest charge of £6.1 million for the year compared with a net credit of £5.3 million last year. The change reflects the funding cost of the major investments and share buy-backs undertaken in the period. Interest payable on gold and silver leases rose to £3.5 million in the year, compared with £1.4 million last year. This rise reflects higher average holdings and also high lease rates, particularly for silver in the second half of the year.

Exchange translation reduced the group’s profits by £2.1 million compared with 2000/01. The group benefited from the stronger US dollar which averaged $1.43/£ compared with $1.48/£ for our last financial year. However, this benefit was more than offset by the impact of other currencies, particularly the South African rand which averaged R13.7/£ compared with R10.8/£ in 2000/01. To some extent the group was able to mitigate this weakness by linking the prices of products manufactured in South Africa to the Euro or US dollar, which produced higher profits in rands.

Taxation
This year the group has adopted FRS 19, a new accounting standard requiring companies to provide fully for deferred tax. Last year’s results have been restated accordingly. The effect of the new standard is to increase the group’s average tax rate by about 1%, and to increase the net deferred tax liability included in the balance sheet by £44.3 million.

Compared with last year’s restated figure, the group’s total tax charge fell by £4.0 million, as a result of the inclusion of tax credits on the exceptional charges. Excluding these credits, tax was £1.9 million higher than last year, reflecting the growth in profit before tax.

Before exceptional items and goodwill amortisation the average tax rate for the year was 29.9%, which was very similar to last year.

Cash Flow
Johnson Matthey’s net cash inflow from operations rose by 43% to £224.1 million. Working capital showed a small net inflow of £1.9 million. A significant reduction in debtors was achieved, benefiting in part from the fall in the palladium price. Inventories rose significantly at year end, part of which should be temporary, as metal holdings have been increased during the major upgrading of the pgm refinery at Royston.

Capital expenditure rose to £133.8 million, which was nearly £30 million higher than last year and represents about 2.8 times depreciation. Capital expenditure in 2002/03 is budgeted to be somewhat lower, at around 2 times depreciation. As a consequence of the high level of capital expenditure in 2001/02, free cash flow for the group (after interest, tax and dividends but before acquisitions and share buy-backs) was negative at £19.6 million.

The group spent a total of £230.9 million on acquisitions, which included £46.8 million of debt acquired and £40.6 million of loan notes issued as part of the purchase price. We also bought back 4.9 million shares in the year for a cash cost of £45.9 million (an average price of £9.32 per share), which has improved the financial efficiency of the balance sheet, and was earnings enhancing. As a consequence of this expenditure the group moved from a net cash position of £139.9 million at 31st March 2001 to a net borrowing position of £159.0 million at 31st March 2002.

Johnson Matthey’s balance sheet remains very strong, with shareholders’ funds of £813.7 million and gearing (net borrowings / shareholders’ funds and minority interests) of 19%.

Pensions
In the accounts for the year ended 31st March 2002 the group is adopting the transitional arrangements for reporting under FRS 17, the new accounting standard on retirement benefits. Under these arrangements the surplus or deficit arising on the group’s pension funds calculated in accordance with FRS 17 is shown as a note on the accounts on pages 46 and 47.

The group operates significant defined benefit pension schemes in the UK and in the US. At 31st March 2002 the group had a net surplus before tax on these schemes of £106.7 million calculated using FRS 17. Reported earnings for 2001/02 would not have been materially different under the new standard.

Financial Risk Management

We use financial instruments, in particular forward currency contracts and currency swaps, to manage the financial risks associated with our underlying business activities and the financing of those activities. The group does not undertake any trading activity in financial instruments. Our Treasury department is run as a service centre rather than a profit centre.

Interest Rate Risk
At 31st March 2002 the group had net borrowings of £159.0 million. This included £70.2 million (US $100 million) of long term fixed rate borrowings in the form of an issue of US dollar bonds, which carry an interest coupon of 6.36%. The remaining 56% of the group’s net borrowings are funded on a floating rate basis, mainly in the form of loans under committed bank facilities. A 1% change in all interest rates would have a 0.6% impact on group profit before tax. This is well within the range the board regards as acceptable.

Liquidity Policy
Our policy on funding capacity is to ensure that we always have sufficient long term funding and committed bank facilities in place to meet foreseeable peak borrowing requirements. The group has committed bank facilities of £255 million. Borrowings drawn under these facilities at 31st March 2002 amounted to £107.5 million. The group also has a number of uncommitted facilities and overdraft lines.

Foreign Currency Risk
Johnson Matthey’s operations are global in nature with the majority of the group’s operating profits earned outside the UK. The group has operations in 34 countries with the largest single investment being in the USA. In order to protect the group’s sterling balance sheet and reduce cash flow risk, we finance most of our US investment by US dollar borrowings. Although most of this funding is obtained by directly borrowing US dollars, some is achieved by using currency swaps to reduce costs and credit exposure. We also use local currency borrowings to fund our operations in other countries (see page 52).

We use forward exchange contracts to hedge foreign exchange exposures arising on forecast receipts and payments in foreign currencies. Currency options are occasionally used to hedge foreign exchange exposures, usually when the forecast receipt or payment amounts are uncertain. Details of the contracts outstanding on 31st March 2002 are shown on page 55.

Precious Metal Prices
Fluctuations in precious metal prices can have a significant impact on Johnson Matthey’s financial results. Our policy for all our manufacturing businesses is to limit this exposure by hedging against future price changes where such hedging can be done at acceptable cost. The group does not take material exposures on metal trading.

All the group’s stocks of gold and silver are fully hedged by leasing or forward sales. Currently the majority of the group’s platinum group metal stocks are unhedged because of the lack of liquidity in the platinum metal markets.

John Sheldrick
Group Finance Director