The Vitec Group supplies equipment and services to the broadcasting, entertainment and photographic industries. Quoted on the London Stock Exchange, Vitec has manufacturing and/or sales offices in 12 countries: UK (Head Office), France, Germany, Italy, the Netherlands, Israel, Singapore, Hong Kong, China, Japan, Costa Rica and the USA; and sells its products in nearly 100 countries. As Alastair Hewgill, the Group’s Finance Director puts it, “It’s a very complex global business for only £185m turnover!”

Alastair Hewgill, Group Finance Director, has been a member of the Board of Vitec Group Plc since May 2002. Alastair is a qualified chartered management accountant and over the previous 11 years held senior finance positions within GKN plc – including Finance Director of GKN Aerospace Division and Head of Corporate Finance for the Group.

This month in Corporate View, Alastair describes some of the challenges the Vitec Group faces due to its geographical structure – including FX exposures – and explains what measures the company has taken to overcome these and make the business more effective.

What is Vitec Group’s company structure?

The Vitec Group is made up of a number of global businesses. In other words, we manufacture goods in many different countries and sell these products globally. The most recent example is our acquisition in May 2005 of a company in Israel – it manufactures camera bags and equipment in Israel and China and distributes them around the world. In short, the Vitec Group is a very complex business.

Our structure has become more complicated over the past 20 years, as Vitec has grown with each acquisition. Today we own over 17 brands, managed within three divisions: Photographic, Broadcast Systems and Broadcast Services. The expanse of Vitec’s operations is due to the fact we work in niche markets. As these markets are not particularly large, it is quite difficult for our subsidiaries to survive on just their domestic market, even those domiciled in America, so we have to distribute globally to achieve revenue scale.

Our financials illustrate the coverage and complexity of our business: 21% of our sales come from the UK, but only 6% of our sales are to the UK. In other words, 94% of our sales are outside the UK, where of course we have our head office. In addition, more than 100% of our profits come from outside the UK.

Despite our complex structure, we run a lean operation throughout our three divisions. Our management is quite decentralised – the head office comprises just 13 people. Our treasury department is effectively one person, working full-time on day-to-day treasury matters such as financial administration and reporting. The Treasurer reports to the Financial Controller, who is responsible for Vitec’s tactical treasury management. As Group Finance Director, I lead the finance team and have overall responsibility for financial strategy, including risk management, tax and treasury.

With such a complex structure, how do you manage cash effectively?

All our overseas businesses have cash, as we do not allow borrowing around the Group. The reason for this is that borrowing is difficult to manage and our lending banks do not allow any substantial borrowing outside our main loan facility. Our continuous challenge, therefore, is to pool this overseas cash and repatriate it to the UK to pay down central loans. We achieve this effectively in the US and UK, but are less successful elsewhere in Europe. Pooling surplus cash in mainland Europe is difficult. Despite the euro being a common currency in all the mainland European countries where we operate, we have found that pooling within country or across different Eurozone countries is actually very difficult to achieve. This is because the market in Euroland is not homogenous. There are different banks in each country, which in turn means we have many accounts in Europe. We have not found one bank to deal with all our European businesses effectively. Therefore, we have decided that euro pooling, at present, is too hard to implement. Instead, we are currently looking at external lending directly down into one of our main cash-holding businesses so that they manage their spare cash more effectively.

Your financial structure must create various exposures. Can you explain what these are and what the Group does to minimise the impact of these?

With manufacturing sites around the world and global sales, the Vitec Group has all forms of foreign exchange exposures. These exposures are very significant too – as most of our assets, sales and profits are overseas. In 2004, Vitec Group’s turnover was £185m, with a gross profit margin of 41%. Without our forward planning and subsequent intervention to counterbalance our translation and transaction exposures, this reported consolidated profit could have been much lower.

Our biggest FX exposure relates to transaction risk because we have substantial exports, particularly from Europe. For example, we sell in dollars and have to change them into euros or sterling. The main example of our dollar-euro exposure is with our Italian business which receives lots of dollars through its dealings with the US, South America and China. To overcome the risk, we sell 75% of these forward or take out options on a 12 month rolling basis. The way this works is when the rates are relatively favourable, we sell forward on a fixed contract. However, when the rates are less palatable, we take out options, as we do not want to lock ourselves into unattractive rates. As an indication, contracts and options to hedge foreign currency receipts, as at 31 December 2004, totalled £10.2m.

We have also used natural hedges to manage our transaction exposures. For example, in 2003 we closed a factory in Munich and moved manufacturing to Costa Rica. This has proved very beneficial because instead of having a euro cost base which was exporting, we now have a dollar cost base selling partly into Europe and the UK, which offsets our dollar revenues. The primary reason for the relocation was manufacturing competitiveness, but the exposure-reducing benefits of the Costa Rica site did influence where we relocated the manufacturing operation. This type of natural hedging solution is a continuous strategy we are pursuing. For example, we are actively looking at sourcing parts and products in dollar-based countries, such as China. Our recent acquisition in Israel is another natural hedge because the company manufactures in two dollar-dealing countries – Israel and China – and then exports.

Our translation exposure comes from reporting our overseas profits in sterling. Most of our profits are, as with our transaction exposures, in dollars and euros. In the past few years these exposures have not affected us greatly because as fast as the dollar has been weakening against the pound sterling, the euro has been strengthening. Hence, the Vitec Group has not hedged translation exposures. However, recently we have recognised that we do have an exposure on our dividend. So although from a translational point of view we can accept we are running somewhat of a risk, at the end of the day, we do have to get our profits back to the UK and pay out a dividend in sterling. Therefore, we are looking at selling enough dollars forward on a 12-month rolling basis to cover our dividend.

We have an interest rate exposure, but we do not hedge it as our debt is not huge at the moment, so the risk is relatively small.

Economic exposure is less influential. Two key commodities we use in our products are aluminium and carbon fibre. The first is affected by aluminium prices, whereas the second is affected by oil prices. We have suffered due to price increases but we would not want to buy oil or aluminium futures to hedge the exposures as the raw material content in our end product is not a sufficiently significant amount of the product cost to warrant hedging for commodity exposures.

With over half of your sales in the US, what impact has the downtrend of the dollar had on your business?

The impact of the prolonged weakening of the dollar has been huge. I liken it to swimming up the Thames when the tide is going out. You can swim like crazy by hedging, but you are effectively going backwards. Our underlying profit in 2004 went up by a little under 30%. However, as over 50% of our sales are in the Americas, the weakened dollar negated this entirely, despite hedging. Unfortunately, this is the nature of our business – but of course the upside is that we are not tied to one economy.

Apart from sourcing more parts from dollar-based economies, our other strategy involves actively exporting products from our US businesses overseas. Our US businesses have a huge domestic market, but we are trying to ensure they do not rely on this, by exporting more too. Our sales are broadly GDP based, so we can look at different countries’ GDPs and target export locations accordingly. This sounds straightforward, but in practice it is not easy to break into new markets, so this strategy is more long-term.

How do you communicate the effects of your FX exposures?

We spend a lot of time analysing foreign exchange and explaining what is happening year-on-year to analysts and our shareholders. In addition, our monthly internal reports detail what the transaction and translation effects are against our internal budget as otherwise the FX movements will obscure the underlying trading variances.

We post a lot of information about our exposures, their effects and our approach to them, on our website. Most recently I have added a currency ready reckoner to our FAQs – available from http://www.vitecgroup.com/assets/spreadsheet/fxtable070305.xls – which gives analysts and shareholders an easy way of seeing what the currency effect will be in 2005 v 2004. For example, an investor can calibrate the effect of the average dollareuro rate going to 1.40 and the dollarpound going to 2.00. The reckoner also helps the eight analysts covering us to have broadly the same FX assumptions, rather than making dissimilar assumptions and producing a spectrum of results. This has been well received for two reasons:

• It shows the company has a clear understanding of the Group’s FX risks.
• It provides users with the information they need to quantify those risks.

“The impact of the prolonged weakening of the dollar has been huge. I liken it to swimming up the Thames when the tide is going out. You can swim like crazy by hedging, but you are effectively going backwards.”

What projects do you plan for the future?

An ongoing project is IFRS compliance. From a transactional point of view, we will adopt hedging under IAS 39. We are already confident we will meet the requirements of IAS generally, but that said, we have had some difficulties with inter-company loans under IAS 21, which has created extra work, particularly with record keeping and creating automated systems. We have many inter-company loans and because IAS classifies them into two types – long-term and short-term – we have had to be careful that we do not create an imbalance of loans within the Group. Otherwise, any currency variation will end up going through the profit and loss account, which could increase our earnings volatility.

The main other projects we are working on include actively trying to improve short and medium-term cash forecasting, in order to make the best use of cash in the Group. Rather than use an off-line spreadsheet-based system, we are trying to incorporate it into our Group consolidation system – we use FDC Comshare.

Another major change we are going to make relates to our borrowings. Currently we have borrowings in dollars, euros and sterling. We are now going to move the majority of our borrowings into dollars and euros, as this better reflects what currencies our assets are denominated in, which makes our balance sheet hedging more effective and will also reduce our interest costs.

Finally, we plan to look at the costs we pay for our banking facilities worldwide and see that we are getting competitive rates.