Meet the Experts, October 2008 CRUF The Corporate Reporting Users’ Forum

Meet the Experts, October 2008

CRUFCRUFThe Corporate Reporting Users’ Forum


Before we say anything….

• The CRUF is a discussion forum - it does not seek to achieve consensus views

• Its participants take part in CRUF discussions and joint representations as individuals, not as representatives of their employer organisations

• We are all speaking in our personal capacities today


Today’s panellists

• Peter Elwin, Cazenove Equities• Nick Anderson, Insight Investment • Peter Reilly, Deutsche Bank• Sarah Deans, JP Morgan• Jed Wrigley, Fidelity Investments


The Corporate Reporting Users’ Forum

• International forum of investors and analysts who engage with standard setters and corporates on reporting

• Meets in London, Frankfurt and Sydney with participants based in a number of other countries including the US

• Guiding principles, comment letters and presentations can be found on www.cruf.com


What are we going to talk about today?

• Effective communication with the capital market• Better information – not necessarily more• Non-GAAP can be helpful, provided it’s reconciled• We read Annual Reports avidly

• Key topics– Cash flow [Nick Anderson]– Segmental reporting [Peter Reilly]

• Questions at the end – we’re happy to discuss fair value accounting!


Cash Flow

Nick AndersonHead of Research

Insight Investment


Cash flow – focusing on the underlying economics

“…adequate information on cash is an essential element of a company’s financial statements. Cash is the lifeblood of a business. If it dwindles the business will die.”

Sir David Tweedie as chairman of the UK ASB

“If you don’t understand the cash flow, then you don’t understand the company.”

Analyst, May 2008


Cash flow disclosure: what’s wrong?

Non-disclosure of key information• Many companies do not provide sufficient disclosure to

reconcile cash flow with changes in net debt. Only by reconciling to changes in net debt can users be certain to have captured all cash flows in their analysis

Presentation• Extracting a satisfactory operating or free cash number can

be very difficult• Many line items are opaque, even to experienced investors


UK ASB Consultation on FRED 10 (1996)

• FRED 10 asked “Do you support the introduction of a requirement to reconcile the movement of cash in the period with the movement in net debt?”

• Of the 52 responses to this question, 47 supported the inclusion of a reconciliation to net debt including the following commentators -

Allied Domecq CIPFA IFMA NAOABI Coopers & Lybrand ICAEW National PowerBass Deloitte & Touche IIMR (now CFA UK) Price WaterhouseBT GEC ICAS Thorn EMIBoots Grand Met KPMG UnileverCBI The Hundred Group Ladbroke Group ZenecaCIMA ICI Marks & Spencer


IFRS: IAS 7 disclosure gaps

Two significant deficiencies with current disclosure requirements –

• Companies are not required to provide the forex translation impact on debt

• The wording of the standard is sufficiently ambiguous to avoid disclosure of acquired debt, requiring the disclosure of only major category assets and liabilities


Current practice

• A number of companies continue to provide a net debt reconciliation

• This is presented either alongside the cash flow statement, in the notes to the accounts or, occasionally, within the MD&A

• We estimate that around one-half of non-financial FTSE100 companies provided a net debt reconciliation in their last annual report and accounts


Presentation

• Many line items are opaque– Disclosure of the movement in the underlying

components of trade working capital (inventories, trade receivables, trade payables) is important

– Disclosure of capital expenditure should separate tangibles and intangibles; additions and disposals

• Greater consistency in the starting point for cash flow statements would introduce clarity, limit confusion and reduce errors

• The starting point should be “operating” (before interest and tax)


We need your help

• Understanding the cash flow profile of a business is always important………but particularly as economic activity slows

• We would expect the IASB’s Financial Statements Presentation project to resolve the current deficiencies in cash flow reporting……but the user need is more immediate

• Please consider how you might improve your cash flow presentation

• We strongly encourage you to provide the additional disclosure necessary to reconcile cash flow with changes in net debt


Segmental Reporting

Peter ReillyEuropean Equity Research

Head of Capital Goods

Deutsche Bank


Segmental reporting – does it matter?

YES!


Segmental reporting – does it matter?

• Segmental reporting is very important– Very few companies are monolithic; segmental reporting provides

crucial colour– Many companies are active in M&A; segmental reporting helps

investors understand and value M&A activity (buying and selling)– Companies are not just the CEO and CFO; segmental reporting

makes divisional management visible to investors (and vice versa)– Sum of parts and break-up valuations can be key value drivers (both

positive and negative)– IFRS 8 offers an opportunity for management to review the

effectiveness of their segmental reports

• Disclosure standards vary very widely– Some companies are excellent (examples to follow)…– …but some are dreadful (un-named examples to follow)


Segmental reporting – Do’s and Don’ts

• Do…– Choose segments that are logical and help investors track trends

and drivers– Provide enough information for investors to assess the performance

of a segment in a holistic way (i.e. not just sales and EBIT)– Provide at least 3-year history at all times– Provide pro forma historicals ahead of changing to new format– Give as much information in the quarters as in the full year– Help investors understand impact of important issues (e.g. currency

fluctuations) at the segmental level – Be honest about corporate costs; allocating excess costs to

segments is not a recommended long-term strategy– Explain how material non-operating income/costs are treated (e.g.

expected return on pension assets)


Segmental reporting – Do’s and Don’ts

• Don’t…– Change segments regularly (especially with poor communication)– Provide commentary that does not align with segment structure– Have large inter-segment adjustments, especially if volatile and

unexplained– Report segment numbers that do not reconcile fully to group P&L,

BS and cash flow– Bundle together unrelated businesses into a vaguely named

segment (‘infrastructure’ is a classic) and then pretend it is a coherent business; investors will see through this

– Boast of the cash generation/high ROCE/strong growth at segment A and then decline to provide any supporting financial evidence

– Produce numbers that do not add up (seriously…)


Segmental reporting – Good practice in action

• Atlas Copco (Swedish Engineering)– For each of 3 segments, Atlas reports:

• Orders and sales growth split into volume, price, currency and structure (i.e. acquisitions and divestments)

• Rolling 12-month ROCE calculated on a sensible basis

• Detailed commentary on business trends by region, end market and product range

• Good disclosure on acquisitions by segment (minimum of date consolidated, acquired revenues and employees)

• …and we get this every quarter

– But we don’t get:• Any segmental cash flow information

• Depreciation/amortisation by segment


More good practice in action

• Roche (Swiss Pharmaceutical) – Only 2 segments but very full disclosure– For Pharmaceuticals (80% of sales) we get

• Sales, EBIT and cash flow for 3 sub-segments, plus sales by therapeutic area, geography and top 20 products

• Very detailed P&L breakdown (detailed disclosure on R&D, royalties, SG&A etc.)

• Detailed explanation of currency impact

– For Diagnostics (20%) we get:• 5 sub-segments but slightly less disclosure (no EBIT breakdown), which

is OK given lower materiality

– Plus we get:• Free cash flow by segment that reconciles down to movement in group

net debt!


Segmental reporting – bad practice examples

• Investors will not applaud if you…– Base all commentary on end markets (industrial automation,

commercial construction etc.) and then report geographically– Produce a segmental free cash flow total that does not reconcile at

all to the group cash flow statement, let alone the balance sheet– Are a telecom company and report wireless and wireline as one

segment when the drivers are completely different– Have a segment called “Workflow and Solutions” whose main

business is making hearing aids


CRUF Guiding Principles

Principles based

Realityand

substance

Clear disclosure supports decision makingPrimaries

+ notes+ extra info

Invested capital

stewardship

ReturnsOp/Fin/InvMaintainable

cash flowdriverstrends


Conclusion

• Financial Reporting is all about telling a story, honestly• Effective communication is the antidote to volatility• Future development of financial standards is very important• Preparers and users must cooperate• Preparers can do much to lead the way by example

We’d welcome questions

Documents

Meet the Experts, October 2008 CRUF The Corporate Reporting Users’ Forum