Detailed Financial Review

Critical accounting policies

The Group's significant accounting policies are set out in Note 1 to the Group's Annual Report & Accounts.

Preparation of the consolidated financial statements requires Directors to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual outcomes could differ from those estimated.

The Directors believe that the accounting policies discussed below represent those which require the greatest exercise of judgement. The Directors have used their best judgement in determining the estimates and assumptions used in these areas but a different set of judgements could result in material changes to our reported results. The discussion below should be read in conjunction with the full statement of accounting policies, set out in Note 1 to the Group's Annual Report & Accounts.

Property, plant and equipment

Rental fleet accounts for £801.7 million, or around 93%, of the net book value of property, plant and equipment used in our business; the great majority of equipment in the rental fleet is depreciated on a straight-line basis to a residual value of zero over 8 years, although we do have some classes which we depreciate over 10 years. The annual fleet depreciation charge of £146.8 million (2009: £138.1 million) relates to the estimated service lives allocated to each class of fleet asset. Asset lives are reviewed regularly and changed if necessary to reflect current thinking on their remaining lives in light of technological change, prospective economic utilisation and the physical condition of the assets.

Intangible assets

In accordance with IFRS 3 (revised) 'Business Combinations', goodwill arising on acquisition of assets and subsidiaries is capitalised and included in intangible assets. IFRS 3 (revised) also requires the identification of other acquired intangible assets. The techniques used to value these intangible assets are in line with internationally used models but do require the use of estimates and forecasts which may differ from actual outcomes. Future results are impacted by the amortisation period adopted for these items and, potentially, by any differences between forecast and actual outcomes related to individual intangible assets. The amortisation charge for intangible assets in 2010 was £2.8 million (2009: £2.7 million). Included in this charge was £2.7 million related to the amortisation of intangible assets arising from business combinations (2009: £2.5 million).

Goodwill of £60.4 million (2009: £51.3 million) is not amortised, but is tested annually for impairment and carried at cost less accumulated impairment losses. The impairment review calculations require the use of forecasts related to the future profitability and cash generating ability of the acquired assets.

Pensions

Pension arrangements for our employees vary depending on best practice and regulation in each country. The Group operates a defined benefit scheme for UK employees, which was closed to new employees joining the Group after 1 April 2002; most of the other schemes in operation around the world are varieties of defined contribution schemes.

Under IAS 19: 'Employee Benefits', Aggreko has recognised a pre tax pension deficit of £3.2 million at 31 December 2010 (2009: £5.8 million) which is determined using actuarial assumptions. The decrease in the pension deficit is a result of the additional contributions made by the Company during the year over and above the cost of accrual of benefits. The Company paid £3.5 million in January 2010 in line with the Recovery Plan agreed for the Scheme following the actuarial valuation at 31 December 2008. In addition higher-than-expected returns were achieved on Scheme assets over the year. The additional contributions and investment returns have been offset by lower net interest rates used to value the liabilities.

The main assumptions used in the IAS 19 valuation for the previous two years are shown in Note 25 of the Annual Report & Accounts. The sensitivities regarding these assumptions are shown in the table below.

Assumptions
Assumption	Increase	Deficit £ million Change	Income statement cost £ million Change
Rate of increase in salaries	0.5%	2.8	0.4
Rate of increase in pensions in payment	0.5%	3.6	0.3
Discount rate	0.5%	(7.2)	(0.4)
Inflation (0.5% increases on pensions increases, deferred revaluation and salary increases)	0.5%	7.9	0.8
Expected return on Scheme assets	0.5%	n/a	(0.3)
Longevity	1 year	1.3	0.1

Taxation

Aggreko's tax charge of 30% is based on the profit for the year and tax rates in force at the balance sheet date. In addition to corporation tax, Aggreko is subject to indirect taxes such as sales and employment taxes across various tax jurisdictions in the approximate 100 countries in which the Group operates. The varying nature and complexity of tax law requires the Group to review its tax positions and make appropriate judgements at the balance sheet date. Further detail, including a detailed tax reconciliation, is shown at Note 9 to the Annual Report and Accounts.

Trade receivables

Trade receivables are recognised initially at fair value and subsequently measured at amortised cost. An impairment is recorded for the difference between the carrying amount and the recoverable amount where there is objective evidence that the Group may not be able to collect all amounts due. Significant financial difficulties of the debtor, probability that the debtor will enter bankruptcy or financial reorganisation and default, or large and old outstanding balances, particularly in countries where the legal system is not easily used to enforce recovery, are considered indicators that the trade receivable is impaired.

The majority of the contracts into which the Group enters are small relative to the size of the Group and, if a customer fails to pay a debt, this is dealt with in the normal course of business. However, some of the contracts the Group undertakes in developing countries are substantial, and are in jurisdictions where payment practices can be unpredictable. The Group monitors the risk profile and debtor position of all such contracts regularly, and deploys a variety of techniques to mitigate the risks of delayed or non-payment; these include securing advance payments and guarantees. As a result of this rigorous approach to risk management, the Group has historically had a low level of bad debt. When a trade receivable is uncollectable it is written off against the provision for impairment of trade receivables account. At 31 December 2010 the provision for impairment of trade receivables in the balance sheet was £33.4 million (2009: £26.2 million).

Currency translation

The volatility of exchange rates during the year increased revenue and trading profit by £23.4 million and £6.5 million respectively as a result of currency movement. Currency translation also gave rise to a £39.1 million increase in net assets as a result of year-on-year movements in the exchange rates. Set out in the table below are the principal exchange rates affecting the Group's overseas profits and net assets.

Per £ Sterling
	2010		2009
	Average	Year End	Average	Year End
Principal Exchange Rates
United States Dollar	1.55	1.55	1.57	1.62
Euro	1.17	1.16	1.12	1.12
Other Operational Exchange Rates
UAE Dirhams	5.68	5.69	5.76	5.95
Australian Dollar	1.68	1.52	1.99	1.80
Source: Reuters

Interest

The net interest charge was £10.1 million, a decrease of £8.0 million on 2009, reflecting the lower level of average net debt during the year and the £3.3 million cost in 2009 of terminating some interest rate swaps. Interest cover, measured on an EBITDA basis, remains very strong and increased to 47.1 times from 22.8 times in 2009.

Effective tax rate

The effective tax rate for the full year is 30.0% compared to 31.0% in the prior year reflecting the geographic mix of profits.

Dividends

If the proposed final dividend of 12.35 pence is approved by shareholders, it will result in a full year dividend of 18.90 pence per ordinary share, giving dividend cover of 4.20 times (2009: 4.97 times).

Cashflow

The net cash inflow from operations during the year totalled £467.9 million (2009: £430.8 million). This funded capital expenditure of £268.8 million, which was £107.9 million higher than in 2009. Net debt at 31 December 2010 was £43.3 million lower than the previous year mainly as a result of the strong cashflow from operating activities. As a result of the decrease in net debt, gearing (net debt as a percentage of equity) at 31 December 2010 decreased to 16% from 29% at 31 December 2009 while net debt to EBITDA decreased to 0.3x (2009: 0.4x).

There was a £23.7 million working capital outflow in the year which, in general terms, reflected increased activity levels across the business. More specifically, Aggreko's working capital position tends to be heavily influenced by our International Power Projects business and also activity levels at our manufacturing operation. In International Power Projects, we saw an increase in all elements of working capital with higher levels of activity driving this. We also saw an increase in International Power Projects' debtor days caused largely by a small number of countries where payments were slower than usual. Since year end, we have received payments from most of these countries, however, this movement underlines the challenge of collecting debt from some of the countries in which our International Power Projects business operates. However, there were no material bad debt write-offs in the year. Our manufacturing operation saw increases in inventory and accounts payable reflecting the increased level of activity in 2010 and early 2011.

Net operating assets

The net operating assets of the Group (including goodwill) at 31 December 2010 totalled £1,065.8 million, £182.0 million higher than 2009. The main components of net operating assets are:

£ million
			Movement
	2010	2009	Headline	Constant currency
Rental fleet	801.7	660.3	21.4%	15.5%
Property and plant	57.1	52.7	8.5%	6.4%
Inventory	117.8	86.3	36.4%	30.9%
Net trade debtors	192.0	136.3	40.9%	34.9%

A key measure of Aggreko's performance is the return (expressed as operating profit) generated from average net operating assets (ROCE). We calculate the average net operating assets for a period by taking the average of the net operating assets as at 1 January, 30 June and 31 December; this is the basis on which we report our calculations of ROCE. The average net operating assets in 2010 were £969.9 million, up 7.4% on 2009. In 2010 the ROCE increased to 32.4% compared with 29.0% in 2009.

Acquisition of Northland Power Services

On 3 December 2010, the Group acquired the assets and business of Northland Power Services. The purchase consideration, paid in cash, comprises a fixed element of $23.7 million (£15.4 million) and further payments of up to a maximum of $2.0 million (£1.3 million) dependent on financial performance during 2011. The fair value of net assets acquired was £9.5 million resulting in goodwill of £7.2 million.

Shareholders' equity

Shareholders' equity increased by £211.3 million to £814.4 million, represented by the net assets of the Group of £946.6 million before net debt of £132.2 million. The movements in shareholders' equity are analysed in the table below:

Movements in shareholders' equity
	£ million	£ million
As at 1 January 2010		603.1
Profit for the financial year	213.1
Dividend1	(39.7)
Retained earnings		173.4
New share capital subscribed		1.7
Purchase of own shares held under trust		(27.2)
Credit in respect of employee share awards		18.7
Actuarial losses on retirement benefits		(0.6)
Currency translation difference		39.1
Movement in hedging reserve		(3.6)
Other2		9.8
As at 31 December 2010		814.4
1 Reflects the final dividend for 2009 of 8.23 pence per share (2009: 6.28 pence) and the interim dividend for 2010 of 6.55 pence per share (2009: 4.37 pence) that were paid during the year. 2 Other mainly includes tax on items taken directly to reserves.

The £213.1 million of post-tax profit in the year represents a return of 26.2% on shareholders' equity (2009: 27.9%).

Treasury

The Group's operations expose it to a variety of financial risks that include liquidity, the effects of changes in foreign currency exchange rates, interest rates, and credit risk. The Group has a centralised treasury operation whose primary role is to ensure that adequate liquidity is available to meet the Group's funding requirements as they arise, and that financial risk arising from the Group's underlying operations is effectively identified and managed.

The treasury operations are conducted in accordance with policies and procedures approved by the Board and are reviewed annually. Financial instruments are only executed for hedging purposes, and transactions that are speculative in nature are expressly forbidden. Monthly reports are provided to senior management and treasury operations are subject to periodic internal and external review.

Capital management

The Group's objective with respect to managing capital is to maintain a balance sheet structure that safeguards the Group's financial position through economic cycles and one that is efficient in terms of providing long term returns to shareholders. If appropriate, the Group can choose to adjust its capital structure by varying the amount of dividend paid to shareholders, by returning capital to shareholders, by issuing new shares, or by adjusting the level of capital expenditure. As discussed above gearing at 31 December 2010 decreased to 16% from 29% at 31 December 2009. Total capital is equity as shown in the Group balance sheet.

Liquidity and funding

The Group maintains sufficient facilities to meet its normal funding requirements over the medium term. At 31 December 2010 these facilities are primarily in the form of committed bank facilities totalling £604.1 million, arranged on a bilateral basis with a number of international banks. The financial covenants attached to these facilities are that EBITDA should be no less than 4 times interest and net debt should be no more than 3 times EBITDA. The Group does not consider that these covenants are restrictive to its operations. The maturity profile of the borrowings is detailed in Note 17 in the Annual Report & Accounts.

Net debt amounted to £132.2 million at 31 December 2010 and, at that date, un-drawn committed facilities were £470.1 million.

Towards the end of 2010, we refinanced £459 million of bank facilities, putting in place new facilities with maturities of 3 and 5 years. In addition, since the year end, we have for the first time raised funding in the US private placement market, securing US$275 million (£177 million), with maturities ranging between 7 and 10 years and with financial covenants the same as our banking facilities. Drawdown of these funds will take place in mid March 2011.

Interest rate risk

The Group's policy is to minimise the exposure to interest rates by ensuring an appropriate balance of fixed and floating rates. The Group's primary funding is at floating rates through its bank facilities. In order to manage the associated interest rate risk, the Group uses interest rate swaps to vary the mix of fixed and floating rates. At 31 December 2010, £110.9 million of the net debt of £132.2 million was at fixed rates of interest resulting in a fixed to floating rate net debt ratio of 84:16 (2009: 61:39)¹.

¹ The increase in this ratio is driven by a decrease in Group net debt rather than an increase in the absolute value of fixed rate debt.

Foreign exchange risk

The Group is subject to currency exposure on the translation into Sterling of its net investments in overseas subsidiaries. In order to reduce the currency risk arising, the Group uses direct borrowings in the same currency as those investments. Group borrowings are predominantly drawn down in the principal currencies used by the Group, namely US Dollar, Euro and Sterling.

The Group manages its currency flows to minimise foreign exchange risk arising on transactions denominated in foreign currencies and uses forward contracts, where appropriate, in order to hedge net currency flows.

Credit risk

Cash deposits and other financial instruments give rise to credit risk on amounts due from counterparties. The Group manages this risk by limiting the aggregate amounts and their duration depending on external credit ratings of the relevant counterparty. In the case of financial assets exposed to credit risk, the carrying amount in the balance sheet, net of any applicable provision for loss, represents the amount exposed to credit risk.

Insurance

The Group operates a policy of buying cover against the material risks which the business faces, where it is possible to purchase such cover on reasonable terms. Where this is not possible, or where the risks would not have a material impact on the Group as a whole, we self-insure.