Financial review

The year to 31 July 2009 was a difficult one. It started with strong momentum carried over from the last financial year, but with the unfolding of the world financial crisis in the first quarter, by the end of the first half, in January 2009, the business was in a very different place. For the whole of the 2009 calendar year the business has been anticipating and reacting to changes in client budgets and trying to steer a course which maintained its ability to service client needs at an acceptable staff-cost ratio. Revenue grew by 3.6% to £65.4m (2008: £63.1m), but when adjusting for currency movements and the consolidation of a previously equity accounted associate, underlying activity was down 13%. This reduced activity resulted in headcount adjustments of a matching scale, which is the main element of the separately identified reorganisation costs of £1.95m. There are a number of adjustments that distort the underlying performance of the Group and in this review the adjusted profit and earnings numbers have been used. Adjusted profit before income tax fell by 20%, to £5.2m (2008: £6.6m) (see note 5), and the adjusted EPS fell by 25%, to 6.48p (2008: 8.62p) (see note 10). The Group EBITDA¹ was £5.5m (2008: £7.4m) and it generated £4.8m cash from operating activities (2008: £8.5m), which helped the Group maintain a positive net funds position of £1.8m (2008: £3.4m)².

The Group has established treasury policies and procedures which monitor exposure to the US dollar and euro, which are the two main operating currencies other than sterling. At the beginning of the financial year the policy of providing protection for the anticipated cash profits arising in these currencies was in place, with the US dollar protected at 1.975 (compared with the actual rate of 2.0 for the previous financial year) and the euro at 1.389 (compared with the actual rate of 1.348 for the previous financial year). The significant weakening of sterling, firstly against the US dollar from August 2008 and then against the euro from November 2008, meant that the moderate amount of range-flexibility in the cover was breached and over the course of the year the contracts that matured generated realised losses of £2.07m, of which £0.38m was reflected in the fair values in the opening balance sheet. Most of the contracts expired during the year and the Group has reassessed its policy on placing forward cover, with the result that cover periods have shortened and cover is now based on the expected surplus cash receipts returned to the UK within the current financial year only.

The use of IFRS in the consolidated accounts continues to generate a number of areas of increased volatility in reported pre-tax profits compared with the position under UK GAAP. In the income statement this year, acquisition costs have been written off as incurred not only on acquisitions that did not complete but also on successful ones, which completed after the year end, which would previously have been treated as part of the investment (see note 30).

Under IAS 27, all entities that are controlled within a group must be included in the consolidated financial statements. Under the agreement signed in 2006 which gave the Group its 40% ownership stake in 463 Communications (‘463’), Next Fifteen had the right to take a controlling stake in 463 during the whole of the financial year ended 31 July 2009. Even though this right was not exercised until October 2009, the financial statements for this year show 463 on a consolidated basis, with the minority interests reflecting the 60% non-owned holding.

The Group has 43 offices in 19 countries and a further four licensed partners.

During the last year the proportion of the Group’s revenue outside the UK was around 75%. US and Canada remained the largest region, accounting for 48% of revenue. With the UK share of revenue being 25%, the Group generated 73% of its revenue in the two strongest markets for public relations services. In Europe and Africa the businesses experienced a downturn in activity in 2009 of 13% but the stronger euro reduced the reported fall in revenue to 3%, at £9.8m (2008: £10.1m). The Asia Pacific region grew by 17% to £7.8m (2008: £6.7m), thanks to stronger currency translation and strong results posted by its operations in India, Malaysia and Japan, but the underlying performance overall was flat.

It is also pleasing to note that the spread of the Group’s key clients has remained similar to last year. The top ten clients now represent approximately 36% of the revenue of the business, with no single client accounting for more than 7% of the total.

The adjusted profit margin of the Group fell to 8.0%, from 10.4% last year, as a consequence of the sudden loss of revenue in some markets and the foreign exchange contract losses noted above. Excluding head office costs (which include the foreign exchange contract losses), the adjusted profit margin was 14.9%, compared with 15.9% last year. The Group has worked very hard in difficult economic circumstances to stay close to its medium-term goal of getting this figure up to 16%. The US is operating well above this level, at an impressive 19.1% but there is still much to achieve in some of the smaller and less sophisticated markets in the APAC region. The staff-cost-to-revenue ratio is critical to managing margin performance and this was reduced to 67% (2008: 67.3%), but is still 2% higher than our medium-term target of 65%.

The net cash generated from operations was strong once again, at £6.3m, which was 177% of operating profit. The main investment activities in the year requiring a cash payment were £2.5m for the purchase of the remaining stakes in Lexis in October 2008 and a deferred-consideration payment for OutCast in November 2008 of £1.8m. Dividends paid to Next Fifteen shareholders totalled £0.9m.

The key movement in the Group’s balance sheet is the further goodwill arising from the final 12.85% stake acquired in Lexis during the year. This transaction also meant that the share purchase obligation was satisfied and the share purchase reserve unwound. The cash balances were £7.1m compared to £9.5m last year following the acquisition payments referred to above. The net funds position after deducting bank loans and finance leases was £1.8m (2008: £3.4m). Net assets at 31 July 2009 were £24.9m (2008: £19.6m).

The Group has a revolving-credit facility from Barclays Bank of £5m to March 2011, which it used to fund the purchases of Lexis, the Bite minorities and OutCast. The facility is available in a combination of sterling, US dollar, and euro at an interest rate of 1.25% over LIBOR. In addition, the Group has a £6m revolving-credit facility with Barclays Bank, repayable in December 2011, to help fund any future acquisitions, at a rate of 2.25% over LIBOR, of which $4m has been used to fund the initial consideration for the purchase of M Booth in August 2009 and $0.5m for the purchase of Upstream Asia in October 2009. Also available is an overdraft facility of £1.5m, available in sterling, US dollar and euro, which is reviewed annually in November. All of the UK businesses are part of a composite accounting system which allows the offset of UK overdrawn and credit balances. In the US, the Group has consolidated facilities with Wells Fargo, supported by a $2m credit line for working capital purposes. The Group aims to return any surplus cash to the UK subject to any local transfer restrictions, and as far as possible to hold only moderate non-deposit cash balances in overseas subsidiaries, subject to working capital needs.

The total tax charge for the year is £0.9m (2008: £1.7m) on consolidated profit before tax of £3.1m (2008: £5.5m). During the year the Group implemented a new transfer pricing policy which resulted in a more tax efficient allocation of worldwide profit and a reduction in the Group’s effective tax rate to 28%, 2% lower than last year. The Group considers 28%-30% to be a realistic effective tax rate range for the current year.

Basic earnings per share, adjusted for the highlighted items shown in note 5, fell 25% to 6.48p (see note 10). This fall reflected the reduced profit levels but was mitigated by the improvement to the tax charge in the year but also reflects the increased number of shares in issue following shares issued for the acquisition of the final stake in Lexis.

The proposed final ordinary dividend per share is 1.25p, which takes the total for the year to 1.7p, held in line with a total dividend of 1.7p last year. It will be paid on 5 February 2010, assuming that it is approved at the AGM on 26 January 2010. The Board continues to view its dividend policy over the medium term and aims to strike a balance between the relevance placed on dividends by shareholders and the needs of the Company to invest for future growth.