2016 Year in review

This improved performance reflects the progress that has been made, and continues to be made, across the Group. Improved operational focus and greater collaboration amongst the businesses is delivering tangible benefit in a market that is starting to recover from multi-year softness, while the Programs of Record in the Sensors & Electronics segment offer opportunities for future growth.

In February 2016, the Company raised £80.8 million via a rights issue, the primary purpose of which was to alleviate the constraints that the Group’s indebtedness was putting on growth opportunities. £48.8 million of the proceeds was used to repay a proportion of the Group’s outstanding US loan notes, significantly reducing the Group’s future finance costs.

Having strengthened the balance sheet, the Group is now fully focusing on the operational priorities that will underpin its future growth. These priorities include capacity investment projects, implementing significant cost saving initiatives, ensuring excellence in contract delivery and delivering improved working capital management.

The effects of this renewed focus are visible in these results and, in particular, the improving operational performance across the Group in the second half of the year.

Site consolidation initiatives are now underway, such as the enhancement of our Chemring Energetic Devices’ facility in Illinois, that will allow the transition of operations to Illinois and subsequent closure of the California facility, delivering $5 million of annual cost savings.

We are also looking to close one of our two Countermeasure facilities in Philadelphia, delivering further ongoing savings.

Since joining the board on 1 May 2016, and my subsequent appointment as Chairman on 1 July 2016, I have taken the opportunity to visit most of our manufacturing operations both in Europe and North America. I have been encouraged by the Group’s diverse portfolio of products and the strength of its market positions, and by the quality of many of our facilities.

But I have been most encouraged by the calibre of our many employees who, through difficult times, have remained committed to Chemring and focused on the goals of collaboration and continued operational improvement. I would like to take this opportunity to thank them for their loyal service and hard work.

A significant amount has been achieved over the past couple of years in terms of re-shaping the Group’s organisational structure, reducing the cost base and improving operational performance. However, if Chemring is to remain at the forefront of its markets, then we need to build on this progress, and commit further investment in both people and practices.

At the start of 2017 we therefore launched the Operational Excellence Programme. This initiative is designed to enable the Group to realise its full potential. It will focus on safety, reliability, on-time delivery, improved productivity and profitability, and reduced working capital. It will develop strategic and operational process sets that are, where appropriate, common across the Group.

Aligned to this programme, a best practice sharing forum will be established for each production and functional area. This will be aimed at determining where within the Group we currently achieve best practice and how we can share this better, what we can do to enhance recognised best practice against our industry background, and how we can roll this out to other business units.

The ability to focus on these operational priorities and growth initiatives comes as a direct result of the rights issue, which has enabled management to focus on managing the business, rather than managing the debt. This could not have happened without the support of our shareholders and I would therefore like to acknowledge and thank them for their continued support.

There is a growing sense of momentum across the Group. We entered the new financial year with a strong order book, excellent strategic positions on long-term programmes, and with a focus on continued operational improvement. Overall, I look to the future with optimism.

Trading summary

Revenue from continuing operations was £477.1 million (2015: £377.3 million). This revenue generated an underlying operating profit of £48.5 million (2015: £34.4 million). Including non-underlying items, total operating profit was £26.2 million (2015: £5.5 million).

Underlying profit before tax increased by 71.7% from £19.8 million to £34.0 million, resulting in underlying earnings per share of 10.3p (2015 as restated: 7.1p).

The closing order book for continuing operations increased by £23.3 million during the year and at 31 October 2016 was £592.9 million (2015: £569.6 million).

The Group’s net debt at 31 October 2016 was £87.6 million (2015: £154.3 million).

An analysis of underlying and total results is set out below:

The use of underlying measures, in addition to total measures, is considered by the Board to improve comparability of business performance between periods.

Underlying measures referred to are stated before costs relating to acquisitions and disposals, business restructuring and incident costs, profit/loss on disposal of businesses, items deemed to be of an exceptional nature, impairment of goodwill and acquired intangibles, impairment of assets held for sale, amortisation of acquired intangibles and gains/losses on the movement in the fair value of derivative financial instruments. A reconciliation of underlying and total operating profit is set out in note 2 of the Group financial statements.

During the year, changes in foreign exchange rates, principally the depreciation of sterling against the US dollar, increased reported revenue from continuing operations by £36.8 million. At constant exchange rates, revenue from continuing operations was £440.3 million, an increase of 16.7%.

Chemring’s operating segments are Countermeasures, Sensors & Electronics and Energetic Systems. An analysis of segmental revenue and underlying operating profit is set out below:

Countermeasures revenue reflected the continued recovery in the segment, increasing by 9.9% on the prior year to £138.3 million (2015: £125.8 million). The impact of the production issues and energetic incidents that were experienced in the first half were partly offset by £2.8 million of insurance proceeds related to an earlier energetic incident. This resulted in a decline in margins from 13.9% to 9.3% and an underlying profit of £12.8 million, compared with £17.5 million in 2015. On a constant currency basis using 2015 rates, revenue was £127.8 million and underlying operating profit was £11.7 million.

Revenue in the Sensors & Electronics segment decreased by 2.2% from the prior year to £96.9 million (2015: £99.1 million), reflecting the completion of production contracts with the US Department of Defense in the comparative period, although revenue grew at the UK businesses. Margins improved from 9.4% to 11.8% and Sensors & Electronics increased its operating profit by 22.6% to £11.4 million (2015: £9.3 million). On a constant currency basis using 2015 rates, revenue was £92.4 million and underlying operating profit was £11.3 million.

Revenue for the Energetic Systems segment increased by £89.5 million to £241.9 million (2015: £152.4 million). This improved performance was primarily as a result of the 40mm ammunition contract with a customer in the Middle East which, despite its delayed start, has performed well and contributed £44.5 million of revenue. Margins improved from 9.9% to 13.1% and Energetic Systems increased its operating profit by 109.9% to £31.7 million (2015: £15.1 million). On a constant currency basis using 2015 rates, revenue was £220.1 million and underlying operating profit was £27.4 million.

Underlying operating profit from continuing operations was £48.5 million (2015: £34.4 million), an increase of 41.0%. The underlying operating margin was 10.2% (2015: 9.1%).

Discontinued operations mainly comprises the release of disposal provisions relating to the European munitions businesses - Mecar, based in Belgium, and Simmel, located in Italy - which were sold in May 2014.

The total operating profit was £30.9 million (2015: £10.4 million). This includes non-underlying costs of £17.6 million (2015: £24.0 million), split between continuing costs of £22.3 million and discontinued credits of £4.7 million.

Net underlying finance expense was £14.5 million (2015: £14.6 million). The reduction reflects the repayment of loan note debt during the year and lower usage of the revolving credit facility, offset by adverse foreign exchange movements and an increase in the amortisation of prepaid facility fees.

Underlying profit before tax from continuing operations was £34.0 million (2015: £19.8 million), an increase of 71.7%. Tax on underlying profit before tax from continuing operations was £7.1 million (2015: £4.1 million), representing an effective tax rate of 20.9% (2015: 20.7%). The tax rate on underlying profit before tax remains comparable to the UK corporation tax rate, and continues to benefit from the utilisation of R&D and other tax credits. Including non-underlying items, the total profit before tax from continuing operations was £8.0 million (2015: £9.1 million loss).

The effective tax rate on the total profit before tax from continuing operations was 18.8% (2015: 41.8%) due to the geographic mix of profits, changes to the amounts of deferred tax assets considered recoverable in respect of both tax losses and US interest limitations, prior year adjustments and the recent changes in UK corporation tax rates.