HIGHLIGHTS
CHAIRMAN'S STATEMENT
The operating profit for the year ended 30 April 2011, before the additional levies paid to the Financial Services Compensation Scheme (FSCS), was £21.6 million, a decline of 10% from the previous year. Adjusted basic earnings per share were 32.9 pence, a decline of 8% compared with 2010.
The year saw a further modest recovery in stockmarkets but economic conditions in the United Kingdom and Ireland remained very difficult. Our Investment Management and Banking division had another satisfactory year. Funds under management and advice increased by 14% to £12.0 billion compared with a rise in the FTSE APCIMS Stockmarket Balanced Portfolio Index of 7%. Divisional operating profits fell by 9% as a result of a decline in net interest income in the continuing low interest rate environment and the slowdown in activity in our fixed interest broking business. The growth in funds under management and advice, one of our key performance indicators, is an encouraging signal for the future. There is a strong direct correlation between growth or decline in the economy and the change in demand for professional services. In current economic conditions it is therefore unsurprising that recovery in our Tax and Business Services division has been relatively slow. Nevertheless, operating income has grown by 3% and we have achieved a return to operating profit before exceptional costs, as explained in the Operating and financial review. We are budgeting for a continuing improvement in the current year.
We have maintained our programme of investment in the business during the year. The move of our fast expanding fund administration business from London to Glasgow was completed in January 2011 and this should facilitate future profitable growth. In April we formally opened our new investment management business in Dublin. As I reported in my interim statement, we have also significantly increased our investment in business development and other marketing activities to make sure that our target audience and its advisers know about the quality of our services.
The financial and economic environment we operate in remains uncertain. Regulatory threats, particularly from Europe, add further to uncertainty. Against this background your board takes a cautious view about the outlook while remaining confident in the medium to long term prospects for the business. Operating profits in the first two months of the new financial year were 2% lower than the previous year. I reported at the interim stage that a number of changes of accounting policy in recent years have had the effect of increasing the difference between reported profits and cash flow. We are showing for the first time in the consolidated cash flow statement the group's net cash position. Net cash balances have grown from £52.2 million to £68.6 million during the year. The board is exploring ways in which it can return excess capital to shareholders consistent with its desire to ensure that shareholders receive payments in respect of the financial year of 21.5 pence per share, a 5% increase over the previous year.
On behalf of the board I would like to thank all of our colleagues who have continued to work exceptionally hard for their clients during the year. I should also like to thank our clients and professional friends for their continued support which, as ever, we value very highly.
Gareth Pearce
Chairman
OPERATING AND FINANCIAL REVIEW
Strategy
Smith & Williamson is a leading independent provider of investment management, accountancy, tax, corporate and financial advisory services to private clients, corporates, professional practices, and non-profit organisations, with 1,400 people in ten offices in the UK and Ireland.
Our prime aim is to help our clients achieve their financial goals, both corporate and personal. With an emphasis on relevant, practical and robust advice, and with our record of innovation, we pride ourselves on being able to meet the needs and ambitions of our clients, be they UK or internationally based.
Since our foundation over a century ago, Smith & Williamson has been managing the financial affairs of private clients and their business interests. We are one of the top ten largest firms of accountants in the UK and our investment management business has over £12 billion of funds under management and advice.
In an award-winning business as diverse as ours, professionalism and teamwork are key. We recognise that clients and intermediaries take comfort from knowing that they can easily reach senior people and decision-makers in our organisation who are able to understand their needs and objectives.
Our business thrives on its people – a pool of highly talented and enthusiastic individuals who deliver a broad and innovative range of services, but without compromising on delivering a genuinely director-led service. Technical excellence underpins how we deliver our services and our teams are dedicated to offering practical financial solutions.
People may ask what sets us apart from our competitors; put simply, it's our people – ambitious, talented and enthusiastic professionals who enjoy what they do and relish the opportunity to work together and with our clients.
To deliver our strategy we have organised the group into two principal operating divisions: Investment Management and Banking, and Tax and Business Services. Both divisions work closely together to provide a comprehensive and integrated service to clients.
The Investment Management and Banking division provides investment services to private individuals, charities and institutions and is regulated by the Financial Services Authority (FSA) in the UK and the Central Bank of Ireland in Ireland.
The Tax and Business Services division offers a broad range of financial advisory and compliance services including assurance and business services, corporate finance, forensic, fund administration, pension and employee benefits, restructuring and recovery, corporate and private tax services to private clients, mid to large corporates, professional practices and non-profit organisations. Smith & Williamson Fund Administration Limited, Smith & Williamson Corporate Finance Limited and Smith & Williamson Financial Services Limited within Tax and Business Services are regulated by the FSA.
Audit services to clients are provided through Nexia Smith & Williamson Audit Limited (Nexia Smith & Williamson) which is legally separate from the group, emphasising its independence as required by regulators. The company carries out statutory audit work, using staff seconded from the group, under service agreements.
Smith & Williamson has been a member of Nexia International since 1998. Nexia is a network of independent accounting and consultancy firms with 590 offices in over 100 countries. Smith & Williamson has a significant interest in Nexia TS, a top ten consulting and accountancy firm in Singapore, with extensive contacts in the Far East, notably in Singapore, China, Indonesia and Taiwan.
Smith & Williamson has been a member of M&A International Inc. since 1996. The network currently comprises 500 M&A professionals operating in every financial centre of the world.
Group results
Group operating income for the year was £171.4 million (2010: £169.0 million) while operating profit was £19.3 million (2010: £23.4 million before goodwill impairment (note 13)). The adjusted operating margin for the group which excludes the additional levies for the FSCS (note 6) and impairment of goodwill (note 13) was 12.6% (2010: 14.2%).
Tax
The overall effective tax rate adjusted for the finance cost of the C shares (note 9) for the year was 25.0% (2010: 26.9% after adjusting for the goodwill impairment (note 13)), calculated as the tax charge in the financial statements of £4.8 million (2010: £6.4 million) divided by the operating profit of £19.3 million (2010: £23.4 million before impairment of goodwill) and dividend income of £0.1 million (2010: £0.4 million). A full reconciliation is set out in note 10.
Returns to shareholders
The board is exploring ways in which it can return excess capital to shareholders consistent with its desire to ensure that shareholders receive payments in respect of the financial year of 21.5 pence per share, a 5% increase over the previous year.
Divisional results
Summaries of the operating performance of Investment Management and Banking, and Tax and Business Services are given below:
Investment Management and Banking
Our Investment Management and Banking division recorded a fall in operating profit of 9% in the year.
Revenue compared to the prior year was flat but changes in market conditions have led to a change in the mix of revenue streams. Fees now account for 58% of the total, up from 50% in 2010, with commission reducing from 37% in 2010 to 32% for 2011.
The average FT APCIMS Balanced Index, based on billing dates, has increased by 7% from 2,839 to 3,034 in the year. This higher market level has made a contribution to the 16% increase in investment management and advisory fees during the year.
Commission levels in the private client and institutional fund management businesses were modestly lower due to market conditions, while the reduction in commission earned by the fixed interest broking operation was more marked, albeit following a number of very successful years.
Banking margin, being the net margin on monies deposited with the wholesale market and the amount paid to clients, fell by 26% in the year, due to the continuing low level interest rate environment and a reduction in our banking book as funds were invested.
Allowing for previous comments, the majority of businesses have performed well with pleasing increases in revenues in most of our regional offices.
Operating profit by business line has moved in line with revenue changes. The increase in expenses from prior year reflects the continued investment in building our sales and distribution network and the set up costs for the new Dublin office which we opened in April 2011. Despite the difficulties facing the Irish economy, we believe considerable opportunity exists for a more sophisticated investment management offering in the region.
Funds under management and advice (FUM) have increased by 14% to £12.0 billion over the year. During the same period the FTSE-100 index rose by 9.3% and the APCIMS Private Investor Stock Market Balanced Portfolio index by 6.9%.
Investment performance, as measured throughout the year by Asset Risk Consultants Limited, shows outperformance relative to our peer group on a risk adjusted basis across the range of different mandates. This view is supported by both the performance of our public funds within our institutional and pooled funds business and the aggregate private client performance figures versus the relevant benchmarks.
On the institutional side, an increase in market levels and continued investment in building the business has seen FUM increase during the year from £1.528 million to £1.699 million. The Short-dated Corporate Bond fund has continued to perform well and has now grown to over £210 million since its launch in April 2009.
During 2012, our key objectives include the continuing development of our Dublin business, which is expected to incur losses in the next year or two as we continue to invest, and to build further growth of FUM in the institutional market and to ensure our funds are marketed effectively to the wider market.
Tax and Business Services
The Tax and Business Services division continued to operate in a difficult economic environment. Fee pressures from clients continued with, in some cases, aggressive pricing by some of our competitors. This, together with a relatively low volume of corporate transactions made revenue growth difficult to achieve.
While there has been a reduction in the value of advisory work for private clients against the prior year, following the introduction of the top 50% income tax rate, our strengths in this market as one of the leading firms has meant that revenue has held up well.
The divisional management of Tax and Business Services measures performance in its eight business lines on a monthly basis principally through the use of management accounting information and, in particular, three key performance indicators, being:
- year on year revenue growth
- gross margin improvement
- lock up management.
Revenue growth
Despite the challenging trading conditions, it is pleasing to report that turnover increased by 3.2%. This return to revenue growth, albeit modest, reflects an improved performance from assurance and business services, corporate finance, financial services, forensic services and fund administration, with an aggregate turnover increase of 4.9%. Fund administration was the fastest growing business line and it is now a key part of our service offering. Corporate tax and private client tax revenues fell by 2.2% as a result of the effect of fewer corporate transactions and higher taxes on private clients, although profitability in both disciplines increased due to tight cost control. Revenue for restructuring and recovery fell by 40% in the year, reflecting the reorganisation of that business line, the departure of the previous head of business and a particularly difficult market place for such services. Substantial one-off costs of £2.1 million were incurred in the year as a result. Our restructuring and recovery business continues to face a challenging market place, although it was pleasing to note that our newly established Dublin restructuring and recovery business performed ahead of expectations, with decent revenue and an operating profit in its first year of operation.
The revenue for the eight business lines within the division, measured by relative revenue, is shown in the pie chart.
Gross margin
The gross margin for the division improved year on year by 1.2% to 38.4%. This masks a more significant improvement of 3.6% across all business lines excluding restructuring and recovery, principally as a result of a reduction of 7% in staff numbers compared to the prior year. We anticipate further improvement in gross margin during the current financial year.
Lock up
Lock up, a measure of the total amount of capital tied up in unbilled income and debtors, is carefully monitored and has reduced steadily in recent years due to more active management. Our lock up at 30 April 2011 stands at just under 3.8 months (2010: 4.2 months).
Operating loss
Operating loss is stated after exceptional items in the year of £3.2 million (2010: £1.8 million). These consist of the reorganisation of restructuring and recovery (£2.1 million), the transfer of most of our fund administration business to Glasgow (£0.9 million) and redundancy costs (£0.2 million). In 2010, we incurred £1.8 million of reorganisation costs.
Operating profit before these exceptional items in 2011 of £1.1 million compares to an operating loss in 2010 of £0.3 million.
We continue to win new high quality work across all disciplines which is reflected in the improved financial performance of seven of our eight business lines. With the exception of restructuring and recovery, all disciplines enjoyed significant increases in profitability in the year with assurance and business services and forensic services returning to profitability, fund administration becoming a profitable business following the losses incurred in its initial years and the remaining business lines showing increased operating profit year on year. Financial services had a particularly good year and reported good revenue growth (5.6%) which flowed through to a greater increase in profitability due to tighter cost control.
Initial results for the first two months of the current financial year show a sound start with marginally increased revenue and good profit improvement; barring unforeseen circumstances, we expect improved performance to continue for the remainder of the year.
Cash flow and capital expenditure
Cash generation in the year was strong and, at 30 April 2011, the group's net own cash amounted to £68.6 million as compared to £52.2 million at 30 April 2010. Capital expenditure incurred in the year totalled £2.2 million (2010: £6.5 million). Dividends amounting to £5.1 million (2010: £17.8 million) were paid to shareholders, including the shareholders of C ordinary shares, in the year. This comprised the final dividend for the prior year of £2.4 million and an interim dividend of £2.7 million for the current year.
Capital, treasury and liquidity
At 30 April 2011, the group had net assets, excluding intangible assets, of £58.8 million (2010: £54.7 million), largely represented by cash and cash equivalents which are held principally in our regulated entities. Capital adequacy is monitored daily and the use of regulatory capital is monitored on a monthly basis. In addition to stress tests undertaken as part of the Internal Capital Adequacy Assessment Process (ICAAP), the effect of returns to shareholders and investment requirements are considered in the light of regulatory capital adequacy. Appropriate buffers are maintained against adverse business conditions.
The treasury operations in respect of the group's cash, together with any investment management clients' cash not held on a segregated client money basis are carried out by the banking department, which is overseen by the banking committee. The banking department places funds with, and holds interest bearing securities issued by, banks, building societies and central governments on an appropriately diversified basis.
The Investment Management and Banking division operates as a net provider of liquidity to the banking markets and does not rely on wholesale funding to finance its operations. The Tax and Business Services division had borrowings of £10.5 million at 30 April 2011 (2010: £12.9 million). The remainder of group borrowings comprise funding for the Smith & Williamson Holdings Limited Employee Benefit Trust (EBT) and the debt component of the C ordinary shares (note 9).
The part of the group subject to supervision by the FSA (the ICAAP group) operates under the Individual Capital Guidance provided by the FSA. Note 38 provides further details. In addition, Smith & Williamson Investment Management Limited is subject to the FSA's Internal Liquidity Adequacy Assessment regime. Disclosures required under Pillar 3 can be found on our website.
Employment
We aim to provide staff with the best development and training opportunities, ensuring that they meet the regulatory requirements laid down by the appropriate governing bodies, including compliance with those standards required by the Retail Distribution Review (RDR).
By consulting regularly with staff we aim to take on board their feedback, enabling us to better understand and address their needs and tailor new initiatives accordingly. The group places considerable value on consultation with its staff and has continued to keep them informed on matters affecting their employment as well as factors affecting the performance of the group.
The group regularly monitors the external market to ensure that compensation packages are reasonable and competitive and regularly reviews its remuneration policy to ensure that it drives appropriate behaviours and complies with regulatory requirements. The involvement of staff in the group's performance through participation in various share schemes is actively encouraged; further details of these are given in note 28.
The group is committed to equality of opportunity in employment for all of its existing and potential members of staff. This is demonstrated through the application of its recruitment and employment policies, as well as through the working relationships between colleagues. The group is also committed to the prevention of any form of discrimination and to the promotion of a harmonious and diverse working environment where individuals are treated with respect and dignity. It is our policy to give full consideration to applications from disabled people. If employees become disabled, wherever practicable arrangements are made to continue their employment.
The firm's success and the expertise of our people continue to be recognised. The firm won more than ten awards during the year, including, Investment House of the Year (STEP Private Client Awards 2010/11), Investment Performance – Absolute Returns Portfolios (PAM Awards 2011), Best Growth Wealth Manager and Best Wealth Manager for Inheritance Tax and Succession Planning (Investors Chronicle/FT Awards), Best High Net Worth Tax Team (LexisNexis Taxation Awards 2010) and Winner of Small Deal of the Year (M&A Awards).
Information technology
Infrastructure upgrades for two of our regional offices were completed on schedule to facilitate the move of the fund administration team and further settlement operations functionality to our Glasgow office and for the establishment of an investment management team in our Dublin office. The latter has also required enhancements to our investment management and banking systems to cater for the Irish regulatory requirements and to automate parts of the system where the core currency will now be euros for some clients. Significant system changes have had to be introduced during the year to meet new regulatory requirements. These include the introduction of new liquidity risk management software and system development to meet 'Single Customer View' reporting regulations for the FSA and to enhance reporting on large exposures. Our straight through processing systems have also been enhanced to provide electronic links for deals in collective funds.
A large number of the system developments planned for the coming year are again to meet new regulatory requirements. Telephony changes also need to be in place later this year to enable business mobile phone conversations to be recorded for FSA regulated staff.
Property
In August 2010 we expanded onto an additional floor in our Glasgow office, taking on a further 2,234 sq ft of space, to accommodate the move of the fund administration and the settlement operation teams to Glasgow. In March 2011 we signed a licence on 400 sq ft of meeting room space in the centre of Dublin to assist the expansion of the investment management business. In April 2011 we signed an agreement to lease 7,210 sq ft of space in the centre of Belfast and are planning to move into the space from our existing offices in September 2011.
Corporate responsibility and environmental policy
Smith & Williamson views corporate responsibility as the need to act responsibly in managing the impact of our business activities on clients, colleagues, investors, suppliers, the community and the environment. Our policies reflect this view together with our desire to make a contribution to the communities in which we work and to minimise our impact on the environment.
Our group's corporate responsibility committee has continued to promote our aim to contribute to a sustainable future through our staff, our marketplace, our communities and the environment. Our charities committee has also continued to support staff and clients in their desire to contribute to the local community.
Principal risks and uncertainties
In addition to the financial risks set out in note 39, the group is exposed to the following non-financial risks:
Regulatory risk
The group is subject to the extensive regulation applicable to financial services and accountancy businesses. Changes in regulation could require additional capital to be raised or could reduce profitability. Failure to comply with regulatory requirements could result in fines or other enforcement action. The group monitors regulatory changes, assesses the impact any changes may have on the business and plans to ensure there is sufficient resource to implement those changes.
Infrastructure risk
Inappropriate securities settlement, corporate action, custody or administration procedures or failures in IT development could expose the group to loss or reduced profitability. The group's governance structure places responsibility on board committees meeting regularly to appraise such risks. The group is committed to retaining competent staff who operate effective procedures under diligent and experienced managers.
Business conduct risk
Litigation, complaints and claims could arise from conduct of business in breach of the group's obligations to its clients. The group's policy of staff training, coupled with appropriate internal procedures, a commitment to client service and a culture of treating clients fairly mitigate these risks.
Competition and reputational risk
The group operates in a competitive market and there is a risk that existing clients will leave or that we will fail to gain new clients due to poor service, failure to respond to changes in the marketplace and the loss of reputation consequent on these failings or due to inadequate investment in marketing or distribution or the loss of key individuals. These risks are managed by the group's continued investment in its people, a strong awareness of developments in its marketplace and ongoing enhancements to the services it offers.
Acquisition risk
Acquisitions create a financial risk of poorer than anticipated financial performance and operational risk through disruption resulting from their integration. Potential acquisitions are subject to rigorous review prior to approval by the board and committees are established to oversee the integration of acquisitions within the group.
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