Annual Report & Accounts 2010

Roddy Murray, Group Finance Director

Group Finance Director's Statement

BSS has coped well
in difficult economic conditions

The financial review provides a summary of how the Group has performed during the year and provides additional information to that contained in the financial statements set in Accounts section. The report also comments further on the Group’s funding and liquidity; risks and policies and the key performance measures that are used to manage the ongoing performance of the Group.

Financial Review

The financial strength of the Group has improved significantly despite a period of economic turmoil that stretches back to 2008. BSS has coped well in difficult trading conditions: with resilient revenue, a strong trading ethos and careful management of resource, cost and investment. We have absorbed the worst of the recession and are well placed to meet the challenges of 2010/11 and beyond.

We are encouraged that in the worst year on year reduction in economic activity in more than 70 years, the BSS Group has delivered revenue growth, profit before tax of £44.2m and free cash flow of £21.4m. The 10% final dividend increase reflects our confidence in the future outlook.

The challenge of the last 24 months has been to ensure that BSS anticipates the impact of change in the markets we serve ahead of demand slowing and to act ahead of the downturn in order to protect earnings and cash flow. Cost and resources employed have been scaled down across the business in the face of recessionary markets. Like for like costs were reduced by 5.6% in the financial year ended 31 March 2010, saving £13.4m, compared to a 2.3% reduction in like for like revenue. The exceptional cost of this change, £3.1m, relates to reduction in like for like employee numbers of 222 (4.5%). Cash generation throughout this challenging year has been positive with free cash flow in the year of £21.4m, from which dividends of £9.2m have been paid and £12.4m invested in acquiring two businesses, DHS and UGS. Both businesses have significant growth potential.

Long term value for our shareholders is achieved by focusing on delivering sales growth, improved profitability, cash generation and a solid return on capital employed. These shared goals drive decision making and behaviour in the Group with the financial objectives aligned to this end.

Key to delivering revenue growth and strong returns for our shareholders is identifying opportunities where BSS can bring added value. Investment decisions are made in the context of a clear plan. We aim to build the specialist distribution capability of the Group in the UK through organic growth complemented with selective acquisitions that take the business into adjacent markets. This development can be achieved by leveraging existing knowledge and skills within the business to better effect and at manageable risk.

We have continued to selectively invest throughout the economic downturn and are confident that the Group will make further progress in 2010/11 with new growth opportunities targeted.

Earnings per Share

Return on Capital

Net Debt

The five year record for financial measures used by the Group is set out below:

* After adding back exceptional costs and amortisation of acquired intangibles.

Financial Results

For the year ended 31 March 2010, Group revenue increased by 0.9% to £1,352.4m (2009: £1,340.6m). Like for like revenue, which excludes the impact of acquisitions and new branches, decreased by 2.3% (2009: 0.7% decrease), with a 1.8% like for like growth (2009: 4.2% decrease) in the second half of the year. As the year progressed the business became stronger with like for like revenue growth in quarter four of the financial year of 6.6% against a 2.6% decrease in quarter three.

The Domestic Division has shown resilience throughout the key winter months of the ‘heating season’, benefiting from sustained cold weather and a strong final quarter, despite January’s snow disruption. There are clear signs of an ‘early cycle’ recovery with new build residential activity picking up and the price environment improving.

The Industrial Division has absorbed the impact of a reduction in commercial new build activity but both government spend and core repair and maintenance work has held up well. Diversification and new growth opportunities should cushion the impact of reduced public sector investment in future years.

Both Buck & Hickman and BPT have faced tough trading conditions with their manufacturing and construction customers facing the full impact of the recession. Revenue trends improved in the second half as both businesses have made progress in recruiting new customers in preparation for growth.

Revenue growth on an organic basis, which includes the benefit of new branches, was up 0.6%, with bolt on acquisitions contributing a further 0.7% growth. The Group acquired Direct Heating Spares Limited (‘DHS’) in April 2009 at a cost of £6.2m and Underground Supplies Limited (‘UGS’) in early February 2010 for £5.2m (including acquired debt). DHS achieved a 35% ROCE in its first year of Group ownership.

New branches contributed 2.9% growth to Group revenue with a further 18 branches opened in the year. New branches continue to provide a satisfactory return on capital with their performance closely monitored. New branches continue to represent a good use of shareholder capital.

Gross profit of £286.6m was £20.0m (6.5%) down on last year. The gross margin percentage was 21.2%, down 1.7% on 2009. The reduction in gross margin percentage reflects competitive market conditions, increased contract sales and adverse mix from strong trading performance from F & P Wholesale. The underlying gross margin differential narrowed in quarter four of the financial year relative to last year reflecting signs of price stability in the marketplace and improving economic conditions.

Costs of £237.0m were £5.2m (2.1%) down on last year. Excluding the impact of acquisitions and new branches like for like costs were 5.6% down on last year. Bad debts written off cost £7.3m (0.54% of revenue) an increase of £0.4m on the prior year. An exceptional charge of £3.1m (2009: £1.2m) was made for redundancy costs and amortisation of acquired intangibles cost £2.3m (2009: £2.2m).

Group cost to sales ratio, prior to exceptional costs and amortisation of intangibles, was 17.1% against 17.8% in 2009. Adjusted operating profit of £55.0m was £12.8m (19%) down on the prior year (2009: £67.8m). The impact of the like for like sales decrease and lower gross margin percentage was partly offset by costs savings and contribution from new branches and businesses acquired. Based on adjusted operating profit, operating margin in the year was 4.1%, 1.0% below prior year (2009: 5.1%).

The adjusted operating profit reduction in the Domestic Division of £4.2m (11.4%) reflects the impact of competitive price conditions and adverse sales mix through the recessionary months partly offset by cost savings and a £2.2m contribution from DHS. Industrial Division operating profit was down £4.9m (16.3%) reflecting slower commercial new build activity, competitive conditions and poor trading in Southern Ireland. Specialist Division made £2.0m against £4.7m in 2009. The Division absorbed the full impact of the contraction in manufacturing activity in 2009.

Group interest charges decreased from £6.6m to £4.8m reflecting the reduction in LIBOR against the prior year. Interest cover was a healthy 10.8 times (2009: 9.1 times) and gearing closed the year at 33.3% (2009: 37.1%).

Profit before tax decreased by £13.6m (23%) to £44.2m (2009: £57.8m).

The tax charge for the year was £12.8m (29.0% of profit before tax) compared with a £16.8m charge in 2009 (29.1%). The total tax charge is above the basic rate due to expenditure not eligible for tax relief.

Earnings per share were 25.4p (2009: 33.3 pence). Adjusted EPS is 28.5p (2009: 35.2 pence) based on adjusted earnings after adding back exceptional costs and amortisation of acquired intangibles. There is no material difference between earnings per share and fully diluted earnings per share.

Shareholders’ Return

Total equity has increased in the year by £24.3m (10.5%) to £255.9m (2009: £231.6m).

The share price on 31 March 2010 was 285p (31 March 2009: 288p), having been at a high in the year of 328p and a low of 238p. The share price on 21 May 2010, the latest practical day before the publishing of these accounts was 310p. At the year end the market capitalisation was £354.4m (2009: £355.7m), which represents 1.4 times (2009: 1.5 times) shareholders’ funds.

Based on operating profit generated in the year, return on capital employed (equity and debt) was 14.5% against 20.3% in 2009.

Given the positive trends in revenue and earnings and a more optimistic assessment of outlook, the Board recommends that the final dividend is increased by 10% to 6.09 pence per share (2009: 5.54p), making a total for the year of 7.98p (2009: 7.43p).

Cash Flow

Free cash flow in the year of £21.4m (2009: £27.9m) was £6.5m lower than last year reflecting lower profits partly offset by lower capital expenditure. The working capital to sales ratio increased from 14.0% to 14.4% of sales during the year.

Working capital in the year, excluding acquisitions, increased by £6.3m (3.3%) against 6.6% like for like revenue growth in the final quarter of the year. Tight control of working capital has been maintained and in-take of stock has been carefully managed to meet sales expectations.

Net debt decreased in the year by £0.7m to £85.3m (2009: £86.0m) with free cash flow of £21.4m offset by the cost of acquiring DHS £6.2m and UGS £5.2m plus dividends of £9.2m. Borrowings and interest cover remain at comfortable levels relative to earnings and the free cash flow of the Group.

Debt Facilities

The Group has a mixture of unsecured bank borrowings, unsecured loan notes at fixed and floating rates and retained profits to fund its day to day activities. The $125m of US$ loan notes are repayable in 2013 ($75m) and 2016 ($50m) and are used to fund the core debt of the Group. The loan notes were swapped into sterling at $1.73 = £1. There is no currency risk. In April 2009 the Group refinanced its Revolving Credit Facility (‘RCF’) replacing the existing £100m facility with a £90m facility which is repayable in April 2012. This facility is provided by a syndicate of banks which is used to fund bolt on acquisitions and supplementary working capital requirement. In addition there is a £50m overdraft facility that was renewed in December which is used to fund the Group’s fluctuations in working capital as part of our short term borrowings.

The Group had unutilised credit facilities of £127.3m as at 31 March 2010. The ratio of net debt to earnings before interest tax depreciation and amortisation (‘EBITDA’) was 1.47 times (2009: 1.18 times) at year end.

Capital Expenditure

During the year the Group invested £10.0m (2009: £15.4m) in capital expenditure of which £2.2m was invested in opening new branches; £4.4m upgrading IT systems and £3.4m upgrading branches, trade counters and warehouse facilities. IT investment reflects upgrade to existing networks and infrastructure as part of a staged implementation to improve core systems.

Capital expenditure and significant disposals are subject to capital appraisal reviews with clear authority levels in place throughout the Group.

Pension Funds

The Group has three closed final salary pension schemes. The total Group pension deficit calculated on an IAS 19 basis for the defined benefit schemes was £26.2m at 31 March 2010 (2009: £30.9m).

Despite a reduction in the AA long bond yield from 6.6% to 5.6%, which has added £28m to pension liabilities in the year, the three Group schemes have benefited from a relatively high level of its asset base (89%) being held in equities. As the equity markets have recovered the appreciation in assets has exceeded the increase in liabilities. The Trustees of the three schemes take comfort from the strong financial covenant of the Group and the Board’s prudent financial management. At the year end, the deficit represented 7% (2009: 9%) of the Group market value.

Financial Risk Management

The Group Treasury team continues to co-ordinate the Group’s banking and borrowing requirements, and controls exposure to foreign exchange and interest movements. The aim of this team is to minimise the effect of changes in external and internal conditions on the financial performance and net assets of the Group. The Group manages these risks using Board approved policies and procedures and does not enter into speculative contracts. Derivative instruments are used but only to manage our exchange and interest exposure.

Interest Rate Risk

As at the year end, 85% of the Group’s net debt is subject to interest rate hedging through swap transactions. The Group uses these interest rate swaps to manage its exposure to variable interest rates. Further information is set out in the notes to the full financial statements.

Liquidity Risk

The Group finances its operations through a mixture of retained profits, bank borrowings and private placement finance. The borrowings are denominated primarily in Pounds Sterling and the Private Placement debt is denominated in US Dollars. Cash deposits are placed with banks at floating rates on periods ranging from overnight to monthly depending on forecast cash flow requirements and earn interest at prevailing rates in the money market. The maturity profile of borrowings is set out in notes 15 and 16 to the financial statements. The Group maintains the mixture of long term, medium term and short term committed facilities as part of its liquidity risk management, which enables the Group to ensure that it is able to meet the funding needs of the business.

Currency Risk

The Group’s exposure to foreign currency risk is increasing as direct sourcing actively increases. The Group’s wholly owned Irish subsidiary’s revenues and expenses are denominated in Euros. The Group faces minimal currency exposure on the translation of profits earned within this subsidiary and its related net assets. The Group’s trade purchases from overseas suppliers are either purchased in pounds sterling or in the relevant foreign currency. The Group enters into finance contracts to buy foreign currency forward to lock input costs at levels that enable the commercial teams to price and trade effectively. The Group’s balance sheet transaction exposure relates primarily to foreign currency trade creditors and is not material to the Group. Furthermore the Group’s US denominated borrowings have been converted to sterling using currency swaps.

Credit Risk

The Group has no significant concentration of credit risk and limits the amount of credit exposure to any particular customer across all trading Divisions via credit insurance and a Group wide credit limit. It has policies in place to ensure that sales of product are made to customers only with an appropriate credit standing and history. Regular credit review meetings are held to manage key debtors and overdue debts. Consequently, management believe that no further credit risk provision is required in excess of normal provision for doubtful debtors which stand at £7.9m (2009: £8.0m) at 31 March 2010.

Roddy Murray

Group Finance Director
25 May 2010