Final Results

Hornby PLC 02 June 2006 HORNBY DELIVERS SEVENTH YEAR OF PROFIT GROWTH AS INTERNATIONAL OPERATIONS COME ON STREAM Hornby Plc ('Hornby'), the international hobby products group, has today announced its preliminary results for the year ended 31 March 2006. •Pre-tax profits up 8% to £8.2 million (2005: £7.6 million)* *Both years reported on the basis of IFRS •Turnover reduced by 2% to £44.1 million (2005: £45.0 million) •Earnings per share up 4% to 15.64p (2005: 15.06p) •Profits generated in newly acquired overseas subsidiaries •Acquisition of French distributor MKD completed •Hornby Digital Control System launched at London Toy Fair •Final dividend of 5.4p recommended - Total dividend up 10% to 7.7p (2005:7.0p) Frank Martin, Chief Executive of Hornby, said, ' We are delighted with the performance that the Group has delivered. This is the seventh consecutive year of profits growth. Despite the challenging backdrop of our core UK market, we have demonstrated once again the robust nature of the hobbyist market. Our international operations are now profitable and we are confident that they will continue to deliver encouraging progress in the future. ' The launch of the Scalextric Sport Digital System has been extremely successful. This major advance in technology has been further developed to offer digital control racing across a wider range of price points, thus bringing significantly enhanced play-value into the mass market for slot racing. Advances in technology have also enabled us to launch the Hornby Digital Control System, which has been extremely well received. I am confident, as we roll this out in our other model railway brands, that this will prove to be a further boost to sales growth. ' Hornby's revenue base is now much broader. We have made a number of acquisitions in Europe and they have all been fully integrated into the Group. We have established a strong brand portfolio across a number of different markets. ' Looking to the future, we remain confident that our overseas operations will continue to drive our growth. We are now focused on building the scale of our marketing and sales distribution, in both Model Railways and Scalextric slot car racing so that we can take advantage of the opportunities in important markets in Germany, Italy, France and Spain. I look forward to reporting further progress. The Hornby Group is in excellent health.' -ends- Date: 2 June 2006 For further information contact: Hornby Plc cityPROFILE Frank Martin, Chief Executive Simon Courtenay John Stansfield, Finance Director Andrew Harris 01843-233500 020-7448-3244 On 2 June 2006: 020-7448-3244 Web: www.hornby.com or: www.scalextric.com High resolution images are available for the media to view and download free of charge from www.vismedia.co.uk Hornby Plc - Chairman's Statement Year ended 31 March 2006 Introduction I am delighted once again to report an encouraging performance for the year. This has been achieved despite the background of a weaker consumer environment in the UK, our main market. Whilst overall sales decreased by 2% to £44.1 million, pre-tax profit at £8.2 million is 8% above last year's result (£7.6 million). Both years are reported on the basis of IFRS. Basic earnings per share rose by 4% to 15.64p. We highlighted on a number of occasions during the year, the difficult conditions in the UK market. However, as a result of early action to bring costs in line with sales expectations we were able to mitigate the worst effects of the sales downturn in the UK. Shareholders will be aware that the management team has also taken steps to broaden and diversify the Group's revenue streams. We have acquired a number of overseas businesses to take advantage of the opportunities in new markets. These businesses have been fully integrated and are performing very well. Significantly, both the recently established Hornby Italia and Hornby France subsidiaries were able to contribute positively to Group profit in the year. Dividend Reflecting the continued progress that the Group has made, the Board is recommending a final dividend of 5.4p per ordinary share. This will be paid to shareholders on the register at 28 July 2006 and will be paid on 18 August 2006. Taken together with the interim dividend, this gives a total dividend for the year of 7.7p, an increase of 10% over the dividend of 7.0p declared in the previous financial year. We remain committed to rewarding our shareholders with a dividend of approximately 50% of earnings per share. Review of the Business Despite the backdrop of a difficult trading environment in the UK market we are pleased with the performance of our UK business. Weaker consumer demand, first reported at our AGM in July 2005, continued through to Christmas. However our strong network of independent retailers and in-store concessions continued to offer a prominent high-street presence. This, coupled with a strong new product introduction programme in the period January-March 2006, resulted in sales in this final quarter of the year exceeding our earlier expectations, confirming once again the defensive nature of our hobby-based products in times of general consumer uncertainty. One of the most significant developments in recent years has been the launch in 2004 of the Scalextric Sport Digital System (SSD). Customer reaction has been excellent. SSD is now gaining recognition worldwide as the system of choice for digital slot car racing, combining easy compatibility with existing systems and an excellent record of reliability. This year we have introduced a number of new products within SSD, aimed at securing wider distribution around the world, at mass-market price points. We believe that, over time, the market will move decisively towards digital control. The patented SSD technology places Hornby in pole position to take advantage of this shift in the market. At the London Toy Fair in January 2006 we launched the Hornby Digital Control System for model railways. This system uses similar technology to SSD and both systems will benefit from the economies of scale thus derived. In this way the Group is also able to leverage investment in Research and Development. The price points of the Hornby system are very competitive and the system has been designed with ease of operation in mind. We expect an increasing proportion of our model railway products to be sold as digital-enabled over the coming years. We plan to roll out the launch of the Hornby system, suitably branded, through our overseas subsidiaries at the Toy Fairs in 2007. International subsidiaries The UK market for model railways represents only c.10% of the total European market. The major manufacturers in Europe have experienced difficulties in recent years as a result of their continued focus on manufacturing in Europe. Hornby embarked upon a strategy some 3 years ago to acquire a series of strong European brands that would lend themselves to relocation of manufacturing to China and the subsequent revitalisation of their European distribution. The first of these acquisitions, our Spanish operation Electrotren, made good progress in expanding the distribution of the Superslot brand in Spain during the year, supported by the exclusive rights in Spain during 2005 to use on slot-car racing products the image and name of Formula 1 World Champion Fernando Alonso. Consequently overall sales revenues increased significantly. However, a reduction in the number of new Electrotren model railway introductions occurred during the year, as a result of longer lead times associated with the latest high specification designs now being developed. Consequently Electrotren made a reduced contribution to Group profit during the year. New model introductions are now on track and we are looking forward to a year of significant progress from Electrotren. Shareholders will recall that we acquired certain assets of Lima SpA in December 2004, and subsequently commenced trading as Hornby Italia. We have made excellent progress in re-establishing this business. During the year, we have relocated the operations to new premises in Brescia, Northern Italy and commenced production in China of the first ranges. We have also improved the sales and distribution network in Europe and this has shown through in the financial results. This has been very much a year of transition for Hornby Italia, and therefore the achievement of an operating profit is particularly encouraging. Similarly, the achievement of a positive operating profit in Hornby France is also encouraging. We acquired the goodwill and certain assets of our French distributor MKD in December 2005, and began trading as Hornby France from 1 January 2006. The rationale for this acquisition was based on our ownership of the French brand leader in model railways - Jouef - acquired as part of the Lima assets. It was clear that the opportunity to relaunch the Jouef brand in France via a wholly owned Hornby company would deliver the best return to our shareholders. That Hornby France has been able to make a contribution to profit in its first 3 months of trading bodes well for the future performance of this subsidiary. We expect both Hornby Italia and Hornby France to produce a significantly improved performance in the new financial year. The European subsidiaries in total contributed operating profits of £453,000 to the Group result. Results in Scalextric USA were much better than the previous year. Sales were up by 9% at $5.1 million. The loss before tax of $141,000 in the previous year was turned round to a profit before tax of $116,000 as a result of actions taken to reduce overheads and increase sales efforts. In addition, as previously reported, margins generated in Hornby Hobbies in the UK on sales made to Scalextric USA have the effect of increasing significantly the overall contribution to Group profit of our US operation. We are looking for a further improvement in the USA during the new financial year. In our International subsidiaries, both in Europe and the USA, we now have committed management teams who are capable of driving further sales and profits growth. Product development Our product development programme is the engine room of our business and we have continued to focus on maintaining a full new product pipeline. During the year we have increased our resources in this area, to cope with the additional demands of our subsidiaries and to design new products specifically for those markets. We are confident that as these newly designed products come on stream, there will be a resurgence of interest in our ranges throughout Europe, in the same way as our Hornby model railways business in the UK benefited from the influx of new products produced in China from 2000 onwards. Outlook Three years ago we recognised that although the Group was performing well, the Hornby model railway business was effectively trapped in the UK market as a result of the scale (00) and the exclusive focus on UK subject matter. It was clear that in order to ensure a continued pattern of sales and profits growth we had to expand our activities outside the UK. Our acquisitions of Electrotren in Spain, the Lima assets in Italy and the assets of MKD in France now provide the Group with the widest brand and product portfolio in the worldwide model railway market, together with the distribution infrastructure to capitalise on these assets. We have proved that we have the expertise to re-invigorate our hobby brands in the UK and we have enjoyed a significant renaissance in the popularity of model railways and slot car racing. We have worked hard to extend the appeal of our brands across the age ranges and to increase sales. We now have a major opportunity to repeat this success with our overseas businesses, both in model railways and slot racing. We own a superb portfolio of brands which have strong potential for growth. We expect trading in the UK market to be challenging again in the new financial year. However, the overseas subsidiaries are all now extremely well placed to become the main drivers of growth in the business during the coming years. The outlook for the Group is bright and we look forward to the future with confidence. Neil Johnson Chairman 2 June 2006 GROUP INCOME STATEMENT FOR THE YEAR ENDED 31 MARCH 2006 Group 2006 2005 (unaudited) (unaudited) £'000 £'000 REVENUE 44,113 45,006 Cost of sales (20,820) (22,613) ------------------------------------------------------------ GROSS PROFIT 23,293 22,393 Distribution costs (1,504) (1,312) Selling and marketing costs (9,924) (9,508) Administrative expenses (3,354) (3,910) Other operating (expenses)/income (217) 51 ------------------------------------------------------------ GROUP OPERATING PROFIT 8,294 7,714 Finance income 30 47 Finance costs (160) (176) ------------------------------------------------------------ PROFIT BEFORE TAXATION 8,164 7,585 Taxation (2,306) (1,993) ------------------------------------------------------------ PROFIT FOR THE YEAR 5,858 5,592 ============================================================ EARNINGS PER ORDINARY SHARE Basic 15.64p 15.06p Diluted 15.08p 14.38p All of the activities of the Group are continuing. GROUP BALANCE SHEET AT 31 MARCH 2006 Group 2006 2005 (unaudited) (unaudited) £'000 £'000 ASSETS NON-CURRENT ASSETS Goodwill 8,116 7,751 Intangible assets 1,608 1,418 Property, plant and equipment 5,539 5,096 Deferred tax assets 355 353 ------------------------------------------------------------ 15,618 14,618 ------------------------------------------------------------ CURRENT ASSETS Inventories 8,227 7,526 Trade and other receivables 9,325 7,199 Cash and cash equivalents 829 1,860 ------------------------------------------------------------ 18,381 16,585 ------------------------------------------------------------ LIABILITIES CURRENT LIABILITIES Borrowings 119 23 Trade and other payables 6,914 7,637 Current tax liabilities 1,542 1,100 ------------------------------------------------------------ 8,575 8,760 ------------------------------------------------------------ NET CURRENT ASSETS 9,806 7,825 ------------------------------------------------------------ NON-CURRENT LIABILITIES Borrowings 44 80 Deferred tax liabilities 217 222 Provisions for other liabilities and charges 300 369 ------------------------------------------------------------ 561 671 ------------------------------------------------------------ NET ASSETS 24,863 21,772 ============================================================ SHAREHOLDERS' EQUITY Share capital 376 373 Share premium 5,050 4,906 Other reserves 2,466 2,483 Retained earnings 16,971 14,010 ------------------------------------------------------------ TOTAL EQUITY 24,863 21,772 ============================================================ GROUP STATEMENT OF CHANGES IN EQUITY for the years ended 31 March 2006 and 31 March 2005 Capital Share Share Redemption Revaluation Other Retained Total Capital Premium Reserve Reserve Reserves Earnings* Equity (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) £'000 £'000 £'000 £'000 £'000 £'000 £'000 Balance at 1 April 2004 370 4,797 55 757 1,688 11,022 18,689 Profit for the period - - - - - 5,592 5,592 Amortisation of revaluation surplus - - - (17) - 17 - Issue of shares 3 109 - - - - 112 Share based payments - - - - - (84) (84) Exchange adjustment offset in reserves - - - - - 26 26 Purchase of own shares - - - - - (278) (278) Shares vested - - - - - 64 64 Dividends - - - - - (2,349) (2,349) -------------------------------------------------------------------------------------------------------------------- Balance at 31 March 2005 373 4,906 55 740 1,688 14,010 21,772 Adoption of IAS 32 and IAS 39 - - - - - (38) (38) -------------------------------------------------------------------------------------------------------------------- Balance at 1 April 2005 373 4,906 55 740 1,688 13,972 21,734 Profit for the period - - - - - 5,858 5,858 Amortisation of revaluation surplus - - - (17) - 17 - Issue of shares 3 144 - - - - 147 Share based payments - - - - - 158 158 Exchange adjustment offset in reserves - - - - - (111) (111) Purchase of own shares - - - - - (364) (364) Shares vested - - - - - 138 138 Dividends - - - - - (2,697) (2,697) -------------------------------------------------------------------------------------------------------------------- Balance at 31 March 2006 376 5,050 55 723 1,688 16,971 24,863 ==================================================================================================================== * Attributable to equity holders of the Company. GROUP CASH FLOW STATEMENT FOR THE YEAR ENDED 31 MARCH 2006 Group 2006 2005 (unaudited) (unaudited) £'000 £'000 CASH FLOWS FROM OPERATING ACTIVITIES Cash generated from operations 7,546 9,222 Interest received 30 47 Interest paid (160) (176) Tax paid (1,939) (2,557) -------------------------------------------------------------------------------- Net cash generated from operating activities 5,477 6,536 -------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of trade assets and related costs (1,072) (5,971) Proceeds from sale of property, plant and equipment 23 227 Purchase of property, plant and equipment (2,545) (2,220) -------------------------------------------------------------------------------- Net cash utilised in investing activities (3,594) (7,964) -------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of ordinary shares 147 112 Purchase of own shares by STIP (364) (278) Finance lease capital payments (23) (30) Dividends paid to Company's shareholders (2,697) (2,349) -------------------------------------------------------------------------------- Net cash utilised in financing activities (2,937) (2,545) -------------------------------------------------------------------------------- Effect of exchange rate movements (60) 27 -------------------------------------------------------------------------------- Net decrease in cash and bank overdrafts (1,114) (3,946) Cash and bank overdrafts at beginning of the year 1,860 5,806 -------------------------------------------------------------------------------- CASH AND BANK OVERDRAFTS AT END OF YEAR 746 1,860 ================================================================================ CASH AND CASH EQUIVALENTS CONSIST OF: Cash and cash equivalents 829 1,860 Bank overdrafts (83) - -------------------------------------------------------------------------------- CASH AND BANK OVERDRAFTS AT END OF YEAR 746 1,860 ================================================================================ NOTES TO THE CASH FLOW STATEMENT (a) CASH FLOW FROM OPERATING ACTIVITIES Group 2006 2005 (unaudited) (unaudited) £'000 £'000 Profit for the financial year 5,858 5,592 Taxation 2,306 1,993 Interest payable 160 176 Interest receivable (30) (47) Amortisation of intangible assets 97 33 Depreciation 2,075 1,850 Profit on disposal of tangible fixed assets (11) (29) Share based payments 158 (84) Gain on financial derivatives (38) - Decrease in provisions (69) (158) (Increase)/decrease in inventories (219) 258 Increase in trade and other receivables (2,058) (1,171) (Decrease)/increase in trade and other payables (683) 809 -------------------------------------------------------------------------------- CASH GENERATED FROM OPERATIONS 7,546 9,222 ================================================================================ (b) ANALYSIS OF NET FUNDS 31 March Net Cash Foreign 31 March 2005 Flows Exchange 2006 (unaudited) (unaudited) (unaudited) (unaudited) £'000 £'000 £'000 £'000 Cash and cash equivalents 1,860 (971) (60) 829 Bank borrowings - within one year - (78) - (78) - after one year - (5) - (5) ----------------------------------------------------------------------------------------------- 1,860 (1,054) (60) 746 Due within one year: Finances leases (23) (18) - (41) Due after one year: Finance leases (80) 41 - (39) ----------------------------------------------------------------------------------------------- NET FUNDS 1,757 (1,031) (60) 666 =============================================================================================== SEGMENTAL REPORTING The primary reporting format for segmental purposes is geographic, as this is the basis on which the Group is organised and managed. Transactions with and balances to the other segments have been identified above and eliminated. Hornby's secondary segment is business and as the Group operates on a single business segment, further analysis is not required here. Rest Total of Reportable Intra Year ended UK USA Europe Segment Group Group 31 March 2006 (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) £'000 £'000 £'000 £'000 £'000 £'000 Revenue - External 34,196 2,952 6,965 44,113 - 44,113 - Other segments 3,301 - 566 3,867 (3,867) - ----------------------------------------------------------------------------------------------------------------- Operating profit 7,747 94 453 8,294 - 8,294 Interest expense - External (151) - (9) (160) - (160) - Other segments - (30) (551) (581) 581 - Interest income - External 13 3 14 30 - 30 - Other segments 581 - - 581 (581) - ----------------------------------------------------------------------------------------------------------------- Profit before tax 8,190 67 (93) 8,164 - 8,164 Taxation (2,307) (16) 17 (2,306) - (2,306) ----------------------------------------------------------------------------------------------------------------- Profit for the year 5,883 51 (76) 5,858 - 5,858 ================================================================================================================= Segment assets 32,169 990 15,483 48,642 (14,860) 33,782 Less inter company debtors (14,403) - (457) (14,860) 14,860 - ----------------------------------------------------------------------------------------------------------------- Total assets 17,766 990 15,026 33,782 - 33,782 ================================================================================================================= Segment liabilities 7,387 916 15,476 23,779 (14,860) 8,919 Less inter company creditors (13) (899) (13,948) (14,860) 14,860 - ----------------------------------------------------------------------------------------------------------------- Total liabilities 7,374 17 1,528 8,919 - 8,919 ================================================================================================================= Other segment items Capital expenditure 1,800 42 1,719 3,561 - 3,561 (including acquisitions) Depreciation 1,779 9 287 2,075 - 2,075 Amortisation of intangible assets - - 97 97 - 97 ----------------------------------------------------------------------------------------------------------------- Rest Total of Reportable Year ended UK USA Europe Segment Elimination Group 31 March 2005 (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) £'000 £'000 £'000 £'000 £'000 £'000 Revenue - External 39,572 2,488 2,946 45,006 - 45,006 - Other segments 2,229 - - 2,229 (2,229) - ----------------------------------------------------------------------------------------------------------------- Operating profit 7,411 (38) 341 7,714 - 7,714 Interest expense - External (143) (15) (18) (176) - (176) - Other segments - (21) (327) (348) 348 - Interest income - External 41 - 6 47 - 47 - Other segments 348 - - 348 (348) - ----------------------------------------------------------------------------------------------------------------- Profit before tax 7,657 (74) 2 7,585 - 7,585 Taxation (1,871) 20 (142) (1,993) - (1,993) ----------------------------------------------------------------------------------------------------------------- Profit for the year 5,786 (54) (140) 5,592 - 5,592 ================================================================================================================= Segment assets 29,285 929 12,435 42,649 (11,668) 30,981 Less inter company debtors (11,631) - (37) (11,668) 11,668 - ----------------------------------------------------------------------------------------------------------------- Total assets 17,654 929 12,398 30,981 - 30,981 ================================================================================================================= Segment liabilities 8,398 981 11,498 20,877 (11,668) 9,209 Less inter company creditors (9) (956) (10,703) (11,668) 11,668 - ----------------------------------------------------------------------------------------------------------------- Total liabilities 8,389 25 795 9,209 - 9,209 ================================================================================================================= Other segment items Capital expenditure 2,082 43 6,189 8,314 - 8,314 (including acquisitions) Depreciation 1,590 9 251 1,850 - 1,850 Amortisation of intangible assets - - 33 33 - 33 ----------------------------------------------------------------------------------------------------------------- NOTES: 1. Basis of preparation The financial information for the year ended 31 March 2006 has been prepared in accordance with International Accounting Standards ('IAS') and International Financial Reporting Standards ('IFRS') as adopted by the European Union ('EU') and also as issued by the International Accounting Standards Board, International Financial Reporting Interpretations Committee interpretations and with those parts of the Companies Act 1985 applicable to companies reporting under IFRS. This information does not constitute statutory accounts and has not been audited. References to IFRS throughout refer to the application of International Accounting Standards and International Financial Reporting Standards. Hornby Plc consolidated financial statements were prepared in accordance with UK Generally Accepted Accounting Principles ('UK GAAP') until 31 March 2005. In preparing Hornby Plc 2005 consolidated financial information, management has amended certain accounting, valuation and consolidation methods applied in the UK GAAP financial statements to comply with IFRS. The comparative figures in respect of the year ended 31 March 2005 were restated to reflect these adjustments, except as described in the accounting policies. Reconciliations and descriptions of the effect of the transition from UK GAAP to IFRS on the Group's equity and its net income and cash flows are provided in note 6. 2. Non statutory accounts These statements do not constitute statutory financial statements within the meaning of Section 240 of the Companies Act 1985. The financial statements for the year ended 31 March 2005 were prepared in accordance with UK GAAP and have been delivered to the Registrar of Companies and on which the auditors made an unqualified report. The comparative figures for the year ended 31 March 2005 have been prepared as set out above and are an abridged statement of the full financial statements (as restated for IFRS) for that period. 3. Earnings per share The calculation of earnings per ordinary share is based on the profits after taxation for the period of £5,858,000 (year ended 31 March 2005 - £5,592,000) and the weighted average number of ordinary shares in issue during the period of 37,447,229 (year ended 31 March 2005 - 37,141,538). The calculation of diluted earnings per ordinary share is based on the weighted average number of ordinary shares in issue as adjusted to assume conversion of all dilutive potential ordinary shares, 38,842,053 (year ended 31 March 2005 - 38,888,321). 4. Short Term Incentive Plan 164,861 ordinary shares to the value of £364,397 were acquired by the Employee Benefit Trust in June 2005 in accordance with the incentive plan, details of which were included in the 2005 Annual Report and Accounts. The Trust waives its right to dividends. 5. Principal Accounting Policies The principal accounting policies that the Group has adopted in its 31 March 2006 financial statements being prepared under IFRS, and which have been consistently applied in the preparation of this financial information, are set out below. Basis of consolidation The Group financial statements consolidate the financial statements of the Company and all its subsidiaries as at 31 March each year prepared under IFRS using consistent accounting policies. The results of subsidiaries acquired are included in the consolidated profit and loss account from the date control passes. Intra group sales are eliminated on consolidation. Foreign currency translation Transactions in foreign currencies are translated at the exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated at the exchange rates ruling at the balance sheet date and any exchange differences are taken to the income statement. On consolidation, income statements and cash flows of foreign subsidiaries are translated into pounds sterling using average rates that existed during the accounting period. The balance sheets of foreign subsidiaries are translated into pounds sterling at the rates of exchange ruling at the balance sheet date. Gains or losses arising on the translation of opening and closing net assets are recognised in the statement of changes in equity. Intangible assets (a) Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the Group's share of the net identifiable assets of the acquired subsidiary at the date of acquisition. Goodwill recognised under UK GAAP prior to 1 April 2004, the date of transition to IFRS, is stated at net book value as at this date. Goodwill on business combinations recognised subsequent to 1 April 2004 is tested annually for impairment and carried at cost less accumulated impairment losses. (b) Trade names Trade names are capitalised at fair value as at the date of acquisition. They are carried at their fair value less accumulated amortisation and any accumulated impairment losses. Amortisation is calculated using the straight-line method to allocate the fair value of trade names over their estimated economic life of 20 years. (c) Existing customer relationships Existing customer relationships are capitalised at fair value as at the date of acquisition. They are carried at their fair value less accumulated amortisation and any accumulated impairment losses. Amortisation is calculated using the straight-line method to allocate the fair value of customer relationships over their estimated economic life of 10 years. (d) Research and development Research expenditure is recognised as an expense as incurred. Costs incurred on development projects (relating to the design and testing of new products) are recognised as intangible assets when it is probable that the project will be a success, considering its commercial and technological feasibility, and costs can be measured reliably. Other development expenditures are recognised as an expense as incurred. Tangible fixed assets Land and buildings are shown at cost or valuation less accumulated depreciation. Assets revalued prior to the transition to IFRS use this valuation as deemed cost at this date. Depreciation is provided at rates calculated to write off the cost or valuation of each asset, on a straight-line basis (with the exception of tools and moulds) over its expected useful life, as follows: Freehold buildings - 30 to 50 years Plant and equipment - 5 to 10 years Motor vehicles - 4 years Tools and moulds are depreciated at varying rates in line with the related estimated product sales on an item-by-item basis up to a maximum of 4 years. Investments in subsidiaries Investments in subsidiaries included as non-current assets are stated at cost less any provision for impairment. Impairment of assets Assets that have an indefinite useful life are not subject to amortisation and are tested annually for impairment. Assets that are subject to amortisation are reviewed for impairment when events or changes in circumstances indicate that the carrying value may not be recoverable. An impairment loss is recognised for the amount by which the asset's carrying value exceeds its recoverable amount, which is considered to be the higher of its value in use and fair value less costs to sell. In order to assess impairment, assets are grouped into the lowest levels for which there are separately identifiable cash flows (cash-generating units). Cash flows used to assess impairment are discounted using appropriate rates taking into account the cost of equity and any risks relevant to those assets. Inventories Inventories are stated at the lower of cost and net realisable value. Cost is determined using the first-in, first-out (FIFO) method. The cost of finished goods and work in progress comprises raw materials, direct labour, other direct costs and related production overheads (based on normal operating capacity). Net realisable value is based on the anticipated selling price less further costs expected to be incurred to completion and disposal. Provisions are made against those inventories considered to be obsolete or excess to requirements on an item-by-item basis. There are no significant differences between balance sheet and replacement cost values. For these purposes replacement cost is based upon latest invoice prices before the balance sheet date. Cash and cash equivalents Cash and cash equivalents includes cash in hand, deposits held at call with banks, other short-term highly liquid investments with original maturities of three months or less and bank overdrafts. Bank overdrafts are shown within current liabilities on the balance sheet. Deferred tax Deferred tax is provided on all temporary differences at the balance sheet date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax assets are recognised for all deductible temporary differences, carry-forward of unused tax assets and unused tax losses, to the extent that it is probable that taxable profit will be available against which the deductible temporary differences, and the carry-forward of unused tax assets and unused tax losses can be utilised. The carrying amount of deferred income tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred income tax asset to be utilised. Deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the year when the asset is realised or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted at the balance sheet date. Tax relating to items recognised directly in equity are recognised in equity and not in the income statement. Pension costs During the year the Group operated a defined contribution money purchase pension scheme under which it pays contributions based upon a percentage of the members' basic salary. The scheme is administered by trustees either appointed by the Company or elected by the members (to constitute one third minimum). Contributions to defined contribution pension schemes are charged to the income statement according to the year in which they are payable. Share option scheme The Group operates an executive share scheme. For all grants of share options and awards, the fair value as at the date of grant is calculated using an appropriate option pricing model and the corresponding expense is recognised over the vesting period. The Company has taken advantage of the transitional provisions of IFRS 2 'Share Based Payments' in respect of equity-settled awards and has applied IFRS 2 only to equity settled awards granted after 7 November 2002 that had not vested before 1 January 2005. Short term incentive plan (STIP) The STIP investment is carried at the cost of the shares acquired less the cost of the shares vested. This investment in own shares is presented as a deduction from shareholders' funds. The matched element of the STIP which has a condition of employment attached to it is spread over the vesting period of the shares and recognised in the income statement over this period. Provisions Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events and it is more likely than not that an outflow of resources will be required to settle the obligation and the amount has been reliably estimated. The expense relating to any provision is presented in the income statement net of any reimbursement. Provisions are measured at the present value of management's best estimate of the expenditure required to settle the present obligation at the balance sheet date. If material, provisions are determined by discounting the expected future cash flows of the Group at rates that reflect current market assessments of the time value of money. Revenue recognition Revenue comprises the fair value of the sale of goods and services, net of value added tax, rebates and discounts and after eliminating sales within the Group. Revenue is recognised as follows: (a) Sales of goods Sales of goods are recognised when a Group entity has delivered products to the customer; the customer has accepted the products; and collectability of the related receivables is reasonably assured. (b) Sales of services Sales of services are recognised in the accounting period in which the services are rendered, by reference to completion of the specific transaction, assessed on the basis of the actual service provided as a proportion of the total services to be provided. (c) Royalty income Royalty income is recognised on an accruals basis in accordance with the substance of the relevant agreements. (d) Sales returns The Group establishes a sales returns provision at the period end that reduces income in anticipation of customer returns of goods sold in the period. Segmental reporting The Group's primary reporting format is geographical segments and secondary format is business segments. A geographical segment is a component of the Group that operates within a particular economic environment and is subject to risks and returns that differ from those components operating in other economic environments. A business segment is a component of the Group that provides a group of related products and is subject to risks and returns that are different from those of other business segments. Operating profit of each segment includes revenue and expenses directly attributable to or can be allocated on a reasonably basis. Segment assets and liabilities are those operating assets and liabilities directly attributable to or can be allocated on a reasonable basis. Leases The Group enters into operating and finance leases. Assets held under finance leases are initially reported at the fair value of the asset with an equivalent liability categorised as appropriate under liabilities due within or after one year. The assets are depreciated over the shorter of the lease term and their useful economic lives. Finance charges are allocated to accounting periods over the period of the lease to produce a constant rate of return on the outstanding balance. Rentals are apportioned between finance charges and the reduction of the liability, and allocated to net interest. Assets under operating leases are charged on a straight-line basis over the lease term. Derivative financial instruments From 1 April 2004 to 31 March 2005 In accordance with IFRS 1, 'First Time Adoption of International Financial Reporting Standards', the Group has elected not to apply IAS 32, 'Financial Instruments: Disclosure and Presentation', and IAS 39, 'Financial Instruments: Recognition and Measurement' to the period ended 31 March 2005. The Group has continued to adopt UK GAAP in the accounting for and disclosure of financial instruments in that period. The derivative instruments used by the group to manage its currency risk are forward rate contracts. Forward currency contracts entered into with respect to trading transactions were accounted for under UK GAAP as hedges, with the instruments impact on profit not recognised until the underlying transaction was recognised in the profit and loss account. The notional amounts of interest rate swaps and forward currency contracts were not recorded on the balance sheet. From 1 April 2005 onwards Derivatives are initially recognised at fair value on the date a derivative contract is entered into and are subsequently remeasured at their fair value. The Group documents at the inception of the transaction the relationship between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. The Group also documents its assessment, both at hedge inception and on an ongoing basis, of whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values of the hedged items. (a) Fair value hedge Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with any changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. (b) Derivatives that do not qualify for hedge accounting Certain derivative instruments are not considered effective and do not qualify for hedge accounting. Such derivatives are classified as at fair value through the income statement, and changes in the fair value of derivative instruments that do not qualify for hedge accounting are recognised immediately in the income statement. 6. First time adoption of International Financial Reporting Standards The Group has applied IFRS 1 'First Time Adoption of International Financial Reporting Standards' for its initial implementation of IFRS. The Group's date of transition to IFRS is 1 April 2004 and comparative information in the financial statements has been restated to reflect the Group's adoption of IFRS except where otherwise required or permitted by IFRS 1. IFRS 1 requires an entity to comply with each IFRS effective at the reporting date for its first financial statements prepared under IFRS. As a general rule, IFRS 1 requires such standards to be applied retrospectively. However, the standard permits several optional exemptions from full retrospective application. The Group has elected to take advantage of the following exemptions:- •The Group has adopted IFRS 3 'Business Combinations' to the extent that it applies to acquisitions after 1 April 2004. Acquisitions before that date have been recorded under previous accounting rules as the Group has taken advantage of the exemption permitted in IFRS 1. All goodwill has been tested for impairment in accordance with our accounting policy. •The Group has taken advantage of the exemption in IFRS 1 regarding cumulative translation differences. Accordingly, the cumulative translation differences for all foreign operations are deemed to be nil at the date of transition to IFRS. •The Group has applied the exemptions in IAS 32 'Financial Instruments: Disclosure and Presentation' and IAS 39 'Financial Instruments: Recognition and Measurement', and applied these standards from 1 April 2005 only. •The Group has taken advantage of the exemptions allowed in IFRS 1 regarding IFRS 2 'Share based payments'. The Group has applied the exemptions for share based payments granted on or before 7 November 2002. •The Group considers the land and buildings revaluation performed under UK GAAP as comparable to the fair value at the date of the transition to IFRS. Accordingly, the Group has elected to use this valuation as deemed cost at the date of transition to IFRS, and stated the property at valuation, net of accumulated depreciation. Main impacts of International Financial Reporting Standards Outlined below are those International Financial Reporting Standards which have an impact upon the financial information of Hornby Plc. Details of adjustments are set out in the reconciliations to UK GAAP below. IFRS 3 - 'Business Combinations' The standard deals with accounting for business combinations including goodwill and intangible assets. The Group's previous policy under UK GAAP was to amortise goodwill, which has now ceased, and to test for impairment, normally on an annual basis, when there is an indication that the carrying value of an asset might not be recoverable. Where appropriate, in respect of business combinations completed after the date of transition to IFRS, separately identified intangible assets have been valued and are subject to amortisation. IAS 12 - 'Income Taxes' This standard requires entities to provide for deferred taxation based on temporary differences between the carrying amount of assets and liabilities and their tax base. Consequently, the Group has made additional provision for deferred taxation on tax deductible amortisation on purchased goodwill and deferred tax adjustments in respect of share based payments. IAS 21 - 'The Effects of Changes in Foreign Exchange Rates' Income statements and cash flows of foreign subsidiaries are reported in sterling using average rates of exchange that existed during the accounting period rather than the closing rates at the end of the accounting period as was previously permitted by UK GAAP. IAS 10 - 'Events after the balance sheet date' The standard does not permit dividends declared after the balance sheet date to be recognised as a liability. Consequently, under IFRS, the Group no longer makes provision for dividends not approved by the period end. Actual dividends paid in the period are charged to shareholders' equity. IFRS 2 - 'Share Based Payments' Previously the cost of awards to employees (including conditional rights) was charged to the income statement over the period to which the employees' performance related. Historically, provision has been made for the cost of awards based on the share price ruling at grant date. Under IFRS 2, share awards are measured at fair value at grant date and recognised as an expense over the vesting period. The impact of this standard on the financial statements of the Group is a small reduction in the charge to the income statement for the year ended 31 March 2005 and an equivalent increase in shareholders' funds, net of deferred tax. Additionally there is a small reduction in the cumulative charge to retained earnings at the date of transition to IFRS. IAS 14 - 'Segment Reporting' As previously, the Group presents primary segmental reporting based on its three geographic regions being the UK, the USA and Rest of Europe. The Group operates as a single business segment. Reconciliation of IFRS Income Statement Year ended Year ended 31 March 31 March 2006 2005 (unaudited) (unaudited) £'000 £'000 Profit for the period under UK GAAP 5,326 5,156 Share-based payments (158) 84 Amortisation of goodwill reversal 593 297 Amortisation of intangible assets reversal 149 35 Amortisation of intangible assets (97) (33) Financial derivatives 38 - Taxation 7 53 ------------------------------------------------------------------ Profit for the period under IFRS 5,858 5,592 ================================================================== Reconciliation of profit - UK GAAP to IFRS Year ended 31 March 2005 UK GAAP Effect of IFRS IFRS (unaudited) (unaudited) (unaudited) £'000 £'000 £'000 REVENUE 45,006 - 45,006 Cost of sales (22,613) - (22,613) ---------------------------------------------------------------------------------- GROSS PROFIT 22,393 - 22,393 Distribution costs (1,312) - (1,312) Selling and marketing costs (9,508) - (9,508) Administrative expenses (4,293) 383 (3,910) Other operating income 51 - 51 ---------------------------------------------------------------------------------- GROUP OPERATING PROFIT 7,331 383 7,714 Finance income 47 - 47 Finance costs (176) - (176) ---------------------------------------------------------------------------------- PROFIT BEFORE TAXATION 7,202 383 7,585 Taxation (2,046) 53 (1,993) ---------------------------------------------------------------------------------- PROFIT FOR THE YEAR 5,156 436 5,592 ================================================================================== Reconciliation of Balance Sheet - UK GAAP to IFRS At 1 April 2004 At 31 March 2005 UK GAAP Effect of IFRS UK GAAP Effect of IFRS IFRS IFRS (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) (unaudited) £'000 £'000 £'000 £'000 £'000 £'000 ASSETS NON-CURRENT ASSETS Goodwill 4,017 - 4,017 7,503 248 7,751 Intangible assets - - - 1,367 51 1,418 Property, plant and equipment 4,436 - 4,436 5,096 - 5,096 Deferred tax assets 240 (240) - 344 (213) 131 ------------------------------------------------------------------------------------------------------------------------ 8,693 (240) 8,453 14,310 86 14,396 ------------------------------------------------------------------------------------------------------------------------ CURRENT ASSETS Inventories 7,369 - 7,369 7,526 - 7,526 Trade and other receivables 5,977 - 5,977 7,199 - 7,199 Cash and cash equivalents 5,806 - 5,806 1,860 - 1,860 ------------------------------------------------------------------------------------------------------------------------ 19,152 - 19,152 16,585 - 16,585 ------------------------------------------------------------------------------------------------------------------------ LIABILITIES CURRENT LIABILITIES Borrowings - 30 30 - 23 23 Trade and other payables 8,443 (1,656) 6,787 9,525 (1,888) 7,637 Current tax liabilities 1,443 - 1,443 1,100 - 1,100 ------------------------------------------------------------------------------------------------------------------------ 9,886 (1,626) 8,260 10,625 (1,865) 8,760 ------------------------------------------------------------------------------------------------------------------------ NET CURRENT ASSETS 9,266 1,626 10,892 5,960 1,865 7,825 ======================================================================================================================== NON-CURRENT LIABILITIES Borrowings 103 - 103 80 - 80 Deferred tax liabilities - 26 26 - - - Provisions for other liabilities and charges 527 - 527 369 - 369 ------------------------------------------------------------------------------------------------------------------------ 630 26 656 449 - 449 ------------------------------------------------------------------------------------------------------------------------ NET ASSETS 17,329 1,360 18,689 19,821 1,951 21,772 ======================================================================================================================== SHAREHOLDERS' EQUITY Share capital 370 - 370 373 - 373 Share premium 4,797 - 4,797 4,906 - 4,906 Other reserves 2,500 - 2,500 2,483 - 2,483 Retained earnings 9,662 1,360 11,022 12,059 1,951 14,010 ------------------------------------------------------------------------------------------------------------------------ TOTAL EQUITY 17,329 1,360 18,689 19,821 1,951 21,772 ======================================================================================================================== IFRS Adjustments At At 1 April 2004 31 March 2005 (unaudited) (unaudited) £'000 £'000 Goodwill - per UK GAAP 4,017 7,503 Amortisation written back - 297 Lima intangibles fair value adjustment - (49) -------------------------------------------------------------------------- 4,017 7,751 -------------------------------------------------------------------------- Goodwill amortisation relating to acquisitions prior to 1 April 2004 and charged to profit since that date have been reversed. Goodwill relating to Lima assets acquired was reduced and reallocated to intangible assets. Intangible assets - per UK GAAP - 1,367* Amortisation written back - 35 Lima intangibles fair value adjustment - 49 Amortisation of fair value - (33) -------------------------------------------------------------------------- - 1,418 -------------------------------------------------------------------------- Intangible assets amortisation relating to acquisitions prior to 1 April 2004 and charged to profit since that date have been reversed. Intangible assets relating to Lima assets acquired increased upon fair valuing. Intangible assets relating to acquisitions post 31 March 2004 are amortised over their useful life. * Shown in the 31 March 2005 Report and Accounts within goodwill. Deferred tax assets - per UK GAAP 240 344 Accelerated capital allowances 9 63 Short term incentive plan (73) (108) Share options - 29 Revaluations (227) (222) Pensions 15 14 Trade discount 3 3 General provisions 7 8 -------------------------------------------------------------------------- (26) 131 -------------------------------------------------------------------------- Borrowings - per UK GAAP - - Finance lease commitments < 1 year 30 23 -------------------------------------------------------------------------- 30 23 -------------------------------------------------------------------------- Finance lease capital commitments due in less than one year. Trade and other payables - per UK GAAP 8,443 9,525 Finance lease commitments transferred to borrowings (30) (23) Dividend reversal (1,626) (1,865) -------------------------------------------------------------------------- 6,787 7,637 -------------------------------------------------------------------------- Dividends accrued but not declared, proposed or approved are reversed. Retained earnings - per UK GAAP 9,662 12,059 Dividend reversal 1,626 2,588 Dividend payment - (723) Amortisation of goodwill reversal - 297 Amortisation of intangibles reversal - 35 Amortisation of intangibles fair value - (33) Deferred taxation (266) (213) -------------------------------------------------------------------------- 11,022 14,010 -------------------------------------------------------------------------- There are no material differences between the cash flow statements presented under IFRS and the cash flow statements previously presented under UK GAAP. 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