Hargreaves Services : Interim Results

HARGREAVES SERVICES PLC

(the 'Group' or 'Hargreaves')

Interim Results for the six months ended 30 November 2016

Hargreaves Services plc (AIM: HSP), a diversified group delivering key projects and services to the infrastructure, energy and property sectors, today announces its interim results for the six months ended 30 November 2016.

FINANCIALS

HIGHLIGHTS

· Overall performance in the first half was in line with management expectations;

· Strong prospects in Germany expected to drive outperformance in second half as announced in December;

· Property & Energy portfolio development progressing well with planning permission granted for an energy-from-waste plant near Grangemouth and the planning decision on our Blindwells development expected in March;

· Good progress being made with the integration of CA Blackwell to establish our new Specialist Earthworks division;

· Wind down of coal mining activities and the commencement of the site restoration programme at Tower underpins the expectation of full repayment of Joint Venture loans;

· Legacy asset realisation programme progressing well, with all surplus coal and coke stocks contracted;

· Net debt expected to fall materially during the second half, with the final outcome dependent on the timing of material property disposals;

Commenting on the interim results, Chairman David Morgan said:'It is pleasing to see how much progress we have made towards the three strategic goals we set ourselves a year ago. First, earnings from the continuing Distribution & Services operations are well set to deliver operating profit within the target range that we set. Second, good progress is being made in creating and then delivering the targeted £35m-£50m uplift in value from our Property & Energy portfolio. Lastly, it is very gratifying to see the progress that has been made in the realisation of cash from the legacy assets and the increasing confidence that this realisation will be achieved without the need for any net impairment of the book value.'

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INTERIM STATEMENT

Hargreaves Services plc announces its interim results for the six months ended 30 November 2016.

BUSINESS REVIEW

The Board is pleased with the progress that has been made during the period towards the achievement of the strategic goals set out in the 2016 Repositioning Strategy. In this regard, good progress has been made with the stabilisation of our Distribution & Services activities, the development of the Property & Energy portfolio and in realising cash from the Legacy Assets.

Trading in the first half was in line with management expectations. Revenue was £170.9m compared with £174.8m in the prior period as the reduction in coal sales and industrial services revenues following the closure of Redcar steelworks and a number of coal-fired power stations was largely offset by the £40.0m of revenue contributed by CA Blackwell. Underlying Operating Profit for the first half was £2.1m compared with £4.1m in the comparative period. Cash performance was in line with expectations with net debt of £36.9m at the end of the first half.

The table below summarises the results for the period by Operating Division.

Review of Underlying Performance

Distribution & Services

The table below shows revenue and underlying operating performance across our Distribution & Services operations.

Coal Distribution

Revenue in Coal Distribution was £68.5m, a reduction of £37.1m on the £105.6m in the comparative period, due to lower levels of thermal coal being traded and a £26.7m reduction in metallurgical coal sales following the closure of the Redcar steelworks, which led to our decision to exit metallurgical coal trading in the UK.

As set out in our strategy the Group remains committed to the sourcing and distribution of coals for the speciality markets. Sales of speciality coal totalled 329,000 tonnes in the first half and were in line with management expectations. On-going coal production is focused on speciality coal and currently limited to the House of Water site in Scotland which yields a high proportion of speciality coals. The new coal processing plant at the Killoch railhead has been successfully built and commissioned and is delivering the expected improvements in speciality coal yield from the House of Water site.

Production at the Tower site by our joint venture Tower Regeneration Limited is addressed in the Legacy Asset Realisations section below.

In Europe our associate operation has traded well in the first half. Favourable recent market conditions have resulted in a very strong order book to start the second half and the Board expects the Group's share of the operation to exceed its profit expectation for the full year by approximately £3m. The Group is encouraged by the opportunities presented by the European markets which are much larger and are proving to be more robust than the UK.

Industrial Services

The UK operation produced a strong first half performance, ahead of management expectations, although, due to the closure of Redcar steelworks and a number of coal fired power stations, this performance was significantly lower than the comparative period. Revenue in the UK was £23.4m compared with £41.8m in the comparative half last year. The UK strategy remains focused on growing outside of our traditional coal and steel sectors.

The international operations generated revenue growth, although the level of growth achieved was lower than the ambitious targets set. Reported revenue was £7.3m, 35% higher than the £5.4m posted in the comparative period. The £0.4m operating loss posted in the first half was below the £0.2m operating profit posted in the comparative period and behind management expectations following the delay to one major project.

Given the overall profile of contracts and planned site outages, our expectation for the Division continues to be that operating profit will be weighted to the second half and a strong second half profit performance is expected.

Logistics

The bulk haulage operations performed in line with management expectations in the first half in both revenue and profit terms. Progress continues to be made in re-aligning our fleet in a market that now has negligible coal movements. Revenue and underlying operating profit were £25.1m and £0.7m respectively, compared with £28.0m and £0.7m in the comparative period. The improvement in margin from 2.6% to 2.9% reflects the progress made in aligning the business to the areas of activity.

Specialist Earthworks

The new Specialist Earthworks business incorporates the CA Blackwell acquisition and the recently formed Group plant pool operation. Revenue for the first half was £40.0m relating to the CA Blackwell operations acquired in January 2016. The Division recorded an underlying operating profit of £1.1m. The Division was formed with the acquisition of Blackwell and hence there are no comparative numbers.

Good progress continues to be made on the integration of the business and a new leadership team has been established. As the integration has continued, our understanding and assessment of the costs to conclude two specific contracts has highlighted a shortfall in fair value provisions of £2.7m. Consequently as reported on 22 December 2016 we have adjusted our assessment of fair value and have increased goodwill from £0.8m to £3.5m. The Group acquired the CA Blackwell group in full knowledge of, and at a price that reflected, a number of historic contractual challenges. The Board is confident that the acquisition was well structured and presented good value for shareholders.

The Group continues to support the Hemerden tungsten mine operated by Wolf Minerals and is in negotiation to vary the existing contract to the benefit of both parties. Enabling works have now commenced on the A14 project as we await conclusion of negotiation on the earthworks sub-contract. The Group continues to work through the back log of old contracts and claims, many of which were identified in due diligence and either provisioned on acquisition or covered by warranties or cash escrow as part of the transaction consideration.

Our strategy for developing the CA Blackwell business remains unchanged. Once we have worked through the historic contractual issues, we will focus the business on the sectors offering the best fit to our competences and resources. We see strong synergy and overlap with our skills in bulk road transport, mining and brownfield restoration and remediation.

Property & Energy

Although disappointed by the planning delays with respect to the Blindwells project, the Board is generally pleased with the continuing development of the Property & Energy portfolio.

As expected, realisations were limited in the period. The Property business contributed £1.4m of revenue in the first half and a net operating loss of £0.8m. Progress continues to be made on further short term realisations and management anticipates reporting an improved positionat the time of the full year results.

Encouraging progress also continues to be made in planning terms across a number of sites, most notably, Blindwells, Westfield, Monckton and Maltby. The main focus of attention in the first half was, and remains, the delivery of planning consent for the Blindwells site and the Board understands that the planning decision is now due in March.

Good progress continues to be made in working to achieve the realisation of properties acquired as part of the Blackwell transaction. The Group has allowed an extra six months to achieve a full realisation and is confident that the value to be obtained will cover the current book values.

The book value of the Group's Property & Energy portfolio is held at historic cost, which stood at £32.3mat 30November 2016. In addition to continuing to account for property realisations, the Group has commissioned a formal valuation of its property portfolio and expects to report that value, alongside the historic cost book value, in the upcoming Preliminary Results in August 2017. It is the intention of the Board to update and report this valuation on an annual basis to provide shareholders with an opportunity to understand and track progress in its development.

Encouraging progress has also been made with the development of the Group's energy interests. We are pleased to report that the Earls Gate Energy from Waste project at Grangemouth, Scotland, has received planning permission, an important step in its development progress. A planning application has also been submitted for an energy plant at Westfield, a former open cast coal site in Fife, Scotland, as part of a broader master-planning initiative.

Work continues on a number of projects to develop value from the Group's 75MW of grid connections and we remain focused on expanding the 70MW of consented on-shore wind capacity. The Board sees significant potential future value from these initiatives.

During the period the total capital expenditure on property and energy development projects amounted to £3.2m.

Legacy Asset Realisations

We are pleased with the progress the Group has made towards realising the value from its portfolio of legacy assets.

Surplus coal and coke stocks with a balance sheet value of £10.9m at 31 May 2016 have all been contracted for sale. No loss or impairment against book value is expected and the coal is expected to have been realised into cash by the end of the financial year.

The Board is also pleased with progress at the Tower Joint Venture. Hargreaves expects to reach agreement with its joint venture partners to optimise the utilisation of plant at Tower, in exchange for a lower contract margin. This agreement will preserve the fleet's value and is expected to maximise plant disposal proceeds when liquidity returns to the heavy plant markets. This, in combination with the improved coal proceeds achieved through the higher coal price, significantly increases the likelihood of recovering the full amount of our outstanding loans, including future accrued interest.

Net Debt

Net Debt at 30 November 2016 was £36.9m. Whilst working capital requirements associated with the Specialist Earthworks business are expected to increase as the A14 contract ramps up, net debt is targeted to reduce significantly in the second half as our contracted coal stocks are delivered. Although legacy asset sales and property disposals all carry a degree of timing risk management expects that year end net debt will not exceed £10m.

Dividend

Reflecting the progress made together with the visibility on the prospects for the second half of the year the Board has approved the payment of an interim dividend of 2.7p per share. The interim dividend will be payable on 7 April 2017 to shareholders on the register at 24 February 2017.

Recent Trading and Outlook

The Distribution & Services operations are well placed to deliver a strong result for the second half. The Board expects to deliver an operating profit in the region of £3m higher than previous expectations, mainly arising from profit outperformance in Europe. Although the longer-term visibility of performance in the European business remains low, due to the trading nature of the business, the Group remains impressed and encouraged by the performance of the European management team and the opportunities presented by the larger and more resilient European carbon markets. The Board will work with and support local management to identify strategies to improve the predictability and visibility of earnings.

The Board expects the Industrial Services operation to deliver a stronger performance in the second half in operating profit terms. A delay in the commencement of a major project in Hong Kong will mean that, although the operation will grow year on year, it is likely to under-perform against internal profit targets. The Logistics and Specialist Earthworks businesses are expected to deliver in line with management's expectations in the second half.

In Property the focus remains on the delivery of planning permission for the Blindwells site, with a decision expected next month.

Excellent progress continues to be made in the development of the Group's portfolio of energy projects. Many of these projects present significant value creation opportunities but are specialist and capital intensive. The Group is working to structure these assets into a separate legal entity to provide greater flexibility in deciding how these projects could be exploited. This is expected to optimise longer term value without adding complexity to the Group's business whilst minimising any impact or demands on the Group's balance sheet.

The Board remains confident of achieving its previously stated five year target for the creation of value from its Property & Energy portfolio. The publication of independently assessed market valuation numbers at the time of the Preliminary Results should provide investors with a better indication of that potential.

Efforts will continue to achieve the orderly marketing and disposal of legacy assets. The management team has demonstrated that it understands the markets for and valuations of these assets and we remain confident that the legacy asset positions will be exited for a value no less than the overall balance sheet position.

Summary

The Board is pleased with the performance and re-positioning of the business and is confident that the business will continue to demonstrate excellent progress towards realising the intrinsic value of the Group's operations and the value inherent in the Group's balance sheet. As debt levels reduce through the second half of the year careful consideration will be given to the application of cash to create shareholder value.

FINANCIAL REVIEW

Revenue

Following the turbulent and challenging conditions the Group experienced across all of its markets in prior periods, the Group enjoyed a more stable trading environment during the six months to 30 November 2016. Reported Revenue decreased by £3.9m from £174.8m in the six months to 30 November 2015 to £170.9m in the six months to 30 November 2016.

Operating Profit and Margins

Underlying operating profit reduced by £2.0m from £4.1m to £2.1m, largely driven by the reduced level of coal trading activity within our Distribution & Services division. Revenues from the sale of coke, bulk and metallurgical coal were significantly lower, due to continuing negligible thermal coal shipments and the impact of the closure of Redcar steelworks in the period to 30 November 2015.

The acquisition of CA Blackwell in January 2016 has been successfully integrated into the Group and contributed £1.1m of underlying operating profit. The Logistics business generated an operating profit of £0.7m, consistent with the comparative period. The series of steel and power plant closures which occurred last year, combined with the continued challenging conditions and delays in major projects in Hong Kong, resulted in operating profit in the Industrial Services operations in the first half falling from £3.0m to £0.2m. This fall was largely in line with current management expectations and timing of projects and outages in the second half is expected to be more favourable than in the first half.

The Property & Energy division made good progress in the period with regard to the development of a number of property sites and energy projects. This early progress is yet to translate into reported financial returns, with the division reporting a £0.8m operating loss for the period.

The process to complete the realisation of legacy assets into cash started well in the first half and generated an operating profit contribution of £0.6m in the period. The book value of legacy assets at 30 November 2016 totals £42.0m, a significant decrease from the £60m of assets reported at 31 May 2016.

Following the previously announced restructure of central operations, the cost of the corporate division has decreased significantly from £3.4m to £2.4m for the six months to 30 November 2016.

Reported Group continuing operating profit fell from £4.9m to £0.1m whilst continuing profit before tax decreased from £0.8m to £0.2m.

Goodwill

The Group completed the acquisition of CA Blackwell in January 2016. Following experience with the business, the Group has re-measured goodwill in respect of two historic contracts where it became clear in the first half that further work and defect rectification would be required. Consequently, an increase of £2.7m has been recognised in goodwill with a corresponding decrease in acquired net assets of £2.7m. The decrease in acquired net assets reflects an increase in contract accruals at the acquisition date. This brings the goodwill to a total of £3.5m for the acquisition. No further revisions are expected to be required and the Board remains comfortable with the carrying value of the revised goodwill amount given the cash and profits that it expects to generate from the business.

Retirement Benefit Obligations

The Group is a member of two industry-wide defined benefit pension schemes and one concessionary fuel scheme as a result of its former deep mining operations at Maltby Colliery.

UK gilt yields remain weak and the falls over the first half have given rise to an increase in accounting estimates of the defined benefit pension scheme deficits. As a result, the Group has recognised an estimated increase in its defined benefit pension deficit of £4.1m, from £5.7m at 31 May 2016 to £9.8m at 30 November 2016. The Directors remain committed to funding these schemes. A full valuation is currently under review and is expected to be completed by 31 May 2017.

Interest

In the six months to 30 November 2016, continuing net finance expenses for the Group increased by £0.3m from £0.9m to £1.2m. This movement reflects a modest increase in average Group net debt levels during the period. Net debt (comprising cash and cash equivalents, bank overdrafts and other interest bearing loans and borrowings) at 30 November 2016 was £36.9m. The Group expects net debt to fall in the second half.

Taxation

Income tax expense for the first half was £0.2m compared with £0.5m for the six months ended 30 November 2015. This charge includes £146,000 relating to the impact on deferred taxation of the planned reduction in the UK corporation tax rate to 17%. The tax charge on current period results has been calculated based upon an estimated effective tax rate for the full year of 1.7%. This effective tax rate is significantly lower than the current UK corporation tax rate due to the expected utilisation of previously unrecognised tax losses within the Group's Specialist Earthworks business.

Earnings per Share

Reported basic earnings per share decreased by 0.52p from 0.49p to a loss of 0.03p, reflecting the small reported profit after tax during the period. Underlying diluted earnings per share decreased by 96.0% from 7.04p to 0.28p.The weighted average diluted number of shares in the period decreased slightly from 32.3m to 32.2m, as a result of a reduced number of unvested share options in employee share schemes.

Net Debt

Net debt increased by £4.6m from £32.3m at 31 May 2016 to £36.9m at 30 November 2016. The net debt increase reflects the Group's strong operating cash inflows since 31 May 2016, benefiting from the unwinding of legacy coal inventories. This was offset by the seasonal stock build in advance of the colder winter months as well as tax payments of £6.2m in the period, including a £5.2m advance payment in respect of the lease planning arrangement carried out in the year ended 31 May 2011.

Group net assets decreased from £131.4m at 31 May 2016 to £129.2m at 30 November 2016. Gearing (measured as net debt compared to net assets) at the end of November 2016 was 28.6%, compared with 24.6% at 31 May 2016.

The Group's financial position remains strong with net debt at 30 November 2016 equal to 2.6 times the last 12 months' earnings before interest, tax, depreciation and amortisation ('EBITDA'), comfortably below our maximum covenant levels.

Cash Flow

Net cash flow from operating activities, before working capital movements, generated an inflow of £4.2m. Movements in working capital have resulted in a cash inflow of £2.3m for the period, making total cash inflow from operating activities of £6.5m.

The improvement within the working capital of the Group has been driven by the realisation of legacy assets, totalling £15m in the first half. This improvement has been offset by seasonal stock builds within our Coal Distribution business unit, as well as the anticipated unwind of the strong working capital position reported at 31 May 2016.

Tax payments of £6.2m included a final advance payment to HMRC of £5.2m in respect of the lease planning arrangement previously reported upon.

Net capital expenditure in the six months to 30 November 2016 was a net spend of £3.4m, a reduction of £0.9m compared to the period to 30 November 2015. Significant capital expenditures included development of the Group's Property & Energy projects, investment in surface mine stripping assets and capital investments in our Blackwell Plant business. Proceeds from sale of property, plant and equipment of £3.6m were mainly generated from surplus plant disposals, as we continue to orientate and synergise our yellow plant fleet.

Repayment of finance lease liabilities totalled £5.2m for the period, an increase of £2.4m compared to the prior period. This reflects the increase in the size of the Group's yellow plant fleet following the acquisition of CA Blackwell in the prior year.

The final dividend of 0.6 pence per share was paid in October 2016, resulting in a cash payment of £0.2m.

Condensed Consolidated Statement of Comprehensive Income

for the six months ended 30 November 2016

Condensed Consolidated Balance Sheet

as at 30 November 2016

Condensed Consolidated Balance Sheet (continued)

as at 30 November 2016

* Figures are audited excluding impact of restatement to intangible assets and trade and other payables