Operations and performance
Underlying operating profit by financial reporting segment
| 2011 | 2010 | % change |
Highways (£m) | 4.5 | 19.4 | (76.8) |
Government and Business Services (£m) | 7.4 | 15.0 | (50.7) |
Regulated Industries (£m) | 2.0 | 2.9 | (31.0) |
Management Consulting (£m) | 1.8 | 3,9 | (53.8) |
Underlying operating profit (£m) | 15.7 | 41.2 | (61.9) |
Group summary
Mouchel has experienced another challenging year as the Government reassessment of its spending priorities continues to have an impact on the Group. Uncertainty over the outcome of the refinancing of our bank borrowing facilities in the first half of the year had a negative impact on the business. Speculation about the Group’s financial stability led to several takeover approaches and between early December 2010 and March 2011 the Group was in an ‘offer period’, conducting takeover talks with a number of parties. This made the first six months particularly difficult. With the ending of the ‘offer period’ we are able to refocus on winning new contracts and delivering on our commitments. The uncertainty the ‘offer period’ caused, together with a tough trading environment, had an adverse impact on the Group performance, particularly within Management Consulting.
As a result, Mouchel suffered a significant decline in revenue of 14.7% to £539.6m (excluding exceptional items) (2010: £632.6m). Underlying operating profit from operations fell by 61.9% to £15.7m (2010: £41.2m). After pre-exceptional net finance costs of £10.7m (2010: £10.7m), underlying profit before taxation was £5m (2010: £30.5m), a decline of 84%. The adjusted loss per share on the same basis to was (0.5) pence (2010: earnings per share: 18.9 pence), reflecting the decrease in normalised profit before taxation.
Exceptional items before tax increased by 54% to £69.8m (2010: £45.2m), of which £21.9m (2010: £17.6m) was a cash cost to the Group. Significant items include goodwill impairment (£45.3m); amortisation of arrangement fees (£7.2m); and amortisation of intangible assets (£6.4m). Also included are net £4.5m of exceptional items relating to contracts. The two most significant relate to Holleran and a business process reengineering (BPR) contract in the Middle East.
The BPR contract was a project undertaken across four Municipalities in the UAE. The project is substantially complete, but a number of tasks remain outstanding, and are due to be closed out by the end of 2011. Contained within the exceptional loss for this contract of £3.9m are provisions to reflect further costs for completion. In addition, debt and work in progress of circa £12m on this contract was outstanding at 31 July 2011, which has been discounted to recognise that monies are not expected to be received until the next calendar year. Of the total exceptional charge, approximately £12m has been paid out in cash during the year.
The goodwill impairment represents the full impairment against the Management Consulting business of £41.3m and £4m in relation to Gas Experts Ltd. The significant downturn in the Management Consulting business during the year and the expectation of a continued difficult environment for the foreseeable future led to the impairment provision. On a statutory basis, the loss before tax increased from £14.7m to £64.8m. Underlying cashflow from operations of £39.3m (2010: £70.3m) represented a 250% conversion of underlying profit from operations of £15.7m (2010: £41.2m). After special pension fund payments of £7.2m (2010: £7.9m), in line with our pension deficit recovery plan; net capital expenditure of £4.4m (2010: £10.6m); restructuring costs of £21.9m (2010: £17.6m) and interest and tax of £9.5m (2010: £7.1m), the Group had net bank borrowings of £87.7m (2010: £83.3m).
Banking
On 29 November 2011, Mouchel agreed amendments to the terms of our principal banking facilities (£129m term loan and £35m revolving credit facility) which expire up to 31 March 2014. The purpose of the amendments was to avoid a breach of the banking facilities which would otherwise have occurred upon publication of the 2011 Accounts; to provide for a £16m increase in the facilities available to £180m (repayable on, or before, 28 February 2013); and to amend covenants with a view to avoiding future financial covenant breaches, which would otherwise be expected to arise prior to April 2013. The amended credit facilities comprise:
a £129m term loan,
a £35m revolving credit facility, and
an additional £16m secured revolving credit facility (the ‘Top-up facility’) in place until 28 February 2013.
Pursuant to the amendments, we have agreed to pay an amendment fee of £2.25m on the earlier of 31 January 2013, and the date of the relevant restructuring, to issue warrants over 5% of the existing issued share capital of the Company at a subscription price of 0.25p per share, subject to standard anti-dilution provisions, which replaces the existing contingent obligation to provide warrants to the lenders, and to pay an additional fee – the equity tracker fee – which is payable upon a change of control and that is the economic equivalent of 5% of the enlarged issued share capital.
As explained (in the Chairman’s statement), it is intended that a restructuring of the Group’s balance sheet would take place prior to the end of the current financial year in the interests of the Group and its stakeholders. This restructuring may include the injection of sufficient additional equity capital to enable a refinancing of the business or a change of control (the ‘Restructuring’). If the Restructuring is achieved by 31 July 2012, then, depending on the timing of the Restructuring, either no restructuring fee would be payable or a fee of between £1.5m and £3m would be payable. In the event that a Restructuring is not achieved by 31 July 2012, an amendment fee of £8m would be payable. Such additional amendment fees shall be payable on the earlier of 31 January 2013 or the date of the relevant Restructuring. Pending the repayment of the Group’s banking facilities in full, the restriction on dividend payments will remain in place.
The interest margin on the term loan will remain unchanged at 3.85%. The interest margin on the revolving credit facilities will be 6.5%, apart from the margin on the Top-up facility which shall be at 10%. The provision that there will be an increase in the interest margin of 2% if an additional voluntary repayment of £30m has not been made by 31 May 2012 has been removed. Furthermore, the obligatory repayment of £7.5m, due in 31 July 2012, has been extended to 28 February 2013, when the Top-up facility shall also be repayable. The new facilities do not contain any financial covenants other than a quarterly adjusted EBITDA measure running up to January 2013, after which time the covenants revert back to the original agreement from April 2013 (see note 20).
As a result of the impairment charges arising in the year ended 31 July 2011, the directors believe the current restriction set out in the Company’s articles of association is no longer appropriate. The directors will request approval at the 2012 AGM to permit the current borrowing limit to be exceeded up to a maximum borrowed limit of £225m until the 2013 AGM and to ratify any and all infringement by the directors prior to the 2012 AGM of their duties to restrict the Group’s borrowings.
The Board believes that the facility amendments demonstrate the support of the Banks. The facilities have been constructed to provide the Board with time to right-size the Group balance sheet, whilst providing economic incentives to achieve this right-sizing at the earliest practical opportunity. The amendments provide the Company with critical time to identify and implement value creation initiatives to enhance value. Whilst the Top-up facility is relatively expensive, the Group intends to use it sparingly, if at all, but it provides the Group with critical working capital headroom.
Cashflow and working capital
At the operating cashflow level, net cash generated from operations before exceptional items was £39.3m for the year versus £70.3m for the previous year, with equivalent annual cash conversion ratios of 250% and 171% respectively. The improvement in cash conversion ratio was driven by a reduction of working capital of £11.2m resulting from a combination of targeted UK cashflow improvement plans and a reduction in revenue. Cash generated from operations in 2011 was consumed by net exceptional costs of £21.9m (2010: £17.6m) relating to this year’s charges and amounts provided for in 2010; net interest, including interest rate swap payments and exceptional finance costs, of £12.3m (2010: £9.2m) and capital expenditure of £4.4m (2010: £10.6m). The remainder relates mainly to pension deficit funding of £7.2m (2010: £7.9m). During the year £6.3m was drawn down under the loan facility.
Taxation
The effective charge on profit before tax and exceptional items is £5.6m (2010: £9.3m), which represents an effective tax rate of 112.9% (2010: 30.4%). The difference between the effective rate and the statutory rate of 27.33% reflects a corporation tax credit offset by deferred tax adjustments arising from the change in future deferred tax rates from 27% to 25% and an assessment of the recoverability of deferred tax assets in the light of Mouchel’s losses in 2011.
Pensions
The Group operates three main defined benefit schemes; namely, the Mouchel Superannuation Fund, the Mouchel Staff Pension Fund and the Mouchel Business Services Ltd Pension Scheme. All remaining employees, who contribute to a pension, are members of the Group’s defined contribution
scheme.
Mouchel has admitted body status for a number of schemes. During the year, for one of these schemes the pension deficit risk was passed back to the customer following a renegotiated contract on 1 June 2011, leading to a curtailment gain.
We account for all of our defined benefit schemes under International Accounting Standard (IAS) 19 Employee Benefits.
The Government’s decision to move to using the Consumer Price Index (CPI) rather than the Retail Price Index (RPI) as the inflation measure to determine the minimum pension increases to be applied to public sector schemes has had a significant impact on the scheme itself. A £7.7m gain as a result of this change has been accounted for within other Comprehensive Income.
The IAS 19 charge for the year was £1.8m compared with £6.5m last year. The decrease was mainly attributable to a £2.2m reduction in current service cost, which includes the benefit from the closure of the Group’s schemes to future accrual with effect from January 2011; £0.9m improvement in the finance income; and £1.9m curtailment gain on third-party schemes (Teesside Pension Scheme), which has been included within exceptional items.
At 31 July 2011, the total deficit under IAS 19 was £32.8m compared with £53.0m at 31 July 2010. The movement in the deficit compared with a year ago reflects the credit of £7.7m resulting from the change from RPI to CPI, actuarial gains in the intervening period and contributions made by the Group of £11.6m.
Dividends
The Group does not plan to pay a dividend in relation to the year ended 31 July 2011 (2010: 2.25p). Following the revision of the Group’s banking facilities on 29 November 2011, the Board is now unable to pay dividends until the banking facilities have been repaid in full.
Loss/earnings per share
Adjusted earnings per share decreased from 18.9p to (0.5)p. Adjusted earnings per share is calculated after adding back shares held by the employee trusts to the weighted average number of shares. Earnings are adjusted to exclude amortisation of intangible assets arising from business combinations, impairments of intangible assets arising from business combinations and other exceptional items (net of taxation). Basic loss per share increased from 12.1p to 61.7p.
On behalf of the Board
Rod Harris
Group Finance Director
29 November 2011