City's Finances (Part Two)

This is the next part in a series of articles written by Colin Savage first published in MCIVTA's newsletter with reference to City's Finances. With the permission of Colin and MCIVTA (thank you Heidi) it is re-published here. I think you'll find this to be another informative, interesting and factual article.

The Annual Report and the AGM

Firstly, thanks to everyone who gave me feedback. It was very positive and has encouraged me to carry on in the same vein. So here's the next instalment, covering what goes into the Annual Report and what happens at the Annual General Meeting.

Like any business, Manchester City plc prepares annual accounts. With them being a public company, these accounts are sent to shareholders and are made generally available to anyone else who is interested. The link for these is as follows: http://www.plusmarketsgroup.com/reports.shtml?ISIN=GB0005599336.

These follow a fairly standard pattern as required by company law and market regulation. So what's in there and what does it all mean? I'm going to concentrate on the general headings here but I will go into the 2005 figures in more detail in subsequent articles.

Taking the 2005 Report as my template, the first page (2) details the directors and the various advisers - our main bankers, auditors, solicitors, etc. Nothing terribly remarkable here - all our advisers are well known and very reputable companies. Brian Bodek used to be a partner at Kuit, Steinart, Levy, one of the solicitors we use. He left in 1998 but is still listed as a consultant.

The next few pages (3 - 7) contain the Chairman's Statement. This is a report on the past year written by John Wardle and sums up our financial performance, on-field performance and other items of interest. In most company reports, these tend to be pretty formulaic, with little illuminating comment. It should be noted at this point that these accounts cover the year to 31May 2005, which is our financial year-end. However, any significant changes between then and the finalisation of the report have to be reported. One such change was the sale of Shaun Wright-Phillips to Chelsea, for a guaranteed £21m, and Wardle talks of his surprise at SWP's sudden change of heart.

One of the statements that is revealing concerns the uses of the proceeds from that. These include investing in the Academy, reducing outstanding borrowing and paying off all outstanding instalments on players purchased in previous seasons. Oh, and whatever's left might be spent on new players. So, in other words, goodbye to any lingering hopes we might have had that the sale represented a superb opportunity to build a strong squad that could capitalise on our eighth place finish. He makes it clear that he considers it more important to strengthen the balance sheet than the team. He also talks about reducing the debt and backs it up with some figures to show how our debt is reducing. Net external debt, he tells us, is down from £50m in 2004 to £38.5m and total debt down from the oft-quoted £62.2m in 2004 to £57.7m. So that's good isn't it? Well in the next article I'll discuss our debts but in the meantime make a note of what you think our total debt really was in 2005. The answer might surprise you.

The next few pages (8 -15) are the Directors Report and associated statements. There is some detail about each director although it doesn't make it clear whether each director is executive or non-executive (as it should). I talked about the difference between the two in my last article and identified which directors fell into each camp. The Report is in a pre-defined format but there are some interesting bits worth noting. Firstly, each director has to formally retire and offer themselves for re-election every three years and in 2005 it was Brian Bodek's turn. This is usually fairly straightforward but some of you may remember that Magnier and McManus were able to put pressure on the Manchester United board by voting against the re-election of a couple of retiring directors. We can see that, just before the year-end, Ashley Lewis resigned as a director.

The next section on Substantial Interests is really important. It lists any shareholdings known to consist of 3% or more of the total shares. This means we know who the major shareholders are and whether there have been any changes from the previous year. Generally speaking, any significant changes would have to be reported at the time they occurred, rather than waiting until the accounts are published. Therefore we already know that Mark Boler became a member of the Board earlier this year.

The first section on Page 10 (Corporate Governance) is particularly interesting in this report. It details how the company ensures that it is managed correctly at the highest level. They should comply with something called the Combined Code, which sets out best practice in this area, and they should be able to demonstrate how this was achieved during the year in question. So they talk about regular board meetings and scrutiny of the financial results to ensure any problems are identified early.

The Combined Code talks about the establishment of committees to ensure that proper financial controls and suitable accounting policies are in place (the Audit Committee) and one that covers all aspects of directors' and senior management remuneration (the Remuneration Committee). These should both be made up of at least two, non-executive directors, according to the Code. The Audit Committee should ultimately ensure that a Chief Executive and/or Finance Director are looking after the financial side of things properly but look who's one of the two members of the Audit Committee. It's none other than Alistair Mackintosh, who IS our Chief Executive (and therefore an executive director rather than the non-executive suggested by the Combined Code. So effectively he is checking his own work, particularly as he was also our Finance Director previously (and still is to all intents and purposes). Up to 2005, Ashley Lewis had been on the Audit Committee but he was no longer a Director at this point. I wrote to Alistair Mackintosh to query this after the last AGM and he replied that our external auditors were happy with this. However, he did not make it clear how they had indicated this. It could be that he meant that they had not said they were unhappy, which is not quite the same as specifically saying they accept the situation. It will be interesting to see if the position has changed in the next report.

The Remuneration Committee report takes up the next few pages (12 -14) and this is another safeguard designed to ensure that the executives and senior managers don't simply award themselves inflated salary and benefit packages.

There is a section on share options, which are supposedly a device to reward executives for their performance by giving them a stake in the company, potentially at an advantageous price. A share option gives an executive the chance to buy shares within a defined time period at a fixed price. Mackintosh therefore has the ability to buy up to 200,000 shares at any point up to March 2010 at 45p each, regardless of the market price at the time. If the market price were significantly in excess of 45p then this would be a very valuable benefit but it is clearly not in his interest to pay 45p for shares that anyone else can currently buy for 29p. The incentive, from his point of view, is to push the share price up via attracting external investment at a suitable price or superb financial performance.

The final part of this section details the shareholding of each director and their remuneration for the year. Mackintosh received a salary of over £170,000, a bonus of £50,000 plus a £10,603 contribution to his pension fund.

Page 15 is a statement of the directors' legal responsibilities.

Page 16 contains the Auditors Report. The auditors are an external, properly qualified accountancy company (in our case KPMG). They are supposed to ensure that the accounts presented fairly represent the true state of affairs of the company. They will have examined the accounting records and checked that the accounting policies we use to state the figures are appropriate, prudent and take into account all foreseeable circumstances. They will ensure that transactions have been properly recorded and reflected in the accounts. So, for example, they would want to be sure that our attendance figures are recorded accurately and that all the associated revenue from those tickets had found its way into the accounts. As a former auditor myself, I had to do things like count millions of bricks in a brick-maker's yard (as the correct stock figure is critical) and stay in a casino all night until seven in the morning to ensure that the cash and chips were properly counted and balanced. So if you see someone in a suit and tie going round with a clipboard during a game counting heads, you know what they're doing! The auditors will (or should) have questioned the directors on key matters, where required and their answers will be reflected in these accounts. I'll talk about some of the accounting policies in subsequent articles but at this point will say that there can be many different ways to represent the financial situation of a transaction or asset and these can have a material impact on the figures. Therefore it is important that an appropriate policy is used.

Finally the auditors express their opinion that, in this case, the accounts fairly represent our financial situation. This is not an absolute, cast-iron guarantee that things are OK however as a board determined to misrepresent their figures (eg Enron) will do so. KPMG (one of my former employers, I should add) are one of the biggest and most reputable accountancy firms in the world but even they can get things wrong. They signed off the accounts of another former employer in 2001, just weeks before this company collapsed in a big heap! This is still all subject to legal proceedings so I'd better not say any more. If they do uncover material irregularities then they should say so in the auditors report but someone adding up their expenses wrong is not usually going to affect anything to any great degree.

The auditors are engaged by the directors but carry out their work on behalf of the shareholders, who have to formally re-elect them every year at the AGM. They can also be changed by the directors if they feel the situation warrants it. It is most important that the external auditors are seen to be independent of the directors. Therefore it would not be appropriate for a close relative of one of the directors to be responsible for the independent audit. It could be seen as a little surprising that the Manchester office of KPMG is the one which carries out our audit, as this could involve City fans on the auditors' staff having access to details that other fans don't, even though they have a strict duty of confidentiality. However, when I think about it, if we were to use the London office there is the danger that too many Manchester United fans could potentially be poking their noses into our books so, on the whole, it's probably safer using the local office.

The rest of the report contains the real meat and bones, ie the figures. I'm going to cover each section in detail in subsequent articles but there are the accounts themselves, consisting of three financial statements, plus the associated notes. The financial statements follow a prescribed format. The first (Page 17) is the Profit and Loss Account and this shows our total income and expenses during the year under review, together with the equivalent figures for the previous year. (Page 18 is to do with property valuations and their impact on our profit or loss).

The second major financial statement (Page 19) is the Balance Sheet and this shows our assets (ie the things we own or are owed) against our liabilities (the things we owe to others). The third and final statement is the Cash Flow Statement. This reveals how much cash we actually generated or consumed in total in the year. I'll discuss this in more detail later in the series but it is important to be aware that a company can report healthy profits but not actually generate any cash and, for a football club, cash is crucial as we need it to fund transfers. In some ways it is the most important and revealing of the three statements.

If you have a copy of the accounts or are viewing them on-line, you will see a column called "Notes" in all three statements and figures in this column.

These are references to the final section which, not surprisingly, is the Notes to the accounts (Pages 21 - 38). They say the devil is in the detail and this section is the Underworld. There are explanations of the accounting policies adopted and more detailed explanations of some of the figures in the accounts. Therefore you will find in here how our turnover is split between gate receipts, TV income and other income, plus many other items of interest, including details of our debts and how we pay for the stadium.

So that is the Annual Report. When this has been issued and shareholders have had some time to digest it, it forms one of the central parts of the Annual General Meeting. This is a statutory meeting where the shareholders are invited to attend and have the chance to question the board and generally takes place in December at CoMS. Typically there will be a number of formal pieces of business:
- A vote on the adoption of the accounts. This means that the
shareholders get the chance to say whether they agree with the accounts as presented. Any contentious items can be queried with the board at this point.
- A vote to re-appoint the auditors (or appoint different ones)
- A vote on the re-election of directors. Each director has to stand down
and offer himself for re-election on a regular basis and ensuring a couple of directors were not re-elected was how Magnier & McManus signalled their displeasure with the Manchester United board. With close to 50% of the shares in the hands of two directors, there would need to be a serious fall-out between Boler, Wardle & Makin to do the same thing at City.
- A vote on any other resolutions presented by the board. This could be
an increase in the number of shares issued or a change to the rules of the company to allow them to do something they couldn't do before. Sometimes these can be seemingly innocuous but have a sting in the tail. Some will require a simple majority (ie over 50%) in favour but some more far-reaching ones might need two-thirds or three-quarters of the votes in favour.

As far as the voting is concerned, you can (if a shareholder) turn up in person and a few hundred did last year. You can request that your vote is cast a certain way or that someone else has the ability to cast a vote on your behalf as they see fit. As I said, this is the one real chance you get as a shareholder to question the board and hear what they have to say and the City AGM has been the scene of many a verbal bloodbath in the past!

At the last AGM, Stuart Pearce gave a short speech about the playing side and answered some questions but no discussion of individual players and their contracts is allowed. Finally there was an open Q & A session but it only lasted half-an-hour. The questions range from the serious (the SWP transfer) to the banal. The board should come out of this session feeling they've been put through a mangle but have succeeded in justifying their actions to shareholders. They had a very easy ride in 2005 but hopefully, with all this knowledge MCIVTA readers will have, they will have to earn their money at the next AGM.

In the next article I will be discussing the financial situation regarding CoMS and analysing our debts. I think I can assure you of a fascinating read!