Guide for Investors and Analysts
To assist investors and analysts to better understand
our Company and our financial statements, this
guide will appear on our website. The guide will
include an explanation of some financially significant
terminology used in the engineering and project
management business, as well as provide some
guidance for comparing companies in this sector.
It is our intention to communicate our results as openly and
transparently as possible, with interpretive commentary to
make them understandable.
Accounting Principles
We report in accordance with International Financial
Reporting Standards (IFRS). Within the possible choices
allowed by IFRS, our accounting policies enhance
transparency by limiting the ability of management to
influence results. Our full accounting policies are described
in the financial statements section of the annual report, but
here are some noteworthy examples:
All marketing costs1 are expensed. It is permissible
according to IFRS and common in the engineering and
project management business to capitalise marketing costs
related to a project at the end of a reporting period, if
management believes that there is a high likelihood that the
project will be secured. Such a policy has potential for
abuse and therefore Bateman Engineering writes off
marketing costs for all projects not secured by the end of the
reporting period.
Revenues and Profits for lump-sum turnkey (also known as
LSTK, EPC or Fixed Price) contracts are recognised on a
straight line basis (measured by percentage of completion),
while providing for any contingencies that may arise during
the completion phase. Forecast losses are recognised
immediately. The percentage completion of a project is
determined by dividing the total actual cost incurred to date,
by the total forecasted costs to completion (which include all
project specific provisions).
New Orders and Order Book
New Orders and Order Book are key indicators of the future
prospects of engineering and project management companies.
New Orders are the cumulative amount of new orders and
change orders (to existing contracts) received during the
period. When a New Order or change order is in a currency
other than the reporting currency (USD), it is computed by
converting the order value to USD at the exchange rate
prevailing on the date the order is received.
An order is only an order if all conditions precedent have
been met. It is common practice in the engineering and
project management business to “take to book” a new order
as soon as the contract with the client is signed. However, it
is common for contracts to have conditions precedent, most
notably related to project financing. We therefore take to
book new orders only once all conditions precedent have
been met and the contract has become effective.
Order Book is the value, on a given date, of the unexecuted
portion of all active orders previously received. It reflects the
amount of guaranteed revenue for future periods, and is also
commonly referred to as “forward order book” or “backlog”.
The Order Book is computed as follows:
Order Book at the previous reporting date
+ New Orders received during the period
- Revenue recognised during the period
± Exchange differences
= (closing) Order Book on the reporting date
LSTK vs EPCM Strategy
(or why do some project engineering companies have greater
Gross Profit margins than others)
Bateman Engineering pursues an LSTK (lump-sum turnkey, also
referred to as “EPC” or “Fixed Price”) strategy, which means it
usually contracts to deliver, on a given date and for a fixed
price, a process plant working to agreed specifications.
The common alternative strategy is EPCM (Engineering,
Procurement and Construction Management, also known as“Cost Plus” or “reimbursable”). Under an EPCM contract the
contractor gets paid to manage the project but without much
price risk.
In an LSTK project the entire cost (capital value) of the
project is paid over to the contractor, who in turn pays
suppliers and subcontractors (and often makes a profit on
such payments). The capital value of the project is thus
recognised as revenue by the contractor. Cost overruns or
cost savings are for the account of the contractor. LSTK
contracts typically carry a lower profit margin (in %) than
EPCM contracts but, because of their bigger size, the profit
in absolute terms can be greater.
In an EPCM contract, the contractor only gets paid for its
manhours, and suppliers and subcontractors are paid directly
by the client. As a result, only the manhour component of
the project is recognised as revenue by the contractor. Cost overruns or cost savings are usually to the account of the
client. EPCM contracts typically carry a higher profit margin
(in %) than LSTK contracts, but on a far smaller contract size.
LSTK contracts involve a higher degree of risk and require a
strong balance sheet. However, for a company which knows
how to manage the risk, the potential reward is higher profit.
Many mining companies, and in particular “junior” mining
houses, build process plants only once in a few years, and as a
result lack the in-house resources to supervise an EPCM
contractor, and are not adept at managing project risk.
Bateman Engineering manages risk on an ongoing basis and
can charge a premium for relieving the client from project risk.
There is a growing demand for LSTK contracting, because:
- The shortage of skilled personnel in the metallurgical and
mining industry worldwide is forcing clients to assign
more responsibility for projects to their contractors.
- Finance-providers to projects in the mining sector often
require the main contractor to provide a fixed (LSTK)
price so as to minimise lending risk.
The following table illustrates the costs borne by a client on a
USD100 million project when carried out through LSTK and
EPCM contracts. It is a highly simplified representation and
each contract has a different cost structure, but it demonstrates
how an LSTK contractor can generate higher profits than an
EPCM contractor for a given project, even though the EPCM
contractor may have a higher profit margin (in percentages):
| Amounts in USD million |
EPCM |
LSTK |
| Total project value (capital expenditure) |
100 |
100 |
| Costs borne by client divided as follows: |
|
|
Contractor services
|
15 |
19 |
Client in-house project management and insurance
|
5 |
– |
Equipment, construction, infrastructure and third
party services (includes profit to LSTK contractor)
|
80 |
80 |
| |
100 |
100 |
| Revenue recognised by contractor |
15 |
100 |
| Sample contractor’s profit margin |
15 % |
10 % |
| Profit for contractor |
2.25 |
10.00 |
Project engineering companies with high gross profit and
profit after tax margins often pursue an EPCM strategy, while
other companies (like Bateman Engineering) pursue an LSTK
strategy with lower margins but higher potential profits.
As a result of heightened demand in the industry, which has
resulted in overstretched suppliers and contractors, shortage
of skills and wage inflation, a hybrid form of contracting is
gaining popularity. The aim of a hybrid contract, which can
contain elements of both EPCM and LSTK, is to either more
effectively manage risk associated with the unknown or to
provide appropriate incentives, in the form of bonuses,
should the contract be completed within a specified period.
Focus on Profit After Tax
When valuing companies, profitability parameters often
considered include EBIT (Earnings Before Interest and Tax),
EBITDA (Earnings Before Interest, Tax, Depreciation and
Amortisation), PBT (Profit Before Tax) and PAT (Profit After Tax).
We believe that in valuing Bateman Engineering the most
appropriate profit parameter is PAT, for the following reasons:
- Bateman Engineering believes that an efficient, long-term
sustainable low tax rate adds shareholder value and has
therefore invested considerable resources to put such a
structure in place.
- In order to maximise its performance, Bateman
Engineering needs not only to excel in the engineering
disciplines but also in its financial planning. Bateman
Engineering therefore structures each contract on a tax
efficient basis, in conformity with the economic and
industrial realities of the project, given the circumstances
of the project and in full compliance with all tax rules,
including in particular international transfer pricing rules.
- The tax planning involved on a project by project basis
and the maintenance of a Dutch/ Luxembourg / Swiss
structure have a cost currently well in excess of
USD1 million a year, and will grow with the growth of
the Company (although not linearly).
- This cost is captured in Cost of Sales (reducing Gross
Profit) and in the Selling, General and Administrative
costs, both of which reduce EBIT. A focus on EBIT
therefore penalises us because it includes the costs of tax
optimisation without the benefits.
- The benefits of this investment in tax optimisation are in
the form of a low sustainable tax rate, which we currently
estimate to be approximately 20 %.
- Bateman Engineering is not a capital intensive company
(except for the Metal Recovery business), and thus does
not have substantial depreciation or amortisation.
Accordingly, EBITDA is not very relevant to us.
Bateman Engineering’s Tax Structure
Bateman Engineering’s tax structure is designed to optimise
two taxation aspects:
- Income tax on profits earned in the ordinary course of
business; and
- Tax on dividends distributed by subsidiaries to the top
holding company of the Group.
Income Tax
Income tax optimisation is achieved through careful
planning, transfer pricing, the utilisation of Group losses,
and inherent opportunities and favourable advanced tax
rulings in certain jurisdictions.
Tax Exemption on Dividends received in Holland
Pursuant to Dutch tax rules, dividends received by Bateman
Engineering N.V. from its subsidiaries in Luxembourg, South
Africa1 and certain other countries will typically be exempt
from tax in the Netherlands.
Summary of Tax Structure – 20 %Tax Rate
The future overall corporate income tax rate of Bateman
Engineering will depend on the mix of projects executed and
the location of clients in each case, on changing tax
regulations and on other factors, and cannot be projected with
accuracy, but management expects it to be approximately
20 %, based on currently prevailing tax laws and rulings.
