Welcome to Compass Group's IFRS 15 Conference Call. Hosting today's call is Laura Kerr, Group Financial Controller and Sandra Mora, Head of Investor Relations and Corporate Affairs. A link to the slides related to this call can be found on the Investor Relations section of our website, www.compassgroup.com. Following the presentation, you will have the opportunity to ask questions. Today's call is being recorded.
I will now turn the call over to Laura Carr. Please go ahead.
Thank you, and good afternoon, everyone. Thank you very much for dialing in today to hear about how the adoption of the new revenue standard, IFRS 15, will have a very minimal impact on Compass Group. My name is Laura Carr, and I am the Group Financial Controller here at Compass. We plan to give you a brief overview of the expected impact of the new standard and then open the call for any questions that you may have. Before we get into the new standard, we thought it may be helpful to go back to basics and remind you of our business model and how we generate revenue.
Compass is primarily a food service provider. We generate revenue by providing food service to our clients. Additionally, we provide cleaning and other soft support services. Revenue is recognized when the service is performed or when the goods, I. E.
Food, drinks or meals, are sold to either the client or directly to the consumer. We've given a couple of examples here in the slides. When we perform food services for our clients, we typically bill them on a monthly basis. In a fixed price contract, revenue is calculated as the number of meals served that month times the agreed fixed price of a meal. In a management fee contract, we would invoice them the value of the cost incurred that month plus an agreed management fee.
We also generate revenue directly from consumers. So we may have a P and L contract with a local hospital where we operate a coffee shop. In this example, the revenue is generated as we sell food and drink to consumers at the coffee shop. It is important to note that we do not have any long term contract accounting, So we do not make any judgments or estimates regarding the level of completion of a service in order to recognize revenue. Compass makes investments in clients where the returns are attractive.
These investments are typically capitalized and amortized over the life of the client contract. Some examples of client investments include purchasing equipment to enable us to provide our services at the client site, such as ovens or catering equipment in the kitchen. Or we may pay a client to gain exclusive access to their consumers, for example, at a sports stadium. And sometimes we pay a client signing on bonus to secure a contract. Currently, client investments are reported as either property, plant and equipment, PP and E, contract intangibles or prepayments depending on their nature.
As you'll see from the slides that follow, under IFRS 15, Compass will make some balance sheet reclassifications of client investments to provide more meaningful disclosure of the investments that we make. The new revenue standard IFRS 15 will apply to Compass for the FY 2019 financial year. In summary, IFRS 15 will not have a significant impact on the timing and recognition of revenue for Compass. Given that we have a simple business model, we already follow simple revenue recognition principles and we do not use long term contract accounting. We will discuss the impact on each line item on the next couple of slides, but the key headlines are that we expect absolute revenue will be reduced by less than 0.5%.
Absolute profit will be increased by a minor amount, and therefore margin will increase modestly. When we release the financials on an IFRS 15 basis in FY 2019, we will restate the comparatives for FY 2018. And therefore, as a result, there will be no impact on our key performance indicators of organic revenue growth and margin progression, assuming all other things remain equal. Therefore, our guidance and outlook remain unchanged by IFRS 15. As already mentioned, we will also reclassify some of our client investments on the balance sheet.
This mainly relates to the creation of a new balance sheet category called contract fulfillment assets. And finally, given that this is an accounting change only, there is no impact on net cash or free cash flow. We will now run through the line items where IFRS 15 has an impact on the financial statements. Firstly, please note that these numbers are FY 2018 estimates and have not been finalized nor have they been audited. We will report the final numbers in our interim results next year.
Looking at the income statement. Revenue will be very slightly reduced. We estimate by less than 0.5% as some amounts that were previously treated as an expense will now be deducted from revenue. Operating profit will increase slightly by circa 0.3% as we will now be required by IFRS 15 to capitalize sales force commissions. The P and L impact will be the timing difference between the previous practice of expensing these costs as incurred compared to capitalizing and amortizing them over the life of the contract.
As a result of these small changes to revenue and profit, our absolute margin will increase by around 4 basis points. I would just like to reiterate again that when we report under IFRS 15, the comparatives will also be adjusted in the same way. So we do not expect any impact to our key KPIs of organic revenue growth or margin progression if all things other things are equal. And finally, EBITDA will also increase slightly as the sales commissions are no longer expensed and EBITDA will not include the amortization charge from those commissions. Moving on to the balance sheet.
The main change under IFRS 15 will be a reclassification of client investments and the creation of a new category called contract fulfillment assets. We estimate this reclassification will move approximately £800,000,000 out of intangibles and into contract fulfillment assets. The prior year balance sheet will also be reclassified to enable comparability. There will be a new contract related asset on the balance sheet as we are required to capitalize sales force commissions. These costs were previously expensed as incurred.
We estimate this brought forward asset to be approximately £40,000,000 and the related deferred tax liability to be around £10,000,000 As a result of the capitalization of these sales commissions, we expect overall net assets to increase by less than 2%. Finally, we expect that IFRS 15 will have a less than 10 basis points impact on our return on capital employed measure. This is due to a slight increase in NOPAT and a small increase in average capital employed, both as a result of the capitalization of sales commissions. As the comparative will also be restated, there will be no impact to ROCE progression. To clarify the time line for the implementation of the new standard, we will apply IFRS 15 for our year ending 30th September 2019, and we will then restate our FY 2018 results retrospectively to provide comparable data.
We will not restate any prior history. When we report our full year results for FY 2018 this November, the financial statements and investor presentation will include an updated quantification of the expected impact of IFRS 15 on FY 2018. In May next year, at our FY 2019 interim results, the accounts will be presented on an IFRS 15 basis for the first time with the restated comparatives for 2018. And then in November 2019, when we present our full year results, again, those will be on an IFRS 15 basis with the FY 2018 comparative restated. Hopefully, that very brief overview has clarified that IFRS 15 will not have a material impact on Compass.
We look forward to giving you more details in the FY 2018 financial results in November. But in the meantime, we'd like to open the call now for any questions that you may have. Thank you.
We'll now take a question from Jamie Rollo of Morgan Stanley. Please go ahead.
Yes. Hi there. Afternoon everyone. I'm just wondering, I mean, as you say, it's not really important. There's no impact on cash.
Why are you going to the trouble of reclassifying these intangible assets then?
I think because an IFRS fifteen has the ability to allow you to capitalize assets related to a contract, it just makes sense to us to use that contract fulfillment assets really defines exactly what those assets are. Contract fulfillment assets really defines exactly what those assets are.
Okay. But you could have reclassified them before. It's not like you're prevented from doing that before IFRS 15, were you?
Well, no. No, it's not. There's no change ultimately. It's just that IFRS 15 has specifically got the wording, which says that you can capitalize costs incurred to fulfill a contract. So we think that those particular words are very applicable to us.
You're right. It doesn't change the balance sheet. It's just a categorization.
Okay. Well, obviously, it would have quite
a big EBITDA impact, but I mean, not that that matters so much. But you're not it wasn't you're not concerned about potential impact that it would have had to EBITDA then?
Well, no, I don't think it would have any impact to EBITDA. It's just a balance sheet, classification between intangibles and contract fulfillment assets.
Right. I'm just thinking because other companies that have done this generally moved. At the moment, it's an amortization charge of those intangibles, but the standard is suggesting that comes off revenues. I think it would have been an EBITDA impact, but obviously no EBIT or earnings impact.
Sorry,
yes. The other thing is sorry.
So The point is, Jamie, that I don't the IFRS fifteen is not changing our view that the monies that we invest in our clients are investments and therefore should be amortized in expense. It's not a deduction of revenue. That's quite a key point.
Okay. And just the other question was and this is obviously a slightly sort of arcane area, but I or accounting expert read the rules to suggest that you could only separate out that benefit, I. E, the big of the client investment, if it was sufficiently separable from the actual vendor product itself, the contract? And that in reality, you wouldn't pay an upfront bonus, for example, if you didn't expect to get economics from the contract with the customer. So why how can these be separated into a separate category if essentially they are part of the contract, they're part of the same thing, they wouldn't be done if there weren't a fee to be received on the contract?
To your point, so contract fulfillment asset may be specifically for us to refurbish a restaurant at a client site. So it's pretty separable. And we feel that, that asset then will allow us to generate the revenues from the contract over the period of the life. So that's why we feel that we can capitalize it and then we spread those costs over the life of the contract.
But we using that example, you wouldn't do the refurbishment and spend the money if you weren't going to get a return back on that and therefore it's inseparable from the contract itself, isn't it? Or else you wouldn't be spending the money to begin with.
Yes. But I think the accounting is that we invest it and then it generates revenue throughout the life of the contract. So it feels appropriate then to capitalize it. It will be clearly visible on the balance sheet as a contract fulfillment asset and then that will be amortized over the life of the contract where we generate the return.
Okay. Okay. Thank you very much.
Thanks, Jamie.
We will now take another question. We'll take a question from Tim Ramsgill from Credit Suisse. Please go ahead.
Thanks. Good afternoon. Just one question for me really. So again on the same topic of client investments, as Jamie mentioned, there's other companies dealing with this in a different way, including Sodexo, your closest peer. So just to be clear, do you have excuse me, did you have any choice in how you go about accounting for it?
Could you have taken that write off, that effect of that D and A charge to that client investment as a deduction to revenues? Or you feel that wasn't a possible option for you?
Hi, Tim. So I think the IFRS 15 for us hasn't changed the way that we view our accounting. I think that's the key message that we're trying to bring today. So it's not a question of choice. We feel that we're creating an asset when we invest in our clients, and they will capitalize today on a non IFRS 15 basis, and we'll continue the same treatment in the future on an IFRS fifteen basis.
So I think I appreciate you're referencing differences to our competitors, but I think we're different today, And we're very comfortable with our view today that we are creating an asset that should be amortized over the life of the contract. Does that answer your question?
I think so. Yes. I guess, look, the way that if my understanding is correct, the way that they account for it does a couple of things. One, it means that the CapEx to sales numbers that they tend to quote are understated relative to yourselves, which I think is misunderstood by a lot of investors. So it's sort of an important consideration.
And then they do ultimately capitalize it, but the amortization of that asset or the depreciation, if you like, of that asset is taken as a deduction to revenues. So it kind of just ends up where you just end up with a situation where we've got some different treatment going on by 2 very otherwise very similar companies?
Yes. And obviously, we don't we wouldn't comment on the accounting policy. And so we purpose of this call is to really reassure you that our treatment is consistent with how we do things. So obviously, if we did do what you were just referring to, we'd have a lower revenue number and our absolute margin percentage would be higher.
But
I think we're really comfortable with how we do it today. And the good news for us is as we've done a very deep dive in IFRS 15 and reviewed everything that all the current treatments remain valid. So the only real change in policy the capitalization of sales force commissions, which is not a choice under IFRS 15.
Okay. Fine. And then just one very, very quick one. I suspect the answer is no. But in terms of sort of H1, H2, is there anything within any of what you've sort of unearthed thus far that suggests that there's a seasonality to any of these effects that mean that we might see a sort of modest impact for on a full year basis, but there might be any skew in terms of H1?
I don't there's nothing that I know at the moment. And as soon as if we did think that there was some impact, we'd get back to it, that'll probably be in November. I don't think there should be.
Okay, great. Thank you.
Thank you.
We'll now take another question from Jafar Mestari from Exane.
Hi, good afternoon. Just have a quick question on that total £800,000,000 of asset reclassification. Could you maybe talk to the geographical breakdown of those assets? And as a separate point, the end markets breakdown, whether some of your verticals are particularly subject to that, something about sports and leisure in particular? Thank you.
Yes. I mean, just as you can see in our segmental analysis that we already provide, a big chunk of that GBP 800,000,000 will obviously be in North America, where the sort of contract structures that we have do lend themselves to client investments. And in terms of sort of sectors, I don't think we give that breakdown, but obviously there are higher sort of CapEx investments in health care and education as you probably imagine.
Thank you.
And sports and leisure. Thanks.
Thanks.
We'll now take another question from Najit El Kassier from Berenberg Bank.
Good afternoon, everyone. Just in regarding the equity, was this change in accounting would impact your equity or not really?
No, not really. Only the sales force commission piece. So the net assets change is less than 2%. It's a very minor amount.
Okay. Thank you very much.
Thank you.
We'll now take another question from Jarrod Castle from UBS.
Thanks. Just on the contract assets, the circa 40,000,000 dollars on average, what will the amortization period be? And then just secondly, on sales force commissions, in absolute terms, how stable is that amount? And how much will you be capitalizing each year? Thanks.
I mean, I think the €40,000,000 should be capitalized over our average contract length, which I think we say is about 3 to 5 years. It's a relatively stable number, and it's obviously very small as we're highlighting today. It's the brought forward net book value is £40,000,000
euros And relative to that amortization, so let's say 4 years, dollars 10,000,000 in terms of further sales force commissions, is that roughly the run rate? I mean, is that number do you expect that number is pretty stable after amortization or moves around a lot?
It should be relatively stable. And don't forget the timing difference in the P and L on adoption is actually the difference between expensing and capitalizing and amortizing. So the P and L impact on transition is smaller than the ongoing amortization rate.
Okay. Thank you.
Thank you.
We will now take another question from Jamie Rollo from Morgan Stanley.
Please go ahead. Yes. So one more, thanks. One more, if I may. What's the so the €800,000,000 again back on that, what's the P and L amortization charge associated with that, please?
I'm just trying to think. I mean, the total amortization, I think, of all contract intangibles is about €193,000,000 last year off the top of my head. So it's a big chunk of that, I think. I have to get back to you, Jamie, on the exact number, sorry. But it's obviously It's
not changing, though. Yes. Sorry.
No, no change, sorry. There's no change to how we amortize them. It's just literally a balance sheet categorization change.
Okay. And if I look at that €800,000,000 number, which I think is equivalent to the I think it was €900,000,000 a year ago in the 2017 accounts. That's sort of other client contracts intangibles, I. E, not the ones arising in acquisition. The historic cost of that was about €1,600,000,000 As you say, the amortization charge, I think, was a couple of €100,000,000 So that sort of 8 year useful economic life, that is longer than 3 to 5 years average contract length.
Could you just talk a bit about how that works? Obviously, you're signing up pretty long term contracts with Higher Ed and Sports and Leisure. But to get the average of 8 years, that just seems quite on the high side, doesn't it?
Yes. No, you're right. I think the 3% to 5% is sort of the global average of contracts. And you're exactly right that as we invest in the areas, particularly in North America, in those higher ed and education contracts, they are longer. And therefore, that's where the CapEx is.
So the average useful economic life is higher in those investments.
Okay. But to get an average of 8, you're obviously signing some 15, 20 years?
Exactly, yes.
Okay. Thank you.
And you can see from the North American sort of wins that we announced that they are very big contracts and very yes.
Thank you.
Great. Thanks.
We will now take another question from Richard Clarke of Bernstein. Please go ahead.
Hi. Good afternoon. Just on the sales force commissions. So €40,000,000 capitalized, so we're talking roughly $10,000,000 a year, maybe slightly more. So that's about 0.5% of your new business wins per year.
Is that a good way to think about it? Is that sort of the run rate of commissions you're paying? And then the variability by geographies where you've said the U. S. Has a slightly bigger margin impact, is that because you pay more commissions in the U.
S. Than you do in other geographies?
I think I mean, the overall picture is a very small number. They do tend to skew towards the U. S. And I haven't really thought about it on a new business percentage win. But yes, if it's £10,000,000 a year, it's a very small number.
Now to remember, there's an element of sales force commissions that's paid in year 2 or year 3 depending on the performance of the contract.
Okay. Thanks. We will now take another question from Tim Barrett from Numis.
Hi there. Sorry if I missed this, but did you say exactly what you're netting off revenue now? So what that 50 basis points reduction in revenue relates to? Thanks.
I don't think you did miss it. And so we're saying it's up to about 50 basis points. So fundamentally nothing's changed under IFRS 15. But as we've done a very detailed review through the adoption process building up contract by contract, there are some payments to clients that we feel we do not receive a distinct good or service in return. So under IFRS 15, we've cleaned that up and there will now be a deduction of revenue.
Okay. And that's about £100,000,000
It's definitely less than 0.5%. So I'm giving myself a bit of wiggle room till November, but it's less than yes, it's not it's going to be less than that.
Okay. And you said that's stuff you didn't feel you were getting a return on?
No, not a return. It's just that if you look at the IFRS 15 lens, you have to be very clear that you'll receive a distinct good or service in return for that payment. And I think there's some areas that we just wanted to be very prudent. So we've taken the decision to deduct them from revenue. But it's very, very minor if you think about the size of our revenues.
Sure. All right. Thanks.
There are no more questions in the telephone queue at this time.
Thanks very much. If anyone else has any further questions, just give us a ring. Thanks for joining. Thank you.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.