Preliminary Results

Cello Group plc

('Cello' or the 'Group')

Preliminary Results for the twelve months ending 31 December 2016

Strong 2016 performance - robust gross profit growth.

Cello Group plc (AIM:CLL, "Cello" or "the Group"), the pharmaceutical and consumer strategic marketing group, today announces its final audited results for the year to 31 December 2016.

Financial Highlights

· Revenue up 5.4% to £165.3m (2015: £156.7m)

· Gross profit up 7.1% to £92.7m (2015: £86.5m)

· Like-for-like1 gross profit growth of 5.9%

· Constant currency like-for-like gross profit growth of 2.9%

· Headline2 profit before tax up 0.8% to £10.2m (2015: £10.1m)

· Headline basic earnings per share3 flat at 8.66p (2015: 8.72p)

· Statutory basic loss per share 3.23p (2015: earnings of 3.54p)

· Net debt of £5.1m (2015: £4.2m)

• Full Year dividend up 18.9% to 3.40p (2015: 2.86p)

• Good start to 2017

Divisional Highlights

· Cello Health like-for-like gross profit growth of 6.2%, operating margin maintained at competitive levels.

· Cello Signal like-for-like gross profit growth of 5.5%, headline operating margins improving to 10.3%.

Operational Highlights

· Continued good progress executing the long-term strategy of Cello Health

· Cello Health product offering expands into digital and quantitative products

· Pulsar continues to grow very strongly and enters the US market

· Consolidation of Signal businesses behind the digitally led Signal brand

· Acquisition of Defined Health in 2017 supported by £15m equity fundraise

Mark Scott, Chief Executive, commented:

"Cello Health is now in a strong position to accelerate its global growth, with a particular focus on the US market. Cello Signal is making steady progress against its goals, with the Pulsar social media product continuing to grow strongly, as well as increasingly supporting the digital communications capability of Cello Health."

1 Like-for-like measures exclude the results from companies acquired in the year and results from start-ups which are defined in note 2.

2 Headline measures exclude, where applicable, restructuring costs, share based payments, amortisation of intangible assets, impairment charges, acquisition accounting adjustments, start-up losses, the provision for VAT payable and other one -off items.

3 Headline earnings per share is defined in note 10.

4 Headline operating margin is calculated by expressing headline operating profit as a percentage of gross profit.

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CHAIRMAN'S STATEMENT

Cello Group had a good 2016. Cello Health and Cello Signal have continued to perform well and reap the benefits of coming together under their respective brand structures. The Group reported a 7.1% increase in gross profit to £92.7m (2015: £86.5m) with headline profit before tax up 0.8% to £10.2m (2015: £10.1m).

Cello Health saw a particularly strong performance from its US operations as the client offer broadened and key clients continued to grow. The Board is excited by the recent acquisition of Defined Health in early 2017 which will contribute to further deepening the client list of Cello Health. We have also been pleased to have secured considerable support from new and existing shareholders to fund this acquisition and our future growth plans.

Cello Signal had a good year, with the full rebranding of key businesses behind the Cello Signal Brand. Signal's social media analytics product, Pulsar, continued to grow fast, and is now operationally profitable. It has been launched fully in the US in early 2017.

The Group was pleased to conclude its VAT issue during the year and this is now fully settled. Net debt at year end was £5.1m (2015: £4.2m), prior to the recent £15m fundraise. The Group has confirmed its commitment to a 40% dividend pay-out target.

The Board believes that Cello Group is positioned to secure a prosperous future. We have strength in our operations, our geographic footprint, the quality of our people and importantly a clear vision about where we need to go next in implementing our long-term growth strategy.

OUR BUSINESSES AND THEIR MARKETPLACES

Cello Health

Cello Health provides a bespoke combination of core capabilities of Insight, Consulting and Communications to a wide range of pharmaceutical clients around the world. This client base includes 22 of the 25 largest pharmaceutical organizations, as well as a growing number of smaller bio-tech clients. These core capabilities are all represented physically in the UK, and also in the US.

The global healthcare market remains robust, with a positive outlook. Current reports indicate that there are over 13,000 products in development, and a recent forecast from Evaluate Pharma suggests that worldwide spending in R&D is set to rise from $154bn in 2016 to $172bn by 2020. The aging global population associated with a myriad of age related diseases is projected to increase by an average of 27m people a year over the next 25 years, reaching 1.6bn by 20505. Advances in scientific understanding are producing novel ways of identifying conditions, diagnosing and treating patients. Over the last few years we have seen many breakthroughs, including advances in gene therapy and gene editing technologies such as CRISPR, new targeted therapies and increased focus on biomarkers and patient stratification. In addition, research into microbiome, proteomics, genomics and metabolomics offer new ways of identifying novel target mechanisms for difficult to treat conditions.

This all suggests that demand for Cello Health's type of services will continue to increase and all indications are that sustained growth is likely for the foreseeable future in this area.

Cello Signal

Cello Signal competes in two key markets; firstly, the market for direct marketing, CRM, CSM and targeted brand communications; and secondly the market for market research and insight analytics. By combining the latest digital technology with creative output, Cello Signal helps clients achieve greater engagement and traction with existing and new customers. Cello Signal's client list includes a range of leading financial service companies, tech business, utilities, charities, gaming clients, government bodies and consumer brands.

The market for targeted brand communications has progressively shifted from traditional direct marketing models dominated by database management and targeted mail and email, towards interactive, real time customer engagement using technology platforms. This has fundamentally been driven by the availability of big data sets and interactive communications channels to deploy them. The evolving systems based trigger marketing industry, which builds on software platforms and engages with social media channels, appears to be set for good growth. Signal has made rapid strides in migrating down the automated engagement route, deploying tools such as TriggerHub to automate the process by which clients engage with their customers in an iterative, targeted fashion informed by customer behaviour.

The insight and market research industry has similarly been disrupted by digital technology, centred on the growth of social media as a primary channel for gaining access to large but highly targeted samples at low cost and high speed. Cello Signal's Pulsar product precisely targets this new growth innovation in the industry. The overall market for such social media analytics work is forecast to grow from $1.6bn in 2015 to $5.4bn by 20206. Pulsar is a highly competitive offering in this fast growing market. In addition, Cello Signal has a wide exposure to the global tech client community through its consumer research activity, with clients ranging from EA games to Apple and Facebook. As such it is exposed to a fundamentally solid growth demand for such services overall.

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5 US Census Bureau – An Aging World6 Market and markets report 2016

CHIEF EXECUTIVE'S OPERATIONAL REVIEW

Cello Health (www.cellohealth.com)

Cello Health consists of four capabilities: Cello Health Insight, Cello Health Consulting, Cello Health Communications and Cello Health Consumer. The Board of Cello Health continues to focus on implementing its long-term strategy around four key growth pillars:

Branding

We have now successfully transitioned all key businesses to the Cello Health brand. The Cello Health brand has become well established across our client base and has provided the basis for effective collaboration across our businesses and client engagements. This has ensured that Cello Health is easy to do business with and efficiently engages with client contracting processes.

Over 70% of our Consulting and Communications work is global in nature. In addition, we have seen a significant shift in our Insight operations where our US client base has moved from a domestic focus to a more international profile (59% in 2016 vs. 38% in 2015). This signals the ongoing strengthening of our reputation and reach not only in the US but globally. Combined with a broader spread of new clients, market awareness of the Cello Health brand is growing rapidly.

Global Expansion

Creating a sizeable US business remains a key goal of Cello Health's growth strategy. Within our global consulting capability over 60% of our revenues are now generated and delivered to clients in the US vs. 40% in 2015. In line with our view on the strategic importance of this region, significant investment has been made in our US BioConsulting business. As a result of these investments, our US consulting team won 10 new clients in 2016.

We have also strengthened our core US operations, particularly Cello Health Insight, with key senior hires. This includes adding specialist device and design expertise within the US Insight team to drive business in this burgeoning area. In addition, Market Access has been a key priority area and we are delighted to have hired Yi Han PhD, to lead our US Market Access business. The acquisition of Defined Health early in 2017 further strengthens our reach into the US biotech area, with a focus on early stage asset development. Our US communications business has performed strongly in 2016, delivering strong growth whilst also strengthening its senior management team with the hire of Rick Lang to lead our digital communications business.

Overall, our US based Health businesses added 27 new client companies to their collective roster in 2016. We now have offices in all key US locations to service our US client base, both on the East Coast (Boston, Manhattan, Northern New Jersey, and Philadelphia) and the West Coast, as well as in the Mid-West of the United States. We will continue to invest in these locations to support our growth in the Biotech, Orphan, Rare and Specialist Disease markets. By the end of 2016, 35% of our healthcare revenues were generated from the US and we believe that the US offers significant opportunity for further growth. This region is a key focus for 2017 and beyond.

In addition, we made changes to the European communications business, with the appointments of Isaac Batley as Chief Operations Officer for Cello Health Communications Europe and Steve Smith as Chief Commercial Development Officer.

Innovation

Innovation is key to our business and keeps us ahead of our competitors. 2016 saw continued progress being made, with Cello Health's Insight digital capabilities going from strength to strength, with a 67% increase in revenue vs 2015. This has been driven by a combination of our expanded client base and new offerings such as 'Living Lens' searchable video technology. Cello Health Insight conducted more than £1m worth of eVillage projects in 2016 and the majority of our research projects across the Cello Health Insight business now contain a digital component.

2016 saw further success with significant growth in IQ, our quantitative research practice, with a 53% year-on-year increase in revenue. The senior team has been strengthened, with additional appointments in both the UK and US. A key source of growth has been the expansion of 'tracker' work which has doubled year-on-year, bringing more ongoing, predictable revenue whilst also bolstering opportunities for ad-hoc follow up work. Our specialist hard-to-get data brand, Kudos, has begun the process of building a panel of doctor respondents to allow more efficient continuous data gathering.

During 2016, we also strengthened our focus, presence and capability in Early Asset Development and Commercialisation. Cello Health Consulting has made a particularly strong push into the fast evolving biotech arena. Within one year we have moved 17% of our total consulting revenue into this strategically important space where critical decisions and cutting edge science take place. In our Insight operations, approximately £6m of revenue was generated with a specific focus on Rare Diseases and Early Asset Development and Commercialisation in 2016.

Collaboration

Since the start of 2015, in excess of £11m revenue has been generated by collaborative projects across Cello Health. As in 2015, collaborative projects were commissioned by both established and completely new clients, confirming that the blended approach we now provide has opened up new opportunities we were previously unable to access. Internal collaboration teams have worked together to develop new thinking in a number of key service areas, developing best practice solutions based on integrated thinking across Consulting, Insight and Communication fields.

There is also an increasing amount of client collaboration between Cello Health and Cello Signal in the digital space. Social media listening is fast becoming an important area of interest to our healthcare clients. Cello Signal over the last few years has invested heavily in developing a state of the art software offering under the Pulsar brand. During 2016, teams from Cello Health and Cello Signal worked closely on developing this offering to suit the needs of our healthcare clients, with the subsequent launch of Pulsar Health. Progress to date has been promising and we expect significant growth to come from this area in 2017.

In summary, Cello Health strengthened its core operations in 2016 and continued to make progress in executing its long term strategy. Our client base remains strong, we continue to attract the best people, and are successful in developing and retaining talent. As reported earlier in the year, Cello Health reduced its exposure to the consumer market, following the tougher trading period experienced by Cello Health Consumer. However, we saw strong like-for-like revenue growth across Cello Health core operations at competitive margins despite this temporary headwind. 

Cello Signal (www.cellosignal.com)

2016 was a key year in Cello Signal's evolution towards fulfilling its potential as a global proposition. Significant progress was made against the strategic framework we laid out in 2015, consisting of 4 key pillars:

Developing the Signal Brand 

Signal uses technology to help clients unlock the value of their brands by achieving more customised and interactive engagement with customers. The combination of our creative talent, communication skills and digital capability gives Signal a unique advantage globally as we compete to service the world's leading brands.

It has become clear to the Signal board that clients are demanding greater integration in the way different technical communications capabilities are used to create more effective and impactful integrated marketing campaigns. In particular, ensuring that web, mobile, CRM, social and digital advertising are connected to create a single, positive experience for the end customer. Our client community is increasingly rethinking their own internal marketing structures and removing silos to allow closer skills integration. The Signal board responded to this trend, recognising that we needed a more connected offer to allow us to assemble teams around these broader client challenges. Consequently, we have unified behind the Signal Brand and built a powerful client facing proposition founded on greater connectivity across our capabilities. 'Signal', is now our largest employer and delivered 74% of divisional profits in 2016. Its focus is CRM, Software Engineering and Digital Marketing. It is now the largest part of the Cello Signal Group and, alongside Pulsar and 2CV, forms our primary engine of profit and growth going forward.

Digital and Technology Innovation: Pulsar and TriggerHub

Pulsar is a platform that Cello has invested in significantly over the years with continuous improvements to the functionality and robustness of the product. Pulsar Platform is an Audience Intelligence tool, precisely responding to the desire of clients and their agencies to extract clear actionable insights from large scale data sources. Pulsar allows clients to rethink their segmentation strategies and audience building abilities via access to social data.

In 2016, Pulsar introduced three new powerful analysis features; Image Tagging, Emotional Analysis and Image Text Extraction which give Pulsar's clients the ability to gain more insight than ever before across all social data channels. It is also one of a handful of such platforms globally that is now able to use Facebook data, giving it a real competitive advantage. Pulsar's annual software license sales have now reached a run rate of circa £4m per annum from its UK base alone, with a larger and dedicated US sales office being opened early in 2017, giving it a critical mass of sales and operating as a true SaaS model.

Although at an earlier stage of development than Pulsar, Signal has also developed an automation platform, TriggerHub, giving clients with complex databases the ability to automate the personalisation of web, email, SMS and Print communication on a rolling basis. This means that end customers receive communication which is more relevant to them and potentially via a channel they have selected. Technically this is known as a Multi-Channel Communication Management offer ("MCCM").

'Automated workflows' are typically applied where the client is performing the selection and personalisation of the message to be delivered. Each data supply is used only once, and each data record generally relates to one outbound communication. TriggerHub, by contrast, standardises and stores data records, adding and updating on an ongoing basis. The system itself performs the selection and personalisation of the outbound communications, and results in a dynamic sequence of communications based on the response of the recipient.

Signal Health: Partnering with Cello Health

Over the years, Cello has identified that many health clients are hungry for new ways of helping them build brands, utilising the varied digital and technology platforms that exist. With our expertise across a range of channels and communication solutions, Signal is uniquely placed to provide a fresh and innovative perspective on healthcare client's brand challenges.

The cross-over opportunity is readily demonstrated by Pulsar Health which combines the same core technology and data sources used in general client sectors but is directed against recurring health issues and supported by a growing health knowledge base across marketing, customer support and research teams. Pulsar Health was launched during 2016 and early indications of client traction are very positive.

During 2016 much of our work in public sector and Charities has been in the Health arena and Signal is actively pursuing more direct work with commercial consumer health clients, building on our recent appointment by the European Federation of Pharmaceutical Industries & Associations.

Building the US footprint

Insight and innovation continue to lead our service offering in the US. Los Angeles and San Francisco are well established, with larger offices recently taken in LA to support the gaming community client base which has been established there alongside Vanity Fair, HASBRO and Netflix who all came on board as clients in 2016. This push into the US market has been assisted by the UK based innovation team, who have developed strong relationships with clients such as Marriott and HP in the US. Their work has successfully taken strategy development tasks through into digital design and build.

In summary, Signal's objectives for 2017 are to continue to make the division more cohesive and single minded behind a digital-first strategy, with the US market and the health sector as our primary growth focus.

GROUP FINANCE DIRECTOR'S REPORT

Total Group gross profit was £92.7m (2015: £86.5m) on revenues of £165.3m (2015: £156.7m). Headline profit before tax was £10.2m (2015: £10.1m). Both divisions of the Group performed well and in line with expectations. Like-for-like gross profit growth for the whole Group was 5.9%. Constant currency like-for-like gross profit growth was 2.9%.

The Group's headline operating margin was 11.5% (2015: 12.2%) with a headline operating margin of 18.1% in Cello Health (2015: 19.7%), and 10.3% in Cello Signal (2015: 9.8%).

Finance costs were £0.3m (2015: £0.4m). Finance costs are dropping as average net debt drops during the year, but non-utilisation costs on the debt facility are still incurred.

The Group's reported tax charge was £0.8m (2015: £1.7m) with a headline tax rate of 25.7% (2015: 25.8%). The headline tax rate is dropping as the UK Corporation Tax rate drops, offset by higher relative profits in the US, which attract a higher tax rate. The reconciliation of the tax charge to reported loss before tax is at note 7.

Headline basic earnings per share was largely flat at 8.66p (2015: 8.72p).

Statutory loss before tax was £1.7m (2015: profit of £5.0m). A reconciliation of headline profit before tax to the statutory loss before tax can be found at note 2.

As at 31 December 2016 total Group estimated future acquisition-related obligations are £2.9m, substantially payable in May 2017, with a maximum of £0.6m payable in new ordinary shares.

The Group benefitted from a stronger dollar in 2016 compared with 2015, with average US$:£ exchange rates strengthening from 1.53 in 2015 to 1.35 in 2016. The Group currently generates around $4.1m of headline operating profit in the USA. So far in 2017 the dollar has continued to strengthen to around 1.24.

During the year, the Board announced its commitment to pay a higher percentage of headline earnings per share as dividend. This pay-out ratio has been increased to 39% of full headline earnings per share. The Board is therefore proposing a final dividend of 2.40p per share (2015: 2.02p), giving a total dividend for the year of 3.40p per share (2015: 2.86p) representing an increase of 18.9%. The dividend has now grown every year since 2006 and has grown by 10.0% or more for each of the past six years. Subject to shareholder approval, the final dividend will be paid on 26 May 2017 to all shareholders on the register at 5 May 2017, and will be recognised in the year ending 31 December 2017.

Cello Health Financial Performance

Overall like-for-like gross profit growth in Cello Health was 6.2%. This excellent performance was driven by very strong performances from the three capabilities of Cello Health that are orientated towards pharmaceutical clients. These three capabilities (Insight, Consulting and Communications) delivered like-for-like gross profit growth of 10.5%. On a constant currency basis, overall the like-for-like gross profit growth in Cello Health was 1.7%. If Cello Health Consumer was excluded then constant currency like-for-like gross profit growth was 5.3%.

As previously indicated, a UK business within the Cello Health Consumer division, had a more difficult year and gross profit dropped year-on-year. This business was breaking even during the second half of the year, but loss making prior to that. This factor explains the drop in Cello Health's headline operating margin to 18.1% (2015: 19.7%). An impairment charge of £4.9m (2015: £nil) has been recognised in respect of this business. Headline operating margins excluding Cello Health Consumer were a healthy 20.3% (2015: 20.9%).

As previously announced, the Group made a payment of £1.2m (including related costs) in respect of removing employment restrictions from certain employees of Cello Health BioConsulting Inc. This business start-up continues to develop and while it was operationally loss making in 2016, it is expected to contribute in 2017. 

In 2017 the Group was pleased to acquire the trade and assets of Defined Health Research Inc. The strategy is to continue on the path to increasing US exposure in the pharmaceutical marketplace and where necessary, make prudent acquisitions to do so.

Cello Signal Financial Performance

Cello Signal had a good year with like-for-like gross profit growth of 5.5% which increased headline operating profits to £4.5m (2015: £4.0m) at a higher operating margin of 10.3% (2015 9.8%). This growth was driven by strong spend from the financial sectors, but also continued spend from technology, charity, government and utility clients. On a constant currency basis the like-for-like gross profit growth was 4.2%.

Pulsar ended the year with 257 clients, up from 188 at the start of 2016, generating £0.3m of revenue per month from licence sales going forward into 2017. The product continues to evolve and grow in 2017. During 2016 Facebook data was incorporated for the first time, vastly increasing the size of the dataset analysed. Pulsar was operationally profitable in 2016 and continues to grow. Pulsar has been launched in the US in 2017, and early signs are that average contract sizes are higher and the product is being well received.

During the year, the research operation in Hong Kong was closed. The results of this operation are shown within its discontinued operations.

Non Headline Charges

The Group has incurred a number of charges in the income statement below headline operating profit, which are:

During 2016, the Group incurred restructuring costs of £1.2m (2015: £0.7m). This mainly relates to redundancy payments, predominately within Cello Signal and within Cello Health Consumer. Structural changes were also implemented to consolidate property commitments, integrate the offer further and reduce operating costs.

During the year the Group settled the long running issue with HMRC regarding the VAT status of certain supplies made to charitable clients. In July 2016, a payment of £5.2m (including interest and penalties) was made in full and final settlement. The Group is comfortable that ongoing arrangements are compliant with the new stricter interpretation of the legislation. The process of recovery from clients has commenced, and while progress is slow, over £0.3m had been recovered by 31 December 2016.

The Group continues to invest in start-up activity. The major investment in the year relates to Cello Health BioConsulting. This business was established in 2015, and in 2016 the Group made a payment of £1.2m (including related costs) to the previous employer of the core initial employees in order to release them from their prior employment restrictions. This payment was disclosed in the interim statements in September 2016. The business has continued to develop its project stream and income pipeline and had its largest wins in the second half of 2016. Operating losses relating to this business totalled £0.7m in 2016.

Acquisition related employee remuneration expense of £1.2m (2015: £1.6m) is the necessary income statement charge which relates to the spreading of deferred consideration payments made to certain employees of the Group over the term of the deferred consideration measurement period. 

As previously disclosed, following the weaker performance within the consumer division of Cello Health, the carrying value of this business has been assessed for impairment. The results of that assessment are that an impairment charge of £4.9m (2015: nil) is necessary.

Balance Sheet and Cash Flow

Operating cash flow before tax of £6.5m (2015: £8.2m) during the year represented a 62.0% (2015: 78.5%) conversion of headline operating profit. However, operating cash flow is stated after the cash settlement of some non-headline items. If the VAT settlement, the start-up losses and the restructuring costs were added back to operating cash flow then the operating cash flow percentage would be 143% (2015: 93%). The VAT settlement in particular represents the settlement of a provision that was built up over 2014, 2015 and 2016. The underlying operating cash flow of the business is therefore very healthy and operating profits turn into cash on a prompt basis.

The Group's net debt position at 31 December 2016 was £5.1m (2015: £4.2m). The net debt:ebitda7 ratio at 31 December 2016 was 0.42 (2015: 0.35). Group debt facilities are renewable in March 2018. Total debt facilities are £20.0m, with a £4.0m overdraft facility.

Total future deferred consideration obligations at 31 December 2016 total £2.9m (2015: £2.2m). In line with recognised accounting practices, the cost of this deferred consideration is spread over the length of the deferred consideration period. Accordingly, the Acquisitions-related Employee Remuneration Expense is £1.2m (2015: £1.6m). This will be substantially settled in May 2017.

On 31 January 2017, the Group was pleased to announce the acquisition of the trade and assets of Defined Health Research Inc, a biotech consultancy based in New Jersey, USA. Initial consideration was $5.75m, of which $5.25m was in cash and the balance was settled by the issuance of new ordinary shares. At the same time, the Group announced a placing of new equity to raise £15.0m of cash, which was used to fund the initial cash consideration and the balance of which will be used to fund further acquisition and investment opportunities in 2017.

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Risks and Uncertainties

The Company regularly reviews the risks and uncertainties facing the business through a regular series of Board and operational meetings. The Directors believe the current largest risks are as follows:

1. Economic conditions

The Group's business is domiciled in the UK but 45% (2015: 41%) of the Group's revenues are from clients based overseas. It is clear that income from clients is impacted by the prevailing economic conditions. Global economic and geopolitical uncertainty is increasing following Brexit and the US election. However, the broad spread of clients across sector and geography mitigates this risk.

2. Loss of the Group's key clients

Client relationships are crucial to the Group and the strength of them is key to its continued success. The risk is mitigated by our client base being broadly spread and by several of our pharmaceutical clients being subject to longer term master service agreements. The loss of any large client would require replacement. The Group's client review programmes help mitigate this risk.

3. Loss of key staff

The Group's Directors and staff are critical to the servicing of existing business and the winning of new accounts and the departure of key staff could be a risk to maintaining client service. With that risk in mind all senior staff are subject to financial lock-ins and long-term incentive arrangements, as well as being under contractual non-compete and non-solicit clauses.

Current Trading and Outlook

The Group has begun 2017 with good levels of forward bookings and already secured a good level of new business wins. Following the recent fundraise to finance the acquisition of Defined Health, the Group is in the process of expanding its global footprint. The Board is confident that expectations for 2017 will be met.

Allan Rich

Non-Executive Chairman

21 March 2017

CONSOLIDATED INCOME STATEMENT

for the year ended 31 December 2016

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

for the year ended 31 December 2016

CONSOLIDATED BALANCE SHEET

as at 31 December 2016

CONSOLIDATED CASH FLOW STATEMENT

for the year ended 31 December 2016

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

SIGNIFICANT ACCOUNTING POLICIES

(1) Basis of Preparation

The consolidated financial statements of Cello Group plc have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union ("IFRSs"), interpretations issued by the IFRS Interpretations Committee ("IFRS IC") and the Companies Act 2006 applicable to companies reporting under IFRSs. The consolidated financial statements have been prepared under the historical cost convention. The Group's principle accounting policies have been applied consistently throughout the year.

The Group's business activities, performance and position and an assessment of the risks and uncertainties are set out in the Chairman's Statement. An assessment of the critical accounting estimates and judgements are set out in accounting policy 9.

(2) Going Concern

During the year the Group generated a loss before tax on continuing activities of £1.7m and excluding non-recurring restructuring costs and other non-headline charges the Group generated a profit before tax of £10.2m.

The Group meets its day-to-day working capital requirements through its bank facilities. At 31 December 2016 the Group's bank facilities consisted of a £4.0m overdraft facility and a £20.0m revolving credit facility ("RCF"). The RCF is committed to March 2018. £7.7m of the RCF is undrawn at 31 December 2016. In addition, on 1 February 2017, the Group raised £15.0m (before expenses) by way of placing of 15,463,919 new ordinary shares of 10p each. US$5.25m of these proceeds were used immediately to acquire the trade and assets of Defined Health Inc. and Cancer Progress LLC. 

The Group's forecasts and projections show that the Group is able to operate within the level of its current facilities and its covenants.

After reviewing the Group's performance and forecast future cash flows, the Directors consider the Group has adequate resources to continue in operational existence for the foreseeable future. The Group therefore continues to adopt the going concern basis in preparing the Group's financial statements.

(3) Basis of Consolidation

The Group's financial statements consolidate the financial statements of the Company and all of its subsidiary undertakings. Subsidiaries are all entities over which the Group has control. The Group controls an entity when the Group 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. Subsidiaries are fully consolidated from the date on which control is transferred to the Group and are de-consolidated from the date that control ceases.

The Group uses the acquisition method of accounting to account for business combinations. The consideration transferred is measured as the fair value of the assets given, equity instruments issued and liabilities incurred to former owners of the acquire at the date of acquisition. Identifiable assets and liabilities acquired and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any non-controlling interest. The excess of the cost of acquisition over the fair value of the Group's share of the identifiable net assets acquired is recorded as goodwill.

Acquisition-related costs are expensed as incurred.

Inter-company transactions, balances and unrealised gains are eliminated on consolidation. Accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the Group.

The Group treats transactions with non-controlling interests as transactions with equity owners. For purchases of non-controlling interests, the difference between any consideration paid and the relevant share acquired of the carrying value of net assets of the subsidiary is recorded in equity.

(4) Foreign Currencies

Sterling is the functional currency of the Company and the presentational currency of the Group. The functional currency of subsidiaries is the local currency of the primary economic environment in which the entity operates.

Foreign currency transactions are translated into the functional currency using the exchange rate prevailing at the date of the transaction. Foreign exchange gains or losses on monetary assets and liabilities denominated in foreign currencies resulting from the settlement of such transactions and from the translation to the rate prevailing at the year end are recognised in the income statement.

The financial statements of subsidiaries whose functional currency is different to the presentational currency of the Group are translated into the presentational currency of the Group on consolidation. Assets and liabilities are translated at the exchange rate prevailing at the balance sheet date. Income and expenses are translated at the average exchange rate for the year, unless exchange rates fluctuate significantly during the year, in which case the exchange rates at the transaction date are used. Exchange differences arising on consolidation are recognised in other comprehensive income and the cumulative effect of these as a separate component in equity.

 (5) Revenue, Cost of Sales and Revenue Recognition

Revenue comprises the fair value of the consideration received or receivable from services provided by the Group or from the sale of licences to use software products developed by the Group in the ordinary course of the Group's activities.

Services include fees, commissions, rechargeable expenses and sales of materials provided by the Group. Revenue is shown net of Value Added Tax and discounts.

Revenue derived from fees is recognised as contract activity progresses, in accordance with the terms of the contractual agreement and the stage of completion of the work. The stage of completion is assessed based on the proportion of actual hours or costs incurred as a proportion of total hours and costs expected to be incurred, or milestones completed, as appropriate to the contract. Where recorded revenue exceeds amounts invoiced to clients, the excess is classified as accrued income and where recorded revenue is less than amounts invoiced to clients, the difference is classified as deferred income.

Revenue derived from retainers is recognised evenly over the contract period.

Revenue derived from commissions, rechargeable expenses and sale of materials is recognised when the risk and rewards have been transferred to the client in line with the individual contract.

Revenue derived from the sale of licences to use the software products developed by the Group are recognised evenly over the licence period.

Cost of sales include amounts payable to external suppliers where they are retained at the Group's discretion to perform part of a specific client project or service where the Group has full exposure to the benefits and risks of the contract with the client. Cost of sales does not include direct labour costs.

(6) Discontinued Operations

A discontinued operation is a component of the Group that has been disposed of or closed. These operations represent a separate major line of business or geographical area of operations and can be closely distinguished operationally and for financial reporting purposes from the rest of the Group.

(7) Headline Measures

The Group believes that reporting non-GAAP or headline measures provides a useful comparison of underlying business performance and this reflects the way the business is reported internally and controlled. Accordingly, headline measures of operating profit, finance income, finance costs, profit before taxation and earnings per share exclude, where applicable, restructuring costs, amortisation of intangible assets, impairment charges, acquisition accounting adjustments, start-up losses, share option charges, fair value gains and losses on derivative financial instruments and the provision for VAT payable. These are items that, in the opinion of the Directors, are required to be disclosed separately, by virtue of their size, nature or incidence, to enable a full understanding of the Group's underlying financial performance.

A reconciliation between reported and headline profit before taxation is presented in note 2. In addition to this, a reconciliation between reported and headline operating profit is presented in note 3 and a reconciliation between reported and headline earnings per share is presented in note 10. Headline measures in this report are not defined terms under IFRSs and may not be comparable with similarly titled measures reported by other companies.

(8) Goodwill

Goodwill represents the excess of consideration over the fair value of the Group's share of the identifiable net assets acquired at the date of acquisition. Goodwill is carried at cost less accumulated impairment losses. Impairment losses are recognised in the income statement and cannot subsequently be reversed.

Goodwill is allocated to cash-generating units ("CGUs") for the purposes of impairment testing. The allocation is made to those cash-generating units that are expected to benefit from the business combination in which the goodwill arose.

The carrying value of goodwill for each CGU is reviewed annually for impairment, or more frequently if the events or changes in circumstances indicate a potential impairment. An impairment loss is recognised for the amount by which the assets carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an assets fair value less costs to sell and its value-in-use.

(9) Accounting Estimates and Judgements

The Group makes estimates and judgements concerning the application of the Group's accounting policies and concerning the future. The resulting estimates may, by definition, vary from the actual results. Estimates are based on historical experience and various other assumptions that management and the Board of Directors believe are reasonable.

The Directors consider the critical accounting estimates and judgements used in the financial statements and concluded that the main areas of judgements are:

i. Revenue recognition policies in respect of contracts which straddle the year end.

The Group is required to make an estimate of the project completion levels in respect of contracts which straddle the year end for income recognition purposes. Estimates are based on expected total costs and revenues from each contract. Total expected costs are reviewed at each period and determined based on actuals to date versus managements historic experience in relation to similar contracts. This involves a level of judgement and therefore differences may arise between the actual and estimated result. Where immaterial differences arise they are recognised in the income statement for the following reporting period. Any material changes to these estimates would affect revenue recognised in the financial statements and the level of deferred or accrued income on the balance sheet.

ii. Contingent deferred consideration payments in respect of acquisitions and acquisition-related employee remuneration.

The Group has estimated the value of future amounts payable in respect of acquisitions. The estimate is based on management's estimates of the relevant entity's future performance. If these estimates change in the future as the earn out progresses, the amount of the provision will vary. Any changes to the carrying value of the provision are recognised in the income statement.

As part of a typical acquisition an amount is also payable to the employees of the acquired company. These acquisition-related employee remuneration costs are calculated using the same estimates of the relevant entity's future performance as the deferred consideration payable. If these estimates change in the future, as the earn out progresses, the amount of the employee liability, which is recognised over the earn out period, will vary. Any changes to the carrying value of these liabilities are recognised in the income statement.

iii. Valuation and amortisation period of separately identifiable intangible assets on acquisitions.

The Group is required to value the separately identifiable intangible assets acquired as part of a business combination. In order to value some of these intangible assets, the Group must make assumptions as to future cash flows derived from these costs and estimate the expected lives of these assets. Changes to these estimates would affect the resulting valuation of goodwill and the amortisation charge recognised in the financial statements.

iv. Impairment of goodwill and intangible assets acquired as part of a business combination.

The Group tests goodwill and intangible assets acquired as part of a business combination annually for impairment, in accordance with the Group's accounting policies. The recoverable amount is based on value-in-use calculations, which requires estimates of future cash flows and the discount rate to apply in order to calculate the present values of these cash flows. The estimates used and sensitivity of these assumptions is disclosed in note 11.

NOTES TO THE PRELIMINARY ANNOUNCEMENT

1 Post Balance Sheet Events

On 1 February 2017, the Group raised £15.0m (before expenses) by way of a placing of 15,463,919 new ordinary shares of 10 pence each at a price of £0.97 per ordinary share. The placing, which was oversubscribed, received strong support from both new and existing institutional shareholders.

On 1 February 2017, some of the proceeds from the placing of shares were used to complete the acquisition of the trade and assets of Defined Health Research Inc and Cancer Progress LLC, a business delivering scientific strategic advisory services to a wide range of US, European and global clients. The initial consideration was US$5.75m, of which US$5.25m was payable in cash and the balance was satisfied by the issue of 398,904 new ordinary shares. Further cash consideration will be paid to the vendors of the acquisition on a dollar for dollar basis to the extent that the acquired net current assets of Defined Health are over US$0.75m at the date of completion. In addition, deferred consideration of up to US$3.25m will be payable dependent on performance over the period from 1 February 2017 to 31 December 2019. These further payments will be in a mixture of cash and new ordinary shares, with a minimum overall cash consideration of 73%.

2 Non-GAAP Measures

The Group believes that reporting non-GAAP measures provides a useful comparison of underlying business performance and reflects the way the business is controlled. The Group reports two types of non-GAAP measure, Headline measures and like-for-like gross profit.

Headline measures 

Non-headline gains and losses are items that, in the opinion of the directors, are required to be disclosed separately, by virtue of their size, nature or incidence, to enable a full understanding of the Group's underlying financial performance. Accordingly headline measures exclude, where applicable, the effect of the following items:

i. Restructuring costs - these costs principally relate to redundancy costs. Further details are provided in note 5.

ii. Charge for VAT payable and related costs - these costs relate to the VAT payable to HMRC in respect of certain charity clients. Further details are provided in note 15.

iii. Employment settlement and related costs - these costs relate to the payment made to the prior employer of senior staff hired to establish the Cello Health BioConsulting business, in respect of post-employment restrictions.

iv. Start-up losses - these are defined as the net operating result in the period of the trading activities that relate to new offices, new products, or new organically started businesses. Activities so defined will cease being separately identified where, in the opinion of the directors, the activities show evidence of becoming sustainably profitable or are closed, whichever is earlier. In any event start-up losses will cease being separately identified after two years from the commencement of the activity. Further details are provided in note 6.

v. Amortisation of intangible assets - this is in respect of amortisation charged against separately identifiable intangible assets acquired as part of a business combination.

vi. Acquisition related employee remuneration expense - costs with regards to deferred payments payable to vendors and certain employees of a company in accordance with the share purchase agreement of the acquired company. In accordance with IFRS 3 Business Combinations, these costs are recognised in the income statement by virtue of employment conditions in the relevant share purchase agreement

vii. Share option charges - these costs represent the fair value of share options charged to the income statement and are separately identified due to their nature.

viii. Impairment of goodwill. Further details are provided in note 11.

Headline measures in this report are not defined terms under IFRS, and may not be comparable with similarly titled measures reported by other companies.

A reconciliation between statutory and headline (loss)/profit before taxation is presented in below:

Like-for-like gross profit

Like for like gross profit measures exclude the results from companies acquired in the year, and they also exclude the results of acquired companies in the prior year to the extent that those companies were not in the group in that prior year. Like for like gross profit measures also appropriately exclude the impact of start ups, which are defined in note 6. In aggregate, these adjustments are detailed in the table below.

Like for like measures are also calculated both with and without the impact of movements in currency. These measures are also disclosed in the table below.

3 Segmental Information

For management purposes, the Group is organised into two operating segments, Cello Health and Cello Signal. These segments are the basis on which the Group reports internally to the plc's Board of Directors, who have been identified as the chief operating decision makers. 

Revenue and costs not included in one of these operating segments, for example central overheads and results from start-up operations, have not been allocated to an operating segment in line with the way they are reported to the chief operating decision makers.

The principal activities of the operating segments are as follows:

Cello Health

The Cello Health Division provides market research, consulting and communications services principally to the Group's pharmaceutical and healthcare clients.

Cello Signal

The Cello Signal Division provides market research and direct communications services principally to the Group's consumer-facing clients.

Revenues derived from the Group's largest client are less than 10.0% of the Group's total revenue. Revenue derived from the largest client in each operating segment also represents less than 10.0% of external revenue in each segment.

Sales between segments are carried out at arms-length. The revenue from external parties reported to the chief operating decision maker is measured in a manner consistent with that in the income statement.

The Group's operations are materially located in the United Kingdom and the US.

The following table provides an analysis of the Group's revenue by geographical market, based on the location of the client:

The following table provides an analysis of the Group's non-current assets, excluding deferred tax costs, by geographical location:

4 Administrative Expenses

5 Restructuring Costs

6 Start-up Losses

Changes to the UK corporation tax rates were substantively enacted as part of the Finance Bill 2015 (on 26 October 2015) and the Finance bill 2016 (on 7 September 2016). These include reductions to the main rate of corporation tax to 19.0% from 1 April 2017 and to 17.0% from 1 April 2020. Deferred taxes at the balance sheet date have been measured using these enacted tax rates in these financial statements.

8 Discontinued Operations

The loss from discontinued operations relates to the Group's operations in Hong Kong which were closed during the year. In accordance with FRSS non-current assets held for sale and discontinued operations, the income statement for the year ended 31 December 2015 has been re-presented to include income and expenses of the discontinued operations within loss from discontinued operations.

An analysis of the results from discontinued operations is as follows:

10 (Loss)/Earnings per Share

Basic (loss)/earnings per share is calculated by dividing the earnings attributable to ordinary shareholders of the parent by the weighted average number of ordinary shares outstanding during the year, excluding treasury shares and shares in employee benefit trusts, determined in accordance with the provisions of IAS 33 Earnings per share.

Diluted (loss)/earnings per share is calculated by dividing earnings attributable to ordinary shareholders of the parent by the weighted average number of ordinary shares outstanding during the year adjusted for the potentially dilutive ordinary shares.

The Group's potentially dilutive shares are shares expected to be issued as deferred consideration on acquisitions and share options issued.

Headline earnings per share is calculated using headline post-tax earnings for the year, which excludes the effect of restructuring costs, start-up losses, amortisation of intangibles, impairment charges, acquisition accounting adjustments, share option charges and other exceptional costs.

The recoverable amount for each CGU is determined using a value-in-use calculation. This calculation uses budgeted pre-tax headline operating profit adjusted for non-cash transactions to generate cash flow projections. The budgets are approved by management based on past experience and historic trends. An underlying growth rate of 2.0% per annum in years 2 to 5 has accordingly been used for those years.

After year 5 a long term growth rate has been applied in perpetuity. This growth rate is based on estimated long term growth rates for the markets Cello operated in. Accordingly, a terminal value has been applied using an underlying long-term growth rate of 2.0%. No additional Cello specific growth has been assumed beyond year 1.

The pre-tax cash flows are discounted to present value using the Group's pre-tax weighted average cost of capital ("WACC"), which was 10.3% for 2016 (2015: 9.1%). This rate was calculated using the Capital Asset Pricing Model with an estimated cost of debt and equity, with appropriate small company risk factors.

The impairment review performed at 31 December 2016 resulted in an impairment charge of £4.9m to The Value Engineers ("TVE") CGU to its recoverable amount which equals its calculated value-in-use. The TVE CGU forms part of the Consumer Health operation within the Cello Health business. The impairment charge was a result of the reduction in profitability within this CGU, a position which the Board considers is unlikely to recover to its previous levels of profitability.

The impairment review did not result in an impairment of goodwill for any other CGU.

Sensitivity to changes in assumptions

The impairment review of the Group is sensitive to changes in the key assumptions, most notably the pre-tax discount rate, the terminal growth rate and projected operating cash flows. Reasonable changes to these assumptions are considered to be:

· 1.0% increase in the pre-tax discount rate.

· 1.0% reduction in the terminal growth rate.

· 10.0% reduction in projected operating cash flows.

The table below shows the variation to the recoverable amount at of the TVE CGU at 31 December 2016 with reasonable changes, in isolation, to the key assumptions:

At 31 December 2016, the value-in-use exceeds the total goodwill value across the Group by £64.7m. 

Reasonable changes to the assumptions used, considered in isolation, would not result in an impairment of goodwill for any of the Groups CGUs other than the TVE CGU. 

The following changes to the key assumptions, in isolation, would be needed before the recoverable amount being equal to the carrying value of goodwill in the CGU with the smallest headroom, other than the TVE CGU:

· An increase in pre-tax discount rate of 3.1% to 13.4%

· A decrease in terminal growth rate of 2.5% to (0.5)%

· A decrease in operating cash flows of 24.2%