18 | BUSINESS REVIEW| Our financial performance
2012. We anticipate that further costs will be incurred during 2012 as remaining actions are implemented.
The outsourcing expense of £2.7m represents project management, implementation and consultancy costs incurred in connection with outsourcing of our back and middle office to State Street. Whilst this arrangement became effective part way through 2011, we continue to incur expenses associated with the transition to State Street’s long-term, strategic operating platform. We anticipate this project will complete during 2012.
As disclosed in the 2010 Financial Statements, the Group had received put option notices under a Limited Liability Partnership Agreement from the two Individual Members of F&C Partners LLP, the Group’s former fund of hedge funds business. The Group had sought a Court declaration as to the validity of the exercise of these notices. During 2011, the High Court held that the put options were validly exercised and required the Group to meet the option exercise price, of £7.8m plus costs and interest. As a consequence, the 2011 Income Statement includes a £1.9m net cost, representing the Group’s professional fees and interest on the option proceeds. The put option payments, plus the estimate of the Individual Members costs to be borne by the Group, totalling some £10.7m, represent a goodwill payment to acquire the remaining 40 per cent. of F&C Partners LLP. However, as the group already controlled 60 per cent. of this business, IFRS requires that these amounts are recognised directly in reserves as a transaction between shareholders of the Group.
Operating margin The Group’s underlying operating margin for 2011 was 24.4 per cent. compared to 27.6 per cent. in 2010. Key reasons for the reduction in Group operating margin include the weaker performance fee yield compared to prior years and the full year impact of the acquisition of Thames River, which has a lower operating margin than the rest of the Group. Operating margin represents one of management’s key performance indicators, and is measured as underlying operating profits as a percentage of net revenues.
For this purpose, adjusted operating profits represent operating profits before the impact of exceptional items but after deducting variable compensation payable to members of Thames River partnerships. As the results of the cost savings programmes are delivered, operating margin should improve from its 2011 level.
Financing revenue and expenses The Group’s Finance Revenue increased to £17.2m (2010: £11.1m). The principal reasons for this increase were £3.7m of performance- related income from carried interest investments, and an increase of £2.0m in expected returns on pension plan assets.
Our finance costs rose by £1.8m to £35.4m, with the majority of this increase representing the full-year interest cost of the additional senior loan notes issued part way through 2010 as part of the financing for the Thames River acquistion.
Amortisation and impairment of intangible assets Under IFRS, when an acquisition is made, there is a requirement to recognise separately the fair value attributed to intangible assets, in our case, management contracts. The excess of consideration over the fair value of net assets acquired represents the business value and infrastructure and is recognised as goodwill.
Management contracts are separated by client category and are amortised over their estimated useful lives. Where an indicator of impairment occurs, such as greater than anticipated fund losses, we are required to review the carrying value of these contracts.
No such indicators of impairment arose during 2011 and accordingly no impairment charges were recognised.
We are also required to conduct an annual impairment review of the carrying value of goodwill. This review demonstrated that there was no impairment and hence no requirement to write-down goodwill.
Foreign exchange A large proportion of the Group’s business is conducted outside the UK and, consequently, the Group has significant exposure to foreign exchange rate movements. The main areas which are potentially exposed to exchange rate fluctuations are our revenues and our assets and liabilities. Approximately 52 per cent. of the Group’s assets under management are denominated in Euros and, accordingly, a significant proportion of the Group’s revenues are earned in Euros. During 2011, negligible exchange differences were recognised in the Income Statement and some £2.0m of losses were recognised in reserves in respect of revaluation of foreign operations.
F&C REIT Our minority interest partners in F&C REIT, the Group’s property asset manager, currently own 30 per cent. of the business. In certain circumstances, they can require F&C to purchase their interests at future dates and, under IFRS, a liability for this potential obligation is included in our financial statements. As this option is required to be carried at its fair value, representing 30 per cent. of the value of F&C REIT, it is revalued each year, with any revaluation gain or loss reflected in the Income Statement. During 2011, a downward revaluation resulted in a gain of £8.7m being included in the 2011 Income Statement. This gain is excluded from underlying earnings.
In addition to the arrangements described above, the F&C REIT minority interest partners have the opportunity to increase their ownership interest from 30 per cent. to 40 per cent. should F&C REIT achieve certain stretching financial targets over agreed periods. For accounting purposes, the valuation of the option provided by the earn-out mechanism is treated as a share-based payment expense and included in the Income Statement. As a result of a re-assessment of the likelihood of these financial targets being achieved, a credit of £4.8m was recognised in the Income Statement during 2011 and, consistent with prior years, this amount has been excluded from underlying earnings.
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