Dechra Pharmaceuticals
Annual Report 2006

Plain-text annual report

Developing Pharmaceuticals Improving Animal Health Annual Report and Accounts 2006 Dechra House Jamage Industrial Estate Talke Pits Stoke-on-Trent ST7 1XW Staffordshire England t: +44 (0)1782 771100 f: +44 (0)1782 773366 e: corporate.enquiries@dechra.com www.dechra.com Registered in England No. 3369634 D e c h r a ® P h a r m a c e u t i c a s P L C A n n u a l l R e p o r t a n d A c c o u n t s 2 0 0 6 Advisers 85 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Merchant Bank & Financial Advisers Registrars NM Rothschild & Sons Limited Computershare Services PLC PO Box 82 The Pavilions Bridgwater Road Bristol BS99 7NH Financial PR Citigate Dewe Rogerson 9 The Apex 6 Embassy Drive Edgbaston Birmingham B15 1TP New Court St Swithins Lane London EC4P 4DU Stockbroker & Financial Advisers Dresdner Kleinwort 30 Gresham Street London EC2P 2XY Principal Bankers Bank of Scotland 55 Temple Row Birmingham B2 5LS Auditors KPMG Audit Plc 2 Cornwall Street Birmingham B3 2DL Lawyers DLA Piper Rudnick Gray Cary LLP Victoria Square House Victoria Square Birmingham B2 4DL Welcome to Dechra Our Strategy To continue the development of our veterinary pharmaceutical portfolio and increase our pharmaceutical penetration into international markets. Our Business An emerging pharmaceutical business, focused on the veterinary market. 1 0 f o o r P 6 0 0 2 / 8 0 / 8 0 e t a D 3 1 3 2 1 . o n b o J Contents 01 Highlights 02 Chairman’s Statement 04 Global Markets 05 Directors’ Business Review Review of the year Financial Review 24 Directors and Senior Management 26 Directors’ Report 28 Corporate Governance 32 Audit Committee Report 34 Directors’ Remuneration Report 40 Social, Ethical and Environmental Responsibilities 41 Statement of Directors’ Responsibilities in respect of the Annual Report and the Financial Statements 42 Independent Auditors’ Report 43 Consolidated Income Statement 44 Consolidated Balance Sheet 45 Consolidated Statement of changes in Shareholders’ Equity 46 Consolidated Statement of Cash Flows 48 Notes to the Consolidated Financial Statements 72 Financial History 74 Company Balance Sheet 75 Reconciliation of Movements in Shareholders’ Funds 76 Accounting Policies 78 Notes to the Financial Statements 85 Advisers Pharmaceuticals Dechra Veterinary Products Marketing and development of licensed branded pharmaceuticals to the veterinary profession worldwide. Arnolds Veterinary Products UK market leading supplier of veterinary instruments and equipment, and suppliers of critical care fluids and equipment. Dales Pharmaceuticals Licensed manufacturer of human and veterinary pharmaceuticals for DVP and third party customers. Developing Pharmaceuticals Improving Animal Health Services National Veterinary Services UK market leader in the supply of pharmaceuticals and added value services to the veterinary profession, including management information systems and consumer and internet services. NationWide Laboratories Multi-disciplined independent commercial veterinary laboratory. Cambridge Specialist Laboratory Services Primary care and secondary referral specialist veterinary immunoassay laboratory. 01 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Highlights Revenue £’000 232,471 210,267 170,202 179,309 186,843 Dividend per share pence 6.24 5.20 4.70 4.12 4.12 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 up 10.6% up 20.0% Operating Profit £’000 Operating cash flow £’000 12,312 11,255 8,773 9,184 8,162 13,549 13,997 10.576 6,397 6.542 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 up 9.4% up 3.3% Clinical trial work required to obtain regulatory approval for Vetoryl® Capsules and Felimazole® Tablets in the USA is progressing in line with expectations and is expected to be completed prior to the end of 2007. 14% pre-tax profit growth after product development expenditure increase of 30.9%. Cash conversion rate at 114% of operating profit. Final dividend per share payment increased by 23.7%, total dividend per share for the year increased by 20%. (cid:2) (cid:2) (cid:2) (cid:2) 02 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Chairman’s Statement Developing Pharmaceuticals Improving Animal Health I am pleased to report that we continue to make solid progress across the Group. This is reflected in the positive performance by our Pharmaceuticals and Services Divisions, both of which achieved strong revenue growth and improvements in profitability. Overall, our strategic focus firmly remains the on- going development of the Group’s own branded veterinary pharmaceutical portfolio for the world’s companion animal markets. Financial Highlights These are the first full year results to be presented using International Financial Reporting Standards (“IFRS”). The comparative figures for the year ended 30 June 2005 have been restated accordingly. Group revenue increased 10.6% from £210.3 million to £232.5 million. Operating profit increased by 9.4% to £12.3 million (2005: £11.3 million) and profit before taxation rose 13.8% to £11.0 million (2005: £9.7 million). Basic earnings per share was 14.71 pence, up 6.8% from the 13.77 pence achieved in 2005. Cash flow continued to be strong with cash flow from operations being 114% of operating profit. As at 30 June 2006, the Group had net funds of £1.1 million compared to net debt of £4.9 million at 30 June 2005. Interest cover was 9.7 times. Capital expenditure during the year totalled £2.2 million which principally comprised IT upgrades at our distribution and manufacturing businesses and an expansion of capacity at our distribution business. Further details on the financial results are contained in the Business Review. Dividend In line with our progressive dividend policy and our confidence in the business, the Directors are recommending a 23.7% increase in the final dividend to 4.33 pence per share (2005: 3.50 pence per share). This, together with the interim dividend of 1.91 pence per share (2005: 1.70 pence per share), makes a total dividend for the year of 6.24 pence per share (2005: 5.20 pence per share), a 20% increase. Total dividend cover is 2.3 times profit after taxation. The final dividend, which is subject to Shareholder approval at our Annual General Meeting to be held on Wednesday 18 October 2006, will be paid on 24 November 2006 to Shareholders on the Register at 27 October 2006. to thank all of our people for the tireless hard work, focus and commitment to the business. Prospects Current trading remains in line with management expectations and we continue to maintain confidence in the future. We have an increasing number of opportunities to market and exploit our own-developed branded veterinary products on a global basis, and also to further extend our strong position within our Services business. Following the launch of Vetoryl® Capsules by our European Marketing Partner in France, Germany and the Benelux countries, we expect to see a reasonable contribution in 2007 towards revenues. The clinical trial work required to obtain regulatory approval for Vetoryl® Capsules and Felimazole® Tablets in the USA is progressing in line with our expectations and these trials are expected to be completed prior to the end of 2007. People On behalf of the Board and all our Shareholders, I warmly welcome all staff who joined us during the year and I would like to take this opportunity Michael Redmond Chairman 5 September 2006 “Our protocols for Vetoryl® clinical trials within the USA have been approved by the FDA and trials have commenced in several dogs with new cases being identified daily. We anticipate completing the trials on schedule prior to the end of the 2007 calendar year” Global Markets The USA represents the largest companion animal market in the world, with around 70 million dogs and 80 million cats Japan has over 13 million dogs, while Canada and Australia also represent sizeable companion animal markets 90% of the world’s companion animal market is in North America, Western Europe and Japan There are approximately 6.5 million dogs, 7 million cats and 1 million horses in the UK 05 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Business Review Review of the Year The Business and Its Markets Dechra Pharmaceuticals PLC (“Dechra”) comprises six businesses operating under two divisions, Pharmaceuticals and Services. Both divisions are focused on the veterinary market with a key area of specialisation being on companion animal products. The Group’s main focus is delivering organic growth from its two divisions; however, the key strategy to deliver medium to long-term growth is the development of our own branded veterinary pharmaceutical products for licensing internationally. Dechra employs 698 people who operate out of 16 locations. Number of employees 613 630 591 682 698 The USA represents the biggest companion animal market in the world with the number of dogs and cats estimated at 70 million and 80 million respectively. American veterinarians are very advanced in their knowledge of small animal medicine, a key advantage when marketing specialised products such as Dechra’s own brands. Sources indicate that Americans spend more per companion animal than any other nation. Within the UK there are approximately 6.5 million dogs, 7 million cats and 1 million horses. The UK companion animal market is also considered to be highly advanced in terms of spend per animal and veterinarian competence. The UK veterinary market, including livestock products, has consistently outperformed the Retail Price Index (“RPI”) over the past seven years. GB Vetenary Market Growth as measured by GFK Retail Price Index (“RPI”) % 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 00 01 02 03 04 05 06 Year ended 30 June As at 30 June 02 03 04 05 06 The veterinary market for companion animal products is dominated by North America, Western Europe and Japan. Key drivers within the companion animal market are the increasing medical and surgical capabilities of veterinary surgeons, increased life expectancy of pets and ultimately the consumer’s passion for their animals. Developing Pharmaceuticals Improving Animal Health The remainder of the EU, in terms of the number of animals, is potentially commensurate with the USA. Despite this, however, the market value is currently considerably less as the average spend on dogs and, particularly, cats is lower. The majority of pets do not have regular contact with a veterinary surgeon and with the exception of some major conurbations, small animal veterinary science is not as advanced. Japan represents a considerable market opportunity with over 13 million dogs. Other territories with sizeable companion animal markets are Canada and Australia. Product Development Strategy Our product development is focused entirely on prescription only veterinary medicines for dogs, cats and horses, with our main area of specialisation being endocrinology. Most of our projects utilise existing pharmaceutical entities that are typically used within the human market, therefore the majority of product creation is development and not research based. There are a number of benefits to our strategy relative to traditional human and veterinary pharmaceutical R&D, which include: An identified, existing pharmaceutical product can often be brought to full licence for the veterinary market within five years; (cid:2) 06 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Business Review Review of the Year continued Developing Pharmaceuticals Improving Animal Health After minimal expenditure on early explorative project evaluation, an identified human pharmaceutical has a high probability of achieving a veterinary licence; Development projects have a high probability of success with relatively low cost; research-based projects are usually expensive with low probability of product success; Products developed for other species, i.e. food producing animals, take considerably longer to license as expensive food safety and toxicological studies are required; Clinical trials for veterinary medicines typically require a few hundred cases, while human trials demand several thousand. Legislation There are two pieces of EU legislation, which the Directors believe have been implemented to encourage development of specialised veterinary products for relatively small markets. Dechra considers this legislation to be favourable towards its strategy: “The Prescribing Cascade”: The basic principles of this legislation are that the veterinary surgeon must prescribe a veterinary licensed product above any other alternative. Therefore, any products licensed specifically for animals must be used instead of a human ethical or generic product, irrespective of price; EU law gives a novel product ten years protection from generic competitors, irrespective of its patent status. Licensing Authorities Dechra considers one of the most unpredictable aspects of product licensing is the response time from the Regulatory Authorities globally. EU regulators provide definitive response times based on a number of working days, which can vary depending on the type of application. However, these time lines can be stopped intermittently if the assessor considers that parts of the application need further supporting information. The US Food and Drug Administration (“FDA”) have recently introduced similar targets for novel products; however, whilst progress is being made, it will be a number of years before they meet statutory targets. Currently, there is an extensive backlog of applications for generic products for the American market, where the FDA have no obligations on response time. Other regulators, such as Canada and Japan, make no commitment to time lines and as a result the process can take several years. Key Strengths The Directors believe that the Group has exceptional skills and expertise that are relevant to delivering its strategy: The recognition of opportunities for specialised and niche pharmaceutical products for the veterinary market achieved from knowledge gained from the Group’s strong UK market position; In-house formulation of products into preparations suitable for the target species; International experience and proven track record of regulatory and licence delivery; Successful design and management of international clinical field trials; Industry leading veterinary and commercial personnel throughout the Group. Achievements During the last five years we have licensed four specialist products, of which Vetoryl® Capsules and Felimazole® Tablets currently represent our biggest opportunities for international growth. Vetoryl® is a novel and patented product for the treatment of Cushing’s Disease (excess cortisol or hyperadrenocorticism) in dogs. It is the only licensed product within the EU and is the only recognised safe and efficacious product for the treatment of Cushing’s Disease around the world. Launched in the UK on a provisional marketing authorisation in September 2001, Vetoryl® has been well received by veterinarians, with revenue now in excess of £2.9 million per year. It achieved mutual (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) 07 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 recognition for approval within Europe in 2005 and was recently launched within the key European territories. Felimazole® is the first veterinary licensed product for the treatment of feline hyperthyroidism. Felimazole® received marketing approval in 2002 and has achieved revenues in excess of £2.4 million in the financial year. Felimazole® was launched into most major EU territories during the 2005 financial year. Both Vetoryl® and Felimazole® have been granted an expedited review status by the FDA in the USA. The principal advantage to an expedited review is that there is a target 90-day response from submission of information (however, as previously indicated, the FDA are currently not meeting their targets). To date, we have submitted the safety and UK based efficacy parts of the dossiers; in both instances clear guidance has been provided by the FDA on requirements for further USA-based clinical trial work. In the USA, the various sections of the dossier can be submitted independently, i.e. when one section is complete it can be sent for review as opposed to the whole application being made concurrently. We anticipate filing our manufacturing sections by the end of this 2006 calendar year and the efficacy sections, containing data from the USA-based clinical trials, during the 2007 calendar year. Development Update There have been a number of achievements within our development programme throughout the financial year: Vetoryl® Capsules have received approval for marketing in 19 major European territories. This is a major achievement for our Regulatory team and is now the third product we have successfully licensed throughout key European markets following the approval of Felimazole® last year and Hypercard in 2003; Our protocols for Vetoryl® clinical trials within the USA have been approved by the FDA and trials have commenced in several dogs with new cases being identified daily. We anticipate completing the trials on schedule prior to the end of the 2007 calendar year; Clinical trials for Felimazole® are also progressing well within the USA. A significant number of cats have now commenced the trial and, as with Vetoryl®, we anticipate the trials to be completed prior to the end of the 2007 calendar year; After twelve months’ negotiations of both a technical and commercial nature, we have signed a marketing agreement for Vetoryl® in Japan with Kyoritsu Seiyaku (“KS”). KS are Japan’s leading companion animal pharmaceutical supplier and have Product Development Dr Susan Longhofer, Product Development and Regulatory Affairs Director; Keith Collis, Regulatory Affairs Director over sixty representatives marketing to veterinary practices. The Japanese Regulators will require clinical trials to be conducted in Japan. These will be the responsibility of KS and it is anticipated that it will be at least three years to gain approval in this significant territory; Complete dossiers have been submitted for Vetoryl® to the Canadian and Australian authorities. The complete Felimazole® dossier has been submitted in Canada. We estimate that the review process in these territories will take two to three years prior to marketing authorisations being approved; A new 10mg small dog Vetoryl® Capsule is at an advanced stage of development for all markets, with approval anticipated for Europe within the next twelve months. The USA approval is expected to be concurrent with the full application; Further investment has also been made into our pharmaceutical development laboratory in terms of equipment and people, as we continually strengthen our in-house product development formulation capabilities. We currently have a number of other products under development; due to commercial sensitivity we believe it to be appropriate to treat the nature of these projects as confidential. (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) 08 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Business Review Review of the Year continued Developing Pharmaceuticals Improving Animal Health Case Study After their elderly owners were no longer able to look after them, lifelong companion corgis Molly and Digger were found a new home with Anne Craghill and her family in 2000. Shortly after Molly and Digger had settled into family life, Anne became concerned that all was not well with Molly — her water intake seemed excessive, she was constantly tired and her co- ordination and attention were far from perfect. Following a visit to the local veterinary practice, initial blood tests suggested that Molly was hypothyroid and was immediately put on a thyroid supplement therapy. However, several months passed and with Molly showing no sign of improvement, further tests were undertaken that then confirmed that Molly had hyperadrenocorticism, also known as Cushing’s disease, due to a pituitary tumour. Molly was prescribed Vetoryl, Dechra’s own developed drug which is licensed in the EU for the treatment of Cushing’s disease. Cushing’s occurs when a dog produces excessive amounts of cortisol, which is an important hormone that affects the body’s protein, carbohydrate and fat metabolism. When these levels are too high, it becomes harmful to the animal and has a damaging effect on the function of many organs and the body’s metabolism. This can result in a number of serious conditions. Digger was also treated with Vetoryl therapy and soon after, his coat began to grow back and his other symptoms subsided. Vetoryl contains the active ingredient trilostane, which blocks the chemical reaction triggered in the body to stimulate the production of cortisol, and allows the dog to lead a near normal life. While there is no cure for Cushing’s, the therapy helps to block further progress and damage by regulating the amount of cortisol in the body. Thanks to Vetoryl, Molly’s excessive drinking subsided and she became more energised; as Molly was improving, Anne began to become increasingly concerned with Digger. Although the two corgis are unrelated, like Molly, Digger had begun to drink excessively. He had also become incontinent, started scavenging for food and when being groomed, was losing large chunks of hair — the vet suspected Cushing’s disease once again. Digger, now aged 10, has been treated with Vetoryl since October 2005 and Molly, aged 11, for three years — both corgis, despite maturity, are now healthy and happy dogs and have adapted well to the Vetoryl treatment without any side-effects. Dechra Veterinary Products, as part of its education programme, runs continuing professional development seminars which give the veterinary profession the opportunity to keep abreast of new developments in veterinary science. 07 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 “Due to the unique nature of Vetoryl® and Felimazole® the products will be sold on a technical basis, i.e. education of veterinary surgeons and opinion leaders which is achieved through technical marketing, sponsoring congress lectures, and through conducting regional educational roadshows” 11 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Developing Pharmaceuticals Improving Animal Health “We currently have a number of other products under development; due to commercial sensitivity we believe it to be appropriate to treat the nature of these projects as confidential” Pharmaceuticals Division Directors’ Business Review Review of the Year continued DVP UK Giles Coley, Managing Director; Chris Kingdon, Pharmaceutical Sales Director; Gwenda Bason, Pharmaceutical Marketing Director; Mark Sallin, Finance Director Our Pharmaceuticals Division comprises Dechra Veterinary Products (“DVP UK”), Dechra Veterinary Products USA (“DVP USA”), Arnolds Veterinary Products (“Arnolds®”) and Dales Pharmaceuticals (“Dales”). DVP UK DVP UK, located in Shrewsbury, England, employs 30 people. This business markets and sells our own branded, licensed veterinary pharmaceuticals in the UK, and manages the relationships with our EU marketing partners. We have over 50 licences; however, there are 12 key brands which represent over 90% of DVP’s revenue. We have three UK marketing agreements; with Virbac Corp. to market Soloxine within the UK and Ireland, with Biopure to market Oxyglobin in the EU, and with Peptech to market Ovuplant in the EU. Soloxine is used for the treatment of hypothyroidism in dogs and currently has UK sales of approximately £800,000 per year; this contract is due to expire in March 2007. Ovuplant is a seasonal equine fertility product, launched in the UK in Spring 2005; development has commenced to license the product within the rest of the EU. Felimazole® and Vetoryl®, together with Equipalazone®, the market leading equine non- steroidal anti-inflammatory drug, are marketed within the EU by various partners, the key territories being serviced by Janssen, Intervet and Orion. As outlined in the Financial Review in this report, DVP had a very successful year. Felimazole® revenue increased by 34%, predominantly as a result of the introduction of the new 2.5mg product presentation which was launched last year. It is estimated that over 50,000 cats are now being treated with Felimazole® daily. Vetoryl’s® market penetration has also increased with over 2,100 of the UK’s 3,500 veterinary practices now prescribing Vetoryl®. The reduction in the pack size from a pot of 100 capsules to blister packs of 30 had a temporary depressive effect on UK revenue in the year as the number of capsules in the supply chain was reduced. This has now reversed out and solid growth is being delivered. The marketing department has been strengthened and restructured during the year with greater accountability being given to the marketing managers, with individual product categories being assigned to specific teams. Our business in Eire has been restructured and we have taken on direct sales responsibility with the appointment of a Business Development Manager for the territory. We have also strengthened our management team with the appointment of a European account manager to develop our relationship with our marketing partners and drive sales of our products within Europe. 12 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Business Review Review of the Year continued DVP USA Mike Eldred, President; Chip Whitlow, Vice-President Sales & Marketing Arnolds Andrew Groom, Instruments Business Director; Becky Watkins, Marketing Co-ordinator; Kerry Boyd, Critical Care Marketing Manager DVP US This business, established in 2005 and located in Kansas City, Missouri, USA, currently has two employees. As outlined under Product Development, both Vetoryl® and Felimazole® are at an advanced stage of the licensing process, with full submissions being targeted to be completed by the end of 2007. The Directors consider that the US market represents the biggest single opportunity for our own international expansion. We believe that to gain full value from our products, the best route to market will be to create a Dechra brand within the USA. In order to achieve this, we currently market one minor product with the intention of establishing the Dechra brand, developing distributor relationships, creating a customer database and establishing accounting and logistics systems prior to the approval of our own key products. It is our intention to distribute our products through the existing network of veterinary suppliers within the USA, who also provide first line sales support. Our American function will be structured predominantly around marketing and technical support, with a team of up to 12 people being employed to coincide with the launch of our first major product. Due to the unique nature of Vetoryl® and Felimazole® the products will be sold on a technical basis, i.e. education of veterinary surgeons and opinion leaders which is achieved through technical marketing, sponsoring congress lectures, and through conducting regional educational roadshows. Pre-marketing has already commenced; the majority of world opinion leaders now understand and support the benefits of our products. Arnolds® Arnolds®, located in Shrewsbury, England, employing 23 people, is a well-established brand within the UK veterinary market and sells licensed critical care fluids, instruments, consumables and equipment to veterinary practices. Critical care products, branded Vetivex, drive the growth within Arnolds®. The revenue from instruments and surgery equipment is difficult to maintain given the low barriers to entry, cheap unregulated imports and the increasing number of small business entrants. The majority of products are branded “Arnolds”; however, we do have a number of important long-term marketing agreements which include 3M, B Braun and Portex (Smiths Medical). Throughout the year we have continued to build on the Vetivex range of critical care fluids which were purchased from Gambro BCT in April 2005. We have increased market share by 4% to 37.5% on a moving annual total basis and revenue has now exceeded £1.2 million per annum. Many of our disposable products, which are associated with critical care, have also been branded Vetivex to leverage brand strength. 13 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Dales Steve Dewar, Operations Director; Gareth Davies, Sales & Marketing Director; Kirsty Ireland, Finance Director; Mike Annice, Managing Director Dales Dales, located in Skipton, England, employing 129 people, is a fully Medicines and Healthcare Products Regulatory Agency (“MHRA”) approved pharmaceutical manufacturer with multi- competence in both batch size and dose form. Dales manufactures the vast majority of our own branded licensed pharmaceutical products, which are marketed through DVP, but also derives approximately 50% of revenues from third party contract manufacturing, predominantly for human pharmaceutical companies. This is Dechra’s only significant source of revenue not derived from the veterinary market. As major pharmaceutical companies continue to rationalise their manufacturing centres, our multiple scale production and specialisation (i.e. controlled drugs) capabilities allow us to maintain and write new contracts. The third party contracts make a significant contribution to the manufacturing overheads and, whilst many contracts are substantial, our relationships with key customers are important and new contracts are being written, contract manufacturing is not key to the Group’s long- term growth prospects. Throughout the year, we have continued to strengthen our technical department with further appointments being made within the Quality Assurance and Quality Control departments. We Developing Pharmaceuticals Improving Animal Health have successfully introduced a new Quality Management System, which provides the framework for anticipated future worldwide compliance requirements and is the basis for continual improvement. The improvement in the business has already been witnessed within the year as, despite these appointments, the overall headcount has reduced due to increased efficiency and investment in new equipment. The Dales management are at an advanced stage of implementing a new integrated IT system, which is expected to go live prior to the end of 2006. 14 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Services Division Directors’ Business Review Review of the Year continued Developing Pharmaceuticals Improving Animal Health NVS Tony Scott, Operations Director; Caitrina Harrison, Sales & Marketing Director; Martin Riley, Managing Director; Dan Shipman, Finance Director; Colin Higham, Buying Director Our Services Division comprises National Veterinary Services (“NVS®”), NationWide Laboratories (“NWL”) and Cambridge Specialist Laboratory Services (“CSLS”). NVS® NVS, located in Stoke-on-Trent, England, employing 453 people, is the UK market leader, as measured in terms of market share, in the supply and distribution of veterinary products to veterinary practices and other approved outlets. NVS stocks a range of over 12,000 products including pharmaceuticals, pet products, consumables and accessories. NVS has also developed a range of IT solutions for veterinary practices which are branded “Vetcom®”. Vetcom’s principal objective is to collect orders and transmit electronically. Approximately 80% of NVS’ orders arrive automatically with no human input required. This is considered to be a major advantage to our customers and also reduces our operating costs. With over 30,000 invoiced lines per working day, significant numbers of additional personnel would be required to handle this business manually. NVS distributes to 1,500 customers daily utilising its own fleet of vans and Heavy Goods Vehicles (“HGVs”). The centralised inventory in Stoke-on- Trent is picked and packed throughout the afternoon and evening and then distributed overnight to trunking depots by the HGVs on large trailers. Van drivers are then employed locally at these depots who distribute the goods to the customers. NVS operates on a Sunday until Thursday shift which allows customers to place orders up until 7.00 p.m. Monday to Thursday and any time over the weekend up to 11.00 a.m. on Sunday for a next working day delivery. Larkhall Carlisle York Stoke-on-Trent Godmanchester Gloucester Hertford Bracknell Swanscombe Tiverton NVS services companion animal practices, livestock practices and agricultural merchants, with approximately 60% of sales being in favour of companion animal related products. As with other divisions within Dechra, NVS benefits from the solid growth in the veterinary market as outlined previously in this report. The wholesale market in which NVS trades saw a major consolidation within the year with the acquisition of GenusXpress by Dunlops. There are now only two major full-line competitors to NVS within the mainland UK, the other business being Centaur Services. NVS saw good growth within the year and gains in market share, which now stands at 44%. NVS launched a new IT solution, Vpod, in March 2006, a hand-held, stand-alone, electronic, online ordering device. To date, 100 have been installed as veterinary practices recognise the benefits of this system to maintain optimum stock levels and the flexibility to place orders at any time of day. Over the last five years, NVS has been investing in automation within the warehouse. This has continued during this financial year with an investment in excess of £700,000. This investment increases our capacity and provides improved operational efficiencies. The warehouse has been extended with a new 16,000 sq. ft. mezzanine floor and significant improvements and extensions have been made to the semi- automated picking circuit. There have been two major management changes at NVS within the year. Martin Riley was appointed as Managing Director and Caitrina Harrison as Sales & Marketing Director. “The NVS warehouse has been extended with a new 16,000 sq. ft. mezzanine floor and significant improvements and extensions have been made to the semi-automated picking circuit” 16 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 “NVS saw good growth within the year and gains in market share, which now stands at 44%” 17 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Business Review Review of the Year continued Developing Pharmaceuticals Improving Animal Health “After twelve months’ negotiations of both a technical and commercial nature, we have signed a marketing agreement for Vetoryl® in Japan with Kyoritsu Seiyaku, Japan’s leading companion animal pharmaceutical supplier” Laboratories Tariq Shah, Sales & Marketing Manager; Jamie Whitwam, Food Microbiology and Business Development Manager; Dr Peter Graham, Managing Director Laboratories NWL is located in Poulton-le-Fylde, England and employs 44 people. It is a first referral veterinary laboratory, providing histology, pathology, haematology, chemistry and microbiology services to veterinary practices. Whilst a certain amount of simple chemistry is performed at veterinary practices, nearly all veterinary practices will outsource more advanced analytical tests, often requiring expert interpretation of results. We consider NWL to offer the highest level of service within this sector. We were the first veterinary laboratory to gain UKAS (United Kingdom Accreditation Service) approval. NWL also offers other services such as Allervet, a pet and equine allergy testing programme and Petscreen, a chemotherapy sensitivity test for small animal tumours. CSLS, located in Sawston, England, employs 6 people. It operates as a first and second referral laboratory, with its key area of expertise being endocrinology. The second referral work, i.e. providing services for NWL and some of NWL’s competitors, is mainly derived from specialisation in radio-immuno-assays. The business also provides precise assays which support the dosage regimes and patient monitoring of our key products, Vetoryl® Capsules and Felimazole® Tablets. The laboratories management team, established over the last two years, has begun to realise benefits from the changes they have implemented. New account gains have been good and new services have been introduced. Allervet, a pet allergy testing programme introduced last year, has exceeded expectations. We are also starting to build on the microbiology laboratory at NWL by providing services for food quality testing. This is a potentially large market and offers good growth opportunities. 18 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Business Review Financial Review Developing Pharmaceuticals Improving Animal Health Key Performance Indicators Revenue — pharmaceuticals — services — inter-division 2006 £’000 23,252 215,556 (6,337) 2005 £’000 21,381 194,611 (5,725) 232,471 210,267 Operating profit before product and USA development cost 13,950 12,493 Product and USA development cost Operating profit Operating margin — Before product and USA development cost — After product and USA development cost Cash conversion rate Gearing Return on capital employed (pre-tax) Revenue per employee Inventory days Receivables days Financial Ratios Interest cover Effective tax rate Dividend cover (1,638) (1,238) 12,312 11,255 6.0% 5.3% 114% (4.7%) 34.9% 336 38 42 5.9% 5.4% 120% 21.6% 34.0% 310 38 43 9.7 times 31.6% 2.3 times 7.2 times 27.6% 2.6 times Review of Operating Performance Group Performance The Group achieved revenue growth of 10.6% for the year whilst operating profit grew by 9.4%. This was despite the start-up losses incurred by our US operation and a 30.9% increase in product development expenditure. Operating profit before these costs increased by 11.7% compared to last year. The Group achieved a pre-tax profit of £11.0 million, an improvement of 13.8% compared to last year. Pre-tax profit before product development and USA costs increased by 15.9%. The results are reviewed in more detail on a divisional basis below: Pharmaceuticals Division Revenue Own branded pharmaceuticals 2006 £’000 2005 £’000 12,316 10,915 Instruments, consumables, critical care and equipment 5,127 4,436 Third party contract manufacturing 5,809 6,030 Total revenue 23,252 21,381 Operating profit 4,868 4,292 19 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 £4.9m £8.7m Pharmaceuticals Services 1,079 10.59 11.28 9.39 14.71 13.77 (4,859) (10,110) (14,728) (14,988) 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 Operating profit by division Net Cash/(Borrowings) £’000 Earnings per share pence Revenue from own branded pharmaceuticals continued to show strong growth, achieving a 12.8% increase over the previous year. As already emphasised, the development of this area of the business is the key strategic driver to long-term growth. Most of the increase this year came from our key products Vetoryl® Capsules and Felimazole® Tablets. Vetoryl® achieved global revenue of £2.90 million, a 35.9% increase on the £2.13 million achieved last year. Felimazole® generated global revenue of £2.41 million, a 34.1% increase over last year. During the year, Vetoryl® became our largest product measured by global revenue with increasing amounts being sold overseas. In May 2006, we made the first shipment to our European marketing partner following the approval of Vetoryl® within the European Union. We are also selling substantial amounts into the USA under the FDA waiver scheme for named patients. Our USA operation commenced marketing one small product during the financial year. Although the revenue generated of £326,000 (US$589,000) was modest, we have managed to establish the Dechra brand within the USA and establish relationships with the key distributors that we will work with following the launch of Vetoryl® and Felimazole® into this market. Revenue from instruments, consumables, critical care and equipment increased by 15.6% to £5.13 million. This was entirely due to the excellent performance of the Vetivex® range of critical care fluids that we acquired in April 2005. The revenue achieved was £1.25 million which, as already noted, was derived from a significant gain in market share. Revenue from other instruments and consumables continued to struggle in the face of low cost competitors and “grey market” imports. Revenue from third party contract manufacturing fell slightly due to the timing of customer delivery requirements. However, continued efficiency improvements enabled our manufacturing operation to increase operating profit by 14.6% despite the lower revenue. The order book at 30 June 2006 was strong at £2.0 million and, subsequent to the year end, a significant new contract has been agreed. Operating profit for the pharmaceuticals division increased by 13.4% to £4.9 million. This was even after a 30.9% increase in product development expense and the start-up losses incurred by our USA operation. Operating profits before these costs improved by 17.6% and reflects the higher margins achieved by our own branded pharmaceuticals and increased efficiency at our Dales manufacturing operation. Services Division Revenue Veterinary wholesaling Vetcom 2006 £’000 2005 £’000 210,940 190,634 819 785 Laboratories 3,797 3,192 Total revenue 215,556 194,611 Operating profit 8,681 7,973 Revenue from veterinary wholesaling increased by 10.7% to £210.9 million. This compared to market growth as measured by GfK, an independent market analyst, of 5.3% for the 20 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Business Review Financial Review continued Developing Pharmaceuticals Improving Animal Health same period. Revenue was boosted by NVS gaining, towards the end of the 2005 financial year, a number of veterinary practice accounts who had joined together as a buying and marketing group. Other account gains were also made during the year. Following the Competition Commission review of the veterinary market in 2003, the agricultural market was opened up to us. Revenue from sales to agricultural merchants reached nearly £2.6 million for the year, an increase of 17.1% over 2005. Revenue from our various IT products, branded Vetcom, increased by 4.3%. Our laboratories had an excellent year, achieving revenue growth of 19.0%. This reflected new veterinary practice account gains following a concerted sales and marketing effort and the introduction of new services such as Allervet, our pet and equine allergy testing programme. The overall veterinary wholesaling market continues to be competitive with upward pressure on discounts allowed to our customers. We largely negated this by further operational efficiencies and improvement of our gross margin. The division did, however, see a small reduction in operating margin from 4.10% to 4.03%. The Services Division has always been a strong cash generator and this provides the Group with the financial resources to invest in the development of our own branded pharmaceuticals. Unallocated Central Costs These costs comprise the charge in respect of share-based payments under IFRS2, Non- Executive Director fees and corporate legal, taxation and advisory fees. Central costs for the year increased from £1.0 million to £1.24 million. The principal reason for the increase was a rise in the charge for share- based payments (including national insurance) from £398,000 to £515,000. Return on Capital Employed (“ROCE”) A key focus of the Group has been to make efficient use of the capital that we employ. We measure ROCE by dividing profit before financing and taxation by average operating assets utilised during the year. Operating assets exclude cash and cash equivalents, borrowings, tax and deferred tax balances. We were pleased to achieve a further increase in ROCE this year from 34.0% to 34.9%. This reflected the strong trading performance and the continued focus on working capital management. Net Finance Expense The net finance expense reduced by 18.4% to £1.27 million. This was due to the strong cash flow achieved during the year. The net finance expense was covered a healthy 9.7 times by operating profit (2005: 7.2 times). Taxation The effective tax rate this year was 31.6% compared to 27.6% last year. The rate this year was higher than the standard rate of 30% because of the losses of our USA subsidiary for which no tax asset has been recognised and expense items not deductible for tax purposes. A full reconciliation to the standard rate is shown in note 7 to the financial statements. During the year, additional tax credits totalling £429,000 relating to share-based payments were recognised. However, under IFRS rules, these had to be taken directly to equity rather than credited to the income statement. The 2005 tax rate was less than 30% due to tax relief on goodwill payments that had not been previously recognised. Earnings Per Share and Dividend Earnings per share increased by 6.8% over last year. The lower rate of growth when compared to pre-tax profit was due to the higher tax charge. The Board is proposing a final dividend of 4.33p per share (2005: 3.50p) which, when added to the interim dividend of 1.91p (2005: 1.70p) already paid, gives a total dividend for the year of 6.24p (2005: 5.20p). The 20% increase over last year reflects the strong cash flow performance of the Group and the Board’s confidence in the future. “Throughout the year we have continued to build on the Vetivex range of critical care fluids and have increased market share by 4% to 37.5% on a moving annual total basis and revenue has now exceeded £1.2 million per annum” 22 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Business Review Financial Review continued Developing Pharmaceuticals Improving Animal Health Cash Flow The Group aims to achieve a cash conversion rate of at least 100% (defined as cash generated from operations as a percentage of operating profit). This year, a cash conversion rate of 114% (2005: 120%) was achieved. The financial position at the end of the year was strong with equity shareholders’ funds standing at £23.9 million. This compares with just £1 million at 30 June 2001, our first year end following the listing of our shares on the London Stock Exchange. The Group also has available a £5 million revolving credit facility committed until 2010 and a £4 million overdraft facility renewable annually to fund the Group’s working capital requirements. These are only partially utilised at peak working capital points during the year. Total capital investment during the year was £2.16 million (2005: £2.43 million). The major items were upgrades to our IT systems at NVS and Dales and an expansion of our central warehouse capacity at NVS. This figure also includes £195,000 (2005: £321,000) of development costs that met the criteria for capitalisation. Financial Position at the End of the Year Non-current assets Intangible assets Property, plant & equipment Deferred tax assets Working capital Current tax liability Net cash/(borrowings) 2006 £’000 2005 £’000 7,527 7,039 5,595 445 13,567 11,774 (2,505) 1,079 4,946 406 12,391 12,127 (2,057) (4,859) Net assets 23,915 17,602 The increase in non-current assets is due to the investments detailed above whilst the reduction in working capital reflects further improvements in receivables days. During the year there was a drive to convert customers of our largest business, NVS, to pay by direct debit. It is pleasing to report that 1,250 accounts are now paying by this means. The strong cash flow during the year converted net borrowings of £4.9 million at 30 June 2005 to net funds of £1.1 million at 30 June 2006. Shareholders will be aware that the working capital requirements of the Group vary both intra-month and during the course of the year, reaching their peak in the period December–February. The Group will therefore return to a net borrowings situation at the next reporting date of 31 December 2006. Group Funding The Group is funded by £28.2 million of called up share capital, a £17.2 million term loan from Bank of Scotland repayable in instalments ending in 2010 and various finance lease and hire purchase contracts. Treasury Policy The Group’s treasury policy is set by the Board and monitored by the Group Finance Director. The Company does not speculate on short-term interest rate or exchange rate movements. The Group seeks to hedge for interest rate risk between 20% and 80% of its outstanding borrowings. Currently, £5.733 million of outstanding loans are subject to a floor and ceiling arrangement whereby the effects of fluctuations in LIBOR rate are limited to between 4.53% and 5.50%. All finance leases and hire purchase contracts are at fixed rates. Foreign exchange exposure is hedged naturally as far as possible by matching receipts and payments in the relevant foreign currency. To this end, the Group maintains Euro and US Dollar accounts. Unmatched foreign currency exposure is hedged by the Group Finance Director in accordance with Group policy. No borrowings are denominated in foreign currencies. 23 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 General Market Conditions The overall veterinary market has shown robust growth for many years. However, there have in the past been periods when the market has suffered a significant slowdown. This can be caused by external “shocks” such as BSE or Foot & Mouth or general economic conditions. Our past experience has been that these slowdowns have been short term in nature. However, given the relatively high operational gearing of NVS, in particular, any future market slowdown could have a material effect on short- term profitability. Summary of Risks The Group has procedures in place to control and, as far as possible, mitigate against the above risk factors. It must be emphasized, however, that these procedures can only control rather than eliminate risk. Liquidity Management The Group’s cash position is monitored on a daily basis by the Group Finance Director. As noted above, the Group has available overdraft and revolving credit facilities from the Bank of Scotland for its day-to-day working capital requirements. Further information on Financial Instruments is show in note 20 to the consolidated financial statements. Risks and Uncertainties Like every business, the Group faces risks and uncertainties in both its day-to-day operations and the achievement of its long-term strategic objectives. The Group has well-established procedures for identifying and controlling risk. Significant risks and procedures to control them are reviewed at Divisional Board Meetings on a monthly basis and by the Main Board on a quarterly basis. The main potential risk areas identified by the Directors are as follows: Regulatory Like the human pharmaceutical industry, the veterinary industry is tightly regulated. Our major operational sites are required to be licensed either by the MHRA or the Home Office, and our products by the Veterinary Medicines Directorate (“VMD”). Inspections by these bodies are carried out regularly. All of our new pharmaceutical products are required to be approved for sale by the relevant Regulatory Authority in each territory. The main regulatory risks faced by the Group are: Failing to operate our businesses in accordance with their licences resulting in disruption to operations. Potential reclassification of major pharmaceutical products from prescription only to a lower category causing loss of revenue. Failure to satisfy the regulatory authorities on new product submissions causing product launches to be delayed or aborted. Changes to the law or adverse reactions causing threat to existing products. Corporate Veterinary Practices The growth of corporate veterinary practices has been a feature of the veterinary market over the last few years. Most corporates currently trade with NVS. The rise of corporate practices provides both opportunities and risks to the Group. The opportunities arise when a corporate group acquires veterinary practices not currently trading with NVS. The risks arise from the potential increased buying power of corporates causing pressure on gross margin. Additionally, a payment default could cause a material impairment charge. (cid:2) (cid:2) (cid:2) (cid:2) 24 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors and Senior Management Executive Directors Non-Executive Directors Ian Page Chief Executive Aged 45, Ian joined the Group’s principal trading subsidiary NVS at its formation in 1989. He was also part of the MBO in 1997. In 1998, he was appointed Managing Director at NVS. He joined the Board in 1997 and became Group Chief Executive in November 2001. Ian has played a key role in the development of the Group’s growth strategy. Prior to joining the Company, he gained extensive knowledge and experience through various positions he held within the pharmaceutical and veterinary arena. Simon Evans BCom, ACA Group Finance Director Aged 42, Simon qualified as a Chartered Accountant in 1988 and spent seven years at KPMG. He joined NVS in 1992 and was appointed Group Finance Director in 1997 following the MBO. He played a major role in the management buy-out of the Group from Lloyds Chemists in 1997 and its subsequent listing on the London Stock Exchange in 2000. Ed Torr Development Director Aged 46, Ed joined NVS as Sales Director in 1997 and he was appointed Managing Director of Arnolds and Dales in 1998. He relinquished this role in 2003 to focus on his Main Board responsibilities, specifically the strategic development of the Group’s licensed veterinary pharmaceutical portfolio in key international territories. Prior to joining the Group, he worked within the animal healthcare sector for a number of companies including ICI, Wellcome and Alfa Laval Agri. Michael Redmond Non-Executive Chairman Aged 62, Michael joined the Group as a Non-Executive Director in April 2001, and was appointed Chairman in July 2002. He has extensive pharmaceutical industry experience having begun his career with Glaxo and through senior positions with Schering Plough Corporation. In 1991, he joined Fisons plc and in 1993 was appointed to the Board as Managing Director of the Group’s Pharmaceuticals Division. Michael left Fisons in 1995 following its takeover by RPR. He is also Executive Chairman at Synexus Clinical Research PLC. Michael is Chairman of the Nominations Committee. Malcolm Diamond MBE Senior Non-Executive Director Aged 57, Malcolm joined the Board in August 2000 and is also Chairman of the Remuneration Committee. He is a Non-Executive Director at the Unicorn AIM VCT 11 Investment Fund, and a Senior Non-Executive Director at Centurion Electronics Group plc. His other directorships include Chairman at CWO Limited, Jacksons Fencing Limited and My Marketing Limited. In addition, Malcolm advises a number of private businesses on their strategic planning, management development programmes and marketing initiatives. Malcolm was previously Chief Executive at Trifast plc, a role he held for 18 years. Neil Warner BA, FCA, MCT Non-Executive Director Aged 53, Neil joined the Board in May 2003. He is Finance Director at Chloride Group PLC, a position he has held since 1997. Prior to this, he spent six years at Exel PLC (formerly Ocean Group PLC) where he held a number of senior posts in financial planning, treasury and control. He has also held senior positions in Balfour Beatty PLC (formerly BICC Group plc), Alcoa and PricewaterhouseCoopers. Neil is Chairman of the Audit Committee. 1 2 Pictured from left: Neil Warner Michael Redmond Malcolm Diamond Pictured from left: Ed Torr Ian Page Simon Evans 1 5 2 6 3 7 4 Pictures: 1 Stephen Whitehouse 2 Peter Graham 3 Giles Coley 4 Susan Longhofer 5 Martin Riley 6 Mike Annice 7 Mike Eldred Senior Management Mike Annice BSc (Hons), MRPharmS Managing Director, Dales Pharmaceuticals Aged 46, Mike graduated from The School of Pharmacy at Aston University in 1980. Prior to joining Dales in 1990 as Site Manager, he worked within the Hospital Pharmacy Service, Glaxo and SSS International (formerly Cupal Pharmaceuticals). He was appointed Technical Director at the time of the Group’s MBO. Mike was appointed Managing Director at Dales in March 2002. Giles Coley BSc Managing Director, Arnolds Veterinary Products and Dechra Veterinary Products UK Aged 44, Giles joined Arnolds in 1999 as Sales & Marketing Manager. He took over the role of Managing Director from Ed Torr in October 2003. Prior to this, Giles spent 14 years with Genus (formerly MMB) in various management roles in agricultural business consultancy. He holds a BSc in Agricultural Technology gained at Harper Adams University. Mike Eldred BA, MBA President, US Operations, Dechra Veterinary Products Aged 36, Mike was appointed in November 2004 to head up the Group’s sales and marketing drive in the United States. He has over 12 years’ professional experience in the US animal health sector, having held senior positions in business development, sales and operations at Virbac Corporation, and international marketing and operational positions at Fort Dodge Animal Health. Mike began his career with Sanofi Animal Health where he managed the pharmaceutical and biological production planning activities. Dr Peter Graham BVMS, PhD, CertVR, DipECVCP, MRCVS Managing Director of NationWide Laboratories and Cambridge Specialist Laboratory Services Aged 38, Peter was appointed Managing Director of NationWide Laboratories and Cambridge Specialist Laboratory Services in 2003. Peter graduated from the University of Glasgow Vet School in 1989, where he remained as Small Animal House Physician and Research Scholar until 1995. During this period he was awarded the RCVS Certificate in Veterinary Radiology and a PhD on the Epidemiology and Management of Canine Diabetes Mellitus. He contributed to the initial commercialisation of biochemistry and endocrinology lab services at the University of Glasgow. Between 1995 and 2002, Peter was Assistant Professor at the world’s largest specialist veterinary endocrinology laboratory in Michigan State University, USA, leading it as Section Chief from 2000. He was awarded Diplomate of the European College of Veterinary Clinical Pathologists in 2002. Dr Susan Longhofer DVM, MS, DipACVIM Product Development and Regulatory Affairs Director Aged 48, Susan joined the Group in June 2005. She has 17 years’ industry experience in development and worldwide registration of animal health pharmaceuticals having worked for multinational corporations including Virbac Corporation, Heska Corporation and Merck Research Laboratories. Her veterinary degree is from Texas A&M University and her MS is from the University of Wisconsin, Madison. She was awarded Diplomate status in the American College of Veterinary Internal Medicine in 1992. She has a number of Academic and Professional Honours including membership on the Board of Directors of the American Heartworm Society and the Executive Council of the American Academy of Veterinary Pharmacology and Therapeutics. Martin Riley Managing Director, National Veterinary Services Aged 42, Martin was appointed Managing Director of National Veterinary Services in 2005. A graduate of the Welsh Agricultural College in Aberystwyth, Martin has extensive knowledge of the animal healthcare and veterinary sectors. Before joining the Group, he previously held several senior positions over an 18 year period with the pharmaceutical manufacturer Merial Animal Health. Company Secretary Stephen Whitehouse, FCCA Company Secretary Aged 58, Stephen was appointed Company Secretary at the time of the Group’s flotation in 2000. He joined Arnolds Veterinary Products in 1989 as Financial Controller and in 1992, he assumed the role of Financial Director at Arnolds, a position he held until 1994, when he became General Manager/Finance Director. Between 1996 and 1998, he also took on the responsibility as Managing Director. He was also a member of the MBO team in 1997. Prior to joining the Group, he worked for 12 years at GKN Sankey and 10 years at British Oxygen. 26 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Report The Directors present their Annual Report and Audited Financial Statements for the year ended 30 June 2006. Principal Activity The Group manufactures and sells pharmaceuticals and also markets and sells veterinary equipment and related services including computer systems, predominantly to the UK veterinary market, but also to overseas markets. The Company acts as a holding company to all Group subsidiaries. Share Capital Details of the changes in share capital are shown in note 21 to the financial statements. Results and Dividends The results for the year and financial position at 30 June 2006 are shown in the consolidated income statement on page 43 and balance sheet on page 44. The Directors recommend the payment of a final dividend of 4.33p per share which, if approved by shareholders, will be paid on 24 November 2006 to shareholders registered at 27 October 2006. An Interim Dividend of 1.91p per share was paid on 7 April 2006, making a total dividend for the year of 6.24p (2005: 5.20p). The total dividend payment is £3,231,000 (2005: £2,656,000). Business Review and Future Developments A review of the Group’s activities during the year and likely future developments are dealt with in the Chairman’s Statement on page 2 and the Directors’ Business Review on pages 5 to 23. Directors The Directors who held office throughout the year were as follows: M. Redmond (Chairman) I.D. Page S.D. Evans E.T.W. Torr M.M. Diamond N.W. Warner The interests of the Directors in the share capital of the Company are shown in the remuneration report on pages 34 to 39. During the year, no Director had a disclosable material interest in any contract or arrangement with the Company or any of its subsidiaries. The Company’s articles of association require one-third of the Company’s Directors to retire by rotation at the annual general meeting and also if they have held office for more than thirty-six months since appointed or last elected. S.D. Evans and M.M. Diamond retire by rotation and, being eligible, offer themselves for re-election. Biographical details of the Directors can be found on page 24 of this report and accounts. Political and Charitable Contributions The Group made no political or charitable contributions during the year. Research and Development The Group has a structured research and development programme with the aim of identifying and bringing to market new pharmaceutical products. Investment in research and development is seen as key to further strengthen the Company’s competitive position.The expense on this activity for the year ended 30 June 2006 was £1,378,000 (2005: £1,053,000) and a further £195,000 less £60,000 amortisation (2005: £321,000 less £41,000 amortisation) was capitalised as development costs. Employees The Group has a policy of offering equal opportunities to employees at all levels in respect of conditions of work. Throughout the Group it is the intention of the Directors to provide possible employment opportunities and training for disabled people and employees who become disabled, having due regard to aptitude and abilities. Further details can be found in our Social, Ethical and Environmental Responsibilities Statement on page 40. 27 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Suppliers The Company does not follow any code of practice or standard regarding the payment of suppliers but seeks to agree the terms of payment with suppliers prior to the placing of business and it is the Company’s policy to settle liabilities by the due date. At 30 June 2006, the Group had an average of 77 days (2005: 77 days) purchases outstanding in creditors. The Company had an average of Nil days (2005: Nil days) purchases outstanding in creditors. Substantial Shareholdings As at 17 August 2006, the Company is aware of the following material interests representing 3% or more of the issued share capital in the Company. No. of Shares % of Shares Held Schroder Investment Management Insight Investment Legal & General Investment Management Barclays Global Investors Platinum Fund Managers INVESCO Asset Management Rathbones OLIM 5,883,851 4,509,756 3,964,880 3,415,806 2,336,860 2,129,532 1,937,992 1,591,500 11.32 8.68 7.63 6.57 4.50 4.10 3.73 3.06 Audit Information The Directors who held office at the date of the approval of this Directors’ Report confirm that, so far as they are each aware, there is no relevant audit information of which the Company’s auditors are unaware, and each Director has taken all the steps that he ought to have undertaken as a Director to make himself aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. Auditors A resolution to reappoint KPMG Audit Plc as auditors is to be proposed at the forthcoming Annual General Meeting. Directors’ Indemnity Insurance The Directors benefited from qualifying third party indemnity provisions in place during the financial year and at the date of this report. Annual General Meeting The 2006 Annual General Meeting of the Company will be held at 10.00 am on 18 October 2006. Notice of the meeting together with the Annual Report and financial statements are posted to shareholders not less than 23 days prior to the date of the Annual General Meeting. The package sent to shareholders includes a summary of the business to be covered at the Annual General Meeting, where a separate resolution is prepared for each substantive matter. Where a vote is taken on a show of hands, the level of proxies received for and against the resolution and any abstentions are disclosed at the meeting. In addition to the adoption of the 2005/2006 report and accounts, resolutions dealing with the re-election of Directors and the resolution dealing with the approval of the Directors’ remuneration report, there are five other matters which will be considered at the Annual General Meeting. These relate to the reappointment of KPMG Audit Plc as auditors, declaration of the final dividend, the ability for the Directors to unconditionally allot shares up to one-third of the Company’s issued share capital plus share option schemes, the disapplication of pre-exemption rights in relation to the previous resolution and to empower the Company to buy back up to 5% of its issued share capital. By order of the Board S.P. Whitehouse Company Secretary Dechra Pharmaceuticals PLC 5 September 2006 28 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Corporate Governance Revised Combined Code The Board recognises its accountability to shareholders and is committed to maintaining high standards of corporate governance. In the opinion of the Directors, the Company has complied throughout the period under review with Section 1 of the July 2003 FRC Combined Code on Corporate Governance (the Combined Code) in all aspects apart from the membership of Board Committees, the details of which are set out below. Application of the principles of the Combined Code The following report details how the Company has applied the principles of Section 1 of the Combined Code to its activities. Section 1 of the Combined Code sets out the main and supporting principles of good governance for companies, which is split into the sections detailed below. Board of Directors The details of the Board of Directors are shown on page 24 and in the Directors’ Report on page 26. There is a clear division of responsibilities between the Chairman and Chief Executive. The Chairman is responsible for leadership of the Board, ensuring its effectiveness and setting its agenda. The Chief Executive is responsible for the management of the Company, implementing policies and strategies determined by the Board. The Board consists of the Non-Executive Chairman, two other Non-Executive Directors and three Executive Directors (including the Chief Executive). The Board considers M.M. Diamond to be the Senior Independent Director. The Board considers that all the Non-Executive Directors are independent of management and free of any business or other relationship which could materially interfere with the exercise of their independent judgement, and are not dependent on the Company for their primary source of income or paid by the Company in any capacity other than as a Non-Executive Director. In addition, no Non-Executive Director has previously been a senior manager of the Company, and has not participated in the Company’s incentive bonus scheme or pension scheme. M. Redmond was considered by the Board to be independent at the date of his appointment as Chairman. On appointment, the Directors are required to seek election at the first AGM following appointment. At least two members of the Board are required to retire from office by rotation at the Annual General Meeting subject to all Directors having submitted themselves for re-election every three years. Conduct of Board Meetings The Board normally has eleven Board Meetings per annum including two meetings where the full year and half year results are dealt with. Strategy meetings are convened as required with a minimum of one meeting per year. In addition, the Board has three standing committees — the Audit, Remuneration and Nominations committees, the details of which are shown on page 29. The Board has reserved to itself powers relating to matters that it considers significant to the Group’s business, operational and financial risks. These include the approval of corporate policies, strategy, plans and budgets, acquisitions and disposals of companies or businesses; major investment and financial decisions; appointments to the Board; and major management or organisational changes. At all Board meetings an agenda is established reflecting the Directors’ responsibilities. This comprises reports from the Chief Executive, Finance Director, Development Director and Operating Company Directors, reports on the performance of the business, major items of strategic planning, investments and significant policy issues. The Board considers at least annually the strategic plans of the Group and individual businesses. Periodically, the Directors receive presentations from management concerning key areas of the Group’s operations. Attendance at meetings was as follows: Name Michael Redmond Malcolm Diamond Neil Warner Ian Page Simon Evans Ed Torr Board (11 meetings) Audit (2 meetings) Remuneration (3 meetings) Nomination (1 meeting) 11 9 10 11 11 10 2 2 2 N/A N/A N/A 3 3 3 N/A N/A N/A 1 1 1 N/A N/A N/A Note: N/A denotes that the Director is not a member of this committee, but may attend by invitation of the committee. 29 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Full year and interim results are reviewed by the Audit Committee and the Board and approved prior to publication. Other price sensitive information may be published only with the approval of the Board. Each Director is entitled on request to receive information to enable him to make informed judgements and adequately discharge his duties. In addition, all Directors have access to the advice and services of the Company Secretary and senior managers generally, and may take independent professional advice at the Company’s expense in connection with their duties. The Company Secretary is responsible to the Board for ensuring that Board procedures are followed and that applicable rules and regulations are complied with. The Board has developed a formal process of reviewing its own effectiveness and the effectiveness of the Board committees. This is based on a combination of written reviews by individual Directors, discussion with the Chairman and review by the Board as a whole. As part of this process the Board considers the performance of individual Directors. This process has been undertaken during the year. All newly appointed Directors receive an induction programme to the Company including corporate governance training and background to the Company. All Directors are encouraged to keep up to date on all matters relevant to the Group and attend briefings and seminars as appropriate. Board Committees The Board has three standing committees — the Audit, Remuneration and Nominations Committees. The Board has reviewed membership of these committees and has confirmed its view that it is appropriate that all the Non-Executives should participate as members of these committees, so that they are fully involved in monitoring the governance issues affecting the Company, including Executive remuneration, succession planning and risk management. There is therefore no provision for fixed periods of membership of the committees nor is the Chairman of the Board excluded from membership as recommended by the Combined Code. The Board considers that the Chairman should continue his membership of the Audit and Remuneration Committees in that he has a wide experience and knowledge gained through his directorships with other companies. The Board has delegated specific responsibilities to the committees, as described below. The terms of reference of the Audit, Remuneration and Nomination Committees are available on the Company’s website and on request to the Company Secretary. The Audit Committee The Audit Committee comprises N.W. Warner (Chairman), M. Redmond, and M.M. Diamond. The activities of the Audit Committee are shown in the Audit Committee Report on pages 32 and 33. The Audit Committee met twice during the year, the attendance record being shown in the table of attendance above. The Remuneration Committee The Remuneration Committee comprises M.M. Diamond (Chairman), M. Redmond, and N.W. Warner. The Remuneration Committee met three times during the year, the attendance record being shown in the table of attendance above. The terms of reference for the Remuneration Committee include the following responsibilities: To develop the remuneration strategies that drive performance. To provide levels of reward which reflect that performance both for Executive Directors and designated senior managers. To approve terms and conditions, bonus schemes, pensions and related matters. A report on the remuneration of Directors appears on pages 34 to 39. The Nominations Committee The Nominations Committee comprises M. Redmond (Chairman), M.M. Diamond, and N.W. Warner. The Nominations Committee normally meets once a year. The terms of reference of the Nominations Committee include the following responsibilities: To oversee the plans for management succession. To recommend appointments to the Board. To evaluate the effectiveness of the Non-Executive Directors. To consider the structure, size and composition of the Board generally. (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) 30 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Corporate Governance Internal Control The Directors are responsible for maintaining the Group’s system of internal control, and for reviewing its effectiveness. The system of internal control aims to safeguard the Company’s assets, ensure that proper accounting records are maintained, ensure compliance with statutory and regulatory requirements and ensure the effectiveness and efficiency of operations including the assessment and management of risk. The system of internal control is designed to manage rather than eliminate risk of failure to achieve business objectives and can only provide reasonable assurance and not absolute assurance, particularly against material misstatement or loss. The Group has a well-established framework of internal financial and operational control for identifying, evaluating and managing the risks faced by the Group. This framework has been in place throughout the year under review, and has continued up to the date of approval of the annual report. In complying with the Internal Control requirements of the Combined Code, the Directors have taken guidance from the Institute of Chartered Accountants in England and Wales publication “Internal Control: Guidance for Directors on the Combined Code” (“the Turnbull Guidance”). As a result, the Board prepares and updates a quarterly thorough review of relevant risk areas and systems of internal control. The review is structured by business area and key risk strategy and is based upon a summary of information prepared and reviewed by divisional management on an ongoing basis. The current review was prepared to 30 June 2006. The Group’s key systems of internal control include: Business Plans Business plans provide a framework from which annual budgets and forecasts are agreed with each business unit, including financial and strategic targets against which business performance is monitored. The plans are reviewed by executive management, and then by the Board for ultimate approval. Actual performance during the year is monitored monthly against budget, forecast and previous year. Full year forecasts are updated at regular intervals during the year based on trended historical data and realistic forecasts. Investment Approval The Group has clear requirements for the approval and control of expenditure. Strategic investment decisions involving both capital and revenue expenditure are subject to formal detailed appraisal and review according to approval levels set by the Board. Operating expenditure is controlled within each business with approval levels for such expenditure determined by the individual businesses. Management Structure Executive management are responsible for the identification, evaluation and management of the significant risks applicable to their business areas. The risks are assessed on a periodic basis and may be associated with a variety of internal and external sources. The Company and its business units operate control procedures designed to ensure complete and accurate accounting of financial transactions and to limit the loss of assets due to fraud. Measures taken include physical controls, segregation of duties in key areas, and internal reviews and checks. Key functions such as tax, treasury, insurance, legal and personnel are controlled centrally. Risk Control Responsibility for monitoring the Group’s system of internal control rests with the Board. It is assisted by the Audit Committee, which reviews the interim and annual reports provided to shareholders, the audit process and the systems of internal control and risk management, the latter by way of consideration of the Board’s updated progress report and action plan regarding internal controls. Whilst the Board recognises this does not constitute an internal audit function, it believes that due to the size of the Group this review provides sufficient comfort as to the controls in place. The Audit Committee reviews the requirement for an internal audit function annually. The Board has reviewed the effectiveness of the Group’s internal control systems for the period from 1 July 2005 to the date of approval of the financial statements which has included quarterly business risk reviews and quarterly internal control reporting. The Board reviews the operation and effectiveness of its control assessment on a regular basis. External Audit The external auditors are engaged to express an opinion on the Company’s Annual Report and Accounts. They independently and objectively review management’s reporting of the Group’s consolidated results and financial position. In addition, they review the systems of internal control and the data contained in the Annual Report and Accounts to the level necessary for expressing their audit opinion. 31 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Investor Relations Relationships with shareholders receive high priority and a rolling programme of meetings between institutional shareholders and Executive Directors is held throughout the year. These meetings are in addition to the annual and interim results presentations and the Annual General Meeting and seek to foster mutual understanding of the Company’s and shareholders’ objectives. M. Redmond (Chairman) attended a number of the annual results presentations. Such meetings are conducted so as to ensure protection of share price sensitive information that has not already been made generally available to the Company’s shareholders. Similar guidelines also apply to communications between the Company and parties such as financial analysts, brokers and the press. The Company also organises site visits on a periodic basis. All members of the Board usually attend the Annual General Meeting. The Chairmen of the Audit Committee, Remuneration Committee and Nominations Committee will normally be available to answer shareholders’ questions at that Meeting. Notice of the Meeting, together with the Annual Report and financial statements, is posted to shareholders not fewer than 23 days prior to the date of the Annual General Meeting. The information sent to shareholders includes a summary of the business to be covered at the Annual General Meeting, where a separate resolution is prepared for each substantive matter. Where a vote is taken on a show of hands, the level of proxies received for and against the resolution and any abstentions are disclosed at the Meeting. At the Annual General Meeting there is an opportunity, following the formal business, for informal communications between investors and Directors. Going Concern After consideration of budgets and other financial information, the Directors are satisfied that the Group is in a sound financial position with adequate resources to continue in operation for the foreseeable future. For this reason, the Group’s financial statements have been prepared on the basis that the Group is a going concern. 32 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Audit Committee Report Committee Membership The members of the Audit Committee are currently: Neil Warner (Chairman of the Audit Committee) Michael Redmond (Chairman of the Company) Malcolm Diamond (Senior Independant Director) The Audit Committee considers that Neil Warner has recent and relevant financial experience gained through his position as Finance Director of Chloride Group PLC. Attendance at the meetings by the Committee members is detailed within the Corporate Governance report on page 28. Committee Meetings and Responsibilities The Audit Committee met twice during the year ended 30 June 2006. The external auditors attend meetings of the Committee other than when their appointment or performance is being reviewed. The Chief Executive, Group Finance Director and other senior finance staff attend as appropriate. The performance, cost and independence of the external auditors is reviewed annually by the Audit Committee, together with a review of the level of service provided by the external auditors to the Group. The Audit Committee has discussions at least once a year with the auditors without management being present. The scope of the year’s audit is discussed in advance by the Audit Committee. Audit fees are reviewed and approved by the Audit Committee. Professional rules require rotation of the Group Audit Engagement Director. This has taken place during the period being reported on. The annual appointment of the auditors by our shareholders at the Annual General Meeting is a fundamental safeguard but, beyond this, controls are in place to ensure that additional work performed by the auditors is appropriate and subject to proper review as discussed below. The main responsibilities of the Audit Committee are set out in the written terms of reference and are: To monitor the integrity of the financial statements of the Company, reviewing the annual and interim reports in detail to ensure they present a balanced assessment of the Company’s position and prospects which is understandable to shareholders and potential investors. To review the effectiveness of the Company’s internal controls and risk management systems as described on page 30 and, in conjunction with the auditors, consider the accounting policies adopted by the Company. To review the Company’s whistle-blowing arrangements. To oversee the relationship with the external auditors. The Committee makes recommendations to the Board on the appointment of the external auditors, approves their remuneration, monitors their independence and objectivity, and monitors the effectiveness of the audit process and sets the policy for non-audit work. To make recommendations to the Board on the requirement for an internal audit function. Given the systems of internal control discussed on page 30, and due to the present size of the Group, the Audit Committee currently believes that an internal audit function is not required. (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) 33 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Auditor Independence With respect to non-audit assignments undertaken by the external auditors, the Company has developed a policy to ensure that the provision of such services does not impair their independence or objectivity. When considering the use of the external auditors to undertake non-audit work, the Chief Executive and Group Finance Director do at all times give consideration to the provisions of the Smith report with regard to the preservation of independence. The Chief Executive and the Group Finance Director have authority to commission the external auditors to undertake non-audit work where there is a specific project with a cost not exceeding £25,000 and total non-audit fees in any year do not exceed £80,000. This work has to be reported to the Audit Committee at the meeting where the Annual Report is considered. If the cost is expected to exceed the established levels then the prior approval of the Audit Committee is required before the work is commissioned. In all cases, other potential providers are adequately considered. The external auditors annually confirm their policies on ensuring audit independence and provide the Committee with a report on their own audit quality procedures. Effectiveness Review During the year, the Committee reviewed its own effectiveness through a process led by the Committee Chairman. The results of the review were advised to the Committee and the Board. Based on the Committee’s review of the performance of the external auditors and on the planning and execution of the annual audit, the Committee has recommended to the Board that a resolution to reappoint KPMG Audit Plc be proposed at the forthcoming Annual General Meeting. N.W. Warner Chairman — Audit Committee 5 September 2006 34 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Remuneration Report This Report is presented in accordance with Schedule B of the Combined Code annexed to the listing rules of the FSA and the Directors’ Remuneration Report Regulations 2002 (“the regulations”). The regulations require the Company’s auditors to report on certain “auditable” information required to be included in the Directors’ Remuneration Report. The audited information has therefore been separately highlighted. The Board is responsible for the Group’s remuneration policy and setting Non-Executive fees, although the task of determining and monitoring the remuneration packages of Executive Directors has been delegated to the Remuneration Committee. Remuneration Committee The Remuneration Committee is responsible for ensuring that the remuneration packages provided to Executive Directors are appropriate to individual levels of experience, responsibility and performance, are consistent with the Company’s remuneration policy and are in line with the principles of good corporate governance. The committee considers remuneration packages payable to Executives at comparable companies when setting remuneration of Executive Directors and also considers pay structures around the Group. The Remuneration Committee comprises solely Non-Executive Directors: M.M. Diamond, M. Redmond and N.W. Warner. The Committee usually meets twice a year and is chaired by M.M. Diamond. During the year, the Chief Executive attended all of these meetings in order to assist on matters concerning remuneration of other Senior Executives within the Group. The Chief Executive was not present during the part of the meetings where his own remuneration was discussed. The attendance record of the members is shown on page 28. During the year, the Remuneration Committee received advice from New Bridge Street Consultants LLP on executive remuneration, pensions and other benefits. Remuneration Policy The Company’s policy on Directors’ remuneration for the forthcoming year is that its remuneration packages should be capable of attracting, rewarding and retaining Executive Directors whilst being arrived at responsibly and fairly, when compared with similar organisations. The remuneration packages of Executive Directors are structured to include a performance related element linked to corporate and individual objectives. Both the Executive Incentive Plan and the Executive Bonus Scheme are performance related. Bonuses are non-pensionable. Remuneration for Non-Executive Directors is limited to salary only with no performance related element. The Company’s policy on the remuneration of all Directors is reviewed annually. Once remuneration has been approved by the Board, the Chairman of the Remuneration Committee, where considered appropriate, will consult the Company’s principal shareholders regarding remuneration issues. This Remuneration Report is included in the Annual General Meeting agenda for shareholder approval. Components of the Remuneration Package Basic Salary The basic salary of each Executive Director is reviewed annually and is determined taking into account the responsibilities and performance of the individual, together with independently furnished information on rates for similar positions in comparable industry sectors. Details of salaries, bonuses and benefits paid to Executive Directors are included in the table headed “Summary of Remuneration” shown on page 38. Benefits in kind Executive Directors receive other benefits, including the use of a fully expensed car, medical cover and life insurance. This provides an overall package that is competitive with similar companies. Pensions The Company operates a Group Stakeholder personal pension scheme which has been effective since 1 July 2005. The previous pension scheme was closed on 25 July 2006, all contributions having been transferred to a S32a contract. 35 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Share Option Schemes The Company operates the Approved Share Option Scheme, the Unapproved Share Option Scheme together with a savings related share option scheme. Executive Directors are entitled to participate in the Company savings related share option (“SAYE”) scheme and the Executive Incentive Plan discussed below. However, Executive Directors are not entitled to participate in either the Approved Share Option Scheme or the Unapproved Share Option Scheme. The table on page 39 provides an analysis of outstanding SAYE Directors’ Share Options. Executive Incentive Plan Following its approval by shareholders at the Annual General Meeting on 23 October 2003, the Company operates the Executive Incentive Plan for Executive Directors and other key employees. The Executive Incentive Plan aims to provide a clear link between the remuneration of Executive Directors and the creation of value for shareholders by rewarding Executive Directors for the Company’s performance in terms of Total Shareholder Return (“TSR”). Under this plan, the Remuneration Committee makes awards to Senior Executives of shares in the Company, with vesting to individuals being subject to the achievement of performance targets. The first target is based on TSR over a three year measurement period (commencing at the beginning of the financial year in which the awards are made) expressed as an annual percentage return over that period. The TSR is calculated and compared to the TSR’s of all other companies in the FTSE Small Cap Index for the entire measurement period. If the Company is ranked in the top quartile of the list of TSR’s achieved by the companies in the FTSE Small Cap Index over the measurement period, all of the shares over which an award had been made will vest. If the TSR of the Company is ranked in the second quartile then the number of shares which will vest is determined by reference to a straight-line graph which ensures that 30% of the shares over which the award has been made will vest on the achievement of a TSR that places the Company at the bottom of the second quartile and all of the shares will vest on an achievement of a TSR that places the Company at the top of the second quartile. If the TSR of the Company is ranked in the third or fourth quartile then none of the shares over which an award had been made will vest and the relevant participant will not be entitled to any of the shares. In addition to the TSR performance target, no award will vest unless, in the opinion of the Remuneration Committee, the underlying financial performance of the Company has been satisfactory over the measurement period. Initial awards granted under the Plan were made during the year ended 30 June 2004, the measurement period for these awards commencing on 1 July 2003 and ended on 30 June 2006. In accordance with the rules of the plan, awards granted since the initial award are limited to 50% of basic salary. The measurement period for the grants for this financial year commenced on 1 July 2005 and ends on 30 June 2008. The levels of grants made under the first three years of the scheme are shown on page 38. Executive Bonus Scheme This scheme rewards Executive Directors for achieving operating efficiencies and profitable growth in the relevant year by reference to challenging, but achievable operational performance targets derived at the beginning of the financial year. The bonus is calculated on formulae, which are determined each year by the remuneration committee. Executive bonuses for the year ended 30 June 2006 for the achievement of group performance targets are set out below. I.D. Page S.D. Evans E.T.W. Torr Bonus payable for achievement of 95% of profit target (% of Salary) 30% 21% 21% In addition, for I.D. Page an additional 20% will be payable on achievement of 105% of target. This bonus will be pro-rated on achievement of between 95% and 105% of target. S.D. Evans and E.W. Torr will receive an additional 14% on achievement of 105% of target. This bonus will be pro-rated on achievement of between 95% and 105% of target. 36 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Remuneration Report Executive Directors’ bonus payments for the forthcoming year will have a potential maximum of 60% of salary. The payable thresholds are as follows: Achievement of 95% of target Achievement of 97.5% of target Achievement of 100% of target Achievement of up to 105% of target Achievement of over 105% of target Bonus payable for achievement of profit target (% salary) 7% 25% 33% 42% 50% An additional 10% bonus will be payable on the achievement of personal objectives set by the Chairman for the Chief Executive, and by the achievement of personal objectives set by the Chief Executive for the Executive Directors. Contracts of Service Each Executive Director has a service contract with the Company which contains details regarding remuneration, restrictions and disciplinary matters. Executive Directors are appointed on contracts terminable by the Company on not more than 12 months’ notice and by the Director on 6 months’ notice. Non-Executive Directors have a service contract for an initial 12 month period which is thereafter terminated by either party giving 12 months’ notice. Participation in share option schemes, bonus schemes or entitlement to a pension is not allowed under the service contract. Details of Directors’ service contracts and notice periods are set out below: Name M. Redmond I.D. Page S.D. Evans E.T.W. Torr M.M. Diamond N.W. Warner Notice Period Commencement Director 25 April 2001 23 August 2000 23 August 2000 23 August 2000 23 August 2000 2 May 2003 12 months 6 months 6 months 6 months 12 months 12 months Company 12 months 12 months 12 months 12 months 12 months 12 months There are no expiry dates applicable to either Executive or Non-Executive Directors’ service contracts. The Company may, in its absolute discretion at any time after written notice of termination has been given by either party, lawfully terminate the service contract by paying to the Director an amount equal to his salary entitlement for the unexpired period of notice together with an amount representing the fair value of any other benefits to which the Director is contractually entitled for the unexpired period of notice (subject in either case to a deduction at source of income tax and national insurance contributions). In the event that the service contract is terminated partway through any financial year, the Director shall not be entitled to any bonus in respect of that financial year. Non-Executive Directors’ compensation is confined to 12 months’ remuneration. Individual Directors’ eligibility for the various elements of compensation is set out below: Name M. Redmond I.D. Page S.D. Evans E.T.W. Torr M.M. Diamond N.W. Warner Salary 12 months 12 months 12 months 12 months 12 months 12 months Bonus Benefits n/a Nil Nil Nil n/a n/a n/a 12 months 12 months 12 months n/a n/a Where applicable, payment of this compensation would be in full and final settlement of all claims other than in respect of share options and pension arrangements. 37 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 In an appropriate case the Directors would have a regard to the departing Director’s duty to mitigate loss, except in the event of dismissal following a change of control of the Company. Other than as described above, there are no express provisions within the Directors’ service contracts for the payment of compensation or liquidated damages on termination of employment. No awards of compensation for loss of office or any other reason have been made to any person, whether a Director or a former Director, during the year. No compensation payments were made to Executive or Non-Executive Directors during the year. Directors’ Shareholdings The beneficial interests of the Directors in office at 30 June 2006 and their families in the share capital of Dechra Pharmaceuticals PLC were as follows: Shareholdings M. Redmond I.D. Page S.D. Evans E.T.W. Torr M.M. Diamond N.W. Warner Total Shareholder Return The adjacent graph shows the total shareholder return performance of the Company over the past six years compared with the total shareholder return over the same period for the FTSE Small Cap Total Return Index. The FTSE Small Cap Index is considered to be an appropriate index as the Company is a constituent of that index. The information shown relates to the six-year period since the Company’s flotation on the London Stock Exchange in September 2000. Total shareholder return is the performance target for the Executive Incentive Plan. 250 200 150 100 50 0 Ordinary Shares 2006 Ordinary Shares 2005 35,000 592,167 669,131 343,832 5,000 2,206 35,000 592,167 669,131 343,832 5,000 2,206 Dechra TSR FTSE Small Cap TSR 0 0 t p e S 0 0 v o N 0 0 n a J 1 0 r A M 1 0 y A M 1 0 n u J 1 0 g u A 1 0 t c O 1 0 c e D 2 0 b e F 2 0 r a M 2 0 l u J 2 0 y a M 2 0 t p e S 2 0 v o N 2 0 n a J 3 0 r a M 3 0 y a M 3 0 n u J 3 0 g u A 3 0 t c O 3 0 c e D 4 0 b e F 4 0 r p A 4 0 y a M 4 0 l u J 4 0 t p e S 4 0 v o N 5 0 n u J 5 0 r a M 5 0 r p A 5 0 n u J 5 0 g u A 5 0 t c O 5 0 c e D 6 0 b e F 6 0 r a M 6 0 y a M 38 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Directors’ Remuneration Report Audited Information The auditors are required to report on the information contained in the remainder of this report. Summary of Remuneration Salaries & Fees £’000 Bonuses £’000 Other Benefits £’000 Executive Directors I.D. Page (Chief Executive) S.D. Evans E.T.W. Torr Non-Executive Directors M. Redmond (Chairman) M.M. Diamond N.W. Warner 175 120 115 46 26 24 506 74 35 34 — — — 143 Executive Incentive Plan Awards made under the Executive Incentive Plan are as follows: I.D. Page S.D. Evans E.T.W. Torr Initial share price at date of award pence 126 159.5 251 126 159.5 251 126 159.5 251 Award date Exercise dates Performance period 2003 2004 2005 2003 2004 2005 2003 2004 2005 2006–2007 2007–2008 2008–2009 2006–2007 2007–2008 2008–2009 2006–2007 2007–2008 2008–2009 2003–2006 2004–2007 2005–2008 2003–2006 2004–2007 2005–2008 2003–2006 2004–2007 2005–2008 20 14 15 — — — 49 2006 Number of shares 120,000 48,589 34,861 80,000 33,096 23,904 80,000 31,348 22,908 Total 2006 £’000 269 169 164 46 26 24 698 2005 Number of shares 120,000 48,589 80,000 33,096 80,000 31,348 Total 2005 £’000 229 140 140 41 24 21 595 2004 Number of shares 120,000 80,000 80,000 The actual performance target in respect of the 2003 scheme has been calculated and confirms that Dechra Pharmaceuticals PLC Total Shareholder return for the three-year period to 30 June 2006 has resulted in a performance that places the Company in the top quartile of the FTSE small cap comparator group of companies for the measurement period. The full award for 2003 is therefore exercisable in accordance with the plan rules. 39 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 SAYE Scheme Directors’ entitlements under the SAYE Scheme are as follows: I.D. Page S.D. Evans E.T.W. Torr Market price at date of grant pence Award date 3 April 2003 15 October 2004 15 October 2004 18 October 2005 48 198 198 255 Exercise price pence 39 158 158 204 Exercise dates June 2008 Jan 2008 Jan 2008 Dec 2008 At 30 June 2005 number 42,115 7,641 3,056 — 52,812 Exercised number Granted number Lapsed number — — — — — — — — 2,750 2,750 — — — — — At 30 June 2006 number 42,115 7,641 3,056 2,750 55,562 The middle market price for the Company’s shares on 30 June 2006 was 240p and the range of prices during the year was 210p to 267.25p. Pension Entitlement All Executive Directors were members of the Dechra Pharmaceutical PLC Group Stakeholder personal pension scheme throughout the year. Contributions made by Dechra Pharmaceuticals PLC on behalf of the Executive Directors during the year are based on a percentage of pensionable salary and were paid as follows: I.D. Page S.D. Evans E.T.W. Torr Age 45 42 46 Contributions 2006 £000 Contributions 2005 £000 21 14 14 49 19 13 12 44 Effectiveness Review During the year, the Committee reviewed its effectiveness through a process led by the Committee Chairman. The findings were reported to the Committee and the Board. By order of the Board M.M. Diamond Chairman Remuneration Committee 5 September 2006 40 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Social, Ethical and Environmental Responsibilities A responsible approach to our stakeholders and the wider community is seen by the Board to be fundamental to the Group. The conduct of the Group towards social, environmental, ethical and health and safety issues is recognised to have an impact on our reputation and the implementation of policies and systems continues. The Board takes ultimate responsibility for corporate social responsibility (CSR) and continues to be committed to developing and implementing appropriate policies to create and maintain long-term value for shareholders. Sound business ethics help to minimise risk, ensure legal compliance and enhance company efficiency. The need to review and manage risks to the short and long-term value of the Company arising from CSR is recognised by the Board and it considers that it has received adequate information to review these risks and has not identified any risks to the business that could affect its future value. Environmental Policy Dechra recognises the importance of good environmental controls. It is the Company’s policy to comply with and exceed environmental legislation currently in place, adopt responsible environmental practices and be committed to minimising the impact of its operations on the environment. The Group is a registered member of a compliance scheme in respect of the Waste Packaging Obligations Regulations and, in addition, all of the National Veterinary Services depots recycle waste cardboard back to UK paper mills, and waste polythene is also recycled back to UK recycling agents. A fleet of low CO2 emission diesel vehicles is maintained with these vehicles being replaced every three years via leasing agreements. In addition, a number of LPG powered vehicles are being used in and around the London area. Our manufacturing unit continues to comply with and better effluent discharge standards into local water supplies, this being monitored by Yorkshire Water Authority. Standard operating procedures are in operation to ensure that contaminated waste is disposed of under strict controls. Exhaust air is fully filtered from the manufacturing unit before discharge. This unit continues its work towards ISO14001 status. Dechra continues to review its environmental controls and encourage its own staff, suppliers and customers to achieve similar standards. The Development Director is the nominated Director responsible for environmental policies. Business Ethics The Board expects all of the Group’s business activities to be conducted in accordance with high standards of ethical conduct and full compliance with all applicable national and international legislation. This includes, in particular, the provision of a safe working environment including health and safety awareness, maintenance of fair and competitive employment practices, opposition to any bribery or corrupt business practices, treating suppliers on a fair basis to build long-term relationships to our mutual benefit, and being responsive for our customers’ needs and providing a high standard of customer care. A “whistle-blowing” policy is in place whereby employees may report, in confidence, any suspect wrongdoings within the business where they feel unable to discuss any such issue directly with local management. This policy is available to all employees via staff handbooks and the Dechra Pharmaceuticals web site. Open and honest communication is positively encouraged between employees and management throughout the business. Health and Safety Policy Dechra Pharmaceutical PLC attaches great importance to the health and safety of its employees and the public. The management are responsible and committed to the maintenance, monitoring and promoting of a policy of Health and Safety at work, to ensure the care and well-being of its employees and on-site visitors. All of its sites are registered with the British Safety Council. Each unit within the Group has an active Health and Safety Committee comprising representatives from both management and employees. The workforce nominates employee representatives. These committees meet on a regular basis to carry out a review of risk assessments and standard operating procedures as well as investigating any concerns raised by individual employees. Each site has the requisite number of employees trained in Health and Safety legislation. A full health and safety report is presented at Divisional Board Meetings on a regular basis in the presence of Executive Directors. These reports are summarised for subsequent review by the Board. A transport risk review committee has been established to assess risks related to the vehicle fleet and establish control procedures. This includes a quarterly licence check of all individuals who are able to drive company vehicles, an investigation into all accidents and a disciplinary procedure for speeding offences. It is proposed to introduce driver assessments during the coming year. This committee meets six times a year and issues raised by this committee are included at Health and Safety meetings. The Finance Director is the nominated Director responsible for Health and Safety policy. Employees It is the Group’s policy to encourage employee involvement as the Directors consider that this is essential for the successful running of the business. The Group keeps employees informed of performance, developments and progress by way of regular team briefing sessions and notices. The manufacturing site is registered with “Investors in People” and operates a Works Council. It is the Company’s policy to provide equal recruitment and other opportunities for all employees, regardless of sex, religion, race or disability. The Group gives full consideration to applications from disabled people, where they adequately fulfil the requirements of the role. Where existing employees become disabled, it is the Group’s policy whenever practicable to provide continuing employment under the Company’s terms and conditions and to provide training and career development whenever appropriate. The Group has encouraged employees to share in the growth of the Company through eligibility to participate in the SAYE share option scheme. 41 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Statement of Directors’ Responsibilities in respect of the Annual Report and the Financial Statements The Directors are responsible for preparing the Annual Report and the Group and Parent Company financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare Group and Parent Company financial statements for each financial year. Under that law they are required to prepare the Group financial statements in accordance with IFRSs as adopted by the EU and have elected to prepare the Parent Company financial statements in accordance with UK Accounting Standards. The Group financial statements are required by law and IFRSs as adopted by the EU to present fairly the financial position and the performance of the Group; the Companies Act 1985 provides in relation to such financial statements that references in the relevant part of that Act to financial statements giving a true and fair view are references to their achieving a fair presentation. The Parent Company financial statements are required by law to give a true and fair view of the state of affairs of the Parent Company. In preparing each of the Group and Parent Company financial statements, the Directors are required to: select suitable accounting policies and then apply them consistently; make judgements and estimates that are reasonable and prudent; for the Group financial statements, state whether they have been prepared in accordance with IFRSs as adopted by the EU; for the Parent Company financial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the Parent Company financial statements; and prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Group and the Parent Company will continue in business. The Directors are responsible for keeping proper accounting records that disclose with reasonable accuracy at any time the financial position of the Parent Company and enable them to ensure that its financial statements comply with the Companies Act 1985. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities. Under applicable law and regulations, the Directors are also responsible for preparing a Directors’ Report, Directors’ Remuneration Report and Corporate Governance Statement that comply with that law and those regulations. The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) 42 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Independent Auditors’ Report to the Members of Dechra Pharmaceuticals PLC We have audited the Group and Parent Company financial statements (the “financial statements”) of Dechra Pharmaceuticals PLC for the year ended 30 June 2006 which comprise the Consolidated Income Statement, the Consolidated and Parent Company Balance Sheets, the Consolidated Statement of Cash Flows, the Consolidated Statement of Changes in Shareholders’ Equity and the related notes. These financial statements have been prepared under the accounting policies set out therein. We have also audited the information in the Directors’ Remuneration Report that is described as having been audited. This report is made solely to the Company’s members, as a body, in accordance with section 235 of the Companies Act 1985. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company, and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of directors and auditors The Directors’ responsibilities for preparing the Annual Report and the Group financial statements in accordance with applicable law and International Financial Reporting Standards (IFRSs) as adopted by the EU, and for preparing the Parent Company financial statements and the Directors’ Remuneration Report in accordance with applicable law and UK Accounting Standards (UK Generally Accepted Accounting Practice) are set out in the Statement of Directors’ Responsibilities on page 41. Our responsibility is to audit the financial statements and the part of the Directors’ Remuneration Report to be audited in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland). We report to you our opinion as to whether the financial statements give a true and fair view and whether the financial statements and the part of the Directors’ Remuneration Report to be audited have been properly prepared in accordance with the Companies Act 1985 and, as regards the Group financial statements, Article 4 of the IAS Regulation. We also report to you whether in our opinion the information given in the Directors’ Report is consistent with the financial statements. The information given in the Directors’ Report includes that specific information presented in the Directors’ Business Review that is cross-referenced from the Business Review and Future Developments section of the Directors’ Report. We also report to you if, in our opinion, the Company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information specified by law regarding Directors’ remuneration and other transactions is not disclosed. We review whether the Corporate Governance Statement reflects the Company’s compliance with the nine provisions of the 2003 FRC Combined Code specified for our review by the Listing Rules of the Financial Services Authority, and we report if it does not. We are not required to consider whether the Board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the Group’s corporate governance procedures or its risk and control procedures. We read the other information contained in the Annual Report and consider whether it is consistent with the audited financial statements. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. Our responsibilities do not extend to any other information. Basis of audit opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements and the part of the Directors’ Remuneration Report to be audited. It also includes an assessment of the significant estimates and judgements made by the Directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the Group’s and Company’s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements and the part of the Directors’ Remuneration Report to be audited are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements and the part of the Directors’ Remuneration Report to be audited. Opinion In our opinion: the Group financial statements give a true and fair view, in accordance with IFRSs as adopted by the EU, of the state of the Group’s affairs as at 30 June 2006 and of its profit for the year then ended; the Parent Company financial statements give a true and fair view, in accordance with UK Generally Accepted Accounting Practice, of the state of the Parent Company’s affairs as at 30 June 2006; the financial statements and the part of the Directors’ Remuneration Report to be audited have been properly prepared in accordance with the Companies Act 1985 and, as regards the Group financial statements, Article 4 of the IAS Regulation; and the information given in the Directors’ Report is consistent with the financial statements. KPMG Audit Plc Chartered Accountants Registered Auditor 5 September 2006 2 Cornwall Street Birmingham B3 2DL (cid:2) (cid:2) (cid:2) (cid:2) 43 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Year ended 30 June 2006 £’000 2005 £’000 Note 2 232,471 210,267 (199,205) (180,550) 33,266 (10,309) (10,645) 12,312 725 (1,993) 11,044 (3,487) 7,557 14.71p 14.36p 6.24p 29,717 (9,073) (9,389) 11,255 355 (1,909) 9,701 (2,674) 7,027 13.77p 13.54p 5.20p 2 3 4 5 7 9 9 8 Consolidated Income Statement For the year ended 30 June 2006 Revenue Cost of sales Gross profit Distribution costs Administrative expenses Operating profit Finance income Finance expense Profit before taxation Income tax expense Profit for the year attributable to equity holders of the parent Earnings per share (pence) Basic Diluted Dividend per share (interim paid and final proposed for the year) 44 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Consolidated Balance Sheet At 30 June 2006 ASSETS Non-current assets Intangible assets Property, plant and equipment Deferred tax assets Total non-current assets Current assets Inventories Trade and other receivables Cash and cash equivalents Total current assets Total assets LIABILITIES Current liabilities Borrowings Trade and other payables Current tax liabilities Total current liabilities Non-current liabilities Borrowings Total non-current liabilities Total liabilities Net assets EQUITY Issued share capital Share premium account Hedging reserve Merger reserve Retained earnings Note 10 11 13 14 15 16 19 17 18 19 21 Total equity attributable to equity holders of the parent The financial statements were approved by the Board of Directors on 5 September 2006 and are signed on its behalf by: I.D. Page Director S.D. Evans Director As at 30 June 2006 £’000 7,527 5,595 445 2005 £’000 7,039 4,946 406 13,567 12,391 21,957 35,347 19,738 77,042 90,609 (3,417) (45,530) (2,505) (51,452) (15,242) (15,242) (66,694) 23,915 519 27,693 (71) 1,720 (5,946) 23,915 20,390 33,708 13,924 68,022 80,413 (1,502) (41,971) (2,057) (45,530) (17,281) (17,281) (62,811) 17,602 511 26,953 — 1,720 (11,582) 17,602 45 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Consolidated Statement of Changes in Shareholders’ Equity For the year ended 30 June 2006 Year ended 30 June 2005 At 1 July 2004 Profit for the period being total recognised income and expense for the period Dividends paid Share-based payments including deferred tax Shares issued At 30 June 2005 Year ended 30 June 2006 At 1 July 2005 as previously stated Impact of adoption of IAS32 and IAS39 on 1 July 2005 (see note 1(g)) At 1 July 2005 — restated Profit for the period being total recognised income and expense for the period Dividends paid Share-based payments including current and deferred tax Shares issued Issued share capital £’000 Share premium account £’000 510 26,784 — — — 1 511 511 — 511 — — — 8 — — — 169 26,953 26,953 — 26,953 — — — 740 Hedging reserve £’000 Merger reserve £’000 Retained earnings £’000 Total £’000 — — — — — — — (71) (71) — — — — 1,720 (17,012) 12,002 — — — — 7,027 (2,473) 876 — 7,027 (2,473) 876 170 1,720 (11,582) 17,602 1,720 (11,582) 17,602 — 1,720 — (71) (11,582) 17,531 — — — — 7,557 (2,777) 856 — 7,557 (2,777) 856 748 At 30 June 2006 519 27,693 (71) 1,720 (5,946) 23,915 46 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Consolidated Statement of Cash Flows For the year ended 30 June 2006 Cash flows from operating activities Profit for the period Adjustments for: Depreciation Amortisation Gain on sale of property, plant and equipment Finance income Finance expense Equity-settled share-based payment expenses Income tax expense Operating cash flow before changes in working capital Increase in inventories Increase in trade and other receivables Increase in trade and other payables Cash generated from operations Interest paid Income taxes paid Net cash from operating activities Cash flows from investing activities Proceeds from sale of property, plant and equipment Interest received Purchase of property, plant and equipment Capitalised development expenditure Purchase of other intangible fixed assets Net cash from investing activities Cash flows from financing activities Proceeds from the issue of share capital New borrowings Repayment of borrowings Dividends paid Net cash from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at start of period Cash and cash equivalents at end of period Shown as: Cash and cash equivalents Bank overdraft Year ended 30 June 2005 £’000 2006 £’000 7,557 7,027 886 136 (23) (725) 1,993 427 3,487 13,738 (1,567) (1,736) 3,562 13,997 (1,890) (2,618) 9,489 23 672 (1,320) (195) — (820) 780 705 (1,582) (2,777) (2,874) 5,795 13,924 19,719 19,738 (19) 19,719 902 74 (42) (355) 1,909 488 2,674 12,677 (3,411) (787) 5,070 13,549 (2,022) (1,996) 9,531 140 355 (644) (321) (1,100) (1,570) 138 13,160 (1,538) (2,473) 9,287 17,248 (3,324) 13,924 13,924 — 13,924 47 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Reconciliation of net cash to movement in net borrowings Net increase in cash and cash equivalents Repayment of borrowings New borrowings New finance leases Other non-cash changes Movement in net borrowings in the period Net borrowings at start of period Net cash/(borrowings) at end of period Year ended 30 June 2005 £’000 2006 £’000 Note 5,795 1,582 (705) (649) (85) 5,938 (4,859) 1,079 17,248 1,538 (13,160) (438) 63 5,251 (10,110) (4,859) 23 48 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 1. Accounting Policies Dechra Pharmaceuticals PLC is a company domiciled in the United Kingdom. The consolidated financial statements of the Group for the year ended 30 June 2006 comprise the Company and its subsidiaries. (a) Statement of Compliance The consolidated financial statements have been prepared and approved by the Directors in accordance with International Financial Reporting Standards (“IFRS”) as adopted by the European Union and with those parts of the Companies Act 1985 applicable to companies reporting under IFRS (“adopted IFRS”). The Company has elected to prepare its Parent company financial statements in accordance with UK GAAP and are separately presented on pages 73 to 82. The accounting policies set out below have, unless otherwise stated, been applied consistently to all periods presented in these Group financial statements and in preparing an opening IFRS balance sheet at 1 July 2004 for the purposes of the transition to adopted IFRSs. The principal exemption is that, as more fully explained below, financial instruments accounting is determined on a different basis in 2006 and 2005 due to the transitional provisions of IAS32 and IAS39. Reconciliations of the income statement, balance sheet and net equity from previously reported UK GAAP to IFRS are shown in note 27. The Group’s significant accounting policies are listed below: (b) First Time Adoption The Group has applied IFRS1 ‘First time adoption of International Financial Reporting Standards’ in its initial application of IFRS. The Group is required to select appropriate accounting policies under IFRS and, subject to a few exemptions detailed below, apply them retrospectively to its financial statements such that all comparative information is presented on the same basis. Accordingly this necessitates the restatement of the balance sheet at 1 July 2004, the date of transition (this being the date of the beginning of the earliest financial year for which full comparative information is required) as well as at 30 June 2005. IFRS1 permits certain exemptions to the full retrospective restatement. The exemptions that have been adopted by the Group are as follows: Business combinations — business combinations made prior to 1 July 2004 have not been restated in accordance with IFRS3 ‘Business Combinations’. Share-based payments — IFRS2 ‘Share-based payments’ has only been applied to awards of share options granted after 7 November 2002 which had not vested by 1 January 2005. Financial instruments — IAS32 ‘Financial Instruments: Disclosure and Presentation’ and IAS39 ‘Financial Instruments: Recognition and Measurement’ have been adopted prospectively from 1 July 2005 with no restatement of comparative information which continues to be presented in accordance with UK GAAP. (c) Basis of Preparation The financial statements are presented in Sterling, rounded to the nearest thousand. They are prepared on the historical cost basis except for derivative financial instruments that are stated at fair value. The preparation of financial statements in conformity with adopted IFRSs requires management to make judgements, estimates and assumptions that affect the application of policies and reported amounts of assets and liabilities, income and expenses. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis of making the judgements about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods. The restated financial information for the transition to IFRS at 1 July 2004 and the year ended 30 June 2005 and the adoption of IAS32 and IAS39 at 1 July 2005 has been prepared in accordance with adopted IFRS and consistently in accordance with the accounting policies as set out below. IFRS7 ‘Financial Instruments Disclosure’ has not yet been applied. IFRS7 is applicable to years commencing on or after 1 January 2007 and was available for early application but has not yet been applied by the Group in these financial statements. The application of IFRS7 in the year to 30 June 2006 would not have affected the income statement or balance sheet as the standard is concerned only with disclosure. The Group plans to adopt it in the year to 30 June 2008. (d) Basis of Consolidation (i) Subsidiaries Subsidiaries are entities controlled by the Company. Control exists when the Company has the power, directly or indirectly, to govern the financial and operating policies of an entity so as to obtain benefits from its activities. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases. 49 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 1. Accounting Policies continued (e) (f) (g) (ii) Transactions Eliminated on Consolidation Intra-group balances and any unrealised gains and losses or income and expenses arising from intra-group transactions are eliminated in preparing the consolidated financial statements. Foreign Currency Transactions Transactions in foreign currencies are translated at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated to Sterling at the foreign exchange rate ruling at that date. Foreign exchange differences arising on translation are recognised in the income statement. Non-monetary assets and liabilities that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction. Non-monetary assets and liabilities denominated in foreign currencies that are stated at fair value are translated to Sterling at the foreign exchange rates ruling at the dates the fair value was determined. Derivative Financial Instruments (applicable to 30 June 2005) All financial assets and liabilities are carried at cost (amortised as appropriate) less, in the case of financial assets, provisions for permanent diminution in value. Short-term debtors and creditors that meet the definitions of a financial asset or liability respectively have been excluded from the numerical disclosures as permitted by FRS13 “derivatives and other financial instrument disclosures” as detailed in note 20. Derivative Financial Instruments (applicable from 1 July 2005) The Group uses derivative financial instruments to manage its exposure to foreign exchange and interest rate risks. In accordance with its treasury policy, the Group does not hold or issue derivative financial instruments for speculative purposes. However, derivatives that do not qualify for hedge accounting are accounted for as trading instruments. On adoption of IAS32 and IAS39, the comparative financial statements have not been restated. As permitted under IFRS1 ‘First time adoption of International Financial Reporting Standards’ the comparative statements continue to hedge account under UK GAAP. On 1 July 2005, the fair values of derivatives used for hedging were included in a hedging reserve. The corresponding adjustments were to decrease trade and other receivables by £58,000, increase trade and other payables by £44,000 and increase the deferred tax asset by £31,000. As the Group has not adopted hedge accounting under IAS39 from 1 July 2005 the hedging reserve is frozen and will only be released to the income statement when the related forecast transactions occur. Derivative financial instruments are recognised initially at fair value. Subsequent to initial recognition, derivative financial instruments are stated at fair value. The gain or loss on remeasurement to fair value is recognised immediately in the income statement. The fair value of interest rate swaps, floors and ceilings is the estimated amount that the Group would receive or pay to terminate the instrument at the balance sheet date. The fair value of forward exchange contracts and options is their quoted market price at the balance sheet date, being the present value of the quoted forward price. (h) Property, Plant and Equipment Owned Assets (i) Items of property, plant and equipment are stated at cost less accumulated depreciation (see below) and impairment losses (see accounting policy m). (ii) (iii) (iv) Leased Assets Leases under the terms of which the Group assumes substantially all the risks and rewards of ownership are classified as finance leases. Assets acquired by finance leases are stated at an amount equal to the lower of their fair value and the present value of the minimum lease payments at inception of the lease, less accumulated depreciation and impairment losses. Subsequent Costs The Group recognises in the carrying amount of an item of property, plant and equipment the cost of replacing part of such an item when that cost is incurred if it is probable that the future economic benefits embodied with the item will flow to the Group and the cost of the item can be measured reliably. All other costs are recognised in the income statement as an expense as incurred. Depreciation Depreciation is charged to the income statement on a straight-line basis over the estimated useful lives of each part of an item of property, plant and equipment. Land is not depreciated. Assets in the course of construction are not depreciated until the date the assets become available for use. The estimated useful lives are as follows: short leasehold buildings plant and fixtures motor vehicles period of lease 10%–331/3% 25% The residual value, if not insignificant, is reassessed annually. (cid:2) (cid:2) (cid:2) 50 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 1. Accounting Policies continued Intangible Assets (i) (i) Goodwill All business combinations are accounted for by applying the purchase method. Goodwill represents amounts arising on acquisition of subsidiaries, associates and joint ventures. In respect of business acquisitions that have occurred since 1 July 2004, goodwill represents the difference between the cost of the acquisition and the fair value of the net identifiable assets acquired. In respect of acquisitions prior to this date, goodwill is included on the basis of its deemed cost, which represents the amount recorded under previous GAAP. The classification and accounting treatment of business combinations that occurred prior to 1 July 2004 has not been reconsidered in preparing the Group’s opening IFRS balance sheet at 1 July 2004. Goodwill is stated at cost less any accumulated impairment losses. Goodwill is not amortised but is allocated to cash generating units and is tested annually for impairment. (ii) Research and Development Costs Expenditure on research activities, undertaken with the prospect of gaining new scientific or technical knowledge and understanding, is recognised in the income statement as an expense is incurred. The Group is also engaged in development activity with a view to bringing new pharmaceutical products to market. Internally generated costs of development are capitalised in the balance sheet unless those costs cannot be measured reliably or it is not probable that future economic benefits will flow to the Group, in which case the relevant costs are expensed to the income statement as incurred. Due to the strict regulatory process involved, there is inherent uncertainty as to the technical feasibility of development projects often until regulatory approval is achieved, with the possibility of failure even at a late stage. The Group considers that this uncertainty means that the criteria for capitalisation are not met unless it is highly probable that regulatory approval will be achieved and the project is commercially viable. Where development costs are capitalised, the expenditure includes the cost of materials, direct labour and an appropriate proportion of overheads. (iii) (iv) (v) Capitalised development expenditure is stated at cost less accumulated amortisation and impairment losses. Other Intangible Assets Other intangible assets that are acquired by the Group are stated at cost less accumulated amortisation and impairment losses. Expenditure on internally generated goodwill and other intangibles is recognised in the income statement as an expense is incurred. Subsequent Expenditure Subsequent expenditure on capitalised intangible assets is capitalised only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditure is expensed as incurred. Amortisation Amortisation is charged to the income statement on a straight-line basis over the estimated useful lives of intangible assets unless such lives are indefinite. Goodwill and intangible assets with an indefinite useful life are systematically tested for impairment at each balance sheet date. Other intangible assets are amortised from the date that they are available for use. The estimated useful lives are as follows: (j) (k) software capitalised development costs patent rights marketing authorisations product rights 5 years 5–10 years Period of patent Indefinite life Period of product rights Trade and Other Receivables Trade and other receivables are stated at their amortised cost. Inventories Inventories are stated at the lower of cost and net realisable value. Net realisable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and selling expenses. The cost of inventories is based on the first-in, first-out principle and includes expenditure incurred in acquiring the inventories and bringing them to their existing location and condition. In the case of manufactured inventories and work in progress, cost includes an appropriate share of overheads based on normal operating capacity. (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) 51 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 1. Accounting Policies continued (l) Cash and Cash Equivalents Cash and cash equivalents comprise cash balances and call deposits. Bank overdrafts that are repayable on demand and form an integral part of the Group’s cash management are included as a component of cash and cash equivalents for the purpose of the statement of cash flows. (m) Impairment The carrying amounts of the Group’s assets, other than inventories and deferred tax assets, are reviewed at each balance sheet date to determine whether there is any indication of impairment. If any such indication exists, the asset’s recoverable amount is estimated. The recoverable amount of assets is the greater of their net selling price and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. For an asset that does not generate largely independent cash inflows, the recoverable amount is determined for the cash-generating unit to which the asset belongs. For goodwill, assets that have an indefinite useful life and intangible assets that are not yet available for use, the recoverable amount is estimated at each balance sheet date and, in the case of goodwill, at the date of transition to IFRS. An impairment loss is recognised whenever the carrying amount of an asset or its cash-generating unit exceeds its recoverable amount. Impairment losses are recognised in the income statement. Impairment losses recognised in respect of cash-generating units are allocated first to reduce the carrying amount of any goodwill allocated to the cash-generating units (group of units), and then to reduce the carrying amount of the other assets in the unit (group of units) on a pro rata basis. An impairment loss in respect of goodwill is not reversed. (n) (o) (p) In respect of other assets, an impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortisation, if no impairment loss had been recognised. Dividends Dividends are recognised in the period in which they are approved by the Company’s shareholders or, in the case of an interim dividend, when the dividend is paid. Interest-Bearing Borrowings Interest-bearing borrowings are recognised initially at fair value less attributable transaction costs. Subsequent to initial recognition, interest-bearing borrowings are stated at amortised cost with any difference between cost and redemption value being recognised in the income statement over the period of the borrowings on an effective interest basis. Employee Benefits (i) Pensions The Company operates a Group stakeholder personal pension scheme for certain employees. Obligations for contributions are recognised as an expense in the income statement as incurred. (ii) Share-Based Payment Transactions The Group operates a number of equity-settled share-based payment programmes that allow employees to acquire shares of the Company. The Group also operates a Long Term Incentive Plan for Directors and Senior Executives. The fair value of shares or options granted is recognised as an employee expense on a straight-line basis in the income statement with a corresponding movement in equity. The fair value is measured at grant date and spread over the period during which the employees become unconditionally entitled to the shares or options (the vesting period). The fair value of the shares or options granted is measured using a valuation model taking into account the terms and conditions upon which the shares or options were granted. The amount recognised as an expense in the income statement is adjusted to take into account an estimate of the number of shares or options that are expected to vest together with an adjustment to reflect the number of shares or options that actually do vest except where forfeiture is only due to market-based conditions not being achieved. The fair value of grants under the Long Term Incentive Plan has been determined using the Monte Carlo simulation model. The fair values of options granted under all other share option schemes have been determined using the Black-Scholes option pricing model. 52 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 1. Accounting Policies continued Trade and Other Payables (q) Trade and other payables are stated at their amortised cost. (r) (s) Revenue (i) Goods Sold Revenue from the sale of goods is recognised in the income statement when the significant risks and rewards of ownership have been transferred to the buyer. This is normally when the buyer takes delivery of the goods. Appropriate provision is made, based on past experience, for the possible return of goods and discounts given to customers. (ii) Milestone Payments Milestone payments received from the granting of distribution and marketing rights for products are recognised in the income statement over the period in which the Company fulfils all of its obligations relating to such payments. Expenses (i) Operating Lease Payments Payments made under operating leases are recognised in the income statement on a straight-line basis over the term of the lease. Lease incentives received are recognised in the income statement evenly over the period of the lease, as an integral part of the total lease expense. (ii) (iii) Finance Lease Payments Minimum lease payments are apportioned between the finance charge and the reduction of the outstanding liability. Net Financing Costs Net financing costs comprise interest payable on borrowings, interest receivable on funds invested, foreign exchange gains and losses, and gains and losses on hedging instruments that are recognised in the income statement (see accounting policy g). Interest income is recognised in the income statement as it accrues. The interest expense component of finance lease payments is recognised in the income statement using the effective interest rate method. (t) Income Tax Income tax on the profit or loss for the year comprises current and deferred tax. Income tax is recognised in the income statement except to the extent that it relates to items recognised directly in equity, in which case it is recognised in equity. Current tax is the expected tax payable on the taxable income for the year using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. Deferred tax is provided using the balance sheet liability method and represents the tax payable or recoverable on most temporary differences which arise between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes (the tax base). Temporary differences are not provided on: goodwill that is not deductible for tax purposes, the initial recognition of assets or liabilities that affect neither accounting nor taxable profit and do not arise from a business combination; and differences relating to investments in subsidiaries to the extent that they will probably not reverse in the foreseeable future. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates expected to apply in the period in which the liability is settled or the asset is realised and is based upon tax rates enacted or substantively enacted at the balance sheet date. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised. Deferred tax assets are reduced to the extent that it is not probable that the related tax benefit will be realised against future taxable profits. The carrying amounts of deferred tax assets are reviewed at each balance sheet date. Segment Reporting A segment is a distinguishable component of the Group that is engaged either in providing products or services (business segment), or in providing products or services within a particular economic environment (geographical segment), which is subject to risks and rewards that are different from those of other segments. Operating Profit and Operating Cash Flow Operating profit and operating cash flow is stated before investment income and finance costs. (u) (v) 53 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 2. Segmental Analysis The Group’s primary reporting segment is business divisions which correspond with the way the operating businesses are organised and managed within the Group and its secondary segment is geographical origin. Segment results, assets and liabilities comprise those items directly attributable to particular segments as well as items which can reasonably be allocated to those segments. Inter-segment transactions are entered into applying normal commercial terms that would be available to third parties. Unallocated items comprise mainly corporate assets, expenses, loans and borrowings together with the elimination of inter-segment transactions. The composition of the segments is detailed in the Directors’ Business Review section of this report. The following table analyses revenue and operating profit accordingly: Business Segment Revenue External customers Inter-segment Total revenue Operating profit Finance income Finance expense Profit before taxation Income tax expense Profit for the year Assets Intangible assets Property, plant and equipment Other assets Total assets Liabilities Borrowings Other liabilities Total liabilities Pharmaceuticals 2005 £’000 2006 £’000 Services Unallocated Total 2006 £’000 2005 £’000 2006 £’000 2005 £’000 2006 £’000 2005 £’000 17,001 6,251 15,783 5,598 215,470 86 194,484 127 — (6,337) — (5,725) 232,471 — 210,267 — 23,252 21,381 215,556 194,611 (6,337) (5,725) 232,471 210,267 4,868 4,292 8,681 7,973 (1,237) (1,010) 12,312 11,255 725 (1,993) 11,044 (3,487) 355 (1,909) 9,701 (2,674) 7,557 7,027 5,104 3,571 11,071 4,630 3,590 9,460 2,423 2,024 64,235 2,409 1,356 57,058 19,746 17,680 68,682 60,823 — — 2,181 2,181 — — 1,910 1,910 7,527 5,595 77,487 7,039 4,946 68,428 90,609 80,413 (508) (3,026) (33) (3,842) (1,056) (41,965) (340) (37,964) (17,095) (3,044) (18,410) (2,222) (18,659) (48,035) (18,783) (44,028) (3,534) (3,875) (43,021) (38,304) (20,139) (20,632) (66,694) (62,811) Net assets/(liabilities) 16,212 13,805 25,661 22,519 (17,958) (18,722) 23,915 17,602 Other Segment Items Capital expenditure — intangible assets — property, plant and equipment Total capital expenditure Share-based payments charge Depreciation and amortisation 552 469 1,021 — 566 1,421 341 1,762 — 490 72 1,066 1,138 — 456 288 381 669 — 486 — — — 515 — — — — 398 — 624 1,535 2,159 515 1,022 1,709 722 2,431 398 976 54 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 2. Segmental Analysis continued Geographical Segment In presenting information on the basis of geographical segments, IAS14 ‘Segment Reporting’ requires segment revenues to be based on the geographical location of customers. In this respect, £228,191,000 arises from customers in the UK (2005: £207,173,000) and £4,280,000 from customers in the rest of the world (2005: £3,094,000). The table below gives additional information in respect of segment revenue and segment operating profit, based on the geographical location of the business unit supplying the goods or services. Segment assets and capital expenditure are based on the geographical location of the assets and expenditure. Activities in the UK comprise all operating segments. Overseas operations comprise pharmaceuticals only. UK USA Unallocated Total 2006 £’000 2005 £’000 Revenue by geographical origin 232,145 210,267 Operating profit by geographical origin 13,809 12,450 Total assets 88,190 78,453 Capital expenditure — intangible assets — property, plant and equipment Total capital expenditure 624 1,532 2,156 1,709 709 2,418 2006 £’000 326 (260) 238 — 3 3 3. Finance Income Bank interest receivable Other interest receivable Fair value gains on derivative financial instruments Total finance income 4. Finance Expense Bank loans and overdrafts Finance charges payable on finance leases and hire purchase contracts Fair value losses on derivative financial instruments Total finance expense 2005 £’000 — 2006 £’000 — 2005 £’000 2006 £’000 2005 £’000 — 232,471 210,267 (185) (1,237) (1,010) 12,312 11,255 50 — 13 13 2,181 1,910 90,609 80,413 — — — — — — 624 1,535 2,159 2006 £’000 627 52 46 725 2006 £’000 1,913 64 16 1,993 1,709 722 2,431 2005 £’000 355 — — 355 2005 £’000 1,877 32 — 1,909 55 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 5. Profit before Taxation The following items have been included in arriving at profit before taxation: Cost of inventories recognised as an expense Impairment of inventories included in above figure Depreciation of property, plant and equipment — owned assets — under finance leases Amortisation of intangible assets (Profit) on disposal of property, plant and equipment Impairment of receivables Operating lease rentals payable Research and development expenditure as incurred Auditors’ remuneration for audit services (including £60,000 (2005: £31,000) in respect of the Parent Company) Auditors’ remuneration for other services Analysis of total fees paid to the auditors: Audit services Further assurance services Tax compliance services Tax advisory services Other services 6. Employees The average numbers of staff employed by the Group during the year, which includes Directors, were: Manufacturing Distribution Administration The costs incurred in respect of these employees were: Wages and salaries Social security costs Other pension costs Share-based payments charge (see note 22) Related party transactions — the remuneration of key management was as follows: Wages and salaries (including benefits in kind) Social security costs Other pension costs Share-based payments charge 2006 £’000 197,127 83 802 84 136 (23) 455 2,042 1,378 99 137 99 28 53 56 — 236 2005 £’000 178,933 521 807 95 74 (42) 767 1,776 1,053 89 111 89 8 36 48 19 200 2006 Number 2005 Number 132 364 195 691 2006 £’000 12,895 1,171 338 515 14,919 2006 £’000 1,176 151 85 384 1,796 146 344 189 679 2005 £’000 11,081 997 281 398 12,757 2005 £’000 914 117 75 283 1,389 Key management comprises Executive Directors, the Product Development and Regulatory Affairs Director and the Divisional Managing Directors. Details of the remuneration, shareholdings, share options and pension contributions of the Executive Directors are included in the Remuneration Report on pages 34 to 39. The Group operates a stakeholder personal pension scheme for certain employees. The Group contributed between 4% and 12% of pensionable salaries which amounted to £338,000 (2005: £281,000). 56 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 7. Income Tax Expense Current tax — charge for current year — adjustment in respect of prior years Total current tax expense Deferred tax — origination and reversal of temporary differences — adjustment in respect of prior years Total deferred tax expense Total income tax expense in the income statement All taxation is in the United Kingdom. 2006 £’000 3,491 (58) 3,433 4 50 54 2005 £’000 3,001 (233) 2,768 (37) (57) (94) 3,487 2,674 The tax on the Group’s profit before tax differs from the standard rate of UK corporation tax of 30% (2005: 30%). The differences are explained below: Profit before taxation Tax at 30% Effect of: — depreciation on assets not eligible for tax allowances — disallowable expenses — overseas trading losses — under-recovery of deferred tax on share-based payments — adjustments in respect of prior years 2006 £’000 11,044 3,313 27 33 78 44 (8) 2005 £’000 9,701 2,910 22 2 30 — (290) Total income tax expense 3,487 2,674 Additional current tax credits of £367,000 (2005: £nil) and deferred tax credits of £62,000 (2005: £388,000) have been recognised directly in equity. 8. Dividends Final dividend paid in respect of prior year but not recognised as a liability in that year 3.50p per share (2005: 3.15p) Interim dividend paid 1.91p per share (2005: 1.70p) Total dividend 5.41p per share (2005: 4.85p) recognised as distributions to equity holders in the period Proposed final dividend for the year ended 30 June 2006 4.33p per share (2005: 3.50p) Total dividend paid and proposed for the year ended 30 June 2006 6.24p per share (2005: 5.20p) 2006 £’000 1,794 983 2,777 2,248 2005 £’000 1,606 867 2,473 1,789 3,231 2,656 In accordance with IAS10 ‘Events After the Balance Sheet Date’, the proposed final dividend for the year ended 30 June 2006 has not been accrued for in these financial statements. It will be shown as a deduction from equity in the financial statements for the year ending 30 June 2007. The proposed final dividend for the year ended 30 June 2005 is shown as a deduction from equity in the year ended 30 June 2006. 57 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 9. Earnings per Share Earnings per ordinary share have been calculated by dividing the profit attributable to equity holders of the parent after taxation for each financial period by the weighted average number of ordinary shares in issue during the period. Basic earnings per share Diluted earnings per share The calculation of basic and diluted earnings per share is based upon: Earnings for basic and diluted earnings per share calculations Weighted average number of ordinary shares for basic earnings per share Impact of share options Weighted average number of ordinary shares for diluted earnings per share 2006 Pence 14.71 14.36 £’000 7,557 No. 2005 Pence 13.77 13.54 £’000 7,027 No. 51,385,648 1,227,342 51,022,645 879,018 52,612,990 51,901,663 10. Intangible Assets Cost At 1 July 2004 Additions At 30 June 2005 and 1 July 2005 Additions At 30 June 2006 Amortisation At 1 July 2004 Charge for the year At 30 June 2005 and 1 July 2005 Charge for the year At 30 June 2006 Net book value At 30 June 2006 At 30 June 2005 and 1 July 2005 At 1 July 2004 Goodwill £’000 Software £’000 Develop- ment costs £’000 Patent rights £’000 Product rights £’000 Marketing authori- sations £’000 4,385 — 4,385 — 4,385 — — — — — 4,385 4,385 4,385 — 288 288 429 717 — 33 33 58 91 626 255 — 310 321 631 195 826 80 41 121 60 181 645 510 230 789 — 789 — 789 — — — — — 789 789 789 — 278 278 — 278 — — — 18 18 260 278 — — 822 822 — 822 — — — — — 822 822 — Total £’000 5,484 1,709 7,193 624 7,817 80 74 154 136 290 7,527 7,039 5,404 Goodwill is allocated across cash generating units and consequently a consistent approach in assessing the carrying value of this amount is taken. Key assumptions made in this respect are given in note 12. Development costs are internally generated. All other additions to intangible assets were acquired outside the Group and have been measured at cost at the time of acquisition. The amortisation charge is recognised within administrative expenses in the income statement. During the year ended 30 June 2003, the Group entered into an agreement with Bioenvision, a company based in the USA, to acquire the exclusive marketing and development rights of Trilostane for animal health applications in the USA and Canada. Trilostane is the active ingredient in the Group’s branded product Vetoryl®. The first stage payment of £789,000 including legal costs was made in 2003 and has been capitalised as a patent right. Depending upon certain milestones being achieved, the Group is committed to making two further payments. The second stage payment of US$750,000 becomes payable on the submission of a New Animal Drug Application to the US Food and Drug Administration (“FDA”) and the final payment of US$3,000,000 becomes payable on the FDA granting a marketing authorisation for Vetoryl®. Once a marketing authorisation has been granted and the patent right can be applied commercially, the patent rights will begin to be amortised. The Product Rights of £278,000 are the rights to Thyroxyl, which is being sold commercially in the USA. This amount is being amortised over 15 years being the term of the agreement. The marketing authorisations relate to the Vetivex® range of products. The Vetivex® marketing authorisations are regarded as having indefinite useful economic lives and have not been amortised. Ownership of the marketing authorisations rests with the Group in perpetuity. There are not believed to be any legal, regulatory or contractual provisions that limit their useful lives. Vetivex® is an established range of products which are relatively simple in nature. Accordingly, the Directors believe that it is appropriate that the marketing authorisations are treated as having indefinite lives for accounting purposes. 58 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 11. Property, Plant and Equipment Freehold land £’000 Short leasehold buildings £’000 Motor vehicles £’000 Plant and fixtures £’000 Cost At 1 July 2004 Additions Disposals At 30 June 2005 and 1 July 2005 Additions Disposals At 30 June 2006 Depreciation At 1 July 2004 Charge for the year Disposals At 30 June 2005 and 1 July 2005 Charge for the year Disposals At 30 June 2006 Net book value At 30 June 2006 At 30 June 2005 and 1 July 2005 At 1 July 2004 Net book value of assets held under finance leases At 30 June 2006 At 30 June 2005 and 1 July 2005 At 1 July 2004 Assets in the course of construction included above Contracted capital commitments 13 — — 13 — — 13 — — — — — — — 13 13 13 — — — 2,627 60 (243) 2,444 157 — 2,601 511 147 (243) 415 135 — 550 2,051 2,029 2,116 77 — — 596 — (58) 538 — (105) 433 541 54 (58) 537 1 (105) 433 — 1 55 — — 32 Total £’000 9,196 722 (616) 9,302 1,535 (290) 10,547 3,972 902 (518) 4,356 886 (290) 4,952 5,595 4,946 5,224 5,960 662 (315) 6,307 1,378 (185) 7,500 2,920 701 (217) 3,404 750 (185) 3,969 3,531 2,903 3,040 1,028 1,105 224 149 2006 £’000 1,444 823 224 181 2005 £’000 269 379 59 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 12. Impairment Reviews Goodwill, indefinite life assets and intangible assets not yet available for use are tested for impairment annually, or more frequently if there are indications that amounts might be impaired. The impairment test involves determining the recoverable amounts of the relevant cash- generating unit, which corresponds to the higher of the fair value less costs to sell or its value in use. Value in use calculations have been performed using the methods and assumptions detailed below: (a) (b) Goodwill The carrying amount of goodwill shown in note 10 comprises £2,154,000 (2005: £2,154,000) relating to the acquisition of North Western Laboratories Limited and £2,231,000 (2005: £2,231,000) relating to the acquisition of Anglian Pharma plc. For the purpose of annual impairment reviews the goodwill relating to North Western Laboratories has been allocated to the Laboratories cash-generating unit whilst the goodwill relating to Anglian Pharma plc has been allocated to the Dales Pharmaceuticals cash- generating unit. The recoverable amount of both units is based on value in use calculations. The value in use of each of these cash-generating units has been determined by discounting projected future cash flows by a pre-tax discount rate of 11.6%, being the Directors’ estimate of the weighted average cost of capital of the Company. Projected future cash flows have been derived from the annual budget for the year ending 30 June 2007 extrapolated over a 10 year period applying a growth rate of 5% per annum up to year five. No growth in revenues are assumed beyond year five. In both cases, the value in use is significantly higher than the carrying amount and no impairment provision is therefore required. Indefinite Life Assets As disclosed in note 10, the Directors consider that the Vetivex® marketing authorisations with a carrying amount of £822,000 have an indefinite life. Their value in use has been determined by discounting projected future cash flows by a pre-tax discount rate of 11.6%, being the Directors’ estimate of the weighted average cost of capital of the Company. Projected future cash flows have been derived from the annual budget for the year ending 30 June 2007 extrapolated over a 10 year period applying a growth rate of 5% per annum up to year five. No growth in revenues are assumed beyond year five. The value in use is significantly higher than the carrying amount and no impairment provision is therefore required. (c) Intangible Assets not yet available for use The Group is developing an intangible asset in respect of authorisation to market our product Vetoryl® in the USA. This intangible asset will only be available for use once marketing authorisation is received from the FDA. The carrying amount in respect of this intangible asset is as follows: Payment to acquire patent rights to Trilostane (the active ingredient of Vetoryl®) Subsequent development costs 2006 £’000 789 323 1,112 2005 £’000 789 128 917 Value in use has been determined by discounting the projected cash flows by a pre-tax discount rate of 16.6%. The higher discount rate reflects the uncertainty of the timing of future cash flows. Projected cash flows have been determined from a detailed marketing plan covering a five year period from product launch extrapolated up to 30 June 2016. No growth in revenues is assumed after the fifth year following launch. The marketing plan uses data on the market size and market penetration taking into account our experience in launching Vetoryl® in other territories. Based upon the above calculation, the value in use is significantly higher than the carrying amount and no impairment provision is required. 60 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 13. Deferred Taxes (a) Recognised deferred tax assets and liabilities Deferred tax assets and liabilities are attributable to the following: Intangible assets Property, plant and equipment Inventories Receivables Cash and cash equivalents Borrowings Payables Current tax liabilities Share-based payments Assets Liabilities Net 2006 £’000 2005 £’000 — — — 98 — — 38 — 813 949 — — — 45 — — 103 — 683 831 2006 £’000 (193) (311) — — — — — — — (504) 2005 £’000 (153) (272) — — — — — — — (425) 2006 £’000 (193) (311) — 98 — — 38 — 813 445 2005 £’000 (153) (272) — 45 — — 103 — 683 406 On the basis that all deferred income taxes relate to the UK and that there is a legally enforceable right to offset current tax liabilities against current tax assets, deferred income tax assets and liabilities have been offset. (b) Unrecognised deferred tax assets Tax losses 2006 £’000 108 2005 £’000 30 No deferred tax asset has been recognised in respect of the losses incurred by the Company’s USA subsidiary due to the uncertainty of achieving taxable profits in the USA against which the losses can be offset. (c) Movement in temporary differences during the year Intangible assets Property, plant and equipment Inventories Receivables Cash and cash equivalents Borrowings Payables Current tax liabilities Share-based payments Intangible assets Property, plant and equipment Inventories Receivables Cash and cash equivalents Borrowings Payables Current tax liabilities Share-based payments Balance at 1 July 2004 £’000 Recognised in income £’000 Recognised in equity £’000 Balance at 30 June 2005 £’000 (69) (296) — 24 — — 61 — 204 (76) (84) 24 — 21 — — 42 — 91 94 — — — — — — — — 388 388 (153) (272) — 45 — — 103 — 683 406 Balance at 1 July 2005 £’000 Adoption of IAS39 £’000 Recognised in income £’000 Recognised in equity £’000 Balance at 30 June 2006 £’000 (153) (272) — 45 — — 103 — 683 406 — — — 17 — — 14 — — 31 (40) (39) — 36 — — (79) — 68 (54) — — — — — — — — 62 62 (193) (311) — 98 — — 38 — 813 445 61 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 14. Inventories Raw materials and consumables Work in progress Finished goods and goods for resale 15. Trade and Other Receivables Trade receivables Other receivables Prepayments and accrued income Trade receivables are stated after an impairment provision of £2,035,000 (2005: £1,761,000). 16. Cash and Cash Equivalents Cash at bank and in hand Short-term deposits The short-term deposits are repayable on demand. 17. Trade and Other Payables Trade payables Other payables Other taxation and social security Accruals and deferred income 18. Current Tax Liabilities Corporation tax payable 2006 £’000 1,443 117 20,397 21,957 2006 £’000 33,476 1,073 798 35,347 2006 £’000 4,552 15,186 19,738 2006 £’000 41,988 491 1,373 1,678 45,530 2006 £’000 2,505 2005 £’000 1,021 694 18,675 20,390 2005 £’000 31,778 1,112 818 33,708 2005 £’000 3,857 10,067 13,924 2005 £’000 38,175 313 1,650 1,833 41,971 2005 £’000 2,057 62 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 19. Borrowings Current liabilities Bank loans and overdrafts Finance lease obligations Non-current liabilities Bank loans Finance lease obligations Arrangement fees netted off Total borrowings At the year end, the Group had the following unutilised borrowing facilities: Revolving credit facility Bank overdraft facility 2006 £’000 3,019 398 3,417 14,200 1,147 (105) 15,242 18,659 2006 £’000 5,000 4,000 9,000 2005 £’000 1,400 102 1,502 17,200 271 (190) 17,281 18,783 2005 £’000 5,000 4,000 9,000 The term loan from Bank of Scotland is secured by a fixed and floating charge on the assets of the Group. Interest is charged at 1.25% over LIBOR. The loan is repayable in instalments up to 30 June 2010. The overdraft facility is renewable annually whilst the revolving credit facility is committed until 30 June 2010. The maturity of the bank loans and overdrafts is as follows: Payable: Within one year Between one and two years Between two and five years 2006 £’000 3,019 4,000 10,200 17,219 2005 £’000 1,400 3,000 14,200 18,600 The minimum lease payments and the present value of minimum lease payments payable under finance lease obligations are: Within one year Between one and two years Between two and five years Total minimum lease payments Future finance charges Present value of lease obligations Further information on the interest profile of borrowings is shown in note 20. Minimum Lease Payments 2005 £’000 2006 £’000 Present Value of Minimum Lease Payments 2005 £’000 2006 £’000 503 444 835 1,782 (237) 1,545 130 151 161 442 (69) 373 398 375 772 1,545 — 1,545 102 125 146 373 — 373 63 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 20. Financial Instruments The Group adopted IAS32, ‘Financial Instruments: Disclosure and Presentation’ and IAS39, ‘Financial Instruments: Recognition and Measurement’ with effect from 1 July 2005. As allowed by the transitional provisions, comparative information for the year ended 30 June 2005 is presented under UK GAAP. The Group’s financial instruments comprise cash deposits, bank loans and overdrafts, finance lease obligations, derivatives used for hedging purposes and trade receivables and payables. Treasury Policy Treasury policy is set by the Board and monitored by the Group Finance Director. The Group does not speculate on short-term interest or exchange rate movements. Derivatives are used only to hedge underlying commercial positions and are not used for speculative or trading purposes. Financial Risk Management (i) Interest rate risk All cash deposits and bank loans and overdrafts bear interest at floating rates linked to base rate or LIBOR and are consequently exposed to cash flow and interest rate risk. The Group seeks to hedge interest rate risk on between 20% and 80% of outstanding bank loans. By way of a separate derivative financial instrument, £5,733,000 of outstanding loans are subject to a floor and ceiling arrangement whereby the Group’s exposure to fluctuations in LIBOR are limited to a minimum rate of 4.53% and a maximum rate of 5.50%. All finance leases and hire purchase contracts are at fixed rates determined at the inception of the contract. Sensitivity — a 1% increase in interest rates would reduce Group profit before taxation by £158,000. (ii) Foreign exchange risk Foreign exchange exposure is hedged naturally as far as possible by matching receipts and payments in the relevant foreign currency. The Group maintains Euro and US Dollar bank accounts for this purpose. Unmatched foreign currency exposure is hedged at the discretion of the Group Finance Director within the parameters set by the Board. Hedging instruments allowed to be used are forward contracts and options to purchase the relevant foreign currency. No borrowings are denominated in foreign currencies. (iii) Credit risk Cash is only deposited with highly rated UK-based banks. The Group offers trade credit to customers in the normal course of business. Trade and bank references are obtained prior to extending credit. Insurance is held in respect of overseas receivables. (iv) (v) Concentration of credit risk The Group sells to a large number of customers and, with the exception of corporate veterinary practices and veterinary wholesalers, credit risk is not highly concentrated. The largest customer accounted for approximately 3.0% of gross trade receivables at 30 June 2006. Liquidity risk Liquidity risk is the risk that the Group will not have sufficient funds to meet liabilities. Cash forecasts identifying the liquidity requirements of the Group are produced quarterly. These are reviewed to ensure sufficient financial headroom exists for at least a 12 month period. The Group’s undrawn borrowing facilities at 30 June 2006 are detailed in note 19. Maturity of Financial Instruments The maturity of financial instruments excluding short-term receivables and payables are shown in notes 16 and 19. Interest Rate Profile The following table shows the effective interest rate at the balance sheet date of interest-bearing financial assets and liabilities and the period in which they reprice or mature. 64 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 20. Financial Instruments continued 2006 Carrying Value £’000 Effective Interest Rate % Period to re-pricing or maturity within 3 months £’000 1–2 years £’000 2–3 years £’000 3–4 years £’000 4–5 years £’000 Financial assets — bank deposits (a) Financial liabilities — bank loans (b) — finance leases (c) 15,186 (17,114) (1,545) (18,659) 4.0 6.0 7.3 15,186 (17,114) — — — (62) — — (3) — — — (787) — (693) (a) Floating rate at 0.5% below base rate. (b) Floating rate at 1.25% above LIBOR. (c) Various fixed interest rates with a weighted average rate of 7.3%. Foreign Currency Profile At 30 June 2006, the Group had no material financial assets or liabilities denominated in foreign currencies. Derivatives The Group held the following derivatives at 30 June 2006: Interest rate floor and ceiling Carrying Value £’000 2 Gross amount hedged £’000 5,733 Although used for the purpose of hedging interest rate risk, this derivative has been designated as held for trading financial instrument for the purposes of IAS39, with changes in fair value being taken through the income statement. The instrument matures on 31 December 2007. All loans held by the Group are measured at amortised cost. Fair Values of Financial Instruments The following table summarises the carrying values and fair values of financial assets and liabilities. Financial assets Cash and cash equivalents (a) Trade receivables (a) Derivatives (c) Financial liabilities Bank loans (a) Finance leases (b) Trade payables (a) Derivatives (c) 2006 2005 Carrying Value £’000 Fair Value Carrying Value £’000 £’000 Fair Value £’000 19,738 33,476 2 53,216 (17,114) (1,545) (41,988) — (60,647) 19,738 33,476 2 53,216 (17,114) (1,583) (41,988) — (60,685) 13,924 31,778 77 45,779 (18,410) (373) (38,175) — (56,958) 13,924 31,778 19 45,721 (18,410) (400) (38,175) (44) (57,029) (a) Due to the nature and/or short-term maturity of these financial instruments, carrying values approximate to fair values. (b) The fair values of these financial instruments are based upon discounted cash flows, using discount rates based upon the Group’s cost of borrowing at the balance sheet date. (c) The fair values of these financial instruments are based upon the amount that the Group would receive or pay to terminate the instrument at the balance sheet date, being the market price of the instrument. 65 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 20. Financial Instruments continued 2005 Financial Instruments Disclosure An explanation of the Group’s treasury policies and controls is set out on pages 22 and 23. As permitted by Financial Reporting Standard 13, short-term debtors and creditors meeting the definition of a short term asset or liability are excluded from these disclosures. Fair Value of financial assets and liabilities (a) The Group’s financial assets and liabilities are, with the exception of finance leases, the floor and ceiling arrangement (see (b) below) and the currency option (see below), at floating rates of interest and therefore their fair value and book value are equal. Finance leases are at various fixed rates of interest; however, the difference between book value and fair value is not material. At 30 June 2005 the Group had a foreign currency swap option for $3.00 million to exchange sterling for US dollars at any time before 31 December 2005. Its book value at 30 June 2005 was £77,000 whilst the fair value was £19,000. Interest rate risk profile of financial liabilities as at 30 June 2005 (b) Financial liabilities principally comprise the Group’s borrowings of bank loans and overdrafts from the Bank of Scotland. These are secured by fixed and floating charges on the assets of the Group. All interest is payable at floating rates of 1–1.25% above LIBOR. The Group also has finance lease commitments of £373,000 with a weighted average fixed interest rate of 8.9% over a weighted average term of 45 months. During the year, the Group entered into an interest rate floor and ceiling arrangement which effectively fixes the LIBOR rate to within the range 4.53%–5.50% over one-third of the Group’s bank borrowings (£6.2 million at 30 June 2005). This arrangement expires on 31 December 2007. At 30 June 2005, the book value was £nil whilst the fair value was (£44,000). Foreign currency exposure profile (c) There were no material foreign currency monetary assets or liabilities that would give rise to gains or losses in the profit and loss account. Maturity of borrowings (d) Details are shown in note 19. Maturity of facilities (e) At 30 June 2005 the Group had an undrawn committed revolving credit facility of £5 million maturing in between two to five years and an overdraft facility of £4 million which is renewable annually. 21. Share Capital Authorised Issued at start of year New shares issued At end of year Ordinary shares of 1p each 2006 2005 £’000 No. £’000 No. 750 511 8 519 75,000,000 51,120,964 794,038 51,915,002 750 510 1 511 75,000,000 50,977,857 143,107 51,120,964 During the year, 794,038 new ordinary shares of 1p (2005: 143,107 new ordinary shares of 1p) were issued following the exercise of options under the Unapproved and SAYE Share Options Schemes. The consideration received was £748,000 (2005: £170,000). The holders of ordinary shares are entitled to receive dividends as declared or approved at General Meetings from time to time and are entitled to one vote per share at meetings of the Company. 66 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 22. Share-based Payments During the year, the Company operated the Unapproved Share Option Scheme, the Approved Share Option Scheme, the Executive Incentive Plan and the Save As You Earn (“SAYE”) Share Option Scheme as described below: Unapproved and Approved Share Option Schemes Under these Schemes, options are granted to certain executives and employees of the Group (excluding Executive Directors) to purchase shares in the Company at a price fixed at the average market value over the three days prior to the date of grant. For the options to vest, there must be an increase in earnings per share of at least 12% above the growth in the UK Retail Price Index (RPI) over a three year period. Once vested, options must be exercised within 10 years of the date of grant. Executive Incentive Plan Under this plan Executive Directors and selected Senior Executives are awarded shares in the Company subject to a Total Shareholder Return (“TSR”) target. The TSR target measures the Company’s TSR performance against the FTSE Small Cap Index over a three year measurement period (commencing at the beginning of the financial year in which the awards are made). 100% of the shares vest if the Company achieves an upper quartile performance, 30% of the shares vest at median performance and awards vest on a straight-line basis for performance in between. No shares vest if performance is below median. In addition, awards will only vest if, in the opinion of the Remuneration Committee, the performance of the Company has been satisfactory. SAYE Option Scheme This Scheme is open to all UK employees. Participants save a fixed amount of up to £250 per month for either three or five years and are then able to use these savings to buy shares in the Company at a price fixed at a 20% discount to the market value at the start of the saving period. The SAYE options must ordinarily be exercised within six months of the completion of the relevant savings period. The exercise of these options is not subject to any performance criteria. Outstanding awards and the movement during the year are shown below: Year ended 30 June 2006 Unapproved Share Option Scheme 14 September 2000 22 April 2002 11 April 2003 Exercise price per share Pence At 1 July 2005 Number Exercise period Exercised Number Granted Number Lapsed Number At 30 June 2006 Number 2003–2010 2005–2012 2006–2013 120 153.5 58.5 343,000 317,000 99,500 (210,000) (229,500) (17,000) 759,500 (456,500) — — — — (2,000) — — 131,000 87,500 82,500 (2,000) 301,000 Approved Share Option Scheme 2 April 2004 3 December 2004 5 April 2005 15 March 2006 2007–2014 2007–2014 2008–2015 2009–2016 134.5 180 202.5 252 Executive Incentive Plan 5 December 2003 9 October 2004 3 October 2005 SAYE Option Scheme 26 April 2001 9 April 2002 3 April 2003 15 October 2004 18 October 2005 Total 2006–2007 2007–2008 2008–2009 2004–2006 2005–2007 2006–2008 2007–2009 2008–2010 — — — 158 129 39 124 204 137,000 30,000 179,000 — 346,000 505,000 210,739 — 715,739 29,896 29,078 873,523 142,619 — — — — — — — — — — — — — 177,000 (14,000) — (8,000) (2,000) 123,000 30,000 171,000 175,000 177,000 (24,000) 499,000 — — 205,141 — (28,213) — 505,000 182,526 205,141 205,141 (28,213) 892,667 — (1,766) (335,772) — — — — — — 111,078 (1,708) (14,742) (41,358) (13,492) (12,748) 28,188 12,570 496,393 129,127 98,330 1,075,116 (337,538) 111,078 (84,048) 764,608 2,896,355 (794,038) 493,219 (138,261) 2,457,275 Weighted average exercise price 74.6p 94.2p 136.3p 89.0p 79.9p 67 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 22. Share-based Payments continued Year ended 30 June 2005 Unapproved Share Option Scheme 14 September 2000 22 April 2002 11 April 2003 Exercise price per share Pence At 1 July 2004 Number Exercise period Exercised Number Granted Number Lapsed Number At 30 June 2005 Number 2003–2010 2005–2012 2006–2013 120 153.5 58.5 433,000 352,500 105,000 (78,000) (17,500) — 890,500 (95,500) — — — — (12,000) (18,000) (5,500) 343,000 317,000 99,500 (35,500) 759,500 Approved Share Option Scheme 2 April 2004 3 December 2004 5 April 2005 2007–2014 2007–2014 2008–2015 134.5 180 202.5 Executive Incentive Plan 5 December 2003 9 October 2004 SAYE Option Scheme 26 April 2001 9 April 2002 3 April 2003 15 October 2004 Total 2006–2007 2007–2008 2004–2006 2005–2007 2006–2008 2007–2009 — — 158 129 39 124 143,000 — — 143,000 505,000 — 505,000 73,297 59,387 985,279 — — — — — — — — (13,978) (16,662) (16,967) — — 30,000 181,000 (6,000) — (2,000) 137,000 30,000 179,000 211,000 (8,000) 346,000 — 210,739 210,739 — — — 144,147 — — — (29,423) (13,647) (94,789) (1,528) 505,000 210,739 715,739 29,896 29,078 873,523 142,619 1,117,963 (47,607) 144,147 (139,387) 1,075,116 2,656,463 (143,107) 565,886 (182,887) 2,896,355 Weighted average exercise price 71.3p 119.2p 105.9p 89.8p 74.6p For options exercised during the year, the weighted average market price at the date of exercise was 241p (2005: 194p). The weighted average remaining contractual lives of options outstanding at the balance sheet date was 3.5 years (2005: 4 years). As allowed by the transitional provisions of IFRS1 and IFRS2, included above are options over shares that have not been recognised in accordance with IFRS2 as the options were granted before 7 November 2002. The fair values for shares granted under the Unapproved, Approved and SAYE Option Schemes have been calculated using the Black- Scholes Option Pricing Model. The fair value of shares awarded under the Executive Incentive Plan have been calculated using a Monte Carlo Simulation Model which takes into account the market-based performance conditions attaching to those shares: The assumptions used in calculating fair value are as follows: Executive Incentive Plan Date of grant Number of shares awarded Share price at date of grant Exercise price Expected life Risk-free rate Volatility Dividend yield Fair value per share Unapproved and Approved Share Option Schemes Date of grant Number of shares awarded Share price at date of grant Exercise price Expected life Risk-free rate Volatility Dividend yield Fair value per share 15/3/06 177,000 252p 252p 5 years 4.32% 36% 2.15% 79p 5/4/05 181,000 212p 202.5p 5 years 4.61% 36% 2.40% 69p 3/10/05 205,141 251p Nil 3 years 4.21% 36% 2.07% 169p 3/12/04 30,000 179.32p 180p 5 years 4.53% 36% 2.61% 54p 9/10/04 210,739 164p Nil 3 years 4.69% 36% 2.95% 105p 2/4/04 147,000 136p 134.5p 5 years 4.76% 36% 3.19% 40p 5/12/03 505,000 123p Nil 3 years 4.57% 36% 3.27% 78p 11/4/03 124,000 59p 58.5p 5 years 4.12% 36% 7.04% 11p 68 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 22. Share-based Payments continued Save as You Earn Option Scheme Date of grant Number of shares awarded Share price at date of grant Exercise price Expected life — three year scheme — five year scheme Risk-free rate — three year scheme — five year scheme Volatility Dividend yield Fair value per share — three year scheme — five year scheme 18/10/05 111,078 255p 204p 15/10/04 144,147 160p 124p 3/4/03 1,034,938 54p 39p 3.25 years 5.25 years 3.25 years 5.25 years 3.25 years 5.25 years 4.25% 4.31% 36% 2.04% 88p 101p 4.56% 4.64% 36% 2.92% 55p 61p 3.78% 4.14% 36% 7.63% 14p 14p National Insurance contributions are payable by the Company in respect of some of the share-based payments. These contributions are payable on the date of exercise based on the intrinsic value of the share-based payments and are therefore treated as cash-settled awards. The Group had an accrual at 30 June 2006 of £241,000 (2005: £181,000), of which £49,000 (2005: £56,000) related to vested options. The total charge to the Income Statement in respect of share-based payments was: Equity-settled share-based transactions Cash-settled share-based transactions The above charge to the Income Statement was included within administrative expenses. 23. Analysis of Net Cash/(Borrowings) Bank loans and overdraft Finance leases and hire purchase contracts Cash and cash equivalents Net cash/(borrowings) 2006 £’000 427 88 515 2005 £’000 273 125 398 As at 30.06.06 £’000 (17,114) (1,545) 19,738 1,079 As at 30.06.05 £’000 (18,410) (373) 13,924 (4,859) 24. Operating Leases At the balance sheet date the Group had outstanding commitments for future minimum rentals payable under non-cancellable operating leases as follows: Within one year Between one and five years In five years or more 2006 £’000 1,912 4,626 4,535 2005 £’000 1,716 4,058 4,919 11,073 10,693 25. Contingent Asset/Liability Dechra Limited, a subsidiary of Dechra Pharmaceuticals PLC, is in dispute with Vet Tec Systems Limited (“Vet Tec”) where each party is alleging breach of contract on the part of the other. Vet Tec provide the veterinary practice management software marketed by the Group under the brand “Vetcom Open”. Neither party has, as yet, commenced legal proceedings and the amount and timing of any asset or liability from this dispute is currently uncertain. No amounts have been included in the financial statements in respect of this dispute. 69 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 26. Critical Accounting Judgements and Key Sources of Estimation Uncertainty Critical Judgements in applying the Group’s Accounting Policies In the process of applying the Group’s accounting policies as described in note 1, the Directors have made the following judgements that have the most significant effect on the amounts recognised in the Financial Statements. Intangible Asset — Vetoryl® USA As described in note 12, the Group is carrying a total amount of £1,112,000 in respect of Vetoryl® USA. Recoverability of this amount is dependent upon obtaining FDA approval to market Vetoryl® in the USA. Based upon positive discussions with the FDA (evidenced by the product being granted expedited review status) and the obtaining of marketing approval in the European Union, the Directors concluded that the obtaining of marketing authorisation in the USA is highly likely and that the criteria for recognising an intangible asset have been met. Key Sources of Estimation Uncertainty The key sources of estimation uncertainty which may cause a material adjustment to the carrying amount of assets and liabilities are discussed below: Impairment of Goodwill and Indefinite Life Intangible Assets The Group determines whether goodwill and indefinite life assets are impaired at least on an annual basis. This requires an estimation of the value-in-use of the cash-generating units to which they are allocated. Estimating the value-in-use requires the Group to make an estimate of the expected future cash flows from the cash-generating unit and also to choose a suitable discount rate in order to calculate the present value of those cash flows. Further detail on the assumptions used in determining value-in-use calculations is provided in note 12. Impairment of Receivables The Group has estimated impairment of receivables by assessing recoverability of amounts due on a customer by customer basis. As described in note 20, credit risk is not highly concentrated with the exception of Corporate Veterinary Practices and Veterinary Wholesalers. If the receivables due from one of these large customers proved to be irrecoverable then an additional impairment provision may be required. 27. Explanation of Transition to IFRS As stated in Note 1, these are the Group’s first consolidated financial statements prepared in accordance with adopted IFRSs. Consistent accounting policies set out in note 1 have been applied in preparing comparative information for the year ended 30 June 2005 and the preparation of the opening IFRS balance sheet at 1 July 2004 (the Group’s date of transition). In preparing its opening balance sheet and comparative information for the year ended 30 June 2005 the Group has adjusted amounts reported previously in financial statements prepared in accordance with UK GAAP. The adjustments from the conversion to IFRS had no impact upon the cash flows of the Group although there are a number of presentational differences under IFRS. An explanation of the principal changes in accounting policies and how the transition from UK GAAP to IFRS has affected the Group’s income statement, balance sheet and net equity is summarised below. (a) IFRS Reconciliation of Income Statement Comparatives Revenue Cost of sales Gross profit Operating expenses Operating profit Finance income Finance expense Profit before taxation Income tax expense Profit attributable to equity holders of the parent Earnings per share (pence) Basic Diluted Notes a a b, c, d, e f Year ended 30 June 2005 Published UK GAAP £’000 208,197 (178,480) 29,717 (19,305) 10,412 355 (1,909) 8,858 (2,590) 6,268 12.28p 12.08p IFRS adjustments £’000 Restated under IFRS £’000 2,070 (2,070) — 843 843 — — 843 (84) 759 1.49p 1.46p 210,267 (180,550) 29,717 (18,462) 11,255 355 (1,909) 9,701 (2,674) 7,027 13.77p 13.54p 70 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Consolidated Financial Statements For the year ended 30 June 2006 27. Explanation of Transition to IFRS continued (b) IFRS Reconciliation of Balance Sheet Comparatives 1 July 2004 Published IFRS UK GAAP adjustments £’000 £’000 Notes a b c b d d e f d g Non-current assets Intangible assets — goodwill — software — other intangibles Property plant and equipment Deferred taxes Total non-current assets Current assets Inventories Trade and other receivables Deferred taxes Cash and cash equivalents Total current assets Total assets Current liabilities Borrowings Trade and other payables Current tax liabilities Proposed dividend Total current liabilities Non-current liabilities Borrowings Provisions Deferred taxes Total non-current liabilities Total liabilities Net assets Equity Called up share capital Share premium account Merger reserve Retained earnings Total equity attributable to equity holders of the parent (c) Reconciliation of Equity Equity under UK GAAP Write-back of proposed dividend Deferred tax Lease incentive Capitalisation of development costs Write-back of goodwill amortisation Equity under IFRS 30 June 2005 IFRS Published Restated UK GAAP adjustments under IFRS £’000 £’000 £’000 3,821 — 1,889 5,201 — 564 255 510 (255) 406 4,385 255 2,399 4,946 406 IFRS £’000 4,385 — 1,019 5,224 — 10,628 10,911 1,480 12,391 16,979 32,889 — — 20,390 33,708 4 13,924 49,868 68,026 — — (4) — (4) 20,390 33,708 — 13,924 68,022 4,385 — 789 5,224 — 10,398 16,979 32,889 — — 49,868 60,266 — — 230 — — 230 — — — — — 230 60,496 78,937 1,476 80,413 (5,347) (36,944) (1,275) (1,606) — (89) — 1,606 (5,347) (37,033) (1,275) — (1,502) (41,826) (2,057) (1,789) — (145) — 1,789 (1,502) (41,971) (2,057) — (45,172) 1,517 (43,655) (47,174) 1,644 (45,530) (4,763) — (174) (4,937) — — 98 98 (4,763) — (76) (17,281) — — (4,839) (17,281) — — — — (17,281) — — (17,281) (50,109) 1,615 (48,494) (64,455) 1,644 (62,811) 10,157 1,845 12,002 14,482 3,120 17,602 510 26,784 1,720 (18,857) 10,157 — — — 1,845 1,845 510 26,784 1,720 (17,012) 511 26,953 1,720 (14,702) 12,002 14,482 — — — 3,120 3,120 1 July 2004 £’000 10,157 1,606 98 (89) 230 — 12,002 511 26,953 1,720 (11,582) 17,602 30 June 2005 £’000 14,482 1,789 402 (145) 510 564 17,602 71 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Explanatory notes to the UK GAAP to IFRS Reconciliations Income Statement a. Under IAS18 ‘Revenue’ certain items, such as the sale of trading data to suppliers, have been reclassified to revenue from cost of sales. There is no impact on profit, earnings per share or net assets. b. c. d. e. Under UK GAAP, goodwill was amortised over its estimated useful life. Under IFRS3 ‘Business Combinations’, goodwill is not amortised but is subject to annual impairment review. This has resulted in a credit to the income statement of £564,000 for the year ended 30 June 2005. Under UK GAAP the accounting policy of the Group was, in general, to write off all development expenditure to the income statement as incurred. Under IAS38 ‘Intangible Assets’ development expenditure meeting the required criteria must be capitalised. This has resulted in a credit to the income statement of £280,000 for the year ended 30 June 2005. Under IFRS2 ‘Share-based Payments’, the cost of employee share options recognised in the income statement is based upon the excess of the fair value of the option over the exercise price at the date of grant. Under UK GAAP, the cost recognised was generally the intrinsic value being the difference in exercise price and market price at the date of grant of the option. The change in method of calculation has resulted in a net credit of £55,000 in respect of the year ended 30 June 2005. Under UK GAAP, the benefit of lease incentives received (in the form of rent-free periods) was spread over the period until the rent reverts to market rates. Under IAS17 ‘Leases’, the benefit must be spread over the entire lease period. This change has resulted in an additional charge to the income statement of £56,000 for the year ended 30 June 2005. f. The income tax expense has been adjusted to reflect the tax effect of the above adjustments. Balance Sheet a. The increase in goodwill reflects the write-back of amortisation previously charged under UK GAAP. b. c. d. e. f. g. Under IAS38 ‘Intangible Assets’, software costs that are not an integral part of the related hardware are classed as intangible assets. They have therefore been reclassified from property, plant and equipment. There is no impact on the income statement or net assets. The increase in other intangible assets represents capitalised development costs under IAS38 ‘Intangible Assets’. The calculation of deferred tax under IAS12 ‘Income Taxes’ can be different from UK GAAP, under which deferred tax is calculated based upon income statement timing differences. The principal reason for the increase in the deferred tax asset is that deferred tax in respect of share-based payments is calculated by reference to a figure which differs from the charge for such payments in the income statement. Deferred tax in respect of share-based payments charged directly to the income statement is also taken to the income statement but any excess tax relief over this amount is taken directly to equity. The increase in trade and other payables represents the balance of lease incentives received that are being spread over the remaining lease periods. Under IAS10 ‘Events After the Balance Sheet Date’ dividends are recognised when they are paid or approved by the shareholders. This generally results in a later recognition in the financial statements than under UK GAAP. The increase in retained earnings at 30 June 2005 is made up as follows: net adjustments to the income statement of £759,000 — reduction to credit to equity in respect of share-based payments of (£55,000) — capitalised development costs at 1 July 2004 of £230,000 — increase in lease incentives carried forward at 1 July 2004 of (£89,000) — de-recognition of the final dividend of £1,789,000 — credit to deferred tax recognised directly in equity of £486,000 — 72 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Financial History Income statement Revenue Operating profit before exceptional items and goodwill amortisation Profit before taxation Profit after taxation Earnings per share — basic (pence) — adjusted (pence) Dividend per share (pence) Average number of employees Balance sheet Non-current assets Working capital Current tax liabilities Deferred tax liabilities Net cash/(debt) Shareholders’ funds Cash flow Cash flow from operating activities Net interest paid Tax paid Capital expenditure Acquisitions Equity dividends paid Financing Changes in cash in period * Reported under IFRS † Reported under UK GAAP 2006* £’000 2005* £’000 2004† £’000 2003† £’000 2002† £’000 232,471 210,267 186,843 179,309 170,202 12,312 11,044 7,557 14.71 14.71 6.24 691 13,567 11,774 (2,505) — 1,079 23,915 13,997 (1,218) (2,618) (1,492) — (2,777) (97) 5,795 11,255 9,701 7,027 13.77 13.77 5.20 679 12,391 12,127 (2,057) — (4,859) 17,602 13,549 (1,667) (1,996) (1,925) — (2,473) 11,760 17,248 9,184 7,369 5,081 9.97 11.28 4.70 643 10,398 11,318 (1,275) (174) (10,110) 10,157 10,576 (1,012) (1,864) (546) — (2,192) (2,588) 2,374 8,162 5,685 3,833 7.52 9.39 4.12 615 11,302 12,189 (1,032) — (14,988) 7,471 6,542 (1,384) (2,066) (1,224) 32 (2,078) (3,410) (3,588) 8,773 7,308 5,058 10.12 10.59 4.12 500 11,608 10,256 (1,387) — (14,728) 5,749 6,397 (1,126) (2,155) (2,704) (3,823) (1,927) (765) (6,103) 35 73 Dechra Pharmaceuticals PLC Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Annual Report and Accounts 2006 Company Financial Statements Contents 74 Company Balance Sheet 75 Reconciliation of Movements in Shareholders’ Funds 76 Accounting Policies 78 Notes to the Financial Statements 74 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Company Balance Sheet At 30 June 2006 Fixed assets Investments Current assets Debtors Cash at bank and in hand Creditors: amounts falling due within one year Net current liabilities Total assets less current liabilities Creditors: amounts falling due after more than one year Net assets Capital and reserves Called up share capital Share premium account Hedging reserve Profit and loss account Total equity shareholders’ funds Note iii iv v v ix x x x 2006 £’000 53,408 53,408 43,536 1,638 45,174 2005 restated* £’000 53,408 53,408 41,471 1,345 42,816 (52,090) (48,331) (6,916) (5,515) 46,492 47,893 (14,095) (17,010) 32,397 30,883 519 27,693 (71) 4,256 32,397 511 26,953 — 3,419 30,883 * The comparatives have been restated for the adoption of FRS20 and FRS21 by the Company (see note xi). The financial statements were approved by the Board of Directors on 5 September 2006 and are signed on its behalf by: I.D. Page Director S.D. Evans Director 75 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Reconciliation of Movements in Shareholders’ Funds For the year ended 30 June 2006 At start of year as previously stated Prior year adjustments (see note xi) At start of year as restated Impact of adoption of FRS26 on 1 July 2005 (see note i) At 1 July 2005 as restated Profit for the financial year Share-based payments charge Dividends paid New shares issued At end of year 2006 £’000 33,111 (2,228) 30,883 (71) 30,812 3,187 427 (2,777) 748 2005 £’000 32,655 (2,394) 30,261 — 30,261 2,437 488 (2,473) 170 32,397 30,883 76 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Accounting Policies (i) Principal Accounting Policies of the Company Accounting Principles The Company Balance Sheet has been prepared under the historical cost convention except for derivatives which are stated at fair value in accordance with applicable UK accounting standards and the Companies Act 1985. The Company has adopted FRS20, share-based payments, FRS21 (IAS10), Events After the Balance Sheet Date and from 1 July 2005, FRS25 (IAS32), Financial Instruments: Disclosure and Presentation, FRS26 (IAS39), Financial Instruments: Measurement and FRS28 Corresponding Amounts in these financial statements. The adoption of these standards represents a change in accounting policy and accordingly the comparative figures have been restated where required. Details of the effect of the change in policy are given in note xi. Basis of Preparation No Profit and Loss Account is presented for the Company as permitted by Section 230(3) of the Companies Act 1985. The profit dealt with in the accounts of the Company was £3,187,000 (2005: £2,437,000). Investments Investments held as fixed assets are stated at cost less any impairment losses. Where the consideration for the acquisition of a subsidiary undertaking includes shares in the Company to which the provisions of section 131 of the Companies Act 1985 apply, cost represents the nominal value of the shares issued together with the fair value of any additional consideration given and costs. Derivative Financial Instruments (applicable to 30 June 2005) All financial assets and liabilities are carried at cost (amortised as appropriate) less, in the case of financial assets, provisions for permanent diminution in value. Derivative Financial Instruments (applicable from 1 July 2005) The Company uses derivative financial instruments to manage its exposure to foreign exchange and interest rate risks. In accordance with its treasury policy, the Company does not hold or issue derivative financial instruments for speculative purposes. However, derivatives that do not qualify for hedge accounting are accounted for as trading instruments. On adoption of FRS25 and FRS26, the comparative financial statements have not been restated. As permitted, the comparative statements continue to hedge account under UK GAAP. On 1 July 2005, the fair values of derivatives used for hedging were included in a hedging reserve. The corresponding adjustments were to decrease trades and other receivables by £58,000, increase trade and other payables by £44,000 and increase the deferred tax asset by £31,000. As the Company has not adopted hedge accounting under FRS26 from 1 July 2005 the hedging reserve is frozen and will only be released to the profit and loss account when the related forecast transactions occur. Derivative financial instruments are recognised initially at fair value. Subsequent to initial recognition, derivative financial instruments are stated at fair value. The gain or loss on remeasurement to fair value is recognised immediately in the profit and loss account. The fair value of interest rate swaps, floors and ceilings, is the estimated amount that the Group would receive or pay to terminate the instrument at the balance sheet date. The fair value of forward exchange contracts and options is their quoted market price at the balance sheet date, being the present value of the quoted forward price. Cash Flow Statement As the ultimate holding company of the Dechra Pharmaceuticals PLC Group, the Company has relied upon the exemption in FRSI (Revised) not to present a cash flow statement as part of its financial statements. 77 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Dividends Dividends are recognised in the period in which they are approved by the Company’s shareholders or, in the case of an interim dividend, when the dividend is paid. Dividends receivable from subsidiaries are recognised when either received in cash or applied to reduce a creditor balance with the subsidiary. Interest-Bearing Borrowings Interest-bearing borrowings are recognised initially at fair value less attributable transaction costs. Subsequent to initial recognition, interest-bearing borrowings are stated at amortised cost with any difference between cost and redemption value being recognised in the income statement over the period of the borrowings on an effective interest basis. Employee Benefits (i) Pensions The Company operates a Group stakeholder personal pension scheme for certain employees. Obligations for contributions are recognised as an expense in the profit and loss account as incurred. (ii) Share-Based Payment Transactions The Company operates a number of equity-settled share-based payment programmes that allow employees to acquire shares of the Company. The Company also operates a Long Term Incentive Plan for Directors and Senior Executives. The fair value of shares or options granted is recognised as an employee expense on a straight line basis in the income statement with a corresponding movement in equity. The fair value is measured at grant date and spread over the period during which the employees become unconditionally entitled to the shares or options (the vesting period). The fair value of the shares or options granted is measured using a valuation model, taking into account the terms and conditions upon which the shares or options were granted. The amount recognised as an expense in the profit and loss account is adjusted to take into account an estimate of the number of shares or options that are expected to vest together with an adjustment to reflect the number of shares or options that actually do vest except where forfeiture is only due to market-based conditions not being achieved. The fair value of grants under the Long Term Incentive Plan has been determined using the Monte Carlo simulation model. The fair values of options granted under all other share option schemes have been determined using the Black-Scholes option pricing model. Taxation The charge for taxation is based on the profit for the year and takes into account taxation deferred because of timing differences between the treatment of certain items for taxation and accounting purposes. Deferred tax is measured on a non-discounted basis at the tax rates that are expected to apply in the periods in which the timing differences reverse and is provided in respect of all timing differences which have arisen but not reversed by the balance sheet date, except as otherwise required by FRS19 “Deferred Tax”. Financial Guarantee Contracts The Company has not adopted amendments to FRS26 in relation to financial guarantee contracts which will apply for periods commencing on or after 1 January 2006. Where the Company enters into financial guarantee contracts to guarantee the indebtedness of other companies within its group, the Company considers these to be insurance arrangements, and accounts for them as such. In this respect, the Company treats the guarantee contract as a contingent liability until such time as it becomes probable that the Company will be required to make a payment under the guarantee. The Company does not expect the amendments to have any impact on the financial statements for the period commencing 1 July 2006. 78 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Financial Statements For the year ended 30 June 2006 (ii) Directors and Employees Total emoluments of Directors (including pension contributions) amounted to £698,000 (2005: £595,000). Information relating to Directors’ emoluments, share options and pension entitlements is set out in the Directors’ Remuneration Report on pages 34 to 39. Including Directors, the average number of staff employed during the year solely in an administrative function was 8 (2005: 3). The costs incurred in respect of these employees were: Wages and salaries Social security costs Other pension costs Share-based payment charge (iii) Fixed Asset Investments Cost and net book value At 1 July 2005 and 30 June 2006 A list of principal subsidiary undertakings is given in note xii. 2006 £’000 601 77 61 173 912 2005 £’000 151 14 14 165 344 Shares in Subsidiary Undertakings £’000 53,408 Where subsidiaries are acquired for shares, or a combination of shares and cash, statutory merger relief has been applied and accordingly cost includes the nominal value of shares issued. (iv) Debtors Amounts owed by subsidiary undertakings Group relief receivable Deferred taxation (see note viii) Other debtors Prepayments and accrued income 2006 £’000 42,403 775 260 11 87 2005 restated* £’000 40,433 537 200 191 110 43,536 41,471 Included in debtors are amounts of £260,000 (2005: £200,000) due after more than one year. * The comparatives have been restated for the adoption of FRS20 and FRS21 by the Company (see note xi). (v) Creditors Bank loans (see note vi) Amounts due to subsidiary undertakings Other creditors Other taxation and social security Accruals and deferred income 79 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Falling due within one year 2006 £’000 3,000 48,551 8 60 471 2005 restated* £’000 1,400 46,624 8 23 276 52,090 48,331 In accordance with FRS21, Events after the Balance Sheet Date, the proposed final dividend for the year ended 30 June 2006 of 4.33p per share has not been accrued for in these financial statements. It will be shown in the financial statements for the year ending 30 June 2007. The total cost of the proposed final dividend is £2,248,000. Bank loans (see note vi) (vi) Borrowings Borrowings due within one year Bank loan Borrowings due after more than one year Aggregate bank loan instalments repayable between one and two years between two and five years Arrangement fees netted off Total borrowings Falling due after more than one year 2006 £’000 2005 £’000 14,095 17,010 2006 £’000 3,000 3,000 4,000 10,200 14,200 2005 £’000 1,400 1,400 3,000 14,200 17,200 (105) (190) 14,095 17,095 17,010 18,410 The term loan from Bank of Scotland is secured by a fixed and floating charge on the assets of the Group. Interest is charged at 1.25% over LIBOR. The Company guarantees certain borrowings of other Group companies, which at 30 June 2006 amounted to £1,239,000 (2005: £nil). * The comparatives have been restated for the adoption of FRS20 and FRS21 by the Company (see note xi). 80 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Financial Statements For the year ended 30 June 2006 (vii) Financial Instruments Changes in fair value credited to profit and loss 2006 £’000 30 2005 £’000 — Details of valuation techniques and fair values of each category of financial instruments are given in note 20 to the Consolidated Financial Statements in the section headed ‘Fair values of Financial Instruments’. (viii) Deferred Tax At 1 July 2005 (included in debtors) Prior year adjustment As restated Adoption of FRS 26 on 1 July 2005 Transfer to profit and loss account At 30 June 2006 (included in debtors) The amounts provided for deferred taxation at 30% (2005: 30%) are as follows: Short term timing differences Total (ix) Called up Share Capital Issued share capital At 1 July 2005 New shares issued At 30 June 2006 Authorised share capital At 30 June 2006 and 30 June 2005 £’000 restated* (217) 17 (200) (31) (29) (260) 2005 £’000 (217) (217) 2006 £’000 (260) (260) Ordinary Shares of 1p each £’000 No. 511 8 519 51,120,964 794,038 51,915,002 750 75,000,000 During the year, 794,038 new ordinary shares of 1p were issued following the exercise of options under the Unapproved and SAYE share option schemes. The consideration received was £748,000 (2005: £170,000). Share Options Details of outstanding share options over ordinary shares of 1p at 30 June 2006 under the various Group share option schemes are shown in note 22 to the Consolidated Financial Statements. * The comparatives have been restated for the adoption of FRS20 and FRS21 by the Company (see note xi). 81 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Share premium account £’000 26,953 — 26,953 — 26.953 740 — — — 27,693 Hedging reserve £’000 — — — (71) (71) — — — — (71) Profit and loss account £’000 5,647 (2,228) 3,419 — 3,419 — 3,187 (2,777) 427 4,256 (x) Reserves At 1 July 2005 as previously stated Prior year adjustment (see note xi) As restated Adoption of FRS26 on 1 July 2005 At 30 July 2005 as restated New shares issued Profit for the financial year Dividend (see note 8 to Consolidated Financial Statements) Share-based payments charge At 30 June 2006 (xi) Changes in Accounting Policy The Company has adopted the following standards FRS20, Share-Based Payments, FRS21, Events After the Balance Sheet Date, and, with effect from 1 July 2005, FRS25, Financial Instruments: Disclosure and Presentation, and FRS26, Financial Instruments: Measurement. Under previous UK GAAP, the cost of granting employee share options recognised in the income statement was the intrinsic value of the option being the difference in exercise price and market price at the date of grant of the option. Options issued under Save As You Earn (“SAYE”) schemes were exempt from this requirement. Previously the Company has recognised a charge to the Profit and Loss Account only in respect of the Long Term Incentive Plan. Under FRS20 ‘Share-Based Payments’, the cost recognised in the income statement is based upon the excess of the fair value of the option over the exercise price at the date of grant. Although this results in an additional charge in respect of the Company’s Approved, Unapproved and SAYE share option schemes, there is a reduction in the charge in respect of the Long Term Incentive Plan. The net result is a credit of £55,000 for the year ended 30 June 2005. There is no impact on net assets or distributable reserves as a result of this adjustment which is taken directly to equity. An additional deferred tax charge of £17,000 has been made to reflect the tax effect of the above adjustment. Under FRS21 ‘Events After the Balance Sheet Date’ final dividends are generally recognised in the subsequent accounting period to which they would have been recognised under previous UK GAAP. At 30 June 2005, the final dividend for 2005 of £1,789,000 (2004: £1,606,000) has been added back to net assets as part of distributable reserves and appears as a deduction from equity in the year ended 30 June 2006. Similarly, dividends receivable from subsidiaries are generally recognised in the subsequent accounting period to which they would have been recognised under previous UK GAAP. At 30 June 2005, dividends of £4,000,000 (2004: £4,000,000) have been deducted from net assets as part of distributable reserves and are included within profit for the year in the year ended 30 June 2006. The Company adopted FRS25 and FRS26 with effect from 1 July 2005. In accordance with the transitional provisions of these standards, the comparative financial statements for 2005 have not been restated. 82 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Notes to the Financial Statements For the year ended 30 June 2006 (xii) Subsidiary Undertakings The principal subsidiary undertakings of the Company, all of which are wholly owned, are: Company Country of Operation Country of Incorporation Principal Activity Dechra Limited§ UK Great Britain Wholesaler, marketer and manufacturer Dechra Investments Limited National Veterinary Services Limited* Arnolds Veterinary Products Limited* Dales Pharmaceuticals Limited* Veneto Limited North Western Laboratories Limited Cambridge Specialist Laboratory Services Limited† Anglian Pharma Manufacturing Limited‡ Anglian Pharma Limited UK UK UK UK UK UK UK UK UK Great Britain Great Britain Great Britain Great Britain Great Britain Great Britain Great Britain Great Britain Great Britain of pharmaceuticals; Wholesaler and marketer of veterinary products, instruments and equipment; Provider of veterinary laboratory services Holding company Non-trading Non-trading Non-trading Holding company Non-trading Non-trading Non-trading Holding company Dechra Veterinary Products LLC USA USA Distributor of veterinary products * § † ‡ 100% of ordinary share capital held by Veneto Limited. Voting preference shares held by Dechra Pharmaceuticals PLC Employee Benefit Trust. 100% of ordinary share capital held by Dechra Investments Limited. 100% of ordinary share capital held by North Western Laboratories Limited 100% of ordinary share capital held by Anglian Pharma Limited. Shareholders’ Notes 83 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 84 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Shareholders’ Notes Advisers 85 Dechra Pharmaceuticals PLC Annual Report and Accounts 2006 Merchant Bank & Financial Advisers Registrars NM Rothschild & Sons Limited Computershare Services PLC PO Box 82 The Pavilions Bridgwater Road Bristol BS99 7NH Financial PR Citigate Dewe Rogerson 9 The Apex 6 Embassy Drive Edgbaston Birmingham B15 1TP New Court St Swithins Lane London EC4P 4DU Stockbroker & Financial Advisers Dresdner Kleinwort 30 Gresham Street London EC2P 2XY Principal Bankers Bank of Scotland 55 Temple Row Birmingham B2 5LS Auditors KPMG Audit Plc 2 Cornwall Street Birmingham B3 2DL Lawyers DLA Piper Rudnick Gray Cary LLP Victoria Square House Victoria Square Birmingham B2 4DL Welcome to Dechra Our Strategy To continue the development of our veterinary pharmaceutical portfolio and increase our pharmaceutical penetration into international markets. Our Business An emerging pharmaceutical business, focused on the veterinary market. 1 0 f o o r P 6 0 0 2 / 8 0 / 8 0 e t a D 3 1 3 2 1 . o n b o J Contents 01 Highlights 02 Chairman’s Statement 04 Global Markets 05 Directors’ Business Review Review of the year Financial Review 24 Directors and Senior Management 26 Directors’ Report 28 Corporate Governance 32 Audit Committee Report 34 Directors’ Remuneration Report 40 Social, Ethical and Environmental Responsibilities 41 Statement of Directors’ Responsibilities in respect of the Annual Report and the Financial Statements 42 Independent Auditors’ Report 43 Consolidated Income Statement 44 Consolidated Balance Sheet 45 Consolidated Statement of changes in Shareholders’ Equity 46 Consolidated Statement of Cash Flows 48 Notes to the Consolidated Financial Statements 72 Financial History 74 Company Balance Sheet 75 Reconciliation of Movements in Shareholders’ Funds 76 Accounting Policies 78 Notes to the Financial Statements 85 Advisers Developing Pharmaceuticals Improving Animal Health Annual Report and Accounts 2006 Dechra House Jamage Industrial Estate Talke Pits Stoke-on-Trent ST7 1XW Staffordshire England t: +44 (0)1782 771100 f: +44 (0)1782 773366 e: corporate.enquiries@dechra.com www.dechra.com Registered in England No. 3369634 D e c h r a ® P h a r m a c e u t i c a s P L C A n n u a l l R e p o r t a n d A c c o u n t s 2 0 0 6 

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