Yu Energy Regulatory News (YU.)

Yü Group PLC

(the "Group" or the "Company")

Findings from the Accounting Review

Yü Group PLC (AIM: YU.) provides an update following the announcement on 24 October 2018 regarding several areas of significant concern in relation to the Group's performance. These concerns led to a combined reduction to profitability of around £10 million when compared with market expectations. As announced on 5 November 2018, the Board subsequently appointed DLA Piper LLP and PwC LLP to conduct an independent forensic investigation (the "Review").

The findings from the Review have recently been presented to the Group's Board and Audit Committee. After assessing the outcome of the Review, and after performing additional internal analysis of its trading performance and balance sheet, the Board believe a further reduction in profitability is anticipated of between £2.75 million and £3.25 million. 

Consequently, the Group forecasts an Adjusted Loss Before Tax of between £7.35 million and £7.85 million1 for the year ended 31 December 2018.

The Group held £11.0 million of cash at 30 November 2018 and continues to have no debt outstanding.

Ralph Cohen, non-Executive Chairman, said "The events of recent weeks have been deeply distressing for the shareholders, directors and for all of the Company's stakeholders. The Review has confirmed serious historic failures in the systems and processes within the Group's finance function. These are now being addressed by our new Chief Financial Officer, who is implementing all necessary improvements. It will take time for these measures to produce their full results and for unsatisfactory sales contracts to time-expire. While the task ahead is daunting, I have every confidence that the entire Yu Group team will face it with a determination to achieve the desired results and to restore the fortunes of the Company."

[1] The Adjusted Loss Before Tax excludes charges for Share Based Payments, gains or losses on derivatives contracts, and, for Financial Year 2018, exceptional restructuring costs, provisions made on first adoption of IFRS 9, and the costs of the Review. It is also is based on a working assumption that the corrections will not result in a restatement of prior year accounts.

Overview

The following key findings and assumptions are noted from the Review and the Board's further internal analysis:

· The Review confirmed that the assessment of the level of corrections to the 30 September 2018 balance sheet were appropriate;

· The Review identified the underlying cause for the level of corrections is centred around material weaknesses in key internal systems and controls across the customer to invoicing and cash cycle;

· A further reduction in profitability of between £2.75 million and £3.25 million is now expected due to:

o additional decline in gross margin achieved across the Group's contract portfolio; and

o additional balance sheet corrections following the detailed external and internal forensic investigations;

· The Board is focussed on ensuring the Group can achieve profitability as soon as possible, and is continuing to work on detailed budgets taking in to account current trading performance and the findings from the Review; and

· The Group expects to release a trading update at the end of January 2019 to provide further guidance.

The Review & Internal Analysis

The issues and concerns announced on 24 October 2018 had been identified following an internal review of the Group's balance sheet as at 30 September 2018. Due to the materiality of the corrections, the Board appointed DLA Piper LLP and PwC LLP to conduct an independent forensic review, during which the advisers had full access to the Group's records as they required.

The Review centred around the following key areas:

· a reconstruction of the trade debtors' ledgers of the Group to validate the account balances held, and to analyse invoicing and cash receipts at a transactional level;

· a calculation of potential accrued income, and its recoverability, compared to the balance held;

· an assessment of material risks and the effectiveness of internal controls;

· an assessment of new internal controls and accounting processes now being utilised by the Group in relation to bad debt provisioning and accrued income recognition; and

· a review of other accounting processes and policies, and of data integrity, to identify any other adjustments required.

Trade debtors and billing data was reviewed by PwC from 2014 to the end of November 2018, with significant analysis performed under a variety of methodologies in order to assess a range of positions and areas for additional investigation.

In addition to the Review, the Board have investigated:

· the gross margin achievable on the contract book of the business; and

· other balance sheet and accounting processes and balances.

The Findings

The Review concluded that:

· the Board's assessment of the adjustment of the 30 September 2018 balance sheet was appropriate;

· The Group's internal controls were inadequate, including a failure to perform certain key financial reconciliations, incorrect management of systems, and poor data quality resulting from complex and manual ledger processes;

· Where controls were in place they tended to be informal and therefore applied inconsistently; and

· New accounting processes have now been implemented in relation to estimating levels of accrued income and bad debt provisioning. These processes are more in line with industry norms but do require embedding, monitoring and revision over time to evaluate their appropriateness.

Following the Review findings and further internal analysis, the Board have concluded that a further reduction in the gross margin of the business is anticipated, and that certain other balance sheet corrections are appropriate, which are described below.

Financial Impact

Based on the findings of the Review and the Board's own internal analysis, the 2018 Adjusted Loss Before Tax2 of the Group includes the following impacts:

· a £6.4 million impairment of the 30 September 2018 balances of trade debtors (due to ledger reconciliation issues) and accrued income (due to a reassessment of the amount billable to customers);

· a £1.3 million increase, from the £0.1 million held at 31 December 2017, in the bad debt provision which is required at 30 September 2018, based on newly adopted internal accounting processes; and

· a further £1.0 million related to accruals and fixed assets.

2 It is the current working assumption of the Board that all adjustments required will be treated as losses to be reported in the year ended 31 December 2018. If the year ended 31 December 2017 requires a restatement to reduce profitability, losses declared for the year ended 31 December 2018 would decrease by a corresponding amount.

As a consequence of the corrections to the position at 30 September 2018, and based on new financial analysis, the Board has reassessed the Group's underlying profitability based on the contracts it has secured. As a result of this reassessment, the margins achieved across the contract book are significantly below the level which was previously expected. The Board note:

· the gross margin now being recognised on existing contracts is leading to a greater dilution of the gross margin achieved across the contract book than previously anticipated;

· in view of the contracted nature of the Group's activities, such business will continue to dilute the gross margin percentage achievable in 2019 and, to a lesser extent, 2020; and

· a reassessment of the Group's growth strategy, in the context of the wider competitive environment and market conditions, is ongoing, with a renewed focus on the underlying profitability of new business.

Corrective & other actions

Since the issues were identified, the Board and the Audit Committee have implemented urgent measures to enhance financial controls, including:

· new policies and procedures in relation to governance, internal controls and risk management;

· management led reviews of risks and internal controls, with a Board approved mandate to implement improvements in a timely manner;

· revised accounting processes in relation to bad debt provisioning and estimation of accrued income;

· enhancement of data integrity and system interfaces, particularly in accounting ledgers and reconciliations; and

· ongoing analysis and internal reporting of the profitability of bookings, and detailed budget modelling, to reforecast the underlying expectation of profitability of the Group.

The Review indicates that the issues arose due to a combination of factors. The Audit Committee is continuing to investigate the failings leading to the corrections, including via key stakeholders and with the external auditors, to ensure all appropriate lessons are learnt and actions are taken accordingly.

The Audit Committee have also requested PwC to follow up on the Review to ensure the appropriate actions have been implemented in relation to their key findings. It is intended that they will undertake an initial follow up in Q1 2019 with a further exercise undertaken in Q2 2019.

Cash Position

Whilst recognising that future cash generation will be impacted as a result of lower than expected profitability, the Board wish to clarify that the adjustments noted have largely been reflected in the cash position of the Group at 30 November 2018. 

The Board confirms that the Group held £11.0 million of cash at 30 November 2018. The reduction in cash from 30 June 2018 to 30 November 2018 was in line with expectations, being primarily due to a scheduled annual industry payment, and an advanced payment against the next year's annual industry payments otherwise due in Q3 2019.

The Group has remained in a cash positive position throughout 2018 and continues to have no debt outstanding. 

Summary

The Board are working to take all necessary and proper actions to ensure the issues highlighted in the findings are thoroughly investigated, and that all requisite actions are implemented.

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