The Pharmaceutical Journal
Vol 268 No 7199 p739-746
25 May 2002

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161st Annual General Meeting summary

Financial Statements 2001

Is the devil really in the detail?

I am happy to comment on the Society's satisfactory financial performance in 2001 as well as providing some detailed answers to questions raised at the annual general meeting. These comments build upon the summary report given by the Treasurer at the AGM (p741).

Financial Performance 2001

In the previous financial year the Society had suffered a post taxation loss of £1.316m due in part to a contribution made to the resale price maintenance campaign of £750,000. However, disregarding that contribution, there was still a deficit for the year of £566,000. Why was this? The answer mainly lies in the fact that the Society's programme of work has been necessarily increasing at a disproportionate rate to the income generated to fund it. The year 2001 would also have been a difficult year and a challenging budget had been set. Tight controls were put in place on expenditure, some established staff posts were left unfilled or delayed and some of the programmes of work were delayed or deferred.

The Council and staff responded well to these initiatives and, by the end of 2001, the costs of the professional activities of the Society were controlled within budget. The total financial performance was further assisted by an improved profit contribution from the Society's publishing activities whose total revenue rose to £10.665m and the profit contribution towards the Society's total programme rose to £3.426m (previous year £2.914m).

A pre-tax surplus of £910,000 was recorded and, after providing for estimated corporation tax, the net surplus was £480,000.

Turning to the balance sheet, the net assets of the Society rose by £480,000 as a result of the retained surplus for the year being transferred to the accumulated fund (reserves). Following the heavy drain upon reserves of the previous year, this has to be regarded as a most satisfactory situation and in line with a stated Council objective of replenishing, over a three-year period, the reserves consumed by the RPM campaign.

Content of financial statements

It is often said that the Society's financial statements should be more transparent and that they are too complicated for non-finance people to understand. Such a view is perfectly understandable but these statements are published documents that need to conform to standards laid down by the Accounting Standards Board. It is also said that more detail should be provided but I should point out that this is not normal within the framework of published accounts.

There is no reason for any member of the Society to feel that information is hidden or secret. The quality of the "Annual review" is good, taken with the "Report of the Council and financial statements", which is also of a good standard and contains adequate disclosures. There is a lot of information available. It is a question of the level of detail of reporting that is sensible and efficient. Any suggestions for improvement would be welcome, but all information gathering and reporting comes at a cost.

The Society has a substantial investment in the areas of financial audit, system review and governance appraisal (see note below). I believe that this spend is justified and helpful. Knowing that these cross-checks are in place should give comfort to the membership and confidence that the stewardship of financial and other resources is sound. It was certainly most disturbing to hear individuals at the AGM questioning the financial stability of the Society and indicating that somehow there was a comparison to be drawn with the Enron scandal. This kind of ill-informed comment is wide of the mark, as even a cursory glance at the latest balance sheet will show.

Audit procedures

The Society has three levels of independent financial and procedural audit at a budgeted cost of around £60,000 per annum. These are as follows:

• An internal audit function is carried out by Baker Tilly, a professional firm well respected in this area. They concentrate upon effective control procedures, risk analysis, governance issues and effective management.

• The Society's external auditors and taxation advisers, appointed for the first time in 2001, are Howarth Clark Whitehill. They were appointed on a competitive tender basis and selected also on relevant experience and capabilities in the "not for profit" and charity sector. HCW made a comprehensive check of the Society's accounting records and also audited and advised on the content of the financial report and statements. I have been impressed with their comprehensive and diligent approach and the quality of their advice. They are in or around the top 10 firms by size in the UK and thus have the resources to tackle an audit of this size.

• The honorary auditors are elected to the role of examining the financial statements and have the ability to ask questions on any part of the Society's financial affairs. They participate in a formal meeting with the President, Treasurer, Secretary and Registrar, Director of Resources and Head of Financial Accounting, at which all outstanding questions are answered before the formal approval and signing of the financial statements.

Specific questions

Although several questions were raised at the discussion forum and the AGM and answered satisfactorily, the financial report section and Treasurer's speech was dominated by three issues that could not be dealt with fully at the meeting. These questions were raised without prior notification by Ash Mehta (chairman of the Society's Hounslow branch), who said that he is a qualified accountant with experience at a high level in this field. I would like now to respond to these questions and will take them in the order in which they were raised.

Please explain how the price to sell the Medicines Testing Laboratory to Tepnel Life Sciences PLC was calculated and indicate what due diligence was carried out on Tepnel? Also explain the price that was used to calculate the number of shares that the Society received in Tepnel Life Sciences as part of the deal

The Medicines Testing Laboratory began its life in 1972 as a service to the forerunner of the Medicines Control Agency. The facility was located at 34 York Place, Edinburgh. The purpose was to have a Government laboratory that would carry out testing of all the samples collected by the Department of Health for compliance and investigation reasons. The operation, as a service to the Department, was in essence a cost recovery exercise with the costs of running the laboratory being underwritten by the Department.

The arrangement continued on the above basis until 1994 when, in line with Government policy on competitive tendering, the exclusive use of the MTL by the MCA was withdrawn and, on a tender basis, the contract of about £1m in value was shared among a number of providers. The MTL remained the official designated laboratory but the value of the contract was reduced to about £600,000. At the same time, the MTL was released from working exclusively for the MCA and was able to look for and take on commercial contracts.

By 1998–99, the turnover at just below £2m had grown to its maximum potential given the size, location and condition of the premises. To progress the business further and make it profitable, it would have been necessary to arrange a move to a modern science park type of site and to invest in new equipment. After two independent studies and reports, the Council was presented in mid 2000 with a number of options, namely:

• To retain the business as a commercial venture and invest around £4m over three years, moving to modern premises and growing the business profitably.

• Given that a loss was likely in 2000 and major contracts would end in 2001, to close the business and incur run-down and closure costs of around £2m.

• To seek a co-investor/synergistic partner to take on the lion's share of the investment and leave the Society as a shareholder.

• To dispose of the business completely, selling the assets, and thus remove any future risk to members.

Given that this business was not profitable (operating loss in year 2000 was £104,000), was about to lose some contracts and was a drain on management time and resources, the Council took the prudent and sensible view that a divestment yielding some funds, removing risk to the Society and protect as many of the staff jobs as possible was the appropriate option. The main challenge was to find a buyer who would be able and willing to develop the business. Eventually, after negotiations with a number of interested parties and due diligence, Tepnel Life Sciences offered the best deal that would meet the above criteria.

It offered a total price of £550,000 with 50 per cent to be paid in cash soon after the date of transfer and the remainder to be satisfied by shares in Tepnel Life Sciences at a price determined by an average of the quoted stock market price for the ordinary shares over the five business days prior to the completion date of the deal.

Since MTL's fixed assets were valued on the balance sheet at less than £200,000 (value at transfer date £189,00), and Tepnel had agreed to take on all the MTL staff, the Council considered that this offer was suitable and the business was transferred on 17 July 2001.

On the question of due diligence on Tepnel, an opinion was sought from the Society's investment advisors and this was taken into account. It was recognised that Tepnel was a young, research based company, and that the shares offered could go down as well as up. However, given that the deal offered would in cash terms be greater than the written-down value of the assets, the Council agreed that it would be acceptable to take 50 per cent of the price in Tepnel shares. The Tepnel shares had to be held for at least two years before sale of any or all of them will be allowed.

Why is there a difference in the year 2000 column in the income and expenditure account compared to the figures published last year?

The Society each year makes a gift aid payment to the Educational Fund, a registered charity. Subsequently this fund grants an amount back to the Society to carry out educational programs on its behalf. In the 2001 financial statements, these entries are shown in a different way from 2000. It is standard practice, for comparative purposes, to show the previous year figures in the same way. There was no alteration to the operating deficit reported in 2000.

The Financial Statements show that the Society has granted loan notes of £750,000 last year. What was the purpose of these and what is the rate of interest? Also, why has a disclosure not been made in line with FRS 13 [Financial Reporting Standard 13]?

Purpose of loan notes
In 2001, the Society acquired Dr Ivan Stockley's Drug Interactions, a valuable addition to the portfolio of the Pharmaceutical Press. This acquisition, which is expected to show a significant profit contribution over the medium and long term, had a total cost of £1.082m. Dr Stockley received an initial payment of £332,000 and agreed to take the balance of the purchase price over a period of up to 10 years. This was deemed to be a suitable way to finance this valuable acquisition as, in cash flow terms, the payments to Dr Stockley can be funded out of the income generated by this reference work, including future electronic versions. Thus Dr Stockley was granted loan notes covering the balance. The loan notes carry a zero rate of interest.

Financial Reporting Standard 13
Accounting standards are set by the Accounting Standards Board and lay down standards to be followed for financial reporting statements. Mr Mehta stated categorically that FRS 13 should have been followed in reporting the loan notes granted to Dr Stockley. So first we must define the scope of FRS 13. There follows an abbreviated description:

Scope "Derivatives and other financial instruments"

Purpose "To improve the disclosures provided in respect of financial instruments to assist with the identification and management of risk to the entity in the way that these instruments are used"

Application "FRS 13 applies to all entities, other than insurance companies and groups, that have one or more of their capital instruments listed or publicly traded on a stock exchange or market and all banks and similar institutions"

Relevance Given that these are private loan notes granted to Dr Stockley, not traded in any way, FRS 13 clearly has no relevance to the Society's financial statements for 2001.

Summary and conclusions

The Society's annual general meeting, and particularly the part devoted to the financials, turned out to be a most interesting experience! Even though a much-improved financial performance was reported and the balance sheet was strengthened, the importance and significance of this fact was diminished on the night by the raising of complex financial questions that required a detailed and accurate response. This tactic unfortunately led to doubt being cast upon the financial reports which, in reality, were positive, fully audited and well presented.

Financial matters are indeed complex, and individuals without financial training can, understandably, find it difficult to follow all of the detail of financial reports. However, it is my feeling that for future AGMs, it will be beneficial if the meeting only accepts questions that have been prenotified to ensure that an appropriate and informed answer can be given and that the members present are not misled by inaccurate and rash statements. I would, of course, support the right of any member to ask appropriate questions on the Society's affairs at all times and to expect to receive accurate and well informed answers. Prenotified questions would undoubtedly ensure a better quality of response and lead to better order and more being achieved at the AGM.