Directors’ report
Financial review
Group operating profit
Group operating profit for the year is £17.7 million (2007: £23.6 million). The year to year reduction reflects, amongst other factors, the following:
- a £1.7 million reduction in Group EBITDA before exceptional items
- a £3.8 million reduction in exceptional costs
- an £8.2 million increase in the amortisation of intangible assets.
Group EBITDA before exceptional items has decreased by 2.4 per cent to £69.3 million. This reduction reflects a combination of the improvement in EBITDA generated by the T&IS, IS and Other segments net of the reduction reported within the I&MS segment. Taking account of the one-off £1.8m credit in respect of pension scheme legislative changes booked to the income statement in the previous year, the level of Group EBITDA would be flat year over year. Despite the reduction in Group EBITDA, a combination of tight capital expenditure management and an inherent reduction in the capital intensity of the I&MS business has seen the level of EBITDA less capital expenditure increase by 2.9 per cent from £37.9 million to £39.0 million.
The Group has incurred exceptional operating costs of £4.0 million in 2008 (2007: £7.8 million) as a result of restructuring activities that have been undertaken during the course of the year. Of this, £2.5 million has been incurred in respect of the efficiency initiatives underway within the I&MS segment.
As a consequence of this reduction in exceptional items, Group EBITDA has increased to £65.3 million from £63.1 million.
Depreciation and amortisation amounted to £47.6 million (2007: £39.6 million). Of this, an amount of £24.0 million (2007: £24.2 million) has been charged in respect of depreciation and a further £8.6 million (2007: £7.4 million) in respect of amortisation of intangible assets arising on the capitalisation of software licences. Amortisation of intangible assets arising on acquisition amounts to £15.0 million (2007: £8.0 million). This has increased due to the full year’s charge in respect of the amortisation of intangible assets arising in respect of the three acquisitions that were undertaken during the course of the previous financial year. In addition, an amount of £2.7 million has been charged as an accelerated write down in respect of an intangible asset representing one customer relationship from the Smart421 acquisition.
Finance costs
Net finance costs amount to £13.3 million (2007: £11.0 million). The increase reflects a combination of higher borrowings as a result of the debt-financed acquisitions undertaken last year and the increase in LIBOR during the course of 2008. The Group has entered into fixed rate arrangements to fix the cost of £100 million of its borrowings, thereby partially mitigating the impact of the LIBOR increase.
Profit before tax
Profit before tax was £4.4 million (2007: £10.6 million), reflecting the lower Group operating profit reported in the year.
Taxation
The net taxation credit of £14.4 million (2007: £13.3 million) arises primarily as a consequence of the recognition of an additional deferred tax asset during the year and reflects our current view of the anticipated utilisation of unclaimed capital allowances in the Group.
The total deferred tax asset is £39.4 million (2007: 25.4 million). We have now recognised the remaining deferred tax asset in respect of unclaimed capital allowances such that the unprovided deferred tax asset has decreased from approximately £22.1 million at 31 March 2007 to £1.3 million at 31 March 2008.
Earnings per share
Basic earnings per share amounted to a profit of 3.65 pence (2007: 4.55 pence). Adjusted basic earnings per share amounted to 4.56 pence (2007: 5.52 pence).
| 2008 £m |
2007 £m |
Change over prior year % |
|
|---|---|---|---|
| H1 | 2.52 | 2.76 | (8.7) |
| H2 | 2.04 | 2.76 | (26.1) |
| Total | 4.56 | 5.52 | (17.4) |
The Group adjusted basic earnings per share includes the financial performance at an Adjusted profit from operations level for all segments of the Group. For the purposes of setting the appropriate distribution level for dividend purposes, the Board excludes the earnings of the I&MS and Other segments from relevant earnings, which for dividend purposes therefore amounted to £31.7 million in 2008.
Group Financing and Investment
Group net debt at 31 March 2008 was £168.9 million (2007: £164.2 million), equating to a net debt to EBITDA ratio just below 2.5 times, in line with our covenants.
A reduction in net cash inflow from operations to £50.0 million (2007: £59.1 million) arises as a consequence of a £15.3 million increase in working capital which reflects:
- £2.7 million (2007: £4.6 million) of this increase relates to the reversal of the profit and loss account credit arising under IAS19 accounting for pensions
- the cash impact of exceptional items in the year totalling approximately £7.1 million. Of this, £3.9 million was in respect of a specific onerous lease settlement and £2.1 million in respect of restructuring costs
- a net increase in receivables and payables of £10.0 million reflecting the volume of trading undertaken in the last month of the financial year within the I&MS business. Subsequent to the year end, a significant part of this working capital position had reversed.
Net cash used in investing activities amounts to £31.9 million compared to a prior year amount of £73.3 million. The 2007 investment levels included £43.1 million in respect of the acquisition of the Mistral, Smart421 and JAM IP businesses.
The net cash cost of servicing the Group debt in the year was £10.7 million (2007: £11.2 million). The cash cost of the dividend was £11.5 million (2007: £7.4 million), reflecting the year on year increase in the interim dividend paid in the year.
As at 31 March 2008, the Group had a gross liability in respect of its pensions arrangements of £9.1 million (2007: £12.7 million). The impact of lower asset valuation and changes in mortality assumptions has been offset by the impact of an increase in the discount rate applied to liability valuation.
Dividend
At the time of the interim results, the Board established a distribution policy closely aligned to the performance of the T&IS and IS segments, being the more mature parts of the Group. As indicated at that time, the Board expected to pay a final dividend consistent with a one third/two thirds split between the interim and final dividends. Accordingly, the Board is proposing a final dividend of 1.88 pence per share (2007: 1.30 pence per share), resulting in a full year dividend of 2.82 pence per share (2007: 1.95 pence), an increase of 44.6 per cent. Subject to shareholder approval at the Company’s Annual General Meeting on 25 July 2008, the final dividend will be payable on 8 August 2008 to Shareholders registered at the close of business on 27 June 2008.
Outlook
Our T&IS business remains resilient with strong margins and predictable cash flows which, as demonstrated by these results, will continue to support our capacity to return value to shareholders through increased dividends.
In the I&MS business where substantial investment has been made in skills and capabilities over the last three years, we are now making progress towards achieving improved performance in line with our medium term targets.
We remain confident that the Group is well positioned for the future with current trading in line with expectations.
Disclosures
The Directors who approved this Report are satisfied that there is no relevant audit information (as defined in the Companies Act 1985) of which the Company’s auditors are unaware. Each of the Directors has taken all reasonable steps to make themselves aware of any relevant audit information and to establish that the auditors are aware of that information.
Going concern
The Directors confirm that, having reviewed the Group’s budget and forecasts, they consider that the Group has adequate resources to continue in operational existence for the foreseeable future. Accordingly they continue to adopt the going concern basis in preparing the financial statements.
Directors & Directors’ interests
The names and biographical details of the Directors of the Company at 31 March 2008 are given in the Board of Directors section. The Directors serving during the year are detailed in the Corporate Governace section. The statement of Directors’ responsibilities is given in the Directors' Responsibilitites section.
Details of Directors’ interests in the Company’s shares at the start and end of the year are given in the Directors' Interests section. There have been no other dealings by the Directors, and nor have any dealings by any of their Connected Persons been notified to the Company, other than the Executive Directors’ ongoing participation in the share incentive plan and Long Term Co-Investment Plan, for which we make monthly RNS announcements as required under s.5.6.1 of the Disclosure and Transparency rules. This information was correct as of 29 May 2008. Details of Directors’ share options have been included in the Share Options section in the Remuneration report section.
Business & risk management
The Group has complied throughout the year with the provisions of the Combined Code relating to internal control having established the procedures necessary to implement the guidance in the Turnbull Report and by reporting in accordance with that guidance.
The Board has overall responsibility for the Company’s system of internal control and for reviewing its effectiveness in safeguarding shareholders’ investments and the Company’s assets.
The role of management is to implement Board policies on risk and control which are designed to manage rather than eliminate the risk of failure to achieve business objectives.
The Group’s risk management process highlights the significant risks faced by each business and support function and, in particular, those which could impact the Group’s ability to successfully achieve its strategic objectives. Each risk is assessed on the basis of the probability of it occurring and the impact should it do so. These risks are reviewed monthly at individual business control meetings, and quarterly for support service functions. The principal risks and challenges, together with action taken or planned to address them, are reviewed by the main Board on a quarterly basis. The Board can then assess whether the overall risk profile of the Group is being maintained at an appropriate level.
Additionally the Group’s auditors report to the Audit Committee any material risks identified during interim and full year audits. These, together with any significant risks identified by the Group’s internal audit function, are highlighted to the Board.
Each year, prior to the insurance renewal, the Group’s insurance brokers meet with the Chief Financial Officer, Director of Group Legal Services and Director of Internal Audit & Risk Management to review the Group’s risk management process.
Significant risks from all these analyses are consolidated in a prioritised Group Risk Register maintained by the Chief Financial Officer. This is reviewed by the Board and updated as risks change and action to address them is taken.
The Board is satisfied that the system of internal control and risk management is embedded in the routine of management decision making and reporting, is being appropriately used to direct resources to the areas of significant risk and is making a positive contribution to the achievement of the Group’s objectives.
Risks
The main risks for the Group, as identified by the Board, are:
Pursuit of appropriate strategies
Control measures include:
- regular management strategic reviews and workshops
- review of the Group’s strategic decision making process by insurers
- regular Board strategy reviews, against the background of experienced management and advisers briefings on technical, market and regulatory developments and competitors’ changing strategies.
Retaining & recruiting the right staff
Control measures include:
- development of a clear grading structure and pay-banding across the Group benchmarked against external comparators
- the availability of a range of attractive benefits including the ability to ‘flex’ part of salary
- investment in learning and development.
These initiatives have resulted in improved employee retention.
Meeting customer expectations
Control measures include:
- structuring of the Company’s business around customer-facing segments and independently benchmarked analysis on levels of customer satisfaction
- increasing emphasis on demonstrable commitment to quality/risk management through certification and compliance with recognised standards such as ISO 27001 (Information Security); ISO 20000 (IT Service Management); ISO 14001 (Environmental) and ISO 9001 (Quality Management)
- alignment of customer satisfaction survey results to the achievement of employee bonus payments
- analysing post installation customer feedback which is routinely collated by our vendor partners, Nortel and Cisco.
The Group’s exposure and management of liquidity, interest rates, foreign currency and credit risk are explained in note 30 of the Financial Statements.
Uncertainties
Principal uncertainties facing the Group include the impact of global technological and regulatory change that may alter the fundamentals of market economics. This particularly influences decisions on investment in next generation UK networks against a background of relaxation in the regulatory constraints on the behaviour of BT as the principal influencer of UK market conditions. The Group relies on internal and external expertise to guide the Board in its decision-making. In addition to working closely with selected technology partners, it participates fully in initiatives to facilitate the transition to new technological and regulatory environments such as 21Consult, NGNUK and NICC.
This expertise and perspective is being used to inform the development of medium term network and technology strategies so that they best reflect the needs of the business as our market evolves.
Organisation
The Board concentrates mainly on strategic development, financial performance and corporate governance. It aims to safeguard the Group’s assets, ensure proper accounting records are maintained and that the financial information used within the business and for publication is reliable. There is a clearly defined organisational structure with established responsibilities, authorities and reporting lines to the Board.
Financial information & control
The Group’s businesses budget on an annual basis, and these budgets are updated at least quarterly. The performance of businesses against these forecasts is monitored by senior executive management at their periodic business reviews and reported to the Board. Key financial and non-financial information (including the KPIs listed in this Report) is reviewed by the Board monthly in order to monitor performance against objectives. There are established procedures for investment evaluation to ensure Board approval for all major capital expenditure commitments and delegations of signing authority for contracts and other documents. Any system of internal financial control can, however, only provide reasonable but not absolute assurance against misstatement and loss. The system of internal financial control described above was in place for the financial year and continues in place in the current financial year.
Monitoring of controls
The Group’s Internal Audit function supports the Directors in assessing the effectiveness of key controls through a structured work programme.
The Director of Internal Audit & Risk Management also has a direct reporting line to the Chairman of the Audit Committee.
Response to any perceived weaknesses
The Directors confirm that they have reviewed the effectiveness of the Group’s financial, operational, compliance and risk management controls.
Areas of actual or potential weakness that may be identified in the audit process (including any reported pursuant to the Group’s ‘whistleblower’ procedures) are reviewed by the Audit Committee with the participation of the external auditors and are graded ‘red’, ‘amber’ or ‘green’. A prioritised programme is agreed that may involve further investigation and analysis or remedial changes in processes or the allocation of additional resources. Progress reports are made to the Board at its scheduled meetings and the adequacy and effectiveness of the response is reviewed at subsequent Audit Committee meetings. Where action is considered necessary to address risks or control weaknesses on the Group Risk Register the Board monitors progress through the monthly business and functional reports.
Creditor payment policies
The Group aims to pay its suppliers within a reasonable period of the invoice being received and in accordance with the Confederation of British Industry prompt payment code. At 31 March 2008, the Company’s trade creditors represented nil days of trade purchases (2007: 46 days).
Charitable & political donations
The Group made a number of charitable donations throughout the year to support community organisations and initiatives totalling £4,810 (2007: £2,900). No political donations were made.
In addition to the figure quoted above, the Group undertakes sponsorship and support activities with organisations across the UK. We also funded a number of employee and customer activities as part of our support of Rays of Sunshine, our Group charity of the year 2007-08. Together, we raised over £36,000 for the charity.
Shares & interests
No shareholder has waived or agreed to waive any dividends or future dividends during the period under review. There are no other disclosable share interests notified to the Company as at 29 May 2008. The Company has not acquired any of its own shares during the period and there is currently no intention to purchase its own shares or undertake any sale or proposed sale of treasury shares. At the Company’s Annual General Meeting on 1 August 2007, authority was given for the Company to purchase up to 51,493,180 of its own shares. This authority expires at the next AGM or 15 months from the date the authority was given.
Employees
Employment strategies within the Group have been designed to deliver growth and development of the Group and its people, linked to business needs. Employment policies are designed to provide equal opportunities irrespective of colour, ethnic or national origin, nationality, sex, sexual orientation, age, religion, marital or disabled status. Full consideration is given to applications for employment, the continuing employment, training and career development of disabled persons.
The Group takes every opportunity to involve and consult with its employees and we believe that employee involvement is an essential contributor to the development of the Group’s businesses. We have undertaken a range of initiatives including senior management ‘roadshows’, an online facility for staff to raise issues anonymously, and regular meetings for all staff at which suggestions are actively encouraged.
We also encourage our employees to become shareholders by offering all employee share schemes such as the Share Incentive Plan (SIP) and the Save as You Earn (SAYE scheme), as we believe this encourages greater employee engagement.
In 2007, we enhanced our SIP leading to more than 70 per cent of our staff becoming shareholders and over 50 per cent actively buying Company shares on a monthly basis.
The Company was awarded the 2007 Proshare Award for Most Effective Communication of an Employee Share Plan in relation to the relaunch of our SIP.
Health and Safety is an integral part of good business management and well established systems of safety management are in place throughout the business. Relevant performance data is included in the table on the inside back cover of this Report.
Key performance indicators
We measure a number of key performance indicators on an ongoing basis. These KPIs are available in the KPI section and are consistent with those KPIs used by management in measuring the performance of the business.
Substantial shareholdings
With the exception of those holdings of ordinary shares listed below, the Directors are not aware of any persons holding three per cent or more of the total voting rights in the Company as at 29 May 2008 as required to be disclosed in accordance with section 9.8.6(2) of the Listing Rules.
| Number of shares |
Percentage held |
|
|---|---|---|
| Aviva PLC | 34,282,876 | 6.65 |
| GAM International Management Limited |
31,255,510 | 6.06 |
| Aberforth Partners LLP | 27,234,861 | 5.28 |
| Invescap PLC | 25,937,862 | 5.03 |
| Legal and General Group | 20,851,731 | 4.04 |
| AXA Investment Managers | 16,196,210 | 3.15 |
| Cyrte Investment Managers | 15,450,000 | 3.00 |
Directors’ indemnities
There have been no qualifying third party indemnity provisions (within the meaning of Section 309 C of the Companies Act) in force during the year and up to the date on which this Report was approved by the Directors.
Additional information for Shareholders
Following the implementation of the EU Takeover Directive into UK law, the following description provides the required information for members where not already provided elsewhere in this Report. This summary is based on applicable English law concerning companies (the Companies Act 1985 and the Companies Act 2006, together ‘the Companies Acts’) and the Company’s current Articles of Association (‘current Articles’) but please note that it is proposed that the Company will adopt new Articles of Association with effect from the conclusion of the Annual General Meeting on Friday 25 July 2008, a summary of which are set out in the Notice of Meeting.
Share Capital
The Company has a single class of share capital which is divided into ordinary shares of 10p each.
Rights & obligations attached to shares
Voting
In a general meeting of the Company, subject to the provision of the current Articles, and to any special rights or restrictions as to voting attached to any class of shares in the Company (of which there are none), voting is as follows:
- on a show of hands, every member present in person shall have one vote; and
- on a poll, every member who is present in person or by proxy shall have one vote for every share of which he or she is the holder.
No member shall be entitled, in respect of any share in the capital of the Company held by him or her, to be present or to vote at any general meeting or class meeting if any call or other sum then payable by him or her to the Company in respect of that share remains unpaid. Currently, all issued shares are fully paid.
Deadline for voting rights
Full details of the deadline for exercising voting rights in respect of the resolutions to be considered at the Annual General Meeting to be held on Friday 25 July 2008 are set out in the Notice of Meeting.
Dividends & Distributions
Subject to the provisions of the Companies Acts, the Company may, by ordinary resolution, declare dividends to be paid to the members not exceeding the amount recommended by the Board. The Board may pay interim dividends, and also any fixed rate dividend, whenever the financial position of the Company, in the opinion of the Board, justifies its payment. All dividends shall be apportioned and paid pro rata according to the amounts paid up on the shares.
Liquidation
Under the current Articles, if the Company is in liquidation, the liquidator may (with the sanction of an extraordinary resolution of the Company and any other sanction required by statute):
- divide amongst the members in specie or in kind the whole or any part of the assets of the Company; or
- vest the whole or any part of the assets of the Company in trustees upon such trusts for the benefit of the members as the liquidator, with the like authority, shall think fit.
Transfer of Shares
All transfers of uncertificated shares shall be made in accordance with and be subject to the Uncertificated Securities Regulations 2001 and the facilities and requirements of the relevant system and in accordance with any arrangements made by the Board.
Subject to the current Articles, any member may transfer all or any of their certificated shares by an instrument of transfer in writing in any usual or common form or in any other form which the Board may approve. The Board may, in its absolute discretion and without giving any reason, decline to register any instrument of transfer of any share (whether certificated or uncertificated) which is not a fully paid share or on which the Company has a lien. The Board may also decline to register a transfer of a certificated share unless the instrument of transfer is left at the Company’s registered office, or at such other place as the Board may determine, for registration, accompanied by the certificate of the shares to which it relates and such other evidence as the Board may reasonably require to show the right of the transferor to transfer the shares. The Board may also refuse to register any transfer of shares (whether certificated or uncertificated), whether fully paid or not, in favour of more than four persons jointly.
If the Board refuses to register a transfer they shall, in the case of certificated shares, within two months of the date on which the transfer was lodged with the Company, send to the transferee a notice of refusal and return the instrument of transfer. In the case of uncertificated shares, the Board will notify such person as may be required by the Uncertificated Securities Regulations 2001 and requirements of the relevant system concerned.
Shares held by Employee Benefit Trusts (‘EBTs’)
The trustees of the Kingston Communications 1999 Employee Benefit Trust and the Kingston Communications 2000 Employee Benefit Trust, vote any shares held in the EBTs as they wish, having due regard to the interests of the employees, as potential beneficiaries. The trustees of the KCOM Group PLC Employee Benefit Trust consult with participants regarding the voting of any investment shares, but may vote any co-investment shares held in the EBT as they wish, having due regard to the interests of the participants. The trustees of the Kingston Communications All Employee Benefit Trust consult with participants regarding the voting of their shares, and vote accordingly.
Amendment of the Company’s Articles of Association
Any amendments to the Company’s Articles of Association may be made in accordance with the provisions of the Companies Act 1985 by way of special resolution.
Appointment & Replacement of Directors
Unless the Company in general meeting shall otherwise determine, the number of Directors shall be not less than two in number. There is currently no maximum number of Directors, although the Company may, in general meeting, fix a maximum.
Directors may be appointed by the Company by ordinary resolution or by the Board. A Director appointed by the Board holds office only until the next following Annual General Meeting and is then eligible for election by the members. The Board may from time to time appoint one or more Directors to hold employment or executive office for such period and on such terms as they may determine and may revoke or terminate any such appointment.
At each Annual General Meeting of the Company, one third of the Directors, or if their number is not three or a multiple of three, then the number nearest to but not exceeding one third, shall retire from office. Where the number is less than three, one Director shall retire. The Directors retiring by rotation each year shall be those who have been the longest in office since their last appointment or re-appointment. If at any Annual General Meeting where a Director retires by rotation the position has not been otherwise filled, then the retiring Director may, if willing, be reappointed.
The Company may by ordinary resolution with special notice remove a Director.
Powers of the Directors
The business of the Company will be managed by the Board who may exercise all the powers of the Company, subject to the provisions of the Company’s Memorandum of Association, the current Articles, the Companies Acts and any resolution of the Company.
Allotment of Shares
At the Annual General Meeting in 2007, the Company (and thereby the Directors) was authorised by the members to allot shares up to an aggregate nominal amount of £17,164,393 (representing approximately one third of the Company’s issued share capital at the time). Authority was also given at the same time for the partial disapplication of pre-emption rights, up to a maximum aggregate value of £2,574,659 (representing approximately five per cent of the Company’s issued share capital at the time). As at the date of this report the Company has issued 1,609,622 shares since that date.
Repurchase of Shares
At the Annual General Meeting in 2007, the Company was authorised by members to purchase its own shares, up to a maximum of 51,493,180 (representing approximately 10 per cent of the Company’s issued share capital at the time). To date the Company has not purchased any of its own shares.
Significant Agreements – Change of Control
The following significant agreement contains provisions entitling the counterparties to exercise termination or other rights in the event of a change of control of the Company:
- under the £250,000,000 multi currency revolving loan facility agreement dated 28 February 2007 between, amongst others, the Company, The Royal Bank of Scotland PLC (as the facility agent) and the banks and financial institutions named therein as lenders (the ‘Credit Facility’), the facility agent may, if the majority of the lenders so require, by no less than 7 days’ notice to the Company, cancel the total commitments of the lenders under the Credit Facility and declare all outstanding loans made under the Credit Facility, together with accrued interest, and all other amounts accrued under the Credit Facility immediately due and payable. For these purposes, a ‘change of control’ occurs if any person or group of persons acting in concert gains control of the Company.
The Company’s share schemes, details of which are contained in the Directors’ Remuneration Report, contain provisions which take effect in the event of a change of control, as a result of which options and awards may vest and become exercisable on a change of control. The provisions do not entitle participants to a greater interest in the shares of the Company than that created by the initial grant or award under the relevant scheme.
Compensation for Loss of Office – Change of Control
There are service contracts between the Company and two of its Directors which provides for compensation for loss of office or employment following a change of control of the Company (please refer to the Directors’ Remuneration Report on page 22 for further explanation). The Company does not have any other agreements with any other Director or employee that would provide compensation for loss of office or employment resulting from a takeover.
Re-election
Paul Simpson and Kevin Walsh retire from the Board at the Annual General Meeting and, being eligible, offer themselves for re-election. Graham Holden and Paul Renucci, having been appointed to the Board since the last Annual General Meeting and, pursuant to the Company’s Articles of Association, are standing for re-election.
Annual General Meeting
The Annual General Meeting will be held at the Kingston Communications Stadium, Kingston upon Hull on 25 July 2008 at 11am. The Notice of Meeting accompanies this Annual Report and is also available on our Group website, www.kcom.com. At the meeting, the Company will be seeking shareholder approval for, amongst other matters:
- authority to purchase shares, subject to a maximum of one third of the Company’s issued ordinary share capital
- authority to purchase its own shares, subject to a maximum of ten per cent of the Company’s issued ordinary share capital
- adoption of new Articles of Association to ensure consistency with the provisions of the new Companies Act 2006.
The Directors consider that all the resolutions proposed are in the best interests of the Company and it is their recommendation that shareholders support these proposals as they intend to do so in respect of their own holdings.
Auditors
PricewaterhouseCoopers LLP have indicated their willingness to continue in office and a resolution to re-appoint them will be proposed at the Annual General Meeting.
They have provided an independent audit opinion on these accounts which can be found in Independent Auditors' Report section.
This report has been reviewed and approved by the Board of KCOM Group PLC.