Annual Report and Accounts 2007/08

Directors’ report

Integration & Managed Services

The Integration & Managed Services business has had a challenging year. The business entered the 2008 financial year with strong growth expectations based on the opportunities that were visible at that stage.

As the year progressed, it became apparent as a result of changing market conditions, that revenue from our largest industry vertical, financial services, would fall short of our initial expectations. In addition, we experienced a material decline in revenue from a major customer using our applications integration skills. These factors had an impact on the overall revenue and profitability of the I&MS business in the year.

Overall revenue within I&MS has increased by 2.7 per cent to £278.4 million. This growth includes the full year impact of the prior year acquisitions of Smart421 and JAM IP with pro-forma organic growth at 0.3 per cent. It is encouraging to note that our second half year on year organic revenue growth is 3.8 per cent following a decline in the first half of 3.1 per cent year on year.

The mix of I&MS revenue comprises 39.7 per cent from the design, supply of related products and implementation of solutions, 3.2 per cent from consulting services and 57.1 per cent from recurring services.

The overall financial performance for the I&MS segment was impacted significantly by revenue weakness with overall EBITDA before exceptionals of £8.6 million (EBITDA margin: 3.1 per cent) and Adjusted profit from operations of £1.4 million similarly falling short of our initial expectations. The I&MS planned revenue profile was weighted to the second half of the year, particularly within Affiniti, and this served to further highlight the impact of the revenue shortfall as there was insufficient time remaining in the financial year to materially adjust the overall cost base of the business.

The year on year profitability within I&MS has been impacted by the following anticipated factors:

• a £5.0 million year on year reduction in the contribution of one of our public sector long term managed service contracts. The contract has been extended to March 2011. The high level of profitability reported in the previous financial year from this contract was consistent with the end of the final build phase of the contract. The Group had, over the previous six years, designed and progressively built this network. A significant proportion of the contract value was recognised in the previous year in line with our revenue recognition policy. Prior to this, there had been significant levels of capital expenditure associated with the contract although going forward these amounts are negligible
• the impact of implementing new ‘in life’ support arrangements for customers using Cisco technology led to a £1.9 million increase in operating expenditure. Prior to these arrangements, Cisco spares had been capitalised and depreciated over the life of the contract thereby not impacting EBITDA. Although this adversely affected EBITDA margins, it is anticipated that this will result in a more favourable cash profile over the life of a contract through lower spares stock holding.

As market conditions weakened, the operational gearing of the business, together with our planned weighting to the second half, meant our ability to fully offset the shortfall in sales during the second half was limited. However, we began implementing, during the second half, a series of changes to drive improved performance in the coming year.

These include:

• the restructuring of the management team following the appointment of Paul Renucci to the Board of Directors in November 2007 with responsibility for the Affiniti business
• the closure of two of our regional offices with a further four scheduled to close over the next nine months
• completion of a number of systems integrations in the last quarter of the year. This, coupled with other projects around the Group, has removed approximately 20 ‘duplicate’ operating and financial systems in the last 12 months
• investment in a new professional services management tool designed to drive improved utilisation and management of our pre-sales, consultancy, project management and implementation capability within the Affiniti business. This will improve productivity enabling a marked reduction in the use of third parties to meet peaks and troughs in workflows
• completion of the restructuring of the public sector sales team within Affiniti at the end of the third quarter of the year
• the integration of three technical and field engineering resource groups across the Group.

Overall, we will have seen a progressive reduction in the total headcount across Affiniti and our shared engineering resources through a combination of effective and leaner management, redundancy, redeployment and natural attrition.

At the same time as we have implemented these changes, we have continued securing important new customers, as well as extending relationships with existing customers. New customer contracts secured include Innocent Drinks, Threadneedle, Mid Yorkshire NHS Trust, Mercedes UK & UK Companies and a substantial project with State Street Bank. Ford, an existing customer, has recently signed a three year extension to their contract covering Europe. We have also recently renewed a three year contract with the East Midlands Broadband Consortium for the provision of broadband services to schools in the East Midlands through the prime contractor Synetrix.

These contracts all underpin the improvement we have seen in the value of our Affiniti contract order book which stood at £186.0 million at 31 March 2008 (2007: £159.6 million). This increase is all within our recurring services income and provides a solid base to the current and subsequent years.

The second half revenue growth reported within I&MS is encouraging and provides us with confidence as to our growth targets. Our ability to exploit the enhanced skills within I&MS across our customer base will help drive growth although the revenue impact of this to date has been modest as a percentage of our overall revenue. This aspect of the development of our business will take some time to come to fruition.

Overall, the improved order book of contracts, together with the skills and capabilities of the businesses and the changes outlined above, provide us with a platform from which to drive I&MS towards our medium term targets and deliver an acceptable level of return on both sales and the capital employed in this segment of the business.

Consistent with the business strategy, the year has illustrated the reduced capital intensity of this segment of our business and it can be seen that, despite the shortfall and year on year reduction in EBITDA, the business reported positive levels of EBITDA less capital expenditure and Adjusted profit from operations.