Pendragon
Annual Report 2018

Plain-text annual report

ANNUAL REPORT 2018 IN THIS REPORT “We continue to focus on our strategic priorities and the reallocation of our capital into the areas we see as providing the strongest long-term growth. We have seen strong performance in used cars in the second half of the year, with the transformation of preparation facilities and processes now embedded in our Car Stores. We anticipate this will carry on into 2019 and beyond as our new Car Store businesses further boost our used car growth. New car sales have been subdued and consumer confidence has been adversely affected in the period by macro newsflow, however, our Software business is continuing to win market share and has now deployed systems in twelve overseas countries. 04 Our Leasing business has grown profitability with a stable base of vehicles under management.” STRATEGIC HIGHLIGHTS Our business model, focus and strategic direction. 09 BUSINESS PROFILES Learn more about our four businesses: UK Motor division, our Independent Software Vendor (Pinewood), Fleet and Leasing (Pendragon Vehicle Management) and US Motor division. We also share an introduction to our new online marketplace Carstore.com. 18 PRODUCING USED CARS Behind the scenes of what happens in our new Production Factories to make a car ready for sale. 2 Pendragon PLC Annual Report 201826 OPERATIONAL AND FINANCIAL REVIEW 41 DIRECTORS REPORT DIRECTORS REPORT STRATEGIC REPORT Strategic Highlights 04 06 Operational and Financial Highlights 07 Financial Summary 08 Performance Indicators 09 Business Profiles 18 20 Life at Pendragon PLC Producing Used Cars FINANCIAL STATEMENTS FINANCIAL STATEMENTS 72 OPERATIONAL AND FINANCIAL REVIEW Industry Insight 24 28 Business Review 32 Financial Review 34 Balance Sheet 35 Risk Overview DIRECTORS REPORT Corporate Social Responsibility Report Board of Directors 42 44 Corporate Governance Report 48 50 Committee Reports 56 Directors’ Remuneration Report 69 Directors’ Report FINANCIAL STATEMENTS 73 74 83 84 85 86 87 88 Director’s Responsibility Statements Independant Auditor’s Report Consolidated Income Statement Consolidated Statement of Comprehensive Income Consolidated Statement of Changes in Equity Consolidated Balance Sheet Consolidated Cash Flow Statement Reconciliation of Net Cash Flow to Movement in Net Debt 89 Notes to the Financial Statements 160 Company Balance Sheet 161 Company Statement of Comprehensive Income 162 Company Statement of Changes in Equity 163 Notes to the Financial Statements of the Company 170 Advisors, Banks and Shareholder Information 171 5 Year Group Review 3 Pendragon PLC Annual Report 2018 STRATEGIC HIGHLIGHTS Welcome to our 2018 Annual Report. Our goal of doubling our used car revenue by 2021 remains unchanged and we’re moving ever closer to achieving our ambitions. “We will continue to invest in more used car sales capacity as we move towards our goal of doubling our revenue by 2021. We expect to continue to grow our software revenues with our SaaS licencing to international users. We expect broadly double digit revenue growth for the foreseeable future. We anticipate the sale of our US business to realise in excess of £100 million.” STRATEGIC HIGHLIGHTS Double used car revenue by 2021 • Invested in and launched Carstore.com website in December 2018. Software – global growth • Good progress growing our Software as a Service (‘SaaS’) licences to international users. In 2018 we have implemented • Recruited a Used Car Director to manage the operation and the software into customers with an addressable user base roll out of used Car Stores. of over 1,600 (2017 : 729). • Opened three purpose built Car Stores and converted four • Our overseas activities now encompass twelve countries of former new car franchised dealerships to Car Stores. which Germany, Norway, Sweden, Switzerland, Thailand and • Opened four used car refurbishment factories to industrialise Philippines were added in 2018. this process. • Strong used car profitability in the second half of 2018. Board changes • As previously announced, Trevor Finn, Chief Executive will US Motor Group - disposal • Completed the first disposal of a franchise in the US. Further retire from the role of Chief Executive of Pendragon PLC on 31 March 2019. Mark Herbert joined Pendragon on 4 March disposals are well progressed. 2019 as Chief Executive designate and will be appointed to Premium Brand Franchises • As part of our committed three year plan to reduce the • As previously announced, Tim Holden, Finance Director, will step down on 31 March 2019. His successor, Mark Willis, will capital deployed in this area, we have sold six premium take up the role of Chief Finance Officer and joins the Board brand franchises (including two in February 2019) and on 8 April 2019. the Board as Chief Executive on 1 April 2019. agreed lower capital expenditure levels. • This has released £46.7 million of capital comprising consideration and capital expenditure avoided. 4 Pendragon PLC Annual Report 2018BUSINESS SEGMENTS We have four main business divisions that make up our Group: UK MOTOR Sale and servicing of vehicles in the UK INDEPENDENT SOFTWARE VENDOR Licencing of Software as a service to automotive businesses FLEET AND LEASING Supply of new vehicles and fleet management to businesses US MOTOR (Discontinued) Sale and servicing of vehicles in the US US Motor 12% Leasing 19% Software 15% UK Motor 54% Underlying Operating Profit by business £41.1m UK Motor £14.8m Leasing £11.7m Software £8.6m US Motor E W N u S V E H ICLE RETAILIN used car p p l y p art exchanges f inventor o f r o m y G G IN S A E L D N A T E E L F tory n e v n i r a c d e s u f o y l p p u S “Each business generates independent profits, but also supports our strategic ambition to double used car revenue by 2021.” USED VEHICLE RETAILING M arket leading s y s t e m r o f SOFTWA R E V E H I C L E T e c h f n o r i c a v l e h i c l e q u i e r e c o n d p m e n t a n itio d nin e x p g ertise S E R V I C E & R E P AIR 5 Pendragon PLC Annual Report 2018 OPERATIONAL AND FINANCIAL HIGHLIGHTS OPERATIONAL AND FINANCIAL HIGHLIGHTS • Group Revenue -1.3% L4L (-2.4% total) Primarily the impact of a decline in premium new car sales. • Used Revenue -0.3% L4L (-0.9% total) Used vehicle revenue, excluding nearly new vehicles, grew by 2.9% against a used car market that fell 2.2%. L4L used gross profit up 4.9%. Used gross profit increased by 27.6% (L4L) in the UK Motor division in H2 2018 driven by very strong margins in the second half of the year. • Car Store Revenue in our Car Store business grew by £83.6m, an increase of 38.5%. Gross profit was up 42.2%. Including the impact of start-up and transformation costs the operating loss for the business was £11.9m (2017:loss £6.9m). • Underlying Profit Before Tax £47.8m (2017: £60.4m) Underlying profit before tax down £12.6 million due to decline in UK motor division new vehicle gross profit and the investment in new Car Store sites and refurbishment • New Revenue -2.2% L4L (-3.8% total) Outperformed the UK market which was down 6.8% in 2018 with UK new revenue factories. down 5.2% L4L. Gross profit down 8.3% following continuing margin pressure in the Premium sector. • Aftersales Revenue -0.5% L4L (-1.8% total) Gross profit down 1.5%. Our retail aftersales revenue grew by 2.1% with • Non Underlying charge of £92.2m (2017: £4.9m credit) including a non-cash charge principally for impairment of goodwill and non-current assets in our UK Motor Group of £(95.8)m taking into account trading and market conditions. margins reduced as a result of labour cost increases. • Stable Balance Sheet Net debt £127.6m (2017:£124.1m) with • Software Revenue +7.0% L4L (+7.0% total) Gross profit up 8.0% in spite of investment in new product development for international markets. Net Debt : Underlying EBITDA unchanged at 0.9. • Capital Allocation A final dividend of 0.7p is being proposed to maintain dividend earnings cover of at least two times. At this stage in the company’s investment cycle our share • Leasing Revenue -11.7% L4L (-11.7% total) Gross profit up 35.3% benefiting from utilising the factory refurbishment for buyback programme is paused. The Board continues to monitor the relative merits of freehold property ownership end of contract disposals. against the lower capital requirements of operating leasehold premises, as we continue to grow our physical footprint. • Operating Cost +2.5% L4L (+24.3% total) Includes transformation costs of the new preparation process offset by cost saving actions taken during the year. £M REVENUE GROSS PROFIT OPERATING PROFIT/(LOSS) PROFIT/(LOSS) BEFORE TAX EPS LIKE FOR LIKE* UNDERLYING** £4,509.8 £540.4 £79.2 £50.8 N/A (-1.3%) (+0.6%) (-9.3%) (-20.5%) £4,627.0 £550.5 £76.2 £47.8 2.8p (-2.4%) (-0.4%) (-9.1%) (-20.9%) (-15.2%) £4,627.0 £550.5 £(14.4) £(44.4) (3.6p) TOTAL (-2.4%) (-0.4%) * like for like (L4L) results include only current trading businesses which have been trading for 12 consecutive months. ** underlying results that exclude items that are not incurred in the normal course of business and are sufficiently significant and/or irregular to impact the underlying trends in the business Continuing results are stated on an underlying basis. 6 Pendragon PLC Annual Report 2018FINANCIAL SUMMARY 4,537.0 4,739.1 4,627.0 559.6 552.9 550.5 12.3 11.7 11.9 2016 2017 2018 2016 2017 2018 2016 2017 2018 £4,627.0M REVENUE £550.5M GROSS PROFIT 11.9% GROSS MARGIN 101.2 83.8 76.2 75.4 60.4 47.8 3.9 3.3 2.8 2016 2017 2018 2016 2017 2018 2016 2017 2018 £76.2M UNDERLYING OPERATING PROFIT £47.8M UNDERLYING PROFIT BEFORE TAX 2.8P UNDERLYING EPS 100.4 91.4 73.0 65.3 124.1 127.6 91.7 (14.4) (44.4) 2016 2017 2018 2016 2017 2018 2016 2017 2018 £(14.4M) OPERATING (LOSS)/PROFIT £(44.4M) (LOSS)/PROFIT BEFORE TAX £127.6M NET DEBT NOTE: Throughout this document, Alternative Performance Measures have been used which are non-GAAP measures that are presented to provide readers with additional financial information that is regularly reviewed by management and should not be viewed in isolation or as an alternative to the equivalent GAAP measure, see note 1 of the Financial Statements for details. 7 Pendragon PLC Annual Report 2018PERFORMANCE INDICATORS KEY FINANCIAL MEASURES KPI Definition 2018 Performance Change Underlying EPS Underlying profit after tax divided by weighted average number of shares 2.8p down 15.2% Underlying PBT Underlying profit before tax excludes items that are not incurred in the normal course of business and are sufficiently significant and / or irregular to impact the underlying trends in the business £47.8m down 20.9% Underlying Operating Margin Underlying operating profit divided by underlying revenue 1.6% down 11.1% Underlying Net Debt Net debt : underlying EBITDA is the ratio of our net debt to underlying EBITDA Ratio 0.9 no change KEY STRATEGIC MEASURES KPI Definition 2018 Performance Change Aftersales Retail Labour Sales Retail labour sales is activity direct to consumers for the servicing and repair of motor vehicles (like for like) Retail growth 2.1% down 1.3% Used Revenue All used revenues (like for like) £2,108.6m down 0.3% Online Growth Website visits to Evanshalshaw.com, Stratstone.com and Carstore.com 28.7m visitors up 5.1% 8 Pendragon PLC Annual Report 2018BUSINESS PROFILES 10 UK Motor 12 Independent Software Vendor 14 Fleet and Leasing 15 US Motor 16 Online Marketplace 9 Pendragon PLC Annual Report 2018BUSINESS PROFILES UK MOTOR Sale and servicing of vehicles in the UK. Strategic focus • Continue to invest in the transformation of our business model to deliver a market leading share in the used vehicle and aftersales markets in the UK. • Double our used car revenue by 2021 by developing our national network linked to a superior online buying experience. “Our UK Motor division is recognised through our two main consumer brands in the UK, Evans Halshaw and Stratstone, complemented by our used car only brand, Car Store” Evans Halshaw Evanshalshaw.com represents 11 volume franchises across the UK, retailing new and used cars, light commercial vehicles (LCV) and heavy goods vehicles (HGV). There is also a significant focus on the service and repair of these vehicles. Our Sell Your Car initiative focusses on an independent car buying service, as an alternative to the more traditional part exchange option for consumers. These activities both result in a supply of used cars for sale. Stratstone Stratstone.com is our premium brand, representing ten prestige manufacturers. Stratstone is focused on the retail of new and used cars, and service and repair. Stratstone has also adopted our award winning ‘Move Me Closer’ initiative, that enables customers to move any used car in the UK to a location nearest to them. The scheme makes over 28,000 used cars available at every location. Car Store In 2018 we completed our move to make all of our non- franchise locations part of the Car Store division of our UK Motor business. We now have 32 Car Store locations. At the end of 2018 we launched a new online marketplace for the brand. Details of Carstore.com and our proposition can be found on page 16. We opened four used car refurbishment factories, three purpose built Car Stores and converted four former new car franchised dealerships to Car Stores in 2018. 10 Pendragon PLC Annual Report 2018 Evans Halshaw 118 Ford 39 Vauxhall 30 Citroën 15 Renault 6 Dacia 6 Peugeot 6 DAF 4 Hyundai 4 Nissan 4 Kia 3 SEAT 1 Stratstone 59 Land Rover 11 Jaguar 9 Mercedes-Benz 8 BMW 7 MINI 7 Smart 6 Porsche 5 Aston Martin 3 Harley-Davidson 2 Ferrari 1 Car Stores 32 WEBSITE VISITS UP 5.1% 28.7M VISITS 177 UK FRANCHISE POINTS 256K VEHICLES SOLD UK USED CAR GROSS PROFIT UP BY 5.1% 32 OWN FRANCHISE SUPPORTED BY 4 FACTORIES 11 Pendragon PLC Annual Report 2018BUSINESS PROFILES INDEPENDENT SOFTWARE VENDOR Licencing of Software as a Service to automotive business users. Strategic focus • Pinewood, our software business, is core to our strategic plan to transform the Group. • We have an objective to achieve at least double digit growth in revenue in the Software as a Service (“SaaS”) business for the foreseeable future, which will be achieved by globalisation of the products and services we offer. • Pinewood is fast becoming a global business with users in 13 countries worldwide. “Our Dealer Management System is split by role-type, collating common tasks together to make dealerships more efficient. With one central database, all information is shared throughout the system.” Integration with Microsoft Outlook Digital Workshop Scheduling Customer Contact Plans Digital Vehicle Health Checks Dealer Management System Features Every part of the business in one place. From CRM, to workshop workflows and parts processing, financial analysis and stock management. Pinewood works with most vehicle manufacturers to provide global solutions. Our interconnected module structure provides visibility and access to Stock feeds to websites Customer Mapping tools Technician job cards Wholesale Funding information across dealership operations, preventing the need for double keying or multiple add-on systems. This is a valuable time saving asset for our users, facilitating increased SMS Integration Reporting Suite Social Media integrations Tyre Hotel productivity and reduced inputting time. 7% GROWTH IN REVENUE MICROSOFT PARTNER USERS IN 13 COUNTRIES UK EUROPE Ireland Switzerland Netherlands Germany Norway Sweden 5APPS AFRICA South Africa Namibia Zimbabwe ASIA PACIFIC Hong Kong Thailand Philippines 12 Pendragon PLC Annual Report 2018 Integration with over 50 manufacturers Cars: Commercial Vehicles: Motorbikes: Pinnacle Apps Our apps are designed to streamline processes and improve efficiency across the whole dealership. Our fully integrated suite of apps work seamlessly with our Pinewood DMS. Our apps are multi-platform and users can choose their preferred tablet or mobile, across iOS, Windows and Android devices. Tech+ Improve the service and repair experience, including video integration Host+ Integrated video processes including 360° tours of a used vehicle and technician time management. in stock, or visually identifying work required following a health check. Pay+ Fully integrated, PCI-DSS P2PE accredited card payment app. Stock+ Respond to enquiries with personalised videos, instantly update Parts+ Issue parts on-the-move, saving time with our in-built barcode scanner. stock information and store vehicle documentation. 13 Pendragon PLC Annual Report 2018 BUSINESS PROFILES FLEET AND LEASING Supply of new vehicles and fleet management to businesses. Strategic focus • Retain low capital base and high return on investment from the Leasing business. • Maintain at least double digit growth in revenue and gross profit. “At Pendragon Vehicle Management we supply fleet vehicles and provide services to help customers manage their fleets, improving efficiency, • Provide a used vehicle supply to the Group to support the goal of doubling reducing costs and saving time.” used revenue by 2021. Pendragon Vehicle Management At pendragonvehiclemanagement.co.uk our Business to Business (B2B) brand focusses on comprehensive solutions for fleet customers. Utilising market leading fleet software, tailored options are developed for the ever evolving requirements of businesses. From a variety of options on Fleet Management, to all elements of Fleet Funding across cars and commercial vehicles, business solutions are crafted to focus on customer priorities, from uptime to driving cost control. Pendragon Vehicle Management has evolved to offer bespoke Business to Employee (B2E) schemes as an alternative to company cars option for employees. In addition there are also a variety of Daily Rental and flexible rental solutions for customers. Fleet Management Fleet Funding Telematics Duty of Care Fuel Cards Contract Hire For Cars Contract Purchase Outsourced Administration Maintenance and Accident Repair Management Contract Hire For Vans Sale and Leaseback Business to Employee Schemes • Businesses can offer employees brand new cars as a company benefit. Rental Solutions • Fast response service with over 300,000 • No company car or company car tax complications, and there is no benefit vehicles ready to access. in kind tax to pay. • Real time Rental Management system • Motivational tool to drive engagement managed by Pendragon Vehicle • Daily and also flexible (three months and Management. beyond) rental options available. • Unlike salary sacrifice schemes this offers an alternative direct to employee • Car, van and specialist vehicle hire, delivered contract (through a Personal Contract Hire agreement), reducing company within four hours. administration. GROSS PROFIT INCREASED BY 35.3% 14 OPERATING PROFIT UP £5M B V R L A MEMBER DRIVER APP Pendragon PLC Annual Report 2018US MOTOR Sales and servicing of vehicles in the U.S. Strategic focus • We are selling the US Motor Group, as we have concluded that it is economically right to realise its value. • We are expecting proceeds in excess of £100 million before tax. • Further disposals are well progressed. “In July 2018 we completed the disposal of our Aston Martin business, the disposal process for the rest of the US business is progressing well.” Pendragon North America Hornburg.com is a local brand that has been serving Southern California since 1947. Focussed on the sale and service of premium vehicles, Hornburg represents Jaguar and Land Rover across four locations. Our Chevrolet outlet in Puente Hills is our additional vehicle franchise in California, retailing new Chevrolet and pre-owned domestic vehicles and also offering service and repair. Jaguar 4 Land Rover 4 Aston Martin Disposal completed July 2018 Chevrolet 1 Jaguar Santa Monica Land Rover Santa Monica Jaguar Los Angeles Land Rover Rover Los Angeles Jaguar Newport Beach Land Rover Newport Beach Chevrolet Puente Hills Jaguar Mission Viejo Land Rover Mission Viejo 15 Pendragon PLC Annual Report 2018BUSINESS PROFILES ONLINE MARKETPLACE Sale and servicing of vehicles in the UK. Strategic focus • Continue to invest in the transformation of our business model to deliver a market leading share in the used vehicle and aftersales markets in the UK. • Double our used car revenue by 2021 by developing our national network linked to a superior online buying experience. Carstore.com recently We launched Carstore.com, the new online marketplace for our Car Store brand. The website provides our customers with an easy-to-use experience when buying or selling their car with the capability of a fully online experience. Carstore.com is an important part of our strategy as we look to double the revenues we generate from used car sales by 2021. “In late 2018 we launched our online marketplace, Carstore.com. We’re transforming how people buy cars.” Buy your next car online With our network of 32 physical locations supporting our online marketplace, our customers can do as much of the car buying experience through our new website as they wish. From selecting any car from our 6,000 available, to be delivered to them in 96 hours, customers can visit our stores to test drive and still buy their car online with both monthly and one-off payment options available. We understand their needs when buying a car online, which is why all of our cars have passed a 128-point inspection by the AA and have an AA warranty and breakdown cover. We also offer a 14-day money back guarantee for added customer confidence. Sell your car to Car Store Customers can now judge their car’s condition online and receive an instant price valuation for their car. They can choose to call into store or book a 30 minute appointment with one of our Customer Service Assistants assessing the vehicle. This service is available at every location. When a customer chooses to sell their car to Car Store we guarantee the best price. 16 Pendragon PLC Annual Report 2018FULFILMENT NETWORK It is important our physical experience matches expectations set through our online marketplace. We aim through our integrated systems and team training, for the blend of online and offline customer journey to be seamless. Our in store premises vary from custom build premises to adapted former franchise retailers, but we aim for the facilities to deliver a consistent customer experience, setting out customer expectations online and delivering in store. We have also begun to deploy new hardware solutions across the Car Store fulfilment network. These range from children’s entertainment zones, customer kiosks to browse and order cars online, to the use of hand held tablets across the hosting and customer service teams. 6000+ CARS AVAILABLE TO BUY ONLINE ANY CAR TO ANY LOCATION IN 96 HOURS 14 DAY MONEY BACK GUARANTEE EVERY CAR IS AA INSPECTED 4.7/5 STARS GOOGLE 14 DAY PRICE PROMISE 3 CAR STORE AT MORRISONS LOCATIONS 32 SELL MY CAR VALUATION POINTS 30 MINUTE DRIVE AWAY APPOINTMENTS Production Factories Own Franchise Points 4 PRODUCTION FACTORIES 32 OWN FRANCHISE 17 Pendragon PLC Annual Report 2018PRODUCING USED CARS HAVE YOU EVER WONDERED HOW A USED CAR BECOMES READY FOR SALE? In many of our franchise locations across the UK we have on premises and on site reconditioning of used cars for their local forecourt. On site vehicle technicians balance the consumer demand of retail servicing alongside preparing used cars (such as part exchanged vehicles) for sale. Here, we go behind the scenes in our Production Factories – we have created a new supply chain to prepare inventory for our Car Store retailers. DAILY DELIVERIES Every day transporters arrive at the refurbishment facility with fresh vehicles for the production teams to assess and recondition. Our team assesses each car as it comes off the transporter. As we purchase every single vehicle from our customers through our part exchange and Sell My Car schemes (regardless of the vehicle’s condition), at this stage the vehicles are evaluated to either proceed to the factory or be disposed of through our trade channels. INVENTORY MANAGEMENT As a piece of inventory, every vehicle is loaded into our system through our Pinewood mobile application Stock+ as the cars arrive on site at the factory. The detailed specifications and notes are available across all modules of our system, from vehicle management to accounts. Vehicles that fit with our criteria for a sales opportunity proceed to our AA inspection area. INDEPENDENT INSPECTORS We have teams of inspectors from our partner, the AA. Each vehicle is independently reviewed to AA specifications to achieve a pass. The testing includes 128-points checked and a road test. Some cars pass straight away and proceed to being prepared for advertising, others require some additional work to achieve our standards. Recommended works are completed onsite by our trained specialist teams, covering all areas of mechanical repair. Each car requiring work is then retested by the AA inspectors. With a pass sticker in the window and all documentation in our system, each car now includes a complimentary three month warranty and 12 months AA breakdown cover as standard. 18 1. 2. 3. Pendragon PLC Annual Report 2018“Every Car Store vehicle for sale has an independent 128 AA inspection pass” 4. 5. READY FOR SALE Each car proceeds to valeting for internal and external preparation, including its Carstore.com sticker. Sales begin online and speed is critical to have cars advertised as quickly as possible. ADVERTISED SAME DAY Valeted and photo ready, each car proceeds to the photography booths at the refurbishment facility to be captured for adverts on our online marketplace. Images are uploaded through our Pinewood mobile application Stock+ and vehicles feed onto our website daily. 96 HOUR MOVES TO ANY LOCATION Customers can self serve online and move the vehicle of their choice to any outlet in the Car Store network. DAILY DROP OFFS Every day transporters take vehicles ready for customers from the Production Factories to our fulfilment network. Logistics is triggered directly by the customer through the self service capability on Carstore.com, requesting the car be transferred (to test drive, or having purchased the car online), or placed in the best market based on our stock replenishment and customer demand data. EVERY CAR AVAILABLE TO DRIVE AWAY SAME DAY 6. 19 Pendragon PLC Annual Report 2018LIFE AT PENDRAGON We know it is our team members that make the biggest difference to our customers and our business. Our Find, Keep, Grow approach focuses on channelling our passion into programmes for our team members to flourish. FIND Our Find strategy focusses on how we attract new talent and pipeline talent for the future. As an evolving retailer we have created new roles that appeal to a wider and more diverse labour pool, making a tangible difference to our diversity agenda. We launched our new careers website and digital attraction strategy in 2018, in conjunction with the implementation of new recruitment systems and processes. Investing in technology enables us to build sustainable channels and is a real game changer for us and the candidate. We were shortlisted for the Best Online Candidate Experience Award 2019, and won Best Use of Mobile in the OnRec Awards. These accolades reflect our commitment to attracting team members that reflect our customer base and aspirations for the future. 20 KEEP We recognise that the nature of work is changing with demand for greater flexibility and personal development. From introducing more family-friendly working patterns, to new learning opportunities, we have launched a number of initiatives in 2018 in our mission to make our business irresistible to team members. We have signed the Time to Change pledge in support of the mental health agenda. Launched in March 2018 our commitment includes trained Mental Health first aiders, learning programmes for leaders, and participation in a number of events. These have included Wellbeing Awareness Month, Mental Health Week and fundraising for the charity Mind. Our aim is to make mental health openness a part of our day-to- day working lives. In August 2018 we relaunched our MyReward benefits mobile application. Every team member can access a range of exclusive company benefits, from retail discounts to offers, as well as find support and advice on wellbeing. Responding to the changing nature of work, and the different types of roles we have in our Group, our Pinewood and Central Operations offices have been remodelled to introduce collaborative workspaces. These environments aim for innovation to thrive. Pendragon PLC Annual Report 2018GROW Our Pendragon Academy in the centre of the UK has been a hive of activity as we develop our team members. This facility provides a hub for our classroom based learning, and is supported by our extensive e-learning suite. From developing our team members skills with new processes and technology, to our talent programmes supporting apprentices and graduates at the start of their careers, we have a variety of ways to support our team members’ personal development. In 2018 we introduced a new talent programme, Releasing Your Potential, as well as creating opportunities for leaders to develop their capabilities through modular courses. Delivering today’s needs whilst balancing future skills is a key focus for our Grow strategy. Interactive, inspirational learning has also been a part of our activities to develop our team members. In 2018 we introduced our monthly Speakers’ Corner. This is an opportunity for any team member in any team to hear from senior leaders on a variety of personal development topics, and pose questions. Team members can attend in person, or view these talks online. “Our people strategy is simple. We find, we keep and we grow exceptional people.” YEARS OLD 16 86 YEARS OLD YOUNGEST TEAM MEMBER OLDEST TEAM MEMBER 254 APPRENTICES 9,880 TEAM MEMBERS 182 TEAM MEMBERS ON TALENT PROGRAMMES 27% FEMALE 73% MALE 6,683 TRAINING DAYS COMPLETED 160,644 HOURS OF E LEARNING COMPLETED 40,099 TRAINING HOURS COMPLETED 21 Pendragon PLC Annual Report 2018LIFE AT PENDRAGON “Our internal events aim for our team members to feel #ProudToBePendragon. We create experiences that motivate, recognise and inspire.” As part of our Grow strategy and our aims for team members to strive for excellence, we have comprehensive programme of events for our team. These range from conferences to share best practice and deliver important messaging consistently, to incentive travel to reward high performing team members setting the standard in their field. To compliment our events programme we have also further embedded Office 365 and its suite of products into our day to day work and evolved our internal communications methodology to include more focus on video, and engaging, interactive communications methods. 878 TEAM MEMBERS JOINED INTERNAL COMMUNICATIONS CONFERENCES 963 TEAM MEMBERS ATTENDED RECOGNITION EVENTS Extra Mile Recognising your peers, Team Building High performing teams that highlighting moments in our day to day work understand their part to play and emotionally and simply saying thank you goes a long way. investing in each other is key to our success. 1841 TEAM MEMBERS ATTENDED AN INTERNAL EVENT 55 TEAM MEMBERS TRAVELLED INTERNATIONALLY ON INCENTIVES CELEBRATING SUCCESS It is essential that team members feel valued for their contributions to the success of our business. We encourage daily peer-to-peer recognition through initiatives such as our Extra Mile nomination scheme, which culminates in quarterly lunches with senior leaders to celebrate local moments. We also have annual incentive schemes which include prizes such as international trips for our highest performers. Conferences Networking and sharing best practice, whilst recognising and celebrating achievements with stakeholders is an important part of our communications strategy. Annual Awards Recognising those team members and teams that are setting the standard for excellence across our Group, telling their stories and celebrating our shared success. International experiences Creating unforgettable memories for team members, and their support network, for those achieving a the highest level, and making these experiences aspirational goal for future attendees. 22 Pendragon PLC Annual Report 2018 878 TEAM MEMBERS JOINED INTERNAL COMMUNICATIONS CONFERENCES TALENT We are focussed on making our business and our sector appeal to future generations, creating a pipeline of future team members to continue the success of our business. We have introduced new roles, blended work and educational programmes, custom recruitment processes, and buddying and mentor schemes to support our diverse talent activities. From apprenticeships in aftersales workshops to customer services, graduate and undergraduate schemes across Central Operations and our retailer network, our population of exciting new team members continues to grow and evolve our business. We also work closely with our manufacturer partners to provide skills training and personal development at the highest level, as well as with local educational authorities to give our talent the very best support and recognition for their hard work and commitment. COMMUNITY As a prominent business in many communities across the UK, we encourage our teams to be close to their customers as a valued part of their local community. We have a framework to support charitable activities through the year across all of our locations, and join many wider activities to fit with our diversity and inclusivity agendas, such as International Women’s Day and Pride. We also utilise our facilities to support communities. Events such as the high profile Power of Women event in London, the launch of a contemporary motivational and inspirational 10-week TV series, to regional business networking events. #adollar fordawson CAR CAFÉ In 2018 we expanded our community car event Car Café across the whole of the UK. We held 20 events from Glasgow to Cardiff over the summer months. Free to attend, we have hosted thousands of guests at our breakfast meets in locations ranging from retailer forecourts to airports. Both drivers and spectators of all ages come together to celebrate vehicles of all varieties. We are joined by team members, customers and local enthusiasts celebrating all things automotive. 23 Pendragon PLC Annual Report 2018INDUSTRY INSIGHT NEW CAR VEHICLE REGISTRATIONS FOR YEAR ENDED 31 DECEMBER ('000) UK Retail Registrations UK Fleet Registrations UK New Registrations Group Represented* UK Retail Registrations Group Represented* UK Fleet Registrations Group Represented* UK New Registrations 2017 Change % 2018 1,052.2 1,314.9 1,123.9 1,416.8 2,367.1 2,540.7 700.6 906.5 746.4 992.0 1,607.1 1,738.4 -6.4% -7.2% -6.8% -6.1% -8.6% -7.5% Source: new car vehicle registrations data from the ‘Society of Motor Manufacturers and Traders’. *Group Represented is defined as national registrations for the franchised brands that the Group represents as a franchised dealer. USED CAR MARKET The used car market in 2018 in the UK was 7.61 million units, of 2018 around 21% of the car parc is represented by less than three year old cars, around 19% is represented by four to six which was a fall of 2.2% over 2017. However, this represents year old cars and 60% is greater than seven year old cars. a market opportunity that is 3.2 times the size of the new car The demand for servicing and repair activity is less impacted market. Despite challenging economic conditions, the used than other sectors by adverse economic conditions, as motor market is more stable and provides a more reliable supply vehicles require regular maintenance and repair for safety, chain than the new vehicle sector. We believe the market will economy and performance reasons. be broadly flat in 2019. AFTERSALES MARKET The main determinant of the aftersales market is the number of vehicles on the road, known as the ‘car parc’. The car parc in the UK has risen to over 34.6 million vehicles in 2018, a rise Overall, we expect at least for the next three years to see continuing growth in the car parc. NEW CAR MARKET The UK new car market was 2.367 million in 2018 which is a of 0.9% on the prior year. The car parc can also be segmented reduction of 6.8% over the prior year. The UK new car market into markets representing different age Groups. At the end is divided into two markets, retail and fleet. The retail market Units 10.0m 9.0m 8.0m 7.0m 6.0m 5.0m 4.0m 3.0m 2.0m 1.0m 0 24 UK CAR PARC BY AGE OF VEHICLE 5 1 0 2 6 1 0 2 7 1 0 2 8 1 0 2 9 1 0 2 0 2 0 2 5 1 0 2 6 1 0 2 7 1 0 2 8 1 0 2 9 1 0 2 0 2 0 2 5 1 0 2 6 1 0 2 7 1 0 2 8 1 0 2 9 1 0 2 0 2 0 2 5 1 0 2 6 1 0 2 7 1 0 2 8 1 0 2 9 1 0 2 0 2 0 2 5 1 0 2 6 1 0 2 7 1 0 2 8 1 0 2 9 1 0 2 0 2 0 2 0-3 YEARS 4-6 YEARS 7-10 YEARS 11-15 YEARS >15 YEARS Source: Callcredit (2014 to 2017) and Pendragon (2018 to 2019) Pendragon PLC Annual Report 2018Units 3.0m 2.8m 2.6m 2.4m 2.2m 2.0m 1.8m 1.6m 1.4m 1.2m 1.0m 0.8m 0.6m 0.4m 0.2m 0 UK NEW CAR MARKET 2.63m 2.69m 2.54m 2.37m 2.31m 2.29m 1.43m 1.49m 1.42m 1.32m 2.48m 1.30m 1.18m 1.21m 1.21m 1.12m 1.05m 2014 2015 2016 2017 2018 2019 2020 PRIVATE FLEET/BUSINESS PENDRAGON FORECAST Source: SMMT (2013 to 2017) and Pendragon (2018 to 2019) is the direct selling of vehicle units to individual customers The new retail market was down by 6.4% in 2018, and the new and operates at a higher margin than the fleet market. The fleet market fell by 7.2% in the year. retail market is the key market opportunity for the Group and represents 44% of the total market in 2018. The fleet market Our expectations are in line with the Society of Motor represents the sale of multiple vehicles to businesses, and is Manufacturers and Traders (“SMMT”) which is currently predominately transacted at a lower margin and consumes forecasting that the overall 2019 market will be 2.3% lower than higher levels of working capital than retail, and represented in 2018. 56% of the market in 2018. Units 10.0m 8.0m 6.0m 4.0m 2.0m 0 UK USED CAR MARKET 7.4m 7.9m 7.8m 7.6m 7.7m 7.8m 7.9m 2015 2016 2017 2018 2019 2020 2021 Source: Callcredit (2015 to 2017) and Pendragon (2018 to 2021) 25 Pendragon PLC Annual Report 2018OPERATIONAL AND FINANCIAL REVIEW 28 Business Review 32 Financial Review 34 Balance Sheet 35 Risk Overview 26 Pendragon PLC Annual Report 201927 Pendragon PLC Annual Report 2018BUSINESS REVIEW STRATEGY AND BUSINESS REVIEW The business has four areas as follows: • Leasing – provides a high Return on Investment stable • UK Motor – sale and servicing of vehicles in the U.K. profitability stream and used vehicle supply • Software – licencing of Software as a Service to automotive • US Motor – sale and servicing of vehicles in the U.S. business users (£m) Underlying REVENUE UK Motor Software Leasing US Motor Revenue GROSS PROFIT UK Motor Software Leasing US Motor Gross Profit OPERATING PROFIT UK Motor Software Leasing US Motor Operating Profit Gross Margin (%) Operating Margin (%) 2018 2017 Change (%) L4L Change (%) 4,074.4 4,243.6 16.9 57.3 478.4 15.8 64.9 414.8 4,627.0 4,739.1 456.7 14.9 18.8 60.1 550.5 41.1 11.7 14.8 8.6 76.2 11.9% 1.6% 471.0 13.8 13.9 54.2 552.9 52.3 10.9 9.8 10.8 83.8 11.7% 1.8% -4.0% +7.0% -11.7% +15.3% -2.4% -3.0% +8.0% +35.3% +10.9% -0.4% -21.4% +7.3% +51.0% -20.4% -9.1% +0.2% -0.2% -2.8% +7.0% -11.7% +15.3% -1.3% -2.0% +8.0% +35.3% +10.9% +0.6% -21.0% +7.3% +51.0% -20.4% -9.3% +0.2% -0.2% UK MOTOR Pendragon is the UK’s leading automotive online retailer with During late 2018 we launched the new Carstore.com website which offers a uniquely differentiated customer proposition, 32 used car only Car Stores and 177 franchise points. We including the ability for a customer to fully transact online, represent a range of volume and premium products that we either for full payment or utilising one of our finance options. sell and service. We are continuing to invest in further online capability and platforms to ensure we provide best in class service to our Overall, our UK Motor business revenue has reduced by 4.0% customers. in the year and by 2.8% on a like for like basis. Gross profit has reduced by 3.0% in the year and by 2.0% on a like for like basis. Our investment in Car Stores to expand our network in the UK continues. Following the opening of three purpose built Car The UK Motor Business has achieved an underlying operating Stores in the first half of the year, in the second half of the year profit of £41.1 million (2017: £52.3 million) in the period despite we closed former new car franchise dealerships, to repurpose because of adverse trading conditions in the new car market and open the sites as Nottingham Car Store, Stoke Car Store, and start up and transformation costs in our Car Store business. Borehamwood Car Store and Swansea Car Store in the period. In contrast to the new car performance, used cars gross profit has grown, particularly in the second half of 2018. Given the In 2017 the Group achieved record used revenue growth of impact of trading and market conditions on future cashflows, there has been a non-cash impairment of goodwill and non- 15.8%. Against this extremely strong comparative, like for like revenue fell by 1.0% in the year. Excluding nearly new vehicles, current assets relating to the UK Motor Business as set out in used vehicle revenue grew by 2.9% against a used car market the Financial Highlights section. We continue to see growth in reduction in the year of 2.2%. our online business, with visits to Carstore.com, Evanshalshaw. com and Stratstone.com up 5.1% to 28.7 million visitors from In order to facilitate future used revenue growth, in 2018 we 27.3 million visitors in the prior year. opened four dedicated used car refurbishment factories to 28 Pendragon PLC Annual Report 2018industrialise this process. Whilst this process transformation during 2018. Overall aftersales revenue fell by 2.3% on a like during the year has impacted used revenue growth and profits, for like basis as a result of closing a parts distribution point we are confident looking forward that this will aid growth, in favour of utilising the site as a Car Store. Aftersales gross together with the new and repurposed former franchise sites profit fell by 3.3% on a like for like basis with margin impacted providing additional capacity. by labour cost inflation for skilled technicians. We have incurred transformation costs in the year comprising New car national registrations were down 6.8% in 2018 and we the disruption that occurred during the transition to a factory outperformed the UK market with our L4L new revenues down preparation process and the start-up costs of the Car Store by 5.2%. Gross profit was down 8.3% following continuing businesses we have opened during the year. margin pressure in the Premium sector. UK New vehicle sales Used gross profit increased by 4.7% on a like for like basis. This of the year by the impact of the introduction of Worldwide improvement was driven by exceptionally strong used margins Harmonised Light Vehicle Testing Procedure (“WLTP”) which and profitability were adversely affected in the second half in the second half of 2018, when like for like used profit was created disruption to new car sales. 27.6% higher than in the prior year compared with a reduction of 12.6% in the first half of the year. We have settled historic VAT claims relating to the VAT treatment arising from purchases of vehicles from Motability. This was primarily driven by improved used inventory This has resulted in a provision release of £2.3m. During the management and more efficient used car preparation resulting year we sold four premium franchises for consideration of £7.9 in increased margin and significantly reduced numbers of loss- million and avoided capital expenditure of £18.2 million as a making used vehicles in the second half of the year. This has result. The non-underlying profit on disposal was £0.6 million. enabled us to reduce the level of the provision we have for In addition we have completed the disposal of two further loss-making used vehicles. Revenue in our Car Store business premium franchise points in February 2019 for consideration grew by £83.6m, an increase of 38.5%. Gross profit was up of £3.7 million and avoided capital expenditure of £7.3 million 42.2%. Including the impact of start-up and transformation as a result. We have also agreed lower refurbishment costs costs the operating loss for the business was £11.9m (2017 : at certain other premium brand locations bringing the total £6.9m). capital released, comprising disposal proceeds and capital expenditure avoided, to £46.7 million since we started this Retail service revenue increased by 2.1% on a like for like basis strategic initiative. UK MOTOR (£m) Underlying REVENUE Used Aftersales New Revenue GROSS PROFIT Used Aftersales New Gross Profit Operating Costs Operating Profit GROSS PROFIT MARGIN Used Aftersales New Gross Margin (%) Operating Margin (%) 2018 2017 Change (%) L4L Change (%) 2,092.4 337.4 1,644.6 4,074.4 164.2 181.5 111.0 456.7 (415.6) 41.1 7.8% 53.8% 6.7% 11.2% 1.0% 2,125.5 350.6 1,767.5 4,243.6 156.3 191.2 123.5 471.0 (418.7) 52.3 7.4% 54.5% 7.0% 11.1% 1.2% -1.6% -3.8% -7.0% -4.0% 5.1% -5.1% -10.1% -3.0% -0.7% -21.4% 0.4% -0.7% -0.3% 0.1% -0.2% -1.0% -2.3% -5.2% -2.8% 4.7% -3.3% -8.3% -2.0% 0.7% -21.0% 0.4% -0.6% -0.3% 0.1% -0.3% 29 Pendragon PLC Annual Report 2018BUSINESS REVIEW SOFTWARE The income stream from this business continues to grow and customers with an addressable user base of over 1,600. (2017:729). We are receiving substantial interest from a the business model provides a gross margin in excess of 85.0% number of markets, both from large dealer Groups and from with strong recurring revenue. car manufacturers. Pinewood has SaaS users in Europe, in the UK, Ireland, Gross profit is up 8.0% and operating profit is up 7.3% in Switzerland, Netherlands, Norway, Sweden and Germany. In spite of investment in new market localisation to support Africa, in South Africa, Namibia and Zimbabwe and in Asia the deployment of the system into new markets and new Pacific, in Hong Kong, Thailand and the Philippines. customers. Once this investment has been undertaken for a local market, the cost of further roll out to new customers is In 2018 we have implemented SaaS licences into international typically much lower. SOFTWARE (£m) Underlying REVENUE Revenue Gross Profit Operating Costs Operating Profit Gross Profit Operating Margin (%) 2018 2017 Change (%) L4L Change (%) 16.9 14.9 (3.2) 11.7 88.2% 69.2% 15.8 13.8 (2.9) 10.9 87.3% 69.0% 7.0% 8.0% 10.3% 7.3% 0.9% 0.2% 7.0% 8.0% 10.3% 7.3% 0.9% 0.2% LEASING Leasing comprises our fleet and contract hire vehicle activity. of contract. This in turn resulted in a release of provision of £2.8m in respect of vehicles that lose money on disposal. This Our leasing business trades under the ‘Pendragon Vehicle was offset by a reduced level of profitability of £2.0 million Management’ brand and offers a complete range of fleet leasing compared to the prior year on the warranty management and management solutions. Our customers are varied in both activities undertaken in this business. fleet size and business sector. Our services are delivered by maximising the facilities of our wider Group, as well as working Significant growth in the Leasing business was achieved in the very closely with market leading partners. The financing for the year with operating profit up £5.0m (+51.0%). Gross profit leasing business is provided by third parties leading to a very increased by 35.3% as result of the continued growth of the high return on investment. managed vehicle fleet and higher levels of disposals in the period at a strong overall margin. We are pleased with the The majority of vehicle disposals now pass through our Car increasing contribution that this business is providing to the Store factory preparation process and are sold to customers Group and the strong used vehicle supply it generates for our through our dealerships within the Group which has resulted Car Store used vehicle business. in a higher level of profits on disposal of vehicles at the end LEASING (£m) Underlying REVENUE Revenue Gross Profit Operating Costs Operating Profit Gross Profit Operating Margin (%) 30 2018 2017 Change (%) L4L Change (%) 57.3 18.8 (4.0) 14.8 32.8% 25.8% 64.9 13.9 (4.1) 9.8 21.4% 15.1% -11.7% 35.3% -2.4% 51.0% 11.4% 10.7% -11.7% 35.3% -2.4% 51.0% 11.4% 10.7% Pendragon PLC Annual Report 2018US MOTOR The business operates from nine franchise points representing There was a strong performance in aftersales with revenue up 16.8% and gross profit up 15.8% on a like for like basis. Used the following products that we sell and service: Chevrolet, revenue in the period on a like for like basis was 14.2% ahead Jaguar and Land Rover. of the prior year, with gross profit up 12.5%. In the new vehicle department revenue increased by 15.5% in the period, with a On 2 July 2018 we completed the disposal of our single Aston 7.4% increase in gross profit on a like for like basis. Operating Martin business in the US realising proceeds of £3.1 million, costs increased in the year by 18.7% primarily due to the full including goodwill received of £2.6m. Further disposals are year of costs in 2018 for our Chevrolet business. well progressed. (£m) Underlying REVENUE Used Aftersales New Revenue GROSS PROFIT Used Aftersales New Gross Profit Operating Costs Operating Profit GROSS PROFIT MARGIN % Used Aftersales New Gross Profit (%) Operating Margin (%) 2018 2017 Change (%) L4L Change (%) 97.9 43.2 337.3 478.4 5.4 22.7 32.0 60.1 (51.5) 8.6 5.5% 52.5% 9.5% 12.6% 1.8% 85.7 37.0 292.1 414.8 4.8 19.6 29.8 54.2 (43.4) 10.8 5.6% 53.0% 10.2% 13.1% 2.6% 14.2% 16.8% 15.5% 15.3% 12.5% 15.8% 7.4% 10.9% 18.7% 14.2% 16.8% 15.5% 15.3% 12.5% 15.8% 7.4% 10.9% 18.7% -20.4% -20.4% -0.1% -0.5% -0.7% -0.5% -0.8% -0.1% -0.5% -0.7% -0.5% -0.8% 31 Pendragon PLC Annual Report 2018FINANCIAL REVIEW FINANCIAL HIGHLIGHTS The Group has achieved an underlying profit before tax of used cars gross profit has grown, particularly in the second half of 2018. Interest costs increased in the period, mainly £47.8 million in the period despite adverse trading conditions due to higher levels of used car stock and consequently more in the new car market and start up and transformation costs in utilisation of stocking credit facilities. our Car Store business. In contrast to the new car performance, SUMMARY OF FINANCIALS £m Revenue Gross profit Operating (loss)/profit Analysed as: 2018 2017 Continuing Discontinued Total Continuing Discontinued Total Change % 4,148.6 478.4 4,627.0 4,324.3 414.8 4,739.1 490.4 (25.7) 60.1 11.3 550.5 (14.4) 498.7 80.6 Underlying operating profit 67.6 Non-underlying operating (loss)/profit (93.3) Finance expense Analysed as: Underlying net finance costs Non-underlying net finance costs (Loss)/profit before taxation Analysed as: Underlying profit before taxation Non-underlying (loss)/profit profit before taxation Income tax (expense) (Loss)/profit for the year Underlying Earnings per share Dividend per share Gross Margin (%) Operating Margin (%) (27.5) (25.9) (1.6) (53.2) 41.7 (94.9) (3.8) (57.0) 2.5p 11.8% -0.6% 8.6 2.7 (2.5) (2.5) - 8.8 6.1 2.7 (2.3) 6.5 0.3p 12.6% 2.4% 76.2 (90.6) (30.0) (28.4) (1.6) (44.4) 47.8 (92.2) (6.1) (50.5) 2.8p 1.50p 11.9% (0.3%) 73.0 7.6 (24.5) (21.8) (2.7) 56.1 51.2 4.9 (8.7) 47.4 2.9p 11.5% 1.9% 54.2 10.8 10.8 - (1.6) (1.6) - 9.2 9.2 - (3.3) 5.9 0.4p 13.1% 2.6% 552.9 91.4 83.8 7.6 (26.1) (23.4) (2.7) 65.3 60.4 4.9 (12.0) 53.3 3.3p 1.55p 11.7% 1.9% -2.4% -0.4% -9.1% +14.9% +21.4% -40.7% -20.9% -49.2% -15.2% -3.2% +0.2% -2.2% NON-UNDERLYING ITEMS Non-underlying income and expenses are items that are not market conditions on future cash flows. Pension costs of £12.1 million comprise interest and for 2018 a £10.5 million charge incurred in the normal course of business and are sufficiently to re-align the pension liabilities to reflect the guaranteed significant and/or irregular to impact the underlying trends minimum pensions for all pension members. The Group in the business. During the year the Group has recognised a recorded gains on the sale of properties and businesses in 2018 net charge of £92.2 million of pre-tax non-underlying items of £15.7 million against a loss in 2017 of £0.1m. This included against a credit of £4.9 million in 2017. These include non- £12.4 million on the sale of surplus property during the year and cash impairments, principally of goodwill and non-current gains of £3.3 million on the disposal of businesses. During the assets amounting to £95.8 million which have been necessary previous year the Group benefited from a £7.7 million credit following assessments of the carrying value of those assets in respect of VAT reclaims and associated interest following a which have been calculated by taking into account trading and Supreme Court ruling. £m Settlement of historic VAT issues Impairment of goodwill, property, plant and equipment and assets held for sale Gains/(losses) on the sale of businesses and property Pension costs Total non-underlying items before tax Non-underlying items in tax Total non-underlying items after tax 32 2018 2017 - (95.8) 15.7 (12.1) (92.2) 3.0 (89.2) 7.7 - (0.1) (2.7) 4.9 0.8 5.7 Pendragon PLC Annual Report 2018CAPITAL ALLOCATION The net debt to underlying EBITDA ratio was 0.9. We are SHARES REPURCHASED AND BUYBACK During the year the Group repurchased £6.7 million of its own expecting proceeds from the disposal of our US business in shares, as part of a £20.0 million share buyback programme. excess of £100 million before tax. Proceeds of £3.1 million have The Group has repurchased £18.2 million of its own shares since already been generated on the disposal of our single Aston the launch of the programme with 61.1 million shares cancelled. Martin US business in early July and further disposals are well progressed. We planned to release £100 million of capital from our Premium At this stage in the Group’s growth and investment cycle, the buyback has been paused in February 2019. franchise locations over a three year period. During the first The buyback programme is capable of being stopped and year of this process we have completed six such disposals and restarted. This flexibility enables the Group to pursue optimal agreed lower capital expenditure levels which has resulted in a capital allocation. total release of £46.7 million of capital comprising consideration and capital expenditure avoided. This included four franchise location disposals during 2018 and two in February 2019. PENSIONS The net liability for defined benefit pension scheme obligations has increased from £62.8 million at 31 December 2017 to £68.3 The Group intends to build a national network in the UK for the million at 31 December 2018. This increase in obligations of Car Store Used Vehicle business. As this model matures, the £5.5 million is largely the net effect of the expense recognised Board is continuing to evaluate the relative merits of freehold to equalise guaranteed minimum pensions less contributions property ownership against the lower capital requirements paid; movements in the respective assets and liabilities of of operating leasehold premises as we continue to grow our the Pension Scheme largely offset each other, reflecting the physical footprint. The company has ongoing capital expenditure requirements, hedging in place and an improvement in mortality assumptions. The Group contributed £7.5 million to the Pension Scheme in the year following the Group commitment to pay contributions and will continue to pursue organic and acquisitive growth and of £7.0 million from 1 January 2017, increasing by 2.25% investment opportunities. thereafter until July 2022. 33 Pendragon PLC Annual Report 2018FINANCIAL REVIEW BALANCE SHEET AND CASH FLOW The following table summarises the cash flows and net debt of the Group for the twelve month periods ended 31 December 2018 and 31 December 2017 as follows: SUMMARY CASHFLOW AND NET DEBT (£m) Underlying Operating Profit Before Other Income Depreciation and Amortisation Share Based Payments Working Capital and Contract Hire Vehicle Movements* Operating Cash Flow Tax Paid Underlying Net Interest Paid Capital Expenditure – Car Store Capital Expenditure – Franchise Capital Expenditure – Underlying Replacement Capital Expenditure – Business Acquisitions Capital Expenditure – Property Business and Property Disposals Net Franchise Capital Expenditure Dividends Share Buybacks Other Increase In Net Debt Opening Net Debt Closing Net Debt 2018 76.2 27.4 0.7 (16.2) 88.1 (10.9) (24.8) (6.8) (12.6) (30.6) - (6.5) 30.2 (26.3) (22.5) (6.7) (0.4) (3.5) 124.1 127.6 2017 83.8 28.5 (1.7) 18.3 128.9 (16.1) (20.0) (17.5) (25.5) (13.8) (17.8) (24.6) 2.5 (96.7) (21.3) (4.0) (3.2) (32.4) 91.7 124.1 *includes changes in inventories, changes in trade and other payables, changes in provisions, movement in contract hire vehicle balances, contributions into defined benefit pension scheme and loss on sales of businesses and property PROPERTY AND INVESTMENT, and the expected UK exit from the EU has resulted in ACQUISITIONS AND DISPOSALS Our property portfolio provides a key strength for our business. a continuing level of uncertainty in terms of consumer confidence, manufacturer behaviour in respect of new At 31 December 2018, the Group had £240.5 million of land and car supply and the possible impact of tariffs and currency property assets (2017 : £261.2 million) and property assets for movements. sale of £35.4 million (2017 : £9.6 million). • We will continue to invest in more used car sales capacity as DIVIDEND The Group is proposing a final dividend of 0.70p per share we move towards our goal of doubling our revenue by 2021. • We expect to continue to grow our software revenues with in respect of 2018, bringing the full year dividend to 1.50p our SaaS licencing to international users. We expect broadly per share. We intend to maintain dividend cover (defined as double digit revenue growth for the foreseeable future as we underlying earnings per share divided by dividend per share) invest in product localisation for international markets. at a minimum level of two times, with a progressive dividend • We anticipate the sale of our US business to realise in excess approach in the future, subject to the minimum dividend cover of £100 million before tax. being a minimum of approximately two times. • Further capital will be released through a mixture of disposal proceeds and investment not deployed in respect of our The proposed final dividend will be paid on 30 May 2019 for premium franchise businesses in the UK. those shares recorded on 23 April 2019. OUTLOOK • Economic and market conditions remain relatively subdued Given the economic and market conditions, we expect our performance in 2019 to be broadly stable against 2018, underpinned by our used car profitability. 34 Pendragon PLC Annual Report 2018RISK OVERVIEW & MANAGEMENT PRINCIPAL RISKS Recognising that all businesses entail elements of risk, the Board maintains a policy of continuous identification and Where appropriate, during the year, revised forecasts are prepared and presented for Board review and approval. review of risks which may cause our actual future Group To ensure that information to be consolidated into the Group’s results to differ materially from expected results. The table on financial statements is in compliance with relevant accounting pages 36 to 39 is an overview of the principal risks faced by policies, internal reporting data is comprehensively reviewed. the Group, with corresponding controls and mitigating factors. Reviews of the appropriateness of Group accounting policies The specified risks are not intended to represent an exhaustive take place at least twice a year, under the scrutiny of the Audit list of all potential risks and uncertainties. The risk factors Committee, which considers reports on this from the Group’s outlined below should be considered in conjunction with the Auditor, the application of IFRS and the reliability of the Group’s system for managing risk, described below and in the Group’s system of control of financial information. Corporate Governance Report on page 44. RISK MANAGEMENT AND INTERNAL CONTROLS Accountability The Board is responsible for risk management and internal No material changes have occurred in 2018 which have or are likely to have a material effect on the Group’s internal controls over financial reporting. Controls are designed to ensure that the Group’s financial reporting presents a true and control within the context of achieving the Group’s objectives. fair reflection of the Group’s financial position. The Board has The system of control the Board has established covers both concluded that, as at 31 December 2018, the Group’s systems the Group’s financial reporting and the mitigation of business of control over financial reporting were effective. and operational risks. The system is designed to manage, rather than eliminate, the risk of failure to achieve business objectives, and can provide only reasonable and not absolute assurance Operational and Other Risks Operational management is charged by the Board with against material misstatement or loss. responsibility for identifying and evaluating risks facing the Financial Reporting The Executive Directors oversee the preparation of the Group’s Group’s businesses on a day-to-day basis and is supported by the Risk Control Group (RCG), a Committee formed of two Executive Directors, the Company Secretary and Group Heads annual corporate plan; the Board reviews and approves it and of Information Technology and Internal Audit. The approach to monitors actual performance against it on a monthly basis. risk control and the work of the RCG are described on pages 45 and 46. 35 Pendragon PLC Annual Report 2018RISK OVERVIEW & MANAGEMENT NO. PRINCIPAL RISKS IMPACT BEFORE MITIGATION MITIGATION STRATEGY AND BUSINESS RELATIONSHIPS 1 Our Strategy: Failure to adopt the right strategy or, Failure of our adopted strategy to deliver the desired outcomes or, Failure to implement our strategy effectively or, Our ability to deliver our strategy is impacted by the UK’s decision to leave the EU 2 Our Manufacturer Relationships: Dependence on vehicle manufacturers for the success of our business We miss our profit growth and/or debt management target, alienate key stakeholders and are unable to invest adequately in our business We receive complaints or poor customer satisfaction scores which damage our reputation and ‘customer service’ ethos • Our strategy is informed by significant research and market data • We communicate effectively our adopted strategy to our stakeholders • We invest appropriately in the technological, physical and human resources to deliver our strategy, closely monitor performance against our objectives, and adjust our actions to meet our strategic goals • Our sophisticated management information identifies threats to the success of our strategy both during the planning and implementation phases, and informs mitigating actions, both directionally and operationally • We ensure that we monitor our manufacturer and third party customer service measures and take action in the event of low scores • We focus strongly on efficient use of working capital through embedded disciplines, especially in relation to vehicle inventory • We review capital expenditure plans to ensure our ROI objectives are achievable • Our mitigation steps in respect of Brexit are set out in risk 4 Failure of, or weaknesses in, our vehicle manufacturers’ financial condition, reputation, marketing, production and distribution capabilities, including the potential for supply disruption caused by the UK’s decision to leave the EU and lack of alignment with manufacturers’ remuneration systems for dealers impairs our investments and prevents us achieving our profit goals Failure to maintain good relations with our franchisors either through day-to-day activities or our strategic decisions impairs our ability to generate good quality earnings The Manufacturers change the business model towards direct sales to customers • Our diverse franchise representation avoids over reliance on any single manufacturer • Our close contact with our vehicle manufacturers seeks to ensure our respective goals and strategic decisions are communicated, understood and aligned, to deliver mutually acceptable performance • Our appropriately targeted investment in franchise assets and our performance maintains our reputation as a quality representative for our brand manufacturers • Our investment in marketing initiatives and our online presence supplement and enhance our market presence and offering over and above manufacturers’ marketing efforts • Our diverse franchise representation ensures new vehicle inventory is sourced from a wide variety of countries • Our strategy to develop and maintain revenues from used vehicles, aftersales, and our software and leasing segments reduces our overall reliance on new vehicle franchises 36 Pendragon PLC Annual Report 2018NO. PRINCIPAL RISKS IMPACT BEFORE MITIGATION MITIGATION 3 Our Competitors: Failure to meet competitive challenges to our business model or sector Customers migrate to alternative providers Intermediary companies establish a barrier between us and our customers Revenues and profits fall owing to competitor action • Our detailed market and sector monitoring systems assist early identification and effective response to any competitive or intermediary threats • Our scale, expertise and technological capabilities enable rapid and flexible response to market opportunities • Our well-developed customer relationship management capabilities and online customer offer of fulfilment tools aim to drive industry-leading service and attract customer loyalty • We continually seek to develop new methods of customer interaction, particularly online. This enables the business to anticipate changing customer needs THE UK’s DECISION TO LEAVE THE EUROPEAN UNION (“BREXIT”) 4 Failure to prepare for the UK’s departure from the EU Changes in regulation as a result of Brexit Consumer confidence and economic activity falls New vehicle prices rise as a result of exchange rate changes Fewer purchasers of vehicles Lower demand for vehicle servicing Availability and cost base of appropriate team member resource to run our business effectively • We maintain the right level of legal expertise to interpret, assess and respond to proposed changes in regulation, enabling us to adapt to our model and processes to comply with changes in a seamless manner • We constantly monitor used vehicle market trends and adjust our inventory, pricing and procurement accordingly. • Our diverse franchise representation ensures new vehicle inventory is sourced from a wide variety of countries • Our strategy to develop and maintain revenues from used vehicles, aftersales and our software and legal segments reduces our overall reliance on new vehicle franchises • We constantly monitor and evaluate alternative recruitment, training and apprenticeship methods to fulfil our employment needs ENVIRONMENTAL 5 Progression towards greener technologies, autonomous driving, and/or pay-per-use, rather than owning a vehicle Customers choose greener vehicles we cannot supply Overall vehicle parc reduces Vehicle purchase and use declines, adversely affecting revenue opportunities UK taxes change to penalise road use, fuel type, vehicle use and to increase VAT Lower demand for diesel vehicles and potential impact on diesel vehicle residual values Government policy and consumer sentiment in respect of diesel vehicles impacts the sale of diesel vehicles • We represent vehicle brands which are responding effectively to the greener technology agenda • We identify trends in demand through our sophisticated management information and analysis tools and tailor our model accordingly • We monitor diesel sales to maintain an appropriate inventory profile • Our breadth of relationships with asset finance companies and geographic footprint help us to provide innovative mobility solutions for private and business vehicle users, whatever their needs • We maintain the right level of tax expertise to interpret and assess proposed changes, respond with well-informed advice and effectively assist our strategic planning and the design and implementation of appropriate mitigating actions 37 Pendragon PLC Annual Report 2018RISK OVERVIEW & MANAGEMENT NO. PRINCIPAL RISKS IMPACT BEFORE MITIGATION MITIGATION • We maintain the right level of legal expertise to interpret, assess and respond to proposed changes in regulation, enabling us to adapt our model and processes to comply with changes in a seamless manner • Our culture focuses strongly on good compliance delivering good performance • Our team of compliance specialists design, and we communicate effectively, processes that support our businesses to minimise the risk of non-compliance • In the case of new vehicles, our diverse representation mitigates the risk and for parts we maintain alternative sources of supply where possible • We adopt and regularly update robust business continuity measures, including within our dealer management systems • Our geographic diversity allows prompt deployment of key functions to alternative locations • Our Pinewood business monitors cyber security threats and has systems and processes in place to deal with incidents • We have cyber liability insurance in place • We regularly review our data protection policies, controls, team member training and the use of third party systems • We assess actual outturns of previous estimates to test the robustness of adopted assumptions, and adjust the estimating approach accordingly • We support estimates with reliable external research where available LEGAL AND REGULATORY Significant litigation 6 Regulator action against or otherwise impacting the Group Resources are diverted to taking proceedings or defending legal or regulatory action, at the expense of business efficiency and profit Reputation is damaged by regulatory censure or punitive action Fines and penalties reduce profits Changes in regulations impacting the Group, eg trade tariffs The ability to obtain appropriate inventory is impeded and/or purchase costs rise Disruption to the regulatory environment as a result of the UK’s decision to leave the EU TECHNOLOGY, INFORMATION SYSTEMS AND ESTIMATES Failure of systems 7 Cyber security Data loss, including non compliance with GDPR 8 Reliance on the use of significant estimates which prove to be incorrect Data loss interrupts business, incurs cost of recreating records, causes loss of or impairment to financial and operational control and loss of business opportunities and potentially results in regulator action and possible fines and penalties Website interruptions and other potential consequences of system failure or cyber attack Customer confidence is impaired Group’s financial statements will be wrong, affecting vehicle values where we have committed to purchase at a pre-set price, and the discounted cashflows used to test impairment of goodwill, expected profit or loss on sale of our inventory items and the retirement benefit obligation Reputational damage and inability to raise funding for the Group’s business Revenue and profits all suffer damage 38 Pendragon PLC Annual Report 2018NO. PRINCIPAL RISKS IMPACT BEFORE MITIGATION MITIGATION MACRO-ECONOMIC, POLITICAL AND ENVIRONMENTAL 9 European economic instability and/or UK or USA economic and business conditions deteriorate UK Governmental spending constraints Fewer purchasers of vehicles Vehicle manufacturers oversupply into UK market or alterations to supply terms, damages margins and vehicle values Lower demand for vehicle servicing • Our business model derives revenues from every stage of the vehicle’s life-cycle and has expanded into the older vehicle parc for both vehicle sales and aftersales • We carefully control new vehicle inventory to mitigate effects of overstocking • We invest in and vigorously pursue customer retention initiatives to secure longer term loyalty FINANCE & TREASURY 10 Availability of debt funding Unable to meet debt obligations • Our business model produces strong free cash flow generation Pension liabilities Unsustainable demand of funding occupational pensions schemes • We maintain adequate committed facilities to meet forecast debt funding requirements • Diversification of funding sources, monitor daily our funding requirements • Regular review by our pension trustees of investment strategy and liability reduction and risk mitigation, taking professional advice TEAM MEMBERS AND THE ENVIRONMENT WE WORK IN 11 Failure to attract, develop, motivate and retain good quality team members and leaders Failure to provide safe working and retail environments Failure to control environmental hazards Poor decision making and inability to deliver our strategy and meet our business objectives • We invest in online means of attraction and recruitment, targeting the right quality candidates • We set clear competencies and career goals to Lack of innovation in our business Loss of custom owing to poor quality customer experience delivered by demotivated or untrained team members Illness and injury, lost working time and civil claims Reputational damage and clean-up costs, leading to loss of custom and revenues Regulatory censure, suspension of business, convictions and fines; reputational damage, leading to loss of custom and revenues Availability of appropriate team member resource as a result of Brexit as noted in risk 4 above prevent mishires • We continually review and adapt for the market conditions our employment terms, salaries and performance related pay elements at all levels • We adopt and renew responsive succession plans for all key roles • We leverage our scale to afford training opportunities and progression within the Group • We work to the Health & Safety Executive’s ‘Plan, Do, Check, Act’ framework for managing risk in the workplace and our retail spaces • We allocate clear responsibilities for delivery of safe places to work and shop • We adopt process-driven initiatives to mitigate specific risk areas • We measure and review our performance against appropriate benchmarks • We allocate local accountability for sites’ compliance and provide specialist support to responsible leaders • We monitor site conditions and drive corrective action through audit follow-up 39 Pendragon PLC Annual Report 2018VIABILITY STATEMENT VIABILITY STATEMENT In accordance with provision C.2.2 of the UK Corporate • The ability to adapt to changing environments outside our direct control such as macro-economic, political and Governance Code, published by the Financial Reporting environmental factors, regulation changes, manufacturer Council in September 2014 (the ‘Code’), the Directors have and competitor behaviour. The Board has specifically assessed the viability of the company over the three year reviewed the potential impacts and available mitigating period to 31 December 2021. actions as a result of Brexit. In particular the Board reviewed the causes and consequences of the reduction in The Directors believe this period to be appropriate as: profitability year on year in assessing the risks. We mitigate i) The Group’s detailed plan encompasses this period. these risks through the diverse revenue generation from ii) We typically, at inception, look to attain a revolving credit all parts of the vehicle cycle and wide range of franchise facility for at least four years. representation together with regular monitoring to identify changes quickly. The three year review considers the Group’s profit and loss, cash flows, debt and other key financial ratios over the During 2018, the Board carried out a robust assessment of the period. These metrics are subject to sensitivity analysis which principal risks facing the Group, including those that would involves flexing several of the main assumptions underlying threaten its business model, future performance, solvency or the forecast. Where appropriate, this analysis is carried out liquidity. The Directors believe that the Group is well placed to evaluate the potential impact of the Group’s principal risks to manage its business risks successfully, having taken into actually occurring. The three year review also makes certain account the current economic outlook. Accordingly, the Board assumptions about the normal level of capital recycling likely to believes that, taking into account the Group’s current position, occur and considers whether additional financing facilities will and subject to the principal risks faced by the business, the be required. Based on the results of this analysis, the Directors Group will be able to continue in operation and to meet its have a reasonable expectation that the company will be able liabilities as they fall due for the period up to 31 December 2021. to continue in operation, comply with facility covenants and meet its liabilities as they fall due over the three year period of their assessment. In addition, further discussion of the principal risks and material uncertainties affecting Pendragon PLC can be found within the Annual Report and Accounts on pages 36 to 39. The risk disclosures section of the consolidated financial statements set out the principal risks the Group is exposed to, including strategic, operational, economic, market, environmental, credit, technological, regulatory and team member resource, including the impact of Brexit together with the Group’s policies for monitoring, managing and mitigating its exposures to these risks. The Board considers risks during the year on triannual basis through the Risk Control Group and annually at a Board meeting with ad hoc reporting as required. The principal risks and the mitigation steps that the Board considered as part of this viability statement were as follows: • The ability to adopt and implement an appropriate strategy, including our goal to double used vehicle revenue over five years to 2021 with investment in capacity in the UK and the implementation of the disposals we announced in 2017. This is mitigated by our management information and market data, appropriate investment, monitoring of our performance and focus on financial discipline. • The availability of debt funding, in particular, the successful refinancing of the RCF, when it expires in 2021. 40 Pendragon PLC Annual Report 2018DIRECTORS REPORT 42 Board of Directors 44 Corporate Governance Report 48 Corporate Social Responsibility Report 50 Committee Reports 56 Directors’ Remuneration Report 69 Directors’ Report 41 Pendragon PLC Annual Report 2018BOARD OF DIRECTORS CHRIS CHAMBERS Non-executive Chairman (N*) (R) Chris joined Pendragon on 28 January 2013 and became Chairman on 23 October 2017. He is a banker with particular expertise in retail and property, and is Chairman of Leonteq, Lonrho and a member of the supervisory board of Berenberg Bank. RICHARD LAXER Non-Executive Director (A*) (N) (R) (SID) Richard joined Pendragon on 12 November 2018. Formerly the Chairman and CEO of GE Capital, he has extensive board experience, being a former Non-Executive Director serving on the Boards of several European based banks. GILLIAN KENT Non-Executive Director (A) (N) (R) Gillian joined Pendragon on 23 May 2013. Formerly Managing Director of MSN, UK, Microsoft and holds a number of Non-Executive roles including Ascential plc, Mothercare and NAHL plc as well as working with high growth technology start-ups. MIKE WRIGHT Non-Executive Director (A) (N) (R*) Mike joined Pendragon on 2 May 2018, following an executive career in the international automotive sector, including senior roles at Jaguar Land Rover, Ford and BMW.  In addition to his extensive executive experience, he is involved with a number of government related initiatives, as well as activities spanning education, sport and the arts. MARTIN CASHA Chief Operating Officer Having spent his entire career with Pendragon businesses, from apprentice mechanic to Group General Manager, Martin became Operations Director in September 1995 and Chief Operating Officer in November 2001. Key to memberships and roles * Committee Chairman (A) Audit Committee (N) Nomination Committee (R) Remuneration Committee (F) Audit Committee member with recent and relevant financial experience (SID) Senior Independent Director More detailed professional biographies of the Directors are on the company’s website.www.pendragonplc.com 42 Pendragon PLC Annual Report 2018TREVOR FINN Chief Executive Having spent a career in the retail motor industry, starting as an apprentice mechanic, Trevor became Chief Executive of Pendragon in 1989, when the company first listed on the London Stock Exchange. Trevor retires from the role of Chief Executive of Pendragon PLC on 31 March 2019. MARK HERBERT Chief Executive Designate Mark joined Pendragon on 4 March 2019 as Chief Executive Officer Designate. He will assume the role of Chief Executive Officer on 1 April 2019. Mark brings the experience of a 20 year executive career with Jardine Matheson Group, including positions as a Group Finance Director and a Chief Executive Officer. TIM HOLDEN Finance Director Tim is a chartered accountant and joined Pendragon from KPMG in June 2008, as Group financial controller. He became Finance Director in December 2009. Tim steps down from the company on 31 March 2019. MARK WILLIS Chief Finance Officer Mark will join Pendragon on 8 April 2019 as Chief Finance Officer. Mark joins Pendragon from Ten Entertainment Group PLC where he has been its Chief Finance Officer since taking it through its IPO in April 2017. Company Secretary Richard Maloney Group motor businesses websites www.evanshalshaw.com Registered Office Loxley House 2 Oakwood Court Little Oak Drive Annesley Nottingham NG15 0DR Telephone 01623 725200 www.stratstone.com www.carstore.com www.hornburg.com Group Support business websites www.pinewood.co.uk www.pendragonvehiclemanagement.co.uk www.quickco.co.uk Registered in England and Wales Registered number 2304195 43 Pendragon PLC Annual Report 2018CORPORATE GOVERNANCE REPORT The UK Corporate Governance Code (Code) applies to the and Remuneration, each made up entirely of Non-Executive company and is available on the FRC website at https://www. Directors. The Risk Control Group (RCG) is a Committee of frc.org.uk. Other than where expressly stated, throughout 2018, the Executive Directors, the Company Secretary and Group the company complied in full with the applicable provisions of Heads of Information Technology and Internal Audit. Each the Code. The corporate governance statement as required Committee operates within delegated authority and terms of by Disclosure and Transparency Rule 7.2.1 is set out below. reference, set by the Board, reviewed annually and available to OUR BOARD The Board sets our company’s strategy and ensures we have in view on the company’s website. Details of each Committee’s work appear on the next few pages of this Report. Executive Directors can attend Board Committees at times, to assist their place the financial and human resources we need to meet our business, but only with the Committee’s prior agreement. objectives. We take collective responsibility for Pendragon’s long term success. The Executive Directors, led by the Chief Executive, are responsible for running the company and our LEADERSHIP AND BOARD COMPOSITION As at 12 March 2019, the Board is made up of three Executive Group to effect that strategy, and work within prescribed Directors and four Non-Executive Directors, one of whom is delegated authority, such as capital expenditure limits. The Chairman. The respective responsibilities of the Board, the Executives direct and monitor business performance through Chairman and the Chief Executive are clearly defined by the regular operational meetings with their respective leadership Board in formal responsibilities documents, which the Board teams and set and regularly review the effectiveness of key reviewed and readopted in 2018. The Board is committed operating controls, reporting to the Board on these and to the progressive refreshing of our membership, so as to any variances. The Board as a whole reviews management maintain the right balance of skills, experience, independence performance. Although the Board delegates to the Chief and knowledge of the company to enable us to continue Executive and Finance Director responsibility for briefing operating effectively. In March 2018, Mike Wright joined the key stakeholders, major shareholders and the investor Board as an additional Non-Executive Director and assumed community, the Chairman holds himself available to engage the Chair of the Remuneration Committee. In November 2018, with shareholders, and the Senior Independent Director is Jeremy King stepped down as a Non-Executive Director, ready to perform a similar role, where appropriate. Information Senior Independent Director and chair of the Audit Committee from engagement with all stakeholders is shared with the and Richard Laxer joined the Board as a Non-Executive entire Board and taken into account in financial planning and Director and Senior Independent Director, and assumed chair strategy. The Board has three Committees: Audit, Nomination of the Audit Committee. The Board is actively seeking to PENDRAGON PLC BOARD NOMINATION COMMITTEE REMUNERATION COMMITTEE AUDIT COMMITTEE EXECUTIVE COMMITTEE MAIN BOARD COMMITTEES RISK CONTROL GROUP OPERATIONAL MEETINGS 44 Pendragon PLC Annual Report 2018recruit an additional Non-Executive Director. In October 2018, risk assessment and control fall within the remit of Committees the company announced that Tim Holden would be standing of the Board; details of their work in 2018 appear below. down as Finance Director on 31 March 2019. Mark Willis joins Pendragon on 8 April 2019 as Chief Finance Officer. On 18 THE BOARD’S REVIEW OF RISKS February 2019, the company announced that Mark Herbert joined the company as Chief Executive Officer designate, AND CONTROLS IN 2018 During the year, the Board considered all strategic matters, and will assume the role of Chief Executive Officer and join received key performance information on operating, the Board on 1 April 2019. As announced on 14 December financial and compliance matters and reviewed the results 2018, Trevor Finn will retire from the role of Chief Executive of corresponding controls and risk management. We of Pendragon PLC on 31 March 2019. Trevor will hand over received from the Audit Committee and from the RCG timely his Chief Executive Officer responsibilities to Mark Herbert information and reports on all relevant aspects of risk and and will remain available to support an orderly transition corresponding controls. We reviewed all our key company until his leaving. Other than the changes described above, no policies and ensured all matters of internal control received other changes to Board membership occurred to the date of adequate Board scrutiny and debate. At Board meetings, and publication of this report. In accordance with the UK Corporate informally via the Chairman, all Directors had the opportunity Governance Code, all Directors will be subject to annual re- to raise matters of particular concern to them. There were no election (or election in the case of newly joined Directors) at unresolved concerns in 2018. We concluded that all appropriate the Annual General Meeting of the company. Details of the controls are in place and functioning effectively. Directors offering themselves for election in 2019, together with Directors’ brief biographical details appear on page 42, The Board considers that the Group’s systems provide and gender balance details are on page 48. information which is adequate to permit the identification of key HOW THE BOARD MANAGES RISK The Board and our Committees each operate to a set meeting risks to its business and the proper assessment and mitigation of those risks. Based on the Audit Committee’s and the RCG’s work, the Board has performed a high level risk assessment, agenda which ensures that all relevant risks are identified and to ensure that (i) the principal risks and uncertainties facing addressed by appropriate controls. We review management the Group’s business have been identified and assessed, taking information which helps us to prescribe operating controls and monitor performance against our strategy and business plans. into account any adaptations made to the Group’s business strategies, and (ii) that appropriate mitigation is in place. Our The Non-Executive Directors have particular responsibility for company policies on managing financial risk and application monitoring financial and performance reporting, to ensure that of hedging are set out in note 4.2 to the financial statements. progress is being made towards our agreed goals. The Board’s The principal risks and uncertainties we have identified are on responsibilities also include assessing the effectiveness of pages 35 to 39 and our viability statement is on page 40. internal controls and the management of risk. Specific areas of 45 Pendragon PLC Annual Report 2018CORPORATE GOVERNANCE REPORT WORK OF THE RISK CONTROL GROUP The accountability framework described on page 35 is • subject to the recruitment of an additional Non-Executive Director, the Board and each of its Committees is of the designed to ensure comprehensive management of risk across right size and balance to function effectively; the Group’s businesses. The Risk Control Group (RCG), made • we have satisfactory plans for orderly succession to Board up of the Chief Operating Officer, Finance Director, Company roles; Secretary, and Group Heads of Information Technology and • the Chairman and respective Committee chairmen are Internal Audit, performs detailed work on risk assessment performing their roles effectively; and oversees the effective implementation of new measures • all Non-Executive Directors are independent in character designed to mitigate or meet any specific risks or threats. The and judgment; Chair of the Audit Committee, a representative of the external • no Director has any relationships or circumstances which Auditor and the Group Insurance Risk Leader attend by could affect their exercising independent judgement; and invitation. The RCG reports to the Audit Committee on its work. • the Chairman and each of the Non-Executive Directors The Board and any of its Committees is able to refer specific is devoting the amount of time required to attend to the risks to the RCG for evaluation and for controls to be designed company’s affairs and their duties as a Board member. or modified; this occurs in consultation with operational management. The Executive Directors are responsible for communicating and implementing mitigating controls and BOARD EVALUATION Between January and March 2018 recruitment of an additional operating suitable systems of check. The RCG met three times Non-Executive Director was ongoing. For nine months from in 2018. In addition to reviewing and refining the Group’s March 2018, the Board consisted of seven Directors, consisting corporate risk register, for Board review and adoption, the of three executive and four Non-Executive Directors, including RCG continues to monitor and review the Group’s anti-bribery the non-executive Chairman and was considered to be of controls and data protection controls Consumer Rights Act the correct size and balance to function effectively. During 2015 training, Modern Slavery Act 2015 awareness and further 2018, the Board received informal briefings from company initiatives to reduce incidences of theft and fraud. Following its executives to familiarise Directors with strategic developments review of the Group’s systems of internal control, the RCG has and key aspects of the Group’s business. Formal presentations reported to the Audit Committee that it has not identified any to the Board by senior Group executives focussed on matters weakness in controls which would have a material effect on of strategic importance. The Board and its Committees the Group’s business. The Audit Committee has reviewed and conducted formal evaluations of their effectiveness in 2018, accepted the processes adopted by the RCG in this respect facilitated by the Chairman, addressing questions based and accepted its conclusions. NON-EXECUTIVE DIRECTORS closely on the Code, applicable good governance topics and drawn from best corporate practice. The results were reviewed by the Chairman, the Committee chairmen and the AND INDEPENDENCE The Non-Executive Chairman (who, on appointment to that Board as a whole and the Chairman has factored suggested improvements into our 2019 Board programme. More details role, fulfilled the requirement to be independent) has ensured on the Board’s approach to individual and Board evaluation are that the Board performs effectively though a well-functioning on the company’s website. The company is currently outside combination of Board and Committee meetings and other of the FTSE 350, so is not required to facilitate the evaluation appropriate channels for strategic input and constructive externally. challenge from Non-Executive Directors. The Chairman has held meetings with the Non-Executive Directors without the Executive Directors present, where necessary to assist Board RE-ELECTION OF DIRECTORS In accordance with the UK Corporate Governance code, all effectiveness, and, following the 2018 year end, conducted Directors will be subject to annual re-election or election (in individual meetings with each Director to arrive at his and the the case of new Directors) at the AGM. Board’s assessment of the Directors’ respective contributions, training needs and independence. Led by the Senior Non- Executive Director, the Directors have assessed the Chairman’s INFORMATION AND SUPPORT To ensure our decisions are fully informed and debated, the effectiveness in his role. The Board has routinely operated Chairman ensures our Board’s business agenda is set timely to conflict management procedures and has deemed these procedures effective. Through these, and the evaluations allow appropriately detailed information to be circulated to all Directors before meetings. The Company Secretary facilitates which are described below, we have concluded that:- the flow of information within the Board, attends all Board • the Board’s collective skills, experience, knowledge of the meetings and is responsible for advising the Board and its company and independence allow it and its Committees Committees, through their respective chairmen, on corporate to discharge their respective duties properly; governance and matters of procedure. All Directors have 46 Pendragon PLC Annual Report 2018Director Chris Chambers (B) (I) (N) Gillian Kent (I) Jeremy King* (I) (A) Mike Wright** (I) (R) Richard Laxer*** (I) (A) Trevor Finn Martin Casha Tim Holden Board 10/10 10/10 8/8 7/9 2/2 9/10 10/10 9/9 Audit Nominationº Remuneration N/A 3/3 3/3 2/2 N/A N/A N/A N/A 3/3 3/3 3/3 2/2 N/A N/A N/A N/A 3/3 3/3 2/2 2/2 N/A N/A N/A N/A (I) Considered by the Board to be independent; the Chairman is required to fulfil this criterion at appointment but not thereafter. (B) Chairman of the Board. (A) Audit Committee Chairman (N) Nomination Committee Chairman (R) Remuneration Committee Chairman. *Resigned from the Board as Non-Executive Director, Senior Independent Director and Chair of Audit Committee on 12 November 2018. Acting Remuneration Committee Chairman until appointment of Mike Wright. **Appointed as Non-Executive Director and chair of the remuneration Committee on 26 March 2018. *** Appointed as Non-Executive Director, Senior Independent Director and chair of the Audit Committee on 12 November 2018. Shows the number of meetings attended out of the total a Director was eligible to attend. Where the Nomination Committee is undertaking a specific recruitment, continuing Directors only are eligible to attend. access to support from the Company Secretary on matters of location, provide a forum for sharing both company and local procedure, law and governance and in relation to their own information. At all levels, communications aim particularly to induction and professional development as Board members. recognise the achievements of individual team members and All Directors are entitled to take independent advice at the celebrate outstanding personal and business performance, company’s expense, and to have the company and other through peer recognition and widely publicised awards. Each Board members provide the information required to enable year we review our incentive and recognition programmes them to make informed judgements and discharge their duties aligned to the Group’s business objectives. effectively. COMMUNICATION We aim to meet the challenges presented by our size and DIVERSITY AND EQUALITY OF OPPORTUNITY We are an equal opportunity employer, committed to ensuring that our workplaces are free from unfair discrimination, within geography through innovation in internal communications. the framework of the law. We aim to ensure that our team Internal website messaging, video and face to face presentations members achieve their full potential and that, throughout all as well as electronic newsletters and social media content our attraction, recruitment, selection, employment and internal keep team members up-to-date with the company’s strategy promotion processes, all employment decisions are taken and performance. Team members’ views on our performance without reference to irrelevant or discriminatory criteria. The and services are actively gathered via targeted electronic company’s diversity and equal opportunities policy is available surveys. Regular briefings for all team members, held at each at www.pendragonplc.com 47 Pendragon PLC Annual Report 2018CORPORATE SOCIAL RESPONSIBILITY REPORT Number of Group Employees by category Director Senior Manager All Employees as at 31 December 2018 as at 31 December 2017 Female Male Total Female Male Total 1 0 6 5 7 5 1 0 5 5 6 5 2,438 6,756 9,194 2,379 6,973 9,352 GENDER BALANCE We describe our approach to Board composition diversity in COMMUNITY We are predominantly a retail operator, with a tangible the Nomination Committee’s report on page 54. presence in the many communities our businesses serve. HEALTH AND SAFETY We take seriously our responsibility to our team members, During 2018, our monthly fundraising events supported a range of national charities, including the British Heart Foundation, Help for Heroes, Macmillan Cancer Support, Cancer Research, customers and the public. We aim to ensure that all team Comic Relief and Children in Need. Our Academy and retail members in the course of their roles, and all who work in or businesses also generate community involvement through visit our facilities or receive our services, so far as is reasonably local engagement, contributing to their local areas in a variety practicable, experience an environment and practices which of ways. Individuals and businesses organise charity events are safe and without risk to their health. to support schools, hospitals and local children’s and medical charities as well as the Group wide monthly nominated charity. Our policy is to identify and assess all potential risks and The company supports and encourages these activities and hazards presented by our activities and to provide systems and we welcome the opportunities they present for team-building procedures which allow all team members in their daily work to within our businesses, engagement with the communities they take responsible decisions in relation to their own and others’ serve and recognition of charitable causes with whom our health and safety. We publish a clear hierarchy of responsibility team members and their families have connections. to team members and reinforce this through regular monitoring by a variety of means. We promote awareness of potential risks and hazards and the implementation of RESPONSIBLE SOURCING All our Group’s sites are situated within the UK or US and corresponding preventative or remedial actions through our at each of them we operate in strict compliance with all on-line health and safety systems, operations manuals and applicable labour relations laws. We have no presence, either regular communications on topical issues. Our health and directly or via sub-contractors, in any areas which present safety management system provides our UK leadership and any risk of the exploitation of men, women or children in the team members with detailed access to information, guidance workplace. We work with vehicle manufacturers and other and control measures. suppliers who manage their supply chains in a responsible way, free from the exploitation of labour. We have adopted an Anti- ACCIDENTS AT WORK Historically, we have assessed our safety record against relevant Slavery and Human Trafficking Policy, available to view on our website, together with our Anti-Slavery and Human Trafficking published benchmarks. This year, as a result of changes to the Statement for the year ending 2018. Health & Safety Executive sector categorisations, the natural sector comparator for our Group is Wholesale and Retail Trade ENVIRONMENT AND GREEN HOUSE GAS (GHG) and Repair of Motor Vehicles and Motorcycles. There has been an increase in RIDDOR1 reported accidents in 2018, rising to 38 per 10,000 employees (2017: 31 per 10,000 employees). EMISSIONS REPORTING Although not generally regarded as a high environmental impact sector, motor retailing and its associated after sales Whilst this is higher than the relevant sector average (24 per service activities carries with it a range of responsibilities 10,000 employees), this is primarily as a result of our improved reporting system for accidents, the increased accuracy of our relating to protection of the environment. Our policy is to promote and operate processes and procedures which, so far as reporting and improved classification of RIDDOR and non- is reasonably practicable, avoid or minimise the contamination RIDDOR accidents. We continue to target specific hazards of water, air or the ground; and to manage responsibly the by- and risks for improved results through additional monitoring products of our activities, such as noise, waste packaging and and promotion of safe working processes. substances and vehicle movements. During the year, we have 1RIDDOR: the Reporting of Injuries, Diseases and Dangerous Occurrences Regulations 2013. 48 Pendragon PLC Annual Report 2018 Global Greenhouse Gas Emissions Data Source Tonnes of CO2 01.01.18 – 31.12.18 01.01.17 – 31.12.17 C02 emitted from facilities C02 emitted from driving activities Intensity ratio (tonnes of CO2 per £k) 11,461 9,179 4.5 14,517 9,403 5.1 continued to be registered with and have complied with our and estimated usage for our US businesses. We also include obligations under the Department for Environment, Food and emissions from driving activity, comprising data verified Rural Affairs’ (DEFRA) carbon reduction commitment scheme. internally, including estimates of distances travelled during test The company’s statement of environment policy is available at drives, transportation of vehicles and parts between sites, and www.pendragonplc.com business travel (excluding commuting by means which are not owned/controlled by us). GREENHOUSE GAS EMISSIONS This section includes our mandatory reporting of greenhouse gas emissions for the period 1 January 2018 to 31 December REDUCING CARBON AND WASTE During the year, we have continued to assess and monitor our 2018, pursuant to the Companies Act 2006 (Strategic Report energy use and, where practicable, to implement measures and Directors’ Report) Regulations 2013. designed to reduce our activities’ environmental impact, which, over time, we anticipate will help reduce our carbon footprint. Our methodology to calculate our greenhouse gas emissions is based on the ‘Environmental Reporting Guidelines: including The Group has undertaken mandatory energy assessments mandatory greenhouse gas emissions reporting guidance’ of our sites in accordance with the ESOS Regulations 2014. (June 2013) issued by DEFRA using DEFRA’s 2018 conversion We continue to use the results of this assessment to identify factors. In some cases, we have extrapolated total emissions further energy saving opportunities. To conserve energy, we by utilising available data from part of the reporting period, continue, where practicable, to install LED lights at our sites, and extending it to apply to the full reporting period. limit the duration of periods when full lighting is used on our We report our emissions data using an operational control and fit insulators to limit the escape of heat. approach to define our organisational boundary. We have reported all material emission sources for which we deem We continue to seek to limit our paper consumption and waste, ourselves to be responsible, including both our UK businesses through increasingly paperless communications and systems. sites out of hours, keep external doors closed when not in use, 49 Pendragon PLC Annual Report 2018AUDIT COMMITTEE REPORT The Audit Committee is a Committee of the Board and has been chaired by Richard Laxer since November 2018, made up entirely of Independent Non-Executive Directors. Their names and qualifications are on page 42 and attendance at meetings in the table on pages 47. KEY RESPONSIBILITIES OF THE AUDIT COMMITTEE • monitors the integrity of the financial statements and LLP, and are satisfied that KPMG have addressed these in the 2018 audit cycle. KPMG LLP also gave formal assurance to the formal announcements company of its ability as Auditor to place reliance on the work • reviews and approves the Annual Report and Accounts of the internal audit team and concluded that the scope and for adoption by the Board quality of the internal audit work done reflects an effective, • recommends to the Board the selection of the external well-functioning team. Key aspects of those discussions and Auditor and its terms of appointment and monitors its relevant considerations and conclusions are below:- effectiveness and independence • governs policy for the allocation of non-audit work to the audit firm KEY ACCOUNTING JUDGEMENTS The table on page 90 are the key accounting judgements that • reviews internal controls and risk management the Committee considered and discussed with the Auditor. • monitors the effectiveness of the internal audit function The Committee is satisfied that appropriate judgements have • reviews and monitors whistleblowing arrangements been made. Its terms of reference detail its key responsibilities and appear, with relevant background information, on the company’s AUDIT RISK CONSIDERED BY THE COMMITTEE The table below sets out the key audit risks applied, for the website www.pendragonplc.com. 2018 year results, which the Committee considered and discussed with the Auditor, and the Committee’s conclusions. THE COMMITTEE’S WORK IN 2018 The Audit Committee met three times in 2018 and this report describes its work and conclusions. FINANCIAL STATEMENTS REVIEW The Committee received the Auditor’s memorandum on the company’s 2017 financial statements and the Auditor’s memorandum on the unaudited 2018 interim results. In each case, it discussed the Auditor’s findings with the Auditor, satisfied itself of the integrity of the financial statements and recommended the financial statements for approval by the Board. In addition, the Committee has been through the findings of the FRC review of the audit in 2017 with KPMG Audit risk considered by the Committee Evidence considered and conclusion reached GOODWILL VALUATION The judgements in relation to asset impairment of the carrying The Committee considered the risk that goodwill could be materially overstated in the context of the sensitivity analysis, value of goodwill largely related to the achievability of the also set out in note 3.1. The Committee addressed these matters assumptions underlying the calculation of the value in use through receiving reports from management outlining the of the business being tested for impairment, set out in note basis for the assumptions used, assessing the range and depth 3.1 to the financial statements. These primarily consist of the of information underpinning the assumptions and calculations, Group’s forecasts from 2019 to 2022, which underpin the commissioning a report from a third party export valuer and valuation process. discussions with the Auditors. 50 Pendragon PLC Annual Report 2019 VALUATION OF PARENT COMPANY INVESTMENT This is the risk that the company has investments in its The Committee is supportive of ongoing work to restructure the company’s balance sheet as between PLC and its subsidiaries subsidiary companies, which could be overstated when as an exercise in redressing this balance. considered with current market capitalisation of the company and could impact the ability of the company to pay dividends The Committee received a report from management detailing should the investment be impaired. The value of investments the controls in place to ensure the appropriate recording is underpinned by expectation of discounted future profits and of impairments to the value of subsidiary assets, which was net assets of the subsidiary companies. There is an inherent performed in conjunction with the work done to establish uncertainty in forecasting future profits following the decline in goodwill impairment as described above. The Committee the share price and the profit warning issued in October 2018. were satisfied with management’s conclusion that appropriate controls were in place to book impairment in the value of subsidiary assets. VEHICLE INVENTORY VALUATION This is the risk that the value of inventory set out in note 3.4 The Committee received a report from management which set out factors relevant to an assessment of used inventory to the financial statements could be materially overstated and valuation, including the level of inventory held across the whether or not an appropriate provision had been calculated. business, the ageing of the inventory, the stock turn of the The risk for used vehicles is seen as the most relevant, for inventory and an analysis of market factors including the parc scrutiny. Used vehicle prices can vary depending on a number of used vehicles, the used vehicle market sales rate and historic of factors, including general economic conditions and the movements in used vehicle prices. levels of new vehicle production. The Committee discussed the report from management with the Auditors together with all audit findings. The Committee was satisfied that a comprehensive assessment of inventory valuation had been undertaken and concluded that the judgements applied were appropriate. Overall, the level of used inventory risk remained the same as in the prior year. PENSION SCHEME LIABILITIES The amounts reflected in the financial statements in respect of The Committee ascertained that judgements made on pension scheme were all based on advice from the Group’s pension pension scheme liabilities involve judgements made in relation adviser. The final calculations in respect of the Group’s to actuarial assumptions, long-term interest rates, inflation, defined benefit pension scheme liability were performed by longevity and investment returns. The liabilities are set out our pension scheme actuary. The Committee discussed with in note 5.1 to the financial statements. There is a risk that the the Auditor the assumptions applied, in particular the findings value of the pension scheme liabilities could be materially of the Auditor’s own pension specialist. under or over stated in the context of the sensitivity analysis in that note. Following a court ruling during the year regarding The Committee concluded that the judgements applied were equalisation of GMP between men and women an additional appropriate. pension liability has been recorded UK EXIT FROM THE EUROPEAN UNION (BREXIT) Currency devaluation of Sterling following the 2016 referendum The Committee received a report from the Risk Control Group, which had carried out an initial assessment of potential Brexit result has continued in subsequent years, and remains as an risk to the Group in early December 2018. upward pressure on new vehicle prices and associated finance offers. The risk of a “no-deal” Brexit may cause further upward The Committee considered that the Group retained sufficient pressure on vehicle prices due to import tariffs imposed and financial liquidity and operational facility headroom to cover Sterling’s expected devaluation. Share prices of all UK car any short-term financial stress scenarios resulting from a hard dealers fell after the EU Referendum and have only partly Brexit. recovered. A decline in consumer confidence has continued to reduce UK new sales since April 2017 and the expectation is The Committee noted that in the event that Brexit caused that this will continue into 2019. Other factors such as changes a significant short term financial impact on the Group’s in regulation and the availability and cost base appropriate operations, elements of our strategy could be accelerated to team member resource could also impact the company’s mitigate the impact. operations. Pendragon PLC Annual Report 2019 51 AUDIT COMMITTEE REPORT EXTERNAL AUDITOR • none of the Directors’ independence in considering this APPOINTMENT AND PERFORMANCE EVALUATION The Committee considered Auditor effectiveness and matter is impaired in any way and none has a potential or actual conflict of interest in relation to KPMG, whether independence of the audit, during the year. in regard to its appointment, fees, the evaluation of its performance, any decision as to competitive tender for The Committee arrived at its recommendation to the Board on audit services, or any other matter. the Auditor’s appointment by: • • applying exclusively objective criteria; EU legislation on audit firm rotation the current Auditor could evaluating the ability of the audit firm to demonstrate its not be reappointed after 2023. The Committee also took into account that under the current independence; • assessing the effectiveness of the audit firm in the performance of its audit duties; REVIEW OF NON-AUDIT SERVICES The Committee reviewed the company’s policy on its use of its • reviewing and discussing with the Auditor the results of audit firm for non-audit work. Its main principles are that the an independent review of their audit of the 2017 financial Auditor is excluded from providing certain non-audit services statements by the FRC; and the performance of which is considered incompatible with • assessing the audit firm’s adherence to applicable its audit duties, but is eligible to tender for other non-audit professional standards. work on a competitive basis and can properly be awarded such work if its fees and service represent value for money. The Committee Chairman oversaw the company’s evaluation The policy can be viewed on the company’s website. The of the Auditor’s performance, using questionnaires covering all Committee considered reports on the extent and nature of aspects of the company and Auditor relationship and reviewed non-audit work available, the allocation during the year of that the results with the Committee members and the company’s work to accountancy and audit firms, including KPMG LLP, management. The Committee noted that the current Auditor, and the associated fees. Details of audit and non-audit work KPMG had issued to the company all requisite assurances of performed by KPMG LLP and the related fees appear annually its independence. The Committee reported its conclusions in the notes to the company’s financial statements. A full to the Board, namely, that there are no existing or historical statement of the fees paid to KPMG LLP for work performed relationships or other matters which adversely affect the during the year is set out in note 2.5 to the financial statements independence of KPMG as the company’s Auditor, and no on page 106. Having satisfied itself on each item for its review, performance shortcomings or unresolved issues relating to fee the Committee reported to the Board that:- levels. The lead audit partner, John Leech, has held the poistion for has been adhered to throughout the year, and is operating • the company’s existing policy continues to be appropriate, three years. effectively to provide the necessary safeguards to independence of the external Auditor; POLICY ON AUDIT TENDERING KPMG was appointed as Auditor in September 1997, since • there are no facts or circumstances relating to the award or performance of non-audit work that affect the when, audit services have not been tendered competitively. independence of KPMG LLP as Auditor or justify putting The Committee has concluded that a competitive tender of the out audit work to competitive tender at this time; audit service is not necessary at this time, but acknowledged • no contract for non-audit services has been awarded to that circumstances could arise where a competitive tender for KPMG LLP in any circumstance of perceived or potential audit services is desirable. It recommended the re-appointment conflict of interest or non-compliance with the company’s of KPMG as the company’s Auditor. The Board accepted the policy; and Committee’s recommendation and concluded that:- • the fees KPMG LLP have earned from non-audit services • there are no matters warranting a competitive tender their amount or otherwise, such as might impair its exercise in relation to the provision of audit services, but independence as Auditor. The ratio of non-audit to audit provided during the year are not, either by reason of this position would change if there were to arise at any time any concerns as to the continuing independence or fees was 0.15:1 in 2018 (2017: 0.14:1). performance of the current audit firm (no such concerns The Board accepted these findings. have arisen as at the date of this report); 52 Pendragon PLC Annual Report 2018REVIEW OF INTERNAL AUDIT PERFORMANCE The Committee Chairman oversaw the Committee’s evaluation these and the company’s bribery risk assessment. On its recommendation, the Board readopted the company’s of the Internal Auditor’s performance, using questionnaires anti-bribery policy statements and associated controls. covering all aspects of the internal Auditor work and The Committee considered reports on known instances of relationship to the audit and received the Auditor’s view on alleged wrongdoing and matters reported on the company’s that performance. He reviewed the results with the Committee confidential reporting line and their investigation, reviewed the members and company management and reported the adequacy of whistleblowing procedures and commissioned Committee’s conclusions to the Board. follow-up action and improvements in risk-related controls. REVIEW OF RISK MANAGEMENT AND INTERNAL CONTROLS The Committee reviewed the effectiveness of the company’s Our current anti-bribery value statements and our policies on the control of fraud, theft and bribery risks appear on the company’s website and are drawn to the attention of all system of internal control and financial risk management. It parties seeking to transact with the Group. Our whistleblowing received reports from the Auditor on each of these areas and procedures are published internally on our intranet and from the RCG, whose work is described on page 44) on the their existence is regularly reinforced in our team member company’s risk register, emerging risks and corresponding communications. The policy is available at www.pendragonplc. internal controls. It scrutinised the key risks register, as revised com by the RCG, and approved it for adoption by the Board. Its work informed and supported the Board’s assessments detailed under “How the Board manages risk” on page 45. REVIEW OF ANTI-BRIBERY CONTROLS AND WHISTLEBLOWING The Committee reviewed the company’s anti-bribery APPROVAL This report was approved by the Committee and signed on it’s behalf by:- Richard Laxer Chairman of the Audit Committee processes and controls and evaluated and approved 12 March 2019 53 Pendragon PLC Annual Report 2018NOMINATION COMMITTEE REPORT The Nomination Committee is chaired by Chris Chambers, and made up entirely of independent Non-Executive Directors. Their names and qualifications are on page 42 and attendance at meetings in the table on page 47 above. KEY RESPONSIBILITIES OF THE NOMINATION COMMITTEE • reviews the Board’s size, structure and composition and In February 2019, following Trevor Finn’s decision in December 2018 to retire as Chief Executive Officer, the Committee met for the purposes of recruitment and selection of a replacement • • leads recruitment to Board positions Chief Executive Officer. On 4 March 2019, following the undertakes annual Board performance evaluation recommendation of the Nomination Committee, Mark Herbert satisfies itself on the company’s refreshing of Board joined the company as Chief Executive Officer designate, and membership and succession planning will assume the role of Chief Executive Officer on 1 April 2019. The Nomination Committee is actively leading the process to Its terms of reference detail its key responsibilities and appear, recruit an additional Non-Executive Director. with relevant background information, on the company’s website www.pendragonplc.com . Subject to the recruitment of an additional Non-Executive Director, the Board concluded that the composition and THE COMMITTEE’S WORK IN 2018 The Nomination Committee met three times in 2018. This balance of the Board was now appropriate to the requirements of the company. Details of the annual evaluation of the Board report describes its work and conclusions. are set out below. REVIEW OF BOARD COMPOSITION AND BALANCE In February 2018, the Committee reviewed the structure of EVALUATION The annual evaluations of the Board and its members were the Board, in relation to its size, composition and potential conducted by the Board and are described on page 46. As vacancies. At this stage, as part of the annual review of the part of that process, the Committee conducted an evaluation workings of the Board and its annual valuation, the Committee of its own performance. concluded that a cohort of four, made up of the Chairman and three Independent Non-Executive Directors is sufficient for the Board and its Committees to function effectively. DIVERSITY All appointments made, including those of Board members, adhere to the company’s diversity and equal opportunities In October 2018, following the decisions of Tim Holden to policy, which can be viewed on the company’s website. For step down as Finance Director and Jeremy King to step down Non-Executive Director appointments, where executive as Non-Executive Director and Audit Committee Chairman, search consultants are instructed, they are done so in a the Committee met for the purposes of recruitment and manner consistent with this policy. The company engaged selection of a replacement Chief Finance Officer and Non- an executive search agency for the purposes of recruiting the Executive Director and Audit Committee Chairman. Following Chief Executive Officer and has retained them in the search recommendations of the Nomination Committee, Mark Willis for an additional Non-Executive Director, having considered it was appointed Chief Finance Officer in October 2018 and will appropriate to do so. The company has not adopted a gender assume the role on 8 April 2019. Richard Laxer was appointed balance target for its Board. Non-Executive Director, Audit Committee Chairman and Senior Independent Director in early November 2018. 54 Pendragon PLC Annual Report 2018REMUNERATION COMMITTEE REPORT The Remuneration Committee is a committee of the Board, and has been chaired by Mike Wright since March 2018. It is made up entirely of independent Non-Executive Directors. Their names and qualifications are on page 42 and attendance at meetings in the table on page 47. KEY RESPONSIBILITIES OF THE REMUNERATION COMMITTEE • determines and agrees with the Board the framework for Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013 (the Regulations) and has been prepared in accordance with the UK Corporate Governance Code and remuneration of Executive Directors the UKLA Listing Rules. The parts of the report which have • ensures that Executive Directors are provided with been audited in accordance with the Regulations have been appropriate incentives which align their interests identified. with those of shareholders, and encourage enhanced performance in the short and medium term, as well as achievement of the company’s longer term strategic goals REMUNERATION POLICY There are no changes to the remuneration policy that was • determines targets for any performance related pay approved by our shareholders at the 2017 AGM. The full, schemes shareholder approved, policy is available on the company’s • seeks shareholder approval for any long-term incentive website and sets out our policy on Directors’ remuneration, arrangements recruitment, loss of office, termination of employment and • determines the remuneration of the Chairman change of control. Consistent with market practice, the The terms of reference of the Remuneration Committee are elements of variable remuneration, both in terms of annual available at www.pendragonplc.com. bonus awards made and long term incentive awards granted Remuneration Committee retains full discretion over all THE COMMITTEE’S WORK IN 2018 The Remuneration Committee met three times in 2018. The Directors’ Remuneration Report, beginning at page 56, describes its work and conclusions. REMUNERATION DISCLOSURE This report complies with the requirements of The Large and vesting. The extent of this discretion is more particularly described in the table on page 60. REMUNERATION POLICY The table below summarises the individual elements of remuneration provided to the Executive Directors. It is a summary only and does not replace or override the full, shareholder policy, which is displayed on the company’s and Medium-sized Companies and Groups (Accounts and website (www.pendragonplc.com). Reports) Regulations 2008 and the Large and Medium-sized 55 Pendragon PLC Annual Report 2018DIRECTORS REMUNERATION REPORT REMUNERATION COMMITTEE CHAIRMAN’S LETTER TO SHAREHOLDERS Dear Shareholder As Chairman of the Remuneration Committee, I am pleased to present the Directors’ Remuneration Report for the year ending 31 December 2018. This report has been prepared by the Remuneration Committee and approved by the Board. This remuneration report is split into two sections: the Directors’ Remuneration Policy; which provides an “at a glance” summary of the remuneration policy for which shareholder approval was obtained at the 2017 AGM and which will continue to apply without amendment for the forthcoming year; and the Annual Report on Remuneration. Aligning the Remuneration Policy with strategy and performance The accelerated transformation of our business continued throughout the last year, with significant investment in our used car business in new start up locations and the roll out of used car factories for the refurbishment of used inventory. However, the Remuneration Committee also recognises that despite the ability of our remuneration policy to incentivise and drive the internal delivery of our strategic objectives, the policy does not operate in isolation from sector specific and market factors. In October 2018, we announced that the introduction of the Worldwide Harmonised Light Vehicle Test Procedure (“WLTP”) had created disruption in new car sales, causing significant new vehicle supply disruption and concern in terms of new vehicle sales and profitability. Exogenous factors such as WLPT, uncertainty caused by Brexit and the more general automotive sector downturn currently being experienced means that, in the coming months, the Remuneration Committee will more closely monitor the appropriateness of our remuneration policy in terms of its ability to both incentivise and drive strategic change in our business. Whilst maintaining this watching brief, no changes to our remuneration policy are proposed for the coming year, and the company’s remuneration policy is not subject to shareholder approval. The Remuneration Committee continues to maintain that our current remuneration policy, approved by our shareholders at the 2017 AGM, provides a strong and clear link between our business strategy and incentive arrangements. The full policy is available on the company’s website at www.pendragonplc.com, and in our 2016 remuneration report, and is summarised in the policy table on pages 57 to 59. In October 2018, the company announced that Tim Holden would be stepping down as Finance Director on 31 March 2019. In December 2018, the company announced Trevor Finn’s decision to retire as Chief Executive Officer and Director by no later than 31 March 2019. The Committee thank both Tim and Trevor for their service, and confirm that their exit arrangements will be in line with the approved remuneration policy and disclosed on the company’s website. Mark Herbert joined the company on 4 March 2019 as Chief Executive Officer designate, and assumes the role of Chief Executive Officer on 1 April 2019. Mark Willis joins the company as Chief Finance Officer on 8 April 2019. The remuneration packages for both incoming Executive Directors will be in line with our remuneration policy and will be fully disclosed in our 2019 Annual Report. The Committee intends to fully implement the changes introduced to remuneration reporting by the UK Corporate Governance Code (July 2018) and the Companies (Miscellaneous Reporting) Regulations 2018, and will reflect the new disclosures in our Directors’ remuneration report to be published next year. We continue to maintain the bias in our remuneration policy towards long term incentives, supported through interlinked share ownership and part-deferral requirements within the annual bonus plan. 2018 Outturn The company delivered underlying profit of £47.8m, a decline of - 20.9% year on year. Year end net had has increased by £3.5m or 2.8%, as a result of further investments in line with our clear strategy to provide more reliable and sustainable returns. As both the profit and debt metrics of the bonus targets have not exceeded the prior years result, the Executive Directors did not receive an annual bonus award in respect of 2018 performance. In addition, upon conclusion of the three-year performance period, the Remuneration Committee determined that long term incentives awarded in 2016 will not vest, as the relevant performance conditions to achieve vesting were not satisfied. The 2016 LTIP therefore lapsed in its entirety. Full details of remuneration decisions for 2018 are set out in the Directors’ annual remuneration report on pages 63 to 68. At last year’s AGM, 82.88% of shareholders voted in favour of the Directors’ Remuneration Report. Details of the votes cast are set out on page 68. I hope that you find the information in this report helpful and I look forward to your continued support at the company’s AGM. Yours sincerely Mike Wright Chairman of the Remuneration Committee 56 56 Pendragon PLC Annual Report 2019 Pendragon PLC Annual Report 2018 FUTURE REMUNERATION FOR EXECUTIVE DIRECTORS BASE SALARY ELEMENT AND PURPOSE Provide competitive remuneration that will attract and MAXIMUM OPPORTUNITY Salary levels are eligible for increases during the three-year retain executives of the calibre required to take forward the period that the remuneration policy operates (policy effective company’s strategy. from 27 April 2017). During this time, salaries may be increased each year. Salary increases are determined after taking due account of market conditions and any increases awarded to the wider workforce. Significant changes in role scope may require further adjustments to bring salary into line with new responsibilities. For recent joiners or promotions, whose pay was initially set below market rate, higher than usual increases may be awarded to bring them into line with the market over a phased period as they develop in their role. OPERATION Base salaries are reviewed annually, effective from 1 January. PERFORMANCE METRICS Individual performance is an important factor considered by The Committee sets base salaries taking into account: the Committee when reviewing base salary each year. • the performance and experience of the individual • • concerned; any change in responsibilities; appropriate executive remuneration benchmarking, which may include the following comparator Groups (i) FTSE 250 companies (excluding investment trusts); (ii) companies of a similar size to the Group, currently being those in the bottom quartile of the FTSE 250 and the top quartile of the FTSE Small Cap; (iii) FTSE retailers, broadly the FTSE All Share General Retailers index excluding companies with a market cap greater than £3.5bn; and (iv) selected automotive retailers which are deemed to be the closest comparators to the company. Alternative peer Groups may need to be referenced depending on the business circumstances. Base salaries are paid monthly in arrears. BENEFITS ELEMENT AND PURPOSE Cost-effective, market competitive benefits are provided to MAXIMUM OPPORTUNITY Benefit levels are set to be competitive relative to companies assist Executive Directors in the performance of their roles. of a comparable size. The cost of some of these benefits is not pre-determined and may vary from year to year based on the overall cost to the company of securing these benefits for a population of employees (particularly health insurance and death in service cover). OPERATION Life assurance, private health cover, professional subscriptions, PERFORMANCE METRICS None. home telephone costs and (at executive’s option) company cars. Pendragon PLC Annual Report 2019 Pendragon PLC Annual Report 2018 57 57 DIRECTORS REMUNERATION REPORT PENSION ELEMENT AND PURPOSE Provide cost-effective long-term retirement benefits that will MAXIMUM OPPORTUNITY Post-2009 executives: contribution of 10% of base salary form part of a remuneration package that will attract and or payment of a 10% cash alternative at the option of the retain executives who are able to take forward the company’s executive. strategy. OPERATION Pre-2009 executives: 26% of salary cash supplement in lieu of pension contribution. Post-2009 executives: participation in a defined contribution In line with the UK Corporate Governance Code (July 2018), pension scheme. Pre-2009 executives: deferred membership the Committee intends to ensure that pension contributions for of defined benefit pension scheme. incoming Executive Directors are aligned with those available to the workforce ANNUAL BONUS ELEMENT AND PURPOSE Incentivises achievement of annual objectives which support MAXIMUM OPPORTUNITY Maximum available bonus is equivalent to 100% of base salary. No award is made for flat or negative growth. Maximum bonus the short-term goals of the company, as reflected in the annual is available only for material outperformance of the company’s business plan. annual business plan. OPERATION Annual bonuses are earned over the year and are paid annually PERFORMANCE METRICS Annual bonus is earned based on performance against in arrears after the end of the financial year to which they relate, stretching company financial performance measures as set and based on performance against targets over the year. 25% of assessed by the Committee. At present, financial measures after tax bonus earned is subject to compulsory deferral into used are underlying (adjusted) profit and year-end net debt. the company’s shares until such time as the company’s share A sliding scale of targets is set for each measure, with 12.5% ownership guidelines are met. In such situations where bonus of salary for each element being payable for achieving the is deferred into shares, an Executive Director may be entitled relevant threshold hurdles. to receive dividend payments on such shares. The specific measures, targets and weightings may vary from year to year in order to align with the company’s strategy over each year. The measures will be dependent on the company’s goals over the year under review. VALUE CREATION PLAN (VCP) ELEMENT AND PURPOSE The VCP rewards and retains Executive Directors over the longer MAXIMUM OPPORTUNITY Under the VCP, the maximum aggregate number of ordinary term, whilst also aligning the incentives of those participating shares in the company that can be issued to satisfy awards with the long-term performance of the business and returns under the VCP to all participants is limited to 5% of the for our shareholders. The VCP is the company’s principal long company’s issued share capital at the end of the four year term incentive plan for rewarding and incentivising Executive performance period. At the outset, entitlements of participants Directors. in the pool of returns were split as follows:- Chief Executive Officer – up to a maximum of 30% Chief Operating Officer – up to a maximum of 20% Finance Director - up to a maximum of 10% other below board participants - share of remaining balance of 40% 58 58 Pendragon PLC Annual Report 2019 Pendragon PLC Annual Report 2018 FUTURE REMUNERATION FOR EXECUTIVE DIRECTORS VALUE CREATION PLAN (VCP) OPERATION The VCP operates over a four year period which commenced PERFORMANCE METRICS The performance condition is based on the absolute total on 1 January 2017. Executive Directors, and other eligible shareholder return performance of the company over a four- team members are granted an entitlement to a percentage year period. Participants in the VCP are able to earn shares share in a pool of returns delivered to shareholders, above a equivalent to 10% of any total shareholder return created hurdle rate of return. The participant’s percentage entitlement above a 10% p.a. threshold. is awarded under nil-cost options over shares, with a value calculated to be a proportion of the total shareholder return The VCP replaced the LTIP as the company’s selected long created for shareholders. This is measured over a four year term incentive plan from 1 January 2017. VCP performance period, with a further one year holding period being applicable to any awards vesting. The overall effect of the VCP is that the Executive Directors and other eligible team members will be able to earn shares equivalent to 10% of any total shareholder return created above a 10% per annum compound annual growth rate based on the measurement of absolute total shareholder return generated over the four year VCP performance period. In other words, until shareholders receive a 10% p.a. return, the VCP will not pay out. Beyond that, broadly participants may receive 10% of any further value created subject to cap of 5% of issued share capital. The company used an initial or base share price of the Q4 2016 average share price, which was £0.3016. LONG TERM INCENTIVE PLAN (LTIP) ELEMENT AND PURPOSE Incentivises executives to achieve EPS growth over a three MAXIMUM OPPORTUNITY No further awards will be made to Executive Directors under year period. EPS growth is the measure most appropriate to the LTIP. the company’s strategy. OPERATION Awards are subject to performance conditions measured over PERFORMANCE METRICS Awards vest at the end of a three year performance period, three years and a service requirement. based on achievement of stretching underlying EPS targets. The Committee retains a discretion to refine the choice of shareholder return (TSR) underpin. Threshold performance performance metrics in each year in light of developments attracts vesting of 25% of the award with 100% of awards in the company’s strategy. In the event of a significant or being achieved for maximum performance. There is a straight material change, the Committee would engage in dialogue with line vesting between performance points. The underlying EPS targets operate subject to a positive total shareholders and, if necessary, seek a renewed shareholder approval by ordinary resolution. Following approval of the VCP at the 2017 AGM, the company does not intend to use the long term incentive plan to reward the Executive Directors over the period of the remuneration policy and in the future, and the LTIP remains solely for a legacy award made in 2016. Pendragon PLC Annual Report 2019 Pendragon PLC Annual Report 2018 59 59 DIRECTORS REMUNERATION REPORT POLICY ON EXECUTIVE DIRECTOR SHARE OWNERSHIP POLICY ON NON-EXECUTIVE DIRECTORS’ REMUNERATION The company continues to recognise the importance of The company’s policy on Non-Executive Directors’ Executive Directors building significant holdings of the remuneration is reviewed annually by the Board. Remuneration company’s shares. To encourage share ownership among for Non-Executive Directors is confined to fees alone, without Executive Directors joining the company, these require a performance related element. Non-Executive Directors Executive Directors to aim, within five years of joining the may elect to receive all or part of their fees in the form of Board, to have built a stake in value equal to 100% of their benefits in kind, typically the provision of a motor vehicle for annual salary (200% in case of the Chief Executive). Until such their use. The company considers that the remuneration of time as the policy is met, Executive Directors will be required the Non-Executive Directors remains consistent with the time to defer 25% of annual bonus into the company’s shares and commitments associated with individual positions and wider retain half the after tax number of vested shares received market practice among companies of a comparable size. under the VCP. Fee Type Chairman fee Basic fee: Supplementary fees: Senior Independent Director Audit Committee Chairman Remuneration Committee Chairman Nomination Committee Chairman Fee Level £150,000 £40,000 £4,000 £10,000 £5,000 Nil Change in 2018 None None None None None None None Notes accompanying the future Remuneration Policy table:- 1. Malus and clawback – malus and clawback may operate in respect of the annual bonus, VCP, and long term incentive plan. These provisions will permit the company to reclaim annual bonus payments or reverse VCP or LTIP awards or claim proportionate payments in exceptional circumstances of misstatement or misconduct. These are kept under review, in the light of prevailing Financial Reporting Council guidance. 2. Salary – base salaries are set by reference to the criteria specified in the table above. If a salary is initially set below the market rate, a phased realignment may be made over time. 3. Annual bonus – targets of underlying (adjusted) profit (50%) and year-end net debt (50%) were selected as these measures correlate to measures used in the company’s overall business plan. The split between net debt and profit, and the performance measures attributable to them is determined by the Remuneration Committee who seek external guid- ance on the appropriateness of any performance targets set relative to the market. 4. Long term incentive plans – (i) LTIP: under the company’s current long term incentive plan, performance shares are awarded up to a maximum of 150% of salary if significantly challenging performance targets are attained. The Remuneration Committee selected EPS as this remains the key internal measure of long term financial performance, as well as being well understood by the executives and our investors as providing a clear incentive to deliver the company’s long term growth prospects. An underpin of creating absolute shareholder return has been adopted as this further aligns the interests of executives with those of shareholders. The vesting schedule outlines the vesting percentages in relation to EPS performance targets, which were set after taking into account internal scenario analysis, current market expectations and the current trading environment. (ii) VCP: the introduction of the VCP ensures alignment of rewards with the performance and delivery of our business strategy. The initial or base share price under the VCP was set at £0.3016, being the three month average share price prior to 01 January 2017. The hurdle price was set at £0.442, being the initial or base share price plus 10% compounded annual growth over the four plan years. The total participation pool for the VCP is 10% of the total value created above the hurdle. 5. Pensions – Trevor Finn and Martin Casha ceased to be active members of the Pension Plan in 2006. Tim Holden participated in the defined contribution section of the Pendragon Group Pension Scheme, to which the company made a contribution of 10% of his basic salary. In April 2016, Tim Holden elected to receive a payment of 10% of salary, rather than continue to receive pension contributions. 6. Benefits: benefit levels are set to be competitive relative to companies of a comparable size. 7. Annual Bonus, VCP and LTIP Policy - Remuneration Committee Discretions: The Committee will operate the annual bonus plan, VCP and LTIP in accordance with their respec- tive rules and in accordance with the Listing Rules, where relevant. Consistent with market practice, the Committee retains discretion in a number of respects with regard to the operation and administration of these plans. These include the following (albeit with quantum and performance targets restricted to the descriptions detailed in the future policy table above):- who participates in the plans; • the timing of grant of award and/or payment; • the size of an award and/or payment; • the determination of vesting and/or meeting targets; • discretion required when dealing with a change of control (e.g. the timing of testing performance targets) or restructuring of the Group; • determination of good/bad leaver cases for incentive plan purposes based on the rules of each plan and the appropriate treatment chosen; • adjustments required in certain circumstances (e.g. rights issues, corporate restructuring events, share buybacks and special dividends); and • the annual review of performance measures and weighting, and targets for the annual bonus plan, VCP and LTIP from year to year or on award. The Committee also retains the ability to adjust the targets and/or set different measures and alter weightings for the annual bonus plan and to adjust targets for the VCP or LTIP if events occur (such as a material divestment of Group business) which cause it to determine that the conditions are no longer appropriate and the amendment is required so that the conditions achieve their original purpose and are not materially less difficult to satisfy. The company retains the authority to honour any commitments entered into with current of former Directors that have been disclosed to shareholders in previous remuneration reports (e.g. all historic awards that were granted under any LTIPs that remain outstanding, as detailed in the company’s latest Annual Report), and which remain eligible to vest based on their original award terms. Details of any payments to former Directors will be set out in the Annual Report on remuneration as they arise. With regard to any promotions to Executive Director positions, the company will retain the ability to honour payments agreed prior to executives joining the Board, albeit any payments agreed in consideration of being promoted to the Board will be consistent with the policy on new appointments as an Executive Director detailed in the Remuneration Policy at www.pendragonplc.com 60 Pendragon PLC Annual Report 2018ILLUSTRATION OF OUR REMUNERATION POLICY FOR 2019 The tables below illustrates the operation of the remuneration performance scenarios are provided for each Executive Director. A significant percentage of remuneration is linked to policy and provide estimates of the potential future performance, particularly at maximum levels. remuneration that Executive Directors would receive, in The table below illustrates the remuneration that could be paid the scenarios shown, in accordance with the Directors’ to each of the Executive Directors, based on salaries at the Remuneration Policy. Potential outcomes based on different start of the financial year 2019. Element Fixed Description Minimum On Target Maximum Fixed (comprises base salary, benefits, pension) Included Included Included Annual Bonus Annual bonus Value Creation Plan Long term incentive plan 0% 0% 25% of the maximum bonus1 100% of the maximum bonus1 50% of the average annual IFRS 2 value of the award2 100% of the average IFRS 2 value of the award2 1The maximum bonus available for Executive Directors is equivalent to 100% of base salary. 2Awards made under the VCP will be on a one-off basis with a four year measurement period. For illustrative purposes only, the maximum value displayed here represents 100% of the IFRS 2 value of the award, which is intended to give an estimate of the value of the award on grant. 3The additional reference point under the regulations to show the indicative of indirect share price growth of 50% over the VCP has not been included, as the basis that a 50% share growth would result in a payment less than the maximum scenario already displayed. 61 Pendragon PLC Annual Report 2018DIRECTORS REMUNERATION REPORT We list below the areas of policy the company has adopted in the shareholder approved remuneration policy (available to view on the company’s website). New appointments as Executive Director Including each component of remuneration New appointments as Non-Executive Director Non-executive remuneration How employees’ pay is taken account in executive remuner- ation Directors’ service contracts and exit payments Treatment of fees earned from external Directorships NON-EXECUTIVE DIRECTORS’ APPOINTMENTS All these policy areas remain unchanged from the policy approved by shareholders at the 2017 AGM. Name Commencement Expiry/cessation Unexpired at date of report (months) Chris Chambers Richard Laxer Mike Wright Gillian Kent 23.10.17 12.11.18 02.05.18 20.04.18 31.12.20 31.12.21 31.12.21 31.12.21 21 33 33 33 62 Pendragon PLC Annual Report 2018ANNUAL REPORT ON REMUNERATION THE COMMITTEE’S WORK IN 2018 • determined annual bonus awards in respect of 2017 ADVISERS During 2018, the Chief Executive, Trevor Finn provided advice performance to the Committee but not in respect of his own pay. In addition, • • set the annual bonus plan terms for 2018 external advice was provided by PwC. Pinsent Masons LLP reviewed performance to target under the Value Creation continue to be retained as the company’s share incentive Plan scheme legal advisors, although did not earn fees in 2018. In • tested the performance targets for the company’s 2016 2018, fees of £3,240 were paid to PwC. Pinsent Masons and Long Term Incentive Award vesting PwC are considered to be independent. Pinsent Masons and • • set 2019 Executive Director salary levels PwC do not provide any other services to the Group. The noted remuneration trends across the Group Company Secretary also acts as secretary to the Committee and provides additional advice. SINGLE TOTAL FIGURE (AUDITED INFORMATION) Salary or fees1 £000 Taxable benefits4 £000 Pension5 £000 Bonus6 £000 Long term incentive plan7 £000 Single total figure £000 2018 2017 2018 2017 2018 2017 2018 2017 2018 2017 2018 2017 Executive Directors Trevor Finn Martin Casha Tim Holden Non-Executive Directors Chris Chambers Richard Laxer2 Gillian Kent Jeremy King3 Mike Wright 464 464 292 292 221 221 150 9 40 45 30 69 - 40 50 - 4 8 7 1 - - - - 4 8 6 - - - - - 121 76 22 - - - - - 121 76 22 - - - - - - - - - - - - - 138 87 66 - - - - - - - - - - - - - - - - - - - - - 589 376 250 727 463 315 151 9 40 45 30 69 - 40 50 - 1In the case of Non-Executive Directors, fees include Committee chair fees in addition to the basic Non-Executive Director fee of £40,000, as detailed in the Policy on Non-Executive Directors’ Remuneration in the policy table above at page 57. 2Richard Laxer was appointed on 12.11.2018. Accordingly, his fees are for the period 12.11.18 to 31.12.18. 3Jeremy King stood down from the Board on 12.11.2018. Accordingly, his fees are for the period 01.01.18 to 12.11.18 4Benefits in kind include life assurance, private health cover, professional subscriptions, contribution to home telephone costs and provision of up to two cars (at the Director’s election), one of which is fully expensed. 5Salary supplement in lieu of employer pension contribution, or in the case of Tim Holden, company contribution to defined contribution pension scheme of 10% of basic salary (£22,083 in 2018, £22,083 in 2017). Trevor Finn and Martin Casha ceased to be active members of the Pendragon defined benefit Pension Plan in 2006. Trevor Finn elected to take early retirement benefits from 08.02.08 and is therefore a pensioner member. Martin Casha also elected to take early retirement benefits from 01.07.16 and is therefore also a pensioner member. In April 2016, Tim Holden elected to a receive a payment of 10% of salary rather than continue to receive pension contributions. 6 Bonus Award for 2018 total equivalent to 0% of base salary, 2017 total equivalent to 29.8% of base salary – see page 64 for more detail. 7The performance conditions for the LTIP awarded in 2016 have not been achieved, and consequently these awards lapsed in their entirety. 63 Pendragon PLC Annual Report 2018DIRECTORS REMUNERATION REPORT PENSIONS The Pendragon Pension Plan (Pension Plan) is established for the benefit of the Group’s eligible employees. The Pension PERFORMANCE RELATED PAY FOR 2018: ANNUAL BONUS Given their commercial sensitivity, we do not publish the details Plan operates through a trustee company which holds and of targets in advance. However, the Committee considers the administers its assets entirely separately from the Group’s targets to be measurable and appropriately stretching. For assets. There is no direct investment in Pendragon PLC. 2018, the maximum available annual bonus opportunity was Trevor Finn and Martin Casha ceased to be active members 100% of base salary, only achievable for performance in excess of the Pension Plan in 2006. Tim Holden participated in the of the company’s strategic plan. Payouts are achievable Pendragon Group Pension Scheme, a defined contribution for demanding performance, measured against underlying pension scheme, until April 2016. From April 2016, Tim Holden (adjusted) profit (50%) and year-end net debt (50%). This elected to receive a payment of 10% of basic salary, rather than structure for bonus opportunity for 2018 reflects both the continue to receive pension contributions (10% in 2017). The investor feedback received and the competitive market in which Non-Executive Directors are not eligible to participate in the the company currently operates. Details of the percentages of Pension Plan. salary payable at threshold, target and maximum are set out in the table below. Available Actual outturn 2018 Performance measure Underlying profit Year end net debt Underlying profit Year end net debt % of basic salary payable Level % of basic salary payable Level % of basic salary payable Target aligned to business plan Threshold performance (10% below Target) must exceed prior year’s result 12.5 12.5 In line with Target 31.25 31.25 Maximum ≥10% above Target 50 50 - - - - - - - - - - - - Straight line vesting between performance points It is a pre-requisite requirement that in order to receive a bonus Committee determined that as underlying profit was behind payment on either metric, performance must exceed the the prior year, and year net debt performance marginally above prior years result. For the year ended 31 December 2018, the that of the prior year, no bonus award would be payable. Measure Performance metrics 2018 outturn Performance Payout Threshold Target Maximum Actual % of basic salary payable Underlying profit >£60.4m ≥£63.4m ≥£69.7m Net debt <£124.1m <£124.1m ≤£117.7m Total bonus achieved £47.8m £127.6m 0 0 0 0 64 Pendragon PLC Annual Report 2018 LONG TERM INCENTIVES VESTING IN 2018 The Remuneration Committee assesses the extent to which the performance conditions that apply to the performance related elements of the remuneration framework have been met, following sign off of the company’s audited Annual Report are considered to be commercially sensitive, and we do not publish details of these in advance. VALUE CREATION PLAN (VCP) AWARDS No VCP awards were made in 2018. The Executive Directors and Accounts. This ensures that incentive payments are made were granted a nil cost option over ordinary shares of the following independently audited results being known. company on 26 May 2017. Vesting is based on the growth of absolute total shareholder return generated over the VCP Following an assessment of the performance conditions performance period. The performance period for the award applicable to the 2016 award, the Remuneration Committee comprises the four years (“Performance Period”) commencing determined that the relevant performance conditions to achieve on 1 January 2017. The VCP award gives the Executive Directors vesting were not satisfied (namely that actual underlying EPS the opportunity to share in a proportion of the total value achieved in the financial year ending 31 December 2018 be 4.5p created for shareholders above a hurdle (“Threshold Total or above for 25% vesting: actual EPS achieved was 2.9p. The Shareholder Return”) measured at the end of the Performance 2016 LTIP therefore lapsed in its entirety. Period on 31 December 2020 (“Measurement Date”). The price used for this measurement (“Measurement Total Shareholder BASE SALARY FOR 2019 Base salaries for the Executive Directors will remain unchanged Return”) will be the sum of the average share price for the three months ending on the Measurement Date plus the cumulative from the 2018 salary levels. For incoming Executive Directors, dividends paid per share over the Performance Period. The base salaries will be disclosed in the 2019 Annual Report. starting share price was set at £0.3016 (“Initial Price”), being the three month average share price prior to 1 January 2017. PERFORMANCE RELATED PAY FOR 2019 The annual bonus for the 2019 financial year will operate on the The hurdle price was set at £0.442, being the Initial Price plus 10% compounded annual growth over the Performance Period same basis as for the 2018 financial year and will be consistent (“Hurdle”). The total participation pool for the VCP will be with the policy detailed in the remuneration policy section 10% of the total value created above the Hurdle (“Pool”). The of this report having maximum bonus opportunity, deferral number of shares under the nil cost option will be determined and clawback provisions identical to those in place for 2018. at the end of the Performance Period on the Measurement The performance metrics selected are underlying profit and Date and will be calculated by reference to the Executive year-end net debt, with an equal weighting given to each. Director’s percentage entitlement to growth in value below. Underlying profit and year-end net debt targets have been Any awards which vest after the four year Performance Period set to be challenging relative to the 2019 business plan. The will be subject to a further one year holding period. targets themselves, as they relate to the 2019 financial year, Details of VCP Awards made in 2017 Director Position Trevor Finn Chief Executive Martin Casha Chief Operating Officer Tim Holden Finance Director Percentage entitlement of 10% Pool Percentage entitlement of growth in value 30% 20% 10% 3% 2% 1% RECOVERY AND WITHHOLDING PROVISIONS As detailed in the summary of remuneration policy on pages the withholding of future incentive payouts (including at the point of vesting of an LTIP or VCP award) or through requiring 57 to 59, the clawback provisions that operate in the annual bonus, the LTIP and the VCP enable the Remuneration the overpayment be refunded to the company on a net of tax basis.  The clawback provisions are included in the relevant Committee to recover value overpaid in the event of either a plan documentation so that there is a clear basis on which the material misstatement of the company’s financial results for Remuneration Committee could seek to enforce the provisions any period or misconduct. Should it be considered appropriate should it consider it necessary to do so. to enforce these provisions, value can be recovered through 65 Pendragon PLC Annual Report 2018DIRECTORS REMUNERATION REPORT DIRECTORS’ SHAREHOLDINGS (AUDITED) Trevor Finn Martin Casha Tim Holden Legally owned as at 31.12.2018 Legally owned as at 31.12.2017 19,127,976 19,127,976 9,559,780 9,559,780 2,131,331 2,131,331 Subject to deferral under the annual bonus plan Subject to performance conditions under the relevant long term incentive plan 2016 LTIP1 award 2016 LTIP2 award No No No 1,931,250 1,218,375 920,104 Vested but unexercised share options 0 0 0 1. Performance conditions: vesting is subject to the satisfaction of performance conditions based on achieving defined earnings per share targets measured from the 2015 earnings per share result over a three-year performance period – 4.5p (25% vesting) rising to 5.3p (100% vesting). Actual EPS for the financial year 2018: 2.8p. DIRECTORS’ SHAREHOLDINGS (AUDITED) INFORMATION Directors’ Shareholdings (Audited Information) Each Executive TOTAL SHAREHOLDER RETURN1 The graph below shows the total shareholder return (“TSR”)2 on the company’s shares in comparison to the FTSE Small Director fulfils the requirements of the company share Cap Index (excluding investment companies).3 TSR has been ownership policy applicable to them (i.e. building a 200% of calculated as the percentage change, during the relevant salary share ownership in the case of the Chief Executive and period, in the market price of the shares, assuming that any 100% in the case of the other Executive Directors). There is no dividends paid are reinvested on the ex-dividend date. The company policy on Non-Executive Director share ownership. relevant period is the seven years ending 31 December 2018. The notes at the foot of the graph provide more detail of the TSR calculation. PENDRAGON PLC TSR 2011 - 2018 700 600 500 400 300 200 100 50 0 2011 2012 2013 2014 2015 2016 2017 2018 PENDRAGON PLC - TOTAL RETURN INDEX FTSE SMALL CAP EX INV. TRUSTS - TOTAL RETURN INDEX 1. This report is required, pursuant to the Large and Medium sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013, regulation 18, Performance Graph. 2. Total Shareholder Return (“TSR”) is calculated over the seven years ended on 31 December 2018 and reflects the theoretical growth in the value of a shareholding over that period, assuming dividends (if any) are reinvested in shares in the company. The price at which dividends are reinvested is assumed to be the amount equal to the closing price of the shares on the ex-dividend date plus the gross amount of annual dividend. The calculation ignores tax and reinvestment charges. For each company in the index, the TSR statistics are normalised to a common start point, which gives the equivalent to investing the same amount of money in each company at that time. The percentage growth in TSR is measured over the chosen period. To obtain TSR growth of the relevant index over the chosen period, the weighted average of TSR for all the companies in the index is calculated. In this case, it is the FTSE Small Cap Index (excluding investment companies) as explained in Note 3. The weighting is by reference to the market capitalisation of each company in the index in proportion to the total market capitalisation of all the companies in the index at the end of the chosen measurement period. 3. The FTSE Small CAP index has been selected as it represents the equity market in which the Company was a constituent member for the majority of the relevant seven year period ending 31 December 2018 detailed above. 66 Pendragon PLC Annual Report 2018HISTORY OF CHIEF EXECUTIVE REMUNERATION Chief Executive Total Remuneration £m (single figure) Annual bonus award (% of maximum that could have been paid) Percentage of LTIP1 vesting 2018 589 0% 0% 2017 727 2016 1,605 2015 1,775 2014 2013 3,472 2,961 2012 857 30% 87% 100% 100% 100% 54% 0% 100% 56% 100% 100% 0% 1. Percentage of shares vesting under the Pendragon Long Term Incentive Plan (for 2012, the Pendragon ExSOP) against the maximum number of shares that could have been received. PERCENTAGE CHANGE IN CHIEF EXECUTIVE REMUNERATION The table below illustrates the percentage change in the remuneration awarded to the chief executive between the preceding year and the reported year and that of the Group’s employees across its entire UK business. % change in salary 2018 compared to 2017 % change in benefit 2018 compared to 2017 % change in bonus 2018 compared to 2017 Chief Executive Employees of Company as a whole 0% 0% -100% 4.80% 15.48% -11.01% RELATIVE IMPORTANCE OF SPEND ON PAY The graph below illustrates the difference between spend on remuneration paid to all employees of the company, and dividend (interim and final proposed dividend) compared to the prior year. £40M £30M £20M £10M £0M £21.3M £22.5M £296.9M £297.2M 2017 2018 2017 2018 DIVIDEND TOTAL EMPLOYEE PAY £4OOM £3OOM £200M £100M £0M 67 Pendragon PLC Annual Report 2018 DIRECTORS REMUNERATION REPORT SHAREHOLDERS’ VOTE ON REMUNERATION AT THE 2018 AGM 2017 Directors’ Remuneration Report Votes cast in favour Votes cast against Total votes cast in favour or against Votes withheld Number 739,947,663 152,840,583 892,788,246 9,596,353 Proportion of votes cast 82.88% 17.12% 100% SHARE PRICE INFORMATION AND PERFORMANCE Other than those detailed above, there are no share option or long term incentive schemes in which the Directors are eligible to participate. The middle market price of Pendragon ordinary shares at 31 December 2018 was 22.50 pence and the range during the year was 20.05 pence to 30.85 pence. APPROVAL This report was approved by the Committee and signed on its behalf by:- Mike Wright Chairman of the Remuneration Committee 12 March 2019 68 Pendragon PLC Annual Report 2018DIRECTORS REPORT STRATEGIC REVIEW AND PRESCRIBED REPORTING Our Strategic Review at pages 4 to 25 contains the information, purchases of the company’s ordinary shares (in practice, exercised only if the Directors expect it to result in an increase prescribed by the Companies Act 2006, required to present in earnings per share). Details of movements in the company’s a fair review of the company’s business, a description of the share capital are given in note • to the financial statements. principal risks and uncertainties it faces, and certain of the information on which reports and statements are required by In May 2016, the company announced the commencement of the UK Corporate Governance Code. The Board approved the a programme to buyback an initial £20 million of its ordinary Strategic Review set out on pages 9 to 33 and the Viability shares. Between 20 May 2016 and 31 December 2018, the Statement set out on page 40. Additional information on company purchased and cancelled a total of 61,171,630 which the Directors are required by law to report is set out ordinary shares in the company. In addition, from time to time, below and in the following:- Pendragon provides financial assistance to its independent employee benefits trust to facilitate the market purchase of • • • Corporate Governance Report ordinary shares in the company for use in connection with Board of Directors various of the company’s employee incentive schemes. The Corporate Social Responsibility Report company did not purchase any shares in this way in 2018. • Audit Committee Report • Nomination Committee Report Directors’ Remuneration Report • Directors’ Report BUSINESS AT THE AGM At the AGM, a separate shareholders’ resolution is proposed for each substantive matter. We will issue shareholders with • Directors’ Responsibility Statement the company’s annual report and financial statements together with the notice of AGM, giving not less than the requisite period In the interests of increasing the relevance of the Report and of notice. The notice sets out the resolutions the Directors are reducing the environmental impacts of over-lengthy printed proposing and has explanatory notes for each. At the AGM, reports, we have placed on our website certain background Directors’ terms of appointment are available for inspection information on the company the disclosure of which, in and, as well as dealing with formal AGM business, the Board this Report, is not mandatory. We monitor reaction to takes the opportunity to give an update shareholders on the publication of shareholder information on our website, the company’s trading position. The Chairman and each to help shape our shareholder communication and future Committee Chairman are available to answer questions put by improvements. shareholders present. RESULTS AND DIVIDENDS The results of the Group for the year are set out in the financial statements on pages 90 to 159. An interim dividend of 0.80 pence per ordinary share was paid to shareholders on 23 October 2018 (2017: 0.75 pence). The Directors are recommending a final dividend of 0.70 pence per ordinary share (2017: 0.80 pence) which would, if approved by shareholders at the 2019 AGM, bring total dividends for 2018 to 1.5 pence (2017 total: 1.5 pence). APPOINTMENT AND POWERS OF THE COMPANY’S DIRETORS Appointment and removal of Directors is governed by the company’s articles of association (the Articles), the UK Corporate Governance Code (the Code), the Companies Acts and related legislation. Subject to the Articles (which shareholders may amend by special resolution), relevant legislation and any directions given by special resolution, the company and its Group is managed by its Board of Directors. By resolutions passed at company general meetings, the shareholders have authorised the Directors: (i) to allot and issue ordinary shares; (ii) to offer and allot ordinary shares in lieu of some or all of the dividends; and (iii) to make market 69 Pendragon PLC Annual Report 2018 DIRECTORS REPORT DIRECTORS AND THEIR INTERESTS IN SHARES Current Directors are listed on page 42. Details of the terms of issued ordinary share capital are shown in the table below. All holdings shown are beneficial. None of the Directors holds appointment and notice period of each of the current Directors, options over company shares. Each Executive Director fulfils together with Executives Directors’ respective interests in the requirements of the company’s share ownership policy shares under the company’s long term incentive plan (Non- applicable to them. There is no company policy requiring Non- Executive Directors have none), appear in the Directors’ Executive Directors to hold a minimum number of company Remuneration Report on pages 55 to 68. Directors who served shares. during 2018 and their respective interests in the company’s Directors’ shareholdings Number at 31.12.18 Number at 31.12.17 Martin Casha Chris Chambers Trevor Finn Tim Holden Gillian Kent Richard Laxer Mike Wright 9,559,780 2,000,000 19,127,976 2,131,331 Nil Nil Nil 9,559,780 2,000,000 19,127,976 2,131,331 Nil n/a n/a Jeremy King (resigned 12.11.18) 145,030 145,030 DIRECTORS’ ROTATION The UK Corporate Governance Code (July 2018) imposes an Director of the company or an associated company, qualifying third party indemnity provisions and protection against obligation that all Directors should be subject to annual re- derivative actions. election. Copies of these are available for shareholders’ inspection at the AGM. INDEMNITIES TO DIRECTORS In line with market practice and the company’s Articles, each Director has the benefit of a deed of indemnity from the SIGNIFICANT DIRECT OR INDIRECT SHAREHOLDINGS At 28 February 2019 the Directors had been advised of the company, which includes provisions in relation to duties as a following interests in the shares of the company:- Shareholder Teleios Capital Partners (Zug) Odey Asset Mgt (London) Anders Hedin Invest AB (Regional (Sweden) Hosking Partners (London) Schroder Investment Mgt (London) Dimensional Fund Advisors (London) Black Rock lnc Government of Norway Number of shares Percentage of voting rights of the issued share capital 297,762,244 193,426,898 158,792,303 85,494,471 75,251,586 43,008,008 41,159,326 31,853,532 21.30 13.84 11.36 6.12 5.40 3.08 2.94 2.28 70 Pendragon PLC Annual Report 2018SHARE CAPITAL As at 31 December 2018, Pendragon’s issued share capital The Articles may be obtained from Companies House in the UK or upon application to the Company Secretary. Other comprised a single class: ordinary shares of 5 pence each. The than those prescribed by applicable law and the company’s Articles permit the creation of more than one class of share, procedures for ensuring compliance with it, there are no but there is currently none other than ordinary shares. Details specific restrictions on the size of a holding nor on the transfer of the company’ share capital are set out in note 4.4 to the of shares, which are governed by the Articles and prevailing accounts. All issued shares are fully paid. The company did legislation. The Directors are not aware of any agreement not issue any new shares during the period under review. The between holders of the company’s shares that may result rights and obligations attaching to the company’s ordinary in restrictions on the transfer of securities or the exercise of shares are set out in the Articles. The company is currently voting rights. No person has any special rights of control over authorised to issue up to two-thirds of its current issued share the company’s share capital. capital pursuant to a resolution passed at its 2018 AGM. SHARES HELD BY THE PENDRAGON VOTING RIGHTS, RESTRICTIONS ON VOTING RIGHTS AND DEADLINES FOR VOTING RIGHTS Shareholders (other than any who, under the Articles or the EMPLOYEE BENEFIT TRUST As at 31 December 2018, the company’s Employee Benefit Trust with Accuro Trustees (Jersey) Limited (the Trustee) held terms of the shares they hold, are not entitled to receive such 6,420,093 shares, representing 0.46% of the total issued share notices) have the right to receive notice of, and to attend and capital at that date (2017: 7,676,226; 0.42%). The Trustee has to vote at, all general and (if any) applicable class meetings of waived its voting rights attached to these shares. It holds these the company. A resolution put to the vote at any general or shares to enable it to satisfy entitlements under the company’s class meeting is decided on a show of hands unless (before or share schemes. During the year, the Trustee transferred on the declaration of the result of the show of hands or on the 1,160,935 shares to satisfy such entitlements (2017: 6,515,291). withdrawal of any other demand for a poll) a poll is properly demanded. At a general meeting, every member present in person has, upon a show of hands, one vote, and on a poll, CONTRACTS None of the Directors had an interest in any contract with the every member has one vote for every 5 pence nominal amount Group (other than their service agreement or appointment of share capital of which they are the holder. In the case of joint terms and routine purchases of vehicles for their own use) holders of a share, the vote of the member whose name stands at any time during 2018. The company and members of its first in the register of members is accepted to the exclusion of Group are party to agreements relating to banking, properties, any vote tendered by any other joint holder. Unless the Board employee share plans and motor vehicle franchises which alter decides otherwise, a shareholder may not vote at any general or terminate if the company or Group company concerned or class meeting or exercise any rights in relation to meetings undergoes a change of control. None is considered significant whilst any amount of money relating to his shares remains in terms of its likely impact on the business of the Group as a outstanding. whole. A member is entitled to appoint a proxy to exercise all or any of their rights to attend and speak and vote on their behalf at a POLITICAL DONATIONS The company and its Group made no political donations (2017: general meeting. Further details regarding voting can be found £ nil). in the notes to the notice of the AGM. Details of the exercise of voting rights attached to the ordinary shares held by the company’s Employee Benefit Trust are set out below. None AUDITOR The Directors who held office at the date of approval of this of the ordinary shares, including those held by the Employee Directors’ Report confirm that: so far as they are each aware, Benefit Trust, carries any special voting rights with regard to there is no relevant audit information of which the Group’s control of the company. To be effective, electronic and paper Auditors are unaware; and each Director has taken all the steps proxy appointments and voting instructions must be received that they ought to have taken as a Director to make themself by the company’s registrars not later than 48 hours before a aware of any relevant audit information and to establish that general meeting. By order of the Board Richard Maloney Company Secretary 12 March 2019 the Group’s Auditors are aware of that information. 71 Pendragon PLC Annual Report 2018 FINANCIAL STATEMENTS 73 Director’s Responsibility Statements 89 Notes to the Financial Statements 74 Independant Auditor’s Report 83 Consolidated Income Statement 160 Company Balance Sheet 161 Company Statement of Comprehensive Income 84 Consolidated Statement of Comprehensive Income 162 Company Statement of Changes in Equity 85 Consolidated Statement of Changes in Equity 163 Notes to the Financial Statements of the Company 86 Consolidated Balance Sheet 170 Advisors, Banks and Shareholder Information 87 Consolidated Cash Flow Statement 171 5 Year Group Review 88 Reconciliation of Net Cash Flow to Movement in Net Debt 72 Pendragon PLC Annual Report 2018 STATEMENT OF DIRECTORS’ RESPONSIBILITIES IN RESPECT OF THE ANNUAL REPORT AND THE FINANCIAL STATEMENTS  The Directors are responsible for preparing the Annual Report at any time the financial position of the parent company and and the Group and parent company financial statements in enable them to ensure that its financial statements comply accordance with applicable law and regulations.  with the Companies Act 2006.  They are responsible for such internal control as they determine is necessary to enable the Company law requires the Directors to prepare Group and preparation of financial statements that are free from material parent company financial statements for each financial misstatement, whether due to fraud or error, and have general year.  Under that law they are required to prepare the Group responsibility for taking such steps as are reasonably open to financial statements in accordance with International Financial them to safeguard the assets of the Group and to prevent and Reporting Standards as adopted by the European Union detect fraud and other irregularities.  (IFRSs as adopted by the EU) and applicable law and have elected to prepare the parent company financial statements in Under applicable law and regulations, the Directors are also accordance with UK accounting standards, including FRS 101 responsible for preparing a Strategic Report, Directors’ Report, Reduced Disclosure Framework. Directors’ Remuneration Report and Corporate Governance Under company law the Directors must not approve the financial statements unless they are satisfied that they give The Directors are responsible for the maintenance and a true and fair view of the state of affairs of the Group and integrity of the corporate and financial information included parent company and of their profit or loss for that period.  In on the company’s website.  Legislation in the UK governing preparing each of the Group and parent company financial the preparation and dissemination of financial statements may statements, the Directors are required to:  differ from legislation in other jurisdictions. Statement that complies with that law and those regulations. • select suitable accounting policies and then apply them Responsibility statement of the Directors in respect of the consistently;  annual financial report  • make judgements and estimates that are reasonable, relevant, reliable and prudent;  We confirm that to the best of our knowledge:  • for the Group financial statements, state whether they have been prepared in accordance with IFRSs as adopted • the financial statements, prepared in accordance with the by the EU;  applicable set of accounting standards, give a true and fair • for the parent company financial statements, state view of the assets, liabilities, financial position and profit whether applicable UK accounting standards have been or loss of the company and the undertakings included in followed, subject to any material departures disclosed and the consolidation taken as a whole; and  explained in the parent company financial statements;   • the Annual Report and Accounts includes a fair review of • assess the Group and parent company’s ability to continue the development and performance of the business and as a going concern, disclosing, as applicable, matters the position of the issuer and the undertakings included related to going concern; and  in the consolidation taken as a whole, together with a • use the going concern basis of accounting unless they description of the principal risks and uncertainties that either intend to liquidate the Group or the parent company they face.  or to cease operations, or have no realistic alternative but to do so.  We consider the Annual Report and Accounts, taken as a whole, is fair, balanced and understandable and provides the The Directors are responsible for keeping adequate accounting information necessary for shareholders to assess the Group’s records that are sufficient to show and explain the parent position and performance, business model and strategy.  company’s transactions and disclose with reasonable accuracy Approved by order of the Board Tim Holden Finance Director 12 March 2019 73 Pendragon PLC Annual Report 2018  INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF PENDRAGON PLC 1. Our opinion on the financial statements is unmodified We have audited the financial statements of Pendragon PLC (“the Company”) for the year ended 31 December 2018 which comprise the Consolidated Income Statement, Consolidated Statement of Comprehensive Income, Consolidated Statement of changes in Equity, Consolidated Balance Sheet, Consolidated Cash Flow Statement, Company Statement of Comprehensive Income, Company Statement of Changes in Equity, Company Balance Sheet and the related notes, including the accounting policies in note 1. In our opinion: • the financial statements give a true and fair view of the state of the Group’s and of the parent Company’s affairs as at 31 December 2018 and of the Group’s loss for the year then ended; • the Group financial statements have been properly prepared in accordance with International Financial Reporting Standards as adopted by the European Union; • the parent Company financial statements have been properly prepared in accordance with UK accounting standards, including FRS 101 Reduced Disclosure Framework; and • the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation. Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) (“ISAs (UK)”) and applicable law. Our responsibilities are described below. We believe that the audit evidence we have obtained is a sufficient and appropriate basis for our opinion. Our audit opinion is consistent with our report to the audit committee. We were first appointed as auditor by the shareholders on 28 April 1997. The period of total uninterrupted engagement is for the 22 financial years ended 31 December 2018. We have fulfilled our ethical responsibilities under, and we remain independent of the Group in accordance with, UK ethical requirements including the FRC Ethical Standard as applied to listed public interest entities. No non-audit services prohibited by that standard were provided. 2 Key audit matters: including our assessment of risks of material misstatement Key audit matters are those matters that, in our professional judgment, were of most significance in the audit of the financial statements and include the most significant assessed risks of material misstatement (whether or not due to fraud) identified by us, including those which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team. We summarise below the key audit matters in arriving at our audit opinion above, together with our key audit procedures to address those matters and, as required for public interest entities, our results from those procedures. These matters were addressed, and our results are based on procedures undertaken, in the context of, and solely for the purpose of, our audit of the financial statements as a whole, and in forming our opinion thereon, and consequently are incidental to that opinion, and we do not provide a separate opinion on these matters. 74 Pendragon PLC Annual Report 2018INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF PENDRAGON PLC (CONTINUED) 2. Key audit matters: including our assessment of risks of material misstatement continued The impact of uncertainties due to the UK exiting the European Union on our audit Risk vs 2017: 51 Audit Committee report, page 37 of the Risk Overview and Management, page 40 Viability Statement The risk – Unprecedented levels of uncertainty All audits assess and challenge the reasonableness of Our response – Our procedures included: We developed a standardised firm-wide approach to the estimates, in particular as described in the recoverable amount consideration of the uncertainties arising from Brexit in of goodwill and investments in subsidiaries key audit matter below, and related disclosures and the appropriateness of the going concern basis of preparation of the financial statements planning and performing our audits. Our procedures included: • Our Brexit knowledge: We considered the directors’ assessment of Brexit-related sources of risk for the (see below). All of these depend on assessments of the future group’s business and financial resources compared with economic environment and the Group’s future prospects and our own understanding of the risks. We considered the performance. In addition, we are required to consider the other information • directors’ plans to take action to mitigate the risks; Sensitivity analysis: When addressing going concern, the recoverable amount of goodwill and investments in presented in the Annual Report including the principal subsidiaries, and other areas that depend on forecasts, risks disclosure and the viability statement and to consider we compared the directors’ analysis to our assessment of the directors’ statement that the annual report and the full range of reasonably possible scenarios resulting financial statements taken as a whole is fair, balanced and from Brexit uncertainty and, where forecast cash flows understandable and provides the information necessary for are required to be discounted, considered adjustments to shareholders to assess the Group’s position and performance, business model and strategy. discount rates for the level of remaining uncertainty; • Assessing transparency: As well as assessing individual disclosures as part of our procedures on going concern, Brexit is one of the most significant economic events for the recoverable amount of goodwill, carrying value of UK and at the date of this report its effects are subject to investments, we considered all of the Brexit related unprecedented levels of uncertainty of outcomes, with the full disclosures together, including those in the strategic range of possible effects unknown. report, comparing the overall picture against our understanding of the risks. Our results: As reported under the key audit matters for going concern and the recoverable amount of goodwill and investments in subsidiaries, we found the resulting estimates and related disclosures to be acceptable. However, no audit should be expected to predict the unknowable factors or all possible future implications for a company and this is particularly the case in relation to Brexit. 75 Pendragon PLC Annual Report 2018 INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF PENDRAGON PLC (CONTINUED) 2. Key audit matters: including our assessment of risks of material misstatement continued Our response – Our procedures included: • Funding assessment: We agreed current facilities available to the relevant facility agreements and recent lender correspondence. We inspected the loan agreements in order to determine the covenants attached to the loans and assessed the evidence available to support that they will be met; • • • Historical comparisons: We assessed historical accuracy of management forecasting by comparing the actual cashflows for the year ended 31 December 2018 to the forecast cashflows over the same period; Key dependency assessment: We assessed the impact of assumptions underpinning the cash flow forecasts in order to identify the key dependencies within the forecasts. Sensitivity analysis: We considered sensitivities over the level of available financial resources indicated by the Group’s financial forecasts taking account of reasonably possible (but not unrealistic) adverse effects that could arise from these risks individually and collectively. In particular, we assessed the Group’s downside forecasts based on the risks resulting from Brexit; the assumptions: We Benchmarking assumptions behind the Group’s cashflow forecasts to externally derived data including market forecasts and projected growth and cost inflation; the Evaluating directors’ achievability of the actions the Directors consider they would take to improve the position should the risks materialize. We considered the extent to which the intent and ability of the directors to pursue mitigating actions should such be required were realistic; intent: We evaluated compared • • • Assessing transparency: We assessed the completeness and accuracy of the matters covered in the going concern disclosure by considering whether they accurately reflected the Group’s financing arrangements and the risks associated with the Group’s ability to continue as a going concern. Our results: We found the going concern disclosure without any material uncertainty to be acceptable (2017 result: acceptable). Going Concern Risk vs 2017: Refer to page 89 of the Notes to the financial statements The risk – Disclosure quality The financial statements explain how the Board has formed a judgement that it is appropriate to adopt the going concern basis of preparation for the group and parent company. That judgement is based on an evaluation of the inherent risks to the Group’s and Company’s business model and how those risks might affect the Group’s and Company’s financial resources or ability to continue operations over a period of at least a year from the date of approval of the financial statements. The risks most likely to adversely affect the Group’s and Company’s available financial resources over this period were : • • • Relationship with manufacturers; Execution of the Car Stores new strategy; The impact of Brexit on customer demand. The risk for our audit was whether or not those risks were such that they amounted to a material uncertainty that may have cast significant doubt about the ability to continue as a going concern. Had they been such, then that fact would have been required to have been disclosed. 76 Pendragon PLC Annual Report 2018 INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF PENDRAGON PLC (CONTINUED) 2. Key audit matters: including our assessment of risks of material misstatement continued Recoverable amount of goodwill and investment in subsidiaries Risk vs 2017: (Goodwill £265.9 million, impairment £88.8 million (2017: £361.2 million), parent company investment in subsidiaries £912.4 million, impairment £10.2 million (2017: £922.6 million)) Refer to page 50 Audit Committee report, page 113 (accounting policy) and pages 113-118 (financial disclosures). The risk – Forecast-based valuation Goodwill in the group and the carrying amount of the parent company’s investment in subsidiaries are significant and at risk of irrecoverability following, the profits warning issued by the Group in October 2018 and the Group’s failure to achieve its financial forecasts in the past two years. The Group’s significant goodwill balance is allocated across its Cash Generating Units (CGU’s) which are generally the franchises. During the year, an impairment of £88.8million was recognised against the carrying value of goodwill in a number of CGUs, and an impairment of £10.2million was recognised against the parent company investment in subsidiaries. The estimated recoverable amount is subjective due to the inherent uncertainty involved in forecasting and discounting future cash flows. The effect of these matters is that, as part of our risk assessment, we determined that the value in use of goodwill (and the parent company’s investment in subsidiaries) has a high degree of estimation uncertainty, with a potential range of reasonable outcomes greater than our materiality for the Our response – Our procedures included: • Historical comparisons: We assessed the Group’s budgeting procedures by comparing the Group’s historical budgets to actual performance by CGU; Benchmarking assumptions: We compared the Group’s assumptions to externally derived data in relation to key inputs such as projected market growth and its expected impact on forecasted results, cost inflation, and discount rates; • • Our valuation experience: We used our own valuation specialist to assist us in evaluating the assumptions and methodology used by the Group; Sensitivity analysis: We performed sensitivity analysis for the reasonably possible downsides for key assumptions such as discount rate, growth rate into perpetuity and EBITDA noted above. • • Comparing valuations: We compared the sum of the discounted cash flows to the group’s market capitalisation to assess the reasonableness of those cash flows; and • Assessing transparency: We assessed whether the Group’s disclosures about the sensitivity of the outcome of the impairment assessment to changes in key assumptions reflected the risks inherent in the valuation of goodwill. financial statements as a whole, and possibly many times that amount. The financial statements (note 3.1) disclose the sensitivity estimated by the Group, and the sensitivity in relation to the investment is disclosed in the parent company Our results: We found the Group’s estimate of the recoverable amount of goodwill and investment in subsidiaries, and the resulting impairment charges recognised, to be acceptable (2017 result: acceptable). accounts (note 5). 77 Pendragon PLC Annual Report 2018INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF PENDRAGON PLC (CONTINUED) 2. Key audit matters: including our assessment of risks of material misstatement continued Carrying amount of used vehicle inventory in the UK (£563.2 million (2017: £397.4 million)) Refer to page 51 Audit Committee report, page 124 (accounting policy) and page 124 (financial disclosures). The risk – subjective valuation The Group holds significant levels of used vehicle inventory in the UK. Used vehicle selling prices vary depending upon a number of factors including general economic conditions, falling diesel sales and the levels of new vehicle production. Accounting standards require inventory to be held at the lower of cost and net realisable value. History has shown that the average price of a used vehicle may decline significantly over a short period of time, and therefore the estimation of the net realisable value of used vehicles is a significant judgement area. The risk increases as the age of the used vehicle inventory increases. The effect of these matters is that, as part of our risk assessment, we determined that the carrying amount of used vehicles in the UK has a high degree of estimation uncertainty, with a potential range of reasonable outcomes which are within our materiality for the financial statements as a whole. The financial statements (note 3.4) disclose the sensitivity estimated by the Group. Our response – Our procedures included: • Reperformance: We recalculated the provision provided by the Group and assessed the impact of sensitivity testing on the input assumptions; • Historical comparisons: We considered the Group’s historical trading patterns including performing an analysis of the ageing of the vehicles to challenge the assumptions made in the used vehicle inventory provision. We also assessed the Group’s methodology for calculating the provision by performing a retrospective review of sales prices achieved during the year compared to the prior year provision; Benchmarking assumptions: We compared the Group’s expectations for used car prices to the expectations of market commentators; Tests of details: We assessed the appropriateness of the related inventory provision by comparing the losses incurred on used car sales subsequent to the year end to the level of the year end provision; • • • Assessing transparency: We also considered the adequacy of the Group’s disclosures about the degree of estimation involved in arriving at the vehicle inventory provision. Our results: We found the group’s estimate of the carrying value of UK used inventory to be acceptable (2017 result: acceptable). Post- retirement benefits obligation (£486.3 million (2017: £521.8 million)) Risk vs 2017: Refer to page 51 Audit Committee report, page 147 (accounting policy) and page 147-156 (financial disclosures). Our response – Our procedures included: • Benchmarking assumptions: With the support of our own actuarial specialists, we challenged the key assumptions applied to determine the Group’s post-retirement benefit obligation against externally derived data. The key assumptions tested include discount rate, inflation rate, mortality/life expectancy and rate of pension payments; • Assessing transparency: We also considered the adequacy of the Group’s disclosures in respect of the sensitivity of the deficit to these assumptions. Our results: We found the valuation of the post-retirement benefits obligation to be acceptable (2017 result: acceptable). The risk – subjective valuation Significant assumptions are made in valuing the Group’s post retirement benefit obligation within the overall net pension liability. Small changes in assumptions used to value the Group’s post retirement benefit obligation would have a significant effect on the Group’s net pension liability. The effect of these matters is that, as part of our risk assessment, we determined that the estimated post retirement benefits obligation has a high degree of estimation uncertainty, with a potential range of reasonable outcomes greater than our materiality for the financial statements as a whole, and possibly many times that amount. The financial statements (note 5.1) disclose the sensitivity estimated by the Group. 78 Pendragon PLC Annual Report 2018INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF PENDRAGON PLC (CONTINUED) 3. Our application of materiality and an overview of the scope of our audit Materiality for the Group financial statements as a whole was set at £2.25million (2017: £3.0million) determined with reference to a benchmark of Group loss before tax normalised to exclude the impairment charge recognised in the year, giving a normalised Group profit before tax of £44.4million of which it represents 5.1% (2017: 4.6% of group profit before tax). Materiality for the parent company financial statements as a whole was set at £1.6million (2017: £2.1million), determined with reference to component materiality. This is lower than the materiality we would otherwise have determined by reference to a benchmark of company net assets, of which it represents 0.4% (2017: 0.6%). We agreed to report to the Audit Committee any corrected or uncorrected identified misstatements exceeding £0.1million (2017: £0.2million), in addition to other identified misstatements that warranted reporting on qualitative grounds. We subjected all twenty four (2017: all six) of the Group’s reporting components to full scope audits for Group purposes. The components within the scope of our work accounted for 100% (2017:100%) of the Group’s revenue, profit before tax and total assets. The Group audit team approved the component materialities, which ranged from £0.1million to £1.6 million (2017: £2.1 million), having regard to the mix of size and risk profile of the Group across the components. The Group audit team performed all of the audit work in relation to the twenty four (2017: six) components, including the audit of the parent company. Normalised Group Profit before tax £44.4m (2017:£65.3m) Group materiality £2.3m (2017:£3.0m) £2.3m Whole financial statements materiality (2017:£3.0m) £1.6m Component materiality (2017:£2.1m) £0.1m Mis-statements reported to the Audit Committee (2017:£0.2m) 4. We have nothing to report on going concern The Directors have prepared the financial statements on the going concern basis as they do not intend to liquidate the Company or the Group or to cease their operations, and as they have concluded that the Company’s and the Group’s financial position means that this is realistic. They have also concluded that there are no material uncertainties that could have cast significant doubt over their ability to continue as a going concern for at least a year from the date of approval of the financial statements (“the going concern period”). Our responsibility is to conclude on the appropriateness of the Directors’ conclusions and, had there been a material uncertainty related to going concern, to make reference to that in this audit report. However, as we cannot predict all future events or conditions and as subsequent events may result in outcomes that are inconsistent with judgements that were reasonable at the time they were made, the absence of reference to a material uncertainty in this auditor’s report is not a guarantee that the Group and the Company will continue in operation. We identified going concern as a key audit matter (see section 2 of this report). Based on the work described in our response to that key audit matter, we are required to report to you if: • we have anything material to add or draw attention to in relation to the directors’ statement in Note 1 to the financial statements on the use of the going concern basis of accounting with no material uncertainties that may cast significant doubt over the Group and Company’s use of that basis for a period of at least twelve months from the date of approval of the financial statements; or • the related statement under the Listing Rules set out on page 81 is materially inconsistent with our audit knowledge. We have nothing to report in these respects. 79 Pendragon PLC Annual Report 2018INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF PENDRAGON PLC (CONTINUED) 5. We have nothing to report on the other information in the Annual Report The directors are responsible for the other information presented in the Annual Report together with the financial statements. Our opinion on the financial statements does not cover the other information and, accordingly, we do not express an audit opinion or, except as explicitly stated below, any form of assurance conclusion thereon. Our responsibility is to read the other information and, in doing so, consider whether, based on our financial statements audit work, the information therein is materially misstated or inconsistent with the financial statements or our audit knowledge. Based solely on that work we have not identified material misstatements in the other information. Strategic report and Directors’ report Based solely on our work on the other information: • we have not identified material misstatements in the strategic report and the Directors’ report; • • in our opinion the information given in those reports for the financial year is consistent with the financial statements; and in our opinion those reports have been prepared in accordance with the Companies Act 2006. Directors’ remuneration report In our opinion the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006. Disclosures of principal risks and longer-term viability Based on the knowledge we acquired during our financial statements audit, we have nothing material to add or draw attention to in relation to: • the directors’ confirmation within the viability statement on page 40 that they have carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency and liquidity; the Principal Risks disclosures on pages 35 to 39 describing these risks and explaining how they are being managed and mitigated; and the directors’ explanation in the viability statement of how they have assessed the prospects of the Group, over what period they have done so and why they considered that period to be appropriate, and their statement as to whether they have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions. • • Under the Listing Rules we are required to review the viability statement. We have nothing to report in this respect. Our work is limited to assessing these matters in the context of only the knowledge acquired during our financial statements audit. As we cannot predict all future events or conditions and as subsequent events may result in outcomes that are inconsistent with judgments that were reasonable at the time they were made, the absence of anything to report on these statements is not a guarantee as to the Group’s and Company’s longer-term viability. Corporate governance disclosures We are required to report to you if: • we have identified material inconsistencies between the knowledge we acquired during our financial statements audit and the directors’ statement that they consider that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s position and performance, business model and strategy; or the section of the annual report describing the work of the Audit Committee does not appropriately address matters communicated by us to the Audit Committee. • We are required to report to you if the Corporate Governance Statement does not properly disclose a departure from the eleven provisions of the UK Corporate Governance Code specified by the Listing Rules for our review. We have nothing to report in these respects. 80 Pendragon PLC Annual Report 2018INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF PENDRAGON PLC (CONTINUED) 6. We have nothing to report on the other matters on which we are required to report by exception Under the Companies Act 2006, we are required to report to you if, in our opinion: • adequate accounting records have not been kept by the parent Company, or returns adequate for our audit have not been received from branches not visited by us; or the parent Company financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or • certain disclosures of directors’ remuneration specified by law are not made; or • we have not received all the information and explanations we require for our audit. • We have nothing to report in these respects. 7. Respective responsibilities Directors’ responsibilities As explained more fully in their statement set out on page 73, the directors are responsible for: the preparation of the financial statements including being satisfied that they give a true and fair view; such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error; assessing the Group and parent Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern; and using the going concern basis of accounting unless they either intend to liquidate the Group or the parent Company or to cease operations, or have no realistic alternative but to do so. Auditor’s responsibilities Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or other irregularities (see below), or error, and to issue our opinion in an auditor’s report. Reasonable assurance is a high level of assurance, but does not guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud, other irregularities or error and are considered material if, individually or in aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. A fuller description of our responsibilities is provided on the FRC’s website at www.frc.org.uk/auditorsresponsibilities. Irregularities – ability to detect We identified areas of laws and regulations that could reasonably be expected to have a material effect on the financial statements from our general commercial and sector experience and through discussion with the directors and other management (as required by auditing standards) and discussed with the directors and other management the policies and procedures regarding compliance with laws and regulations. We communicated identified laws and regulations throughout our team and remained alert to any indications of non-compliance throughout the audit. The potential effect of these laws and regulations on the financial statements varies considerably. Firstly, the group is subject to laws and regulations that directly affect the financial statements including financial reporting legislation (including related companies legislation), distributable profits legislation, and taxation legislation, and we assessed the extent of compliance with these laws and regulations as part of our procedures on the related financial statement items. Secondly, the group is subject to many other laws and regulations where the consequences of non-compliance could have a material effect on amounts or disclosures in the financial statements, for instance through the imposition of fines or litigation. We identified the following area as those most likely to have such an effect: Anti-bribery and Corruption Act 2011, recognising the financial and regulated nature of the group’s activities. Auditing standards limit the required audit procedures to identify non-compliance with these laws and regulations to enquiry of the directors and other management and inspection of regulatory and legal correspondence, if any. Through these procedures, we became aware of actual or suspected non-compliance and considered the effect as part of our procedures on the related financial statement items. The identified actual or suspected non- compliance was not sufficiently significant to our audit to result in our response being identified as a key audit matter. Owing to the inherent limitations of an audit, there is an unavoidable risk that we may not have detected some material misstatements in the financial statements, even though we have properly planned and performed our audit in accordance with auditing standards. For example, the further removed non-compliance with laws and regulations (irregularities) is from the events and transactions reflected in the financial statements, the less likely the inherently limited procedures required by auditing standards would identify it. In addition, as with any audit, there remained a higher risk of non-detection of irregularities, as these may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal controls. We are not responsible for preventing non-compliance and cannot be expected to detect non-compliance with all laws and regulations. 81 Pendragon PLC Annual Report 2018INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF PENDRAGON PLC (CONTINUED) 8. The purpose of our audit work and to whom we owe our responsibilities This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members, as a body, for our audit work, for this report, or for the opinions we have formed. John Leech (Senior Statutory Auditor) for and on behalf of KPMG LLP, Statutory Auditor Chartered Accountants One Snowhill, Snowhill Queensway, Birmingham B4 6GH 12 March 2019 82 Pendragon PLC Annual Report 2018CONSOLIDATED INCOME STATEMENT Year ended 31 December 2018 Revenue Cost of sales Gross profit Continuing operations £m Discontinued operations* £m Notes Continuing operations £m Discontinued operations* £m 2018 £m 2017 £m 2.1 4,148.6 478.4 4,627.0 4,324.3 414.8 4,739.1 (3,658.2) (418.3) (4,076.5) (3,825.6) (360.6) (4,186.2) 490.4 60.1 550.5 498.7 54.2 552.9 Operating expenses 2.2 (529.1) (51.5) (580.6) (418.0) (43.4) (461.4) Operating (loss)/profit before other income (38.7) Other income - gains/(losses) on the sale of businesses and property Operating (loss)/profit Analysed as: Underlying operating profit Non-underlying operating (loss)/ profit Finance expense Net finance costs 2.6 13.0 (25.7) 67.6 (93.3) (27.5) (27.5) 2.6 4.3 8.6 2.7 11.3 8.6 2.7 (2.5) (2.5) (30.1) 80.7 10.8 91.5 15.7 (0.1) - (0.1) (14.4) 80.6 10.8 91.4 76.2 (90.6) 73.0 7.6 (30.0) (30.0) (24.5) (24.5) 10.8 - (1.6) (1.6) 83.8 7.6 (26.1) (26.1) Analysed as: Underlying net finance costs Non-underlying net finance costs 2.6 (25.9) (1.6) (2.5) (28.4) - (1.6) (21.8) (2.7) (1.6) - (23.4) (2.7) (Loss)/profit before taxation (53.2) 8.8 (44.4) 56.1 9.2 65.3 Analysed as: Underlying profit before taxation Non-underlying (loss)/ profit before taxation Income tax expense (Loss)/profit for the year Earnings per share Basic earnings per share Diluted earnings per share Non GAAP measure: Underlying basic earnings per share Underlying diluted earnings per share 2.6 2.7 2.8 2.8 2.8 2.8 41.7 (94.9) 6.1 2.7 47.8 (92.2) 51.2 4.9 9.2 - 60.4 4.9 (3.8) (57.0) (2.3) 6.5 (6.1) (50.5) (8.7) 47.4 (3.3) 5.9 (12.0) 53.3 (4.1p) (4.1p) 2.5p 2.5p 0.5p 0.5p 0.3p 0.3p (3.6p) (3.6p) 2.8p 2.8p 3.3p 3.3p 2.9p 2.9p 0.4p 0.4p 0.4p 0.4p 3.7p 3.7p 3.3p 3.3p * The discontinued operations are in respect of the Group’s US business which is currently classified as held for sale (see note 3.3). The notes on pages 90 to 159 form part of these financial statements 83 Pendragon PLC Annual Report 2018CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME Year ended 31 December 2018 (Loss)/profit for the year Other comprehensive income Items that will never be reclassified to profit and loss: Defined benefit plan remeasurement (losses) and gains Income tax relating to defined benefit plan remeasurement (gains) and losses Items that are or may be reclassified to profit and loss: Foreign currency translation differences of foreign operations Notes 5.1 2.7 Other comprehensive income for the year, net of tax Total comprehensive income for the year Total comprehensive income for the period attributable to equity shareholders of the company arises from: Continuing operations Discontinued operations - see note 3.3 2018 £m (50.5) (0.9) - (0.9) - - (0.9) (51.4) (58.0) 6.6 (51.4) 2017 £m 53.3 35.8 (6.3) 29.5 (0.6) (0.6) 28.9 82.2 76.9 5.3 82.2 The notes on pages 90 to 159 form part of these financial statements 84 Pendragon PLC Annual Report 2018CONSOLIDATED STATEMENT OF CHANGES IN EQUITY Year ended 31 December 2018 Balance at 1 January 2018 71.2 56.8 4.3 12.6 (0.8) 281.3 425.4 Share capital £m Share premium £m Capital redemption reserve £m Other reserves £m Translation differences £m Retained earnings £m Total £m Total comprehensive income for 2018 Loss for the year Other comprehensive income for the year, net of tax Total comprehensive income for the year Dividends paid (note 4.5) Own shares purchased for cancellation Own shares issued by EBT Share based payments - - - - (1.2) - - - - - - - - - Balance at 31 December 2018 70.0 56.8 - - - - 1.2 - - 5.5 - - - - - - - - - - - - - - (50.5) (50.5) (0.9) (0.9) (51.4) (51.4) (22.5) (22.5) (6.7) 0.1 0.7 (6.7) 0.1 0.7 12.6 (0.8) 201.5 345.6 Balance at 1 January 2017 71.8 56.8 3.7 12.6 (0.2) 228.1 372.8 Total comprehensive income for 2017 Profit for the year Other comprehensive income for the year, net of tax Total comprehensive income for the year Dividends paid (note 4.5) - - - - Own shares purchased for cancellation (0.6) Own shares purchased by EBT Own shares issued by EBT Share based payments Income tax relating to share based payments - - - - - - - - - - - - - - - - - 0.6 - - - - - - - - - - - - - - 53.3 53.3 (0.6) 29.5 28.9 (0.6) 82.8 82.2 - - - - - - (21.3) (21.3) (4.0) (2.8) 0.1 (1.7) (4.0) (2.8) 0.1 (1.7) 0.1 0.1 Balance at 31 December 2017 71.2 56.8 4.3 12.6 (0.8) 281.3 425.4 The notes on pages 90 to 159 form part of these financial statements 85 Pendragon PLC Annual Report 2018 CONSOLIDATED BALANCE SHEET At 31 December 2018 Non-current assets Property, plant and equipment Goodwill Other intangible assets Deferred tax assets Total non-current assets Current assets Inventories Trade and other receivables Current tax assets Cash and cash equivalents Assets classified as held for sale Total current assets Total assets Current liabilities Trade and other payables Deferred income Current tax payable Provisions Liabilities directly associated with the assets held for sale Total current liabilities Non-current liabilities Interest bearing loans and borrowings Trade and other payables Deferred income Retirement benefit obligations Provisions Total non-current liabilities Total liabilities Net assets Capital and reserves Called up share capital Share premium account Capital redemption reserve Other reserves Translation reserve Retained earnings Total equity attributable to equity shareholders of the Company Approved by the Board of Directors on 12 March 2019 and signed on its behalf by: T G Finn Chief Executive Registered Company Number: 02304195 T P Holden Finance Director The notes on pages 90 to 159 form part of these financial statements 86 Notes 3.2 3.1 3.1 2.7 3.4 3.6 4.2 3.3 3.7 3.9 3.8 3.3 4.2 3.7 3.9 5.1 3.8 4.4 4.4 4.4 4.4 4.4 2018 £m 463.9 265.9 8.2 9.8 747.8 959.6 114.8 4.3 51.4 137.6 1,267.7 2,015.5 (1,175.4) (49.7) - (0.7) (88.6) 2017 £m 479.9 361.2 7.5 11.4 860.0 1,003.5 132.8 - 53.3 11.0 1,200.6 2,060.6 (1,224.2) (50.3) (2.1) (0.7) - (1,314.4) (1,277.3) (179.0) (54.4) (52.2) (68.3) (1.6) (355.5) (1,669.9) 345.6 70.0 56.8 5.5 12.6 (0.8) 201.5 345.6 (177.4) (59.0) (49.9) (62.8) (8.8) (357.9) (1,635.2) 425.4 71.2 56.8 4.3 12.6 (0.8) 281.3 425.4 Pendragon PLC Annual Report 2018 CONSOLIDATED CASH FLOW STATEMENT Year ended 31 December 2018 Cash flows from operating activities (Loss)/profit for the year Adjustment for taxation Adjustment for net financing expense Depreciation and amortisation Share based payments Pension past service costs (Profit)/loss on sale of businesses and property Impairment of goodwill Impairment of assets held for sale Impairment of property, plant and equipment Contribution into defined benefit pension scheme Changes in inventories Changes in trade and other receivables Changes in trade and other payables Changes in provisions Movement in contract hire vehicle balances Cash generated from operations Taxation paid Interest paid Net cash from operating activities Cash flows from investing activities Business acquisitions Proceeds from sale of businesses Purchase of property, plant, equipment and intangible assets Proceeds from sale of property, plant, equipment and intangible assets Net cash used in investing activities Cash flows from financing activities Dividends paid to shareholders Repurchase of own shares Own shares acquired by EBT Disposal of shares by EBT Repayment of loans Proceeds from issue of loans Net cash outflow from financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at 1 January Effects of exchange rate changes on cash held Cash and cash equivalents at 31 December The notes on pages 90 to 159 form part of these financial statements Notes 3.4 3.5 6.1 6.2 3.1, 3.2 3.1, 3.2 4.2 2018 £m (50.5) 6.1 30.0 (14.4) 27.4 0.7 10.5 (15.7) 88.8 1.2 5.8 (7.5) (23.6) (7.6) 61.6 (7.2) (31.9) 88.1 (10.9) (24.8) 52.4 - 10.9 (133.2) 96.0 (26.3) (22.5) (6.7) - 0.1 (10.0) 7.1 (32.0) (5.9) 53.3 4.0 51.4 2017 £m 53.3 12.0 26.1 91.4 28.5 (1.7) - 0.1 - - - (7.3) (102.3) 20.8 134.0 (2.9) (31.7) 128.9 (16.1) (20.0) 92.8 (17.8) - (193.0) 114.1 (96.7) (21.3) (4.0) (2.8) 0.1 (15.0) 20.4 (22.6) (26.5) 84.0 (4.2) 53.3 87 Pendragon PLC Annual Report 2018RECONCILIATION OF NET CASH FLOW TO MOVEMENT IN NET DEBT Net decrease in cash and cash equivalents Repayment of bond and loans Proceeds from issue of loans (net of directly attributable transaction costs) Non-cash movements Increase in net debt in the year Opening net debt Closing net debt 2018 £m (5.9) 10.0 (7.1) (0.5) (3.5) (124.1) (127.6) 2017 £m (26.5) 15.0 (20.4) (0.5) (32.4) (91.7) (124.1) Note: The reconciliation of net cash flow to movement in net debt is not a primary statement and does not form part of the consolidated cash flow statement but forms part of the notes to the financial statements. The notes on pages 90 to 159 form part of these financial statements 88 Pendragon PLC Annual Report 2018NOTES TO THE FINANCIAL STATEMENTS SECTION 1 - BASIS OF PREPARATION Presented below are those accounting policies that relate to the financial statements as a whole and includes details of new accounting standards that are or will be effective for 2018 or later years. To facilitate the understanding of each note to the financial statements those accounting policies that are relevant to a particular category are presented within the relevant notes. Pendragon PLC is a company domiciled in the United Kingdom. The consolidated financial statements of the Group for the year ended 31 December 2018 comprise the company and its subsidiaries and the Group’s interest in jointly controlled entities, together referred to as the ‘Group’ The Group financial statements have been prepared and approved by the Directors in accordance with international accounting standards, being the International Financial Reporting Standards as adopted by the EU (‘adopted IFRSs’). The company has elected to prepare its parent company financial statements in accordance with FRS 101. These are presented on pages 160 to 169. The financial statements are presented in millions of UK pounds, rounded to the nearest £0.1m. They have been prepared under the historical cost convention and where other bases are applied these are identified in the relevant accounting policy in the notes below. Going concern The Group’s business activities, together with the factors likely to affect its future development, performance and position are set out in the Operational Review sections on pages 9 to 17 and pages 26 to 33. The financial position of the Group, its cash flows, liquidity position and borrowing facilities are described in the Financial Review section on pages 32 to 34. In addition, note 4.2 to the financial statements includes the Group’s objectives, policies and processes for managing its capital; its financial risk management objectives; details of its financial instruments and hedging activities; and its exposures to credit risk and liquidity risk. At 31 December 2018, there are undrawn available facilities and, as highlighted in note 4.2 to the financial statements, the Group meets its day-to-day working capital requirements through bank, manufacturer and third party vehicle financing 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 facility. At 31 December 2018, the Group has access to a £300m RCF facility that expires in March 2021. The Group meets it day to day working capital needs, principally though the additional manufacturer and vehicle financing facilities. The Group has forecast daily cashflows for the period to 30 June 2020, based on the Directors current expectation of the Group’s financial performance. The Directors have prepared a reasonably possible down-side scenario forecast taking into account mitigations which are under the Directors control, considering the impact of a no Deal Brexit. This downside scenario forecasts a positive headroom on cash and covenant throughout the period to 30 June 2020. It is on this basis that the Directors believe the Group has adequate resources to continue in operational existence for at least the period to 30 June 2020. Thus they continue to adopt the going concern basis of accounting in preparing the annual financial statements. 89 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 1 - BASIS OF PREPARATION Judgements The Group applies judgement in how it applies its accounting policies, which do not involve estimation, but could materially affect the numbers disclosed in these financial statements. The key accounting judgements, without estimation, that have been applied in these financial statements are as follows: Key judgements Effect on Financial Statements Alternative accounting judgement that could have been applied Effect of that alternative accounting judgement Deferred tax assets: No recognition of certain deferred tax assets as the Group believes their recovery to be too uncertain. Assets held for sale: The Group has announced its intention to dispose of its US business and reduce its premium franchise locations. No recognition of potential assets of £7.9m relating to unutilised tax losses of £13.8m and unrecognised net capital losses of £38.0m. If the Group had determined that the utilisation of the losses was more certain then full or partial recognition of deferred tax assets would have taken place. Recognition of assets within the range £0- £7.9m. Assets held for sale included £37.0m for the US business which we were actively selling at 31 December 2018. The disclosure of the assets and liabilities relating to the other businesses which we expect to sell remain unchanged. If the Group had determined that some or all of the planned disposals were sufficiently advanced to meet the criteria to be classified as assets held for sale then other businesses could have been classified as assets held for sale. Reclassification of further businesses as assets held for sale. Intangibles: Internally generated intangible assets relate to activities that involve the development of dealer management systems by the Software operating segment. Capitalisation of development expenditure is completed only if development costs meet certain criteria. Full detail of the criteria is in note 3.1. Not capitalising development costs. Reduction of £7.1m of asset carrying value. 90 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 1 - BASIS OF PREPARATION Accounting Estimates The preparation of financial statements in conformity with adopted IFRSs requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting year. Although these estimates are based on management’s best knowledge of the amount, events or actions, actual results ultimately may differ from those estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances. Revisions to accounting estimates are recognised in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods. The Directors consider the following to be the key estimates applicable to the financial statements, which have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year or in the long term: Potential impact within the next financial year Potential impact in the longer term Note reference 3 3 3.1 3 3 3 3.4 5.1 3.2 3 3 Key estimate area Key assumption Goodwill impairment Inventory fair value (UK used inventory of £563.2m) Retirement benefit obligations Contract hire vehicle residual values Within the Goodwill calculation we undertake an exercise to estimate future cashflows from each Cash Generating Unit (CGU). We have key assumptions on the growth rates of revenue and gross margin in each of new, used and aftersales which impacts the profit assumed and hence cashflow generation in each CGU. These assumptions are key to calculation of the net present value of cashflows. The further key assumptions are the perpetuity growth rate and discount rate. The Group assessment of fair values of used inventory involves an element of estimation. The key assumption is estimating the likely sale period and the expected profit or loss on sale for each of our inventory items that are held at the year end point. We conduct this analysis by looking at stock by age category and comparing historical trends and our forward expectations on these assumptions. The main assumptions in determining the Group’s retirement benefit obligations are: discount rate, mortality and rate of inflation. Full detail is included in the pension note, 5.1. The vehicles within the Group’s contract hire fleet are subject to a repurchase commitment from the vehicle’s funders at the end of the contract hire period which is pre-determined at the commencement of each contract. The Group has to assess the likely value of these vehicles at the end of their contracts and determine if any impairment is necessary when compared against the repurchase price. This involves estimating the future value of these vehicles using industry data of projected used car values over the periods during which the vehicles are due to be returned together with its own historic data and expectations based on past trends and the model mix in the fleet. 91 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 1 - BASIS OF PREPARATION Basis of consolidation The consolidated financial statements include the financial statements of Pendragon PLC, all its subsidiary undertakings and investments. Consistent accounting policies have been applied in the preparation of all such financial statements. Subsidiaries Subsidiaries are entities controlled by the Group. The Group controls an entity when it is exposed to, or has rights to, variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases. Investments Investments in entities in which the Group has no control are stated at their fair value. When the Group’s share of losses exceeds its interest in an equity-accounted investee, the carrying amount of that interest, including any long term investments, is reduced to zero, and the recognition of further losses is discontinued except to the extent that the Group has an obligation or has made payments on behalf of the investee. Transactions eliminated on consolidation IntraGroup balances and any unrealised gains or losses or income and expenses arising from intraGroup transactions, are eliminated in preparing the consolidated financial statements. Unrealised gains and losses arising from transactions with joint ventures are eliminated against the investment to the extent of the Group’s interest in the entity. Foreign currencies Transactions in foreign currencies are translated to the respective functional currency of Group entities at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated to the functional currency at the foreign exchange rate ruling at that date. Non-monetary assets and liabilities that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction. Non-monetary assets and liabilities denominated in foreign currencies that are stated at fair value are translated to sterling at foreign exchange rates ruling at the dates the fair value was determined. Foreign currency differences arising on retranslation are recognised in profit or loss. The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on consolidation, are translated to sterling at foreign exchange rates ruling at the balance sheet date. The revenues and expenses of foreign operations are translated to sterling at rates approximating to the foreign exchange rates ruling at the dates of the transactions. Foreign currency differences arising on the retranslation of a financial liability designated as a hedge of a net investment in a foreign operation are recognised directly in equity, in the foreign currency translation reserve, to the extent the hedge is effective. To the extent the hedge is ineffective, such differences are recognised in profit or loss. When the hedged net investment is disposed of, the cumulative amount in equity is transferred to profit and loss on disposal. In respect of all foreign operations, any differences that have arisen after 1 January 2004, the date of transition to IFRS, are presented as a separate component of equity. Cash and cash equivalents For the purposes of the cash flow statement, cash and cash equivalents comprise deposits with banks and financial institutions, bank and cash balances, and liquid investments, net of bank overdrafts. Bank overdrafts that are repayable on demand and form an integral part of the Group’s cash management are included as a component of cash and cash equivalents for the purpose of the statement of cash flows. In the balance sheet, bank overdrafts are included in current borrowings. 92 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 1 - BASIS OF PREPARATION Impairment The carrying amounts of the Group’s assets, other than inventories (see note 3.4) and deferred tax assets (see note 2.7), are reviewed at each balance sheet date to determine whether there is any indication of impairment. If any such indication exists, the asset’s recoverable amount is estimated. For goodwill the recoverable amount is estimated at each balance sheet date. The recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset for which the estimates of future cash flows have not been adjusted. For the purpose of impairment testing, assets are Grouped together into the smallest Group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows from other Groups of assets (‘the cash generating unit’). The goodwill acquired in a business combination, for the purpose of impairment testing is allocated to cash generating units. Management have determined that the cash generating units of the Group are the motor franchise Groups and other business segments. An impairment loss is recognised whenever the carrying amount of an asset or its cash generating unit exceeds its recoverable amount. Impairment losses are recognised in the income statement. Impairment losses recognised in respect of cash generating units are allocated first to reduce the carrying amount of any goodwill allocated to cash generating units and then, to reduce the carrying amount of the other assets in the unit on a pro rata basis. The recoverable amount of assets is the greater of their fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. For an asset that does not generate largely independent inflows, the recoverable amount is determined for the cash generating unit to which the asset belongs. An impairment loss in respect of goodwill is not reversed. In respect of other assets, an impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortisation, if no impairment loss had been recognised. The impact of the current year impairment review can be seen in note 3.1. Adoption of new and revised standards and new standards and interpretations not yet adopted In the current year, the Group has adopted the following new standards and interpretations: IFRS 9 Financial Instruments IFRS 15 Revenue from Contracts with Customers Classification and Measurement of Share-based Payment Transactions – Amendments to IFRS 2 Annual Improvements 2014-2016 cycle Transfers to Investment Property – Amendments to IAS 40 Interpretation 22 Foreign Currency Transactions and Advance Consideration The adoption of the new standards and amendments above have had no significant impact. A number of new standards are effective for annual periods beginning after 1 January 2019 and earlier application is permitted; however, the Group has not early adopted the new or amended standards in preparing these consolidated financial statements. 93 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 1 - BASIS OF PREPARATION IFRS 16 Leasing IFRS 16 Leasing is effective for annual periods beginning on or after 1 January 2019. The new standard replaces existing leases guidance, principally IAS 17 Leases. IFRS 16 introduces a single, on-balance sheet lease accounting model for lessees. A lessee recognises a right-of-use (ROU) asset representing its right to use the underlying asset and a lease liability representing its obligation to make lease payments. There are recognition exemptions for short term leases of 12 months or less and leases of low-value items. Lessor accounting remains similar to the current standard – i.e. lessors continue to classify leases as finance or operating leases. The Group has set up a project team which has reviewed all of the Group’s leasing arrangements over the last year in light of the new lease accounting rules in IFRS 16. The standard will affect primarily the accounting for the Group’s operating leases, most notably in respect of property. IFRS 16 is not anticipated to affect the existing accounting treatment of the leasing segment. The Group plans to apply IFRS 16 initially on 1 January 2019, using the modified retrospective approach. Therefore, the cumulative effect of adopting IFRS 16 will be recognised as an adjustment to the opening balance of retained earnings at 1 January 2019, with no restatement of comparative information. The Group plans to apply the practical expedient to grandfather the definition of a lease on transition. This means that it will apply IFRS 16 to all contracts entered into before 1 January 2019 and identified as leases in accordance with IAS 17 and IFRIC 4. The Group will also use practical expedient to account for a lease as a short term lease if it has a remaining term of 12 months or less on transition. Under this approach, the Group would not recognise a ROU asset or lease liability for this lease. Instead, the Group would recognise rentals payable as an expense in its disclosure of total short-term lease expense. The USA segment is classified as an asset held for sale and accordingly the impact of IFRS 16 on that segment has not been calculated. As at the reporting date, the Group has non-cancellable operating lease commitments of £480m, (see note 4.8). Of these commitments, approximately £72m relate to leases in the US Motor segment which is classified as held for sale and £6m relate to short-term leases and low value leases which will be recognised on a straight-line basis as expense in profit or loss. For the remaining lease commitments the Group expects to recognise ROU assets of approximately £196m on 1 January 2019, lease liabilities of approximately £286m, finance lease receivables of approximately of £29m and deferred tax assets of approximately £9m (before adjustments including prepayments and accrued lease payments recognised as at 31 December 2018 of approximately £3m). Overall net assets will be approximately £49m lower, and net current liabilities will be approximately £20m higher due to the presentation of a portion of the liability as a current liability. The Group expects that net profit after tax will decrease by approximately £0.5m for 2019 as a result of adopting IFRS 16. Adjusted EBITDA as presented in note 4.2 is expected to increase by approximately £32m, as the operating lease payments were included in EBITDA, but the amortisation of the ROU assets and interest on the lease liability are excluded from this measure. Operating cash flows will increase and financing cash flows decrease by approximately £32m as repayment of the principal portion of the lease liabilities will be classified as cash flows from financing activities. The Group will reassess the classification of sub-leases in which the Group is a lessor. Based on the information currently available, the Group expects that it will reclassify 17 sub-leases as a finance lease, resulting in recognition of a finance lease receivable of approximately £29m as at 1 January 2019. No significant impact is expected for other leases in which the Group is a lessor. The adoption of IFRS 16 will have no impact on the Group’s current banking covenants. 94 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 1 - BASIS OF PREPARATION Other standards The following amended standards and interpretations are not expected to have a significant impact on the Group’s consolidated financial statements. IFRIC 23 Uncertainty over Tax Treatments. Prepayment Features with Negative Compensation (Amendments to IFRS 9). Long-term Interests in Associates and Joint Ventures (Amendments to IAS 28). Plan Amendment, Curtailment or Settlement (Amendments to IAS 19). Annual Improvements to IFRS Standards 2015–2017 Cycle – various standards. Amendments to References to Conceptual Framework in IFRS Standards. IFRS 17 Insurance Contracts. Alternative performance measures The Group uses a number of key performance measures (‘KPI’s’) which are non-IFRS measures to monitor the performance of its operations. The Group believes these KPIs provide useful historical financial information to help investors and other stakeholders evaluate the performance of the business and are measures commonly used by certain investors for evaluating the performance of the Group. In particular, the Group uses KPIs which reflect the underlying performance on the basis that this provides a more relevant focus on the core business performance of the Group. The Group has been using the following KPIs on a consistent basis and they are defined and reconciled as follows: Dividend per share - dividend per share is defined as the interim dividend per share plus the proposed final year dividend for a given period. Gross margin % - gross margin is defined as gross profit as a percentage of revenue. Like for like - results on a like for like basis include only businesses which have been trading for 12 consecutive months. We use like for like results to aid in the understanding of the like for like movement in revenue, gross profit and operating profit in the business. The difference to underlying results are simply those businesses which are not like for like which have recently commenced operation and therefore do not have a 12 month history plus any retail points closed during the current or previous period. Operating margin % - operating margin is defined as operating profit as a percentage of revenue. Underlying operating profit/profit before tax - results on an underlying basis exclude items that have non-trading attributes due to their size, nature or incidence. The detail of the non-underlying results is shown in note 2.6 and this is also shown on the face of the consolidated income statement to reconcile from the underlying to total results. 95 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 1 - BASIS OF PREPARATION Operating profit reconciliation Underlying operating profit Settlement of historic VAT issues (see note 2.6) Gains/(losses) on the sale of businesses and property (see note 2.6) Past service costs (see note 2.6) Impairment of goodwill (see note 2.6) Impairment of assets held for sale (see note 2.6) Impairment of property, plant and equipment (see note 2.6) Non-underlying operating (loss)/profit items Operating (loss)/profit (Loss)/profit before tax reconciliation Underlying profit before tax Non-underlying operating profit items (see reconciliation above) Non-underlying finance costs (see note 2.6) Non-underlying operating (loss)/profit and finance costs items (Loss)/profit before tax (Loss)/profit after tax reconciliation Underlying profit after tax Non-underlying operating (loss)/profit and finance costs items (see reconciliation above) Non-underlying tax (see note 2.6) Non-underlying operating (loss)/profit, finance costs and tax items (Loss)/profit after tax 2018 £m 76.2 - 15.7 (10.5) (88.8) (1.2) (5.8) (90.6) (14.4) 2018 £m 47.8 (90.6) (1.6) (92.2) (44.4) 2018 £m 38.7 (92.2) 3.0 (89.2) (50.5) 2017 £m 83.8 7.7 (0.1) - - - - 7.6 91.4 2017 £m 60.4 7.6 (2.7) 4.9 65.3 2017 £m 47.6 4.9 0.8 5.7 53.3 96 Pendragon PLC Annual Report 2018NOTES TO THE FINANCIAL STATEMENTS SECTION 1 - BASIS OF PREPARATION Underlying basic earnings per share (‘underlying earnings per share’) – the Group presents underlying basic earnings per share as the Directors consider that this is a better measure of comparative performance. Underlying basic earnings per share is calculated by dividing the underlying profit or loss attributable to ordinary shareholders by the weighted average number of ordinary shares in issue during the period. A full reconciliation of how this is derived is found in note 2.8. Underlying diluted earnings per share – the Group presents underlying diluted earnings per share as the Directors consider that this is a better measure of comparative performance. Underlying diluted earnings per share is calculated by dividing the underlying profit and loss attributable to ordinary shareholders by the weighted average number of ordinary shares in issue taking account of the effects of all dilutive potential ordinary shares, which comprise of share options granted to employees, LTIPs and share warrants. A full reconciliation of how this is derived is found in note 2.8. Net Debt : Underlying EBITDA – the Group uses the ratio of net debt to underlying EBITDA to assess the use of the Group’s financial resources. The reconciliation of this and the composition of underlying EBITDA is shown in note 4.2. Net franchise capital expenditure - total franchise specific (manufacturer new vehicle partners) capital expenditure incurred in the period less franchise specific disposal proceeds. 97 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING This section contains the notes and information to support the results presented in the income statement: 2.1 Revenue 2.2 Net operating expenses 2.3 Operating segments 2.4 Staff costs 2.5 2.6 2.7 2.8 Audit fees Non-underlying items Taxation Earnings per share 2.1 Revenue Accounting policy The Group has adopted and applied IFRS 15 for the year ended 31 December 2018, using the cumulative effect method. The comparative information therefore has not been restated and continues to be reported under IAS 18 and IAS 11. The Group has quantified the effect of IFRS 15 on the reported revenue for the year ended 31 December 2017 and due to its amount being immaterial no comparison table is presented in these financial statements to quantify the impact of the adoption of IFRS 15. Accordingly the Group has not made any significant changes in its accounting policy for revenue other than addressing the small areas identified that were not in line with IFRS 15. As these amounted to a value of less than £0.1m no further disclosure is presented. Revenue is measured based on the consideration specified in a contract with a customer and excludes amounts collected on behalf of third parties. The Group recognises revenue when it transfers control over a product or service to a customer. The following is a description of principal activities from which the Group generates its revenue categorised by the reportable segments as detailed in note 2.3. UK Motor segment and US Motor segment The UK and US Motor segments principally generate revenue from the sale of new and used motor vehicles, together with the supply of motor vehicle parts, servicing and repair activities, collectively referred to as aftersales. Products and services may be sold separately or in bundled packages. Examples of a bundled package will include the supply of a vehicle with an extended warranty or a servicing plan. For bundled packages, the Group accounts for individual products and services separately as they are distinct items, as each performance obligation within that contract is separately identifiable from other items in the bundled package. The consideration is allocated between separate products and services in a bundle based on their stand-alone selling prices. The stand-alone selling prices are determined based on the list prices at which the Group sells these items and are separately identified on the customer’s invoice. The Group has a number of manufacturer partners who will provide goods/services to customers, for example a warranty or free servicing when purchasing a new vehicle. Such items do not have a contractual obligation on the Group as the obligation lies with the manufacturer and therefore no revenue is recognised in respect of these items. 98 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.1 Revenue continued Products and services Nature, timing of satisfaction of performance obligations and significant payment terms New and used The Group recognises revenue on the sale of motor vehicles and parts revenue when they have vehicles, parts and been supplied to the customer. The satisfaction of the performance obligation occurs on delivery or accessories collection of the product. Vehicles are usually paid for prior to delivery though selected corporate operators may be granted terms of up to seven days. Parts are either paid for on delivery or within one month, dependant upon whether or not the customer is retail or has trade terms. Service and repairs The Group recognises revenue when service has been completed. Revenue from services rendered is recognised in the income statement in proportion to the stage of completion of the transaction at the reporting date. The stage of completion is assessed by reference to time expended on services that are charged on a labour rate basis. Revenue is recognised at this point provided that the revenue and costs can be measured reliably, the recovery of the consideration is probable and there is no continuing management involvement with the goods. Payment terms are upon completion of the service or within one month, dependant upon whether or not the customer is retail or trade. Commissions The Group receives commissions when it arranges finance and insurance packages for its received customers to purchase its products and services, acting as agent on behalf of various finance and insurance companies. Any commission earned is recognised when the customer draws down the finance or commences the insurance policy from the supplier which coincides with the delivery of the product or service. Commissions receivable are paid typically in the month after the finance is drawn down. Vehicle warranty The Group offers a warranty product on vehicles supplied with a guarantee period typically ranging from 3 months to 3 years. The Group recognises revenue on warranties on a straight-line basis over the warranty period. The performance obligation of the Group, being the rectification of mechanical faults on vehicles sold, will be the period over which the customer can exercise their rights under the warranty and therefore revenue should be recognised over the period of the warranty. Warranties are paid for prior to the commencement of the policy. The unrecognised income is held within deferred income (see note 3.9). 99 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.1 Revenue continued Leasing The leasing segment generates revenue from the provision of vehicle leasing services, principally to fleets run by various commercial operators. Vehicles are supplied to customers on operating leases and may include servicing and maintenance agreements, which are bundled into the overall contract. For bundled packages, the Group accounts for individual products and services separately as they are distinct items, as each performance obligation within that contract is separately identifiable from other items in the bundled package. At the end of each contract the Group will generate revenue from the disposal of the vehicle, recovery of any rectification work and in some instances additional rentals beyond the original contract term. Products and services Nature, timing of satisfaction of performance obligations and significant payment terms Leasing Where vehicles are supplied to a leasing company for contract hire purposes and the Group undertakes to repurchase the vehicle at a predetermined date and value the significant risks and rewards of ownership are deemed not to have transferred outside the Group and consequently no sale is recognised. As a result the accounting for the arrangement reflects the Group’s retention of the asset to generate future rentals and, in accordance with IAS 17 Leases, the Group is considered to be an operating lessor for all arrangements in place. The initial amounts received in consideration from the leasing company are held as deferred income allocated between the present value of the repurchase commitment, held within trade and other payables and a residual amount of deferred revenue held within deferred income. A finance charge is accrued against the present value of the repurchase commitment and recorded as a finance expense in the income statement. The remaining deferred revenue, which effectively represents rentals received in advance, is taken to the income statement on a straight line basis over the related lease term. No additional disclosures are made under IAS 17 as there are no future rentals receivable. These vehicles are held within ‘property, plant and equipment’ at their cost to the Group and are depreciated to their residual values over the terms of the leases. These assets are transferred into inventory at their carrying amount when they cease to be rented and they become available for sale as part of the Group’s ordinary course of business. Rentals are billed and paid for on a monthly basis. Maintenance The Group offer a maintenance contract to customers to cover routine servicing and unexpected repairs of vehicles under a leasing contract. Revenue is recognised over the period of the contract on a straight line basis. Maintenance contracts are billed and paid for on a monthly basis. Used Vehicles The Group recognises revenue on the sale of ex-contract hire motor vehicles when they have been supplied to the customer. This occurs on delivery or collection of the product. Vehicles are paid for on delivery. 100 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.1 Revenue continued Software The Group, through its Pinewood business, supplies dealer management systems to motor vehicle dealers. These systems include consultancy, training and installation services and the right to use the Group’s software over a contractual period. Products and services may be sold separately or in bundled packages. Examples of a bundled package will include system consultancy, on and off site training for users together with the right for a number of users to use the software. For bundled packages, the Group accounts for individual products and services separately as they are distinct items, as each performance obligation within that contract is separately identifiable from other items in the bundled package. The consideration is allocated between separate products and services in a bundle based on their stand-alone selling prices. The stand-alone selling prices are determined based on the list prices at which the Group sells these items and are separately identified on the customer’s contract and subsequent invoice. Products and services Nature, timing of satisfaction of performance obligations and significant payment terms Software Pinewood supply its software on a hosting basis and licence specific numbers of users to access this service. As such Pinewood supply ‘Software as a Service’ (SaaS). The software licences are provided only in conjunction with a hosting service, the customer cannot take control of the licence or use the software without the hosting service and as such the customer cannot benefit from the licence on its own and the licence is not separable from the hosting services. Therefore, the licence is not distinct and would be combined with the hosting service. The Group’s assessment of its performance obligation under IFRS 15 of providing SaaS is that revenue is recognised over the period of the contract. SaaS is billed one month in advance of a quarterly billing cycle ensuring payment is received prior to commencement of usage. Training and consultancy The Group recognises revenue on the provision of any consultancy time and training at the point of providing and delivering the service. Consultancy hours are billed at the time of delivery. Training courses are billed at the time of booking which may be in advance of the date the training is scheduled for. 101 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS l e b a t e h T . n o i t i n g o c e r e u n e v e r f o g n m i i t d n a s e n i l i e c v r e s / s t c u d o r p r o a m j , t e k r a m l i a c h p a r g o e g y r a m i r p y b d e t a g e r g g a s i d s i e u n e v e r , l e b a t g n w o i l l o f e h t n I d e u n i t n o c s i d l _ _ _ _ _ _ a t o T _ _ _ _ _ _ _ _ r o t o M S U _ _ _ _ _ _ _ g n i s a e L _ _ _ _ _ _ _ _ e r a w t f o S _ _ _ _ _ _ _ r o t o M K U _ _ _ . 3 2 . e t o n e e s , s t n e m g e s l e b a t r o p e r s t i e r a h c h w i , i s n o i s i v d c g e t a r t s i r u o f ’ s p u o r G e h t h t i w e u n e v e r d e t a g e r g g a s i d e h t f o n o i t a i l i c n o c e r a s e d u c n l i o s l a I G N D A R T D N A S T L U S E R - 2 N O I T C E S 102 e u n e v e r f o n o i t a g e r g g a s i D d e u n i t n o c e u n e v e R 1 . 2 m £ 7 1 0 2 m £ 8 1 0 2 m £ 7 1 0 2 m £ 8 1 0 2 m £ 7 1 0 2 m £ 8 1 0 2 m £ 7 1 0 2 . 7 3 2 3 4 , . 6 0 . 8 4 1 4 1 . 9 3 7 4 , . 6 7 8 3 2 . 1 1 2 2 , . 6 9 5 0 2 , . 8 5 1 . 9 4 6 1 . 9 3 7 4 , 1 . 4 8 6 4 , . 6 0 - - . 4 8 7 4 . 8 4 1 4 . 4 8 7 4 - - - - . 0 8 4 1 , 4 - - . 9 4 6 . 3 7 5 . 0 7 2 6 4 , . 8 4 1 4 . 4 8 7 4 . 9 4 6 . 3 7 5 . 6 0 8 3 . 3 0 9 1 , 2 9 . 1 8 9 , 1 . 9 6 1 . 3 7 5 . 0 7 2 6 4 , . 5 3 6 5 4 , . 0 7 3 . 7 5 8 . 2 3 4 . 9 7 9 1 . 2 9 2 . 3 7 3 3 - - - - . 8 4 1 4 . 4 8 7 4 . 8 4 1 4 . 4 8 7 4 - - - - . 9 4 6 . 9 4 6 . 7 8 2 . 2 6 3 . 9 4 6 - - - - . 3 7 5 . 3 7 5 . 5 6 1 . 8 0 4 . 3 7 5 - . 2 5 1 . 6 0 . 8 5 1 - - - - . 8 5 1 . 8 5 1 5 . 1 . 3 4 1 . 8 5 1 m £ 8 1 0 2 - . 3 6 1 . 6 0 . 9 6 1 - - - - . 9 6 1 . 9 6 1 7 . 1 . 2 5 1 . 9 6 1 m £ 7 1 0 2 m £ 8 1 0 2 - - - - . 6 3 4 2 4 , . 4 4 7 0 4 , . 4 4 7 0 4 , s t e k r a m l a c i h p a r g o e g y r a m i r P a c i r e m A h t r o N e p o r u E a c i r f A s r e m o t s u c l a n r e t x e m o r f e u n e v e R . 6 3 4 2 4 , - - . 6 0 5 3 . 5 5 2 1 , 2 . 5 7 6 7 , 1 . 6 3 4 2 4 , 1 . 9 3 2 4 , . 4 7 3 3 e u n e v e r l s e a s r e t f A s e n i l e c i v r e s / s t c u d o r p r o a M j . 4 2 9 0 2 , - - . 6 4 4 6 , 1 . 4 4 7 0 4 , . 9 6 6 0 4 , s r e m o t s u c l a n r e t x e m o r f e u n e v e R e u n e v e r e r a w t f o S e u n e v e r g n i s a e L n o i t i n g o c e r e u n e v e r f o g n m T i i e u n e v e r e u n e v e r i l e c h e v d e s U l i e c h e v w e N e m i t n i i t n o p t A . 0 5 5 . 5 3 6 - - 1 . 9 3 7 4 , . 0 7 2 6 4 , . 8 4 1 4 . 4 8 7 4 . 5 4 5 7 . e m i t r e v O . 6 3 4 2 4 , . 4 4 7 0 4 , s r e m o t s u c l a n r e t x e m o r f e u n e v e R Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.2 Net operating expenses Net operating expenses: Distribution costs Administrative expenses Rents received 2.3 Operating segments 2018 £m (252.7) (332.6) 4.7 (580.6) 2017 £m (264.0) (202.5) 5.1 (461.4) The Group has four reportable segments, as described below, which are the Group’s strategic business units. The segments offer different ranges of products and services and are managed separately because they require their own specialisms in terms of market and product. For each of these segments, the Executive Committee which is deemed to be the Chief Operating Decision Maker (CODM), reviews internal management reports on at least a monthly basis. The review of these management reports enables the CODM to allocate resources to each segment and form the basis of strategic and operational decisions, such as acquisition strategy, closure programme or working capital allocation. The Group operating segment represents franchise groups and other businesses. The Group operating segment represents franchise groups and other businesses. The franchise groups have been aggregated into the following reportable segments: UK Motor and US Motor due to the fact that they have similar economic characteristics such as similar margins and cost structures and therefore aggregations is deemed to be appropriate. The following summary describes the operations in each of the Group’s reportable segments: UK Motor This segment comprises the Group’s motor vehicle retail, parts wholesale and fleet operations, encompassing the sale of new and used motor cars, motorbikes, trucks and vans, together with associated aftersales activities of service, body repair and parts sales. Software This segment comprises the Group’s activities as a dealer management systems provider. Leasing This segment comprises the Group’s contract hire and leasing activities. US Motor This segment comprises the Group’s retail operation in California in the United States encompassing the sale of new and used motor cars, together with associated aftersales activities of service and parts sales. The tables of financial performance presented in the Operational and Financial Review on pages 26 to 33 are based upon these segmental reports. For a breakdown of segment revenue stream please refer to note 2.1. Inter-segment transfers and transactions are entered into under normal commercial terms and conditions that would also be available to unrelated third parties. 103 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.3 Operating segments continued Year ended 31 December 2018 UK Motor £m Software £m Leasing £m Group interest £m Continuing operations Sub total £m Discontinued operations US Motor £m Total £m Total gross segment revenue 4,074.4 Inter-segment revenue - Revenue from external customers 4,074.4 Operating profit before non- underlying items Non-underlying items Operating (loss)/profit Finance expense Finance income 41.1 (93.3) (52.2) - - Segmental (loss)/profit before tax (52.2) 28.3 (11.4) 16.9 11.7 - 11.7 - 0.8 12.5 Other items included in the income statement are as follows: 81.2 (23.9) 57.3 14.8 - 14.8 - - - - - - - - 4,183.9 478.4 4,662.3 (35.3) - (35.3) 4,148.6 478.4 4,627.0 67.6 (93.3) (25.7) 8.6 2.7 11.3 76.2 (90.6) (14.4) (27.5) (27.5) (2.5) (30.0) (0.8) - 14.8 (28.3) (53.2) - 8.8 - (44.4) Depreciation and impairment Impairment of goodwill Impairment of property, plant and equipment Amortisation Share based payments Impairment of assets held for sale Pension past service costs Other income - gains on the sale of businesses and property (22.3) (88.8) (5.8) (0.5) (0.7) (1.2) (10.5) 13.0 (0.3) (39.3) - - - - (2.5) (0.1) - - - - - - - - - - - - - - - - (61.9) (88.8) (5.8) (3.1) (0.7) (1.2) (10.5) (0.3) - - - - - - (62.2) (88.8) (5.8) (3.1) (0.7) (1.2) (10.5) 13.0 2.7 15.7 104 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.3 Operating segments continued Year ended 31 December 2017 UK Motor Software Leasing interest Sub total US Motor Continuing Discontinued Group operations operations £m £m £m Total £m UK Motor £m Software £m Leasing £m Group interest £m Continuing operations Sub total £m Discontinued operations US Motor £m Total £m 73.0 7.6 80.6 (24.5) - 4,341.9 414.8 4,756.7 (17.6) - (17.6) 4,324.3 414.8 4,739.1 10.8 - 10.8 (1.6) - 9.2 83.8 7.6 91.4 (26.1) - 65.3 71.2 (6.3) 64.9 9.8 - 9.8 (2.0) - - - - - - - (11.4) (0.8) Total gross segment revenue 4,074.4 4,183.9 478.4 4,662.3 Total gross segment revenue 4,243.6 Inter-segment revenue (35.3) - (35.3) Inter-segment revenue - Revenue from external customers 4,074.4 4,148.6 478.4 4,627.0 Revenue from external customers 4,243.6 Segmental (loss)/profit before tax (52.2) 14.8 (28.3) (53.2) Segmental profit before tax Operating profit before non- underlying items Non-underlying items Operating profit Finance expense Finance income 52.3 7.6 59.9 (11.1) - 48.8 27.1 (11.3) 15.8 10.9 - 10.9 - 0.8 11.7 £m - 41.1 (93.3) (52.2) - - (22.3) (88.8) (5.8) (0.5) (0.7) (1.2) (10.5) 13.0 £m 28.3 (11.4) 16.9 11.7 - 11.7 - 0.8 12.5 - - - - - - £m 81.2 (23.9) 57.3 14.8 - 14.8 - - - - - - - - (2.5) (0.1) - - - - - - - - - - - - - - (27.5) (27.5) (2.5) (30.0) (0.8) - 67.6 (93.3) (25.7) (61.9) (88.8) (5.8) (3.1) (0.7) (1.2) (10.5) 8.6 2.7 11.3 - 8.8 - - - - - - 76.2 (90.6) (14.4) - (44.4) (62.2) (88.8) (5.8) (3.1) (0.7) (1.2) (10.5) Operating profit before non- underlying items Non-underlying items Operating (loss)/profit Finance expense Finance income Impairment of goodwill Impairment of property, plant and equipment Amortisation Share based payments Impairment of assets held for sale Pension past service costs Other income - gains on the sale of businesses and property Other items included in the income statement are as follows: Other items included in the income statement are as follows: Depreciation and impairment (0.3) (39.3) (0.3) Depreciation and impairment Amortisation Share based payments Other income - losses on the sale of businesses and property Geographical information. (21.9) (0.4) 1.7 (0.1) (0.3) (2.2) - - (36.0) (0.1) - - - - - - (58.2) (1.3) (59.5) (2.7) 1.7 (0.1) - - - (2.7) 1.7 (0.1) 13.0 2.7 15.7 All segments, with the exception of the US Motor Group in the United States originate in the United Kingdom. The US Motor Group segment is a discontinued operation. 105 7.8 (12.2) 56.1 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.4 Staff costs The average number of people employed by the Group in the following areas was: Sales Aftersales Administration Costs incurred in respect of these employees were: Wages and salaries Social security costs Contributions to defined contribution plans (see note 5.1) Cost recognised for defined benefit plans (see note 5.1) Share based payments (see note 4.6) 2018 Number 3,260 4,446 2,174 9,880 2018 £m 272.4 24.1 7.9 12.1 0.7 317.2 2017 Number 3,296 4,495 2,198 9,989 2017 £m 272.1 24.8 5.2 2.7 (1.7) 303.1 Information relating to Directors’ emoluments, share options and pension entitlements is set out in the Directors’ Remuneration Report on pages 55 to 68. 2.5 Audit fees Auditors’ remuneration: 2018 £m Fees payable to the company's Auditor for the audit of the company's annual accounts: 267.0 Fees payable to the company's Auditor and its associates for other services: Audit of the company's subsidiaries pursuant to legislation Audit-related assurance services Tax compliance services Other assurance services 174.8 45.0 95.0 10.0 591.8 2017 £m 253.0 162.9 45.0 65.0 10.0 535.9 106 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.6 Non-underlying items Non-underlying income and expenses are items that are not incurred in the normal course of business and are sufficiently significant and/or irregular to impact the underlying trends in the business. Within operating expenses: Settlement of historic VAT issues Impairment of goodwill Impairment of assets held for sale Impairment of property, plant and equipment Past service costs in respect of pension obligations Within other income - gains on the sale of businesses, property and investments: Gains on the sale of businesses Gains/(losses) on the sale of property Within finance expense: Net interest on pension scheme obligations Total non-underlying items before tax Non-underlying items in tax (see note 2.7 for analysis) Total non-underlying items after tax 2018 £m - (88.8) (1.2) (5.8) (10.5) (106.3) 3.3 12.4 15.7 (1.6) (1.6) (92.2) 3.0 (89.2) 2017 £m 7.7 - - - - 7.7 - (0.1) (0.1) (2.7) (2.7) 4.9 0.8 5.7 The following amounts have been presented as non-underlying items in these financial statements: Goodwill has been reviewed for any possible impairment and as a result of this review there was an impairment charge of £88.8m made during the year (2017: £nil) (see note 3.1). Group property, plant and equipment and assets held for sale have been reviewed for possible impairments. As a result of this review there was an impairment charge against assets held for sale of £1.2m during the year (2017: £nil) and property, plant and equipment of £5.8m (2017: £nil). There were no reversals of previous impairment charges in respect of assets held for sale where anticipated proceeds less a costs to sell have increased over their impaired carrying values (2017: £nil). The past service costs in respect of pension obligations is an estimate of the cost of GMP equalisation, as more fully explained in note 5.1 of these financial statements. The net financing return on pension obligations in respect of the defined benefit schemes closed to future accrual is shown as a non-underlying item due to the irregularity of this amount historically and it is not incurred in the normal course of business. A net expense of £1.6m has been recognised during the year (2017: £2.7m). Other income consists of the profit or loss on disposal of businesses and property. This comprises a £3.3m profit on disposals of motor vehicle dealerships during the year (of which £2.7m was in respect of discontinued operations) (2017: £nil) and a £12.4m profit on sale of properties (2017: loss £0.1m). This does not include routine transactions in relation to the disposal of individual assets, and only relates to the disposal of motor vehicle dealerships and associated properties. 107 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.6 Non-underlying items continued During 2017, the Group recognised a £7.7m credit in respect of the numerous offsets resulting from the 2015 Supreme Court decision in favour of HMRC, in respect of the Group’s long running litigation in respect of financing. The credit of £7.7m was made up of VAT reclaims of £2.2m, interest on VAT reclaims of £3.3m and other items resulting from settlement of historic issues and litigation of £2.2m. 2.7 Taxation Accounting policy Income tax comprises current and deferred tax. Income tax is recognised in the income statement except to the extent that it relates to items recognised directly in other comprehensive income, in which case it is recognised in the statement of comprehensive income . Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. Deferred tax is recognised using the balance sheet liability method, recognising temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The following temporary differences are not recognised: initial recognition of goodwill, the initial recognition of assets or liabilities in a transaction that is not a business combination that affect neither accounting nor taxable profit. The amount of deferred tax recognised is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantively enacted at the balance sheet date. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realised. Estimates and judgements The actual tax on the Group’s profits is determined according to complex laws and regulations. Where the effect of these laws and regulations is unclear, estimates are used in determining the liability for the tax to be paid on profits which are recognised in the financial statements. The Group considers the estimates, assumptions and judgements to be reasonable but this can involve complex issues which may take a number of years to resolve. The final determination of tax liabilities could be different from the estimates reflected in the financial statements but the Group believes that none have a significant risk of causing a material adjustment to the carrying amount of the liability within the next financial year. Deferred tax assets and liabilities require management judgement in determining the amounts to be recognised. In particular, judgement is used when assessing the extent to which deferred tax assets should be recognised with consideration given to the timing and level of future taxable income. The unrecognised deferred tax assets are disclosed below. 108 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.7 Taxation continued Taxation - Income statement UK corporation tax: Current tax on (loss)/profit for the year Adjustments in respect of prior periods Overseas taxation: Current tax on profit for the year Adjustments in respect of prior periods Total current tax Deferred tax expense: Origination and reversal of temporary differences Total deferred tax Total income tax expense in the income statement Factors affecting the tax charge for the period: The tax assessed is different from the standard rate of corporation tax in the UK of 19.00% (2017: 19.25%) The differences are explained below: (Loss)/profit before taxation Tax on (loss)/profit at UK rate of 19.00% (2017: 19.25%) Differences: Tax effect of expenses that are not deductible in determining taxable profit Permanent differences arising in respect of fixed assets Tax rate differential on overseas income Non-underlying items (see below) Impact of UK corporation tax rate change Impact of US corporate tax rate change Adjustments to tax charge in respect of previous periods Total income tax expense in the income statement Taxation - Other comprehensive income Relating to defined benefit plan remeasurement (gains) and losses 2018 £m 5.9 (2.5) 3.4 1.1 0.1 1.2 4.6 1.5 1.5 6.1 2018 £m (37.4) (7.1) 0.1 0.9 0.7 14.0 (0.1) - (1.1) 6.1 2018 £m - - 2017 £m 10.0 (2.7) 7.3 3.5 (0.3) 3.2 10.5 1.5 1.5 12.0 2017 £m 65.3 12.6 0.2 0.7 2.0 (1.9) (0.2) (0.8) (0.6) 12.0 2017 £m (6.3) (6.3) 109 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.7 Taxation continued Tax rate The reduction in the UK corporation tax rate to 19% from 20% (effective from 1 April 2017) and to 17% (effective from 1 April 2020) were substantively enacted on 26 October 2015 and 6 September 2016 respectively. This will reduce the Group’s future UK tax charge accordingly. The UK deferred tax asset as at 31 December 2018 has been calculated based on the expected long term rate of 17% substantively enacted at the balance sheet date. The reduction in the US federal corporate tax rate to 21% (effective from 1 January 2018) was substantively enacted on 20 December 2017. This has reduced the Group’s US tax charge accordingly. The USA deferred tax liability as at 31 December 2018 has been calculated based on the expected long term rate of 21% substantively enacted at the balance sheet date. Factors affecting the tax charge The tax charge/credit is decreased/increased by the release of prior year provisions relating to UK corporation tax returns and also non-deductible expenses including the impairment of goodwill and non-qualifying depreciation. Non-underlying tax credit The tax credit in relation to non-underlying items referred to in note 2.6 is £3.0m (2017: £0.8m). This includes a tax credit of £0.7m (2017: £1.9m) relating to the settlement of certain historic corporation tax issues, a tax charge of £0.8m (2017: £nil) in respect of tax on business disposals (all of which relates to discontinued operations), a tax credit of £0.3m (2017: £nil) in respect of tax on property disposals, a tax credit in respect of the impairment of property, plant and equipment of £0.7m (2017: £nil) , a tax credit of £0.3m (2017: £0.4m) in respect of pension scheme interest and a tax credit of £1.8m (2017: £nil) in respect of pension scheme past service costs. In the prior year a £1.5m charge in respect of the settlement of historic VAT issues was also made. Unrecognised deferred tax assets There are unutilised tax losses within the Group of £13.8m (2017: £13.8m) relating to former overseas businesses for which no deferred tax asset has been recognised pending the clarity of the availability of intra-EU losses. There are also unrecognised capital losses net of rolled over gains of £38.0m (2017: £35.0m). Deferred tax assets/(liabilities) Deferred income tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income taxes relate to the same fiscal authority. The offset amounts are as follows: Deferred tax assets Deferred tax liabilities 110 2018 £m 12.6 (2.8) 9.8 2017 £m 13.1 (1.7) 11.4 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.7 Taxation continued The table below outlines the deferred tax assets/(liabilities) that are recognised on the balance sheet, together with their movements in the year; Property, plant and equipment Retirement benefit obligations Other short term temporary differences Losses Tax assets/(liabilities) Property, plant and equipment Retirement benefit obligations Other short term temporary differences Losses Tax assets/(liabilities) At 1 January 2017 £m (Charged) to consolidated income statement £m (Charged) to other comprehensive income £m Exchange differences £m At 31 December 2017 £m (2.8) 17.6 2.9 1.3 19.0 At 1 January 2018 £m (3.1) 10.7 2.5 1.3 11.4 (0.5) (0.6) (0.4) - (1.5) - (6.3) - - 0.2 - - - (6.3) 0.2 (3.1) 10.7 2.5 1.3 11.4 (Charged) /credited to consolidated income statement £m (Charged) to other comprehensive income £m (1.8) 1.0 (0.7) - (1.5) - - - - - Exchange differences £m At 31 December 2018 £m (0.1) (5.0) - - - (0.1) 11.7 1.8 1.3 9.8 111 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 2 - RESULTS AND TRADING 2.8 Earnings per share Accounting policy The Group presents basic and diluted earnings per share (‘eps’) data for its ordinary shares. Basic eps is calculated by dividing the profit or loss attributable to ordinary shareholders of the company by the weighted average number of ordinary shares in issue during the period. The shares held by the EBT have been excluded from the calculation until such time as they vest unconditionally with the employees. Diluted eps is calculated by dividing the profit and loss attributable to ordinary shareholders by the weighted average number of ordinary shares in issue taking account of the effects of all dilutive potential ordinary shares, which comprise of share options granted to employees and LTIPs. Earnings per share calculation 2018 Earnings per share pence 2018 Earnings Total £m 2017 Earnings per share pence 2017 Earnings Total £m Basic earnings per share from continuing operations Basic earnings per share from discontinued operations Basic earnings per share Adjusting items: Non-underlying items attributable to the parent from continuing operations Non-underlying items attributable to the parent from discontinued operations Non-underlying items attributable to the parent (see note 2.6) Tax effect of non-underlying items from continuing operations Tax effect of non-underlying items from discontinued operations Tax effect of non-underlying items Underlying earnings per share from continuing operations (Non-GAAP measure) Underlying earnings per share from discontinued operations (Non-GAAP measure) Underlying earnings per share (Non-GAAP measure) Diluted earnings per share from continuing operations Diluted earnings per share from discontinued operations Diluted earnings per share Diluted earnings per share - underlying from continuing operations (Non-GAAP measure) Diluted earnings per share - underlying from discontinued operations (Non-GAAP measure) Diluted earnings per share - underlying (Non-GAAP measure) The calculation of basic, adjusted and diluted earnings per share is based on the following number of shares in issue (millions): (4.1) 0.5 (3.6) 6.8 (0.2) 6.6 (0.3) 0.1 (0.2) 2.5 0.3 2.8 (4.1) 0.5 (3.6) 2.5 0.3 2.8 Weighted average number of ordinary shares in issue Weighted average number of dilutive shares under option Weighted average number of shares in issue taking account of applicable outstanding share options Non-dilutive shares under option (57.0) 6.5 (50.5) 94.9 (2.7) 92.2 (3.7) 0.7 (3.0) 34.2 4.5 38.7 (57.0) 6.5 (50.5) 34.2 4.5 38.7 2018 Number 1,405.7 1.4 1,407.1 10.8 3.3 0.4 3.7 47.4 5.9 53.3 (0.3) (4.9) - (0.3) (0.1) - (0.1) 2.9 0.4 3.3 3.3 0.4 3.7 2.9 0.4 3.3 - (4.9) (0.8) - (0.8) 41.7 5.9 47.6 47.4 5.9 53.3 41.7 5.9 47.6 2017 Number 1,422.5 2.3 1,424.8 20.2 The Directors consider that the underlying earnings per share figure provides a better measure of comparative performance. 112 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES This section contains the notes and information to support those assets and liabilities presented in the Consolidated Balance Sheet that relate to the Group’s operating activities. 3.1 Intangible assets and goodwill 3.2 Property, plant and equipment 3.6 3.7 Trade and other receivables Trade and other payables 3.3 Assets held for sale and discontinued operations 3.8 Provisions 3.4 Inventories 3.9 Deferred income 3.5 Movement in contract hire vehicle balances 3.1 Intangible assets and goodwill Accounting policies All business combinations are accounted for by applying the purchase method. Goodwill represents the excess of the cost of acquisition over the net fair value of the identifiable assets, liabilities and contingent liabilities of the acquired subsidiary undertakings at the effective date of acquisition and is included in the balance sheet under the heading of intangible assets. The goodwill is allocated to cash generating units (CGUs), which are franchise Groups and other business units. An impairment test is performed annually as detailed below. Goodwill is then held in the balance sheet at cost less any accumulated impairment losses. Adjustments are applied to bring the accounting policies of the acquired businesses into alignment with those of the Group. The costs associated with reorganising or restructuring are charged to the post acquisition income statement. For those acquisitions made prior to 1 January 2004, goodwill is recorded on the basis of its deemed cost which represented its carrying value as at 1 January 2004 under UK GAAP. Fair value adjustments are made in respect of acquisitions. If at the balance sheet date the fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities can only be established provisionally then these values are used. Any adjustments to these values made within 12 months of the acquisition date are taken as adjustments to goodwill. Internally generated intangible assets relate to activities that involve the development of dealer management systems by the Group’s Pinewood division. Development expenditure is capitalised only if development costs can be measured reliably, the product is technically and commercially feasible, future economic benefits are probable and the Group intends to and has sufficient resources to complete development and to use or sell the asset. The expenditure capitalised includes the costs of labour and overhead costs that are directly attributable to preparing the asset for its intended use. If the development expenditure does not meet the above criteria it is expensed to the income statement. Capitalised development expenditure is measured at cost less accumulated amortisation and accumulated impairment losses and is amortised over a period of five years. Intangible assets other than goodwill are stated at cost less accumulated amortisation and any impairment losses. This category of asset includes purchased computer software and internally generated intangible assets which are amortised by equal instalments over four years and the fair value of the benefit of forward sales orders assumed on acquisition, which is amortised by reference to when those orders are delivered. Subsequent expenditure on capitalised intangible assets is capitalised only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditure is expensed as incurred. Intangible assets arising on an acquisition are recognised separately from goodwill if the fair value of the asset can be identified separately and measured reliably. Amortisation is calculated on a straight line basis over the estimated useful life of the intangible asset. Amortisation methods and useful lives are reviewed annually and adjusted if appropriate. 113 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.1 Intangible assets and goodwill continued Goodwill £m Development costs £m Other intangibles £m 426.9 6.1 - (0.1) (1.4) 431.5 431.5 - (0.4) 0.3 (23.9) 407.5 70.4 - (0.1) 70.3 70.3 - 88.8 - (17.5) 141.6 356.5 361.2 361.2 265.9 15.5 - 2.9 - - 18.4 18.4 3.5 - - - 21.9 10.1 2.2 - 12.3 12.3 2.5 - - - 14.8 5.4 6.1 6.1 7.1 11.4 - 1.7 (0.2) - 12.9 12.9 0.5 (0.4) - (0.3) 12.7 11.1 0.5 (0.1) 11.5 11.5 0.6 - (0.2) (0.3) 11.6 0.3 1.4 1.4 1.1 Cost At 1 January 2017 Business acquisitions Other additions Disposals Classified as non-current assets held for sale At 31 December 2017 At 1 January 2018 Other additions Disposals Exchange adjustments Classified as non-current assets held for sale At 31 December 2018 Amortisation At 1 January 2017 Amortised during the year Disposals At 31 December 2017 At 1 January 2018 Amortised during the year Impairment Disposals Classified as non-current assets held for sale At 31 December 2018 Carrying amounts At 1 January 2017 At 31 December 2017 At 1 January 2018 At 31 December 2018 114 Total £m 453.8 6.1 4.6 (0.3) (1.4) 462.8 462.8 4.0 (0.8) 0.3 (24.2) 442.1 91.6 2.7 (0.2) 94.1 94.1 3.1 88.8 (0.2) (17.8) 168.0 362.2 368.7 368.7 274.1 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.1 Intangible assets and goodwill continued The following have been recognised in the income statement within net operating expenses: Amortisation of internally generated intangible assets Amortisation of other intangible assets Impairment of goodwill Research and development costs 2018 £m 2.5 0.6 88.8 0.5 2017 £m 2.2 0.5 - 0.8 Goodwill is allocated across multiple cash-generating units which are franchise Groups and other business units and consequently a consistent approach to performing an annual impairment test to assess the carrying value of this amount is taken. This value was determined by comparing the carrying value of the asset with the higher of its fair value and value in use (which value is determined by discounting the future cash flows generated from the continuing use of the unit and was based on the following key assumptions): Future cash flows were projected into perpetuity with reference to the Group’s forecasts from 2019 to 2021. The 2019 forecast was derived from the corporate plan, approved by the Board and compiled on a bottom up basis with reference to SMMT data. The 2020-2021 forecasts represent a projection from the 2019 bottom up forecast. It is recognised that the net asset value of the company is lower than the market capitalisation which is a prima facie indicator of impairment. The Group therefore commissioned an independent third party expert valuer to perform calculations, based on the Group’s Board approved corporate plan, to test those forecasts and reconcile them to the Group’s market capitalisation. As a result of this process, the Group adopted a more prudent view of its future cashflows, for the purposes of impairment testing, compared to the Board approved corporate plan. The results of the impairment review indicated that the carrying values of certain CGUs exceeded the higher of the fair value and value in use and a total impairment charge of £88.8m arises on certain CGUs, as described below. For all but three CGUs, value in use was higher than fair value. For the three CGUs where this was not the case, the fair value has been estimated using a Level 2 method, but the differences between value in use and fair value in respect of each affected CGU was not significant. It is anticipated that the units will grow revenues in the future. For the purpose of the impairment testing, a growth rate of 2.0% (2017: 2.4%) has been assumed beyond the business plan. The discount rates are estimated to reflect current market estimates of the time value of money and is calculated after consideration of market information and risk adjusted for individual circumstances. The pre-tax discount rates used are specific to each CGU and vary between 9.7% and 21.1% (2017: single discount rate 10.2%). 115 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS 1 . 6 1 . 6 ) 4 . 1 ( ) 4 . 1 ( . 5 6 5 3 . 4 4 5 m £ . 5 3 1 - - m £ l a t o T m £ s r e h t O n ë o r t i C R L J m £ . 0 8 1 - - t l u a n e R e r o t S r a C - y d o B s p o h s n o t s A n i t r a M l l a h x u a V s e d e c r e M d r o F m £ 1 . 5 2 - - m £ 0 0 . 1 - - m £ 8 2 . - - m £ 3 5 . - - m £ . 8 7 7 - - m £ . 8 7 4 - - - - m £ . 7 9 6 - - m £ W M B 1 . 2 3 s t e s s a t n e r r u c - n o n s a d e fi i s s a C l l e a s r o f d e h l 7 1 0 2 y r a u n a J 1 t A s n o i t i d d A : l w o e b e b a t l e h t n i d e s i r a m m u s e r a s U G C l i a p c n i r p e h t f o s t n e m e v o M d e u n i t n o c l l i w d o o g d n a l s t e s s a e b g n a t n I i 1 . 3 S E I T I L I B A I L D N A S T E S S A G N I T A R E P O - 3 N O I T C E S 116 2 . 1 6 3 1 . 9 5 . 5 3 1 . 0 8 1 1 . 5 2 0 0 . 1 8 2 . 3 5 . . 8 7 7 . 8 7 4 . 7 9 6 1 . 2 3 7 1 0 2 r e b m e c e D 1 3 t A . ) 8 8 8 ( - ) 0 2 ( . . ) 8 0 ( . ) 9 2 1 ( . ) 0 0 1 ( ) 8 2 ( . . ) 7 2 ( . ) 4 3 1 ( . ) 0 0 2 ( . ) 4 0 ( . ) 4 0 ( - - - - 2 . 1 6 3 1 . 9 5 . 5 3 1 . 0 8 1 1 . 5 2 0 0 . 1 8 2 . - - 3 5 . - - . 8 7 7 . 8 7 4 . 7 9 6 1 . 2 3 8 1 0 2 y r a u n a J 1 t A m £ 7 1 0 2 . 8 2 3 3 1 . 6 . 3 0 . 0 2 2 2 . 1 6 3 m £ 8 1 0 2 . 2 7 3 2 4 6 . . 3 0 . 0 2 2 . 9 5 6 2 . 3 0 . 3 0 ) 4 6 ( . ) 4 6 ( . - - - - - - . 9 5 6 2 . 6 2 5 5 . 1 1 . 2 7 1 . 2 2 1 - - - - - - - - - - - - - - . ) 2 4 2 ( - s t e s s a t n e r r u c - n o n s a d e fi i s s a C l s t n e m t s u d a j e g n a h c x E l e a s r o f d e h l l l i w d o o g f o t n e m r i a p m I s l a s o p s i d s s e n i s u B 6 2 . . 4 4 6 . 8 7 2 . 7 9 6 9 7 . 8 1 0 2 r e b m e c e D 1 3 t A t n e m g e s y b l l i w d o o G r o t o M K U r o t o M S U d o o w e n P i g n i s a e L Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.1 Intangible assets and goodwill continued Sensitivity of assumptions The forecasts used to determine impairment are sensitive to the key assumptions used in preparing those forecasts. Future uncertainty with respect to the markets we operate in, further heightened at present as the UK prepares to leave the EU, could all have an effect on our sales volumes and margins and the general costs of doing business. The key assumptions used in our forecasts are therefore the gross profits, profit growth rates and discount rate applied. The sensitivities below indicate the total change in the value in use forecast, keeping other assumptions constant. Such changes would only result in further impairment to the extent that the impact of the sensitivities reduced the calculation of value in use below the carrying value of the respective CGU. For those CGUs already impaired, any worsening of assumptions would lead to further impairment on a pound for pound basis. For those CGUs not already impaired, the estimated headroom before impairment is disclosed. Profit growth rate Discount rate Gross Profit Increase/(decrease) in assumptions Increase/(decrease) in value in use 1.0%/(1.0%) 1.0%/(1.0%) 2.0%/(2.0%) £78.8m/£(66.4m) £(50.7m)/£57.3m £159.1m/(£159.1m) 117 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS . 9 5 6 2 . 6 2 5 . 5 6 0 3 . 3 8 5 2 - . 3 3 5 . 8 8 3 . 6 7 0 1 2 . 1 . 9 0 5 2 . m £ 5 . 1 1 m £ l a t o T m £ * * s r e h t O n ë o r t i C R L J m £ . 2 7 1 - 7 . 1 2 . 1 4 3 . m £ . 2 2 1 - 2 . 1 . 9 0 4 2 . - - m £ . 3 0 . 2 0 . 6 0 t l u a n e R e r o t S r a C m £ - y d o B s p o h s - - - - 1 . 0 m £ 6 2 . - n o t s A n i t r a M m £ . 4 4 6 - m £ . 8 7 2 - m £ . 7 9 6 . 2 8 4 m £ 9 7 . - l l a h x u a V s e d e c r e M d r o F * W M B . 3 0 . 2 0 . 5 0 . 3 6 . 6 4 . 6 2 1 . 7 2 0 2 . . 5 5 5 . 1 1 4 8 . . 2 3 2 A / N . 4 0 . 8 0 0 . 1 e s a e r c n i % 0 . 1 e t a r h t w o r g t fi o r P e s a e r c n i m o o r d a e H e s a e r c e d % 0 . 1 e t a r t n u o c s i D e s a e r c n i % 0 2 . t fi o r p s s o r G m o o r d a e h t n e r r u C e s a e r c n i % 0 1 l s e p i t l u m e u a v l r i a F l e u a v g n y r r a C i S E I T I L I B A I L D N A S T E S S A G N I T A R E P O - 3 N O I T C E S 118 d e u n i t n o c l l i w d o o g d n a l s t e s s a e b g n a t n I i 1 . 3 U G C y b y t i v i t i s n e S . ) 9 8 1 ( ) 0 . 1 ( . ) 5 4 1 ( . ) 8 0 ( ) 4 . 1 ( ) 1 . 1 ( . ) 4 5 4 ( ) 5 2 ( . ) 4 3 ( . ) 0 . 1 ( . ) 8 0 ( ) 4 2 ( . . ) 3 0 ( . ) 2 0 ( . ) 6 0 ( - - ) 1 . 0 ( . ) 2 0 ( . ) 2 0 ( . ) 5 0 ( ) 3 5 ( . ) 0 4 ( . ) 3 2 ( . ) 7 . 1 ( . ) 6 2 1 ( ) 5 5 ( . - - - . ) 3 0 ( ) e s a e r c e d ( % 0 . 1 e t a r h t w o r g t fi o r P t n e m r i a p m i r e h t r u F A / N . ) 8 0 ( ) 0 . 1 ( ) e s a e r c e d ( % 0 1 l s e p i t l u m e u a v l r i a F ) e s a e r c n i ( % 0 . 1 e t a r t n u o c s i D ) e s a e r c e d ( % 0 2 . t fi o r p s s o r G . l e a s f o s t s o c s s e l e u a v l r i a f t a d e u a V * l . l e r u s o c s i d f o s e s o p r u p e h t r o f d e t a m a g a m a l s U G C l i a u d v d n i i s e s i r p m o c ” s r e h t O “ t a h t e t o N * * Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.2 Property, plant and equipment Accounting policy Freehold land is not depreciated. Depreciation is provided to write off the cost less the estimated residual value of other assets by equal instalments over their estimated useful economic lives. On transition to IFRS as at 1 January 2004, all land and buildings were restated to fair value as permitted by IFRS 1, which is then treated as the deemed cost. All other assets are initially measured and recorded at cost. Depreciation rates are as follows: • Freehold buildings – 2% per annum • Leasehold property improvements – 2% per annum or over the period of the lease if less than 50 years • Fixtures, fittings and office equipment – 10 – 20% per annum • Plant and machinery – 10 – 33% per annum • Motor vehicles – 20 – 25% per annum • Contract hire vehicles are depreciated to their residual value over the period of their lease The residual value of all assets, depreciation methods and useful economic lives, if significant, are reassessed annually. The Group recognises in the carrying amount of an item of property, plant and equipment the cost of replacing part of such an item when that cost is incurred if it is possible that the future economic benefits embodied within the item will flow to the Group and the cost of the item can be measured reliably. All other costs are recognised in the income statement as an expense as incurred. Gains and losses on disposal of an item of property, plant and equipment are determined by comparing the proceeds from disposal with the carrying amount of property, plant and equipment and are recognised net within other income in the income statement. The depreciation and impairment charge in respect of property, plant and equipment is recognised within administrative expenses within the income statement. 119 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.2 Property, plant and equipment continued Land & buildings £m Plant & equipment £m Motor vehicles £m Contract hire vehicles £m Cost At 1 January 2017 Business acquisitions Other additions Exchange adjustments Disposals Contract hire vehicles transferred to inventory Classified as non-current assets held for sale At 31 December 2017 At 1 January 2018 Additions Exchange adjustments Business disposals Other disposals Contract hire vehicles transferred to inventory Classified as non-current assets held for sale At 31 December 2018 Depreciation At 1 January 2017 Exchange adjustments Charge for the year Disposals Contract hire vehicles transferred to inventory Classified as non-current assets held for sale At 31 December 2017 At 1 January 2018 Exchange adjustments Charge for the year Impairment Business disposals Other disposals Contract hire vehicles transferred to inventory Classified as non-current assets held for sale At 31 December 2018 254.4 11.4 63.5 (2.4) (0.7) - (6.8) 319.4 319.4 21.7 2.1 (4.3) (1.6) - (43.0) 294.3 55.1 (0.9) 6.2 (0.4) - (1.8) 58.2 58.2 0.6 6.5 1.8 (0.2) (1.3) - (11.8) 53.8 76.2 0.2 14.0 (0.7) (2.7) - (1.0) 86.0 86.0 15.0 0.5 (0.8) (4.7) - (8.8) 87.2 50.1 (0.6) 8.1 (1.0) - (0.7) 55.9 55.9 0.4 8.9 4.0 (0.6) (4.3) - (6.3) 58.0 63.0 - 110.9 (0.1) (121.8) - - 52.0 52.0 92.5 - - (96.0) - (1.8) 185.3 - 82.1 - - (54.2) - 213.2 213.2 65.5 - - - (48.6) - 46.7 230.1 17.6 - 11.5 (12.0) - - 17.1 17.1 - 8.9 - - (19.8) - (0.2) 6.0 50.8 - 33.7 - (25.0) - 59.5 59.5 - 37.9 - - - (20.8) - 76.6 Total £m 578.9 11.6 270.5 (3.2) (125.2) (54.2) (7.8) 670.6 670.6 194.7 2.6 (5.1) (102.3) (48.6) (53.6) 658.3 173.6 (1.5) 59.5 (13.4) (25.0) (2.5) 190.7 190.7 1.0 62.2 5.8 (0.8) (25.4) (20.8) (18.3) 194.4 120 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.2 Property, plant and equipment continued Carrying amounts At 1 January 2017 At 31 December 2017 At 1 January 2018 At 31 December 2018 Land & buildings £m Plant & equipment £m Motor vehicles £m Contract hire vehicles £m 199.3 261.2 261.2 240.5 26.1 30.1 30.1 29.2 45.4 34.9 34.9 40.7 134.5 153.7 153.7 153.5 Total £m 405.3 479.9 479.9 463.9 Included in the amounts for property, plant and equipment above are the following amounts relating to leased assets and assets acquired under hire purchase contracts: Depreciation Charge for the year Carrying amounts At 31 December 2017 At 31 December 2018 Building projects currently under construction for which no depreciation has been charged during the year Future capital expenditure which has been contracted for but not yet provided in the financial statements - property development and refurbishment Cumulative interest charges capitalised as construction costs and included in land and buildings The following items have been charged to the income statement as operating expenses during the year: Depreciation of property, plant and equipment - owned Impairment 2018 £m 11.7 5.7 3.6 62.2 5.8 Land & buildings £m - 0.1 0.1 2017 £m 26.8 7.3 2.6 59.5 - As part of the impairment review of the carrying value of assets described in detail in note 3.1, an impairment of land and buildings and plant and equipment has been recorded in the year. 121 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.3 Assets held for sale and discontinued operations Accounting policy Non-current assets that are expected to be recovered primarily through sale rather than through continuing use are classified as held for sale. Immediately before classification as held for sale, the assets are measured in accordance with the Group’s accounting policies. Thereafter the assets are measured at the lower of their carrying amount and fair value less costs to sell. Impairment losses on remeasurement are recognised in the income statement. Gains are not recognised in excess of any cumulative impairment loss. Non-current assets classified as held for sale are available for immediate sale and a resultant disposal is highly probable within one year. A non-current asset that stops being classified as held for sale is remeasured at the lower of its carrying amount prior to the asset or disposal Group being classified as held for sale, adjusted for any depreciation or amortisation that would have been recognised if the asset had not been classified as held for sale, or, its recoverable amount at the date of the decision not to sell. Discontinued operations The Group announced at the end of 2017 that it intends to dispose of the US motor business and has initiated an active program to find a buyer. At the date of this report this program is still on-going, with an initial sale of the Aston Martin business being concluded in July 2018 realising proceeds of £3.1m. The Group expects that a buyer can be found to conclude a sale of the remainder of the business during 2019. As such the results of the US Business are shown as a discontinued operation within these consolidated financial statements and its non-current assets reclassified as held for sale. No impairment loss has been recognised in the income statement for the year to 31 December 2018 in respect of this transaction. The results of the discontinued operation are set out on the face of the consolidated income statement. Other financial information relating to the discontinued operation for the period is set out below. Assets and liabilities of a disposal Group held for sale As at 31 December 2018, the US motor business was classified as a disposal Group which was stated at fair value less costs to sell and comprised the following assets and liabilities. Goodwill Other intangible assets Property plant and equipment Inventories Trade and other receivables Assets held for sale Trade and other payables Liabilities held for sale 122 £m 6.5 0.1 32.0 68.9 25.1 132.6 (88.6) (88.6) Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.3 Assets held for sale and discontinued operations continued Exchange differences on translation of discontinued operation Other comprehensive income from discontinued operation Net cash from operating activities Net cash from/(used in) investing activities Net cash from financing activities Net cash increase generated by discontinued operation Basic earnings per share from discontinued operation Underlying basic earnings per share from discontinuing operation Diluted earnings per share from discontinued operation Balance sheet 2018 £m - - 2018 £m 7.9 1.1 - 9.0 2018 pence 0.5 0.3 0.5 2017 £m (0.6) (0.6) 2017 £m 10.6 (18.5) 13.3 5.4 2017 pence 0.4 0.4 0.4 The Group has classified the non current assets of the US motor business as held for sale as at 31 December 2018. These comprise of goodwill, intangible fixed assets, property, plant and equipment. The assets in this disposal Group have been reviewed for possible impairment with reference to the expected proceeds on sale less costs to sell, with no impairment deemed necessary. There are no non-current liabilities within the US disposal Group. The Group also holds a number of freehold properties that are currently being marketed for sale which are expected to be disposed of during 2019. Properties are valued using a combination of external qualified valuers and in-house experts. Due to the nature of the market, especially in light of current economic conditions, a property may ultimately realise proceeds that vary from those valuations applied. Assets classified for sale (including disposal Group) comprise: Goodwill Other intangible assets Property, plant and equipment Inventories Trade and other receivables Income statement The following items have been credited/(charged) to the income statement during the year: Income statement category Profit on sale of assets classified as held for sale Other income - gains/(losses) on the sale of businesses and property Impairment of assets held for sale Net operating expenses 2018 £m 6.5 0.1 37.0 68.9 25.1 137.6 2018 £m 0.3 (1.2) 2017 £m 1.4 - 9.6 - - 11.0 2017 £m 0.2 - If the fair value less costs to sell assigned to each property were to be reduced by 10% a further impairment loss of £0.5m would have been recognised (2017: £0.4m). 123 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.4 Inventories Accounting policies Motor vehicle inventories are stated at the lower of cost and net realisable value. Cost is net of incentives received from manufacturers in respect of target achievements. Fair values of stock are conducted regularly utilising our market intelligence and analysis of the market which we conduct by segment and by model, these fair values are updated in the light of any changing trends by model line. The assessment of fair values involves an element of estimation: the Group takes the age profile of our inventories at the year end, estimates the likely sale period and the expected profit or loss on sale to determine the fair value at the balance sheet date. Whilst this data is deemed representative of current values it is possible that ultimate sales values can vary from those applied. Parts inventories are based on an average purchase cost principle and are written down to net realisable value by providing for obsolescence on a time in stock based formula approach. Consignment vehicles are regarded as being effectively under the control of the Group and are included within inventories on the balance sheet as the Group has the significant risks and rewards of ownership even though legal title has not yet passed. The corresponding liability is included in trade and other payables. Movements in consignment vehicle inventory and its corresponding liability within trade and other payables are not included within movements of inventories and payables as stated in the consolidated cash flow statement as no cash flows arise in respect of these transactions until the vehicle is either sold or purchased at which point it is reclassified within new and used vehicle inventory. Motor vehicles are transferred from contract hire activities at the end of their lease term to inventory at their depreciated cost. No physical cash flow arises from these transfers. Balance sheet New and used vehicles Consignment vehicles Vehicle parts and other inventories Carrying value of inventories subject to retention of title clauses 2018 £m 858.1 71.8 32.5 959.6 2018 £m 931.8 2017 £m 870.8 95.5 37.2 1,003.5 2017 £m 897.3 The sensitivity of the key assumptions on our sales prices could have the following impact on the net realisable value of inventory. If our assumptions were £100 per unit worse for those vehicles that are expected to make a loss per unit, the net realisable value of inventory would reduce by £0.4m in the year. Cash flow statement information Movement in inventory Inventory changes in business combinations and disposals Impact of exchange differences Non cash movement in consignment vehicles Classified as held for sale Transfer value of contract hire vehicles from fixed assets to inventory Cash flow decrease due to movements in inventory 2018 £m 43.9 (2.0) (0.7) (23.7) (68.9) 27.8 (23.6) 2017 £m (157.3) 0.3 0.3 25.2 - 29.2 (102.3) 124 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.5 Movement in contract hire vehicle balance Depreciation Changes in trade and other payables and deferred income Purchases of contract hire vehicles Unwinding of discounts in contract hire residual values 3.6 Trade and other receivables Accounting policy 2018 £m 37.9 (1.5) (65.5) (2.8) (31.9) 2017 £m 33.7 19.3 (82.1) (2.6) (31.7) Trade and other receivables are recognised initially at fair value and are subsequently stated at amortised cost using the effective interest method, less any impairment losses. Impairment losses are measured in accordance with IFRS 9, which replaces the ‘incurred loss’ model in IAS 39 with an ‘expected credit loss’ (ECL) model. The new impairment model applies to financial assets measured at amortised cost. Under IFRS 9, credit losses are recognised earlier than under IAS 39. The transition to IFRS and the subsequent change in accounting policy had no material effect on the financial position at 31 December 2017 and therefore no restatement was required. The calculation of ECLs are a probability-weighted estimate of credit losses. Credit losses are measured as the present value of all cash shortfalls (i.e. the difference between the cash flows due to the entity in accordance with the contract and the cash flows that the Group expects to receive). The Group considers a trade or other receivable to be in default when the borrower is unlikely to pay its credit obligations to the Group in full after all reasonable actions have been taken to recover the debt. Credit risk management The Group is exposed to credit risk primarily in respect of its trade receivables and financial assets. Trade receivables are stated net of provision for estimated impairment losses. Exposure to credit risk in respect of trade receivables is mitigated by the Group’s policy of only granting credit to certain customers after an appropriate evaluation of credit risk. Credit risk arises in respect of amounts due from vehicle manufacturers in relation to bonuses and warranty receivables. This risk is mitigated by the range of manufacturers dealt with, the Group’s procedures in effecting timely collection of amounts due and management’s belief that it does not expect any manufacturer to fail to meet its obligations. Financial assets comprise trade and other receivables (as above) and cash balances. The counterparties are banks and management does not expect any counterparty to fail to meet its obligations. The maximum exposure to credit risk is represented by the carrying amount of each financial asset, including derivative financial instruments, in the balance sheet. Before granting any new customer credit terms the Group uses external credit scoring systems to assess the potential new customer’s credit quality and defines credit limits by customer. These limits and credit worthiness are regularly reviewed and use is made of monitoring alerts provided by the providers of the credit scoring systems. The Group has no customer that represents more than 5% of the total balance of trade receivables. 125 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.6 Trade and other receivables continued Balance sheet Trade receivables Allowance for doubtful debts Other receivables Prepayments All amounts are due within one year. 2018 £m 46.3 (0.4) 45.9 52.5 16.4 114.8 2017 £m 60.6 (0.3) 60.3 56.6 15.9 132.8 All trade receivables are classified as loans and receivables and held at amortised cost in the current year and prior year. Total trade receivables held by the Group at 31 December 2018 was £60.1m (2017: £60.3m). No trade receivables have been classified as held for sale (2017: £nil). The average credit period taken on sales of goods is 29 days (2017: 29 days). No interest is charged on trade receivables. The Group makes an impairment provision based on the expected credit losses it deems likely to incur. An expense has been recognised in respect of impairment losses during the year of £0.6m (2017: £0.8m). The ageing of trade and other receivables at the reporting date was: Trade receivables 2018 £m Other receivables 2018 £m Trade receivables 2017 £m Other receivables 2017 £m Not past due Past due 0-30 days Past due 31-120 days Past due 120+ days Provision for impairment 31.9 10.3 3.3 0.8 46.3 (0.4) 45.9 41.7 4.6 6.2 - 52.5 - 52.5 The movement in the allowance for impairment in respect of trade receivables during the year was as follows: Balance at 1 January Utilisation Impairment loss recognised Balance at 31 December 45.3 11.5 3.2 0.6 60.6 (0.3) 60.3 2018 £m 0.3 (0.5) 0.6 0.4 46.1 5.1 5.4 - 56.6 - 56.6 2017 £m 0.3 (0.8) 0.8 0.3 The Directors consider that the carrying amount of trade and other receivables approximates their fair value. 126 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.7 Trade and other payables Accounting policy Trade and other payables are recognised initially at fair value and are subsequently stated at amortised cost using the effective interest method, less any write-offs. Balance sheet Trade payables Contract hire buyback commitments Consignment vehicle liabilities Payments received on account Other taxation and social security Accruals Non-current Current 2018 £m 940.5 81.2 71.8 11.4 17.7 107.2 1,229.8 54.4 1,175.4 1,229.8 2017 £m 968.6 79.5 95.5 16.7 12.1 110.8 1,283.2 59.0 1,224.2 1,283.2 Trade payables are classified as other financial liabilities and principally relate to vehicle funding. Fair value is deemed to be the same as carrying value. The non-current element of trade and other payables relates to contract hire buyback commitments where the Group has contracted to repurchase vehicles, at predetermined values and dates, that have been let under operating leases or similar arrangements. The Group enters into leasing arrangements whereby it agrees to repurchase vehicles from providers of lease finance at the end of the lease agreement, typically two to four years in the future. The repurchase price is determined at the time the agreement is entered into based on the then estimate of a vehicle’s future residual value. The actual value of the vehicles at the end of the lease contract, and therefore the proceeds that can be realised from eventual sale, can vary materially from these estimates. Annual reviews are undertaken to reappraise residual values and to recognise impairment write downs where necessary. 127 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.8 Provisions Accounting policy A provision is recognised if as a result of a past event the Group has a present legal or constructive obligation that can be estimated reliably, and it is probable that the Group will be required to settle the obligation. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability. Vacant property provision A provision for vacant properties is recognised when the expected benefits to be derived by the Group from a lease contract are lower than the unavoidable cost of meeting its obligation under the contract. The provision is measured at the present value of the lower of the expected cost of terminating the contract and the expected net cost of continuing with the contract. The vacant property provision is comprised of the future costs of vacated properties, being predominantly future lease commitments less any contributions from income derived from the subletting of these properties. The present value of future net lease commitments is calculated using a 1.27% discount rate. It is expected that the majority of this expenditure will be incurred over the next four years. The present value of the income from the subleases is £6.7m over the period of the leases and assumes that any sublet properties will remain so until the end of the sublease. VAT assessment The Group has settled its dispute with HM Revenue and Customs in respect of potential VAT issues arising from purchases of vehicles from Motability. The movements in provisions for the year are as follows: Vacant property provision £m VAT assessment £m 2.7 0.5 (0.7) (0.2) 2.3 1.6 0.7 2.3 6.8 - (4.5) (2.3) - - - - Total £m 9.5 0.5 (5.2) (2.5) 2.3 1.6 0.7 2.3 At 31 December 2017 Provisions made during the year Provisions used during the year Provisions released during the year At 31 December 2018 Non-current Current 128 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 3 - OPERATING ASSETS AND LIABILITIES 3.9 Deferred income Property leases Deferred income arose in 2006 from a sale and leaseback arrangement relating to certain dealership properties leased by the Group over a 25 year period. Warranty policies sold The income received in respect of warranty policies sold and administered by the Group is recognised over the period of the policy on a straight line basis. The unrecognised income is held within deferred income. Contract hire Vehicles supplied to a leasing company for contract hire purposes where the Group undertakes to repurchase the vehicle at a predetermined date are accounted for in accordance with IAS 17 Leases, where the Group is considered to be an operating lessor for all arrangements in place. The initial amounts received in consideration from the leasing company are allocated between the present value of the repurchase commitment, held within trade and other payables and a residual amount of deferred revenue held within deferred income. The deferred revenue, which effectively represents rentals received in advance, is taken to the income statement on a straight line basis over the related lease term. At 31 December 2017 Created in the year Recognised as income during the year At 31 December 2018 Non-current Current Property leases £m Warranty policies £m Contract hire £m 12.3 - (0.9) 11.4 10.4 1.0 11.4 13.0 12.6 (6.8) 18.8 5.7 13.1 18.8 74.9 37.6 (40.8) 71.7 36.1 35.6 71.7 Total £m 100.2 50.2 (48.5) 101.9 52.2 49.7 101.9 129 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE This section contains the notes and information to support the elements of both net debt and equity financing as presented in the Consolidated Balance Sheet. 4.1 Accounting policies 4.2 Financial instruments and derivatives 4.3 Net financing costs 4.4 Capital and reserves 4.1 Accounting policies 4.5 4.6 4.7 4.8 Dividends Share based compensation Obligations under finance leases Operating lease arrangements IFRS 9 Financial Instruments is mandatory for reporting periods commencing on or after 1 January 2018 and is therefore adopted in these financial statements. Compared to the previous accounting standard IAS 39, whilst there are changes in disclosure, there are no material changes in the quantification or measurement of financial assets or financial liabilities. A summary of the differences between IFRS 9 and IAS 39, as applied to these financial statements, is provided at the end of this section. A financial instrument is recognised if the Group becomes a party to the contractual provisions of the instrument. Financial assets are derecognised if the Group’s contractual rights to the cash flows from the financial asset expires. Financial liabilities are derecognised if the Group’s obligations specified in the contract expire or are discharged and cancelled. Financial instruments comprise both derivative and non-derivative financial instruments. Non-derivative financial instruments Non-derivative financial instruments comprise investments in equity and debt securities, trade and other receivables, cash and cash equivalents, loans and borrowings, and trade and other payables. Non-derivative financial instruments are recognised initially at fair value. Subsequent to initial recognition non-derivative financial instruments are measured as described below. Trade and other receivables - see note 3.6 Cash and cash equivalents Cash and cash equivalents comprise cash in hand and demand deposits, and other short term highly liquid investments that are readily convertible to a known amount of cash and are subject to an insignificant risk of changes in value. Loans and borrowings Interest-bearing loans and borrowings are recognised initially at fair value less attributable transaction costs. Subsequent to initial recognition, interest-bearing borrowings are stated at amortised cost with any difference between cost and redemption value being recognised in the income statement over the period of the borrowings on an effective interest basis. The effective interest basis is a method of calculating the amortised cost of a financial liability and of allocating interest payments over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments through the expected life of the financial liability, or where appropriate, a shorter period. Trade and other payables - see note 3.7 130 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.1 Accounting policies continued Hedging Instruments The Group holds hedging instruments to hedge currency risks arising from its activities. Hedging instruments are recognised at fair value. Any gain or loss on remeasurement is recognised in the income statement. However, the treatment of gains or losses arising from hedging instruments which qualify for hedge accounting depends on the type of hedge arrangement. The fair value of hedging instruments is the estimated amount receivable or payable to terminate the contract determined by reference to the market prices prevailing at the balance sheet date. The only hedging instrument held by the Group at the balance sheet date was its borrowing in USD to hedge its investment in overseas operations. A gain or loss in respect of an effective hedge of a net investment in an overseas operation is recognised directly in equity. Any ineffective portion of the hedge is recognised in the income statement. 4.2 Financial instruments and derivatives Net Debt Cash and cash equivalents Non-current interest bearing loans and borrowings Cash and cash equivalents Bank balances and bank overdrafts set out below are stated net of legal rights of set-off resulting from pooling arrangements operated by individual banks. Bank balances and cash equivalents Borrowings 2018 £m 51.4 (179.0) (127.6) 2017 £m 53.3 (177.4) (124.1) Carrying value and fair value 2018 £m 51.4 Carrying value and fair value 2017 £m 53.3 As at 31 December 2018, the Group had a £240m credit facility and a £60m senior note, expiring as set out below: Revolving credit facility Senior note Expiry Date March 2021 March 2023 £m 240.0 60.0 300.0 131 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.2 Financial instruments and derivatives continued During 2016 the company signed a £240m 5 year committed bank facility and a £60m 5.75% 7 year debt private placement. The fees and expenses associated with this debt of £2.1m are amortised over the expected life of the facility commencing in 2016. At 31 December 2018, £1.4m had been amortised and £0.7m remains to be amortised in future periods. Revolving credit facility Senior note Current margin 1.40% 5.75% Commitment (non-utilisation) fee 0.49% n/a The margin on the revolving credit facility varies according to a ratchet mechanism linked to the ratio of net debt to underlying EBITDA (after stocking interest). At 31 December 2018, the margin was 1.40%, consequent on the Group having achieved a ratio of less than 1.0. The commitment fee is calculated at 35% of the margin. The interest rate in respect of the senior note is a fixed rate of 5.75% until maturity. The revolving credit facility and the senior note are both subject to the same performance covenants with respect to net debt : underlying EBITDA (after stocking interest) and fixed charge cover. Security Both the revolving credit facility and the senior note are unsecured and rank pari-passu. Summary of borrowings Non-current: Bank borrowings 5.75% Senior note 2023 Other loan notes Finance leases Total non-current Total borrowings Carrying value 2018 £m Fair value 2018 £m Carrying value 2017 £m Fair value 2017 £m 117.3 60.0 0.2 1.5 179.0 179.0 117.3 60.0 0.2 1.5 179.0 179.0 115.7 60.0 0.2 1.5 177.4 177.4 115.7 60.0 0.2 1.5 177.4 177.4 132 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.2 Financial instruments and derivatives continued Reconciliation of movements of liabilities to cash flows arising from financing activities ____Borrowings____ __________Equity_________ Long term borrowings £m Finance Lease £m Share capital £m Other reserves £m Retained earnings £m Total £m At 1 January 2018 175.9 1.5 71.2 72.9 281.3 602.8 Cash flows from financing activities Dividends paid to shareholders Repurchase of own shares Disposal of shares by EBT Repayment of loans Proceeds from issue of loans Other changes The effect of changes in foreign exchange rates Liability-related : Amortisation of fees and expenses Equity-related : Total other changes - - - (10.0) 7.1 (2.9) 4.0 0.5 - - - - - - - - - - - (1.2) - - - - 1.2 - - - (22.5) (22.5) (6.7) 0.1 - - (6.7) 0.1 (10.0) 7.1 (1.2) 1.2 (29.1) (32.0) - - - - - - - - 4.0 0.5 (41.2) (41.2) At 31 December 2018 177.5 1.5 70.0 74.1 211.0 534.1 Interest payments in respect of the above borrowings are reported in operating cash flows in the Consolidated Cash Flow Statement. Fair value hierarchy Financial instruments carried at fair value are required to be measured by reference to the following levels: Level 1: quoted prices in active markets for identical assets or liabilities Level 2: inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices) Level 3: inputs for the asset or liability that are not based on observable market data (unobservable inputs) The revolving credit facility and senior note have been measured by a Level 2 valuation method. 133 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.2 Financial instruments and derivatives continued The effective interest rates for all borrowings are all based on LIBOR for the relevant currency, except for the 5.75% Senior note 2023, which is at a fixed rate. Finance leases are effectively held at fixed rates of interest within the range set out below. Information regarding classification of balances and interest, the range of interest rates applied in the year to 31 December 2018 and repricing periods, is set out in the table below. Bank balances and cash equivalents Loans and receivables 51.4 Amortised cost Floating GBP 0.25% - 2.09% 6 months or less Classification Carrying value  £m Classification Interest classification Interest rate range Repricing periods Borrowings Non - current: Bank borrowings Bank borrowings Other financial liabilities 44.4 Amortised cost Floating GBP 1.88% - 2.12% 6 months or less Other financial liabilities 72.9 Amortised cost Floating USD 2.88% - 3.84% 6 months or less 5.75% Senior note 2023 Other financial liabilities 60.0 Amortised cost Fixed GBP Other loan notes Finance leases Total non-current Total current Total borrowings Other financial liabilities 0.2 Amortised cost Fixed GBP Other financial liabilities 1.5 Amortised cost Fixed GBP 6.00% - 7.93% 179.0 - 179.0 5.75% 12.50% The carrying amounts of the Group’s borrowings are denominated in the following currencies: Pound sterling US dollar Treasury policy, financial risk, funding and liquidity management Financial risk management The Group is exposed to the following risks from its use of financial instruments: 2018 £m 106.1 72.9 179.0 n/a n/a n/a 2017 £m 115.5 61.9 177.4 Funding and liquidity risk - the risk that the Group will not be able to meet its financial obligations as they fall due Credit risk - the risk of financial loss to the Group on the failure of a customer or counterparty to meet its obligations to the Group as they fall due Market risk - the risk that changes in market prices, such as interest rates and foreign exchange rates, have on the Group’s financial performance The Group’s quantitative exposure to these risks is explained throughout these financial statements whilst the Group’s objectives and management of these risks is set out below. 134 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.2 Financial instruments and derivatives continued Treasury policy and procedures Group treasury matters are managed within policy guidelines set by the Board with prime areas of focus being liquidity, interest rate and foreign exchange exposure. Management of these areas is the responsibility of the Group’s central treasury function. Hedging financial instruments are utilised to reduce exposure to movements in foreign exchange rates. The Board does not permit the speculative use of derivatives. Funding and liquidity management The Group is financed primarily by its issued Senior note, revolving credit facility, vehicle stocking credit lines and operating cash flow. Committed facilities mature within appropriate timescales, are maintained at levels in excess of planned requirements and are in addition to short term uncommitted facilities that are also available to the Group. Each business within the Group is responsible for its own day-to-day cash management and the overall cash position is monitored on a daily basis by the Group treasury department. The maturity of non-current borrowings is as follows: Between 2 and 5 years Over 5 years 2018 £m 179.0 - 179.0 2017 £m 115.7 61.7 177.4 Maturities include amounts drawn under revolving credit facilities which are contractually repayable generally within a month of the year end but which may be redrawn at the Group’s option. The maturities above therefore represent the final repayment dates for these facilities. If the amounts drawn at the year end were redrawn at the Group’s usual practice of monthly drawings, the total cash outflows associated with all borrowings, assuming interest rates remain at the same rates as at the year end, are estimated on an undiscounted basis as follows: Bank borrowings Senior note Loan notes Finance leases Carrying amount Con- tractual cashflows 117.3 60.0 0.2 1.5 125.2 74.7 0.4 5.8 179.0 206.1 The Group has the following undrawn borrowing facilities: Expiring in more than two years Within 6 months 6 - 12 months 1-2 years 2-5 years 1.2 1.7 - - 2.9 1.2 1.7 - 0.1 3.0 120.3 67.8 0.4 0.3 188.8 2.5 3.5 - 0.1 6.1 2018 £m 122.7 over 5 years - - - 5.3 5.3 2017 £m 124.3 135 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.2 Financial instruments and derivatives continued Interest rate risk management The objective of the Group’s interest rate policy is to minimise interest costs whilst protecting the Group from adverse movements in interest rates. Borrowings issued at variable rates expose the Group to cash flow interest rate risk whereas borrowings issued at fixed rates expose the Group to fair value interest rate risk. The Group does not actively manage cash flow interest rate risk as the Board believes that the retail sector in which the Group operates provides a natural hedge against interest rate movements. Consequently, it is normal Group policy to borrow on a floating rate basis and all fair value interest rate risk arising from fixed rate borrowings entered into by the Group are usually managed by swaps into floating rate. However, the Group decided on a deviation from this policy in respect of its former 6.875% bond 2020. This bond was issued at a fixed rate of interest and, due to the historically low rates in current floating interest rates, there was relatively low downside risk in maintaining the bond at fixed rate. This policy has been continued in respect of the Group’s £60m Senior note 2023. Interest rate risk sensitivity analysis As some of the Group’s borrowings and vehicle stocking credit lines are floating rate instruments they therefore have a sensitivity to changes in market rates of interest. The table below shows the effect of a 100 basis points change in interest rates for floating rate instruments outstanding at the period end, showing how profit or loss would have varied in the period on the assumption that the instruments at the period end were outstanding for the entire period. 100 basis points increase Tax effect Effect on net assets 100 basis points decrease Tax effect Effect on net assets Foreign exchange risk management Profit/(loss) 2018 £m Profit/(loss) 2017 £m (7.6) 1.4 (6.2) 7.6 (1.4) 6.2 (7.6) 1.5 (6.1) 7.6 (1.5) 6.1 The Group faces currency risk in respect of its net assets denominated in currencies other than sterling. On translation into sterling, movements in currency will affect the value of these assets. The Group’s policy is therefore to match, where possible, net assets in overseas subsidiaries which are denominated in a foreign currency with borrowings in the same currency. The Group has therefore borrowed USD 93.0m (2017: USD 83.5m) against its net assets held in overseas subsidiaries. 136 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.2 Financial instruments and derivatives continued Hedges of net investments in overseas operations A gain or loss in respect of an effective hedge of a net investment in an overseas operation is recognised directly in equity. Any ineffective portion of the hedge is recognised in the income statement. Included within bank borrowings are balances denominated in US dollars which are designated as a hedge of the net investment in the Group’s US subsidiaries. Foreign exchange differences on translation of the borrowings to sterling at the balance sheet date are recognised within the translation differences reserve in equity, net of exchange differences in respect of the net investments being hedged. Aggregate fair value of borrowings designated as hedge of net investment in the Group's US subsidiaries Foreign exchange (losses)/gains on translation of borrowings to sterling at balance sheet date Foreign exchange gains/(losses) on translation of net investments to sterling at balance sheet date Net exchange gain/(loss) recognised within translation reserve in equity 2018 $m 93.0 £m (4.0) 4.0 - 2017 $m 83.5 £m 4.2 (4.8) (0.6) Capital management The Group views its financial capital resources as primarily comprising share capital, issued Senior note, bank loans, vehicle stocking credit lines and operating cashflow. Core debt i.e. total debt required to fund the Group’s net debt : underlying EBITDA target of 1.0 to 1.5, is essentially funded by the Group’s issued Senior note and revolving credit facility. The Group requires its revolving credit facility to fund its day-to-day working capital requirements. A fundamental element of the Group’s financial resources revolves around the provision of vehicle and parts stocking credit lines, provided by the vehicle manufacturers’ funding arms and other third party providers. The Group’s funding of its vehicle and parts inventories is set out below: Manufacturer finance arm Third party stock finance Bank Total inventories 2018 £m 524.2 407.6 96.7 2017 £m 598.6 298.7 106.2 1,028.5 1,003.5 When considering vehicle stocks from a funding risk view point we split the funding into that which is funded by the vehicle manufacturers through their related finance arms and that funded through third party stock finance facilities and bank borrowings. Financing for stock other than through bank borrowings is shown in trade creditors in the balance sheet. Manufacturers’ finance arms tend to vary the level of finance facilities offered dependent on the amount of stocks their manufacturer wishes to put into the network and this varies depending on the time of year and the level of production. Undrawn third party stock finance facilities at 31 December 2018 amounted to £22m (2017: £85m). 137 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.2 Financial instruments and derivatives continued The Group is also responsible for funding the pension deficit. The total financial resources required by the Group to fund itself at 31 December 2018 comprises: Net debt Stock finance Pension deficit 2018 £m 127.6 931.8 68.3 1,127.7 2017 £m 124.1 897.3 62.8 1,084.2 The Board’s policy is to maintain a strong capital base to maintain market confidence and to sustain the development of the business, whilst maximising the return on capital to the Group’s shareholders. The Group’s strategy will be to maintain facilities appropriate to the working requirements of the Group, to grow organically and service its debt requirements through generating cash flow. The Group had set a net debt : underlying EBITDA target range of 1.0 to 1.5 : 1. At 31 December 2018 the net debt : underlying EBITDA ratio achieved was 0.9 : 1, calculated as follows: Underlying operating profit Depreciation Amortisation Underlying EBITDA 2018 £m 76.2 62.2 3.1 141.5 2017 £m 83.8 59.5 2.7 146.0 Net debt (being net debt as set out above) 127.6 124.1 Net debt : underlying EBITDA ratio 0.9 0.9 The key measures which management uses to evaluate the Group’s use of its financial resources, and performance achieved against these in 2018 and 2017 are set out below: Underlying profit before tax (£m) Underlying earnings per share (p) Net debt : underlying EBITDA 2018 47.8 2.8 0.9 2017 60.4 3.3 0.9 The Group’s capital structure and capital allocation priorities were reassessed during 2017 and the conclusion of that review in December 2017 decided the following priorities: UK new car business - a review of capital allocation of Premium Brands was completed and certain franchise locations will be reduced over a three year period. It is estimated that £100m capital will be released through a mixture of disposal proceeds and investment not deployed over the three years from December 2017. US Motor Group - given the strong performance of this division, it is economically right to sell the business to realise its value of approximately £100m before tax. UK used car business - this remains our focus for growth with continued investment to complete our national network achieving our objective to double used car revenue by 2021. The Group has a target range of 1.0 to 1.5 times net debt to underlying EBITDA and is currently trading with financial leverage below this level. 138 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.2 Financial instruments and derivatives continued The Group will continue to pursue organic and acquisitive growth and investment opportunities and evaluate them against the returns generated via the share buyback programme. The buyback programme is currently paused and is capable of being stopped and restarted and this flexibility will enable the Group to pursue other, higher returning, capital allocation opportunities if they arise. The Group may also issue shares or purchase them in the market to satisfy share incentives issued to employees of the Group. The Group encourages employees to be shareholders of the Group, providing selective share option and LTIP schemes from time to time. Certain of the company’s subsidiaries are required to maintain issued share capital at levels to support capital adequacy under Financial Conduct Authority (FCA) requirements. The Group ensures these requirements are met by injections of equity to the subsidiaries in question, when required. Other than specifically set out above, there were no changes to capital management in the year. IFRS 9 v IAS 39 Financial assets IAS 39 classifies financial assets into classes according to their nature i.e. loans and receivables, held to maturity or available for sale. IFRS 9, by contrast, classifies assets according to the business model for their realisation, as determined by the expected contractual cashflows. This classification determines the accounting treatment, and the new classification under IFRS 9 is by reference to the accounting treatment i.e. amortised cost, fair value through other comprehensive income or fair value through profit and loss. Impairment of financial assets IAS 39 adopts an incurred loss approach for measuring impairment while IFRS 9 adopts an expected credit loss approach (ECL). The IAS 39 incurred loss approach relied on a credit event occurring (an actual loss or a debt past a number of days due) before an impairment could be recognised. The IFRS 9 approach does not require a credit event to occur but is based on changes in expectations of credit losses. IFRS 9 also requires that impairment of financial assets be shown as a separate line item in either the statement of comprehensive income or the income statement. Under IAS 39 the Group recorded the impairment of its financial assets (trade and other receivables) within operating expenses. Financial liabilities IFRS 9 largely retains the classification requirements of IAS 39 so there are no material differences. The following table summarises the differences between IFRS 9 and IAS 39, as applied to these financial statements. IFRS 9 classification IAS 39 classification IFRS 9 Carrying value  £m Remeas- urement  £m IAS 39 Carrying value  £m Financial assets Trade and other receivables Cash and cash equivalents Financial liabilities Loans and borrowings Trade and other payables Amortised costs Loans and receivables 139.8 Amortised costs Loans and receivables 51.4 Amortised cost Amortised cost (179.0) Amortised cost Amortised cost (1,318.3) Foreign currency loans used to hedge overseas investments Fair value hedging instrument Fair value hedging instrument (72.9) - - - - - 139.8 51.4 (179.0) (1,318.3) (72.9) 139 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.3 Net financing costs Accounting policy Finance income comprises interest income on funds invested, return on net pension scheme assets and gains on hedging instruments that are recognised in profit and loss. Interest income is recognised as it accrues in profit and loss, using the effective rate method. Finance expense comprises interest expense on borrowings, unwinding of the discount on provisions, interest on net pension scheme obligations and losses on hedging instruments recognised in profit and loss. All borrowing costs are recognised in profit and loss using the effective interest method. Gross finance costs directly attributable to the construction of property, plant and equipment are capitalised as part of the cost of those assets until such a time as the assets are substantially ready for their intended use or sale. Finance expense Recognised in profit and loss Interest payable on bank borrowings, Senior note, bond and loan notes Vehicle stocking plan interest Interest payable on finance leases Net interest on pension scheme obligations (non-underlying - see note 2.6) Less: interest capitalised Total interest expense being interest expense in respect of financial liabilities held at amortised cost Unwinding of discounts in contract hire residual values Total finance expense 2018 £m 8.4 18.1 0.1 1.6 (1.0) 27.2 2.8 30.0 2017 £m 7.0 14.5 0.1 2.7 (0.8) 23.5 2.6 26.1 Interest of £1.0m has been capitalised during the year on assets under construction at an average rate of 5.75% (2017: £0.8m). 140 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.4 Capital and reserves Ordinary share capital Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of ordinary shares are recognised as a deduction from equity, net of any tax effects. Allotted, called up and fully paid shares of 5p each at 31 December 2017 Shares cancelled during the year Allotted, called up and fully paid shares of 5p each at 31 December 2018 There were no issues of ordinary shares during the year. Number 1,424,814,004 (25,664,979) 1,399,149,025 £m 71.2 (1.2) 70.0 25,664,979 ordinary shares having a nominal value of £1.2m were bought back and subsequently cancelled during the year in accordance with the authority granted by shareholders in the Annual General Meeting on 2 May 2018. The aggregate consideration paid, including directly attributable costs, was £6.7m. Since the commencement of the current share buyback programme in 2016, as at 31 December 2018, 61,171,630 shares have been bought back and cancelled representing 4.2% of the issued ordinary shares, at a cost of £18.2m. The holders of ordinary shares are entitled to receive dividends as declared from time to time and are entitled to one vote per share at meetings of the company. All shares rank equally with regard to the company’s residual assets. Capital redemption reserve The capital redemption reserve has arisen following the purchase by the company of its own shares and comprises the amount by which distributable profits were reduced on these transactions in accordance with s733 of the Companies Act 2006. £1.2m (2017: £0.6m) was transferred into the capital redemption reserve during the year in respect of shares purchased by the company and subsequently cancelled. Other reserves Other reserves comprise the amount of demerger reserve arising on the demerger of the company from Williams Holdings PLC in 1989. Own shares held by Employee Benefit Trust (EBT) Transactions of the Group-sponsored EBT are included in the Group financial statements. In particular, the trust’s purchases of shares in the company, which are classified as own shares, are debited directly to equity through retained earnings. When own shares are sold or reissued the resulting surplus or deficit on the transaction is also recognised within retained earnings. The market value of the investment in the company’s own shares at 31 December 2018 was £1.4m (2017: £2.2m), being 6.4m (2017: 7.7m) shares with a nominal value of 5p each, acquired at an average cost of £0.33 each (2017: £0.33). During the year the trust acquired no shares (2017: 8.3m shares, for a consideration of £2.8m) and disposed of 1.3m (2017: 8.1m) shares in respect of LTIP and executive share option awards for a consideration of £0.1m (2017: £0.1m). The amounts deducted from retained earnings for shares held by the EBT at 31 December 2018 was £18.1m (2017: £18.2m). The trustee of the EBT is Salamanca Group Trust (Jersey) Limited. The shares in trust may subsequently be awarded to Executive Directors and employees under the Pendragon 1999 Approved Executive Share Option Scheme, Pendragon 1999 Unapproved Executive Share Option Scheme and to satisfy amounts under LTIPs and the VCP. Details of the plans are given in the Directors’ Remuneration Report on pages 55 to 68. 141 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.4 Capital and reserves continued Dividends on the shares owned by the trust, the purchase of which were funded by interest free loans to the trust from Pendragon PLC, are waived. All expenses incurred by the trust are settled directly by Pendragon PLC and charged in the accounts as incurred. The trust is regarded as a quasi subsidiary and its assets and results are consolidated into the financial statements of the Group. Translation reserve The translation reserve comprises all foreign exchange differences arising from the translation of the net investment in foreign operations as well as from the translation of liabilities held to hedge the respective net investment in foreign operations. 4.5 Dividends Final dividends proposed by the Board and unpaid at the end of the year are not recognised in the financial statements until they have been approved by the shareholders at the AGM. Interim dividends are recognised when they are paid. Ordinary shares Final dividend in respect of 2017 of 0.8p per share (2016: 0.75p per share) Interim dividend in respect of 2018 of 0.8p per share (2017: 0.75p per share) 2018 £m 10.7 11.8 22.5 2017 £m 10.7 10.6 21.3 The Board is recommending a final dividend for 2018 of 0.7p (2017: 0.8p) per ordinary share equating to £9.8m in total in respect of shares in issue at the date of this report (2017: £11.3m). 142 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.6 Share based compensation Accounting policy The Group operates a number of employee share option schemes and an executive share ownership plan ‘exsop’ awarded in 2010. The fair value at the date at which the share options are granted is recognised in the income statement on a straight line basis over the vesting period, taking into account the number of options that are expected to vest. The fair value of the options granted is measured using an option pricing model, taking into account the terms and conditions upon which the options were granted. The number of options that are expected to become exercisable is reviewed at each balance sheet date and if necessary estimates are revised. Executive share options The number and weighted average exercise prices of share options is as follows: Outstanding at beginning of period Exercised during the period Lapsed during the period Outstanding at the end of the period Exercisable at the end of the period Weighted average exercise price 2018 Number of options millions 2018 Weighted average exercise price 2017 Number of options millions 2017 29.89p 11.17p 39.45p 23.63p 23.63p 12.9 (1.3) (6.1) 5.5 5.5 29.76p 12.55p 38.76p 29.89p 21.83p 14.7 (0.8) (1.0) 12.9 7.1 The options outstanding at 31 December 2018 have an exercise price in the range of 8.8p to 31.82p and a weighted contractual life of 4.5 years. All share options are settled in equity. Movements in the number of options to acquire ordinary shares under the Group’s various share option schemes, together with exercise prices and the outstanding position at 31 December 2018 were as follows: Exercise period Date of grant Exercise price per share At 31 December 2017 Number Exercised Number Lapsed Number 20 September 2013 to 19 September 2020 20 September 2010 14.22p 435,977 - 7 October 2014 to 6 October 2021 6 October 2011 8.82p 1,384,451 (626,133) 31 March 2015 to 30 March 2022 30 March 2012 13.50p 1,730,000 (630,000) - - - At 31 December 2018 Number 435,977 758,318 1,100,000 19 September 2017 to 19 September 2024 18 September 2014 31.82p 3,579,500 - (350,000) 3,229,500 1 April 2018 to 31 April 2025 31 March 2015 39.92p 5,729,019 - (5,729,019) - 12,858,947 (1,256,133) (6,079,019) 5,523,795 All grants of share options were issued pursuant to the 2009 Executive Share Option Scheme, which prescribed an earnings per share performance criterion. It is a precondition to the exercise of grants made under the 2009 Scheme that the growth in the company’s earnings per share over the prescribed three year period must exceed by at least 3 percent per annum compound the annual rate of inflation as shown by the RPI Index. 143 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.6 Share based compensation continued The weighted average share price at the date of exercise for share options exercised in the year was 25.5p (2017: 32.4p). All options are settled by physical delivery of shares. The fair value of the services received in return for share options is measured by reference to the fair value of the options granted. The estimate of the fair value of the services received in respect of share option schemes is measured using the Black-Scholes option pricing model. The weighted average fair value of the options at the date of grant for those that are outstanding at 31 December 2018 is 6.4p (2017: 7.0p). Executive Long Term Incentive Plan (‘LTIPs’) The number and weighted average exercise prices of executive LTIPs is as follows: Outstanding at the start of the period Lapsed during the period Outstanding at the end of the period Weighted average exercise price 2018 Number of options millions 2018 Weighted average exercise price 2017 Number of options millions 2017 0.0p 0.0p - 6.3 (6.3) - 0.0p 0.0p 0.0p 7.7 (1.4) 6.3 Movements in the number of options to acquire ordinary shares under the Group’s LTIP, together with the outstanding position at 31 December 2018 were as follows: Exercise period 31 March 2018 Date of grant 31 March 2015 14 September 2019 14 September 2016 At 31 December 2017 Number At 31 December 2018 Number Lapsed Number 3,937,633 (3,937,633) 2,400,000 (2,400,000) 6,337,633 (6,337,633) - - - All grants of LTIPs were issued pursuant to the Long Term Incentive Plan, which prescribed an earnings per share performance criterion. It is a precondition that vesting will not occur if earnings per share growth in the three year performance period does not exceed RPI by at least 4 percent. Vesting will occur between performance points on a straight line basis. All is subject to an underpin of creating absolute total shareholder value. In the case of the company, this means that growth in the value of a shareholding in the company must exceed the growth in the value of shares in the comparator index the company is in, currently the FTSE Small Cap. The fair value of the services received in return for the LTIPs is measured by reference to the fair value of the LTIPs granted. The estimate of the fair value of the services received in respect of the LTIPs is measured using the Black-Scholes option pricing model. The weighted average fair value of the options at the date of grant for those that are outstanding at 31 December 2018 is nil (2017: 34.2p). The Group recognised a total net expense of £0.7m (2017: £1.7m credit) as an employee benefit cost in respect of all equity- settled share based payment transactions included within administration costs. 144 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.7 Obligations under finance leases Accounting policies Leases are classified as finance leases wherever the lease transfers substantially all the risks and rewards of ownership to the Group. All other leases are treated as operating leases. Assets held under finance leases are recorded at inception at the lower of the fair value of the asset and the present value of the minimum payments required to be made under the lease. Subsequent to initial recognition, the asset is accounted for in accordance with the accounting policy applicable to that asset. The corresponding liability is recorded as a finance lease obligation. The finance charge element of rentals paid under these leases is expensed so as to give a constant rate of finance charge on the remainder of the obligation. Finance charges are expensed in the income statement and the capitalised leased asset is depreciated over the shorter of the lease term and the asset’s useful economic life. Finance leases Amounts payable under finance leases: Within one year In the second to fifth years inclusive After five years Less: future finance charges Present value of lease obligations Amount due for settlement within one year Amount due for settlement in over one year Minimum lease payments Present value of minimum lease payments 2018 £m 0.1 0.4 5.3 5.8 (4.3) 1.5 2017 £m 2018 £m 2017 £m 0.1 0.4 5.4 5.9 (4.4) 1.5 0.1 0.3 1.1 1.5 - 1.5 - 1.5 1.5 0.1 0.3 1.1 1.5 - 1.5 - 1.5 1.5 The Group’s obligations under finance leases comprise properties on long term leases with a lease term of between 50 and 75 years. The effective interest rates are shown in note 4.2 above. The Group’s obligations under finance leases are secured by the lessors’ charges over the leased assets. All leases are on a fixed repayment basis and no arrangements have been entered into for contingent rental payments. 145 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 4 - FINANCING ACTIVITIES AND CAPITAL STRUCTURE 4.8 Operating lease arrangements Leases are classified as operating leases wherever the lease does not transfer substantially all the risks and rewards of ownership to the Group. Rentals paid under operating leases are charged directly to the income statement on a straight line basis over the period of the lease. Leases subject to predetermined fixed rental uplifts have their rentals accounted for on a straight line basis recognised over the life of the lease. Lease incentives received and paid are recognised in the income statement as an integral part of the total lease expense over the term of the lease. The Group as lessee At the balance sheet date, the Group had outstanding commitments for future minimum lease payments under non- cancellable operating leases, which fall due as follows: Within one year In the second to fifth years inclusive After five years 2018 £m 46.0 169.2 264.5 479.7 2017 £m 43.4 159.3 338.0 540.7 The Group leases a number of properties, the majority of which are motor vehicle showrooms with workshop and parts retail facilities, with varying lease periods. None of the leases includes contingent rentals. In addition there are other leases in respect of items of plant and equipment which includes the rental of motor vehicles hired for short term usage, typically as courtesy cars. The following amounts have been charged to the income statement as operating expenses during the year: Operating lease rentals payable - hire of plant and machinery - property rentals The Group as lessor 2018 £m 2.1 43.8 2017 £m 2.1 43.8 Property rental income earned during the year was £4.7m (2017: £5.1m). No contingent rents were recognised in income (2017: £nil). The Group currently receives rental income on 32 (2017: 32) properties on short term leases. These properties are not treated as investment properties. At the balance sheet date, the Group had contracted with tenants for the following future minimum lease payments: Within one year In the second to fifth years inclusive After five years 146 2018 £m 4.6 15.9 18.5 39.0 2017 £m 4.3 13.7 24.0 42.0 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 5 - PENSION SCHEMES This section explains the pension scheme obligations of the Group. 5.1 Pension obligations Accounting policy The Group operated a number of defined benefit and defined contribution plans during the year. The assets of the defined benefit plan and one defined contribution plan are held in independent trustee administered funds. The Group also operates a Group Personal Pension Plan which is a defined contribution plan where the assets are held by the insurance company under a contract with each individual. Defined contribution plans - A defined contribution plan is one under which the Group pays fixed contributions and has no legal or constructive obligation to pay further amounts. Therefore, no assets or liabilities of these plans are recorded in these financial statements. Obligations for contributions to defined contribution pension plans are recognised as an employee benefit expense in the income statement when they are due. Defined benefit plans - Pension accounting costs for defined benefit plans are assessed by determining the pension obligation using the projected unit credit method after including a net return on the plan assets. Under this method, in accordance with the advice of qualified actuaries, the amounts charged in respect of employee benefits reflect the cost of benefits accruing in the year and the cost of financing historical accrued benefits. The Group recognises all actuarial gains and losses arising from defined benefit plans in the statement of other comprehensive income immediately. The present value of pension obligations is measured by reference to market yields on high quality corporate bonds which have terms to maturity approximating to the terms of the related pension liability. Plan assets are measured at fair value. When the calculation results in a benefit to the Group, the recognised asset is limited to the total of the present value of economic benefits available in the form of any future refunds from the plan or reductions in future contributions to the plan. An economic benefit is available to the Group if it is realisable during the life of the plan, or on settlement of the plan liabilities. Under IAS 19 Employee Benefits, the Group recognises an interest expense or income which is calculated on the net defined benefit liability or asset respectively by applying the discount rate to the net defined benefit liability or asset. Remeasurements arising from defined benefit plans comprise actuarial gains and losses and the return on plan assets (excluding interest) are immediately recognised directly in the statement of other comprehensive income. Actuarial gains and losses are the differences between actual and interest income during the year, experience losses on scheme liabilities and the impact of any changes in assumptions. Details of the last independent statutory actuarial valuation and assumptions are set out below. Pension arrangements The Group operated six defined benefit pension schemes which provides benefits based on final salary (one of which had a defined contribution section) which closed to new members and accrual of future benefits on 30 September 2006 and a defined contribution scheme which was closed to new contributions from April 2006. All affected employees were offered membership of a defined contribution pension arrangement with Friends Provident. A Group Personal Pension arrangement with Legal & General replaced the Friends Provident arrangement from 1 January 2010. Total contributions paid by the Group in 2018 to the Legal & General arrangement were £2.7m (2017: £2.5m). To comply with the Government’s automatic enrolment legislation, the Group chose to participate in the People’s Pension Scheme in April 2013. This is a defined contribution occupational pension scheme provided by B&CE. Total contributions paid by the Group to the People’s Pension in 2018 were £5.1m (2017: £2.6m). The combined contributions to the Group’s Personal Pension arrangement (including the US Motor business) and the Peoples Pension scheme totalled £7.8m in the period. 147 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 5 - PENSION SCHEMES 5.1 Pension obligations continued During 2012 the Trustees merged the six defined benefit schemes into one new defined benefit scheme, ‘the Pendragon Group Pension Scheme’, which remains closed to new members and accrual of future benefits. The assets of the six schemes have all been transferred into the new scheme and the benefits previously accrued in the six schemes were transferred without amendment of the benefit entitlement of members to the new scheme. The scheme is subject to the funding legislation outlined in the Pensions Act 2004 which came into force on 30 December 2005. This, together with documents issued by the Pensions Regulator, and Guidance Notes adopted by the Financial Reporting Council, set out the framework for funding defined benefit occupational pension schemes in the UK. The Board of the Trustees of the pension scheme is currently composed of two member nominated trustees (i.e. members of the pension scheme nominated by other members to be trustees), two employer representatives and a professional independent trustee. The former independent chair of trustees retired at 31 December 2017 and the professional independent trustee became chair during 2018. The Trustee of the scheme is required to act in the best interest of the scheme’s beneficiaries. The appointment of the Trustee is determined by the scheme’s trust documentation. Under IAS 24, the pension schemes are related parties of the Group. At 31 December 2018 there was an outstanding balance of £0.8m (2017: £0.8m) payable to the pension schemes. Funding The Pendragon Group Pension Scheme is the liability of the parent company only, and not of any subsidiaries: it is therefore only recognised in the financial statements of the parent company. The Scheme is fully funded by the subsidiary companies of the group, as the parent company does not generate cash inflows itself. The funding requirements are based on the Scheme’s actuarial measurement framework set out in the funding policies of the Scheme. Employees are not required to contribute to the plans. Explanation of the Pension Deficit The liability to pay future pensions is a liability to settle a stream of future cashflows. These future cashflows have the following profile: m £ t n e m y a P l a u n n A 30 25 20 15 10 5 0 148 2020 2030 2040 2050 2060 2070 2080 2090 2100 2110 Deferreds Pensioners Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 5 - PENSION SCHEMES 5.1 Pension obligations continued ‘Deferred’ are those pension scheme members not yet drawing a pension as at 31 December 2018; ‘Pensioners’ are those in receipt of pension at 31 December 2018. The actual total cash liabilities shown above are estimated at £796m. The value of these liabilities discounted to present value at 31 December 2018 are £486.3m. In order to meet those future cashflows, the Pension Scheme has to grow its assets sufficient to settle those liabilities. The risk of the future value of those assets is dependent on the financial return; the liabilities will change dependent on the rate of inflation (as most pensions are inflation adjusted) and longevity (how long the pensioner lives for and therefore in receipt of pension). The pension deficit is the gap between those assets and liabilities and can be calculated in one of two ways, both of which are arithmetically identical: either forecast future assets at the asset growth rate to offset against actual liabilities or discount future liabilities by the asset growth rate and compare with the present value of the assets. The latter method is the one commonly adopted and accounting standards require that the asset growth rate (the discount rate) should be estimated on a similar basis for every company, to enhance comparability and to assume a relatively low level of risk. The more realistic picture is provided by the actuarial valuation which considers what the best estimate of the asset growth rate should be and hence what the gap is that the Group will be required to fund through cash contributions. These actuarial valuations are conducted every three years (the triennial valuation). The last triennial valuation was conducted as at 31 December 2015 giving the following comparison: As at 31 December 2015 Assets Liabilities Pension deficit Discount rate used Inflation IAS 19 (Accounts) £m 396.9 (440.3) (43.4) 3.90% 2.1%-3.9% Actuarial valuation £m 397.0 (432.1) (35.1) 4.20% 1.8%-3.7% The triennial valuation of the pension scheme reflecting the position as at 31 December 2015 was agreed by the Trustees on 13 March 2017. The company has agreed with the trustees that it will aim to eliminate the deficit over a period of 5 years and 7 months from 1 January 2017 by the payment of deficit recovery contributions of £7.0m each year, increasing at 2.25% p.a. These contributions include the expected quarterly distributions from the Central Asset Reserve over the recovery period. The next triennial valuation of the pension scheme will reflect the position as at 31 December 2018. Central Asset Reserve Pendragon PLC is a general partner and the Pendragon Group Pension Scheme is a limited partner of the Pendragon Scottish Limited Partnership (the Partnership). The Partnership holds £34.5m of properties which have been leased back to the Group at market rates. The Group retains control over these properties, including the flexibility to substitute alternative properties. As such, the Partnership is consolidated into the results of the Group. During the year the Group has paid £2.9m to the Pendragon Group Pension Scheme through the Partnership (2017: £2.8m) and will increase by 2.25% on 1 August each year until the leases expire on 31 July 2032. These payments could cease in advance of that date if the Pension Scheme’s actuarial valuation reaches a point where there is a surplus of 5% over the liability value (on the actuarial triennial valuation basis). The Pension Scheme therefore has a right to receive a future stream of rental receipts. No asset is recognised in these financial statements as the Group has to consent to any proposed disposal of this asset by the Pension Scheme. However, if the Group became insolvent the properties themselves would be retained by the Pension Scheme. 149 2020 2030 2040 2050 2060 2070 2080 2090 2100 2110 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 5 - PENSION SCHEMES 5.1 Pension obligations continued IAS 19 assumptions The assumptions used by the actuary in performing the triennial valuation at 31 December 2015 are the best estimates chosen from a range of possible actuarial assumptions which, due to the timescale covered, may not necessarily be borne out in practice. The IAS 19 assumptions have been updated at 31 December 2018 and differ from those used for the earlier independent statutory actuarial valuations explained above. The principal assumptions used by the independent qualified actuaries for the purposes of IAS 19 for all schemes were: Inflation - RPI Inflation - CPI Discount rate 2018 3.25% 2.25% 2.85% 2017 3.25% 2.25% 2.55% 2016 3.35% 2.35% 2.70% Mortality table assumption * VitaCurves CMI 2017 M (1%) / S2PMA CMI 2016 M (1%) / S2PMA CMI 2015 M (1%) VitaCurves CMI 2017 F (1%) S2PFA CMI 2016 F (1%) S2PFA CMI 2015 F (1%) *The mortality table assumption implies the following expected future lifetime from age 65: Males aged 45 Females aged 45 Males aged 65 Females aged 65 2018 Years 22.8 24.9 21.8 23.7 2017 Years 23.0 25.0 21.9 23.7 2016 Years 23.2 25.4 21.9 23.9 During 2010 the Government announced a change to the index to be used for pension increases from RPI to CPI. The change applied to certain elements of pension increases depending on the nature of the pension entitlement, the period in which it was earned and the rules of each scheme. The application of either RPI or CPI to calculate the pension liability has been assessed for each scheme and the relevant elements of pension increases within each scheme. 150 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 5 - PENSION SCHEMES 5.1 Pension obligations continued The sensitivities regarding the principal assumptions used to measure scheme liabilities are set out below: Assumption Discount rate Rate of inflation Mortality Change in assumption Impact on scheme liabilities Increase/decrease by 0.1% Decrease/increase of £8.4m Increase/decrease by 0.1% Increase/decrease of £5.3m Increase in life expectancy of 1 year Increase by £15.6m The sensitivities shown above are approximate. Each sensitivity considers one change in isolation. The inflation sensitivity includes the impact of changes to the assumptions for revaluation and pension increases. The average duration of the defined benefit obligation at the period ending 31 December 2018 is 17 years (2017: 18 years). The scheme typically exposes the Group to actuarial risks such as investment risk in assets (the return and gain or loss on assets invested in), inflation risk (as pensions typically rise in line with inflation) and mortality risk (the length of time a pensioner lives for) in respect of liabilities. As the accounting deficit is calculated by reference to a discount rate linked to corporate bonds then the Group is also exposed to interest rate risk i.e. the discounted value of liabilities will rise or fall in line with changes in the interest rate used to calculate (discount) the future pension liabilities to present value. A decrease in corporate bond yields, a rise in inflation or an increase in life expectancy would result in an increase to scheme liabilities. This would detrimentally impact the balance sheet position and may give rise to increased charges in future income statements. This effect could be partially offset by an increase in the value of the scheme’s assets. In order to further mitigate risk, the scheme’s investment strategy was changed during 2017 and now operates within a liability driven framework known as Liability Driven Investments (‘LDI’) i.e. the scheme invests in a mix of assets that are broadly expected to match the expected movement in the net present value of liabilities. This is achieved by investing in assets that are broadly expected to hedge the underlying inflation and interest rate risks of 90% of the liabilities (2017: 80% of the liabilities). The nature of the products available for liability driven investing mean that a greater proportion of the scheme’s assets can be used to invest in assets that are expected to have a higher growth rate than low risk assets. Traditionally, a pension scheme would typically invest in low risk assets such as gilts or cash to broadly match the liabilities of pensions already in payment and invest in higher risk assets such as equities in an attempt to seek growth to fund future pensions for deferred members. Today, the products available for liability driven investing means that each £100 of gilts formerly held can now be replaced with c. £25 of collateral LDI assets and £75 of higher growth assets in order to generate a higher expected return with a similar expected level of risk of volatility. When the LDI investment strategy was put in place in 2017, the investments were rebalanced to hold the required level of LDI collateral assets and the balance invested in a range of diversified growth funds which typically target a return of 3-5% per annum. Additionally, caps on inflationary increases are in place to protect the scheme against extreme inflation. During 2018 a new investment advisor was appointed to the Pension Scheme and the current focus is on further reducing the risk the pension scheme runs in investing in equities, which by their nature are volatile: the pension scheme is considering a strategy to ‘bank’ gains on equities when certain trigger points are met and to re-invest in lower yielding but less risky assets. 151 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 5 - PENSION SCHEMES 5.1 Pension obligations continued The fair value of the scheme’s assets which are not intended to be realised in the short term and may be subject to significant change before they are realised, and the value of the schemes liabilities, which is derived from cash flow projections over long periods and thus inherently uncertain, are: Scheme assets and liabilities UK equities Overseas equities Unit trust Corporate bonds Government bonds Liability driven investments Diversified growth fund Cash Fair value of scheme assets Present value of funded defined benefit obligations Net liability on the balance sheet 2018 £m 129.1 1.9 13.2 - - 58.9 163.1 51.8 2017 £m 2016 £m 193.0 234.5 0.2 17.8 - - 65.6 163.1 19.3 7.8 21.9 10.9 161.2 - - 5.1 418.0 459.0 441.4 (486.3) (521.8) (544.6) (68.3) (62.8) (103.2) None of the fair values of the assets shown above include any of the company’s own financial instruments or any property occupied by, or other assets used by, the company. All of the scheme assets have a quoted market price in an active market with the exception of the Trustee’s bank account balance. UK equities are held as a mixture of pooled funds (where cash is invested in a quoted fund designed by the fund manager) or via a segregated mandate where cash is advanced to a fund manager for direct investment in equities at the discretion of the fund manager. Liability driven investments (‘LDI’) comprises of investments in funds invested mostly in assets akin to gilts. The diversified growth fund comprises of investments with a number of different fund managers in their individual funds, which funds invest in a mixture of UK and global equities, government and non-government bonds, cash and derivatives. An LDI solution does not remove all risks within a pension scheme. Those that remain include: • Demographic risks. For example mortality experience may differ from that assumed when projecting the liability cashflows. • Basis risk. The valuation of the liabilities by the Scheme Actuary may be based on a specific discount rate, or perhaps a market reference yield. The LDI portfolio will be subject to either underlying gilt or swap market rates. To the extent that these differ, it may result in a residual variation between the two valuation approaches. • LIBOR target risk. With derivative positions in place, the assets need to achieve a LIBOR (cash return) based target in order to keep pace with the liabilities. To the extent that this return is not achieved (through poor cash funds, or underperformance of growth assets), this will detract from the funding position. • Counterparty risk. The instruments used in an LDI solution rely on investment bank counterparties to provide the required exposures. If a counterparty defaults, this can lead to a loss of that particular exposure and potentially a loss of any accrued profit on the position. This latter is mitigated by the counterparty placing assets as security or ‘collateral’ to cover accrued profits. It is the policy of the Trustee and the company to review the investment strategy at the time of each funding valuation and keep this under review. The Trustee investment objectives and the processes undertaken to measure and manage the risks inherent in the scheme investment strategy are documented in the scheme’s Statement of Investment Principles. 152 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 5 - PENSION SCHEMES 5.1 Pension obligations continued The Group has reviewed implications of the guidance provided by IFRIC 14 and have concluded that it is not necessary to make any adjustments to the IAS 19 figures in respect of an asset ceiling or Minimum Funding Requirement as at 31 December 2018 and at 31 December 2017. Movements in the net liability for defined benefit obligations recognised in the balance sheet Net liability for defined benefit obligations at 1 January Contributions received Expense recognised in the income statement Actuarial gains and losses recognised in the statement of other comprehensive income Net liability for defined benefit obligations at 31 December The defined benefit obligation can be allocated to the plan’s participants as follows: Deferred plan participants Retirees Actual return on assets Expected contributions in following year Total in the income statement Net interest on obligation Past service cost The expense is recognised in the following line items in the income statement: Administration costs Finance costs 2018 £m (62.8) 7.5 (12.1) (0.9) (68.3) 2018 % 58 42 2018 £m (27.3) 7.3 2018 £m 1.6 10.5 12.1 2018 £m 10.5 1.6 2017 £m (103.2) 7.3 (2.7) 35.8 (62.8) 2017 % 58 42 2017 £m 40.1 7.2 2017 £m 2.7 - 2.7 2017 £m - 2.7 The discount rate used to calculate interest cost for the period ending 31 December 2018 was 2.55%. This compares to the discount rate of 2.70% used in the calculation of the interest cost for the period ending 31 December 2017. Based on the reported deficit of £68.3m at 31 December 2018 and the discount rate assumption of 2.85% the charge in 2019 is expected to be £1.9m. 153 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 5 - PENSION SCHEMES 5.1 Pension obligations continued Past service costs - GMP equalisation Between 6 April 1978 and 5 April 1997, UK legislation on state pensions included provisions as to a state earnings related pension (SERPS). It was possible to contract out of SERPS by making alternative arrangements which provided for guaranteed minimum pensions (“GMPs”), but the regime created a number of inherent inequalities between men and women. Therefore, many occupational pension schemes that involved contracting out of SERPS, despite being compliant with the legislation, created inequalities in relation to the benefits available to male and female members of those schemes. The English High Court ruling in Lloyds Banking Group Pension Trustees Limited v Lloyds Bank plc and others was published on 26 October 2018, and held that UK pension schemes with GMPs accrued from 17 May 1990 must equalise for the different effects of these GMPs between men and women. The trustees of the scheme will need to obtain legal advice covering the impact of the ruling on the scheme, before deciding with the employer on the method to adopt. The legal advice will need to consider (amongst other things) the options for GMP equalisation solutions, whether there should be a time limit on the obligation to make back-payments to members (the “look-back” period) and the treatment of former members (e.g. members who have died without a spouse and members who have transferred out). The Lloyds case gave some guidance on related matters, including the methods for equalisation and decided that method ‘C2’ was lawful in principle and met the minimum requirements to achieve equality. Method C2 is the basis adopted for the purposes of estimation in these financial statements. The past service cost is an estimate of the impact on the accounting liabilities as at 31 December 2018 if the method ‘C2’ were to apply to past and future benefit payments (referred to below as the ‘GMP equalisation impact’), assuming that there would be no limit on the ‘look-back’ period for rectification and only considers members who currently have GMP liabilities within the scheme (and not, for example, members who have died without a spouse or members who have transferred out). GMP equalisation impact The calculation approach involves applying judgement to derive a combined percentage impact on the total value of GMP liabilities within the preliminary results of the scheme funding valuation as at 31 December 2015. This impact is expressed as a percentage of the total scheme funding liabilities (the technical provisions) that is then applied to the accounting liabilities as at 31 December 2018. The estimated GMP equalisation impact for the scheme is an increase of 2.2% of the total value of scheme liabilities on the IAS 19 basis as at 31 December 2018, or £10.5m. The potential estimated range is 1.9% to 2.4% of liabilities (£9.2m to £11.7m charge). The estimates are also sensitive to the mix between pensioners and deferred members. The £10.5m charge (2.2% of liabilities) in these financial statements is based on a mix of 30% pensioners: 70% deferred members. A 50%: 50% mix would result in a charge of £9.7m (2.0% of liabilities). Where companies had not provided for equalisation in the past then the additional obligation is considered to arise from a plan amendment, and the past service cost arising from the change in the benefits payable would be recognised in the income statement. This is the accounting treatment adopted in these financial statements. Actuarial gains and losses recognised directly in the statement of other comprehensive income Cumulative amount at 1 January Recognised during the period Cumulative amount at 31 December 154 2018 £m (50.7) (0.9) (51.6) 2017 £m (86.5) 35.8 (50.7) Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 5 - PENSION SCHEMES 5.1 Pension obligations continued Defined benefit income recognised in statement of other comprehensive income Return on plan assets excluding interest income Experience (loss)/gain on scheme liabilities Changes in assumptions underlying the present value of scheme obligations Changes in the present value of the defined benefit obligation Opening present value of defined benefit obligation Interest cost Past service cost Remeasurements: Experience adjustments Actuarial gains due to changes in demographic assumptions Actuarial (gains)/losses due to changes in financial assumptions Benefits paid Closing present value of defined benefit obligation Movement in fair value of scheme assets during the period Opening fair value of assets Interest income Return on plan assets, excluding interest income Contributions by employer Benefits paid End of period 2018 £m (38.8) (5.2) 43.1 (0.9) 2018 £m 521.8 13.2 10.5 5.2 (17.6) (25.5) (21.3) 486.3 2018 £m 459.0 11.6 (38.8) 7.5 (21.3) 418.0 2017 £m 28.4 4.9 2.5 35.8 2017 £m 544.6 14.3 - (4.9) (4.7) 2.2 (29.7) 521.8 2017 £m 441.4 11.6 28.4 7.3 (29.7) 459.0 155 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 5 - PENSION SCHEMES 5.1 Pension obligations continued History of experience adjustments Present value of defined benefit obligation Fair value of scheme assets Deficit in schemes Actuarial gains and losses on scheme liabilities: Amount Percentage of scheme liabilities (%) Actuarial gains and losses on scheme assets: Amount Percentage of scheme liabilities (%) 2018 £m 486.3 418.0 68.3 2017 £m 521.8 459.0 62.8 2016 £m 544.6 441.4 103.2 2015 £m 440.3 396.9 43.4 2014 £m 495.1 428.7 66.4 (37.9) (7.8%) (7.4) (1.4%) 111.2 20.4% (22.9) (5.2%) 40.5 8.2% (38.8) (8.0%) 28.4 5.4% 49.9 9.2% (0.5) (0.1%) 16.5 3.3% 156 Pendragon PLC Annual Report 2018NOTES TO THE FINANCIAL STATEMENTS SECTION 6 - OTHER NOTES This section contains the notes and information relating to acquisitions and disposals and related party transactions: 6.1 Business combinations 6.3 Related party transactions 6.2 Business disposals 6.4 Contingent liabilities and contingent assets 6.1 Business combinations Accounting policy The Group accounts for business combinations using the acquisition method when control is transferred to the Group (see Basis of preparation in Section 1 above). The results of companies and businesses acquired during the year are included from the effective date of acquisition. Acquisitions on or after 1 January 2010 For acquisitions on or after 1 January 2010, the Group measures goodwill at the acquisition date as: • the fair value of the consideration transferred; plus • the recognised amount of any non-controlling interests in the acquiree; plus if the business combination is achieved in stages, the fair value of the existing equity interest in the acquiree; less • the net recognised amount (generally fair value) of the identifiable assets acquired and liabilities assumed. When the excess is negative, a bargain purchase gain is recognised immediately in profit or loss. The consideration transferred does not include amounts related to the settlement of pre-existing relationships. Such amounts are generally recognised in profit or loss. Costs related to the acquisition, other than those associated with the issue of debt or equity securities, that the Group incurs in connection with a business combination are expensed as incurred. Any contingent consideration payable is recognised at fair value at the acquisition date. If the contingent consideration is classified as equity, it is not remeasured and settlement is accounted for within equity. Otherwise, subsequent changes to the fair value of the contingent consideration are recognised in profit or loss. When share based payment awards (replacement awards) are required to be exchanged for awards held by the acquiree’s employees (acquiree’s awards) and relate to past services, then all or a portion of the amount of the acquirer’s replacement awards is included in measuring the consideration transferred in the business combination. This determination is based on the market based value of the replacement awards compared with the market based value of the acquiree’s awards and the extent to which the replacement awards relate to past and/or future service. Acquisitions between 1 January 2004 and 1 January 2010 For acquisitions between 1 January 2004 and 1 January 2010, goodwill represents the excess of the cost of the acquisition over the Group’s interest in the recognised amount (generally fair value) of the identifiable assets, liabilities and contingent liabilities of the acquiree. When the excess was negative, a bargain purchase gain was recognised immediately in profit or loss. Transaction costs, other than those associated with the issue of debt or equity securities, that the Group incurred in connection with business combinations were capitalised as part of the cost of the acquisition. 157 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 6 - OTHER NOTES 6.1 Business combinations continued Acquisitions prior to 1 January 2004 (date of transition to IFRSs) As part of its transition to IFRSs, the Group elected to restate only those business combinations that occurred on or after 1 January 2003. In respect of acquisitions prior to 1 January 2003, goodwill represents the amount recognised under the Group’s previous accounting framework, UK GAAP. Activity There were no business combinations in the year. During the prior year, on 26 September 2017 the Group acquired the trade and assets of a Chevrolet franchised dealership in California for a total cash consideration paid on completion of £17.6m. In addition the Group acquired the entire ordinary share capital of Suresell Limited on 31 January 2017 for a total cash consideration paid on completion of £0.2m. 6.2 Business disposals Accounting policy The results of businesses disposed of during the year are included up to the effective date of disposal using the acquisition method of accounting. Activity During the year the Group disposed of four UK dealerships representing Jaguar and Land Rover and an Aston Martin franchise in the US. Net assets at the date of disposal: Goodwill Property, plant and equipment Assets held for sale Inventories Trade and other payables Profit on sale of businesses Proceeds on sale satisfied by cash and cash equivalents No cash was disposed as part of any business disposal during the year. During the previous year there were no business disposals. Net book value £m 0.4 4.3 1.4 2.0 (0.5) 7.6 3.3 10.9 158 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS SECTION 6 - OTHER NOTES 6.3 Related party transactions Subsidiaries The Group’s ultimate parent company is Pendragon PLC. A listing of subsidiaries, all of which are wholly owned, is shown within the financial statements of the company on page 167. Transactions with key management personnel The key management personnel of the Group comprise the executive and Non-Executive Directors. The details of the remuneration, long term incentive plans, shareholdings, share option and pension entitlements of individual Directors are included in the Directors’ Remuneration Report on pages 55 to 68. During the three years ended 31 December 2018, and as of 12 March 2019, no Director, nor any associate of any Director, was indebted to the company. During the three years ended 31 December 2018, and as of 12 March 2019, the company has not been a party to any other material transaction, or proposed transactions, in which any member of the key management personnel had or was to have a direct or indirect material interest. Directors of the company and their immediate relatives control 2.35% of the ordinary shares of the company. During the year key management personnel compensation was as follows: Short term employee benefits Post-employment benefits Share based payments 6.4 Contingent assets 2018 £m 1.3 0.2 0.3 1.8 2017 £m 1.6 0.2 (0.6) 1.2 The Group is in discussion with HM Revenue and Customs over issues which may result in additional amounts of VAT receivable to be recognised in future periods. These relate to historical claims in respect of VAT overpaid in prior periods (‘Fleming claims’). Although these amounts, if any, could potentially be significant, it is not possible at present to quantify them. Accordingly no amounts have been included in the 2018 financial statements in respect of these issues. 159 Pendragon PLC Annual Report 2018 COMPANY BALANCE SHEET At 31 December 2018 Fixed assets Investments Loans to subsidiary undertakings Current assets Debtors Creditors: amounts falling due within one year Net current liabilities Total assets less current liabilities Creditors: amounts falling due after more than one year Retirement benefit obligations Net assets Capital and reserves Called up share capital Share premium account Capital redemption reserve Other reserves Profit and loss account Equity shareholders' funds Approved by the Board of Directors on 12 March 2019 and signed on its behalf by: T G Finn Chief Executive Registered Company Number: 2304195 T P Holden Finance Director Notes 5 6 7 8 11 2018 £m 912.4 90.0 1,002.4 40.9 40.9 2017 £m 922.6 90.0 1,012.6 41.2 41.2 (431.1) (437.9) (390.2) (396.7) 612.2 615.9 (177.3) (68.3) (175.7) (62.8) 366.6 377.4 70.0 56.8 5.5 13.9 220.4 366.6 71.2 56.8 4.3 13.9 231.2 377.4 The notes on pages 163 to 169 form part of these financial statements 160 Pendragon PLC Annual Report 2018 COMPANY STATEMENT OF OTHER COMPREHENSIVE INCOME Year ended 31 December 2018 Profit for the year Note Other comprehensive income Items that will never be reclassified to profit and loss: Defined benefit plan remeasurement gains and (losses) Income tax relating to defined benefit plan remeasurement (gains) and losses Other comprehensive income for the year, net of tax Total comprehensive income for the year 2018 £m 16.6 0.8 0.2 1.0 17.6 2017 £m 31.9 37.7 (6.1) 31.6 63.5 The notes on pages 163 to 169 form part of these financial statements 161 Pendragon PLC Annual Report 2018COMPANY STATEMENT OF CHANGES IN EQUITY Year ended 31 December 2018 Balance at 1 January 2018 71.2 56.8 4.3 13.9 231.2 Share capital £m Share premium account £m Capital redemption reserve £m Other reserves £m Retained earnings £m Total comprehensive income for 2018 Profit for the year Other comprehensive income for the year, net of tax Total comprehensive income for the year Transactions with owners, recorded directly in equity Own shares purchased for cancellation Own shares issued by EBT Share based payments Dividends paid (see note 4) Total contributions by and distributions to owners Balance at 31 December 2018 - - - (1.2) - - - (1.2) 70.0 - - - - - - - - 56.8 - - - 1.2 - - - 1.2 5.5 - - - - - - - - 16.6 1.0 17.6 (6.7) 0.1 0.7 (22.5) (28.4) 13.9 220.4 366.6 Total £m 377.4 16.6 1.0 17.6 (6.7) 0.1 0.7 (22.5) (28.4) Balance at 1 January 2017 71.8 56.8 3.7 13.9 196.3 342.5 Total comprehensive income for 2017 Profit for the year Other comprehensive income for the year, net of tax Total comprehensive income for the year - - - Transactions with owners, recorded directly in equity Own shares purchased for cancellation (0.6) Own shares purchased by EBT Own shares issued by EBT Share based payments Dividends paid (see note 4) Total contributions by and distributions to owners Balance at 31 December 2017 - - - - (0.6) 71.2 - - - - - - - - - 56.8 - - - 0.6 - - - - 0.6 4.3 - - - - - - - - - 13.9 31.9 31.6 63.5 (4.0) (2.8) 0.1 (0.6) (21.3) (28.6) 231.2 31.9 31.6 63.5 (4.0) (2.8) 0.1 (0.6) (21.3) (28.6) 377.4 The notes on pages 163 to 169 form part of these financial statements 162 Pendragon PLC Annual Report 2018NOTES TO THE FINANCIAL STATEMENTS OF THE COMPANY 1 Accounting Policies (a) Basic of preparation Pendragon PLC is a company incorporated and domiciled in the UK. These financial statements were prepared in accordance with Financial Reporting Standard 101 Reduced Disclosure Framework (‘FRS 101’). In preparing these financial statements, the Company applies the recognition, measurement and disclosure requirements of International Financial Reporting Standards as adopted by the EU (‘Adopted IFRSs’), but makes amendments where necessary in order to comply with Companies Act 2006 and has set out below where advantage of the FRS 101 disclosure exemptions has been taken. In these financial statements, the Company has applied the exemptions available under FRS 101 in respect of the following disclosures: Cash Flow Statement and related notes; • Comparative period reconciliations for share capital, tangible fixed assets and intangible assets; • Disclosures in respect of transactions with wholly owned subsidiaries; • Disclosures in respect of capital management; • The effects of new but not yet effective IFRSs; • Disclosures in respect of the compensation of Key Management Personnel. • Disclosures of transactions with a management entity that provides key management personnel services to the company. As the consolidated financial statements of the Company include the equivalent disclosures, the Company has also taken the exemptions under FRS 101 available in respect of the following disclosures: • IFRS 2 Share Based Payments in respect of Group settled share based payments; • Certain disclosures required by IFRS 13 Fair Value Measurement and the disclosures required by IFRS 7 Financial Instrument • Disclosures. The accounting policies set out below have, unless otherwise stated, been applied consistently to all periods presented in these financial statements. Judgements The Company applies judgement in how it applies its accounting policies, which do not involve estimation, but could materially affect the numbers disclosed in these financial statements. There are however no such key accounting judgements applied in these financial statements. Accounting estimates The preparation of financial statements in conformity with FRS 101 requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting year. Although these estimates are based on management’s best knowledge of the amount, events or actions, actual results ultimately may differ from those estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances. Revisions to accounting estimates are recognised in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods. The Directors consider the following to be the key estimates applicable to the financial statements, which have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year or in the long-term: 163 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS OF THE COMPANY 1 Accounting Policies continued Key estimate area Key assumption Retirement benefit obligations Investment impairment The main assumptions in determining the Company’s Retirement Benefit Obligations are: discount rate, mortality and rate of inflation. Full detail is included in the pension note in the Consolidated Financial Statements in note 5.1. The balances of investment in subsidiary companies are held at cost less any impairment. It is considered that these investments are one CGU. An impairment exists when their recoverable amount is less than the costs held in the accounts. There are a number of factors which could impact the recoverable amount which creates a risk of this recoverable amount being lower than the investment balance held. Potential impact within the next financial year Potential impact in the longer term Note reference 3 3 3 5.1 Group 5 (b) Deferred taxation Full provision is made for deferred taxation on all timing differences which have arisen but have not reversed at the balance sheet date, except as follows: (i) tax payable on the future remittance of the past earnings of subsidiaries is provided only to the extent that dividends have been accrued as receivable or a binding agreement to distribute all past earnings exists; (ii) deferred tax assets are recognised only to the extent that it is more likely than not that they will be recovered. Deferred tax is measured on a non-discounted basis at the tax rates that are expected to apply in the periods in which the timing differences reverse, based on tax rates and laws substantively enacted at the balance sheet date. (c) Financial instruments The Company holds derivative financial instruments to hedge currency and interest risks arising from its activities. Derivative financial instruments are recognised at fair value. Any gain or loss on remeasurement is recognised in the profit and loss account. However, the treatment of gains or losses arising from derivatives which qualify for hedge accounting depends on the nature of the hedged item itself. The fair value of derivatives is the estimated amount receivable or payable to terminate the contract determined by reference to the market prices prevailing at the balance sheet date. Fair value hedges Where a derivative financial instrument hedges the changes in fair value of recognised assets or liabilities, any gain or loss is recognised in profit and loss. The hedged item is also stated, separately from the derivative, at fair value in respect of the risk being hedged with any gain or loss also recognised in profit and loss. This will result in variations in the balance sheet values of the gross debt and the offsetting derivatives as the market value fluctuates. (d) Investments held as fixed assets are stated at cost less any impairment losses. For Investments the recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset for which the estimates of future cash flows have not been adjusted. (e) Employee benefits - Share based payments The Company operates a number of employee share option schemes. The fair value at the date at which the share options are granted is recognised in profit and loss on a straight line basis over the vesting period, taking into account the number of options that are expected to vest. The number of options that are expected to become exercisable is reviewed at each balance sheet date and if necessary estimates are revised. 164 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS OF THE COMPANY 1 Accounting Policies continued (f) Pension obligations The Company operated a defined benefit and defined contribution plan during the year, the assets of which are held in independent trustee administered funds. Pension accounting costs for defined benefit plans are assessed by determining the pension obligation using the projected unit credit method after including a net return on the plan assets. Under this method, in accordance with the advice of qualified actuaries, the amounts charged in respect of employee benefits reflect the cost of benefits accruing in the year and the cost of financing historical accrued benefits. The Company recognises all actuarial gains and losses arising from defined benefit plans in the statement of other comprehensive income immediately. The present value of pension obligations is measured by reference to market yields on high quality corporate bonds which have terms to maturity approximating to the terms of the related pension liability. Plan assets are measured at fair value. When the calculation results in a benefit to the Company, the recognised asset is limited to the total of the present value of economic benefits available in the form of any future refunds from the plan or reductions in future contributions to the plan. An economic benefit is available to the Company if it is realisable during the life of the plan, or on settlement of the plan liabilities. Under IAS 19 Employee Benefits, the Group recognises an interest expense or income which is calculated on the net defined benefit liability or asset respectively by applying the discount rate to the net defined benefit liability or asset. A defined contribution plan is one under which the Company pays fixed contributions and has no legal or constructive obligation to pay further amounts. Obligations for contributions to defined contribution pension plans are recognised as an employee benefit expense in the income statement when they are due. In accordance with IFRIC 14 surpluses in schemes are recognised as assets only if they represent unconditional economic benefits available to the Company in the future. Provision is made for future unrecognisable surpluses that will arise as a result of regulatory funding requirements. Movements in unrecognised surpluses are included in the statement of recognised income and expense. If the fair value of the assets exceeds the present value of the defined benefit obligation then the surplus will only be recognised if the nature of the arrangements under the trust deed, and funding arrangements between the Trustee and the Company support the availability of refunds or recoverability through agreed reductions in future contributions. In addition, if there is an obligation for the Company to pay deficit funding, this is also recognised. Under the provisions of FRS 101 Pendragon PLC is designated as the principal employer of the Pendragon Group Pension Scheme and as such applies the full provisions of IAS 19 Employee benefits (2011). In line with IAS 19 Employee benefits (2011), the Company has recognised a pension prepayment with respect to an extraordinary contribution made during 31 December 2011 as this does not meet the definition of a planned asset and therefore the amount is held in pension prepayment and will be unwound over the period in which Scottish Limited Partnership Limited makes contributions to the pension scheme. Information relating to pension obligations can be found in the Consolidated Financial Statements in note 5.1. (g) Dividends Dividends proposed by the Board and unpaid at the end of the year are not recognised in the financial statements until they have been approved by the shareholders at the Annual General Meeting. Interim dividends are recognised when they are paid. (h) Own shares held by ESOP trust Transactions of the Group-sponsored ESOP trust are included in the Company financial statements. In particular, the trust’s purchases and sales of shares in the Company are debited and credited directly to equity. 165 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS OF THE COMPANY 1 Accounting Policies continued (i) Contingent liabilities Where the company enters into financial guarantee contracts to guarantee the indebtedness of other companies within its Group, the company considers these to be insurance arrangements, and accounts for them as such.  In this respect, the company treats the guarantee contract as a contingent liability until such time as it becomes probable that the company will be required to make a payment under the guarantee. 2 Profit and loss account of the company and distributable reserves In accordance with the exemption allowed by Section 408 of the Companies Act 2006, the profit and loss account of the company is not presented. The profit after taxation attributable to the company dealt with in its own accounts for the year ended 31 December 2018 is £26.8m (2017: £31.9m). The profit and loss account of the Parent company does not include any unrealised profits. The amount available for distribution under the Companies Act 2006 by reference to these accounts is £220.4m (2017: £231.2m) which is stated after deducting the ESOT reserve of £18.2m (2017: £15.5m). The Group’s subsidiary companies which earn distributable profits themselves are expected to make distributions each year up to the Parent company in due course to ensure a regular flow of income to the company such that surplus cash generated can continue to be returned to our external shareholders 3 Directors Total emoluments of Directors (including pension contributions) amounted to £1.2m (2017: £1.8m). Information relating to Directors’ emoluments, share options and pension entitlements is set out in the Directors’ Remuneration Report on pages 55 to 68. The Directors are the only employees of the company. 4 Dividends Ordinary shares Final dividend in respect of 2017 of 0.8p per share (2016: 0.75p per share) Interim dividend in respect of 2018 of 0.8p per share (2017: 0.75p per share) 2018 £m 10.7 11.8 22.5 2017 £m 10.7 10.6 21.3 The Board is recommending a final dividend for 2018 of 0.7p (2017: 0.8p) per ordinary share equating to £9.8m in total in respect of shares in issue at the date of this report (2017: £11.3m). 5 Investments At 31 December 2017 Impairment At 31 December 2018 Shares in subsidiary undertakings £m 922.6 (10.2) 912.4 In conjunction with the impairment review of goodwill performed for the Group (see note 3.1 of the Group financial statements), a related exercise was performed with relation to the company’s carrying value of its investment in subsidiaries, resulting in an impairment charge of £10.2m. The calculation is sensitive to the assumptions used in valuing the expected future cashflows of subsidiaries. A 2% increase/ (decrease) in the value of expected future cashflows would reduce/(increase) the impairment by £5.6m/(£5.6m). 166 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS OF THE COMPANY 5 Investments continued Incorporated in Great Britain having a registered office at Loxley House, 2 Little Oak Drive, Annesley, Nottingham, NG15 0DR: Alloy Racing Equipment Limited Bramall Quicks Dealerships Limited Car Store Limited CD Bramall Dealerships Limited Chatfields Limited Derwent Vehicles Limited Evans Halshaw Limited Bletchley Motor Contracts Limited Bletchley Motor Group Limited Bletchley Motor Rentals Limited Bletchley Motors Car Sales Limited Bletchley Properties Limited Boxmoor Motors Limited Bramall Contracts Limited National Fleet Solutions Limited Pendragon Vehicle Management Limited Pendragon Finance & Insurance Services Limited * Pendragon Management Services Limited Bridgegate Limited Brightdart Limited Buist Manor Limited C P Evinson Limited C.G.S.B Holdings Limited Calmoon Limited CD Bramall Motor Group Limited CD Bramall Pensions Limited Manchester Garages Limited Merlin (Chatsworth) Limited Miles (Chesham) Limited Motors Direct Limited Motown Limited Munn & Chapman Limited Munn Holdings Limited Neville (EMV) Limited Newport (Gwent) Motor Company Limited Northside Truck Centre Limited Oggelsby's Limited P J Evans (Holdings) Limited Paramount Cars Limited Parkhouse Garage (Newcastle) Limited Pendragon Company Car Finance Limited Pendragon Motor Group Limited Pendragon Premier Limited Pendragon Property Holdings Limited Pendragon Sabre Limited Pinewood Technologies PLC * Reg Vardy (MML) Limited Reg Vardy (VMC) Limited ** Reg Vardy Limited * Stratstone Limited Stripestar Limited Victoria (Bavaria) Limited Chatfields - Martin Walter Limited Pendragon Group Services Limited * Pendragon Overseas Limited * Pendragon Stock Limited Pendragon Stock Finance Limited Vardy Contract Motoring Limited Vardy Marketing Limited Bramall Quicks Limited Car Store.com Limited CD Bramall Limited * Executive Motor Group Limited Stratstone Motor Holdings Limited * Petrogate Limited CD Bramall Pension Trustee Limited Pendragon Demonstrator Finance Limited CD Bramall York Limited Pendragon Demonstrator Finance November Limited Central Motor Company (Leicester) Limited Pendragon Demonstrator Sales Limited Charles Sidney Holdings Limited Charles Sidney Limited Comet Vehicle Contracts Limited Cumbria Vehicles Limited Pendragon Extra Limited Petrogate Properties Limited Pinewood Computers Limited Plumtree Motor Company Limited Davenport Vernon Finance Limited Portmann Limited Davenport Vernon Milton Keynes Limited Premier Carriage Limited Davies Holdings Limited Dunham & Haines Limited Evans Halshaw (Cardiff) Limited Quicks (1997) Motor Holdings Limited Quicks Finance Limited Reades of Telford Limited Evans Halshaw (Chesham) Limited Regency Automotive Limited Evans Halshaw (Dormants) Limited * Reg Vardy (AMC) Limited Evans Halshaw (Midlands) Limited Reg Vardy (RTL) Limited Evans Halshaw Group Pension Trustees Limited Rudds Limited Evans Halshaw Motor Holdings Limited Sanderson Murray & Elder Limited Evans Halshaw Vehicle Management Services Limited Skipper of Aintree Limited Evinson Tractors Limited Excalibur Motor Finance Limited Skipper of Cheltenham Limited Skipper of Darlington Limited Skipper of Plymouth Limited Pendragon Limited Partner Limited * Evans Halshaw (Halifax) Limited Reg Vardy (Property Management) Limited Reg Vardy (Property Management) Limited Executive Motor Group Limited Reg Vardy (TMC) Limited Reg Vardy (TMH) Limited Evans Halshaw.com Limited Pendragon Automotive Services Limited * Stratstone.com Limited Vardy (Continental) Limited Executive Motors (Stevenage) Limited Skipper of Torbay Limited Extra Rentals Limited Folletts Limited G.E. Harper Limited Giltbase Limited Skipper of Wakefield Limited Storm of Leicester Limited Strattons (Service) Limited Strattons (Wilmslow) Limited Godfrey Davis (Trust) Limited Suresell Limited Pendragon Group Pension Trustees Limited * Godfrey Davis Motor Group Limited The Car and Van Store Limited Allens (Plymouth) Limited Hemel Hempstead Motors Limited The Mcgill Group Limited AMG Limited Andre Baldet Limited Arena Auto Limited Automend Limited Kingston Reconditioning Services Limited The Skipper Group Limited Leveling Limited Lewcan Limited Longton Garages Limited Tins Limited * Trust Motors Limited Trust Properties Limited Berkhamsted Motor Company Limited Manchester Garages (Cars) Limited Vertcell Limited Bletchley Motor Company Limited Manchester Garages Holdings Limited Wayahead Fuel Services Limited Incorporated in Great Britain having a registered office at Citypoint, 65 Haymarket Terrace, Edinburgh, Scotland, EH12 5HD: Pendragon General Partner Limited * Incorporated in Great Britain having a registered office at 221 Windmillhill Street, Motherwell, Lanarkshire, ML1 2UB: Reg Vardy (MME) Limited Incorporated in Great Britain having a registered office at 1 Forth Avenue, Kirkcaldy, Fife, KY2 5PS: Bramall Laidlaw Limited Incorporated in the United States of America having a registered office at 2171 Campus Dr Ste 260, Irvine, California: Pendragon North America Automotive, Inc. Penegon West, Inc. Penegon Mission Viejo, Inc. Penegon Newport Beach, Inc. Penegon Glendale, Inc. Lincoln Irvine, Inc. Penegon South Bay, Inc. Penegon Santa Monica, Inc. South County, Inc. Bauer Motors, Inc. Penegon Properties, Inc. Penegon East, Inc. Incorporated in Germany having a registered office at 40210 Düsseldorf,Nordrhein-Westfalen, Germany: Pendragon Overseas Holdings GmbH. * Direct subsidiary of Pendragon PLC ** Pendragon PLC owns 95% of the issued ordinary share capital 167 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS OF THE COMPANY 6 Debtors Amounts due within one year: Prepayments Amounts due after more than one year: Deferred tax (see note 9) 7 Creditors: amounts falling due within one year Amounts due to subsidiary undertakings Bank loans and overdrafts 8 Creditors: amounts falling due after more than one year Bank loans (repayable between two and five years) 5.75% Senior notes 2023 9 Deferred tax 2018 £m 28.7 28.7 12.2 12.2 40.9 2018 £m 418.9 12.2 431.1 2018 £m 117.3 60.0 177.3 2017 £m 29.9 29.9 11.3 11.3 41.2 2017 £m 407.5 30.4 437.9 2017 £m 115.7 60.0 175.7 Deferred income tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income taxes relate to the same fiscal authority. There are no offset amounts as follows: Deferred tax assets The movement in the deferred tax assets for the year is as follows: At 1 January 2017 (Charged)/credited to income statement (Charged) to equity At 31 December 2017 At 1 January 2018 (Charged)/credited to income statement (Charged) to equity At 31 December 2018 Deferred tax asset is shown within debtors (see note 6) 168 2018 £m 12.2 Retirement benefit obligations Other provisions £m 17.7 (0.8) (6.1) 10.8 10.8 0.7 0.2 11.7 0.4 0.1 - 0.5 0.5 - - 0.5 2017 £m 11.3 Total £m 18.1 (0.7) (6.1) 11.3 11.3 0.7 0.2 12.2 Pendragon PLC Annual Report 2018 NOTES TO THE FINANCIAL STATEMENTS OF THE COMPANY 10 Share based payments Details of share schemes in place for the Group of which the company participates as at 31 December 2018 are fully disclosed above in note 4.6 of this report. 11 Called up share capital Allotted, called up and fully paid shares of 5p each at 31 December 2017 Shares cancelled during the year Allotted, called up and fully paid shares of 5p each at 31 December 2018 There were no issues of ordinary shares during the year. Number 1,424,814,004 (25,664,979) 1,399,149,025 £m 71.2 (1.2) 70.0 25,664,979 ordinary shares having a nominal value of £1.2m were bought back and subsequently cancelled during the year in accordance with the authority granted by shareholders in the Annual General Meeting on 2 May 2018. The aggregate consideration paid, including directly attributable costs, was £6.7m. Since the commencement of the current share buyback programme in 2016, as at 31 December 2018, 61,171,630 shares have been bought back and cancelled representing 4.2% of the issued ordinary shares, at a cost of £18.2m. Movements in the number of options to acquire ordinary shares under the Group’s various share option schemes, together with exercise prices and the outstanding position at 31 December 2018 are fully disclosed above in note 4.6 of this report. The market value of the investment in the company’s own shares at 31 December 2018 was £1.4m (2017: £2.2m), being 6.4m (2017: 7.7m) shares with a nominal value of 5p each, acquired at an average cost of £0.33 each (2017: £0.33). During the year the trust acquired no shares (2017: 8.3m shares, for a consideration of £2.8m) and disposed of 1.3m (2017: 8.1m) shares in respect of LTIP and executive share option awards for a consideration of £0.1m (2017: £0.1m). The amounts deducted from retained earnings for shares held by the EBT at 31 December 2018 was £18.1m (2017: £18.2m). The trustee of the EBT is Salamanca Group Trust (Jersey) Limited. The shares in trust may subsequently be awarded to Executive Directors and employees under the Pendragon 1999 Approved Executive Share Option Scheme, Pendragon 1999 Unapproved Executive Share Option Scheme and to satisfy amounts under LTIPs and the VCP. Details of the plans are given in the Directors’ Remuneration Report on pages 55 to 68. Dividends on the shares owned by the trust, the purchase of which were funded by interest free loans to the trust from Pendragon PLC, are waived. All expenses incurred by the trust are settled directly by Pendragon PLC and charged in the accounts as incurred. 12 Retirement benefit obligations Details of Pendragon Group Pension Scheme are fully disclosed above in note 5.1 of this report. 13 Related party transactions Identity of related parties The company has related party relationships with its subsidiaries, its joint venture and with its key management personnel. Transactions with related parties The transaction with Directors of the company are set out in note 6.3 to the consolidated financial statements. 14 Contingent liabilities (a) The company has entered into cross-guarantees with its bankers whereby it guarantees payment of bank borrowings in respect of UK subsidiary undertakings. (b) The company has given performance guarantees in the normal course of business in respect of subsidiary undertaking obligations. 169 Pendragon PLC Annual Report 2018 ADVISORS, BANKS AND SHAREHOLDER INFORMATION Financial Calendar 2019 12 March date of this Report 12 March preliminary announcement of 2018 results 18 April ex-dividend date 2018 proposed final dividend 23 April record date 2018 proposed final dividend 30 May payment of proposed 2018 final dividend Share dealing service Pendragon’s company registrar offers a share dealing service, provided by Link Asset Services (a trading name of Link Market Services). Details appear at www.linksharedeal.com Shareholder and investor information Making some of our corporate materials and policies available on our website reduces the length of this Report. This year we have placed certain background information on policy and 19 September ex-dividend date interim dividend 2019 governance on our website. We also display historic financial 20 September record date 2019 interim dividend 24 October payment of 2019 interim dividend Auditor KPMG LLP Banks Barclays Bank PLC Lloyds TSB Bank plc Royal Bank of Scotland plc Allied Irish Banks plc HSBC Bank plc Stockbrokers Joh. Berenberg, Gossler & Co. KG Jefferies International Limited Solicitors CMS Cameron McKenna Nabarro Olswang LLP Geldards LLP Eversheds LLP How to find Pendragon PLC’s offices Visit Contacts on the company’s website www.pendragonplc.com. Stock Classification The company’s ordinary shares are traded on the London Stock Exchange. Investment codes for Pendragon’s shares are: London Stock Exchange: PDG Bloomberg: PDG.LN GlobalTOPIC and Reuters: PDG.L reports and have a section on company news, which we regularly update on www.pendragonplc.com Online services Shareholders can choose to receive communications and access a variety of share-related services online via the share portal offered by Pendragon’s company registrar. This allows shareholders to manage their shareholding electronically and is free of charge. For details, visit www.mypendragonshares. com Getting company reports online Reduces the environmental impacts of report distribution. To choose online only reporting, visit the share portal and register for electronic form reporting, or contact our registrar, whose details are: Registrar and shareholder enquiries Link Asset Services The Registry 34 Beckenham Road Beckenham Kent BR3 4TU shareholderenquiries@linkgroup.co.uk Tel: 0871 664 0300 170 Pendragon PLC Annual Report 2018 5 YEAR GROUP REVIEW Revenue Gross profit Operating (loss)/profit before other income (Loss)/profit before taxation Basic earnings per share Net assets Net borrowings (note 1) Other financial information 2018 £m 2017 £m 2016 £m 2015 £m 2014 £m 4,627.0 4,739.1 4,537.0 4,453.9 4,000.4 550.5 552.9 (30.1) (44.4) 91.5 65.3 (3.6p) 3.7p 345.6 127.6 425.4 124.1 559.6 100.1 73.0 3.8p 372.8 79.6 548.9 522.6 96.4 79.0 89.8 64.6 5.0p 3.5p 395.1 108.8 339.9 139.6 Underlying profit before tax 47.8 60.4 75.4 70.1 60.2 Underlying earnings per share (note 4) Net debt : underlying EBITDA (note 6) Gross margin Total operating margin (note 2) After tax return on equity (note 3) 2.8p 0.9 11.9% (0.7%) (13.1%) 3.3p 0.9 11.7% 1.8% 13.4% 3.9p 0.6 12.3% 2.2% 14.5% Dividends per share (note 5) 1.50p 1.55p 1.45p 3.7p 0.5 12.3% 2.3% 19.8% 1.3p 3.9 2.9 3.1p 0.8 13.1% 2.2% 15.4% 0.9p 3.8 3.0 2.4 3.5 2.7 3.7 29.2% 24.6% 20.1% 32.0% Dividend cover (times) Interest cover (times) Gearing (note 7) Business summary 2.0 (0.5) 36.9% Number of franchise points 186 194 196 200 213 note 1 Net borrowings comprise interest bearing loans and borrowings, cash and cash equivalents and derivative financial instruments. note 2 Total operating margin is calculated after adding back non-underlying items, and excluding other income. note 3 Return on equity is profit after tax for the year as a percentage of average shareholders’ funds. note 4 Basic earnings per share adjusted to eliminate the effects of non-underlying operating, non-underlying finance and tax items, see note 2.8 of the financial statements. note 5 Dividends per share are based on the interim dividend paid and final dividend proposed for the year. note 6 Full details of the calculation of the net debt : underlying EBITDA ratio are given in note 4.2 to the financial statements. note 7 Gearing is calculated as net borrowings as a percentage of net assets. 171 Pendragon PLC Annual Report 2018 ADDRESS I Pendragon PLC Loxley House, Little Oak Drive, Annesley, Nottingham NG15 0DR TELEPHONE I 01623 725200 E-MAIL I enquiries@pendragon.uk.com WEBSITE I www.pendragonplc.com DESIGN I Creative Services Loxley House, Little Oak Drive, Annesley, Nottingham NG15 0DR 

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