Strategic report

Our business

The 600 Group PLC ("the Group") is a leading engineering group with a world class reputation in the design and distribution of machine tools, the design and manufacture of precision engineered components and the design, manufacture and distribution of industrial laser systems.  The Group operates these businesses from locations in North America, Europe and Australia selling into more than 180 countries worldwide.

During the 53 week period ended 2 April 2016 31% of revenues came from the sale of metal turning machine tools, with a further 17% from other machine tools and 11% from the sale of precision engineered components. Sales of Industrial laser equipment amounted to 26% with the remaining 15% of revenues being from after sales support, spare parts and services from both divisions.

Group businesses serve customers across a broad range of industry sectors, from niche markets for technical education of young engineering apprentices through to high volume production of automotive, aerospace and defence equipment.  A high proportion of revenue is derived from sales via third party distribution channels, in respect of which it is more difficult to track the industry dispersion of end-user customers.

The Group benefits from a high degree of loyalty and repeat business via established distributors in many countries and territories.  In the year ended 2 April 2016 the top 20 customers, of which 17 were distributors, contributed less than 26% of revenues.

By geographical territory of destination

Revenues are generated across many diverse geographical territories, with the principal markets in:

Macroeconomic and industry trends

Machine tools and precision engineered components

The worldwide machine tool industry is estimated at over $70bn in annual sales and is determined by the investment intentions of manufacturers, and is sensitive to changes in the economic and financial climate. Demand responds to economic trends and typically lags the main cycle of the economy.

Gardner Research identified the largest five producer countries of machine tools to be China, Germany, Japan, South Korea and Italy with the largest five countries ranked by consumption as China, USA, Germany, Japan and South Korea.

The global consumption of machine tools was reported as being negative at 10.3% in the latest Oxford Economics data for the year to December 2015 against a relatively flat 2014. In our most important markets USA was -15.6%, Germany -11.9% and UK -8.3%.

Industrial laser systems

Industry use of industrial lasers for material processing has continued to expand worldwide. Laser systems have now become a mainstream manufacturing process covering the areas of laser machining including cutting and drilling, marking, ablation and a host of other niche applications.

Industry spending for the entire global industrial laser market is reported to be $3.3bn and growing between 4% and 6% each year. The laser marking and micro-materials subset of the overall laser industry continues to grow due to enhanced techniques in the speed, cost and quality of the systems being implemented and legislative changes driving a requirement for greater traceability.

Results

Machine tools and precision engineered components

This division operates from Heckmondwike in the UK, Kalamazoo Michigan in the USA, and Sydney and Brisbane in Australia. It designs and develops metal processing machine tools sold under the brand names Colchester, Harrison and Clausing and designs and manufactures precision engineering components under the brand names Pratt Burnerd and Gamet. There is also a spares, accessories and service operation to support the significant number of machines sold over the Group's long history of supplying quality equipment. Sales are made worldwide, with direct sales operations in North America, Europe, and Australia and a network of distributors in all other key end-user markets.

The financial results of these activities, before special items, were as follows:

Revenues overall fell by 7.5% with a 16% fall in the UK and European business and 22% fall in Australia. Revenues and operating profit in our North American operations remained level with the prior year which we consider to be a significant achievement given a 15% industry-wide fall in US consumption. Although the Australian business had a difficult year and was forced to reduce overheads and preserve cash by operating on a four day week basis it has since the financial year end returned to full time working to cope with increased demand and has traded profitably so far this financial year. The Australian operation is also leading the expansion into the South East Asian markets and is responsible for signing up the new distributors in Malaysia, Thailand and Vietnam and it is clear there remains brand recognition in these markets with orders and quotations actively being undertaken.

The UK and European operation experienced difficult market conditions, particularly in Germany, where the weakness of the Euro added pricing pressure. In response to these difficult conditions direct and overhead costs were reduced and the mix of products manufactured in the UK revised during the second half of the financial year. The fall in volume was concentrated on the higher margin component product resulting in a disproportionate fall in operating margins. This was the principal reason for the division's poor overall performance.

Since his appointment as Divisional Managing Director of the machine tool division in August 2015 Don Haselton has been focusing on the introduction to the UK and Europe of the Clausing product range of drills, mills, saws and grinders which are now becoming a regular feature of the package of products we supply in the UK and Europe.

The Clausing range of products has been one of the key reasons behind the sustained growth in the North American operations and represent over 1/3 of their product sales compared to a figure of just 4% for the UK and European operation at present.

Industrial laser systems

Following the acquisition of 80% of TYKMA Inc. in early February 2015, both the TYKMA and Electrox operations were merged into a single industrial laser systems business under a unified management structure. The remaining 20% of TYKMA was purchased at the end of March 2016 just before the financial year end. The integration of the two businesses continued throughout the year with all manufacturing operations centered in a new purpose built facility in Chillicothe, Ohio USA. In the UK we took steps to expand our UK sales presence by signing a distribution agreement with Needham Coding based in Shropshire. This new relationship provides a customer centric operation and increased presence throughout the UK and Ireland and is in addition to the TYKMA Electrox sales and service center located in Letchworth Garden City.

As a result of these actions, operating efficiencies and savings (including those from supplier consolidation) are evidenced in the increased margins we saw towards the end of the financial year. In addition, the restructuring of our entire global sales structure resulted in reduced overall costs and sales operations coming under common leadership.

The worldwide industrial laser systems business now operates under the TYKMA Electrox brand. Industrial laser system solutions are sold for a variety of applications including marking, engraving and micro-material processing to a wide range of industries which includes small companies to large multi-national corporate customers.

The enlarged industrial laser systems division is headed up by David Grimes, the previous CEO of TYKMA, who became a substantial shareholder in the Group as a result of the purchase of the remaining 20% of TYKMA Inc. by the Group at the end of March 2016.

Revenues in this division increased by 43% following the TYKMA contribution being included for a full year for the first time. Operating profit increased substantially but with only the last few months benefitting from the integration of the two companies. We expect this trend will continue to grow and show through in increased margins in the first few months of the current financial year.

Results for the financial year before special items were as follows:

Group revenue

Revenue from continuing operations increased by 3.4% to £45.3m (2015: £43.8m) which although representing only a modest increase over last year was achieved despite the difficult market conditions experienced in the machine tools business in the UK and Europe where turnover fell by 16% and in Australia which suffered a 22% decline.

Costs and margins

Gross margins in the Industrial laser systems division improved as the year progressed and the benefits of the TYKMA Electrox business integration began to take effect. Margins in machine tools were however inevitably  affected by the reduced volumes in the UK and European operation, particularly in the higher margin precision components.

Profit before taxation

Group profit before tax was £1.00m (2015: £3.68m) and the underlying profit figure before special items was £1.48m (2015: £2.02m).

Special items

During the financial year, the Group had a number of transactions, which in the opinion of the directors should be reported seperately for a better understanding of the underlying trading performance of the Group.

A credit of £0.94m (2015: £2.35m) is included in operating profit as a result of the work by the trustees of the UK pension scheme and the company in reducing pension liabilities. A number of transactions took place over the previous and current year including a pension increase exchange, commutation of small pensions and other flexible retirement options. This resulted in actuarial adjustments to the pension liabilities, which are processed through the Consolidated Income Statement.

In addition, as a result of the scheme being in surplus on an accounting basis, a credit of £1.17m (2015: £0.86m) is recorded in interest. No cash was paid to or received from the scheme in respect of these transactions.

As a result of the settlement of the contingent deferred consideration on the acquisition of the remaining 20% of TYKMA Inc. a credit is recorded within financial income of £2.03m. The acquisition occurred earlier than was originally envisaged under the put and call options in place and consequently the amount paid was less than that accrued based on the earnings of the combined industrial laser systems division over the next few years.

Costs incurred on the acquisition of the remaining 20% of TYKMA Inc. amounted to £0.2m. Redundancy and restructuring costs incurred on the integration of the Electrox and TYKMA businesses and the overhead and operating cost reduction in Head Office and UK machine tools business amounted to £1.72m.

During the integration process of TYKMA and Electrox it became clear that the capitalised cost of the software developed by Electrox was not going to be realised as originally envisaged ,would not be sold as a distinct product and that further work would be required to integrate the software with existing systems. As a result it has been decided to impair the value of the work so far and an impairment charge of £2.39m has been shown within special items.

In addition share option costs, amortisation of intangible assets and amortisation of loan note costs which are non-cash costs to the Group have been included in special items. 

Taxation

The current year resulted in a small credit for taxation of £0.14m (2015: charge of £1.33m). Deferred taxation is provided on the pension credits of £2.11m at a rate of 35%, being the rate applicable to any refund from a pension scheme.

The UK businesses continue to benefit from the substantial previous tax losses and no taxation is payable in the UK. The US businesses are subject to taxation on their profits at a rate of 35%.

Net profit and earnings per share

The total profit attributable to equity holders of the parent for the current financial year amounted to £1.16m (2015: £2.33m).

Underlying earnings from continuing operations before special items and related taxation was 1.69p per share (2015: 2.09p) and basic earnings per share was 1.26p (2015: 2.66p)

Financial position and utilisation of resources

Cash flow

Cash generated from operations before working capital movements was £3.03m (2015: £3.02m). Working capital movement was largely due to a reduction in creditors of which part was professional costs relating to the original purchase of 80% of TYKMA towards the end of the prior financial year. £0.81m was expended on redundancy and restructuring costs which largely consisted of redundancy payments at Electrox, UK machine tools and head office, including to the previous CEO.

Interest paid has increased to £0.96m as a result of a full year of interest paid on the loan notes with the final tranche of £806k of loan notes issued in August 2015.

Capital expenditure included replacement machinery for the UK machine tools business and the fit out costs and plant, machinery and fixtures of the two new facilities in the USA; Clausing machine tools in Michigan and TYKMA in Ohio.

Net borrowings

Group net debt at 2 April 2016 stood at £13.89m (2015: £10.8m) comprising net bank and finance lease indebtedness of £6.2m (2015: £4.0m) and the amount outstanding on the new loan notes of £7.70m (2015: £6.78m). The amount outstanding is net of unamortised costs and amounts disclosed in equity reserve of £0.8m in the current financial year (2015: £0.7m).

New increased facilities were agreed with HSBC in the UK in August 2016 following the sale of the Letchworth property. A package of facilities to support the working capital of the UK machine tools business and a term loan secured on the remaining freehold site in Colchester have been put in place totaling £4.95m. In the USA Bank of America supported the 20% TYKMA acquisition in March 2016 with an additional term loan of $1.8m in addition to their existing term and working capital facilities. The Group has a mixture of term loans and revolving working capital facilities with maturities between 1 and 5 years. Headroom on bank facilities was £3.2m at the year-end (2015: £4.2m) and all financial covenants in place were met during the year.

During August 2015 the Group issued the remaining £806k of New 8% loan notes with a maturity of February 2020 to bring the total gross amount issued to the £8.5m agreed under the loan note programme. These loan notes also entitled holders to warrants of equal value to subscribe for new ordinary shares at 20p.

Gearing amounted to 34% of aggregate net assets (2015: 31%)

Going concern

In accordance with FRC guidelines, the Board has assessed the Group's funding and liquidity position. The directors confirm that, after having made appropriate enquiries, they have a reasonable expectation that the Group and the Company have adequate resources to continue operations for the foreseeable future.  Accordingly, the directors continue to adopt the going concern basis in preparation of the financial statements.

Retirement benefits

The accounting surplus at 2 April 2016 was £40.94m (2015: £34.29m). This surplus has been calculated in accordance with the scheme rules and recognised accounting requirements.

As a result of liability reduction exercises undertaken by the UK scheme's Trustees in conjunction with the company, a credit has been taken in the period in the Income Statement of £0.97m to reflect the actuarial reduction in scheme liabilities.

In accordance with the current legislation on taxation of pension surplus returns to a company, deferred taxation has been provided for on the pension entries at 35% as opposed to the normal 20% rate.

In October 2013 the Company reached agreement with the Trustees of the scheme regarding the funding position on a more prudent Technical Provisions basis as at 31 March 2013, which indicated a funding deficit of £25.4m at that date, and estimated a deficit on a full buy-out basis of £51.1m.

It was further agreed that the Technical Provisions deficit would be resolved by an outperformance of the investment returns on the scheme assets of 1% above the return on UK gilts, and that no cash contributions would be required until at least the next funding valuation due as at 31 March 2016.

The formal Actuarial Technical Provisions calculation for 31 March 2016 is currently in

progress but it is expected that a similar agreement will be reached with the Trustees following its completion.

At 2 April 2016, the subsequent performance of the scheme assets, changes in the underlying market conditions and the various liability reduction exercises, indicate that the estimated deficit on a Technical Provisions basis had reduced to £10.6m. On a full buy-out basis the estimated deficit had reduced to £44m by the end of March 2016.

The directors and the Trustees work together on a collaborative basis to continue to monitor investment performance and market conditions closely, to mitigate the risk of mis-matching assets and liabilities to a tactically appropriate level, and to pursue opportunities to secure a full or partial buy-out of UK pension liabilities when conditions permit.

The US retiree health scheme and pension fund deficits reduced slightly during the year due to changes in actuarial assumptions to £1.04m (2015: £1.10m)

Electrox site

As a result of the merger of TYKMA and Electrox, and the centralisation of manufacturing in the USA, the long leasehold UK site in Letchworth became too large for the remaining sales and service operation which has moved to smaller leased premises. The sale of the existing site for a net £2.0m was completed on 11 July 2016 with proceeds used to reduce the UK senior bank debt. A reduction in valuation of £0.45m down to the net proceeds has been taken in the revaluation reserve at the year-end and the property has been classified as an asset held for sale within current assets in the Consolidated Statement of Financial Position.

Share capital and reserves

Share capital and share premium reflect the exercise of 2.75m of share options by Nigel Rogers in August 2015 and the issue of 12m shares at the end of March 2016 in part settlement of the consideration for the remaining 20% of TYKMA Inc.

Neil Carrick

Finance Director

31 August 2016