BUSINESS REVIEW
CHIEF EXECUTIVE'S REPORT
hugh blackwood
group chief executive
Despite the global economic downturn, the International Division achieved impressive revenue growth.
review by division
During the past six months certain parts of the business have been contending with rapidly declining global demand. This has had a particular impact on the UK private sector property market as project funding was cancelled, postponed or delayed. Similar effects were also evident in the property sectors in Dubai and Bangkok.
Across the transportation elements of the organisation, performance held up very well with some benefit deriving from economic stimulus policies in some markets.
Pressure on natural resources, energy and water continued to act as a major driver within our markets especially with growing emphasis on environmental impact and climate change.
Internally, it has been a year of substantial change as the organisation transitioned to a new sector facing management structure based on five core business sectors: Strategic Consultancy, Railways, Buildings & Infrastructure, Environment & Natural Resources and Roads.
This will be the last occasion when the organisation will report in the current format. The new structure will be client based, easier to analyse and understand and we expect will bring new efficiencies to our business.
uk & ireland divisions
UK Central Division managed all commissions within the Roads Sector in England and Wales and has completed another successful year exceeding budgets in both revenue and adjusted* operating profit. Prior to the change in management and reporting structure, the Division also managed some aspects of the natural resources market including the nuclear decommissioning work based in Warrington and Sellafield. Revenue in the Division for the year was £71.8m from which was delivered an adjusted* operating profit of £9.8m at a margin of 13.7 per cent.
Within the Roads Sector, collaborative working with contracting partners and the Highways Agency both on Early Contractor Involvement (ECI) projects and Managing Agent Contractor (MAC) contracts has continued to deliver successful outcomes.
Recent fiscal stimulus by the Government to infrastructure projects in the UK has benefited the Division. Specifically approximately £1bn of construction activity involving the Group in an engineering design role was accelerated following a government statement in November 2008. These projects include the M1 motorway junctions 10 to 13 and the A46 Trunk Road dualling in Nottingham and Lincolnshire. In addition, the A421 dualling project from Bedford to the M1 has reached construction stage and been committed to site.
The Area 7 MAC in which we have a 40 per cent share has progressed well during the year and has also been the recipient of renewed government spending. Unfortunately, this contract ends in June 2009 and we are working on a pipeline of opportunities to replace it. We are currently seeking shortlisting on three similar contracts: Area 14 MAC, Sheffield Highway Maintenance PFI and Lincolnshire County Local Framework.
UK South Division included the majority of the Buildings & Infrastructure Sector’s business conducted in the UK, representing 61.0 per cent of the Division’s revenue. The early signs of a slowdown in the private property sector (residential, commercial and retail) were evident during the first half of the year although financial performance held up well over this period on existing projects. The second half saw a rapid deterioration in the situation, largely as a result of the banking crisis. A number of projects were deferred, postponed or cancelled. The Division had reacted early to the developing situation but we then saw a sudden end to the development bubble in the Middle East and, despite statements to the contrary, the health and education sectors in the UK have been extremely disappointing as secured projects continue to be deferred and delayed.
The combination of these circumstances has resulted in the need to restructure the Building & Infrastructure Sector element of the Division by reducing total sector staff by around 20 per cent. Divisional revenue for the year was £107.9m heavily biased toward the first half (£60.0m versus £47.9m) with adjusted* operating profit of £4.0m (£4.9m versus a loss of £0.9m) representing margin performance of 3.7 per cent (8.2 per cent versus negative 1.9 per cent).
The Strategic Consultancy Sector represented 23.8 per cent of Divisional revenue and has had a successful year providing high level services to clients, particularly in transportation. The maritime and aviation sub‑sectors have been especially buoyant, with an improving position achieved in the oil and gas sector.
The Environment & Natural Resources Sector represented the remaining 15.2 per cent of revenue. Within the environment sub‑sector itself, the Division is providing advice on carbon trading and sustainability issues across a wide range of public and private sector clients. Our contract to manage the National Industrial Symbiosis Programme which helps drive the sustainability agenda by challenging the reuse of industrial waste products through a collaborative network was renewed in 2008 for a further three years. The Division is advising central government on the eco‑towns project and has been appointed to conduct the environmental impact assessment for the Thames Tideway Tunnel.
The Division has had an extremely successful year in the waste sub‑sector, an expanding area of business being driven by environmental legislation in both Europe and the UK. The Group is involved in around 40 per cent of ongoing mechanical biological treatment (MBT) household waste schemes in England and is well placed to take advantage of the ongoing investment programme.
Scotland & Ireland Division continued its long track record of good performance by once again providing strong growth for the Group resulting in revenue and adjusted* operating profit of £35.8m and £3.3m respectively (2008: £31.5m and £2.5m respectively). Margin improved during the year from 8.0 per cent to 9.2 per cent. The acquisitions of recent years continued to provide a broadly based business albeit with a significant public sector component.
The collapse of the Irish economy resulted in downsizing of resources but a small core remains in Dublin positioned to take advantage of any future upturn.
The Division’s dominant Roads Sector delivered seven major schemes for national clients over the course of the year including the completion of the M6 at the Scotland/England border, the M1 Westlink in Belfast, the N8/M8 in the Republic of Ireland and a number of substantial improvement schemes.
Design work continues on the M8 DBFO scheme in Scotland after some delay and the Carlisle Northern Distributor PPP Scheme. Both in Scotland and Northern Ireland there is still considerable activity in the forward planning of future projects, although the outlook for the Irish Republic is less optimistic. Also during the year, advisory framework commissions were reached with South East Scotland Transport partnership and the Strathclyde Partnership for Transport.
In the Building & Infrastructure Sector much of the business of the Division was in the public sector in education and health with work completed on three schools as part of the Borders Schools PPP programme. Work is nearing completion on the Downe Hospital in Northern Ireland while a start has been made on the Royal Victoria Hospital Critical Care Centre in Belfast. In Scotland, the Division has a strong position in the social housing arena, an area of investment currently favoured by the Scottish government.
A modest staff lift‑out from a local consultancy in Middlesbrough provided additional skills in building physics and systems and this new capability is being rolled out across the internal market.
Framework agreements were a key feature of the Environment & Natural Resources Sector within the Division. Relationships with the Northern Ireland Water Services, Scottish Water and Northumbria Water have helped develop a strong position in the field of water engineering. The Division continued to lead the Group’s expertise in renewable energy, particularly in wind farms and remained active in the landscape, environment and tourism market particularly in Northern Ireland.
railways sector
The UK Railways Division’s market remained extremely turbulent during the year, circumstances which delivered two very different halves to the year’s performance. The first half was beset by a number of major workstreams coming to an end with resources being retained awaiting the Crossrail start‑up programme. The second half has been characterised by the securing and mobilisation of the Crossrail On‑Network Contract and the Edinburgh Glasgow Improvement Project. Although challenging projects, these new commissions should help staff utilisation and margins across the key railway engineering disciplines. The Division achieved annual revenue of £43.9m (2008: £44.7m) and an adjusted* operating margin of 2.6 per cent (2008: 5.1 per cent). This represented an improvement in second half earnings which should continue into 2010.
Emerging during the year was a slowing in what has been long term growth of our UK rail market with major projects like West Coast Route Modernisation and Airdrie to Bathgate design finishing. There was also a modest reduction in Network Rail’s track renewals work which was largely offset by an increase in metro work, particularly for London Underground and opportunities on the Crossrail central section. As a result, organisational restructuring has resulted in about 8 per cent of staff leaving the business on the heavy rail side, with the lost revenue being replaced by metro work.
The Division continued to grow its penetration of an increasing metro market worldwide with the acquisition during the year of Benaim and Terence Lee Partnership forming a key part of that growing capability.
Capital utilisation in the Division benefits from the almost exclusively public sector base of clients and funding. Of this current client base, Network Rail, Transport for London and Transport Scotland remain the three dominant clients and an increasing focus on client relationship management is proving beneficial with these important clients.
The order book remains strong but increased competition must be expected in the current economic climate. The medium term will offer considerable prospects in Crossrail, increased electrification, High Speed Line 2, ERTMS (advanced signalling systems) and a series of planned upgrades to the Great Western Route, all of which play to the inherent strengths of the business.
On the international front, the excellent start‑up in Brisbane has been undermined by the slowdown in both public sector funded rail investment and in the mining sector but there remain good prospects in the medium term.
The Division continues its track record of generating business for other Group businesses particularly in the planning and design of station property assets, involvement in the East London Line project being a prime example.
international division
Despite the global economic downturn, the International Division achieved a 43.2 per cent increase in revenue to £100.5m (2008: £70.2m) with an adjusted* operating margin of 4.3 per cent (2008: 5.2 per cent). This excellent revenue growth performance resulted from a planned strategy to increase activity in our regional businesses together with some effect of the foreign exchange movement during the year. Earnings were held back in the businesses in Dubai and Bangkok due to the economic impact on private sector commercial development in these markets. However, the other regional businesses performed well. Provision has been made for emerging bad debts, particularly in the Middle East.
China’s revenue and adjusted* operating profit grew by 45.0 per cent and 30.0 per cent respectively from the previous year and delivered an improved adjusted* operating margin of 7.0 per cent. There are now over 1,100 staff based out of 10 offices in China and the recent acquisition of Benaim continues to perform ahead of expectations. Our two new joint ventures in Chongqing and Wuxi in China are well positioned to take advantage of China’s ongoing investment in infrastructure. A number of large construction projects were successfully completed during the year and at the same time the order book has been topped up by winning several important new commissions in China and Hong Kong for the public sector. The recently announced award of the detailed design of two stations and tunnel works for the MTR South Island line will provide £8m in fees over the next two years. In Hong Kong, almost all private sector investment in buildings and infrastructure has either stopped or been delayed because of the current financial climate and this is unlikely to turn around before the end of 2009. Nonetheless, we remain cautiously optimistic that our business in China will continue to grow during 2009/10.
The Middle East saw major change during the year, starting with growing investment to cater for rapid expansion during the first half of the year, followed rapidly by a significant downturn in the second half, particularly in Dubai, which resulted in a headcount reduction of some 40 staff in the region. In addition, some 20 staff were released in the Bangkok office which was also exposed to the private sector downturn. A particular Middle East casualty has been Oqyana, part of the World Islands development where the property investors suspended the project due to the lack of funds to pay creditors. They are attempting to restructure finance and/or sell the islands but in the meantime this has resulted in an exceptional £2.7m provision booked against this project. Elsewhere in the Middle East, workload is holding up, particularly in Abu Dhabi and Bahrain, albeit with some reprogramming of projects.
Our Indian regional business has continued to grow by some 28.9 per cent in revenue terms with a 56.9 per cent increase in adjusted* operating profit and an adjusted* operating margin of 14.1 per cent. The government is continuing with its major spend on infrastructure and any changes from elections this year are not expected to compromise long term projects; the slump in the private property sector is having very little effect on our Indian business.
There is a similar story in Eastern Europe with substantial growth in revenue, but also accompanied by much strengthening of the adjusted* operating margin to 6.8 per cent up from the previous year’s 6.2 per cent reflecting maturity of the business after a number of years of investment. A planned entry into the property sector has been deferred until market indicators improve.
Although mineral prices have suffered a major correction, there remains a solid demand for our global mining services and the need for renewable energy is increasing demand for our power engineering services, particularly in hydro‑electric schemes.
Apart from some tempering of the Middle East market, all international areas of the business are experiencing continued growth and new orders for the year are encouraging which should serve to underpin revenue targets in 2009/10.
principal risks
Despite the current slowdown in the global economy, our strategy for achieving sustainable growth and margins in the changing climate continues to be focused on managing the diverse markets in which we operate. The Group mitigation strategy includes spreading market risks to achieve an acceptable balance of revenue earned from market sector, geography, public/private client and contract type, to invest in market sectors where growth is more assured, to ensure our commitment to excellence in quality of our services and client care. These factors remain fundamental to mitigating economic risks.
Focus continues on building brand profile and ensuring our values are embedded across stakeholder groups. Building and delivering a high brand profile is fundamental, ensuring access to our markets and that high levels of repeat business are maintained.
There remains an underlying specialist skills shortage in the industry globally. However, changing resource requirements as a result of the current markets has enabled us to rebalance and redeploy our existing resources to be more aligned with the delivery of the strategic plan. We continue to invest in longer term development plans to ensure we are in a strong position to address resourcing requirements ready for any upturn in the economic climate.
The Group has a wide spread of clients across countries and across the public and private sectors, although the majority of the Group’s operations are undertaken in the UK on behalf of UK-based organisations. Policies and procedures are in place to ensure that contracts are only undertaken with clients of an appropriate financial standing and on a basis that gives rise to a commercially acceptable cash flow profile.
However, given the scale of some of our projects, credit exposure to individual clients can at times be significant. The top ten trade receivables balances at the period end amount to 21.8 per cent of total trade receivables. The top ten amounts recoverable on contracts amount to 18.5 per cent of total amounts recoverable on contracts.
The Group’s revenues are substantially derived from the successful performance of the many individual projects and assignments for our clients. There is a risk that poor project performance, or other project risks, could impact upon the results of the Group. Such risks include failures in pricing or estimation at the tender stage leading to a loss-making project, shortcomings in the performance of services leading to non-payment of fees and claims against the Group and client insolvency.
With respect to possible claims, in common with others operating in our markets, the Group maintains professional indemnity insurance to mitigate the impact of a successful legal claim against us. We carry out risk assessments for new projects and have a formal process to consider, amongst other matters, project pricing and the financial strength of clients.
Where possible we seek to mitigate contract risks by agreeing appropriate financial and other liability caps, related limitations and exclusions in appointments. Where adverse project risks materialise, judgements are made regarding the extent to which value will be received in respect of work undertaken both invoiced and uninvoiced and appropriate financial provision made. This includes an assessment of the extent to which clients accept variations or claims, where additional fees are sought as a result of work being undertaken beyond the terms of the original contract, and of clients’ ability to pay. In the event of the project risk taking the form of a claim, the circumstances are investigated and defended as required.
The day-to-day operations of the Group depend on a certain level of committed bank facilities. In recognition of this, new long-term bank facilities were put in place in May this year, which provide £70m of committed credit lines until April 2011. We are operating comfortably within the financial covenants contained in the facility agreement. In addition, we are establishing strong relationships with a number of banks around the world, who we believe will be supportive of our future financing requirements.
Foreign exchange risk arises from future commercial transactions, the performance of the remaining elements of current contracts, assets and liabilities recognised in the balance sheet and net investments in foreign operations. The Group has an overall inflow of US dollars and euros into the UK and has exposure to local currencies on international projects where it pays employees or contractors locally. The Group partially mitigates this exposure by invoicing part of the project revenue in local currency to hedge against local currency expenditure and invoicing the balance in either US dollars or euros with payments to sub-consultants and local suppliers in the currency of the contract. The contracted net exposure is hedged using foreign currency swap contracts.
The Group has an exposure to global interest rates, which the Board continually reviews and has entered into swap contracts to fix interest rates on £9 million of its sterling borrowings.
executive committee
The Executive Committee established in May 2008 has played a significant part in determining the Sector and Regional structure of the business to be implemented in the new financial year. Without doubt, this will enable the Group to strengthen its integrated global enterprise model and bring renewed focus on our worldwide clients and markets.
For the forthcoming year, the Committee will comprise the key operational leadership team including the Group Chief Executive, the Group Finance Director, the two Group Managing Directors, the Sector Managing Directors, the Regional Managing Directors, the Group HR Director, the Group Business Systems Director, the Group Performance Director and the Global Integration Director.
The Committee remains a formal committee of the Main Board and its key role is to support the Chief Executive in implementing the Group’s five year strategic plan by delivering an agreed business plan on an annual basis.
employees
The sudden and dramatic downturn in the global economy has had an impact on our business, particularly in those sectors more dependent on private investment. This has led to the requirement to reduce our labour costs to match our predicted revenue and clearly the impact on those individuals involved has been difficult. However, we have also taken the opportunity to revisit our location strategy, review the effectiveness of our functional organisation and increase the efficiency of our remaining delivery capability.
The two programmes described here represent an example of how we have extracted best value out of the programmes we have in place and our continuing investment in our key talent who will support our ongoing strategic and operational objectives.
- Talent Management. Developing our human capital and deploying this effectively and efficiently to meet our business needs and the requirements of our clients remains central to our success. A significant investment has been made in our best practice global Talent Management programme, the objective of which has been to identify key talent to lead the business in the future and to deliver bespoke learning and development interventions for our talent pools to ensure our future leadership capability both in the short and long term.
- MyBenefits. We continue to seek to offer an attractive and distinctive reward and benefits package for our employees and a significant recent development has been the enhancement of our UK flexible benefits programme to support our objective of increased corporate sustainability. We now offer attractive green travel options including the facility for employees to purchase a bicycle or annual bus season ticket for their journeys to work and employees are able to calculate their personal carbon footprint and make an offsetting donation to charity.
outlook
Over the past six months, active and ongoing measures have been taken to combat the current economic weakness. This has been largely but not exclusively confined to the global private sector property market and the necessary restructuring initiative will result in a reduction of 650 staff across the Group. Despite this, there has been renewed focus on improved cash conversion and collection and a range of internal efficiency improvements.
Given our sector and geographic diversity and our stable financial position, the business is in good shape to face the challenges of the coming year. Our new sector facing management structure allows us to more clearly identify and assess potential growth paths across our geographic regions.
Strategic Consultancy’s key strength is linking the technical knowledge of the Group to the economic and business planning requirements of our clients. We would expect this activity to be maintained at present levels in the UK with new opportunities emerging in Asia-Pacific following the establishment of a new group in Hong Kong over the past year.
Railways continues to be a potential growth sector in most geographies largely dependent on the continuing high levels of government spend. In the UK, the Crossrail development phase presents an extremely valuable addition to the UK rail market alongside the ongoing spending of Network Rail, Transport for London and Transport Scotland, all of whom have substantial long term budgets. The international metro market particularly in the developing economies offers another source of likely opportunity.
Within Buildings & Infrastructure, the private sector remains largely moribund with little sign of an early recovery particularly in the UK. Within the public sector, opportunities are slow and patchy, especially within health and education. Short term opportunities are largely confined to the waste and industrial sub sectors and in buildings assets for transportation projects where the Group has a strong position.
Environment & Natural Resources is the business sector where we bring together energy, water and mining within the umbrella of the environment. This sector is growing in importance for the Group as demands increase for security and diversity of power water and natural resources against the background of the sustainability agenda and renewable targets worldwide.
The Roads Sector represents the Group’s traditional strength and we see its importance continuing both in the UK and internationally. The forward order book is extremely reassuring in Scotland, Northern Ireland and England where we have strong market positions and across our international regions with Eastern Europe and India also expecting substantial growth opportunities.
Our penetration of the North American market is currently modest and confined to our mining interests in Toronto and Vancouver and a project involvement in the United States, all of which is actively managed at present by our UK‑based sector management teams. It has been a stated intention for some time to explore the market further with a view to investment and we expect to see some progress during the coming year.
Despite the ongoing challenges presented by the global economic situation, we are confident that our historic diversity and geographic spread, coupled with our strong financial status, will allow us to continue to deliver our business strategy in the year ahead.
HUGH BLACKWOOD
GROUP CHIEF EXECUTIVE
30 JUNE 2009