27 August 2008

Communisis plc

("Communisis" or "the Company")

Interim results for the six months ended 30 June 2008

Further strong progress made with results ahead of management expectations; good profit run-rate established; strengthened balance sheet

• Profit from operations (before exceptional gains) up by 92% to £7.6m (H1 2007: £4.0m)

• Profit after tax of £4.6m up 110% (H1 2007: £2.2m) 

• Working capital improvements of 2007 maintained

• Net debt reduced to £15.0m (£26.3m at the end of 2007)

• Earnings per share up 110% to 3.30p (H1 2007: 1.57p)

• Interim dividend increased to 0.860p per ordinary share (H1 2007: 0.818p).

Further operational gains made:

• Profitability across all operations improved again through focus on value-added services

• Operational improvements from 2007 continued into the period, with strong profit run-rate and continuing efficiency gains

• 26 of top 100 customers now buy more than one service, up from 24 at the year end

• New customers and better relationships improve Print Sourcing profits by 126% to £1.3m (H2 2007:£0.6m)

• Bath Business Forms business sold in the period bringing additional focus to the Group's value added strategy

• End of second phase of three phase plan now concluded: strong account management disciplines and an integrated portfolio of value-added services provide a platform for future profitable growth

Commenting on the results, Steve Vaughan, Chief Executive, said:

"These interim results mark the end of the second phase of our three-phase plan, outlined at the start of 2007.  Operational performance, profits and cashflows are much improved because of the progress we have made. Our balance sheet is considerably stronger.

"The key to continued strong performance, economic conditions notwithstanding, is to ensure we expand our range of capabilities further up the value chain. Our balance sheet gives us the chance to invest in the business, the skills of our staff, high technology manufacturing and further service development. We will also begin to consider small acquisitions, to complement our existing capabilities. 

"In the meantime, the established profitable run-rate throughout the business, strong balance sheet and sales performance and continued opportunities for efficiency gains mean we are positioned to continue to perform in line with management expectations for both profit and cash generation."

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  Chairman's statement

The interim results for Communisis plc reflect the continuation of the recovery in the company's performance through the focus on valued-added products and the reduction in factory inefficiencies. Profit after tax was £4.6 million compared with £2.2 million for the first half of 2007. Earnings per share increased to 3.3p from 1.6p for the same period last year.

Trading in the first half of the year demonstrated the effect of operational improvements with better quality business generated from our strong customer relationships. We also sold our Business Forms activities based in Bath which will further improve the quality of earnings in future years. Under Communisis' ownership, there were limited growth prospects in the Bath business, and we can now concentrate on higher value added activities. The disposal, which produced an exceptional profit of £1.4 million, was for £12.8 million of which £ 8.2 million was received on the 30th June.

Good balance sheet management meant that Group debt was further reduced to £15.0 million from £26.3 million last December; debt a year ago was £39.1 million. The cash performance, which benefited from the proceeds of the Bath disposal, also reflected the company's continuing strong control over capital expenditure and working capital.

We shall be paying an interim dividend of 0.86p per share which is 5% above last year. This is possible because of our continued improvement in profitability and demonstrates our view that prospects are good for the rest of the year. Whilst we are operating against an uncertain economic background, we are confident that Communisis can continue to deliver profitable services to our high quality customers. 

Peter Hickson

Chairman

  Business review

I am pleased to report that Communisis has met all of its financial and strategic objectives for the first half of 2008. Profit from operations before exceptional items of £7.6m shows the benefits of a strong run-rate from operational improvements. This marks the end of the second phase of our three-phase plan, outlined at the start of 2007. Business quality is improved, with more high-value services and developments in key customer relationships. Our balance sheet has improved considerably, with net debt significantly reduced to £15.0m by strong operating cashflow and the cash inflow from the disposal of the Business Forms business. Following this disposal, the Group comprises four main components - Direct Mail, Print Sourcing, Transactional Services (including statements, bills and cheques) and Technology & Services.

Direct Mail and Business Forms

This segment involves the production of direct mail items and business forms stationery. One of the major events during the half was the sale of the Bath Business Forms business to its management team. The consideration for this transaction, completed 30 June 2008, was £12.8m. Our exit of this business brings two key benefits. The first is to improve focus on our strategy of helping customers improve customer communication. Our Bath Business Forms operations focused on manufacturing in high volume but at low margin, contrasting sharply with the Group's value-added strategy. Under our ownership, Bath profits were in long-term decline because value-added services could not be brought into this business. The second benefit of the sale is a considerable cash inflow, initially of £8.2m, with £4.6m in future years. This will allow us to accelerate investment plans elsewhere. 

The Direct Mail business has shown good improvement from the positive effects of the turnaround actions taken last year. Profit in the segment has increased to £3.6m, an improvement of 640% from the first half last year, and this is all due to Direct Mail. A recurring run-rate is now established after a year of remedial activity and focus on growing better customer relationships. Investment in higher value services continues. The digital print business, started from nothing in October 2007 is now turning over in excess of £1m per annum, and is recognised by Hewlett Packard as the fastest growing business of its type in the world. Data management and response handling are also showing excellent rates of growth. Volumes in the factory are good, although there is still spare capacity. Waste reduction has delivered the potential that we spoke of at the full-year results. Yield on paper used has increased by 6 percentage points to 72%, making a big impression on the £5m of paper that was being wasted each year.

Print Sourcing

Print Sourcing involves the procurement of print and related items for customers, often on long-term contracts. The first half has seen continued changes to this business. We have already announced that our contract with Sainsbury's was not renewed. In many ways, this illustrates the trends in print sourcing that have caused us to adjust our business model over the past 18 months to make better margins. Customers want more than just very cheap print. Expertise in campaign effectiveness is also needed, and technology and expertise to manage the marketing communications process better. Where a customer requires specialised expertise that we do not have, it is very difficult to renew the business and make a sensible margin.

With other customers, where our skills are relevant and well developed, we have had numerous successes. Our largest sector, Financial Services, has continued to produce strong results, as customers concentrate more on sophisticated below-the-line marketing to protect their own market share. Our skills in efficient campaign management, especially where direct mail is involved, make us a formidable competitor. Our skills allow us to complement our specialised manufacturing with a good supply chain and creative ideas for customer interaction. Our major focus has been continuing to expand existing customer relationships - for example with Royal Bank of Scotland, where business has more than tripled year-on-year, including business in all of our segments. Of our top 100 customers, 26 now buy more than one service, up from 24 at the end of 2007.

Smaller print sourcing contracts have also developed strongly, especially those managed by the Print Sourcing team in Newcastle. This part of the business is shrugging off a few years of poor performance. Following changes in management and cost base, a new energy has begun to transform results. The team have won contracts with new customers, including a three-year deal with Starbucks and operational print for Anglian Water. Small relationships with customers are being nurtured, as an incubator for potential future large accounts. The financial performance of our Print Sourcing segment shows the benefits - with profits of £1.3m, up 126% in the first half compared to the second half of 2007.

Transactional Print

Transactional Print includes the production of cheques, statements, bills and other security items, usually on long term contract. Our cheques business has once again performed well. Volume erosion in cheque books is running at about 10% per annum. However, careful attention to cost control has always been at the heart of this business. We have developed a number of new service lines, drawing on considerable experience in security printing and handling of sensitive customer data. These new service lines now make up about 40% of work in the cheques business. They include payroll printing services for several large customers, and secure printing for public bodies. Growth in some of these new markets will in time provide a future beyond cheque books. In the meantime, our margins are strong and efficiencies offset reductions in volume.

Our business in statements and bills has had a good first half. Production has begun on our third contract, for Cooperative Financial Services. Efficiency improvements are under way in the Speke factory and volumes have held up well across our three contracts. This progress is tempered by our disappointment in not closing a potential fourth contract, where the customer has decided to keep the business in-house. 

We must be careful to develop profit streams that do not rely solely on continued production of paper statements. As online statements and bills grow, and our customers take up the possibilities of adding marketing messages to statements, our business model must evolve. It is therefore very significant that during the first half we have secured two separate contracts to manage workflow and document composition for our customers. 

We view document composition as a key part of future transactional mailing. Statement formats are hard-coded into customer computer systems, making them very difficult to alter. This causes our clients problems when they want to adapt rapidly and evolve communications with their customers. Use of the statement to deliver marketing messages is not possible with such inflexible systems. Our document composition offering overcomes this problem. Our partnership with HP-Exstream, the leader in document composition software, enables us to provide a service for customers to change statement formats quickly and easily without the need to amend their computer systems. Document content can be changed daily, if needed - a tremendous advance in reaction time. Our solution also provides a single source of statement composition whichever output method is used - email, website or paper. This helps regulatory compliance and continuity of customer message. For Communisis, our source of profit is expanded beyond the production of paper statements to a more value-adding and profitable part of the business process.

Technology and Services

Technology and Services is a cluster of products and services that show our highest margin and deliver most value to the customer. They include digital asset management services, consultancy on marketing process and a range of IT tools. 

Profits in this segment rose again by 21% compared to the first half of 2007 to £2.4m, and the margin is now 48%. Our technology products are differentiating our offering and customers are noticing. We have expanded our sales of the IQ product to cover Procter and Gamble North America. Xerox has bought our Connect web-based asset management tool. Our technology was at the heart of our proposition to Starbucks. Our general technology capability allows us to make the document composition propositions in our transactional business. These services lines are becoming more pervasive through our business and in many customer engagements, and providing a growing profit stream as a result. In addition, much of this profit is under-pinned by long-term contracts, in contrast to the shorter consultancy-type revenues of a year ago.

Outlook

In planning the future of the business, we have not ignored the general economic climate and the potential threat posed to our business. To date we have not seen any significant change in the level of our customers' spending. There are changes in the pattern of demand - for example to more targeted mailing campaigns - but these have been long anticipated regardless of the economic climate. Indeed, the current uncertainty may serve as a catalyst to accelerate these trends, to our benefit. We remain on the lookout for any spend reduction, and steps are in hand to ensure we can be resilient if this happens.

We have seen a change in the competitive landscape that confronts us. A few big players are concentrating on the very largest deals with the few big customers that want them. These require a wider range of services than Communisis can deliver, and often commit the successful bidder to considerable investment before any reward can be expected. We do not aim to participate in this space, except perhaps as a delivery partner. Conversely, low-value-added players are chasing prices ever lower as their only differentiator. This has long been the case for conventional printing, and we predicted a similar trend in print management some time ago. We will not follow this "nil value-add" model. A gap in the market is opening between these mega-deals and the lowest price approach. Communisis, with its mid-size and well matched range of services, is well-placed to exploit this space. There are numerous customers, from the very largest to smaller companies, and large areas of the public sector, who are becoming more receptive to our approach.

These interim results mark the end of the second phase of our three-phase plan, outlined at the start of 2007. The progress made has seen operational performance, profits and cash flows much improved. Our balance sheet is improved considerably and net debt reduced to £15.0m (£26.3m at the end of 2007). The key to continued strong performance, economic conditions notwithstanding, is to ensure that our range of capabilities expands upwards into the value chain. Our balance sheet gives us the chance to consider small acquisitions and other investments to complement our capabilities. For a good fit, these acquisitions need to improve our value-added services in areas such as campaign effectiveness, data management and creative services. In the meantime, the established profitable run-rate throughout the business, strong sales performance and continued opportunities for efficiency gains means we are positioned to continue to perform in line with management expectations for both profit and cash generation.

  Financial review

With profit from operations before exceptional items up 92% at £7.6m (2007: £4.0m) and net debt levels reduced by a further £11.3m to £15.0m (31 December 2007: £26.3m), Communisis' financial recovery continued strongly in the first half of 2008.

The successful disposal of the high-volume low-margin Bath Business Forms operation was significant to the Group. This transaction, which we have treated as exceptional, completed on 30 June and contributed an additional £1.4m to Group operating profit and £8.2m of the £11.3m reduction in debt.

Profitability

As we begin stage 3 of our strategic plan for the Group, the benefits of stages 1 and 2 are now showing strongly in our reported results. These results are summarised, by business segment, in the table below:

Compared with the equivalent period in 2007, profits grew in each of our four business segments. Operational restructuring costs, which reduced from £13m in 2006, to £3m in 2007 have been further reduced in the first half of 2008 to the point where they are not sufficiently material to merit disclosure. They have accordingly been absorbed in the segments to which they relate.

Our Technology & Services business, which doubled its profits in 2007, continued to grow strongly in the first half of 2008. One-off profits made from consulting opportunities have settled to more sustainable levels from the peaks in 2006 and the first half of 2007. These profits have been more than replaced by 3 to 5 year contracts for our technology solutions. Income and profit on contracts with Procter & Gamble, Xerox, and other key customer accounts are recognised evenly over the life of these deals.  

Under new management, the recovery in our Print Sourcing business continues. Profits have improved to £1.3m in the first half of 2008, more than the £0.9m we reported in total for 2007. We are seeing the benefit of efficiency improvements first delivered in 2007 and more significantly, these are now being supplemented by new business wins.

The turnaround in our Leeds based Direct Mail business, first evidenced in the second half of 2007, is more than sustained in 2008. The business is now growing, both in its core activity, and rapidly in new higher value services. With the upheaval of the 2007 recovery programme in the past and the business now stable, we have been able to invest selectively. This investment will continue to drive growth and efficiency gains. Such has been the success in the Direct Mail operation that declines in both revenue and profit from Business Forms have been absorbed in the overall reported performance of this segment.

Early in 2008 we implemented further efficiency improvements in our cheques business. This, coupled with our growth in markets where we can exploit our security printing skills, enabled our cheque business to match its very strong 2007 result. Our statement and billing business benefited from the new contract with Cooperative Financial Services which came on-stream in January 2008. In addition to this growth, there are emerging efficiency gains linked to investment. Together, these delivered profit growth in our Transactional segment despite the absence of the additional service transition activity associated with the move to Speke enjoyed in 2006 and 2007.

Central costs, at £5.2m, are running at similar levels to the second half of 2007 (£5.0m) reflecting investment in our account management and marketing skills.

The overall tax charge for the period at £3.4m represents an effective rate of 42%. In fact this is distorted by the very high effective rate of tax associated with the disposal of the Bath Business Forms operation (99%). This is explained in the following section and again in Note 3. Excluding this exceptional transaction reveals an underlying effective tax rate of 30% which is in line with management expectations. The effective rate in 2007 was low at 17% following the release of certain contingent provisions which have not repeated in 2008.

Overall, our robust first half performance results in profit after tax more than doubling to £4.6m (2007: £2.2m) and earnings per share increasing to 3.3 pence per share (2007: 1.6 pence per share).

Bath Business Forms

We completed the disposal of our Bath Business Forms operation on 30 June 2008. The financial effect of the transaction itself is shown in detail in Note 7 to these accounts. Aspects of the transaction merit some explanation, in particular the tax treatment, and the pension curtailment gain.

Net tangible assets valued at £8.25m were sold for £12.8m. After accounting for disposal costs of £0.4m, this gives rise to a taxable profit on disposal of £4.15m. The Group also carried a goodwill asset of £3.52m in respect of Bath. Whilst this asset is written off against the profit on disposal, it is not eligible for tax relief. The result is a transaction profit of £0.63m but a tax charge of £1.16m. It is our intention that the taxable gain is rolled over against eligible past and future acquisitions such that no tax is payable in the immediate future, although under IFRS we have made a deferred tax charge.

The reportable profit on disposal is enhanced by the impact of the disposal on the Group pension deficit. Our deficit is reduced by an actuarially estimated £0.75m because the Bath employees, on leaving the Group, become deferred members of the Communisis pension scheme. This deficit reduction, described as a 'curtailment gain', is required to be disclosed in profit from operations.

Overall, the transaction has resulted in an exceptional profit from operations on disposal of £1.38m, offset by a tax charge, all of which is deferred and so has no cash effect, of £1.37m. Accordingly, exceptional items have no material impact on Group reported earnings.

The impact on future earnings, both for the remainder of 2008 and also 2009, of the disposal of our business forms operation, is also expected to be earnings neutral. We will avoid the annual charge for restructuring associated with this declining business, we are able to make savings in central costs, and we have negotiated a volume-related incentive arrangement with the Bath management team. Overall, the impact of these actions is to limit the decline in profit from operations such that the reduction is fully offset by interest receivable on the proceeds from the disposal.

Cash Flow and Net Debt

The table below summarises the Group's key cash flows: