Qinetiq to restructure to reverse slumping profits

The defence group Qinetiq is to cut its running costs by 10 per cent in an attempt to turn around the 34 per cent slump in annual profits.

Despite the difficult annual results published yesterday, the group's shares shot up by more than 12 per cent after its chief executive, Leo Quinn – who took over in November – outlined a major restructuring plan aimed at returning the company to profit growth in two years.

For the 12 months to March, the company showed revenues broadly flat at £1.6bn, while pre-tax profits dropped to £85.7m, from £130m last year.

Investors knew what to expect. Qinetiq, which was spun out of the Government's Defence Evaluation and Research Agency in 2001, has issued two profits warnings in the past year, blaming delays to UK government contracts and changes to the US strategy in Afghanistan.

"It has been a very challenging year," Mr Quinn acknowledged yesterday, as the group cancelled its dividend for the coming year in order to strengthen its balance sheet without a rights issue. But Mr Quinn stressed positive developments including cash conversion of 145 per cent and debts down from £537m to £457m.

But Mr Quinn admitted the company needs radical surgery. His priorities are to bring the debt-to-earnings ratio from 2.5 to below two, to establish a more commercial culture, and to focus on maximising synergies.

Qinetiq has had a turbulent history. It has never lived up to its brief to commercialise its decades of hi-tech military expertise. When it was floated in 2006, senior executives including the former chief executive Graham Love and former chairman Sir John Chisholm were criticised for their windfall profits. And the company was implicated in the Nimrod disaster in Afghanistan, also in 2006, in which 14 servicemen were killed.

Mr Quinn diagnoses Qinetiq's recent problems as the result of "forced growth". The group bought 20 companies in just eight years, leaving little time for proper integration. And it also took on a series of higher-risk, low-margin contracts. "Qinetiq lost its way a little and focused on chasing revenues, both in acquisitions and organically," Mr Quinn said. "Last year, when revenues started to fall, some of the issues around how the acquisitions were integrated and our exposure on some of the contracts started to hit our costs and our profits."

The group faces two major stumbling blocks going forward. One is the parlous state of Britain's public finances and looming cuts to the defence budget. "The defence market globally is challenging to say the least," Mr Quinn said.

The other big challenge is industrial relations. Headcount reductions will be needed to deliver the 10 per cent cost-cutting target. But around half of the company's staff have contract terms left over from their original employment by the Ministry of Defence that are unaffordably generous, according to the management.

"It is a very difficult situation: we have to strike a balance between treating people fairly who leave the company and recognising that the people who remain also have to be looked after," Mr Quinn said. "We have spent £75m on restructuring in the UK in the last three years, but the people who stay in the company have not had a pay rise for 18 months."

Following extensive negotiations, the trade union Prospect is to ballot its members next month on the revised terms Qinetiq is offering.

Yesterday's results offered no outlook for the year ahead, given the uncertainties over both the market and the group's staffing levels. But the City responded positively.

"The strong cash generation has given Qinetiq a bit more breathing room to get on with restructuring," Ed Stacey, an analyst at Execution Noble, said. "The market is no longer worried the company doesn't have the balance strength to see through its plans, and Leo Quinn has given the market a favourable first impression of what he intends to do with the group."