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Financial Review |
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Basis of accounting |
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The financial statements are presented in accordance with applicable law and International Financial Reporting Standards, as adopted by the EU (“IFRS”). The group’s significant accounting policies are detailed in note 3 on pages 54 to 61 and those that are most critical and/or require the greatest level of judgement are discussed in note 4 on page 62.
Operating results
The overall results are commented upon by the chairman in his statement and operational trading is discussed in the operating review on pages 10 to 19. Profit from operations before amortisation of acquisition-related intangible assets and exceptional items (PBITA) amounted to £277.0m, an increase of 8.6% on the £255.0m in 2005 and an increase of 10.0% at constant exchange rates.
Associates
Included within PBITA is £2.8m (2005: £5.3m) in respect of the group’s share of profit from associates, principally from the business of Space Gateway in the US which provides safety services to NASA. Cash flow from associates was £2.7m in 2006, compared to £12.3m in 2005.
Acquisitions and acquisition-related intangible assets
Investment in acquisitions in the year amounted to £98.4m, of which £95.7m was a cash outflow and £2.7m is deferred consideration. This investment generated goodwill of £68.0m and other acquisition-related intangible assets (customer-related) of £22.2m. Larger acquisitions included the purchase of controlling interests in the manned security services provider, Servicios Generales in Chile and the security services and cash services business of Al Majal Security Services in Saudi Arabia, and an increase in the group’s interest in United Arab Emirates. £21.0m of the acquisition spend was on the reduction of minority interest shares in businesses that were already fully-consolidated. The contribution made by acquisitions to the results of the group during the year is shown in note 17 on page 72. The charge for the year for the amortisation of acquisition-related intangible assets other than goodwill amounted to £36.0m. Goodwill is not amortised. Acquisition-related intangible assets included in the balance sheet at 31 December 2006 amounted to £1,170.9m goodwill and £220.6m other.
Exceptional items
There were no exceptional items in the year. An expense of £18.2m was incurred in 2005 in respect of restructuring costs consequential upon acquisitions.
Financing items
Finance income was £81.2m and finance costs £122.2m, giving a net finance cost of £41.0m. Net interest payable on net debt was £42.0m. This is an increase of 23% over the 2005 cost of £34.2m due principally to the rising costs of borrowing and the increase in the group’s average gross debt. The group’s average cost of gross borrowings in 2006 was 4.6% compared to 4.2% in 2005. The cost based on prevailing interest rates at 31 December 2006 was 5.2%. Also included within financing is a net income of £1.0m (2005: cost of £4.9m) in respect of movements in the group’s net pension obligations.
Taxation
The taxation charge of £67.5m provided on profit from operations before exceptional items and amortisation of acquisition-related intangible assets represents a tax rate of 28.6%, compared to 31.2% in 2005. We believe that an effective tax rate of 28-29% is sustainable going forward. The amortisation of acquisition-related intangible assets gives rise to the release of an equivalent proportion of the deferred tax liability established when the assets are acquired, amounting to £10.8m.
In addition, a tax charge of £1.3m has been included within the results from discontinued operations. Potential tax assets in respect of losses amounting to £86.3m have not been recognised as their utilisation is uncertain.
Disposals and discontinued operations
On 22 December 2006 the group agreed the terms for the divestment of G4S Geld-und Wertdienste GmbH, its cash services business in Germany. On 28 December 2006 the group disposed of its US transportation business, being the remaining business of Cognisa. The loss from discontinued operations of £33.4m comprises £19.4m in respect of post-tax trading losses of discontinued businesses and £19.2m
in respect of disposal losses offset by a £5.2m adjustment in respect of prior year disposals.
Businesses disposed of in 2005 included the manned security business of Falck Nederland, the Securicor operations in Luxembourg, a cash services business in Scotland and the security services operations of Cognisa. The disposal of all but the last named of these businesses was required by the European Commission as a condition for their approval of the combination in 2004 between Group 4 Falck and Securicor. During the disposal process the group had only restricted control over these operations and their results were therefore not consolidated. The loss from discontinued operations in 2005 of £13.1m comprises £6.2m in respect of trading losses of both the 2005 and the 2006 disposals and £6.9m in respect of disposal losses.
The cash proceeds from business disposals in 2006 were £9.9m, comprising £6.7m in respect of the Cognisa transportation business and £3.2m in respect of prior year disposals. The contribution to the turnover and operating profit of the group from discontinued operations is shown in note 6 on pages 63 to 66 and their contribution to net profit and cash flows is detailed in note 7 on page 67.
Profit for the period
Profit for the year was £109.9m, compared to £90.7m in 2005. The principal reasons for the increase in profit were the £22.0m increase in operating profit in 2006 and the exceptional costs of £18.2m incurred in 2005, offset by the £20.3m higher loss from discontinued operations in 2006.
Minority interests
Profit attributable to minority interests was £13.4m in 2006 compared to £9.9m in 2005, the increase reflecting minority partner shares in the group’s organic and acquisitive growth.
Earnings per share
Basic earnings per share from continuing and discontinued operations was 7.6p for 2006 compared to 6.4p for 2005. These earnings are unchanged when calculated on a fully diluted basis, which allows for the potential impact of outstanding share options.
Adjusted earnings, as analysed in note 16 on page 71, excludes amortisation of acquisition-related intangible assets, exceptional items, pension financing items and fair value adjustments to financial instruments, all net of tax, and better allows the assessment of operational performance, the analysis of trends over time, the comparison of different businesses and the projection of future performance. Adjusted earnings per share was 12.2p for 2006, an increase of 8.9% over 11.2p for 2005.
Dividends
The directors recommend a final dividend of 2.52p (DKK 0.2766) per share. This represents an increase of 12.5% on the final dividend for the year to 31 December 2005 of 2.24p (DKK 0.2435) per share. The interim dividend was 1.69p (DKK 0.1863) per share and the total dividend, if approved, will be 4.21p (DKK 0.4629) per share, representing an increase of 18.9% over the 3.54p (DKK 0.3865) per share total dividend for 2005.
In proposing this final dividend, the board considered both the appropriate level of dividend cover and the future strategy and prospective earnings of the group. Dividend cover in the current year is 2.9 times, based on adjusted profit. We reaffirm our intention to increase dividends so as to reduce dividend cover to around 2.5 times, with a target of attaining this level within two years.
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Basic earnings per share from continuing and discontinued operations was 7.6p for 2006 compared to 6.4p for 2005. |
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We reaffirm our intention to increase dividends so as to reduce dividend cover to around 2.5 times, with a target of attaining this level within two years. |
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Cash flow
The primary cash generation focus of group management is on the percentage of operating profit converted into cash. The group target over the last 3 years has been an 80% conversion rate. Operating cash flow for 2006, as defined for management purposes, was as follows: |
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2006
£m |
2005
£m |
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| PBITA |
277.0 |
255.0 |
| Less share of profit from associates |
(2.8) |
(5.3) |
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| PBITA before share of profit from associates (group PBITA) |
274.2 |
249.7 |
| Depreciation and amortisation of intangible assets other than acquisition-related intangible assets |
91.1 |
81.4 |
| Increase in working capital and provisions before exceptional items |
(41.7) |
(43.3) |
| Net cash flow from capital expenditure |
(82.5) |
(89.8) |
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| Operating cash flow |
241.1 |
198.0 |
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| Operating cash flow as a percentage of group PBITA |
88% |
79% |
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Working capital increased in both 2006 and 2005 due principally to the growth in turnover. Capital expenditure was tightly controlled at 91% of depreciation (2005: 109%). Overall operating cash generation for the year was good, as a result of improving financial discipline across the organisation.
The group has increased its ongoing target for operating cash generation from 80% to 85% and believes that this allows for the investment necessary to support the group’s growth targets.
The management operating cash flow calculation is reconciled to the net cash from operating activities as disclosed in accordance with IAS7 Cash Flow Statements as follows: |
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2006
£m |
2005
£m |
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| Cash flow from operating activities (IAS7 definition) |
197.1 |
174.5 |
| Net cash flow from capital expenditure |
(82.5) |
(89.8) |
| Add-back cash flow from exceptional items and discontinued operations |
32.0 |
39.7 |
| Add-back additional pension contributions |
24.2 |
15.0 |
| Other items |
- |
5.6 |
| Add-back tax paid |
70.3 |
53.0 |
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| Operating cash flow (G4S definition) |
241.1 |
198.0 |
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The group’s free cash flow, as defined by management, is analysed as follows: |
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2006
£m |
2005
£m |
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| Operating cash flow |
241.1 |
198.0 |
| Net interest paid |
(47.8) |
(38.1) |
| Tax paid |
(70.3) |
(53.0) |
| New finance leases |
(19.6) |
(20.7) |
| Other items |
- |
(5.6) |
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| Free cash flow |
103.4 |
80.6 |
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Free cash flow is reconciled to the total movement in net debt as follows: |
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2006
£m |
2005
£m |
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| Free cash flow |
103.4 |
80.6 |
| Cash flow from exceptional items and discontinued operations |
(32.0) |
(39.7) |
| Additional pension contributions |
(24.2) |
(15.0) |
| Net cash outflow on acquisitions |
(95.7) |
(68.0) |
| Net cash inflow from disposals |
9.9 |
42.1 |
| Net cash flow from associates |
2.7 |
12.3 |
| Dividends paid to minority interests |
(3.0) |
(5.1) |
| Share issues less share purchases |
6.0 |
(10.7) |
| Dividends paid to equity holders of the parent |
(49.8) |
(39.9) |
| Net cash flow from hedging financial instruments |
11.8 |
- |
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| Movement in net debt in the year |
(70.9) |
(43.4) |
| Foreign exchange translation adjustments to net debt |
55.4 |
(27.5) |
| Net debt at 1 January |
(657.3) |
(586.4) |
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| Net debt at 31 December |
(672.8) |
(657.3) |
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Net debt represents the group’s total borrowings less cash, cash equivalents and liquid investments. The components of net debt are detailed in note 37 on page 93.
Financing and treasury activities
The group’s treasury function is responsible for ensuring the availability of cost-effective finance and for managing the group’s financial risk arising from currency and interest rate volatility and counterparty credit. Treasury is not a profit centre and is not permitted to speculate in financial instruments. The treasury department's policies are set by the board. Treasury is subject to the controls appropriate to the risks it manages. These risks are discussed in note 31 on pages 82 to 83.
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Financing
The group’s primary source of finance is a £1bn multicurrency revolving credit facility provided by a consortium of lending banks at a margin of 0.225% over Libor. During 2006, the lending banks exercised their options to extend the term of this facility to 28 June 2011. A further option process is exercisable in the period 90 days prior to 28 June 2007 and if the options are exercised the facility will mature on 28 June 2012. On 1 February 2007 an additional bank added a further £87m to the revolving credit facility on the same terms.
The group has other available facilities of £393.5m.
On 1 March 2007, to further diversify its sources of funding and lengthen the maturity of its debt, the group completed a $550m private placement of unsecured senior loan notes, with maturity and interest as follows: |
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Value
$m |
Interest
rate
% |
Maturity
date |
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| Series "A" |
100 |
5.77 |
March 2014 |
| Series "B" |
200 |
5.86 |
March 2017 |
| Series "C" |
145 |
5.96 |
March 2019 |
| Series "D" |
105 |
6.06 |
March 2022 |
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The proceeds of the issue were used to reduce drawings against the revolving credit bank facility. At the time of receipt the group had, in accordance with treasury policy, converted 55% of its US Dollar interest exposure from floating rates into fixed rates through interest rate swaps. Therefore, the fixed interest rates payable on the notes were swapped into floating rates, at an average margin of 0.60% over Libor, so that the proportion of group debt held under fixed interest rates remained at 55%. The group’s net debt at 31 December 2006 of £672.8m represented a gearing of 69%. The group has sufficient borrowing capacity to finance growth.
Interest rates
The group’s investments and borrowings at 31 December 2006 were at variable rates of interest linked to Libor and Euribor, with the group’s exposure being predominantly to interest rate risk in US Dollar and Euro. The loan notes issued in March 2007 bear interest at fixed rate. The group’s interest risk policy requires treasury to fix a proportion of net debt on a sliding scale, with a maximum of 80% short term debt held at fixed rates, reducing to a maximum of 20% of medium term debt held at fixed rates, utilising interest rate swaps. The maturity of interest rate swaps at 31 December 2006 was limited to five years. The market value of swaps outstanding at 31 December 2006 was £1.9m.
Foreign currency
The group has many overseas subsidiaries and associates denominated in various different currencies. Treasury policy is to manage significant translation risks in respect of net operating assets and income denominated in foreign currencies. The methods adopted are to use borrowings denominated in foreign currency supplemented by forward foreign exchange contracts.
The main currency movement during 2006 was the decline in the US Dollar from $1.72 = £1 at 31 December 2005 to $1.96=£1 at 31 December 2006, impacting not only the group’s dollar-denominated assets but also assets denominated in New Market currencies which follow the dollar. Exchange differences on the translation of foreign operations included in the statement of recognised income and expense, amount to a loss of £31.0m (2005: gain of £30.3m). These differences include a £55.4m gain (2005: £27.5 loss) on the retranslation of net debt, an £11.8m cash inflow (2005: nil) from forward exchange contracts and an £11.6m gain (2005: £6.2m loss) on the market valuation of outstanding forward contracts. The market value of forward contracts outstanding at 31 December 2006 was £5.4m.
Cash management
To increase the efficient management of the group’s interest costs and its short term deposits, overdrafts and revolving credit facility drawings, the group completed implementation of a global cash management system during 2006. At 31 December 2006, 65 group companies participated in the pool, with the number continuing to grow. Credit balances of £78.3m and debit balances of £75.2m were held within the cash pool. IFRS does not permit the netting off of these balances, which are therefore disclosed gross within current assets and liabilities. To obtain additional cash management benefits, particularly within New Markets, further cash pools will be established during 2007.
Pensions
The group's primary funded defined benefit pension schemes are those operated in the UK, but it also operates such schemes in the Netherlands, Ireland and Canada. The latest full actuarial assessments of the UK schemes were carried out at 31 March 2004 in respect of the Group 4 scheme (approximately 8,000 members) and at 5 April 2006 in respect of the Securicor scheme (approximately 20,000 members). These assessments and those of the group's other schemes have been updated to 31 December 2006, including the review of longevity assumptions. |
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On 1 March 2007, to further diversify its sources of funding, the group completed a $550m private placement of unsecured senior loan notes. |
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To increase the efficient management of the group’s interest costs and its short term deposits, overdrafts and revolving credit facility drawings, the group completed implementation of a global cash management system. |
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The group's funding shortfall on the valuation basis specified in IAS19 Employee Benefits was £226m before tax or £158m after tax (2005: £217m and £152m respectively).
The value of the assets in the funds increased by £120m during 2006, continuing the trend of 2005. However, this was counteracted by a reduction in the bond rates used to discount liabilities for IAS19 purposes, and by an increase in inflation assumptions. We believe that, over the very long term in which pension liabilities become payable, investment returns should eliminate the deficit in the schemes in respect of past service liabilities. However, in recognition of the regulatory obligation upon pension fund trustees to address currently reported deficits, additional cash contributions into the two main UK schemes of around £24m are being made in 2007. Such additional contributions will be reviewed annually and reassessed formally at the next actuarial valuation dates, which are 5 April 2009 in respect of the Securicor scheme and 31 March 2007 in respect of the Group 4 scheme.
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Corporate governance
The group’s policies regarding risk management and corporate governance are set out in the Corporate Governance Statement on pages 36 to 38.
Going concern
The directors are confident that, after making enquiries and on the basis of current financial projections and available facilities, they have a reasonable expectation that the group has adequate resources to continue in operational existence for the foreseeable future. For this reason they continue to adopt the going concern basis in preparing the financial statements.
Risks
All businesses are subject to risk and many individual risks are macro-economic or social and common across many businesses. Many risks are to a greater or lesser degree controllable, but some are not controllable. Through its internal risk management process, the group identifies business-specific risks. It classifies the key risks as those which could materially damage the group’s strategy, reputation, business, profitability or assets and these risks are listed below. This list is in no particular order and is not an exhaustive list of all potential risks. Some risks may be unknown and it may transpire that others, currently considered immaterial, become material.
1. Price competition
The security industry comprises a number of very competitive markets. In particular, manned security markets can be fragmented with relatively low economic barriers to entry and the group competes with a wide variety of operators of varying sizes. Actions taken by the group’s competitors may place pressure upon its pricing, margins and profitability.
2. Major changes in market dynamics
Such changes in dynamics could include new technologies, government legislation or customer consolidation and could, particularly if rapid or unpredictable, impact the group’s revenues and profitability.
3. In-sourcing by customers
Outsourcing activities carried out by the group include cash processing and cash management functions on behalf of financial institutions, manned security on behalf of a range of different customers and justice services on behalf of government institutions. If the trend towards such outsourcing were for any reason to be reversed, the group’s revenue and profitability may be adversely affected.
4. Inappropriate investment decisions
Were the group to make acquisitions or capital expenditures that were inappropriate to its strategy or over-priced, or take on excessively onerous contractual obligations, the group’s profitability and returns on capital may be adversely affected.
5. Cash losses
The group is responsible for much of the cash held on behalf of its customers. Increases in the value of cash lost through criminal attack may increase the costs of the group’s insurance. Were there to be failures in the control and reconciliation processes in respect to customer cash, these could also adversely affect the group’s profitability.
6. IT systems
The group makes widespread use of IT systems both for operational management, including tasks such as scheduling and route-planning, and for financial management, including calculating employee wages and billing customers. Failure in these systems, along with the failure of business continuity procedures in the event of physical damage to or inaccessibility of day-to-day operating systems, could result in reputational damage and the loss of revenue and profitability.
7. Deterioration in labour relations
The group’s most significant asset is its large and committed work force. Were the current good relationships between the group and its employees to become strained the group’s operational performance and reputation may be adversely affected.
8. Defined benefit pension schemes
A prolonged period of poor asset returns and/or unexpected increases in longevity could require increases in the current levels of additional cash contributions to defined benefit pension schemes, which may constrain the group’s ability to take advantage of growth opportunities.
9. Terrorist attacks
The group operates in an industry which is sometimes involved in seeking to protect its customers against acts of terrorism. Were terrorist incidents in the future to involve premises or events for which the group is contracted to provide security they could result in brand and reputational damage and so affect earnings and profitability.
10. Regulatory requirements
Security can be a high-profile industry. There is a wide and ever-changing variety of regulations applicable to our businesses across the world. Changes in such regulations may adversely affect the group’s revenues and profitability.
Risk management
The group has a robust risk assessment and control process in place to identify and mitigate the controllable risks faced by the organisation. Mitigation measures include:
1. The group’s diversity
The group operates around 150 businesses across over 100 countries and across a range of product areas. Most of the risks detailed above are market-specific and, therefore, any particular issue could only impact part of the group’s operations.
2. Management structure
The group operates a management structure that is appropriate to the scale and breadth of its activities. Business performance and strategies are reviewed continuously by regional, divisional and group management. Potential issues requiring management attention are therefore identified and there is a
wide range of expertise available throughout the organisation, which is utilised as necessary to address these issues.
3. Authorisation procedures
The group has clear authorisation limits and procedures which are cascaded throughout the organisation. For example, all acquisition proposals have to be submitted for approval to the group capex committee, assessed against the group’s return requirements, evaluated for risk and subject to appropriate due diligence.
4. Group standards
Each of the group’s businesses applies the systems and procedures appropriate to its size and complexity. However, the group requires that these conform to group standards in respect of matters such as operational and financial controls, financial reporting, business continuity planning and project management techniques. Further standards, particularly in respect of IT systems, are applied on a divisional or regional basis.
5. Internal audit
The Internal Audit department operates under a wide remit, which includes ensuring adherence to group authorisation procedures and control standards.
6. Market engagement
Most of the risks to which the group is exposed are market risks. So as to better understand and influence the market, the group is committed to a policy of proactive engagement across its geographic range with customers, industry associations, government regulators and employee representatives. |
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The group has a robust risk assessment and control process in place to identify and mitigate the controllable risks faced by the organisation. |
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The group is committed to a policy of proactive engagement with customers, industry associations, government regulators and employee representatives. |
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