OFR - Seriously prejudicial

After skirmishes with the City over IFRS, the finance director of our fictional company, Distributors plc, begins to grapple with the new business review requirements.

David Tilston.

James's opinion of Gordon Brown had gone up the previous December when he had announced the scrapping of the operating and financial review (OFR). Unfortunately this had been short-lived as the requirements of the business review now appeared almost as onerous. The fact that the Financial Reporting Review Panel would be examining such reports going forward implied the regulators were taking this seriously. So much for reducing red tape!

Worse still the audit committee chairman was a confirmed enthusiast for all things OFR-related. As an ex-FTSE 250 FD he had seized the moral high ground and insisted that the forthcoming annual report should adopt the new business review requirements as best practice. James's more pragmatic arguments had fallen on deaf ears, and he had been asked to produce a draft.

What to do?

James sat down to chew the problem over with his key staff. Hannah, the financial controller, would inevitably pull the detail together. William, the group treasurer, might also have some useful thoughts given Distributors' high gearing and pension deficit levels.

The board had discussed how to approach external communication issues.

There had been some discussion around how the directors could provide a 'fair review' of the business. The CEO had agreed to draft the historic performance summary and to provide further narrative covering the strategic direction of the group. James had been tasked to produce something on forward-looking indicators for the board to consider.

The board had agreed to use OFR guidance as a base and follow an external commentator's structure for organising discussion of outlook under three broad headings, namely:

•    resources, risks and relationships;

•    key trends and factors; and

•    information on future targets.

Resources, risks and relationships

William led off in characteristically unhelpful fashion.

'Well, this is easy. Our debt levels are too high, the banks are nervous, and a good dose of poor trading could take us under,' he said. 'What is more, the pensions regulator could also give us problems given our deficit which the banks will not want to fund.'

'I am not sure that is quite what the board had in mind,' replied James.

'We may have some potential dirty washing, but no way are we going to hang it out in the pages of our annual report!'

'Surely a lot of this is already in the public domain,' interjected Hannah.

'Remember the awful analysts' report that was published a couple of months back? They referred specifically to our limited financial flexibility to withstand external shocks. Can't we just rely on that?'

'I am not sure we can,' noted James. 'I will raise it with our brokers, but I think we need to make relevant disclosures in our accounts rather than rely on external publications which many of our shareholders will not have seen.'

Key trends and factors

This area looked less contentious. 'We can at least point to declining debt levels over the last couple of years,' noted William. 'Our trading performance over the Christmas period was also broadly in line with our competitors,' added Hannah, 'and it looks as if we have held market share.

Are there any market statistics or indices we can refer to?'

James contemplated this point. The overall results had been broadly in line. The level of profitability achieved in the northern region had, however, been better than elsewhere. This was partly down to the portfolio of branches they had there, which mostly dominated their local catchment areas in market towns. The profitability elsewhere in the UK had been much worse. This was largely due to both the weaker branch portfolio in some of the other regions and the emergence of an aggressive new competitor based in the South West. Prices had been cut to hold market share in some areas, impacting profitability.

'The trade body has some long-term indices we can use,' suggested James.

'They do not, however, split out performance on a geographical basis which matches our regions, thank goodness. The market research we commissioned did confirm some of the problems we were facing, particularly in the South West. I doubt very much the board would want to communicate this to our shareholders, as the competitors would have a field day.'

'We could refer to management's delivery of improved performance in the last couple of years and determination to continue this trend going forwards,' commented Hannah. 'Surely that is what all companies would say?' William interjected, with more than a touch of sarcasm in his voice.

Information on future targets

Targets were a problem, there was no getting away from it.

'We know the target is to halve debt levels this year with improved trading and disposal of a few underperforming branches,' noted William. 'We also plan to refinance our medium-term loan facilities before the end of the year to strengthen our financial position. They are the obvious things we could communicate, but it all sounds too much a hostage to fortune.'

'I think we need to move away from our pure financial targets and think about more generic key performance indicators,' said James. 'Ideally these should be indicators which help the investors get a better handle on how trading could develop and what our prospects are going forwards,' he added.

'We could try to produce sales per square foot and organic growth rate statistics,' said Hannah. 'The City has been after these from us for some time. I guess they would also want it on a segmental basis now we have given them a geographic split of performance for the first time under International Financial Reporting Standards,' she added.

'The main problem is the quality of the data. With all the reorganisations and systems changes in the past year I do not believe we can easily get at reliable figures. The figures we currently supply to the board are heavily caveated, and I would feel distinctly uncomfortable disclosing them externally. We simply could not answer all the questions that would arise.'

James agreed. There had been a stormy discussion at the last board meeting when the CEO had been unable to explain to the non-execs why the performance in the eastern division had been so poor. Organic sales growth and improvements in sales per square foot had both been quite positive, as had the external market research on customer perceptions, but the figures somehow did not add up.

Seriously prejudicial?

James could not decide how to handle this whole issue. If the board had to give a fair and balanced review with some element of forward-looking content then it would have to disclose a number of facts that would be quite unpalatable to the market, could potentially encourage competitors and destabilise Distributors' position. He noted that the OFR reporting statement issued by the Accounting Standards Board in January 2006 stated 'no disclosure of information should be made about impending developments or about matters in the course of negotiation if the disclosure would, in the opinion of the directors, be seriously prejudicial to the interests of the entity'.

The board would seize on this exemption to significantly limit disclosure of the above factors. Consequently little additional information would be communicated, and Distributors would be seen to be dodging implementation of the business review regulations.

Now what was James going to say at the next board meeting?

David Tilston is head of group finance at Mowlem and formerly FD of two listed companies as well as chairman of the Education Committee at the Association of Corporate Treasurers

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