Business Review continued
Net finance costs
| 2007 | 2006 | |||
| € million | restated | |||
| Continuing operations | 1,004 | 889 | ||
| Discontinued operation | 95 | 168 | ||
| Average net debt including discontinued operation | 1,099 | 1,057 | ||
| Continuing operations | 69.7 | 60.0 | ||
| Discontinued operation | 5.5 | 7.2 | ||
| Underlying net finance costs1 including discontinued operation | 75.2 | 67.2 | ||
- 1 Excludes certain re-measurement items and economic hedges, total gain of €0.8 million (2006: loss of €0.5 million).
The increase in average net debt of continuing operations from €889 million to €1,004 million was broadly in line with the average value of the fleet on the same basis. The rise in market interest rates during the year, in part mitigated by hedging actions, increased the underlying effective finance rate on continuing operations to 6.9% in 2007 (2006: 6.7%). This increase, together with the higher average net debt, resulted in underlying net finance costs on continuing operations of €69.7 million (2006: €60.0 million). Underlying net finance costs on the discontinued operation reduced to €5.5 million, the increase in market rates being more than offset by the part year of ownership.
Net exceptional charges
Net exceptional charges before taxation of €22.8 million were incurred in the year, summarised as follows:
| € million | 2007 | 2006 | ||
| Restructuring costs | 7.1 | 25.3 | ||
| Goodwill impairment – continuing operations | 4.0 | – | ||
| Independent investigation and associated costs | 4.8 | – | ||
| Project termination (credit)/costs | (2.6) | 7.4 | ||
| Pension scheme amendment | – | (3.2) | ||
| Centrus receivables | (0.7) | (0.6) | ||
| Insurance provision release | (5.7) | – | ||
| Net exceptional charges – continuing operations | 6.9 | 28.9 | ||
| Goodwill impairment and loss on disposal of discontinued operation | 15.9 | – | ||
| Net exceptional charges including discontinued operation | 22.8 | 28.9 |
The net cash cost in 2007 of exceptional items was €11.7 million (2006: €28.9 million).
Restructuring costs of €7.1 million (2006: €25.3 million) were incurred in the year. This was partly in connection with the final elements of the restructuring project the Group commenced in late 2005 covering the roles of its European headquarters, corporate operations, shared service centre and call centres and also certain restructuring activities which commenced in December 2007. Restructuring costs include redundancy costs and onerous lease provisions and in the prior year were net of exceptional pension curtailments of €1.2 million.
In June 2007, the Group acquired the assets of a licensee in Germany. The acquired assets and locations have been integrated into an existing cash-generating unit. The goodwill previously arising in this unit had been fully provided for in the past and following a re-evaluation of the impairment calculations following the latest acquisition, a provision of €4.0 million has been recognised in respect of the goodwill arising.
Following the identification of potential malpractice in Portugal in the year, €4.8 million of costs have been recognised in respect of an independent investigation, both in Portugal and of a review throughout the Group’s corporately-owned operations in Europe, together with certain directly related employee termination costs. The independent investigation confirmed that there was no evidence of malpractice elsewhere in the Group.
Following the Group’s decision in 2004 to terminate an agreement with an IT contractor, a net exceptional credit of €2.6 million (2006: charge €7.4 million) has been recognised, after certain additional termination costs, following the conclusion of a legal case.
During the year the collection of credit hire receivables in respect of the closed Centrus business was again more successful than anticipated, resulting in an exceptional credit of €0.7 million (2006: €0.6 million).
During the second half of 2007 the Group reviewed its methodology for calculating the level of provision required in respect of third party motor liability losses, including those not yet reported. The provision level is inevitably subject to a degree of uncertainty as a result of the significant timescales for claims being made. However, as a result of more accurate industry data being made available, the Group has updated the method of calculating the provision based upon the historic claims profile and the application of insurance industry rental loss development factors. This should ensure a more consistent and robust assessment of the provision requirement. The provision re-assessment resulted in an exceptional credit to the Income Statement of €5.7 million. A periodic re-assessment of the provision requirement will be carried out, based upon the latest claims profile and loss development factors, with a subsequent adjustment made to the provision annually in December if required.
On 25 July 2007, the Group disposed and re-licensed its operation in Greece, Olympic Commercial and Tourist Enterprises SA. In the interim accounts the Group recorded a goodwill impairment charge of €7.1 million to write down the associated goodwill to its estimated fair value. In the second half, a loss on disposal of €8.8 million was recognised, giving a total exceptional charge in the year of €15.9 million.
Certain re-measurement items and economic hedges
The following items have been recognised in the year and are excluded from underlying profit before tax:
| Operating profit | Finance items | Profit before tax | ||||
| € million | € million | € million | ||||
| Re-measurement gains/(losses) on derivative financial instruments | 0.7 | (2.4) | (1.7) | |||
| Economic hedge adjustments | 1.0 | (0.6) | 0.4 | |||
| Foreign exchange gain on borrowings | – | 3.8 | 3.8 | |||
| 1.7 | 0.8 | 2.5 |
Re-measurement gains and losses on derivative financial instruments arise from the recognition in the Income Statement of movements in the fair value of certain derivatives under IAS 39, Financial Instruments: Recognition and Measurement. The Group uses such derivatives to hedge its underlying economic positions, but only applies hedge accounting to those relationships where it is both permissible and practicable to do so.
Re-measurement gains and losses on derivative financial instruments are excluded from underlying profit. However, an economic hedge adjustment is then made to underlying profit to the extent the re-measurement gain or loss economically hedges the movement in a related position that itself has been recognised in underlying profit.
Accounting standards as applied also restrict the recognition of borrowings as part of a net investment in foreign operations. Foreign exchange movements on certain short-term borrowings are therefore recognised in the Income Statement, but are excluded from underlying profit.
Taxation
| € million | 2007 | 2006 | ||
| Underlying taxation: | ||||
| Continuing operations | 11.4 | 8.8 | ||
| Discontinued operation (credit)/charge | (1.1) | 2.4 | ||
| 10.3 | 11.2 | |||
| Charge/(credit) on exceptional items | 6.4 | (5.7) | ||
| Charge on certain re-measurement items and economic hedges | 0.1 | 0.2 | ||
| Taxation charge including exceptional items, certain re-measurement items and economic hedges and discontinued operation | 16.8 | 5.7 |
The underlying effective rate of taxation on continuing operations was 30% (2006 - restated: 30%). The 2007 effective rate was impacted by a reduction of deferred tax assets following the lowering of the UK corporation tax rate. This increase was largely offset by a reduction of deferred tax liabilities following the lowering of the Italian corporation tax rate. The remaining change in the rate is a consequence of results arising in different jurisdictions.
The underlying tax credit in respect of discontinued operations was €1.1 million in 2007 compared to a charge of €2.4 million in 2006. The change primarily arises from a reduction of deferred tax liabilities following the lowering of the corporate tax rate in Greece in 2007.
The tax charge on exceptional, certain re-measurement items and economic hedges in 2007 was €6.5 million compared to a €5.5 million credit in 2006, the charge in the year reflecting a more conservative approach being adopted to the deductibility of certain expenses recorded in the current and prior year.
Fleet
The majority of vehicles continue to be subject to manufacturer re-purchase arrangements, which guarantee a disposal value at the end of the holding period, thereby reducing the Group’s residual value risk exposure. The split between the closing non-repurchase and repurchase vehicles on the Balance Sheet is set out below:
| 2007 | 2006 | |||
| € million (net book amount) | restated1 | |||
| Non-repurchase vehicles on fleet | 448.7 | 509.4 | ||
| Non-repurchase vehicles held for resale | 7.1 | 8.4 | ||
| Manufacturer repurchase vehicles | 878.9 | 907.3 | ||
| Total fleet | 1,334.7 | 1,425.1 |
- 1 Restated following the prior year adjustment regarding Avis Portugal
The average number of fleet units operated in continuing operations during the year increased by 4.3% to 118,000 vehicles. This increase is largely a consequence of the increase in rental volumes partially offset by the improvement in utilisation. Within this total, vehicles under non-repurchase operating leases represented 15.2% (2006: 15.9%). The Income Statement charge for these vehicles, and those vehicles used under short-term hire arrangements, was €79.0 million (2006: €67.3 million), an increase due to the value of this type of vehicle, mainly from the effect of the acquisition of the licensee in Germany in the period, and more cars used on short-term hire arrangements.
Return on capital employed
Return on capital employed (ROCE) for underlying continuing operations improved from 8.5% for 2006 to 9.1% for 2007 primarily as a result of the higher underlying operating profit.
The calculation methodology for the Group’s ROCE is described in detail in Note 26 to the Consolidated Financial Statements.
Shareholders’ funds and returns
At the end of the year, shareholders’ equity was €96.2 million (2006 - restated: €84.3 million). The principal movement in the year was the recognised profit of €14.1 million. This comprised the profit attributable to equity holders recognised in the Income Statement of €3.0 million and net income of €11.1 million recognised directly in reserves. The principal components of the latter are an actuarial gain in respect of the Group’s pension scheme recognised in the year, partially offset by an adverse movement in the cash flow hedge reserve.
Cash flow/net debt movement
| 2007 | 2006 | |||
| € million | restated1 | |||
| Net cash generated from operating activities | 43.6 | 262.1 | ||
| Net cash used in investing activities | (70.6) | (149.4) | ||
| Net cash used in financing activities | (33.8) | (86.4) | ||
| Net change in cash and cash equivalents before exchange | (60.8) | 26.3 | ||
| Other movements in net debt resulting from cash flows | (65.9) | 29.6 | ||
| Debt disposed with the operation in Greece | 196.7 | – | ||
| New finance leases | (48.3) | (110.1) | ||
| Other non-cash movements, including the effects of exchange | 5.3 | (8.1) | ||
| Movement in net debt | 27.0 | (62.3) |
- 1 Restated following the prior year adjustment regarding Avis Portugal.
The decrease in cash generated on operating activities is mainly attributable to increased cash outflows relating to vehicles subject to repurchase agreements. This is partially offset by the reduction in cash used in investing activities, which includes lower cash outflows relating to non-repurchase vehicles. The other main variances in cash used in investing activities are a reduction in financial assets held for trading (this variance being offset in other movements in net debt) and the proceeds arising on the sale of the business in Greece.
The overall higher vehicle cash outflows were mainly due to a planned increase in the value of the closing fleet, after adjusting for the effect of the disposal of Greece.
Net cash outflows on financing activities decreased due to the net new borrowing in the period, this variance being offset in the other movements in net debt.
After allowing for the debt disposed with the operation in Greece, net debt decreased at the year-end by €27.0 million.
Net debt
| 31 December 2007 | 1 January 2007 | ||||||
| restated1 | |||||||
| % | € million | % | € million | ||||
| Interest bearing assets | (6) | 66.3 | (13) | 139.2 | |||
| Debt due within one year | 3 | (31.0) | 23 | (231.7) | |||
| Debt due after one year | 71 | (699.2) | 55 | (559.2) | |||
| Finance leases | 28 | (273.7) | 29 | (292.1) | |||
| Derivative debt instruments | 4 | (43.3) | 6 | (64.1) | |||
| Net debt | 100 | (980.9) | 100 | (1,007.9) | |||
- 1 Restated following the prior year adjustment regarding Avis Portugal.
During the year, the proceeds from the disposal of the operation in Greece, together with a reduction in interest bearing assets, were used to repay a number of loan notes at maturity. As a consequence of that repayment, the percentage of net debt included within the debt due within one year category has fallen from 23% at 1 January 2007 to 3% at 31 December 2007. In addition, there has been an increase in drawings under the Group's syndicated bank facility with a consequent increase in debt due after one year. The percentage of total net debt drawn under finance leases and derivative debt instruments has remained broadly unchanged.
Pensions
The Group operates both funded and unfunded defined benefit pension and statutory termination schemes, as well as defined contribution schemes.
Funded defined benefit schemes
The principal funded scheme is that operated in the United Kingdom.
The difference between the market value of all funded scheme assets and the actuarial value of the funded scheme liabilities at 31 December 2007 was a deficit of €62.5 million (2006: €80.1 million).
The fair value of the scheme assets has increased €6.3 million (2006: €16.3 million increase) in the year. This reflects the increased funding contributions from the Group, offset by an exchange translation loss as a result of the depreciation of sterling. The present value of the scheme obligations has reduced by €11.3 million (2006: €14.3 million increase) largely in line with expectations, with an actuarial gain of €8.9 million (2006: loss €2.1 million) related primarily to the increased discount rate. The Group has strengthened mortality assumptions by introducing a 1% per annum minimum level of improvement within the medium cohort allowance. The non-contributory final salary section of the UK Plan was closed to future service accruals from 1 April 2007 and future service benefits now accrue under the contributory Retirement Capital (cash balance) section of the Plan.
Unfunded defined benefit schemes
The principal unfunded scheme is held in Germany and is closed to new entrants. The actuarial value of all unfunded scheme liabilities was €35.0 million (2006: €41.9 million). The reduction in the deficit is primarily due to actuarial gains related to the increase in the discount rate applied to liabilities.
The underlying charge in the income statement for defined benefit schemes was €10.2 million (2006: €13.8 million), the reduction being due to the closure of the UK final salary scheme and changes in the entitlement rules related to the German pension scheme.
Treasury
Financial risk management objectives and policies
The Group has a centralised treasury function that is responsible for
the management of the Group’s financial risks together with its liquidity
and financing requirements. The treasury function is not a profit centre
and its objective is to manage risk at optimum cost. Treasury operations
are conducted within a framework of policies and guidelines approved
and monitored by a sub-committee of the Board. This framework provides flexibility for the execution of Board-approved strategies. A discussion of
the Group’s financial risk management objectives and policies, and exposure of the Group to various financial risks, is included in Note 26 of the Consolidated Financial Statements.
Current liquidity
The Group funds its operations through a combination of retained earnings, working capital and borrowing facilities. In order to ensure maximum flexibility to changing requirements, the Group seeks to maintain access to
a wide range of funding sources. Financing facilities therefore include bank borrowings, loan notes, finance leases and a commercial paper programme in Belgium.
As at 31 December 2007 the Group had undrawn committed borrowing facilities of €712.4 million (2006: €808.7 million) and additional uncommitted borrowing facilities available of €583.0 million (2006: €496.9 million). The Group also held cash and cash equivalents of €52.1 million (2006: €113.3 million). Of the undrawn committed facilities €228.7 million expire within one year (2006: €226.4 million), €54.6 million between one and two years (2006: €39.4 million) and €429.1 million between two and five years (2006: €542.9 million).
In addition, as at 31 December 2007, the Group had outstanding loan notes and associated derivative financial instruments of €592.5 million (2006: €844.6 million). Of these, €264.0 million matures between two and five years and €327.9 million after more than five years (2006: €249.9 million within one year, €153.4 million between two and five years and €441.3 million after more than five years).
The Group’s committed bank facilities and loan notes are unsecured and certain of these facilities contain a number of normal financial covenants including a maximum limit to the ratio of total net financial debt to underlying EBITDA and the ratio of underlying EBITDA to net interest expense, both measured at 30 June and 31 December each year and on a rolling 12-month basis. For the year ended 31 December 2007 the ratio of total net financial debt to adjusted EBITDA was 2.2:1 (2006: 2.3:1) and the ratio of adjusted EBITDA to net interest expense was 6.1:1 (2006: 6.8:1).
The Group monitors compliance against all its financial obligations and manages its consolidated balance sheet and debt requirements so as to operate within covenanted restrictions through the year. The majority of the Group’s borrowings are raised through Avis Finance Company plc, an indirectly wholly-owned subsidiary of the Company, and proceeds are used to finance the Group’s subsidiaries on an arm’s length basis.
Other funding arrangements
Where commercially beneficial, the Group seeks to optimise financing costs by entering into operating lease transactions where substantially all of the risks and rewards of ownership remain with the lessor. At 31 December 2007, the total commitment to pay operating lease rentals in future periods for land, buildings and vehicles was €190.4 million (2006: €182.9 million). Also at that date, banks have issued on behalf of the Group guarantees
and letters of credit to third parties of €86.5 million (2006: €88.6 million). The majority of these relate to insurance, operating leases and station
rental commitments.
Insurance
The Group is legally obliged to provide all vehicle rental customers with insurance against accidents caused to third parties, and cover is also offered against theft and personal accident. In addition, the Group covers various risks arising from the normal course of business, including damage to property and general liability. Cover is arranged with a number of major insurance companies of strong credit quality to help spread the risk cost effectively. The Group also reinsures a limited amount of the risks through its own captive insurance company, which in turn also buys reinsurance to limit its own exposure.
Accounting standards and policies
The only change in accounting policies impacting the Group in the current year is the additional disclosure requirements required as a result of the implementation of IFRS 7 Financial Instruments: Disclosures.
Martyn Smith
Group Finance Director
