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Operating and Financial Review

In 2004/5 Ofcom was able to deliver greater efficiency savings than anticipated. By delivering projects below our planned operating budget – and also through the rephasing of work which will now be completed (and, therefore, funded) in 2005/6 – we were able to reduce substantially the cost of regulation for the sector.

Principal activities

Ofcom’s duties and powers are derived principally from the Communications Act 2003, which received Royal Assent on 17 July 2003 (footnote 1). One of the consequences of the legislation was the transfer to Ofcom of the functions, property, rights and liabilities of the bodies and office holders which had previously regulated the communications sector (footnote 2). This transfer took place on 29 December 2003 when Ofcom assumed its full statutory powers under the Act.
Ofcom is an independent statutory corporation accountable to Parliament. Its specific duties under the Communications Act 2003 fall into six areas:

ensuring the optimal use of the electro-magnetic spectrum;
ensuring that a wide range of electronic communications services – including high-speed data services – are available throughout the UK;
ensuring a wide range of television and radio services of high quality and wide appeal;
maintaining plurality in the provision of broadcasting;
applying adequate protection for audiences against offensive or harmful material; and
applying adequate protection for audiences against unfairness or the infringement of privacy.

Financial framework

Under Paragraph 8(1) of the Schedule to the Office of Communications Act 2002, Ofcom is required to balance its expenditure with its income in each financial year. Sections 38 and 347 of the Communications Act 2003 also require Ofcom to raise income from each of the sectors it regulates such that it covers the costs to be incurred by Ofcom in regulating that sector. Ofcom must also apportion its common operating costs – those which do not relate directly to any one sector – in a proportionate manner across each of those sectors.

Ofcom raises its funds from a number of sources including:

television broadcast licence fees;
radio broadcast licence fees;
administrative charges for electronic networks and services and associated facilities; and
funding to cover Ofcom’s operating costs for spectrum management in the form of grant-in-aid from the DTI.

Grant-in-aid covers the costs of regulating and managing the wireless spectrum. It also covers those statutory functions and duties which Ofcom must discharge under the Communications Act but for which the Act provided no matching revenue stream. Examples include the statutory public interest test for media mergers and ex post Competition Act investigations in relation to networks and services.

Operating results

Ofcom recorded an operating surplus for the year under review of £22.5m. For 2004/5 Ofcom set an Operating Budget (i.e. operating costs, excluding depreciation, Spectrum Efficiency Scheme and certain non-cash costs such as those for rent-free periods, but including capital expenditure) of £140.6m. In setting that budget, Ofcom built in the five per cent efficiency savings it had already achieved from merging the functions of the five legacy organisations and the headcount reduction of 25 per cent. Ofcom also made a commitment publicly to seek a further five per cent efficiency gain during the 2004/5 year; a target of a further five per cent efficiency gain during 2005/6 and of continuing to seek further efficiencies thereafter to be an RPI-Minus Cost Regulator.

Ofcom’s actual operating costs for 2004/5 were £121.6m, £19.0m lower than budget. Note 2 to the financial statements presents, by sector, Ofcom’s actual outturn for 2004/5 and the table below reconciles between Ofcom’s internal reporting and the financial statements.

The savings against budget reflects higher than expected efficiency gains from bringing together the legacy organisations but also that a number of major projects, scheduled for completion in 2004/5 will now be completed over the forthcoming financial year.

On 31 March 2005, Ofcom published the tariff table for 2005/6 which was based on an estimated outturn for 2004/5 of £124.1m. The final outturn for 2004/5 was £2.5m lower than this and additionally, Ofcom recovered £2.3m more income than was anticipated when the tariff table was published.

This additional income primarily relates to monies received by Ofcom in respect of the over-recovery of fees and under-spending of costs by legacy organisations.

The total £4.8m of ‘extra efficiency gain’ will be passed back to stakeholders during:

2005/6 for income streams that are funded via grant-in-aid from the DTI; and
2006/7 for networks, television and radio stakeholders (i.e. as a credit against 2006/7 licence and administration fees).

As a general rule, income received in excess of operating costs has been deferred on Ofcom’s balance sheet at 31 March 2005. However, the DTI’s funding of Ofcom’s 2003/4 ex-post Competition Act activities in the Network and Services sector gives rise to a surplus of £0.9m because the related costs were recognised in Ofcom’s 2003/4 accounts.

The operating surplus of £22.5m was utilised, primarily, to repay part of the DTI loan (as detailed below). After taking into account the exceptional credit of £3.7m (see Property management below), interest receivable of £1.1m, interest payable on the DTI loan of £1.8m, a dividend of £0.7m received from a former joint venture (see Note 13 to the financial statements), the unwinding of the discount on the vacant property provision of £0.8m and corporation tax payable of £0.2m, Ofcom had a retained surplus for the year of £25.0m.

This compares to a retained deficit of £47.2m in the previous year which, primarily, was the result of Ofcom having nine months of pre-vesting costs (£19.0m) with no related income and the exceptional provision of £22.2m against vacant properties.

2005/6 budget

Ofcom’s Operating Budget for 2005/6 is £133.0m. This is five per cent lower than the 2004/5 budget (eight per cent lower in real terms compared with the 2004/5 Operating Budget plus RPI). Recognising the impact of the re-phasing projects and of projected RPI increases in 2005/6, Ofcom believes that the £133.0m operating budget is a prudent figure.

Taking into account both this reduced budget and the savings against the over-recovery of income in 2004/5, regulatory fees for 2005/6 will reduce by an average of:

26 per cent for television licensees, a total cost reduction to the industry of £8.5m in real terms;
29 per cent for radio licensees, a total cost reduction to the industry of £1.3m in real terms; and
eight per cent for networks and services operations, a total cost reduction to the industry of £2.0m in real terms.

People

At 31 March 2005, Ofcom had 753 (2004: 727) employees and 30 (2004: 102) secondees from the DTI. In the first half of the year under review, certain key posts were still being filled. Thereafter, headcount was largely stable, except that the Operations and Technology Groups were streamlined to meet the requirements of all the sectors regulated by Ofcom. Consequently, Ofcom has recorded an exceptional charge of £5.3m (2004: £nil) for restructuring in the year.

Pensions

Employees of public sector organisations are typically offered membership of a defined benefit pension scheme as part of their remuneration. These schemes typically carry with them significant financial exposure. Ofcom addressed this issue early in its formation so that its primary means of providing pension benefits is a pension allowance provided to all external recruits to Ofcom and those colleagues from the legacy regulators that have chosen this route. This allowance may be used to make contributions to a defined contribution pension scheme.

Ofcom’s approach has proved to be successful in minimising liability whilst also ensuring colleagues are able to set aside funds for retirement. In total, 72 per cent of Ofcom colleagues are employed on terms with a defined contribution pension plan; 23 per cent are on Ofcom terms with a capped exposure defined benefit pension plan; and just five per cent remain on the existing terms inherited from legacy organisations.

For those colleagues who chose to remain on previous employment terms or who moved to Ofcom terms and conditions, Ofcom operates two closed defined benefit pension schemes:

the Ofcom (former ITC) Pension Plan (“the Former ITC Plan”) which Ofcom jointly participates in with S4C and S4C Masnachol; and
the Ofcom Defined Benefit Pension Plan (“the Ofcom Plan”) for those employees who exercised their right to maintain a defined benefit pension, but with a limit on the level of pay increase which would attract a defined benefit pension.

The accounting treatment of these defined benefit schemes is presented in Notes 14 and 26 of the Notes to the financial statements. These show that Ofcom has a pension asset as at 31 March 2005 of £10.6m as measured by Financial Reporting Standard 17 (FRS 17), principally relating to the Former ITC Plan.

The information required to meet the reporting requirements of FRS 17 was not available for the Former ITC Plan for the preparation of the 2003/4 financial statements and therefore the 2004/5 financial statements reflect for the first time a full FRS 17 valuation of this scheme. It is relatively mature, compared to many similar schemes, in that over 85 per cent of the liability relates to pensioners or deferred pensioners. The use of the discounting assumptions stipulated by FRS 17 gives rise to an accounting asset. By contrast, the assumptions used by the Actuary for the actuarial valuation gives rise to a net deficit in the plan at 1 January 2004 of £6.0m and this forms the basis of the recommended annual contributions to the scheme.

Ofcom made (and continues to make) cash contributions to the former ITC Plan on the basis of the actuarial valuation. These cash contributions, rather than the amount charged to operating surplus (as calculated under FRS 17), are included in the expenditure used to calculate the tariffs charged to stakeholders each year.

During the year Ofcom made defined benefit contributions of £3.2m and payments of £2.0m to the defined contribution schemes.

Investments in fixed assets

During the full year period under review, Ofcom invested a total of £5.6m (2004: £16.0m) in fixed assets. Of this balance, £2.0m was invested in fixtures and fittings, primarily in respect of the new national offices in Cardiff, Glasgow and Belfast. A further £1.3m was invested in information systems and equipment, and £2.0m in office and field equipment.

DTI loan

Ofcom’s establishment and restructuring loan of £52.3m is repayable to the Department of Trade and Industry in the period from March 2004 to March 2008. The repayment of the loan capital and interest is funded from the main sources of income for Ofcom. The phasing of repayments is determined under the loan agreement with the DTI. Ofcom has allocated the launch costs for the complete repayment period until March 2008 on a proportionate basis, using the amount of expenditure incurred by the legacy organisations in each sector as the basis for allocation.

Additional funds collected on behalf of HM Treasury

Ofcom’s funding for spectrum management activities is ultimately derived from the fees paid by licensees to the UK Exchequer. In total, those monies, collected by Ofcom on the Government’s behalf, represent a significant contribution to the public purse. In 2004/5, in accordance with section 400 of the Communications Act, Ofcom invoiced and collected £406.0m from wireless communications and broadcasting companies in spectrum revenues and licence receipts.

At 31 March 2005, £35.3m (2004: £37.3m) of spectrum fees were uncollected. Most of these debts will be recovered in the ordinary course of business. No debts may be written off without authorisation from the DTI, and HM Treasury is also consulted in respect of write-off requests for significant balances. At the balance sheet date, the following significant amounts had been outstanding for more than 12 months:

£1.7m owed by Inquam Telecom (Holdings) Limited – a legal agreement between Ofcom and Inquam has agreed a future repayment plan; and
£0.2m owed by Quiktrak (UK) Limited, a company in liquidation. At the date of this report, Ofcom does not expect to recover this debt.

During the year under review, Ofcom repaid £17.8m of the loan and at 31 March 2005, the loan balance outstanding was £28.2m.

Litigation

During the year under review, Ofcom carried out a full review of its liabilities arising from the decisions made by Ofcom and its legacy bodies. As a result of this review, the legal provision in the financial statements has reduced from £1.3m to £0.3m.

Property management

During the first half of the year under review, work was undertaken to complete the fit-out of the new national offices in Cardiff, Glasgow and Belfast. Once this project was completed successfully, the Ofcom Facilities Group focused on actively marketing the most commercially attractive vacant property leased by Ofcom. Significant progress has been made at South Quay (formerly Wyndham House) and Riverside House in particular and further progress is expected in 2005/6.

As in 2003/4, Ofcom has adopted a prudent approach in providing against all future vacant property costs. The provision is based on all future premises cash flows up to the earlier of either the first lease break, or the end of the lease, discounted by Ofcom’s cost of capital. While it is probable that the longer leasehold properties will be disposed of at some stage, it is not possible to estimate the associated income reliably. Ofcom has therefore taken the prudent approach of not recognising any future income unless commitments are already in place or reasonably certain.

In the year ended 31 March 2005, an exceptional credit of £3.7m (2004: charge £22.2m) is recognised in the Income and Expenditure account as a result of the successful sub-letting of properties referred to above. In addition, £4.2m of the vacant property provision was utilised during 2004/5 and after taking into account the unwinding of the 2004/5 element of the discount on the provision of £0.8m, the provision at 31 March 2005 was £15.2m (2004: £22.4m).