KCOM Regulatory News (KCOM)

27 November 2018

KCOM GROUP PLC (KCOM.L)

Unaudited interim results for the six months ended 30 September 2018

KCOM Group PLC (KCOM.L) announces its unaudited interim results for the six months ended 30 September 2018.

Summary

· Group revenue1 declined by 5%

· Group EBITDA1 up by 2%

· Hull & East Yorkshire continues to perform well and in line with market expectations

― Full-fibre deployment remains on target to be available to 100% of addressable market by March 2019

― Percentage of broadband customers taking full-fibre continues to increase

· Poor performance in national business segments driven by:

― Revenue decline in NNS, due to continuing churn

― Broadly flat revenue in Enterprise reflecting disappointing order intake performance

· NNS performance results in non-cash exceptional impairment of goodwill of £32.2 million

· Increase in net debt to £108.5 million (1.6x net debt: EBITDA), driven by:

― Capital investment in Hull & East Yorkshire segment

― Material working capital outflow, due to insourcing a managed service arrangement and unwind of deferred revenue balances in Enterprise

· Interim dividend of 1.00p (2017: 2.00p), reflecting Board's previously announced decision to revise full year dividend commitment to a minimum of 3.00p per share

Graham Sutherland, Chief Executive Officer said, "Despite only joining the business last month, I believe KCOM has considerable skills, assets and capabilities. The full fibre rollout in Hull and East Yorkshire leads the market, provides us with sustainable cash flows and enables the further development of our service offering. However, the current financial performance of our two national businesses is below our expectations, in particular, in National Network Services where we are experiencing high levels of customer churn. In the second half of the year, we will focus on three key priorities - review of our business strategy to identify how we create the best value from KCOM's assets, implementing initiatives to improve business performance and improving transparency through clear metrics on which our progress can be measured. We will be in a position to share outputs from the strategic review in March."

Outlook

The strong performance in Hull & East Yorkshire is expected to continue during the second half of the year, supported in part by the launch in early December of a new unlimited fibre broadband portfolio for consumer customers.

While we have started to take action to address some of the issues in our national segments, we anticipate that the trading performance in Enterprise and National Network Services will remain challenging during the second half of the year and that this will continue into next year. As a business, we are seeking to address these medium-term challenges by reducing cost and complexity at the same time as identifying those opportunities to deliver value from KCOM's assets. The Board believes that the Group has the potential to execute well on those opportunities.

The Board previously announced its intention to recommend a minimum full year dividend of 3.00p per share for the current year.

Financial highlights

Performance review

Basis of preparation

IFRS 15 "Revenue from contracts with customers" and IFRS 9 "Financial Instruments" have been adopted for the first time in the interim financial statements.

The Group has applied both these new standards in the current year only. As a result, our reported numbers in the period are prepared in accordance with IFRS 15 and IFRS 9 and our comparatives are in line with previous accounting standards (IAS 11, IAS 18 and IAS 39).

In aggregate, the standards have an impact of a reduction in revenue of £1.4 million, in EBITDA of £1.5 million and in profit before tax and exceptional items of £0.2 million. The impact of both these new standards is timing only and is cash flow neutral. Further detail is provided in Note 4.

Group performance

The results for the period show a decline in both Group revenue (6%) and EBITDA (3%), compared to the first half of last year. When adjusting for the impact of IFRS 15 and IFRS 9, revenue has reduced by 5% and EBITDA has increased by 2%.

Our Hull & East Yorkshire segment continued to perform strongly with revenue growth across core channels. Our conversion and acquisition of customers onto fibre broadband continues to drive higher ARPU across our consumer base. The final phase of fibre deployment is on track and we expect to have full-fibre available to our whole addressable market by the end of March 2019.

The performance of our two national business segments has been significantly below expectation in the period.

In our Enterprise segment, revenue has remained broadly flat, with both Project and Network related revenues down 3%. EBITDA has improved; however, the prior period was impacted by £6.2 million of losses on complex software contracts. Without the effect of these contracts, EBITDA has declined.

Revenue in our National Network Services (NNS) segment has decreased, with continued churn and a performance well below the market. This performance has led to the Board's decision to impair the carrying value of goodwill of the segment, resulting in a non-cash exceptional charge of £32.2 million.

Remaining exceptional costs relate to restructuring costs.

Net debt increased from £62.6 million at 31 March 2018 to £108.5 million at 30 September 2018, largely because of permanent one-off working capital outflows and the continued investment in the Hull & East Yorkshire infrastructure.

Segmental analysis

The Board makes decisions and manages the business in line with the segmental analysis set out below. This information is presented before exceptional items to provide a better understanding of underlying performance. A reconciliation of the Group's pre-exceptional results is set out in Note 5.

Hull & East Yorkshire

Compared to the first half of the prior year, revenue has reduced by £0.3 million and EBITDA by £0.9 million. The impact of IFRS 15 and IFRS 9 is a reduction in revenue of £0.4 million and in EBITDA of £0.9 million. This is principally due to the change in accounting for routers under IFRS 15 with router sales now recognised at the beginning of a customer contract and the cost recognised as a cost of sale rather than an asset which is depreciated.

Adjusting for the impact of the accounting standards, revenue has grown by £0.1 million over the prior period and EBITDA is in line. The relatively flat overall revenue position reflects the exit of the non-core Contact Centres business. The core channels have delivered revenue growth on a like-for-like basis of 3%.

On a comparable basis, Consumer revenue has increased by 5% compared to the first half of the prior year and our fibre rollout continues to deliver new broadband customers. The number of customers within this broadband base taking a fibre service has increased to 61% at 30 September 2018 (30 September 2017: 44%), supporting a 4% increase in ARPU in the last 12 months.

Business revenue on a like for like basis has also increased by 5% compared to the first half of the prior year. This growth has also been underpinned by our fibre proposition with a further 700 business sites connected since 31 March 2018, supported by take up in the SMB market through utilisation of the government funded voucher scheme.

The success of our award winning ultrafast Fibre-to-the-Premise (FTTP) offering continues. Our deployment is on target and we expect to have made full-fibre available to all our addressable market by March 2019. During the period we have passed a further 15,000 premises, taking our total to 179,000.

The key metrics for our Hull & East Yorkshire segment are as follows:

As anticipated and signalled previously, our non-core Media and Contact Centres revenue has continued to decline. We closed our outsourced Contact Centre on 31 March 2018, at the completion of its largest customer contract.

Despite the increase in core revenues, adjusted EBITDA is flat in the period as the prior half year benefitted from £0.6 million of one-off supplier credits and rebates. The current period benefits by £0.2 million of such items.

Enterprise

Enterprise performance in the period has been disappointing, due to lower than anticipated order intake. Revenue has reduced by £1.2 million and EBITDA has increased by £4.9 million compared to the prior half year. The impact of IFRS 15 and IFRS 9 is a reduction in revenue of £0.9 million and an increase in EBITDA of £0.1 million. This is principally due to the revenue classification of certain customer contracts as 'agent' rather than 'principal' under the new standard. Adjusting for the impact of the new accounting standards, revenue has declined by 1% and EBITDA has improved by £4.8 million. 

Despite the relatively flat revenue position, EBITDA has improved in the period due to losses of £6.2 million of losses on complex software contracts in the prior period. Without the effect of these contracts, gross margin percentage in the current period is comparable at 37% but EBITDA has reduced £1.4 million, which includes continued investment in the Enterprise management team and sales and delivery capability. 

National Network Services

Revenue has reduced by £8.3 million and EBITDA by £5.2 million. The impact of IFRS 15 and IFRS 9 is a reduction in revenue of £0.2 million and EBITDA of £0.6 million.

Adjusting for the impact of the new accounting standards, revenue has declined by £8.1 million and EBITDA by £4.6 million. Although a decline was expected, churn has continued at higher levels than anticipated. Revenue decline has been seen across all product categories which reflects this churn, both in terms of customers leaving and declining use of traditional voice platforms. Voice revenues also continue to be impacted by the industry wide change in the mix of call traffic (e.g. the movement to 03 numbers).

The EBITDA decline is a consequence of this churn with a decreasing marginal contribution towards fixed network operating costs and continued gross margin pressure. The prior period also benefitted from £1.2 million of supplier credits and rebates. The current period benefits by £0.2 million of such items.

In the period we have focused on a specific public-sector opportunity relating to the delivery of Health and Social Care Networks (HSCN). We have seen early success having been named preferred supplier on four aggregated procurements. The process of securing individual customers under the aggregated procurements is ongoing and delivery is expected in the second half of this financial year, continuing into the first half of next year when it will start to positively impact connectivity revenues.

Central

Central costs include PLC and corporate costs, where allocation to the underlying segments would not improve understanding of those segments. These costs include share-based payments and pensions, along with the residual Group cost of finance, HR, risk, legal and communications, once appropriate recharges have been made to the three business segments.

Central costs have decreased from £5.7 million (six months ended 30 September 2017) to £5.3 million.

Exceptional items

The Group incurred exceptional charges of £33.8 million in the first six months of the year. This comprises:

· impairment of NNS goodwill of £32.2 million; and

· restructuring costs of £1.5 million.

Management scrutinises all restructuring costs on a line by line basis to determine whether they meet the exceptional criteria. During the period restructuring costs were incurred in relation to three main areas:

· termination and recruitment costs associated with executive directors (£0.6 million);

· transformation of project delivery (£0.4 million); and

· transformation of central functions (£0.5 million).

The treatment of the termination and recruitment costs associated with executive directors is in line with the Group's accounting policy and such costs are always treated as exceptional. The transformation costs are a completion of activity which had commenced in the prior year in addition to the commencement of a fundamental re-organisation of the Group's Product and Propositions teams.

Net debt and cash flow

Net debt at 30 September 2018 is £108.5 million (31 March 2018: £62.6 million), representing a net debt to EBITDA ratio of 1.6x. Undrawn committed borrowing facilities at 30 September 2018 were £65.0 million (31 March 2018: £105.0 million).

The increase in net debt compared to the year end position arises as a result of a working capital outflow and continued investment in our fibre deployment. As in the prior year, an element of the working capital movement relates to timing which we expect to unwind in the second half of the year. There are however permanent differences principally relating to:

· the successful insource of a managed service arrangement with a key partner delivering overall cost benefit but with a one-off in year working capital outflow (half year impact of £11.0 million; full year impact expected to be approximately £13.0 million); and

· unwind of certain deferred revenue balances.

Underlying working capital continues to be well controlled. Both Days' Sales Outstanding and Days' Purchases Outstanding are consistent with the 30 September 2017 position.

Year end net debt is expected to be c.£115.0 million.

Dividend

Taking into account changes to the Group's medium-term trading performance, cash flow and net debt position, as previously announced, the Board has reviewed the Group's ongoing dividend policy and no longer considers it appropriate to pay an uncovered dividend. As such, the Board has resolved to pay a full-year dividend of not less than 3.00 pence per share for the financial year ending 31 March 2019.

The Group's interim dividend is 1.00 pence per share (30 September 2017: 2.00 pence). The dividend will be paid on 1 February 2019 to shareholders registered on 28 December 2018. The ex-dividend date is 27 December 2018.

Pensions

The IAS 19 pension position at 30 September 2018 is a (net) asset of £3.0 million (30 September 2017: £3.7 million (net) liability and 31 March 2018: £7.5 million liability). The movement from 31 March 2018 arises as a result of a higher discount rate used to calculate the schemes' liabilities (driven by increases in corporate bond yields) offset in part by a reduction in the expected return of schemes' assets.

The agreed level of deficit repair payments across both schemes for the current year is £6.9 million (rising in line with CPI until the year ending 31 March 2020 for the Data scheme and 31 March 2022 for the Main scheme). In addition, the Group makes pre-agreed payments to its pension schemes through the asset backed partnerships. The full year payment for the current year is £2.8 million (2018: £2.7 million). Our next actuarial review is due on 31 March 2019.

On 26 October, the High Court handed down a judgement involving the Lloyds Banking Group's defined benefit pension schemes. The judgement concluded the schemes should be amended to equalise pension benefits for men and women in relation to guaranteed minimum pension benefits. The issues determined by the judgement arise in relation to many other defined benefit pension schemes. We are working with the trustees of our pension schemes, and our actuarial and legal advisers, to understand the extent to which the judgement crystallises additional liabilities for KCOM Group PLC's pension schemes. The impact of this on KCOM Group PLC's pension schemes is currently being evaluated but for typical schemes it is estimated to be between 0% and 4% of total scheme liabilities.

Capital investment

Cash capital expenditure during the period was £18.2 million or £19.1 million before the impact of IFRS 15 (30 September 2017: £18.6 million). The major project in the period was the continued deployment of fibre and the transformation of our network in our Hull & East Yorkshire segment.

The Group's depreciation and amortisation charge for the period is £15.0 million or £16.1 million before the impact of IFRS 15 (30 September 2017: £15.1 million), the increase resulting from the higher capital investment in recent years, which has an ongoing impact on profit before tax.

We are in the process of reviewing our forward looking capital expenditure plans but, as indicated previously, expect a reduction in the year ending 31 March 2021 after completion of our fibre rollout and network transformation.

Tax

The Group's tax charge is £0.4 million (30 September 2017: £2.8 million). The effective tax rate is (2%), which is different to the prevailing rate of corporation tax of 19% principally due to the tax impact of the goodwill impairment. Adjusting for this the effective tax rate is 18% which is broadly in line with the prevailing rate of corporation tax.

Principal risks and uncertainties

The Group has a number of risks and uncertainties which have been identified through the risk

management framework. The risks set out below could have a material adverse impact on the Group:

· growing revenue in our Enterprise segment to offset the decline of network-based revenue -

revenue from legacy activities may decline faster than the revenue from new services grows;

· ability to attract and retain the key technical skills required in our Enterprise segment - many of the services provided by our Enterprise segment are technically complex and require skills that are hard to find and in high demand. Attracting and retaining the right skills is key to being able to deliver the services our customers require;

· substitute technologies entering the consumer market - the development of substitute

technologies without the need for a fixed line could present a competitive threat within the

consumer part of our business;

· upgrading of our network equipment - our equipment requires upgrading as demand for

broadband and cloud-based services increases;

· accuracy, security and confidentiality of customer data - security of customer data is of

paramount importance to our customers and therefore to us;

· customer service, contract governance and delivery - the delivery of our complex contracts is a

key part of the success our Enterprise segment and providing exceptional service to our

customers is one of our key strategic aims. Failure to govern contracts sufficiently may have

reputational or financial impact;

· security and resilience of our networks and IT systems - our networks and IT systems are key to

all that we do and are crucial in delivering service to our customers;

· a breach of our regulatory obligations - we take our regulatory responsibilities extremely

seriously and seek to ensure we are compliant;

· health and safety - it is important to mitigate health and safety risks as far as possible to prevent

incidents from occurring; and

· flooding - flooding (particularly in Hull) has become an increasingly regular occurrence and could

impact our business if we don't take appropriate steps to mitigate the risks.

More detail of the Group's risks is shown on pages 28 to 32 of the Annual report and accounts for the year ended 31 March 2018 and it is the view of the directors that these risks and uncertainties remain appropriate for this interim statement.

Forward looking statements

Certain statements in this interim statement are forward looking. Although the Group believes that the expectations reflected in these forward looking statements are reasonable, we can give no assurance that these expectations will prove to be correct. Because these statements involve risks and uncertainties, actual results may differ materially from those expressed or implied by these forward looking statements.

We undertake no obligation to update any forward looking statements whether as a result of new information, future events or otherwise.

Consolidated interim income statement

The Group adopted IFRS 15 "Revenue from Contracts with Customers" and IFRS 9 "Financial Instruments" on 1 April 2018 retrospectively with the cumulative effect of initial application recognised as an adjustment to opening equity. Prior-year comparatives were not adjusted. Please refer to Note 4 for details.

Consolidated interim statement of comprehensive income

Consolidated interim balance sheet

1 Included within accumulated losses for the six months ended 30 September 2018 is a loss after tax of £21.4 million.

2 The Group adopted IFRS 15 "Revenue from Contracts with Customers" and IFRS 9 "Financial Instruments" on 1 April 2018 retrospectively with the cumulative effect of initial application recognised as an adjustment to opening equity. Prior-year comparatives were not adjusted. Please refer to Note 4 for details.

Consolidated interim statement of changes in shareholders' equity

The Group adopted IFRS 15 "Revenue from Contracts with Customers" and IFRS 9 "Financial Instruments" on 1 April 2018 retrospectively with the cumulative effect of initial application recognised as an adjustment to opening equity. Prior-year comparatives were not adjusted. Please refer to Note 4 for details.

Consolidated interim cash flow statement

Notes to the unaudited interim financial information

1. Basis of preparation and publication of unaudited interim results

General information

KCOM Group PLC is a company domiciled in the United Kingdom.

The Group has its primary listing on the London Stock Exchange. Details of the principal activities of the Group are disclosed on pages 4 to 5 and in the Strategic report in the Group's 2018 Annual report and accounts.

This condensed consolidated interim financial information was approved for issue on 27 November 2018.

This condensed consolidated interim financial information does not comprise statutory accounts within the meaning of section 434 of the Companies Act 2006. Statutory accounts for the year ended 31 March 2018 were approved by the Board of directors on 8 June 2018 and delivered to the Registrar of Companies. The report of the auditors on those accounts was unqualified, did not contain an emphasis of matter paragraph and did not contain any statement under section 498 of the Companies Act 2006.

The condensed consolidated interim financial information has been reviewed, not audited. The review opinion is disclosed on page 39.

This condensed consolidated interim financial information will be published on the Company's website. The maintenance and integrity of the website is the responsibility of the directors. The work carried out by the auditors does not involve consideration of these matters. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

Basis of preparation

This condensed consolidated interim financial information for the six months ended 30 September 2018 has been prepared in accordance with the Disclosure and Transparency Rules of the Financial Conduct Authority (previously Financial Services Authority) and with IAS 34, 'Interim financial reporting' as adopted by the European Union. The condensed consolidated interim financial information should be read in conjunction with the annual financial statements for the year ended 31 March 2018, which have been prepared in accordance with IFRSs as adopted by the European Union.

Going concern

The Group meets its day-to-day working capital requirements through its bank facilities. The Group's forecasts and projections, taking account of reasonably possible changes in trading performance, show that the Group should be able to operate within the level of its current facilities. After making enquires, the Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. The Group therefore continues to adopt the going concern basis in preparing its consolidated interim financial information.

2. Accounting policies

The accounting policies adopted are consistent with those published in the Group's Annual report and accounts for the year ended 31 March 2018, with the exception of "taxation", described below, and those impacted by the initial application of new standards, interpretations, and amendments in the period, as described in Note 4.

Taxation

Taxes on income in an interim period are accrued using the tax rate that would be applicable to the expected total annual earnings.

3. Significant judgements and estimates

In preparing this condensed consolidated interim financial information, the significant judgements made by management in applying the Group's accounting policies and the key sources of estimation uncertainty were the same as those that applied to the Group's Annual report and accounts for the year ended 31 March 2018, in Note 3 on page 96-97, with the exception of changes in estimates that are required in determining the provision for income taxes (see Note 2) and those relating to significant contracts as a result of applying IFRS 15 for the first time.

4. New accounting standards

4.1 Initial application of new standards, interpretations and amendments

The following accounting standards, interpretations and amendments have been adopted by the Group in the current period:

· IFRS 9 "Financial Instruments"

· IFRS 15 "Revenue from Contracts with Customers"

· IFRIC 22 "Foreign Currency Transactions and Advance Consideration"

· Amendments to the following standards:

− IAS 40 "Transfers of Investment Property"

− IFRS 2 "Classification and Measurement of Share-based Payment Transactions"

− IFRS 4 "Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts"

− Clarifications to IFRS 15 "Revenue from Contracts with Customers"

− Improvements to IFRSs (2014 - 2016)

The above new and amended standards do not have a material effect on the Group except as described below:

IFRS 9 "Financial instruments"

In July 2014, the IASB issued IFRS 9 "Financial Instruments", which replaces IAS 39 "Financial Instruments - Recognition and Measurement". Application of the standard is mandatory for annual periods beginning on or after 1 January 2018. Transition to IFRS 9 for the Group took place on 1 April 2018 and in accordance with the transitional provisions of IFRS 9, comparative figures have not been restated.

IFRS 9 introduces three key changes when compared to IAS 39 relating to: the classification and measurement of financial assets and financial liabilities; impairment of financial assets; and general hedge accounting.

Upon adoption of IFRS 9, no change in the classification of financial assets has arisen because, at the date of transition, all financial assets of the Group were held at amortised cost under IAS 39 and continue to be held at amortised cost under IFRS 9. There has also been no change in the classification of financial liabilities since the classification and measurement requirements of IAS 9 have been largely retained under IFRS 9.

The financial asset impairment requirements of IFRS 9 introduce a forward-looking expected credit loss model which results in earlier recognition of credit losses than the incurred loss model of IAS 39. The Group has adopted the simplified approach to provide for losses on receivables and contract assets resulting from transactions within the scope of IFRS 15. Receivables and contract assets have been grouped based on shared credit risk characteristics and days past due and a provision rate matrix derived from historical information has been applied to estimate the expected credit losses.

Adoption of the expected credit loss model has not had a significant impact on the financial statements of the Group. The loss allowances for trade receivables and contract assets as at 31 March 2018 reconcile to the opening loss allowances on 1 April 2018 as follows:

Cash and cash equivalents are also subject to the impairment requirements of IFRS 9 but the identified impairment loss was immaterial.

The hedge accounting requirements of IFRS 9 have also been simplified and are more closely aligned to an entity's risk management strategy. The Group does not currently hedge account, however IFRS 9 introduces a new hedge accounting model which is optional to apply and is closer aligned to commercial activities, such that it may be applied in the future if deemed appropriate.

IFRS 15 "Revenue from contracts with customers"

In May 2014, the IASB issued IFRS 15 "Revenue from Contracts with Customers" which replaces IAS 11 "Construction Contracts" and IAS 18 "Revenue". Application of the standard is mandatory for annual periods beginning on or after 1 January 2018 and requires the Group to use a five step approach to allocate the revenue earned from contracts to individual performance obligations on a relative stand-alone basis.

Transition to IFRS 15 for the Group took place on 1 April 2018 and in accordance with the transition provisions of the standard we have adopted IFRS 15 using the modified retrospective transition method. Consequently, the prior period comparatives have not been restated, and the full cumulative impact of applying this standard retrospectively had been reflected in an adjustment to equity at the date of transition. The following adjustments were made to amounts recognised on the balance sheet at the date of initial application:

1 The amounts stated in this column are as reported and therefore before the adjustments from the adoption of IFRS 9 or IFRS 15.

(i) Routers

Under previous accounting, routers were capitalised and the expense recognised as depreciation over the term of the contract. Under IFRS 15 we will treat routers as a discrete sale and performance obligation, and as a result these assets will no longer be capitalised and the cost will be recognised as an operating expense at the point control passes to the customer. Therefore transition to IFRS 15 resulted in the de-recognition of routers previously capitalised (£1.5 million) and the creation of a contract asset arising from the earlier revenue recognition for the sale of routers which were previously accounted for as part of a bundle (£2.0 million).

(ii) Connection fees

Under IFRS 15, connection fees are included in the transaction price and allocated to the performance obligations identified in the contract resulting in later recognition of revenue. Due to the timing of connection fee payments from customers a contract liability balance of £2.2 million has arisen upon transition to IFRS 15 and unbilled receivables has decreased by £0.1m. Costs of £0.9 million associated with these connection activities have been capitalised on the balance sheet as costs of fulfilling a contract and will be amortised over the term of the contract on a systematic basis in line with the recognition of revenue.

(iii) Costs of obtaining a contract

IFRS 15 requires an asset to be recognised for the incremental costs incurred in obtaining a contract which is then amortised over the period in which the corresponding benefit is received. Therefore upon transition an asset of £1.8 million was recognised relating to deferred customer acquisition costs (e.g. sales commissions). Under previous accounting treatment, these would have been expensed as incurred and thus application of IFRS 15 results in later recognition of selling expenses in the contract lifetime.

(iv) Multi-element contracts

IFRS 15 introduces a clear link between the value provided to a customer and the timing of revenue recognition. A small number of contracts have been identified within the Enterprise operating segment for which we have previously recognised revenue relating to professional services rendered during the 'project phase' of the contract, but under IFRS 15 it has been determined that in these specific instances, the 'project phase' did not represent a separate performance obligation. Therefore, depending on timing of customer payments, for each contract identified there has either been a reduction in contract assets (cumulative impact £0.7 million) or the creation of a contract liability balance (cumulative impact £0.5 million) upon transition to IFRS 15. In a similar manner to the costs associated with connection activities detailed above, professional services costs incurred during the 'project phase' of £0.9 million have been capitalised on the balance sheet as costs of fulfilling a contract. Revenue is being recognised and the fulfilment assets are being amortised on a straight-line basis over the "managed service" phase of the contracts.

(v) Enforceable right to payment

Generally, the 'project phase' in Enterprise contracts does represent a performance obligation and results in the creation of an asset with no alternative use to the Group. Therefore, provided we have an enforceable right to payment, under IFRS 15 we can recognise revenue over time using a suitable stage of completion methodology similar to the accounting treatment previously used. In limited circumstances, where we do not have an enforceable right to payment during the "project phase", a difference in accounting treatment arises. IFRS 15 dictates that if we do not have an enforceable right to payment for performance completed to date then revenue should not be recognised over the project phase, but instead at the point in time that control of the asset transfers to the customer resulting in later recognition of revenue. Upon transition to IFRS 15, this has resulted in a decrease in contract assets of £0.4 million, an increase in contract liabilities of £0.1 million and the creation of a contract fulfilment assets of £0.5 million.

(vi) Licences

The Group frequently enters into multi-element contracts with customers which may include the provision of third party licences. Under previous accounting the revenue associated with the licences was recognised at the point in time that the licences were provided to the customer. Under IFRS 15 we recognise that, for the supply of some licences, we have an ongoing obligation to the customer with respect to these licences as part of the managed service provided and thus we will recognise associated with the licence over the shorter of the contract term and the licence term. Upon transition to IFRS 15 this has resulted in a contract liability of £1.5 million, reduction in unbilled receivables of £0.1m and an asset relating to the cost of fulfilling the contracts of £1.1 million.

(vii) Deferred tax

Due to the changes in the pattern and timing of revenue and cost recognition under IFRS 15, and remeasurements resulting in revenue and costs moving between past and future periods, the principles of IAS 12 give rise to a movement in the deferred tax liability due to temporary timing differences. In addition, a permanent difference arises from the derecognition of routers as capital assets. The net impact is negligible.

(viii) Presentation of contract assets and contract liabilities

The Group has voluntarily changed the presentation of certain amounts in the consolidated balance sheet to reflect the terminology of IFRS 15:

· Contract assets of £2.1 million in relation to incomplete projects where we do not have an unconditional right to consideration have been reclassified upon transition from trade and other receivables; and

· Contract liabilities of £17.4 million which were previously presented as deferred income within trade and other payables are now being presented separately on the balance sheet.

Comparative figures for the items of the financial statements affected by the first-time adoption of IFRS 15 and IFRS 9

The following tables present the consolidated income statement and the consolidated balance sheet as at 30 September 2018 in accordance with IFRS 15 and IFRS 9 as well as the previous accounting treatment in accordance with IAS 11/IAS 18, IAS 39 and related interpretations along with an explanation of the movements in balances:

Consolidated interim income statement

Without the effect of IFRS 15, revenue would have amounted to £143.4 million, £1.4 million higher than reported. The most significant item contributing to this is the recognition of agency relationships. The guidance in IFRS 15 for the distinction between an agent and a principal is based on the concept of 'control' which differs to the previously applied notion of transfer of 'risks and rewards'. This has resulted in a reduction of revenue of £1.8 million within the Enterprise market segment due to sales previously recognised gross of costs being recognised net of costs under IFRS 15 as 'agency' revenue. The impact of this item is £Nil at operating loss, EBITDA and loss before tax. This has been partially offset by a £0.5 million increase in revenue resulting from the timing of project completion in instances where we did not have an enforceable right to payment during the project.

Application of IFRS 15 has also resulted in a decrease in EBITDA of £1.4 million, largely attributable to the change in accounting treatment for routers. Under previous accounting treatment, routers were capitalised and the expense recognised as depreciation over the term of the contract. Under IFRS 15 we will treat routers as a discrete sale and performance obligation, and as a result these assets will no longer be capitalised and the cost will be recognised as an operating expense at the point control passes to the customer. This reclassification of costs and the change in timing of revenue recognition mainly impacts our Hull & East Yorkshire market segment resulting in a reduction of segmental EBITDA of £0.9 million. The overall impact on Group EBITDA is £1.1 million, but the impact at operating loss and loss before tax is negligible due to a reduction in depreciation of £1.2 million.

The impact of these factors is summarised below:

The other category relates to the cumulative impact of the following factors described in Note 4.1:

· connection fees;

· costs of obtaining a contract;

· multi-element contracts licences; and

· application of the forward-looking expected credit loss model.

Consolidated balance sheet

Upon application of IFRS 15, non-current assets have increased by £3.2 million in part due to the first time recognition of contract costs i.e. costs of obtaining and costs of fulfilling a contract of £4.4 million. Previous accounting treatment would have resulted in earlier costs recognition with these costs generally being recognised as incurred. This impact is offset by the derecognition of routers from property, plant and equipment of £1.2 million because under IFRS 15 these are being treated as a discrete sale and performance obligation satisfied at the point in time when the router is delivered to the customer.

Current assets are £0.5 million higher under IFRS 15 due to the recognition of a contract asset for the sale of routers £1.8 million. This is offset by a reduction in contract assets of £0.6 million arising from the de-recognition of revenue for specific contracts where the project phase has not been identified as a performance obligation under IFRS 15. This is also offset by the release of unbilled receivables (£0.7 million) in relation to: connection activities which we have concluded do not represent a performance obligation; and licences where we have concluded that we have an ongoing obligation and thus should not recognise all of the revenue attributable to the licence at the point in time that it is delivered to the customer.

Current liabilities have increased by £3.6 million due to the deferral of connection revenue of £1.9 million, the deferral of licence revenue of £1.2 million and the deferral of "project phase" revenue of £0.5 million.

The difference in the amounts recognised under deferred tax liabilities (£0.1 million) are due to the remeasurement effects in connection with the first-time and continuing application of IFRS 15 in the period to 30 September 2018.

Due to the change in terminology of IFRS 15 and IFRS 9, there has also been a reclassification of certain balances:

· £2.2 million from trade and other receivables to contract assets; and

· £12.7 million from trade and other payables to contract liabilities.

4.2 Standards, interpretations and amendments issued but not yet adopted by the Group

The following accounting standards, interpretations and amendments have been issued by the IASB but had either not been adopted by the European Union or were not yet effective in the European Union at 29 June 2018:

· IFRS 16 Leases

· IFRS 17 Insurance Contracts

· IFRIC 23 Uncertainty over Income Tax Treatments

· Amendments to the following standards:

− IAS 19 Plan Amendment, Curtailment or Settlement

− IAS 28 Long-term Interests in Associates and Joint Ventures

− IFRS 9 Prepayment Features with Negative Compensation

− Improvements to IFRSs (2015 - 2017)

− References to the Conceptual Framework

Of these new standards, interpretations and amendments, only IFRS 16 is expected to have a material impact on the Group's financial statements:

IFRS 16 "Leases"

IFRS 16 replaces IAS 17 "Leases" and will primarily change lease accounting for lessees. Lessor accounting under IFRS 16 is expected to be similar to IAS 17.

For lessees, an operating lease arrangement will give rise to the recognition of a non-current asset representing the right to use the leased item and a loan obligation for future lease payables. Lease costs will be recognised in the form of depreciation of the right to use assets and interest on the lease liability.

This new standard will be applicable to the Group for the year ended 31 March 2020. The Group is continuing to assess the impact of IFRS 16, which is expected to have an impact on the consolidated income statement and the consolidated balance sheet. We are yet to quantify this impact.

Transition to IFRS 16 will take place on 1 April 2019. In accordance with the standard we intend to apply the standard retrospectively with the cumulative effect of initial application being recognised as an adjustment to retained earnings. Under this method of transition, comparative information will not be restated.

5. Segmental analysis

The Group's operating segments are based on the reports reviewed by the KCOM Group PLC Board which are used to make strategic decisions. The chief operating decision-maker of the Group is the KCOM Group PLC Board.

The Board considered three "go to market" segments, Hull & East Yorkshire, Enterprise and National Network Services, along with a Central segment. These segments are consistent with those presented in our Annual report and accounts for the year ended 31 March 2018.

A reconciliation of EBITDA to total (loss)/profit before tax is provided as follows:

The table below shows revenue disaggregated by segment and nature:

The split of total revenue between external customers and inter-segment revenue is as follows:

6. Exceptional items

Exceptional items are separately disclosed by virtue of their size or incidence to improve the understanding of the Group's financial performance.

The Directors continue to recognise the need to differentiate costs incurred outside the normal course of business from the underlying trading performance.

In accordance with IAS 36, the goodwill allocated to the National Network Services segment was tested for impairment after the Directors deemed the performance of the segment in the period to be an indication of impairment. The impairment test resulted in the full impairment of goodwill allocated to the National Network Services segment and as such a charge of £32.2 million has been recognised in the consolidated income statement. This is a non-cash item and is treated as exceptional in line with our accounting policy. See Note 11 for further details.

During the period exceptional restructuring costs of £1.5 million were incurred (six months ending 30 September 2017: £0.7 million). Management scrutinises all restructuring costs on a line by line basis to determine whether they meet the exceptional criteria. During the period restructuring costs were incurred in relation to three main areas:

• Termination and recruitment costs associated with Executive Directors (£0.6 million). In line with the Group's accounting policy these costs are always classified as exceptional.

• Transformation of project delivery capability (£0.4 million). The Group has undertaken a discrete project designed to improve and de-risk our delivery of complex customer contracts. The transformation will enable us to deliver in-flight and future contracts more profitably and help avoid a reoccurrence of the losses on specific contracts incurred in prior years. Costs were also incurred in relation to this project in the prior year. We now consider this project to be complete.

• Transformation of central functions (£0.5 million). The Group has completed the process of centralisation of the technical and customer support teams into centres of excellence designed to provide an improved customer experience, which commenced in the prior year. The Group has also begun a structural re-organisation of its Product and Propositions teams to help design and create new offerings for the go-to-market segments, which is scheduled to complete in the second half of this financial year.

In the six months ended 30 September 2017, the Group recorded an exceptional credit of £1.9 million relating to regulatory matters. The credit resulted from an industry wide settlement which arose as a result of a breach in BT Openreach's contractual and regulatory obligations relating to compensation for misapplying 'Deemed Consent'.

The combined effect of these items is a credit of £0.3 million (6 months ending 30 September 2017: charge of £0.2 million) in respect of current tax and a credit of £1.6 million (6 months ending 30 September 2017: £Nil) in respect of deferred tax.

Cash flow impact of exceptional items was an outflow of £1.7 million (6 months ending 30 September 2017: £1.8 million). The impact on working capital of exceptional items was an outflow of £0.2 million (6 months ending 30 September 2017: outflow of £1.1 million).

7. Finance costs

8. Tax

Taxes on income in interim periods are accrued using the tax rate that would be applicable to the expected total annual earnings. The Group's effective rate is -2% (2017: 19%). The effective rate is 18% if the impact of the goodwill impairment is excluded.

9. (Loss)/earnings per share