Flomerics Investor Relations - Flomerics Group PLC

Flomerics Group PLC, supplier of analysis software to the telecommunications, semiconductor and computer industries, and other sectors of the electronics industries, announces its results for the year ended 31 December 2003.

“The Group has faced two years of falling revenues following an extended period of growth. By making some painful cuts in expenditure, the company has remained profitable and maintained a strong balance sheet. There are good signs now that the bottom has been reached and that the Group can start to benefit during 2004. As the new products start to deliver and the electronics sector returns to growth, we are again seeing good prospects for the years ahead.”

CHAIRMAN’S STATEMENT

In the face of continuing difficult trading conditions, the Group has achieved a profit before tax of £455,000 (2002: £635,000). As expected when we announced our interim results, the second half of the year continued to be challenging. However, the rate of contraction of the revenues was slowed from 14% in the first half (compared to the same period in 2002) to 5% in the second half, at constant exchange rates. The second half of 2003 also showed an increase in turnover over the first half, which followed five consecutive halves when revenue had been decreasing. This is an encouraging sign that the corner has been turned. Also, there is evidence of an increase in activities in the electronics sector, as exemplified by increases in US technology spending and increases in electronics production globally, and we should start to see this reflected in our sales.

Turnover for the year was down by 13%, partly as a result of the weaker dollar; at constant exchange rates turnover was down 10%. However, our measures to reduce administrative costs continued and we were able to offset this fall in revenue by reducing our administrative costs by 10% compared to 2002.

Due to a refund of withholding tax, the tax rate has been reduced to 11% (2002:25%). As long as the Group continues to benefit from the Research and Development tax credit, a rate of between 20 and 25% is likely in future years.

Earnings per share for the year before amortisation of goodwill were 3.3p (2002: 3.8p). Cash balances at 31 December 2003 were £2.5 million (2002: £2.2 million). The Directors propose to pay a dividend of 1p per share (2002:1p). Subject to approval by shareholders, the dividend will be paid on 7 May 2004 to shareholders on the register at the close of business on 13 April 2004.

Customers’ renewals of licences were at a good level and exceeded the budget, but new business was slow across the product range. We are pleased to be able to report that we have retained all of our major corporate accounts, and have increased our presence in a number of them.

The Products

FLOTHERM

FLOTHERM remains the Group’s predominant product and in 2003 accounted for 78% of turnover (2002:76%). Revenue from this product was down 8%, compared to contraction of 13% in 2002.

We were encouraged that renewals held strong, and were ahead of budget and close to the levels achieved in 2002. This represents some stabilisation, but it has not yet filtered through to new sales, which were down compared to 2002.

During the year a major new release of FLOTHERM was delivered to our customers. This includes a number of significant enhancements – among them automatic design optimisation, and solver improvements that can give a tenfold speed-up in analysis time. These have strengthened the product in the marketplace, and have contributed to the stabilisation of FLOTHERM business in the later part of 2003.

In 2004 we will release a new thermal product to complement FLOTHERM. This product, FLO/PCB, is aimed at tackling thermal issues at the printed circuit board (PCB) level – to operate alongside FLOTHERM, which is primarily used for design at the system level (i.e. considering the complete equipment). As explained in the Chief Executive’s Review, the introduction of this product reflects a recognition that, as the importance of thermal design increases, it is increasingly moving from the system-integration stage into the broader electronics design chain. By providing specially tailored solutions for these new classes of user – starting with PCB designers – we are opening up potentially substantial new markets alongside the existing FLOTHERM user base. The first full release of FLO/PCB will be made during the first half of 2004. Prototypes are already in customers’ hands and have been extremely well received.

FLO/EMC

The new FLOTHERM release in 2003 coincided with the release of the first “merged-product” version of FLO/EMC. The interoperability of this new product with FLOTHERM offers major benefits to designers, enabling them to investigate trade-offs between thermal and EMC designs. By utilising a FLOTHERM-style user interface, the new product offers major enhancements in ease of use, and is much better targeted at the identified market needs than our earlier releases – or any current alternative software products.

During 2003 FLO/EMC accounted for 5% of the Group turnover (2002:6%), reflecting a contraction of 12%. This contraction is disappointing, particularly in the light of the new release made mid way through the year. While we remain confident that there is a substantial, and growing, need for the analysis that FLO/EMC provides, our experience is that, currently, the industry is cautious in taking on this new technology, and that therefore the rate of adoption is limited. However there are an increasing number of customers that are reporting major benefits from utilising FLO/EMC – and, as awareness of this spreads, we are anticipating an increase in the rate of adoption.

FLOVENT

FLOVENT accounted for 10% of the Group’s turnover (2002:10%) and suffered contraction of 18%. At the end of 2003 Hassan Moezzi, who was Business Development Director of Flomerics Limited, left to establish his own business distributing FLOVENT in the UK, focussing on Data Centre applications. Hassan joined Flomerics in 1989 and we shall miss his contributions to other areas of the business, but are pleased that he will be retaining close links with the Company. Flomerics will continue to handle FLOVENT business in other territories and other market sectors directly.

MICRO-STRIPES

Micro-Stripes accounted for 7% of Group turnover (2002: 8%) and experienced contraction of 18%. In the first half of the year development focus was concentrated on the converged FLOTHERM and FLO/EMC offering. Enhancements are now being made to Micro-Stripes with a new release scheduled for the second quarter of 2004. We see continuing opportunities for this product in the growing market for high-frequency electromagnetic applications, particularly in antenna system design.

Other Developments and Resources

In 2004 the company will be investing in an offshore development capability with a new office in India. This will enable us to improve the speed of development without significantly increasing costs. The Indian development team will be co-located with a new sales operation, which we are now establishing to capitalise on the growing opportunities in that region.

Staff numbers were further reduced in 2003 to 113 by the end of the year(2002: 127) as we managed costs in line with the revenues. This has placed additional pressures on the staff, who have had to work very hard through these challenging times. We thank them for their continuing strong commitment to Flomerics and for their achievements.

During 2003 we completed the re-organisation of the Group into the three regional territories of America, Europe and Asia Pacific. In this context we were pleased to appoint Lena Evander as Regional Director of Europe. Lena joined Flomerics in 2001 as regional manager of the Nordic office, where she has established a successful sales and support operation.

Prospects

Because of the importance of the US market for the Group’s products, both turnover and profits have been significantly impacted in 2003 by the weaker dollar. Since the end of the year it has weakened further and it currently seems likely that it will adversely affect the results for 2004.

The Group has faced two years of falling revenues following an extended period of growth. By making some painful cuts in expenditure, the company has remained profitable and maintained a strong balance sheet. There are good signs now that the bottom has been reached and that the Group can start to benefit during 2004. As the new products start to deliver and the electronics sector returns to growth, we are again seeing good prospects for the years ahead.

CHIEF EXECUTIVE’S REVIEW

THE END OF THE SLOWDOWN

It is evident that – after two extremely tough years – the slowdown in the electronics industries is largely behind us. Worldwide electronics production is anticipated to return to growth (of just over 5%) in 2003[1]; projections for US technology spending show annual growth of 5% or more from 2003 to 2008[2]; and companies in all sectors of electronics are now fairly consistently reporting growth and profitability,

Of course, this is good news for Flomerics – and we are beginning to see the effects of the improving industrial climate in the stabilisation of our business during the later part of 2003. However, in assessing prospects – particularly in the short-term - we need to recognise: firstly, that it appears likely to take some time for the industry recovery to become fully established; and, secondly, that there can be a time lag in the full effects of the recovery feeding through to Flomerics business.

LONGER-TERM IMPACT

We do, however, remain confident about the longer term. As the industry “normalises”, and returns to sustained growth, we are well positioned to benefit from the consequent strengthening demand for our products. We have, during the slowdown, been successful in maintaining our worldwide market leadership in electronics thermal, and in retaining our strong position in major corporate accounts. We are also delighted to be able to report that a survey undertaken during early 2004 confirms an exceptionally high level of satisfaction among this customer base with Flomerics and its products and services.[3]

Moreover, during 2003 we have completed some major product advances (a major new FLOTHERM release, and the first merged-product FLO/EMC). And – as explained below – we are now moving into a new area of electronics thermal design with a new product that complements FLOTHERM. We therefore enter this period of industry recovery with a strengthened product line, which opens up substantial new markets, and offers real longer-term growth opportunities.

To reinforce this longer-term view, it is worth reiterating the underlying technology trends driving the increasing need for Flomerics products.

Functional densities, power densities, and clock speeds continue to escalate in all classes of electronics equipment[4] – following the familiar “Moore’s Law”. These trends mean that thermal and EMC aspects of electronics design will become increasingly critical over the next few years – and that increasing attention, and investment, will need to be devoted to their resolution – leading to increasing opportunities for Flomerics’ products

ANTICIPATING SHIFTS IN THE THERMAL MARKET

One of the consequences of the increasing importance of thermal issues in electronics design is a shift we are perceiving in the thermal design process.

Hitherto thermal problems have tended to “converge” at the system integration stage of electronics product design. So, currently, when the main “electronics” design has been completed, the thermal design specialist will address thermal issues as part of the final “mechanical” stage of design, when the decisions are made about the enclosure containing the electronics and other aspects of the “physical design”. But thermal problems really arise earlier in the design process – and, as thermal densities increase, this “after the event” approach to resolving them is becoming increasingly inadequate.

We therefore anticipate the increasing need for thermal analysis to move beyond the present thermal engineer (who still retains the pivotal role in the whole thermal design process) into the wider electronics design chain. This leads to new demands for thermal analysis software – and, because there are many more electronics designers than mechanical ones, opens up potential high-volume markets. Addressing these needs requires new, specially tailored thermal products, communicating closely with FLOTHERM, which will still be used by the thermal engineer at the central system-integration stage.

Our first response to this need is to focus attention on FLO/PCB, a new product targeted at the thermal-design needs of the circuit board designer. The product has evolved from in-depth discussions with a number of selected key customers. The first full prototype of FLO/PCB was completed late in 2003, and is now in the hands of a number of customers. The reaction has been extremely encouraging. We therefore anticipate an excellent reaction when we launch the first full release of the product in Q2 this year.

PROGRESS IN EMC

In addition to the thermal market, we have increasingly emphasised the complementary opportunities in electromagnetics compatibility (EMC). Our FLO/EMC product is primarily aimed at existing FLOTHERM customers, for whom it provides a means of analysing the emissions of electromagnetic radiation from their equipment. The levels of such emissions are limited by legislation – and, as functional densities and clock speeds in present-day equipment escalate, reducing, or “containing”, such emissions is becoming an increasingly challenging design issue. With FLO/EMC, alongside FLOTHERM (and FLO/PCB), we offer solutions to the two most critical problems in the “physical design of electronics” – EMC design and thermal design.

During 2003 we released what is effectively a wholly new EMC product. This replaces the earlier stand-alone version of FLO/EMC, and now offers EMC analysis capabilities within the FLOTHERM product architecture. This “merged product” offers a number of major benefits:- it provides the user with the improved user interface available in Flomerics’ core products; it enables users to share data models between FLO/EMC and FLOTHERM (facilitating investigation of the often-necessary trade-offs between thermal and EMC design changes); and it ensures that future investments in the FLOTHERM code series also benefit FLO/EMC.

This new product was released in June 2003. A number of customers have adopted it enthusiastically, and are beginning to benefit from the design efficiencies of using it alongside FLOTHERM – in one case, citing 20% saving in time-to-market[5]. However, it has to be said that the level of business achieved in the early stages of this new product release has been disappointing (a contraction of 12% for the year as a whole), reflecting a more limited rate of adoption by the market than we had anticipated.

There are a number of factors underlying this. First and foremost, it is worth emphasising that, with FLO/EMC (and particularly with this latest release) we are creating a wholly new market, from scratch. The software addresses a critical, and growing, industry need – and, by being first and creating the market, we have excellent opportunities to establish a strong market leadership (as we did with FLOTHERM). However, one characteristic of the “missionary stage” of the launch of a new product of this kind is the need for a period of learning and education, before customers are ready to adopt the new product wholeheartedly, and to adapt their design methodologies accordingly. This can take time – and can be difficult to predict.

The second factor affecting the rate of adoption of FLO/EMC is, we believe, the general state of the industry. Even as electronics companies move into the present recovery, they remain cautious about new commitments (in expenditure, or in “doing things differently”), which makes them less receptive to new solutions (even to current, pressing problems) than they would be in more normal times.

We believe that these are the main factors limiting the rate of adoption of the new release of FLO/EMC. However, underlying this, the messages from the market are strongly positive. There is a recognised – and increasing – need for EMC design analysis as an integral part of the electronics design process; and, currently, FLO/EMC is unique in offering the required capabilities. We are in the exceptional position of being already in ongoing contact with the primary potential market - the FLOTHERM user base – for which the links to FLOTHERM offer substantial additional benefits. As successful experience of FLO/EMC usage grows, and market awareness increases, we are confident that the rate of adoption will accelerate.

TO SUM UP

In summary – we are beginning to see the benefits of the market recovery in the electronics industries. It does, however, remain difficult to predict how quickly the full impact of the increasing market confidence will flow through to Flomerics business.

In the longer term, we anticipate a return to sustainable growth in the FLOTHERM business (in which we have retained our global market leadership) – and we do see significant additional, complementary market opportunities for FLO/EMC and for the new modular thermal product FLO/PCB. We are currently focussed on – and committed to – realising these exciting growth opportunities.

OPERATING & FINANCIAL REVIEW

Areas of operation

The Group's head office and research and development function is located in Hampton Court in the UK. In the US, which in 2003 accounted for 48% (2002:50%) of the Group's revenue, there are four sales and support offices. In addition there are four offices in Europe and three offices in the Asia Pacific region. In 2004 a new sales and off-shore development office will be opened in India.

Performance in 2003

Early in 2003 we identified that our internal revenue expectations for the year were unlikely to be met and the cost base was further reduced in order to manage this situation. The result of this and earlier cost cuts was that administrative costs were reduced by 10% compared to 2002. Cost of sales came down in absolute terms but also as a percentage of turnover, largely due to the latest version of our software which has saved on royalties payable to third party providers. However, the cost reductions did not compensate sufficiently for the decrease in turnover of 13% and as a result the operating margin decreased from 6.0% in 2002 to 3.8% in 2003. This margin it should be noted was considerably impacted by the weaker dollar relative to sterling.

Other income has increased from £26,000 to £101,000, partly because of more interest received on the higher cash balances but also because of rent received (of £46,000) from the Group’s freehold property purchased in 2001. A short-term tenant for this building was found in April.

The Group benefits in the UK from the Research and Development tax credits and this has kept the tax charge low in the UK for the last few years. During the year a refund of withholding tax from Japan (of £38,000) was received and this has brought the tax rate down to 11%, which is unusually low. Without this the Group tax rate would have been 20%.

Research and Development

For the first half of the year efforts were concentrated in completing the converged product of FLOTHERM and FLO/EMC.

In note 3 to the financial statements for the year ended 31 December 2003 the number shown for Research and Development (R&D) for both years has been calculated to include a share of direct overheads, such as rent and associated costs, but does not include a share of central administration costs. In absolute terms the total cost in 2003 was at the same level as 2002, but as a percentage of turnover this represents an increase from 20% to 23%. In 2004 we anticipate that the level of expenditure will be at about the same level as 2003 and this includes the setting up and the running costs in the first financial year of the new development operation in India. Whilst maintaining R&D spend, it is planned that R&D costs should come down as a percentage of turnover in subsequent years.

Financing and the Balance Sheet

Cash generated from operating activities was £0.8 million (2002:£2 million). After capital expenditure of £196,000 (2002: £314,000), tax paid of £76,000 (2002: £234,000) and a dividend paid to shareholders of £146,000 (2002: £146,000) total cash inflow was £331,000 (2002: £1.1 million). The cash balance has thus increased from £2.2 million at the end of 2002 to £2.5 million at the end of 2003 and net funds have improved from £1.5 million to £1.9 million. The only borrowings are £569,000, which is the mortgage on the freehold property that is being repaid over ten years.

In view of the strong cash position the Group does not currently maintain an overdraft facility.

Because of the international nature of the business, there is an exposure to exchange rate fluctuations and in particular to the US dollar, accounting for over 54% of total turnover. Forward exchange rate contracts are taken out against significant cash receipts expected in the UK.

Trade debtors at the end of 2003 were £3.0 million compared to £3.3 million at the end of 2002. The Group bills a disproportionate amount of its turnover in the last quarter of the year and in 2003 this represented 32% of total turnover compared to 28% in the last quarter of 2002. On a count back basis debtor days have improved from 88 to 80 days.

The Group is carrying £458,000 of goodwill (2002:£540,000) relating to the acquisition of Kimberley Communications Limited in 1999. This acquisition brought to the Group ownership of the Micro-Stripes product, which has provided the foundation for the FLO/EMC product. The goodwill is being amortised over ten years.

There are few trade creditors in the normal sense of the words - £204,000(2002:£200,000). Out of a total creditors figure of £3.1 million (2002:£3.5 million), £1.8 million (2002:£1.9 million) is deferred revenue. This relates to the support and maintenance element of the sale that has been invoiced but not recognised as revenue in 2003. It will be recognised as turnover in future periods.

1. The Group recognised unrealised losses on translation of foreign currency net investments of £75,000 (2002: £96,000) in the year which were taken to reserves and are not included in the profits above.

2. The financial information shown for the years ended 31 December 2003 and 2002 set out above does not constitute statutory accounts but is derived from those accounts. The results have been prepared using accounting policies consistent with those used in the preparation of the statutory accounts. The financial information contained in this announcement does not constitute statutory accounts within the meaning of Section 240 of the Companies Act 1985. The financial information for the year ended 31 December 2002 has been extracted from the statutory accounts for that year which have been filed with the Registrar of Companies and which contain an unqualified audit report. The financial information for the year ended 31 December 2003 has been extracted from the draft statutory accounts for that year upon which the auditors have yet to report. Copies of this announcement are available at the registered offices of the Company (81 Bridge Road, Hampton Court, Surrey, KT8 9HH) and at the offices of the company’s nominated advisors, Teather & Greenwood Ltd. (Beaufort House, 15 St Boltolph Street, London EC3A 7QR) for a period of 14 days from the date hereof.

3. The Group’s turnover and profit before tax for each geographic area of operation is:

4. The earnings per share figure for 2003 has been calculated based on the profit on ordinary activities after taxation and the weighted average number of shares in issue of 14,646,580 (2002: 14,646,580 ).

5. In accordance with FRS14 issued in October 1998 the fully diluted earnings per share were 2.74 pence per share (2002: 3.23p). The diluted number of shares was 14,724,000 (2002: 14,709,000)

6. The AGM will be held at 11.30 am on 23 April 2004 at the registered office of the company (81 Bridge Road, Hampton Court, Surrey, KT8 9HH).

[1] Reed Electronic Research, Yearbook of World Electronics Data, 2003.

[2] The Economist, October 4 2003.

[3] For example, in response to the question “Would you recommend Flomerics’ products and services to others?”, a total of 97% would “Strongly Recommend” (59%) or “Recommend”.

[4] For example, recent projections show the heat generated by Intel processors increasing at an accelerating rate, and rising more than tenfold between 2003 and 2010.

The Economist Technology Quarterly March 15 2003.

[5] Flomerics Press Release available on Flomerics Web Site at www.floemc.com/applications/barco/

Flomerics Group PLC - Final Results

Preliminary results for Flomerics