The global economic downturn resulting from the banking crisis heralded a period of austerity that significantly reduced defence spending. QinetiQ’s financial performance weakened and it was uncomfortably close to breaching its covenants in late 2010. The treasury team at the defence and security company immediately took a number of steps to improve the company’s financial position, resulting in a healthy balance sheet in Q112 when the award-winning turnaround project officially ended.
QinetiQ, the former research laboratories of the UK Ministry of Defence, was floated on the London Stock Exchange (LSE) in 2006. Its transition from the civil service to the private sector was incomplete, as inflexible working practices, a large staff, lack of commerciality and an unsustainable cost base were carried forward. With economic conditions looking inclement for the foreseeable future, a turnaround strategy was called for. This focused on strengthening the balance sheet, implementing a cost-cutting drive and enhancements to treasury operations and IT. The now completed project will also stand the company in good stead as another downturn beckons due to the on-going eurozone crisis.
QinetiQ’s new executive team undertook an ambitious self-help programme to restore the company’s financial position following the banking crisis and to address certain operational weaknesses. Slated to take place over 24 months, the majority of the turnaround activities were actually completed in half the time in late 2011, with some minor elements completed early this year. The company’s financial position has been now been transformed. Group treasurer, Stephen Webster, played a key role in the detailed planning and execution of the turnaround programme, ably assisted by his four treasury colleagues who work across the UK, North America and Australia.
To focus on quickly enhancing the health of the balance sheet, QinetiQ undertook a number of measures, including:
- Improved working capital: Operating cash conversion jumped to 150-200% of profits, with increased focus on customer collections. The biggest gains were achieved by changing the approach to unbilled debtors. In the defence industry, stage payments for achieving technical or commercial milestones are common and QinetiQ had historically structured these payments to occur only a few times a year. To overcome this issue the company moved to restructure its deal profile to include more frequent payment milestones, releasing over £100m.
- Held dividends: Dividend payments were put on hold for 12 months while the turnaround occurred.
To cut costs and further improve the balance sheet QinetiQ also:
- Disposed of assets: The company disposed of a number of small, non-core businesses.
- Negotiation of employment terms: Employee contracts had not changed since QinetiQ had moved into the private sector. The new management team put the position to employees that a cost-cutting drive was needed to secure the long-term success of the business and revised redundancy terms were essential, enabling them to drive through necessary changes and rationalisation.
- Renegotiated credit facility: QinetiQ’s treasury team also moved to renew its revolving credit facility (RCF). This did not immediately need to be refinanced, but with banking conditions improving in 2010, Webster and QinetiQ’s chief financial officer (CFO), David Mellors, took the opportunity to discuss the matter in advance with its key relationship banks. A detailed pitch book focused on the company’s unique position as one of a handful of trusted suppliers to the US and UK governments and showed that QinetiQ had solid ‘order cover’ – a good stream of pipeline business extending well into the future. This laid the foundation for a strong credit story; stressing ‘here is a very resilient, long-term business built on solid foundations’, which released extra funds and attracted new banks.
In parallel with these activities, the treasury team worked on three IT projects to enhance its productivity, improve transparency and cut costs. First, it has moved to a new online trading platform, 360T, for processing high volumes of foreign exchange (FX) trades, building a bespoke interface that can upload data without needing to be rekeyed. Second, the team has made better use of an existing SAP enterprise resource planning (ERP) system to improve the management of treasury operations and move away from data being stored in Excel files. And third, an interface with a Misys platform for matching trades between the business and its banks was established, delivering straight-through processing (STP) for all deals.
The refinancing of the group’s principal credit facility redefined its banking and introduced new players. Following a formal tender process, QinetiQ introduced new banking providers in each of its major trading regions. This allowed the firm to implement the latest cash management systems and multi-currency pooling solutions.
With the 24-month turnaround strategy to strengthen the balance sheet achieved ahead of schedule in half the time, the improved financial position of QinetiQ allowed debt buy-back procedures to go ahead and the company quickly returned to paying dividends after its 12 months freeze.
In an outstanding year by any measure, QinetiQ’s treasury team demonstrated last year the benefit that the treasury function can bring to a business. Through a well-planned and smartly executed turnaround strategy it has helped the company transform key indicators by paying off debt and cutting finance costs. It has also secured the safety net of a £275m credit facility and helped prepare the business to seize the opportunities of the future. The key project improvements delivered the following benefits:
- Working capital revived: Debt has fallen by close to £400m, while the banking covenant level has fallen from 3.0 times to less than 1.0 times in just 18 months.
- Strong cash position: QinetiQ has substantial cash reserves on deposit.
- Debt buy-back: With working capital improving, and market conditions not conducive to investment, the treasury team opted to pay down debt while also monetising related swaps. The first tranche of debt purchasing took place in May 2011, with a second round in March 2012.
- A ‘below terms’ RCF: In February 2011, a new banking group was established to provide a revolving credit facility of £275m. It was offered at investment-grade terms, thereby validating the long-term prospects for the business. The decision to go for the refinance was prescient. With sovereign debt and liquidity issues coming to the fore since the eurozone crisis erupted, banks are now passing on some of the pain in raised interest charges.
- Rationalisation: With employees agreeing to new terms of employment, the business downsized the UK organisation by 20% as defence markets weakened.
- Efficiency benefits: The changes made by the treasury team to its IT and procedures have delivered higher levels of automation and saved time, especially at reporting dates.
The cumulative effect of all of these changes has been to introduce a streamlined, more efficient company at QinetiQ that is well funded and able to look towards the future without a large debt burden hanging over it. The work of the treasury team in achieving this turnaround was crucial and the various initiatives they undertook have ensured the on-going survival and, hopefully, the prosperity of the company.
- This case study is based upon an entry into the gtnews Awards for Global Corporate Treasury 2012, sponsored by Bank of America Merrill Lynch (BofA Merrill). The winners of this year’s annual awards, now in its third staging, were only revealed at a gala dinner on 24 May at the Sofitel Grand Hotel in Amsterdam, the Netherlands, after the opening of the two-day gtnews Forum for Global Corporate Treasury conference. This winning QinetiQ entry is shared here from the Treasury Team of the Year category as a best practice guideline and commentary. To see a full report on all the Awards winners and the gala dinner on 24 May please click here.
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