Connect Group PLC

('Connect Group' or 'the Group')

Audited Preliminary Results Announcement for the year ended 31 August 2019

Connect Group, a leading UK specialist distributor, today announces its audited preliminary results for the year ended 31 August 2019.

·      Smiths News delivering a strong performance, but offset by ongoing challenges in Tuffnells

·      Tuffnells impacted by flow-through of legacy issues, compounded by lower volumes and especially challenging final quarter

·      Strategic review of Tuffnells to be conducted, encompassing further actions to drive recovery and assessing longer term role and prospects in the Group

·      As separately announced today, senior management changes and appointment of an Executive Chairman of Tuffnells to provide additional support and expertise during the Strategic Review of Tuffnells

·      Impairment of £45.5m in relation to goodwill, tangible and intangible assets of Tuffnells, resulting in a statutory loss before tax of £37.6m

·      Free cash flow of £8.3m (FY2018: £20.2m) after settlement of legacy cash adjusted items

·      Net Debt £73.9m, down £9.5m (FY2018:£83.4m) and 1.9X net debt:EBITDA, reflecting focus on disciplined capital management

·      Sale and Leaseback of 6 Tuffnells' depots in September 2019, raising proceeds of £9.9m that have further reduced net debt.

Gary Kennedy, Chairman, commented: "In a challenging year, we have been resolute in pursuing a recovery plan that balanced improvements to profitability, with necessary investment and prudent capital management. The revitalised performance of Smiths News and the progress with our central restructure have established a solid foundation for the Group's medium term recovery.  The turnaround of Tuffnells remains our most pressing challenge. The strategic review of that business and the management changes that we have announced today reflects our focus on delivering improvement and removing its drag on overall Group performance."

Enquiries:

Connect Group PLC

Jon Bunting, Interim Chief Executive Officer                                        01793 563641

Tony Grace, Chief Financial Officer                                                        01793 563638 www.connectgroupplc.com 

Buchanan

Richard Oldworth/ Jamie Hooper                                                          020 7466 5000

[email protected] 

www.buchanan.uk.com

Connect Group PLC's Preliminary Financial Results 2019 are available at www.connectgroupplc.com 

A meeting for analysts will be held at the office of Buchanan, 107 Cheapside, London,

EC2V 6DN on 6 November 2019 commencing at 9.30am.

An audio webcast of the analyst meeting will be available from 12 noon today via the following link: https://webcasting.buchanan.uk.com/broadcast/5d9f430234a3cf1389e7d1b0 

About Connect Group

Connect Group PLC is a UK based specialist distributor and a leading provider of distribution solutions in complex and fragmented markets. The Group's networks are focused on serving high drop density early morning deliveries, and the demands of mixed and irregular sized freight.

The Group's core businesses are:

Smiths News is the UK's largest newspaper and magazine wholesaling business with an approximate 55 per cent market share. It distributes newspapers and magazines on behalf of the major national and regional publishers, delivering to approximately 25,500 customers across England and Wales on a daily basis. The speed of turnaround and density of Smiths News' coverage is critical to one of the UK's fastest physical supply chains.

Tuffnells is a leading distributor of mixed and irregular freight, serving small and medium sized enterprises across the UK. Its national network of depots collects and delivers mixed parcel freight consignments, specialising in items of irregular dimension and weight ("IDW"), examples of which include bulky furnishings, building materials and automotive parts. With a mix of local and national clients, Tuffnells offers a range of timed services that are responsive to customer demand.

Notes to Editors:

This document contains certain forward-looking statements with respect to Connect Group PLC's financial condition, its results of operations and businesses, strategy, plans, objectives and performance. Words such as 'anticipates', 'expects', 'intends', 'plans', 'believes', 'seeks', 'estimates', 'targets', 'may', 'will', 'continue', 'project' and similar expressions, as well as statements in the future tense, identify forward-looking statements. These forward-looking statements are not guarantees of Connect Group PLC's future performance and relate to events and depend on circumstances that may occur in the future and are therefore subject to risks, uncertainties and assumptions. There are a number of factors which could cause actual results and developments to differ materially from those expressed or implied by such forward looking statements, including, among others the enactment of legislation or regulation that may impose costs or restrict activities; the re-negotiation of contracts or licences; fluctuations in demand and pricing in the industry; fluctuations in exchange controls; changes in government policy and taxation; industrial disputes; war and terrorism. For a more detailed description of these risks, uncertainties and other factors, please see the section titled "Principal and Emerging Risks" in the preliminary announcement for the full year ended 31 August 2019. These forward-looking statements speak only as at the date of this document. Unless otherwise required by applicable law, regulation or accounting standard, Connect Group PLC undertakes no responsibility to publicly update any of its forward-looking statements whether as a result of new information, future developments or otherwise. Nothing in this document should be construed as a profit forecast or profit estimate. This document may contain earnings enhancement statements which are not intended to be profit forecasts and so should not be interpreted to mean that earnings per share will necessarily be greater than those for the relevant preceding financial period. The financial information referenced in this document does not contain sufficient detail to allow a full understanding of the results of Connect Group PLC. For more detailed information, please see the preliminary announcement for the full-year ended 31 August 2019 which can be found on the Investor Relations section of the Connect Group PLC website - www.connectgroupplc.com. However, the contents of Connect Group PLC's website are not incorporated into and do not form part of this document.

The Group uses certain performance measures for internal reporting purposes and employee incentive arrangements. The terms 'net debt', 'free cash flow', 'adjusted operating profit', 'adjusted profit before tax', 'adjusted earnings per share' 'adjusted EBITDA' and 'Adjusted' are not defined terms under IFRS and may not be comparable with similar measures disclosed by other companies.
 

(1)   The following are the key non-IFRS measures identified by the Group in the consolidated Group financial statements as Adjusted results: Adjusted operating profit is defined as statutory operating profit from continuing operations, excluding the impact adjusting items (defined above). This metric is reconciled on the face of the income statement, with detail of each adjusted item disclosed within note 4. Adjusted profit before tax is defined as statutory profit before tax, excluding the impact of adjusting items (defined above). This metric is reconciled on the face of the income statement, with detail of each adjusted item disclosed within note 4. Adjusted earnings per share; is defined as adjusted PBT, less taxation attributable to Adjusted PBT and including any adjustment for minority interest to result in adjusted profit after tax attributable to shareholders, divided by the basic weighted average number of shares in issue. This metric is reconciled in note 10. Adjusted items are items of income or expense that are considered significant, in nature or value, and are excluded in arriving at Adjusted operating profit. The purpose of excluding these items from adjusted measures is to provide additional performance metrics to users of the financial statements that exclude the impact of the items the directors consider to have a significant impact on reported results and do not relate to the underlying trading activity of the Group. The specific items vary between financial years, and for the current year include certain disposal related costs, legal and regulatory provisions, amortisation and impairment of acquired intangibles including goodwill, impairment of property, plant and equipment, integration costs, business restructuring costs and network re-organisation costs including those relating to strategy changes which are not normal operating costs of the underlying business. They are disclosed and described separately in note 4 of the Group Financial Statements to provide further understanding of the financial performance of the Group. A reconciliation of adjusted profit to statutory profit is presented on the income statement.

(2)   Free cash flow is defined as cash flow excluding the following: payment of dividends, dividends from associates, acquisitions and disposals, the repayment of bank loans, Employee Benefit Trust share purchase, proceeds of share issues and cash flows relating to pension deficit repair. This measure shows the cash retained by the Group in the year and is considered by the directors to provide additional information on the cash available for shareholders' returns. A reconciliation of free cash flow to the net movement in cash and cash equivalents is shown in note 35 of the Group Financial Statements.

(3)   Adjusted EBITDA is calculated as Adjusted operating profit (as defined above) before depreciation and amortisation. This metric is reconciled in the Free Cash Flow table within the Financial Review.

(4)   Net debt is calculated as total debt less cash and cash equivalents. Total debt includes loans and borrowings, overdrafts and obligations under finance leases. A reconciliation of net debt is presented in the Group Cash Flow Statement.

(5)   Continuing operations for FY2018 excludes the sale of the Books division which was sold on 14 February 2018. Discontinued profit for the FY2018 is for the Books division up to the point of disposal.

(6)   FY2019 refers to the full year ended 31 August 2019, FY2018 refers to the full year ended 31 August 2018.

(7)   All movements are calculated to round thousands.

OPERATING REVIEW

INTRODUCTION

In a year of considerable change, we have resolutely focused on our plans for a sustainable recovery of the Group in the medium term. Smiths News, our largest business and the major contributor to our cash flows, had a strong year, and our plans for central cost efficiencies are on track with further opportunities underway. Tuffnells, however, had a challenging year, with its performance hampered by a flow through of legacy issues, compounded by weakening market conditions.

While the Group has made significant progress against many of its recovery targets the underperformance of Tuffnells has materially impacted our overall performance and, as a consequence, we have fallen short in our ambition for stakeholders. We are therefore implementing a strategic review of Tuffnells to determine both the further actions required for a sustainable recovery and, more widely, to assess its future role and prospects in the Group.

Following management changes announced today, Chief Executive Officer Jozef (Jos) Opdeweegh has stepped down from both his executive role and as a director of the Board; Jon Bunting (CEO, Smiths News), has become Interim Chief Executive Officer of the Group; and Michael Holt (non-executive director) has agreed to temporarily become Executive Chairman of Tuffnells for the period of the Tuffnells strategic review. 

FINANCIAL HEADLINES

Group Adjusted profit before tax for continuing operations of £23.2m is down by 18.3% (FY2018: £28.4m) and Adjusted Earnings per Share of 7.9p is down 15.1% (FY2018: 9.3p).  

Following an impairment of £45.5m to the goodwill, tangible and intangible assets of Tuffnells, the Statutory loss before tax is £37.6m (FY2018: loss of £35.5m) and Statutory earnings per share is a loss of 12.9p (FY2018: loss of 15.5p).

The Group generated free cash flow from operations of £8.3m (FY2018: £20.2m), helping to reduce Net Debt by £9.5m to £73.9m (FY2018: £83.4m).

Since the year end, the Group has completed the sale and leaseback of 6 Tuffnells depots for £9.9m, the proceeds of which have been used to further reduce the Group's Net Debt from that reported at the year end. We continue to investigate opportunities for remaining depots, but, with strong underlying finances, our capital management strategy is not dependent on further transactions.

After careful consideration of the Group's overall performance in the year and in light of both ongoing confidence in future positive cash flows and the immediate priorities of the business, the Board has recommended a final and full year dividend for FY2019 of 1.0p (FY2018 3.1p, down 2.1p). 

SMITHS NEWS

Smiths News had a strong year, benefiting from the return to focused management and the removal of legacy costs and resultant losses in Pass My Parcel and distractions inherent in the former integration strategy. Adjusted Operating Profit of £43.6m is up 12.1% (FY2018: £38.9m), driven by structured cost cutting which more than offset the margin impact of declining sales. The accelerated renewal of publisher contracts representing 80% of our revenues at current values, provides certainty for our territories through to at least 2024, allowing us to plan further network efficiencies that will help meet the ongoing challenge of offsetting the impact of falling sales.

Newspaper and magazine sales continue to decline in line with long term trends upon which our efficiency plans are based. Newspaper revenue of £826.8m was down 2%, with price continuing to help offset volume declines; Magazine categories were down by 8%, and 6% on a like for like basis after excluding World Cup sales in FY2018. We continue to plan on the basis of gradual declines which we aim to mitigate through supply chain simplification and process efficiencies.

In the second half of the year, the operations and management of DMD were fully merged into Smiths News. The change reflects a progression of closer working over recent years and will help to mitigate the impact of the key contract loss of British Airways within DMD, which took effect from June 2019.

Looking ahead, our strategy for Smiths News is unchanged: while we are alert to adjacent opportunities, our primary focus is on delivering unmatched service for publishers and retailers, and securing efficiencies in what is a well-established and predictable business model.

TUFFNELLS

Tuffnells' performance was severely challenged by the carry through of legacy issues, including customer losses, poor quality revenues and operational disruption from the prior year. Their impact was made worse by an insufficiently flexible cost base and inconsistent service which resulted in inefficiency and rectification costs. Despite much progress in addressing the underlying issues, the decline in consignment volume, exacerbated by an especially challenging last quarter, has further delayed our expectation of financial performance improvement.

Sales of £164.6m were down by 6.4% (FY2018: £175.2m) resulting in the Adjusted Operating Loss of £14.1m, worsening by £9.1m (FY2018: loss of £5.0m).  The disproportionate impact of declining volumes on profitability reflects the legacy operating model, founded on a relatively high fixed cost base and inflexible processes. Actions we took to review customer rates and exit from unprofitable accounts have been successful in increasing the quality of our revenue, but not without further short term impact on volume. New revenue generation at these more sustainable rates proved especially challenging in what have been disruptive markets, leading to loss of share to competitors over the course of year.

Given the ongoing challenges to performance improvement, an impairment of £45.5m was made to the goodwill, tangible and intangible assets of the business. Furthermore, we have initiated a strategic review of Tuffnells which will be led by our chairman, Gary Kennedy.

While the strategic review will determine our long term plans for Tuffnells, we remain focused on addressing immediate issues.  Swift action has been taken to further reduce operating costs through improved last mile routing, and a wider network efficiency programme is underway. The business has ended the financial year with a lower cost base, which will have a positive impact on any volume improvements.  Our immediate plans are therefore focused on increasing consignment volumes, new customer wins without undermining profitable rates, the delivery of leaner and more flexible costs and improving the quality of service. These KPIs will spearhead our recovery plans in tandem with the strategic review and we will report on progress in due course.

STRATEGIC REVIEW OF TUFFNELLS

We continue to believe that the operational performance of Tuffnells can be improved, with the immediate priority being to identify measures to reduce costs and improve operational flexibility. However, in the light of its continued drag on overall Group performance, the strategic review will also determine the most appropriate structure and strategy for the business, and more widely to consider its role and future in the Group.

To support the strategic review and performance improvement plans, Michael Holt has agreed to become Executive Chairman of Tuffnells for the duration of the process. Michael has been a non-executive director of the Group since October 2018; with deep experience in the distribution and logistics sector he is well qualified to provide insight and direction that will complement the current management team.

While the strategic review will primarily focus on the necessary actions and investment for a medium term recovery, we will maintain our vigorous pursuit of more immediate cost savings, network efficiencies and quality revenue generation in response to the recent decline in consignment volumes.  Throughout the review period, we are conscious of minimising uncertainty for all stakeholders and commit to communicating our progress and conclusions as quickly as possible.

GROUP STRUCTURE AND CENTRAL SERVICES

In October 2018, the Group halted its former integration plans, returning operational management to Smiths News and Tuffnells under a business unit structure, supported by shared central services.  Operationally, the change has been a success, removing distraction while driving ownership and accountability of the two distinct businesses. The structure is now well established and we envisage no material changes as we continue with our medium term plans.

The establishment of the business unit model was delivered in parallel with the creation of a Shared Services Centre, designed to streamline central functions and deliver cost savings while improving service to the operating businesses. Outcomes of particular note include: the off-shoring of select technology, customer and finance services which, when fully implemented, will deliver substantial savings to overheads and future capital requirements; the development and trial of revised operating procedures to ensure consistent best practice in both Smiths News and Tuffnells; and the consolidation of finance functions into a single centre which will commence in December 2019.

Currently underway is a further resizing exercise to ensure our Head Office functions reflect the reduced scope of the Group.

PRIORITIES FOR FY2020

The Group's strategy is founded on building the capability of Smiths News and Tuffnells, through actions and investments that deliver sustainable value over time. While we continue to explore and evaluate potential adjacent opportunities, we do not plan to diversify into new sectors.

The following priorities will spearhead the next phase of our recovery, backed by a commitment to update stakeholders on a regular basis.

1.   Tuffnells Strategic Review - determining the necessary actions and investment for a sustainable recovery of Tuffnells, while evaluating their impact on the overall Group and long term shareholder value.  Revenue generation and cost saving initiatives will be pursued in tandem with the review.

2.   Smiths News cost savings - achieving sustainable efficiencies that aim to offset the margin impact of any decline in core sales.

3.   Network optimisation - delivering efficiencies in both Smiths News and Tuffnells, while improving service and coverage for customers.

4.   Optimising head-office functions - optimising our central costs in line with the new Group structure.

5.   Capital discipline - continuing to reduce Net Debt while meeting the investment needs of the business and delivering attractive returns for shareholders.

6.   Leveraging and energising our people - harnessing the skills and commitment of colleagues as we address immediate challenges and continue our path to performance recovery.

CAPITAL MANAGEMENT

Following review of our Capital Management strategy, we have followed a strict capital discipline, ensuring that free cash from operations funds the investment needed for recovery, with the surplus used to achieve a reduction in Net Debt while maintaining a focus shareholder returns.

The Group's operations continue to generate strong free cash and we anticipate capital requirements remaining within the guidance of 30%-50% of EBITDA. Net Debt at £73.9m represents 1.9x EBITDA, before the benefit of proceeds from the sale and leaseback of selected Tuffnells depots. We remain committed and on track to reducing net debt to 1x EBITDA by the end of FY2021.

The final and full year dividend of 1.0p reflects our ongoing confidence in the Group's cash generative model.

DIRECTORATE CHANGES

Chief Executive Officer, Jozef (Jos) Opdeweegh, has stepped down from both his executive role and as a director of the Board with immediate effect.  Jos has been instrumental in the past 12 months in helping to bring focus to the Group and many changes he has led position us well to meet our ambition in more closely aligning the Group's performance to shareholders' expectations.

Jon Bunting (CEO, Smiths News), who joined Smiths News in 1994 and was appointed to the Board in 2010, has stepped up to become Interim Chief Executive Officer of the Group.  In the light of the strategic review of the Tuffnells business we will review this position at the end of that process.  Jon will retain accountability as CEO of Smiths News through this interim period.

Michael Holt (non-executive director) has agreed for the period of the strategic review process to become Executive Chairman of Tuffnells, with responsibility for providing relevant and current insight to aid both the broader strategic review and targeted profit recovery at Tuffnells.  In order to ensure we retain his expertise and contribution to our wider strategy, Michael will continue as a director of the Group and member of the Board albeit, for the duration of this additional role, he will temporarily relinquish being a member of each of the Audit, Remuneration and Nominations Committees.  However, given the short term and specific nature of his interim role, the Board does not currently consider that it will permanently impair Michael's future independence in accordance with the UK Corporate Governance Code.

SUMMARY AND OUTLOOK

The Group remains focused on a turnaround that is founded on the sustainable improvement of our core businesses underpinned by prudent capital management. Sales in Smiths News have started the year a little slowly but we are confident that performance will be brought back on track over the remainder of the year. In Tuffnells, trading in the year to date is more difficult than anticipated but is expected to stabilise in H2. Our actions to reduce costs and increase the flexibility of the operating model in Tuffnells will continue as we pursue a wider strategic review of the business.

FINANCIAL REVIEW

Overall performance is slightly below market expectations as we continue to address the underlying issues that impacted revenue and costs in FY2018 and flowed through into this year. Smiths News re-established its cost saving rhythm to improve margins, which offset the delayed turnaround in Tuffnells performance.

The  financial position of the Group benefited from positive free cash flow in the year of £8.3m, which reduced Net Debt at year end to £73.9m (FY2018: £83.4m).

CONTINUING ADJUSTED RESULTS - GROUP

Continuing adjusted operating profit of £29.5m, was down £4.4m (13.0%) on the prior year, a recovery in financial performance at Smiths News which was more than offset by the challenging  turnaround at Tuffnells.

Smiths News Adjusted operating profit was up by £4.7m to £43.6m. The structural decline in newspaper and magazine sales, and resultant margin decline, was successfully mitigated by the restoration and catch-up of the network saving programme of £6.5m. In the prior year, Smiths News Adjusted operating profit was favourably impacted by World Cup magazine and sticker sales which generated profits of £2.8m but adversely impacted by a loss in Pass My Parcel of £5.4m. The execution of the closure of the Pass My Parcel proposition has progressed smoothly.

The revenue and profit of DMD has been absorbed into the Smiths News results following the loss of the British Airways contract from June 2019, reflecting the decision to fully integrate the respective operations and marketing functions. Revenue of £24.1m was down £2.4m (9.1%) and Adjusted operating profit reduced by £0.4m (13.3%) to £2.6m, driven primarily by the loss of the British Airways contract from June 2019 and the annualised impact of two publisher contract losses.

Tuffnells reported an Adjusted operating loss of £14.1m, an increase of £9.1m on the prior year (FY2018: £5.0m loss). Performance was hindered by the carry-over of customer losses suffered in the second half of prior year, whilst the second half of FY2019 saw further pressure from a continuing competitive market resulting in lower consignment volumes. Despite the challenging year, management actions to prioritise improvements to revenue quality, cost reduction and standard operating processes have gained traction as we enter the new financial year.

As part of the strategic goal to streamline head office services, an offshore shared service centre has been established with an outsourcing partner, to manage customer service, technology and finance functions.  A restructuring provision of £2.5m was made at year end.

Net finance charges of £6.3m (FY2018: £5.5m) were up on prior year.  Included within net finance charges are: interest costs on borrowing incurred in the period of £5.1m (FY2018: £4.1m), an increase year-on-year as the annualised interest margin charge was higher under the new facility; finance lease interest of £0.1m (FY2018: £0.6m); amortisation of bank arrangement fees £0.5m (FY2018: £0.5m); and pension interest costs £0.2m (FY2018: £0.2m).

Adjusted profit before tax was £23.2m, down 18.3% on last year.

Taxation of £3.8m resulted in an effective tax rate of 16.4%, effective tax rate was lower than last year driven by movements in deferred tax and tax provision in the prior year.

STATUTORY CONTINUING RESULTS - GROUP

Statutory continuing loss before tax of £37.6m is an increase on the prior year by £2.1m (FY2018: £35.5m loss), primarily driven by: an increase in Adjusted trading losses at Tuffnells of £9.1m, impairment charge relating to goodwill and assets of Tuffnells of £45.5m (FY2018: £46.1m); amortisation of acquired intangibles of £6.8m (FY2018: £7.1m); Pass My Parcel exit costs of £0.3m (FY2018 £6.7m); and network and reorganisation costs of £6.4m (FY2018: £3.1m).

At the divisional level, Smiths News statutory operating profit of £36.3m, was up 31.0% on prior year after £7.3m of Adjusted items which included £5.7m network and re-organisation costs; Tuffnells statutory operating loss was £67.6m down £9.9m after impairment of goodwill, tangible and intangible assets of £45.5m and amortisation of acquired intangibles of £6.6m.

The effective statutory income tax rate for continuing operations was 16.2% (FY2018: 7.3%), as the tax impact of Adjusted items was £9.9m (FY2018: £2.9m).

Statutory continuing loss after tax of £31.5m is down by £6.6m (FY2018: £38.1m loss), and Statutory continuing loss per share of 12.9p is up 2.6p (FY2018:15.5p loss).

As a consequence of the Tuffnells impairment, the net liabilities on the balance sheet have increased £28.4m to a reported net liability at 31 August 2019 of £74.3m (FY2018 £45.9m). Following a corporate restructuring in July 2019, the Connect Group PLC company entity balance sheet continues to have distributable reserves of £131.5m to allow future dividend payments.

EARNINGS PER SHARE

Earnings attributable to shareholders on a continuing Adjusted basis of £19.4m resulted in an Adjusted EPS of 7.9p, a decrease of 1.4p on last year, driven by a recovery in Smiths News margins and network restructuring programme, but offset by challenging trading conditions in Tuffnells.

The fully diluted weighted number of shares was 247.1m (FY2018: 246.7m). Fully diluted shares includes a 0.7m diluted share adjustment for employee incentive schemes (FY2018: 0.7m).

Including Adjusted items, statutory earnings per share is up 2.6p to 12.9p (loss per share) (FY2018: 15.5p loss per share).

DIVIDEND

After careful consideration of the Group's overall performance in the year and in light of both ongoing confidence in future positive cash flows and the immediate priorities of the business, the Board has resolved to recommend a final dividend of 1.0p, leaving the full year dividend as 1.0p to be paid in February 2020, a reduction of 2.1p or 67.7% (FY2018: 3.1p).

SMITHS NEWS (including DMD)

The return to focused accountability has restored stability to the Group's largest business.

Revenue was £1,303.3m (FY2018: £1,361.6m) down 4.3%. Newspaper and magazine sales have continued to perform in line with long term trends, with a relatively stronger performance than expected from newspapers helping to offset weaker magazine sales. Newspaper sales of £826.8m were down 2%, with price increases helping to offset volume declines. Combined sales of all magazine categories were down by 8%, on a like-for-like basis they were down 6% after excluding the benefit of the FIFA World Cup album and sticker sales in FY2018.

Good progress has been made with the accelerated renewal of publisher contracts, with new agreements securing 98% of Smiths News' magazine revenues and 80% of its total current revenues, for an average contract extension of five years.  All our existing territories have been retained, providing the necessary certainty to unlock supply chain efficiencies over the contract periods. 

Adjusted operating profit of £43.6m (FY2018: £38.9m) was up £4.7m (12.1%). The new Group structure with two separate accountable business units in Smiths News and Tuffnells, has restored a more focused approach by the Smiths News management team. The restoration and catch-up of the Smiths News network saving programme generated £6.5m of savings in year which mitigates the decline in revenue from newspaper and magazine sales.  Network savings were generated from final mile route reductions and the closure of a single depot at the end of the financial year. The execution of the decision to close Pass my Parcel in the second half of FY2018 has progressed smoothly and exit cost were in line with expected prior year-end provisions. Adjusted Operating profit in the prior year was favourably impacted by the World Cup sales and profits of £2.8m, but offset by Pass My Parcel losses of £5.4m. These have been the primary drivers in the improvement of operating margin in the year to 3.3%.

In January 2019, the Group disposed of its vending coffee business known as Jack's Beans. This sale was in line with the strategy to divest of non-core assets; the business made negligible contribution and there will be no impact on financial performance in the year.

The revenue and profit of DMD has been absorbed into the Smiths News results, reflecting the way in which the business is now managed following the decision to integrate the respective operations and marketing. Revenue of £24.1m was down £2.4m (9.1%) and Adjusted operating profit reduced by £0.4m (13.3%) to £2.6m, in part driven by the loss of two publisher contracts and the British Airways contract from June 2019. Costs were mitigated by prompt action to restructure the operational structure into the Smiths News' Slough depot.

TUFFNELLS

Tuffnells had a particularly challenging year, achieving total revenue of £164.6m down 6.1%, (FY2018: £175.2m), and returning an Adjusted operating loss of £14.1m, down £9.1m (FY2018: £5.0m loss).

Losses were driven by a number of legacy issues carried over from FY2018 which affected consignment volumes and operating cost efficiency. In what became an increasingly competitive market, variability in service standards and customer attrition among the customer base, led to a further loss of volumes, which continued into the second half of the year, but at a slower rate. The decline in parcel volumes combined with a high proportion of operating costs at a depot level being fixed resulted in continuing losses in the second half of FY2019.  Separately, operational costs rose from increases in national living wage and higher sub-contractor rates further squeezed margins. The decline in margins was addressed by management actions to: improve revenue quality with targeted price rises; and changes to final mile deliveries at a regional level to ensure optimum routing and amalgamation of rounds.

Despite the challenging period, we believe that management actions are the right ones for a sustainable recovery.  We continue to prioritise improvements to revenue quality, cost reduction and standard operating processes - these actions are beginning to achieve traction as we enter the new financial year.

ADJUSTED ITEMS

Continuing Operations

The Group incurred a total of £50.9m of adjusted items on a continuing basis, after tax (FY2018: £61.0m).

Adjusting items are defined in the accounting policies in note 1 and in the glossary, in the directors' opinion the impact of removing these items from the adjusted profit give the true underlying performance of the Group and comprises:

(a) Network and re-organisation costs

These are analysed as follows:

·      Executive Team redundancies of £0.9m                                 

·      Outsourcing of £3.2m

·      DMD Restructure of £1.2m

·      Other redundancy and re-organisation costs of £1.1m

Executive Team redundancies

Costs of £0.9m have been incurred relating to the restructure of the Group's previous executive team (FY2018: £nil). These costs are considered to be adjusting given the size and they enable comparability between years with equivalent costs of the executive team.

Outsourcing central functions 

£3.2m of the current year cost relates to the off-shoring of selected technology, customer services and finance functions.  This process has been communicated to employees.  The £3.2m comprises a provision of £2.5m related to expected redundancy costs as part of this transition and £0.7m related to legal and set up costs. Further costs of the offshoring are expected to be incurred during the next financial year. These costs are considered adjusting as the impact of the transition to an off shored central function is considered a one off.  The running costs once the centre is fully operational will be treated as non-adjusting.

DMD Restructure costs

In May 2019, DMD's biggest contract with British Airways was ended.  As soon as notice was given, the business set about a change programme to right size the operations, close sites and reduce teams to reflect the loss of this contract.  This was designed to ensure the business was able to continue to deliver profits in future with its smaller customer contract base.  In total, costs of £1.2m have been incurred or provided.

These costs are considered to be adjusting given the size and they enable comparability between years with equivalent costs of the day to day operations of the business.

Other redundancy and re-organisation costs

£1.1m has been incurred in redundancy and other reorganisation in streamlining the Smiths News and Tuffnells businesses (FY2018 £nil). This is net of a release of £0.4m of redundancy provisions made in the prior year but not incurred.

The prior year included abortive integration costs of £1.6m with regard to the integration programme announced at the end of the previous financial year.

Costs associated with the re-organisation programmes are considered adjusting items given they are part of a strategic programme to drive future cost savings and are significant in value to the results of the Group.

(b) Property

During the prior year the Group made the strategic decision to transfer the vacant Slough depot to the Tuffnells business, resulting in a credit from the release of its onerous lease provision. Onerous charges on property are charged through adjusted items as they form part of the Group's strategic restructuring programme. The reversal of charges has also been made in adjusted items for consistency.

(c) Sale and leaseback professional fees

In January 2019, the Group took the decision to sell the Tuffnells freehold and long leasehold property portfolio and lease it back. During the year the Group incurred £0.7m of costs related to the sale and leaseback programme. The Group subsequently announced the sale of 6 properties on 23 September 2019. Given the magnitude and one-off nature of the transaction as a whole it is considered to be an adjusting item. 

(d) Amortisation of acquired intangibles

A charge of £6.8m (FY2018: £7.1m) has been recognised relating to amortisation of acquired intangibles in Tuffnells. This is considered an adjusting item as it allows comparison between segments and, therefore, consistency in the performance of the Group at a consolidated level.

(e) Pensions

Smiths News incurred professional costs of £2.1m, as a result of the WH Smith Pension Trust (one of the Group's defined benefit pension schemes) entering into an insurance backed annuity 'buy-in' of the Scheme assets, within the section of the Trust sponsored by Smiths News, which minimises the Group's exposure to future pension obligations. These pension charges are not considered to be part of normal operations due to their size and nature and are therefore considered to be an adjusted item.

There is a further £0.1m in relation to equalisation of Guaranteed Minimum Payments (GMP) of the Tuffnells Parcel Express pension scheme. This is considered to be an adjusting item as it was due to a one off change in the interpretation of the law relating to previously recognised cost, this is considered out of control of management and the charge relates to service in prior periods and therefore is considered an adjusting item.

(f) Brierley Hill insurance claim

The Group incurred £0.2m of insurance settlement costs this year in relation to a fatality at Tuffnells' Brierley Hill depot that occurred in January 2016. The Group had previously recognised the cost of the fine and legal costs in relation to this. Given the magnitude, one-off nature and to ensure consistent treatment with previously reported costs it is considered to be an adjusting item.

(g) Impairment of Tuffnells assets 

Management reviewed the carrying value of the Tuffnells business unit and concluded that an impairment charge of £45.5m (FY2018: £46.1m) is required.  This comprises: goodwill £6.0m (FY2018: £46.1m) , acquired intangibles £26.4m (FY2018: nil), other intangibles £0.4m (FY2018: nil) and property, plant and equipment £12.7m (FY2018: nil).

The impairment of Goodwill has no tax impact, the impairment of acquired intangibles has resulted in the release of £4.5m deferred tax liability as a credit to adjusted items income tax. A deferred tax asset of £2.5m has been recognised which has credited adjusted items income tax as a result of the impairment of the other assets.

It is considered adjusting due to its significant value and aids comparability between years to show the underlying performance of the Group.

(h) Pass My Parcel (PMP) exit costs

Following a review of the PMP proposition on 23 May 2018, the Board decided to close the business unit and as a result a charge of £6.7m was booked in the prior year.  This was split £4.7m of contract losses and £2.0m of impairment of associated assets.

Management concluded that losses on winding down the division represented an onerous contract with a cost of £4.7m recognised. This represented the forecast excess of costs over income from the date the Group took the decision to close the division. Of this balance, £2.5m in provisions was held at the year ended 31 August 2018 to cover the remaining costs to close all contracts. In 2019, £2.2m of costs were incurred and booked against this provision.  The remaining £0.3m of the provision has been released this year.

A further £2.0m of impairment charges split £1.0m tangible and £1.0m intangible were recognised to write off the non-current assets relating to the division.

(i) Impairment of tangible assets

In 2018, the Group took the decision to consider the sale of the Jack's Beans division to focus on its core businesses.  Bids received indicated that the net book value of the Jack's Beans assets were overstated and so they were impaired by £1.1m. The Group subsequently disposed of the assets for proceeds equivalent to their revised net book value in January 2019. Given the magnitude, the one-off nature and the Group's strategy to focus on its core businesses it was considered to be an adjusting item.

(j) NMW regulatory compliance

The Group has been in discussion with HMRC regarding an historical underpayment in relation to a misapplication of national minimum wage legislation in Tuffnells. A provision amounting to £1.3m was made in the prior year financial statements. Of this balance, £0.5m related specifically to the estimated fine. The £0.5m fine was classified as adjusting in FY2018. The underpayments and fines were all settled during FY2019.  The remaining £0.2m of the £0.5m fine provision has been released in FY2019. The release was also recognised as an adjusting item to be consistent with prior periods and due to its one-off nature and magnitude.

(k) IPR settlement income

The Group received a one-off £0.5m of income in relation to the settlement of an IPR dispute concerning the proposed use of a similar brand to one of the Group's brands. This is considered adjusting given its size and one-off nature.

FREE CASH FLOW

Free cash flow generation remains one of the Group's key strengths. Free cash flow includes finance lease payments, Adjusted items, interest and tax; but it excludes pension deficit recovery payments.

We continue to focus on cash performance in the period, with the Group generating £8.3m in free cash flow, a decrease of £11.9m (58.9%) on the prior year.

Adjusted EBITDA of £38.8m compared to FY2018 of £45.8m, is down by £7.0m 15.3%, driven by mixed trading performance, recovery in Smith News EBITDA margin offset by higher trading losses at Tuffnells.  Depreciation and amortisation was lower by £2.6m from a combination of Tuffnells properties being treated as held for sale from January 2019 and prior year write off of Pass My Parcel assets which are no longer depreciated.

The increase in working capital in the period was £3.9m (FY2018: decrease £7.7m) driven by a decrease in provisions and unfavourable timing of weekly receipt and monthly payment cycles relative to the year-end date.

Capital expenditure in the year was £8.6m (FY2018: £8.5m) an increase of £0.1m. New and existing depot and network investments were £2.6m (FY2018: £2.1m). Fleet investment was £1.7m (FY2018: £1.7m). Technology and equipment investment was £4.3m (FY2018: £4.7m).

Finance lease payments of £2.8m (FY2018: £3.8m) have declined by £1.0m as existing IT finance lease arrangements are expiring.

Net interest and fees of £5.1m (FY2018: £5.8m) has decreased by £0.7m. The movement comprises increased interest cash costs from a higher margin on the facility of £0.9m, offset by prior year included the cash payment of a bank arrangement fee of £1.6m paid on the new £175m bank facility concluded in October 2017.

Cash tax costs of £2.6m (FY2018: £6.5m) have decreased in the year reflecting the cash lag from declining profits in the current and prior year.

The total net cash impact of Adjusted items was £8.3m (FY2018: £8.3m). This comprised: £4.0m (FY2018: £6.8m) of network reorganisation and restructuring costs; pension buy-in costs £2.0m (FY2018: £nil) and resolution of legacy regulatory matters £2.0m (FY2018:£nil)

NET DEBT

Net debt closed the period at £73.9m, of which £2.5m (FY2018: £5.3m) relates to finance leases.

Net debt reduced compared to prior year, however the Group's Net debt/EBITDA ratio rose to 1.9x, (FY2018: 1.8x) due to the decline in EBITDA.  The reduction in net debt by £9.5m was driven predominantly by free cash flow generation of £8.3m from restored Smiths News EBITDA growth and their cash generation which remained sufficient to offset the deterioration in EBITDA from Tuffnells as it met its trading challenges.

The intra-month working capital cash flow cycle at Smiths News generates a routine and predictable cash swing of around £40m which utilises the Revolving Credit Facility (RCF) of £125m. This results in a predictable fluctuation of net debt during the course of the month compared to the closing net debt position.

Pension funding reduced to £1.6m (FY2018: £4.7m). The reduction of £3.1m resulted from deficit repair contributions to WH Smith Pension Trust no longer being required from October 2018 following the completion of the annuity backed pension 'buy-in'. Pension deficit repair payments are considered as a non-free cash flow item.

Free cash flow generation (after Adjusted items) in the year went towards the repayment of debt as there were no dividend payments in the year (FY2018: £24.1m).

We have a bank facility commitment of £175m with six relationship banks which runs from October 2017 to January 2021. The facility comprises of a term loan of £50m with no amortisation and an RCF for £125m.

PENSION SCHEMES

The Group operates two defined benefit schemes, both closed to new entrants and WH Smith Pension Trust closed to future accrual.

The largest scheme across the Group is the Smiths News defined benefit pension scheme (the WH Smith Pension Trust) which as at 31 August 2019 had an IAS 19 surplus of £24.0m (31 August 2018: £154.5m). However, as the pension scheme is closed to future accrual, this IAS 19 surplus cannot be used to reduce future contributions or as a funding holiday, and as a result the Group has not recognised this surplus on the balance sheet. The Smiths News section of the WH Smith Pension Trust completed the actuarial triennial valuation as at 31 March 2018 and concluded it no longer required funding.

Smiths News had previously agreed with the WH Smith Pension Trust a schedule of cash contributions of £3.3m per annum to March 2020. In October 2018, the Trust entered into an insurance backed annuity to the 'buy-in' of the Scheme assets within the section of the Trust sponsored by Smiths News. This 'buy-in' annuity is recognised as a plan asset and the difference in value is considered an actuarial re-measurement. Further, the schemes actuary to the Trustees notified the Group that no further deficit repair cash contributions will need to be made. As a result the IFRIC 14 deficit repair liability has been released at 31 August 2019 £nil (31 August 2018: £6.7m).

Pension 'buy-in' costs of £2.2m were recorded within Adjusted Items during the year.

The Tuffnells defined benefit scheme IAS19 deficit at 31 August 2019 was £2.9m (31 August 2018: £2.2m). The triennial actuarial valuation of the Tuffnells Parcels Express scheme as at 1 April 2016 was a scheme deficit of £4.3m.  Deficit recovery contributions have been agreed and remain at £0.3m per annum.

The total cash contribution for both defined benefit schemes, which include pension administration fees and disclosed within the cash flow statement, amounted to £1.6m for FY2019 (FY2018: £4.7m).

DISCONTINUED OPERATIONS

There were no discontinued operations in the year.

In the prior year on 14 February 2018, the Group completed the sale of the Books business at a loss of £10.5m. This represented Adjusted operating profit for the Group of £1.8m and adjusted profit before tax of £1.7m in FY2018.

GOING CONCERN

The Group meets its day-to-day working capital requirements through its bank facilities of £175m, agreed in October 2017, with a term to January 2021. The Group's forecasts, taking into account the Board's future expectations of the Group's performance, indicate that there is sufficient headroom within these bank facilities and the Group will continue to operate within the covenants attaching to those facilities.

Considering the principal risks discussed in this report, the directors have a reasonable expectation that the Group and the Parent Company have adequate resources to continue in operation and meet its liabilities as they fall due for a period of at least twelve months from the date of approval of the financial statements and for the period of the three year viability assessment. Thus, the Group and the Parent Company continue to adopt the going concern basis in preparing its consolidated financial statements.

PRINCIPAL AND EMERGING RISKS

The Group has a clear framework in place to continuously identify and review both the principal and emerging risks to the Group. 

Key risks are plotted on risk maps with descriptions, owners, and mitigating actions, reporting against a level of materiality (principally relating to impact and likelihood) consistent with its size. These risk maps are reviewed and challenged by the Executive Team and Audit Committee and reconciled against the Group's risk appetite. As part of the regular principal risk process, a review of emerging risks (internal and external) is also conducted and a list of emerging risks is  maintained and rolled-forward to future discussions by the Executive Team and Audit Committee.  Where appropriate, these emerging risks may be brought into the principal risk registers.  Additional risk management support is provided by external experts in areas of technical complexity to complete our bottom-up and top-down exercises. 

As part of the Board's ongoing assessment of the principal and emerging risks, the Board has considered the performance of the Group, its markets, the changing regulatory landscape and the Group's future strategic direction and ambition. Principal risks previously reported have been reviewed in detail and they have been refined and made more specific compared to the principal risks reported in the 2018 Annual Report.  Two risks that were separately identified in the 2018 Annual Report have been absorbed into principal risks 2 and 4 in this Preliminary Announcement:

·      failure to adequately monitor financial performance and/or delays in the Group's financial performance recovery; and

·      inadequate processes in place to support People initiatives.

Risks are still subject to ongoing monitoring and appropriate mitigation.

The table below details each principal business risk, those aspects that would be impacted were the risk to materialise, our assessment of the current status of the risk and how each is mitigated.

GROUP FINANCIAL STATEMENTS

Group Income Statement for the year ended 31 August 2019

* This measure is described in note 1(4) of the accounting policies and the Glossary to the Accounts on page 45. Adjusted items are set out in note 4 to the Group Accounts.

^*1 The income statement has been restated to show an analysis of costs see note 1.27 for details.

Group Statement of Comprehensive Income for the year ended 31 August 2019

Group Balance Sheet at 31 August 2019

1.     The Group has applied IFRS 15 using the fully retrospective method. See note 36. 

Group Balance Sheet at 31 August 2019 (continued)

Group Statement of Changes in Equity for the year ended 31 August 2019

Group Cash Flow Statement for the year ended 31 August 2019

During the year, cash outflow from operating activities attributed to discontinued operations amounted to £nil (2018: £8.8m inflow) and paid £nil (2018: £4.3m) in respect of investing activities. There were no cash flows associated with financing activities attributable to discontinued operations.

Notes to the accounts

1.         Accounting policies

(1) Basis of consolidation

Connect Group PLC ('the Company') is a company incorporated in England UK under Companies Act 2006. The Group accounts for the year ended 31 August 2019 comprise the Company and its subsidiaries (together referred to as the 'Group') and the Group's interests in joint ventures and associates. Subsidiary undertakings acquired during the period are included in the Group Accounts from the date of acquisition. All significant subsidiary accounts are made up to 31 August and are included in the Group Accounts. Further to the EU IAS Regulation (Article 4) the Group Accounts have been prepared in accordance with International Financial Reporting Standards ('IFRS') as adopted by the European Union ('adopted IFRS') with those parts of the Companies Act 2006 applicable to companies reporting under IFRS.

Unless otherwise noted references to 2018 and 2019 relate to fiscal year ended 31 August 2018 and 31 August 2019 as opposed to calendar year.

The accounts were authorised for issue by the directors on 5 November 2019.

(2) Accounting basis of preparation

The financial information contained within this preliminary announcement for the 12 months to 31 August 2019 and 12 months to 31 August 2018 does not comprise statutory financial statements for the purpose of the Companies Act 2006, but is derived from those statements. The statutory accounts for Connect Group Plc for the 12 months to 31 August 2018 have been filed with the Registrar of Companies and those for the 12 months to 31 August 2019 will be filed following the Company's annual general meeting. The auditor's reports on the accounts for both the 12 months to 31 August 2019 and 12 months to 31 August 2018 were unqualified, did not draw attention to any matters by way of emphasis, and did not include a statement under Section 498 (2) or (3) of the Companies Act 2006. The Annual Report and Accounts will be available for shareholders in December 2019.

(3) Going concern

The Group currently has a net liability position of £74.3m as at 31 August 2019. Given this position the directors have carefully considered the ability of the Group to meet its debts as they fall due. The Group's current banking facility is considered to have adequate headroom, with a total facility of  £175m available to the Group and with a balance undrawn of £95.0m at the 31 August 2019. The Group's forecasts and projections, taking account of reasonable potential variations in trading performance, show that the Group should be able to operate within the level of its current banking covenants defined as a period of not less than 12 months from the date of approval of this report. The directors expect that the Group will be able to negotiate a facility post January 2021 to enable the Group to trade for the foreseeable future.

Despite the uncertain economic environment, the directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. The Group therefore continues to adopt the going concern basis in preparing its consolidated financial statements.

(4) Alternate performance measures

The Company uses a number of Alternative Performance Measures (APMs) in addition to those reported in accordance with IFRS. The directors believe that the APMs, listed in the glossary to this document, are important when assessing the underlying financial and operating performance of the Group and its segments. The APMs do not have standardised meaning prescribed by IFRS and therefore may not be directly comparable to similar measures presented by other companies.

(5) Estimates and judgements

The preparation of these accounts requires management to make judgements, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets and liabilities, income and expense. Actual results may differ from these estimates.

Key sources of estimation uncertainty

Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods.

The key assumption concerning the future, and other key sources of estimation uncertainty at the end of the reporting period that may have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year.

Estimated impairment of goodwill, intangibles and property plant and equipment (PPE)

The Group tests annually whether goodwill has suffered any impairment, it also tests intangibles and PPE when impairment indicators exist in accordance with the accounting policy.

The carrying amounts of cash-generating units (CGU's) have been determined based on value in use calculations. The value determined on the cash generating units has been compared against the assets of the division to calculate impairments. These calculations require the use of estimates (note 13).

Tuffnells

The deterioration in trading performance of the Tuffnells business unit, a current year loss of £14.1m (2018: loss £5.0m), resulted in the Group performing an impairment assessment of goodwill, intangibles and PPE. As a result of the review, the goodwill, acquired intangibles and PPE were impaired, the value of the remaining assets in the division has been written down to their fair value less costs to sell as the value in use does not support them.

Given the results of the value in use review, an impairment charge of £6.0m, £26.4m and £13.2m arose to goodwill, intangibles and PPE respectively. The Directors consider that the assets should be valued based on the fair value less cost to sell and is based on the best estimates. note 13 and 14 include details of directors' assumptions and impact of changing these.

Dawson Media Direct (DMD) - Estimated value of goodwill

The loss of a major contract in DMD has resulted in the value in use of the business unit being sensitive to changes in estimations of future performance. Changes to these estimates would result in an impairment to the goodwill. For details of the sensitivities and the assumptions used to calculate the value in use see note 13.

Provisions

The Group holds a number of provisions which are subject to estimates. The key provisions established in the year relate to restructuring provisions of the offshoring of certain of the Group's central functions and specific operational restructuring projects for further details see note 24.

Key accounting judgements

The significant judgements made in the accounts for the year ended 31 August 2019 are:

Revenue

The Group recognises the wholesale sales price for its sales of newspapers and magazines. The Group is considered to be the principal based on the following indicators of control over its inventory: discretion to establish prices, it holds some of the risk of obsolescence once in control of the inventory and has the responsibility of fulfilling the performance obligation on delivery of inventory to its customers. If the Group were considered to be the agent, revenue and cost of sales would reduce by £1,111.0m (2018: £1,154.5m).

Retirement benefits

Following the completion of the 'buy-in' in October 2018 where the WH Smith Pension Trust entered into an insurance backed annuity of the Scheme assets within the section of the Trust sponsored by Smiths News, the pension schemes actuary notified the Group that future cash contributions by the Group to address the deficit would no longer be required and the Group has released the IFRIC 14 liability. The 'buy-in' annuity is recognised as a plan asset and the difference in value between the value of the insurance asset received of £425m at the date of transaction and the asset transferred in exchange for the policy £555m is considered an actuarial remeasurement recognised within other comprehensive income and is offset by the release of the IFRIC 14 liability.

If this was not considered to be an actuarial re-measurement the resulting difference of £130m would need to be recognised as a charge in the FY2019 income statement.  The offsetting £130m, being the release of the restriction, would continue to be included within other comprehensive income.

Adjusting items

Adjusting items of income or expense that are excluded in arriving at Adjusted operating profit. This enhances the users understanding of the Group's performance as it aids the comparability of information between reporting periods and business units by adjusting for non-recurring or uncontrollable factors which affect IFRS measures, adjusted measures are defined with other APM's in the glossary to this document.

Based on the nature of the transactions that it had Adjusting items totalling £60.8m (2018: £63.9m) and a breakdown is included within note 4.

Onerous contracts

This judgment relates to the year ended 31 August 2018. Present obligations arising under onerous contracts are recognised and measured as provisions. An onerous contract are considered to exist where the Group has a contract under which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received from the contract. The calculation of onerous contract provisions includes estimates of all future costs and income to occur. Significant judgement is applied in the determination of when contracts become onerous. Management concluded that as result of the decision to close the PMP division on 28 May 2018 all further losses of £4.7m would be recognised as an onerous contract loss. See note 24 for further details.

Held for sale assets

In January 2019, the Group took the decision to actively market the Tuffnells freehold, long leasehold property and related assets. Post-sale, the Group would then leaseback these properties. Given the above, the Group considered that the following criteria for recognition of assets held for sale had been met:

·          The properties were available for immediate sale,

·          The properties were being actively marketed,

·          The sale was considered highly probable,

·          The sale was expected to conclude within 1 year of January 2019.

Therefore these properties have been reclassified as assets held for sale. This has resulted in £0.6m of depreciation relating to these properties not being charged. For further details see note 11.

(6) Non-current assets held for sale and disposal groups

Non-current assets held for sale and disposal groups are classified as assets held for sale when their carrying amount is to be recovered principally through a sale transaction and a sale is considered highly probable. They are stated at the lower of their carrying amount or fair value less costs to sell.

Held for sale as assets are assets that have met all the criteria required by IFRS 5 to be classified as held for sale, at which point they are derecognised as non-current assets.

(7) Discontinued operations

In accordance with IFRS 5 'Non-current assets held for sale and Discontinued operations', the net results of discontinued operations are presented separately in the Group Income statement (and the comparatives restated) and the assets and liabilities of operations are presented separately in the Group balance sheet if they meet the held for sale criteria at the balance sheet date.

A cash generating unit would meet the classification of a discontinued operation when considered a material to the Group's overall results.

(8) Revenue

Smiths News - Sales of Newspapers and Magazines

Sales of Newspapers and Magazines are recognised when control of the products has transferred, that is, when the products are delivered to the retailer and there is no unfulfilled obligation that could affect the retailer's acceptance of the products, the risks of obsolescence and loss have been transferred to the retailer. Goods are sold to retailers on a sale or return basis.

Revenue for goods supplied with a right of return is stated net of the value of any returns. Newspapers and magazines are often sold with retrospective volume discounts based on aggregate sales. Revenue from these sales is recognised based on the price specified in the contract, net of the estimated volume discounts. Accumulated experience is used to estimate and provide for the discount and returns, using the expected value method, and revenue is only recognised to the extent that it is highly probable that a significant reversal will not occur. A returns reserve accrual and discount accrual (included in trade and other payables) is recognised for expected volume discounts and refunds payable to customers in relation to sales made until the end of the reporting period. A right to the returned goods (included in other current assets) are recognised for the products expected to be returned. No element of financing is deemed present, because the sales are made with short credit terms, which is consistent with market practice.

A receivable is recognised when the goods are delivered, since this is the point in time that the consideration is unconditional because only the passage of time is required before the payment is due.

Tuffnells - Delivery revenue

Delivery revenue is recognised on delivery when there are no unfulfilled obligations. Retrospective volume discounts based on aggregate sales are often given based on the aggregate sales over a short period. Revenue is only recognised to the extent that it is highly probable and a significant reversal will not occur.

A receivable is recognised when the goods are delivered, since this is the point in time that the consideration is unconditional because only the passage of time is required before the payment is due.

Accrued income on all revenue is recognised when a service has been performed but an invoice has not been raised, the Group accrued income is short term and invoiced close to the service being provided.

(9) Cost of Sales and Gross profit

The Group considers cost of sales to equate to cost of inventories recognised as an expense, net impairment losses on financial assets and distribution costs as these are considered to represent for the Group direct costs of making a sale.

The Group considers gross profit to equal revenue less cost of sales.

(10) Taxation

Tax on the profit or loss for the year comprises current and deferred tax. Tax is recognised in the income statement, except to the extent it relates to items recognised in other comprehensive income or directly in equity. Current tax is the expected tax payable based on the taxable profit for the year, using tax rates enacted, or substantively enacted at the balance sheet date and any adjustment to tax payable in respect of previous years.

Deferred tax is provided on the balance sheet liability method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The amount of deferred tax provided is calculated using tax rates enacted or substantively enacted at the balance sheet date and are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled. Deferred tax assets are recognised to the extent that it is probable that future taxable profits will be available against which these temporary differences can be utilised.

(11) Dividends

Interim and final dividends are recorded in the financial statements in the period in which they are paid.

(12) Capitalisation of internally generated development costs

Expenditure on developed software is capitalised when the Group is able to demonstrate all of the following: the technical feasibility of the resulting asset; the ability (and intention) to complete the development and use it; how the asset will generate probable future economic benefits; and the ability to measure reliably the expenditure attributable to the asset during its development. Subsequent to initial recognition, internally generated intangible assets are reported at cost less accumulated amortisation and accumulated impairment losses, on the same basis as intangible assets that are acquired separately.

 (13) Joint ventures

The Group Accounts include the Group's share of the total recognised gains and losses in its joint ventures on an equity accounted basis.

Investments in joint ventures are carried in the balance sheet at cost adjusted by post-acquisition changes in the Group's share of the net assets of the joint ventures, less any impairment losses. The carrying values of investments in joint ventures include acquired goodwill. Losses in joint ventures that are in excess of the Group's interest in the joint venture are recognised only to the extent that the Group has incurred legal or constructive obligations or made payments on behalf of the joint venture.

(14) Business combinations goodwill and intangibles

The Group uses the acquisition method of accounting to account for business combinations. The cost of an acquisition is measured at the fair value of the assets given, equity instruments issued, liabilities incurred or assumed at the date of exchange. Acquisition related costs are recognised in profit or loss as incurred. Any deferred or contingent purchase consideration is recognised at fair value over the period of entitlement. If the contingent purchase consideration is classified as equity, it is not remeasured and settlement is accounted for in equity. Any deferred or contingent payment deemed to be remuneration as opposed to purchase consideration in nature is recognised in profit or loss as incurred, and excluded from the acquisition method of accounting for business combinations. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured, initially, at their fair values at the acquisition date, irrespective of the extent of any non-controlling interest. The non-controlling interest is measured, initially, at the non-controlling interest's proportion of the net fair value of the assets, liabilities and contingent liabilities recognised.  Goodwill is measured as the excess of the sum of the consideration transferred, the amount of any non-controlling interests in the acquiree, and the fair value of the acquirer's previously held equity interest in the acquiree (if any) over the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed.

Goodwill arising on all acquisitions is initially recognised as an asset at cost and is subsequently measured at cost less any accumulated impairment losses.

The carrying value is reviewed annually for impairment or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Intangible assets arising under a business combination (acquired intangibles) are capitalised at fair value as determined at the date of exchange and are stated at fair value less accumulated amortisation and impairment losses. Amortisation of acquired intangibles is charged to the income statement on a straight-line basis over the estimated useful lives as follows:

Customer relationships                         - 2.5 to 7.5 years

Trade name                                         - 5 to 10 years

Software and development costs           - 3 to 7 years

Computer software and internally generated development costs which are not integral to the related hardware are capitalised separately as an intangible asset and stated at cost less accumulated amortisation and impairment losses.

Assets held under finance leases are depreciated over their expected useful lives on the same basis as owned assets or, where shorter, over the term of the relevant lease. All intangible assets are reviewed for impairment in accordance with IAS 36 'Impairment of Assets' when there are indications that the carrying value may not be recoverable.

(15) Property, plant and equipment

Property, plant and equipment assets are stated at cost less accumulated depreciation and any recognised impairment losses. No depreciation has been charged on freehold land. Other assets are depreciated, to a residual value, on a straight-line over their estimated useful lives, as follows:

Freehold and long term leasehold properties      - over 20 years

Short term leasehold properties                        - shorter of the lease period and the estimated remaining economic life

Fixtures and fittings                                         - 3 to 15 years

Equipment                                                      - 5 to 12 years

Computer equipment                                       - up to 5 years

Vehicles                                                         - up to 5 years

Assets held under finance leases are depreciated over their expected useful lives on the same basis as owned assets or, where shorter, over the term of the relevant lease. All property, plant and equipment is reviewed for impairment in accordance with IAS 36 'Impairment of Assets' when there are indications that the carrying value may not be recoverable.

(16) Leasing

Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases. Property, plant and equipment held under finance leases is capitalised in the balance sheet at the lower of the fair value or the present value of the minimum lease payments and is depreciated over its useful life. The capital elements of future obligations under leases are included as liabilities in the balance sheet. Lease payments are apportioned between finance charges and reduction of the lease obligation so as to achieve a constant rate of return on the remaining balance of the liability.

Property and equipment and vehicle rentals paid under operating leases are charged to income on a straight line basis over the lease term. The benefits of rent free periods and similar incentives are credited to the income statement on a straight-line basis to the first break clause.

(17) Inventories

Inventories comprise goods held for resale and are stated at the lower of cost or net realisable value. Inventories are valued using a weighted average cost method. Cost comprises direct materials and, where applicable, direct labour costs and those overheads that have been incurred in bringing the inventories to their present location and condition.

(18) Financial instruments

Financial assets and financial liabilities are recognised on the Group's balance sheet when the Group becomes a party to the contractual provisions of the instrument. The Group derecognises financial assets and liabilities only when the contractual rights and obligations are transferred, discharged or expire.

Financial assets comprise trade and other receivables and cash and cash equivalents. Financial liabilities comprise trade payables, financing liabilities, bank borrowings.

(19) Trade receivables

Trade and other receivables are initially measured at fair value, which for trade receivables is equal to the consideration expected to be received from the satisfaction of performance obligations, plus any directly attributable transaction costs. Subsequent to initial recognition these assets are measured at amortised cost less any provision for impairment losses including expected credit losses. In accordance with IFRS 9 the Group applies the simplified approach to measuring expected credit losses which uses a lifetime expected loss allowance for all trade receivables. To measure the expected credit losses, trade receivables have been grouped based on shared credit risk characteristics such as the ageing of the debt and the credit risk of the customers. An historical credit loss rate is then calculated for each group and then adjusted to reflect expectations about future credit losses. The Group does not have any significant contract assets.

Classification as trade receivables

Trade receivables are amounts due from customers for goods sold or services performed in the ordinary course of business. They are generally due for settlement within 30 days and are therefore all classified as current. Trade receivables are recognised initially at the amount of consideration that is unconditional, unless they contain significant financing components, in which case they are recognised at fair value. The Group holds the trade receivables with the objective of collecting the contractual cash flows, and so it measures them subsequently at amortised cost using the effective interest method. Details about the Group's impairment policies and the calculation of the loss allowance are provided in note 17.

Due to the short-term nature of the current receivables, their carrying amount is considered to be the same as their fair value.

(20) Trade and other payables

These amounts represent liabilities for goods and services provided to the Group prior to the end of the financial year which are unpaid. The amounts are unsecured and are usually paid within 30 days of recognition. Trade and other payables are presented as current liabilities unless payment is not due within 12 months after the reporting period. They are recognised initially at their fair value and subsequently measured at amortised cost using the effective interest method.

(21) Treasury

Cash and bank deposits

Cash and cash equivalents in the balance sheet comprise cash at bank and in hand and short term deposits with an original maturity of three months or less. In the consolidated balance sheet, bank overdrafts are shown within borrowings in current liabilities. Cash and cash equivalents in the cash flow statement comprise cash at bank and in hand and bank overdrafts held for trading purposes.

Financial liabilities and equity

Financial liabilities and equity instruments are classified according to the substance of the contractual arrangements entered into. An equity instrument is any contract that evidences a residual interest in the assets of the Group after deducting all of its liabilities. Equity instruments issued are recorded at the proceeds received, net of direct issue costs.

Bank borrowings

Interest bearing bank loans and overdrafts are initially measured at fair value (being proceeds received, net of direct issue costs), and are subsequently measured at amortised cost, using the effective interest rate method. Finance charges, including premiums payable on settlement or redemptions and direct issue costs are accounted for on an accruals basis and taken to the income statement using the effective interest rate method and are added to the carrying value of the instrument to the extent that they are not settled in the period in which they arise.

Foreign currencies

Financial statements of foreign operations

The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and are translated at foreign exchange rates ruling at the balance sheet date. The revenues and expenses of foreign operations are translated at an average rate for the period where this rate approximates to the foreign exchange rates ruling at the dates of the transactions.

Foreign currency transactions

Transactions in foreign currencies are recorded using the rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the foreign exchange rate ruling at that date. Foreign exchange differences arising on translation are recognised in the income statement. Non-monetary assets and liabilities that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction. Non-monetary assets and liabilities denominated in foreign currencies that are stated at fair value are translated at foreign exchange rates ruling at the dates the fair value was determined.

(22) Provisions

Provisions are recognised when the Group has a present legal or constructive obligation as a result of a past event and it is probable that an outflow of economic benefits will be required to settle the obligation.  Provisions are measured at the directors' best estimate of the expenditure required to settle the obligation at the balance sheet date and if this amount is capable of being reliably estimated. If such an obligation is not capable of being reliably estimated, no provision is recognised and the item is disclosed as a contingent liability where material. Where the effect is material, the provision is determined by discounting the expected future cash flows.

(23) Retirement benefit costs

The Group operates a number of defined contribution schemes for the benefit of its employees. Payments to the Group's schemes are recognised as an expense in the income statement as incurred. The Group operates two defined benefit pension schemes. The largest scheme The WH Smith Pension Trust is closed to further accrual. The charge to the Group of providing benefits for these two schemes is determined by the Projected Unit Credit Method, with actuarial calculations being carried out at the balance sheet date. Actuarial gains and losses are recognised in full in the period in which they occur in the group statement of comprehensive income. The retirement benefit obligation recognised in the balance sheet represents the present value of the defined benefit, reduced by the fair value of scheme assets. An asset ceiling cap is applied in accordance with IFRIC 14 with an additional liability recognised where there is a contractual obligation to make further payments into the scheme.

(24) Employee Benefit Trust

Smiths News Employee Benefit Trust

The shares held by the Smiths News Employee Benefit Trust are valued at the historical cost of the shares acquired. This value is deducted in arriving at shareholders' funds and presented as the own share reserve in line with IAS 32 'Financial Instruments: Disclosure and Presentation'.

(25) Share schemes

Share based payments

The Group operates several share-based payment schemes, being the Sharesave Scheme, the Executive Share Option Scheme, the LTIP and the Deferred Bonus Plan. Details of these are provided in the Directors' Remuneration report and in note 31.

Equity-settled share-based schemes are measured at fair value at the date of grant. The fair value is expensed with a corresponding increase in equity on a straight-line basis over the period during which employees become unconditionally entitled to the options. The fair values are calculated using an appropriate option pricing model. The income statement charge is then adjusted to reflect expected and actual levels of vesting based on non-market performance related criteria.

Administrative expenses and distribution and marketing expenses include the cost of the share-based payment schemes.

(26) Changes in accounting policies

The Group has applied the following standards and amendments for the first time for their annual reporting period commencing 1 September 2018:

•       IFRS 9, 'Financial Instruments';

•       IFRS 15, 'Revenue from Contracts with Customers';

•       Classification and Measurement of Share-based Payment Transactions - Amendments to IFRS 2;

•       Annual Improvements 2014-2016 cycle;

•       Transfers to Investment Property - Amendments to IAS 40; and

•       Interpretation 22, 'Foreign Currency Transactions and Advance Consideration'.

The Group had to change its accounting policies and make certain retrospective adjustments following the adoption of IFRS 9 and IFRS 15. This is disclosed in note 36. Most of the other amendments listed above did not have any impact on the amounts recognised in prior periods and are not expected to significantly affect the current or future periods.

New Standards and Interpretations not yet applied

At the date of authorisation of these financial statements, the following Standards and Interpretations that are potentially relevant to the Group and which have not been applied in these financial statements were in issue but not yet effective (and in some cases had not yet been adopted by the EU):

•       IFRS 16 Leases

•       IFRS 17 Insurance Contracts

•       IFRIC 23 Uncertainty over Tax Treatments

•       Amendments to IFRS 9 - Prepayment Features with Negative Compensation

•       Amendments to IAS 19: Plan Amendment, Curtailment or Settlement

•       Amendments to IAS 28: Long-term Interests in Associates and Joint Ventures

•       Annual Improvements to IFRS Standards 2015-2017 Cycle.

The Group will apply IFRS 16, which replaces IAS 17, with effect from 1 September 2019. The standard will have a material impact for the Group as it introduces a new lessee accounting model and requires the recognition of assets and liabilities for the majority of leases. Rental costs currently recognised in operating profit will be replaced by depreciation of the assets and finance costs on the liabilities. The total cash outflow for lease payments will not change. However, the payments related to the principal liabilities will be presented as cash outflows from financing activities, as opposed to the current treatment as cash outflow from operating activities.

The Group intends to apply IFRS 16 using the modified retrospective approach; the cumulative effect of initial adoption being recognised as an adjustment to the opening balance of retained earnings as at 1 September 2019 with no restatement of comparative information. The lease liabilities on transition will be the present value of lease payments discounted using the incremental borrowing rate at 1 September 2019. The right-of-use asset will be valued at an amount equal to either the lease liability or the carrying amount as if IFRS 16 had been applied since the start of the lease, but using the discount rate at 1 September 2019 (the date of initial application), determined on a lease by lease basis. The Group plans to take advantage of practical expedients to:

•       apply IFRS 16 only to contracts previously identified as leases under IAS 17 Leases and IFRIC 14 Determining whether an Arrangement contains a Lease;

•       exclude leases where the lease term is 12 months or less from the date of initial application and class such leases as short term leases;

•       exclude low value assets;

•       exclude initial direct costs from the measurement of the right-of-use asset at the date of initial application;

•       use hindsight, such as in determining the lease term if the contract contains options to extend or terminate;

•       apply a single discount rate to a portfolio of leases with similar characteristics; and

•       rely on its assessment as to whether a lease is onerous by applying IAS 37 Provisions, Contingent Liabilities and Contingent Assets immediately before the date of initial application as an alternative to performing an impairment review.

At 31 August 2019, the Group held a significant number of operating leases for which the future undiscounted minimum lease payments amounted to £79.3m as disclosed in note 25 to the consolidated financial statements. On adoption of IFRS 16, the expected effect on the balance sheet is the recognition of 'right of use' assets of around £74.5m, a corresponding lease liability of around £74.5m. The expected effect on the income statement in 2020, based on the leases held on transition, will be an increase in the Group annual depreciation charge of around £16.8m offset by a decrease in rental charges by £18.9m and an improvement in operating profit by £2.1m. The interest charge relating to leased creditors will also increase by £3.4m.  The Group currently has £1.4m of lease incentives, £0.4m of onerous lease provisions, these will be included within the right of use asset on transition. Post year end the Group entered into a sale and leaseback for 6 of its properties the IFRS 16 impact is disclosed within note 11.

As the lease liability is expected to match the right of use asset at 1 September 2019 there is no expected change to deferred tax.

The Group will continue to implement and refine procedures and processes to apply the new requirements of IFRS 16. As a result of this ongoing work, it is possible that there may be some changes to the adoption impact outlined above, before the half year results to 28 February 2019 are issued. However, at this time these are not expected to be material.

The covenant requirements for the Group's committed financing facilities are based on "Frozen GAAP" and therefore are not impacted by the transition to IFRS 16.

There are no other standards that are not yet effective and that would be expected to have a material impact on the entity in the current or future reporting periods and on foreseeable future transactions.

(27) Restatement of Income Statement

The prior year income statement has been restated, to present a split of costs to comply with the principles of IAS 1, this has no impact on overall result for the period.