Financial highlights

• Group turnover up 16% on the corresponding six months to £216.6 million(2003: £187.1 million), including £18.0 million contribution from Diagonal Plc ('Diagonal')
• Continental Europe turnover up 17% on the corresponding six months at £72.5 million (2003: £62.2 million)
• Operating profit before goodwill amortisation* and exceptional items of £4.0 million (2003: £3.0 million)
• Profit before goodwill amortisation* and exceptional items of £4.8 million (2003: £4.1 million)
• Reported loss before tax £7.6 million (2003: £6.8 million)
• Earnings per share before goodwill amortisation* and exceptional items of 2.3p compared to 2.1p in the corresponding six months
• Net cash balance at half-year end of £39.0 million (£62.0 million at 30 June 2004) after expenditure of £20.7 million on the acquisition of Diagonal
• Interim dividend of 1.15p (2003: 1.05p)

*Goodwill arising on acquisitions is in general amortised by Morse over three years, details of which are shown in the profit and loss account.

Business highlights

• Integration of acquired Diagonal business now complete
• Further cost savings identified
• Combined proposition being well received by customers
• 41% of turnover and 54% of gross profit now generated from services
• Improved services gross margins in the UK, Ireland, Germany and Spain
• Significant reduction in losses in French business

Commenting on the results, Richard Lapthorne, Chairman, said:

"During the period, Morse delivered profitable growth, whilst further expanding and broadening the skill base required to achieve its aim of becoming a strategic partner to key customers.

The Diagonal business, which we acquired in August 2004, has proved to be a good fit with our existing skills base and our business proposition is now much stronger than either Morse or Diagonal could previously have offered alone.

We are currently realising 41% of sales and 54% of gross profit from our services operations compared with 8% and 11% respectively when we became a listed company in 1999 and we have now set ourselves the challenge of building a solutions-based business that will account for between 70% and 80% of our profits."

Duncan McIntyre, Chief Executive, added:

"I am particularly pleased by the response of our customers to the successful integration of Diagonal. The process of changing the profile of Morse from a pure reseller to a consulting, technology and support company has been an evolutionary rather than an overnight one. Nevertheless, by proceeding with caution over the last five years, we have avoided paying inflated prices for assets and have maintained a strong balance sheet throughout.

We are confident that, given current trading conditions and with our portfolio of solutions to build upon, the Group can look forward to accelerated development in the second half of this year and we are targeting increased gross margins and profitability over the coming years."

Chairman's statement

Overview

During the period, Morse continued to build revenues and made significant progress in its strategic aim of becoming a trusted partner to global businesses.

Trading conditions remain mixed across our geographical base. The market remains unchanged in the UK with conditions still challenging and competitive. The environment in Spain and Ireland is more positive and there are increasing signs of stabilisation in Germany and France. In order to ensure resources are in place and appropriately targeted in line with the Group's strategy, we are continuing to use our strong financial position to invest in both higher margin and developing business areas.

Since acquiring Diagonal in August 2004, we have already achieved the anticipated £1.5 million of annualised cost savings as a result of combining the two businesses and we have now identified a further £1.0 million of annual savings, mainly related to property, which we expect to realise during the year ending 30 June 2006.

In the six months to 31 December 2004, Group turnover increased by 16% to £216.6 million compared with the same period last year (2003: £187.1 million), of which £18.0 million came from Diagonal. Continental European business accounted for 34% of Group turnover, up 17% to £72.5 million compared with the same period last year (2003: £62.2 million). Operating profit before goodwill amortisation and exceptional items increased by 33% to £4.0 million compared with the same period last year (2003: £3.0 million). The Group's profit before tax, goodwill amortisation and exceptional items for the period was £4.8 million (2003: £4.1 million) and the reported loss before tax was £7.6 million in the six months to 31 December 2004 (six months to 31 December 2003: £6.8 million). Earnings per share before goodwill amortisation and exceptional items increased 10% to 2.3p compared with the same period last year (2003: 2.1p) and the Group remained cash generative, producing a net cash inflow from operations of £0.9 million. At the period end, the Group had a net cash balance of £39.0 million (£62.0 million at 30 June 2004; £70.7 million at 31 December 2003) after the expenditure of £20.7 million on the acquisition of Diagonal.

An interim dividend of 1.15p has been declared (2003: 1.05p) and is payable on 1 April 2005 to shareholders on the register on 4 March 2005.

As a result of the acquisition of Diagonal, 41% of sales and 54% of gross profit are generated from our services operations compared with 8% and 11% respectively when we became a listed company in 1999. Following our listing, the decision was made to seek to transform the business from a value-added reseller to a consulting, technology and support company. To achieve this, we focused on expanding the services side of the business, exploiting the cash generative nature of our infrastructure business to fund new acquisitions and to develop our own intellectual property.

With the market turbulence of recent years, this shift in the balance of our business has afforded us some protection from the trends of product commoditisation and consolidation which have emerged as the IT market matured. The investment we made in the development of the business during this time continues to benefit the Group today at a time when the hardware market is still subject to pricing pressure. While our infrastructure operations will continue to form an important part of our business model and the integrated solutions we provide, we have now set ourselves the challenge of building a solutions-based business that will account for between 70% and 80% of our profits.

Acquisitions

Over the last 18 months we have made three strategic acquisitions that illustrate how we are evolving the Group. In December 2003 we acquired Techsol, to help us reach critical mass in the German market; in April 2004 we acquired CSTIM, which immediately strengthened our credentials in the investment management industry; and in August 2004 our acquisition of Diagonal gave us a leading SAP consultancy, change management expertise, enhanced security capabilities and greater application development capacity. Our strategy remains to seek investment opportunities that will consolidate and extend our geographical and vertical market penetration and our service offerings.

Diagonal has proved to be a good fit with our existing skills base, and has generated new business development opportunities for both Diagonal's and Morse's existing operations. Cross-selling across the combined businesses has been well received by customers and we are confident that this will continue to bear fruit. We successfully completed our initial 100-day integration plan of Diagonal without losing key staff or customers and without impacting day-to-day operations in either organisation. The Group is much stronger as a result and we believe the acquisition has also brought more value to our customers and to alliance partners. Diagonal's SAP business is performing in line with expectations and utilisation rates are good. As announced in our Q2 update in January 2005, the only disappointment which arose was one loss-making, pre-acquisition contract around which discussions are continuing with the client. Diagonal's security business has an excellent proposition and we are focused on identifying ways of scaling this operation more effectively. Diagonal's overall contribution to Group profits of £1.0m is in line with our expectations and we expect this to improve further as integration continues.

Intellectual property

One of the most exciting examples of our development of intellectual property is the interest we are seeing in Diagonal's "Wisdom" electronic document and record management system (EDRMS) which complies with the UK's National Archives specification for record management systems. With the recent Freedom of Information Act coming into force alongside other legislative and regulatory governance initiatives, Wisdom is being considered for adoption by both central and local government agencies. We believe there is a good market for the product both in the UK and in Continental Europe.

Another example of successful intellectual property development was MChex, a carrier grade provider of mobile SMS services, which we sold to Stream Group plc in January 2005. This consumer-facing technology was built and developed within Morse alongside MobileATM, a mobile commerce solution developed in partnership with LINK Interchange Network Ltd, which is expected to launch before the end of our financial year.

This is an exciting time for the Group and we believe our business proposition is now much stronger than either Morse or Diagonal could previously have offered alone.

UK and Ireland

Turnover in the UK and Ireland for the six months ended 31 December 2004 increased by 15% to £144.1 million compared to the same period last year (2003: £124.9 million) and operating profit before goodwill amortisation and exceptional items was £2.3 million (2003: £2.9 million).

The acquisition of Diagonal provided a significant boost to UK sales, and helped us continue to deliver growth despite a decline in infrastructure revenues of approximately 1%, compared with the same period last year. As anticipated, trading conditions remained particularly challenging in the infrastructure market and our margins in this area reduced by 2 percentage points compared to the same period last year, but we expect our focus on key partners to help strengthen this performance going forward.

Our established service practices - enterprise and service management, technology integration and project management - continued to perform well and our flexible resourcing business delivered a strong performance. The contribution from Diagonal, together with another good performance from our business in Ireland, had a direct impact on overall gross margins, which increased during the period to 20.6% (2003: 19.7%).

As the balance of our business evolves, we will continue to refine our cost base. In particular, we plan to reduce our property requirements in the coming financial year.

Including the acquisition of Diagonal, headcount increased to 1,340 (2003: 829).

Germany

Turnover in Germany for the period increased by 27% to £37.1 million compared to the same period last year (2003: £29.1 million) and operating profit before goodwill amortisation and exceptional items increased to £1.1 million (2003: £0.1 million).

Market conditions in Germany have continued to show signs of stability, and the integration of the Techsol business we acquired in December 2003 is now complete. Our short-term focus has been on realigning our staff base to enhance sales and as this begins to feed through, we will be looking to expand our professional services and business consulting capability in the region, as well as investigating opportunities to increase penetration in the north and west of Germany.

As the business stabilised and increased its level of services sales during the period, gross margins increased to 17.6%, compared with 16.9% in the same period last year. Overall headcount was reduced from 228 to 192 half-year on half-year.

France

Turnover in France for the six months ended 31 December 2004 increased by 6% to £22.2 million compared to the same period last year (2003: £21.0 million).

We are now seeing indications of improvement in the French market. Reflecting this, France continued to reduce its operating losses before goodwill amortisation and exceptional items to £0.2 million in the six months ended 31 December 2004 compared with £0.7 million in the corresponding period in 2003. Gross margins have shown volatility as project business feeds through but moved back to the more normal level of around 15% in the six months ended 31 December 2004. Overall headcount was reduced from 150 to 122 half-year on half-year.

We are optimistic that this stabilisation will continue and that our French business will return to profitability in due course.

Spain

Spain has continued to perform well during the period. Turnover increased 9% to £13.2 million compared to the same period last year (2003: £12.1 million) and gross margin increased to 21.2% (2003: 19.0%), reflecting success in moving to a more broadly-based technology integration business. This development has been achieved whilst taking care not to erode the strong relationships the business has established with its existing customers and partners, and gives the management team a very strong base from which to move forward. The growth in staff numbers to 103 at 31 December 2004 (2003: 73) reflects the development of the services offerings within the business.


Sector verticals

Finance

Turnover in the sector for the six months to 31 December 2004 was £97.7 million, an increase of 7% on the same period last year (2003: £91.1 million). There has been no substantial change in market conditions during the period, with most of the additional revenue coming from the retail finance sector and increased utilisation of our flexible resourcing and managed services businesses.

Telecommunications

Turnover in the sector for the six months to 31 December 2004 was £36.3 million, an increase of 34% on the same period last year (2003: £27.0 million). The sector as a whole appears to be more self-confident and we are continuing to generate sales by helping companies use their IT more effectively and, as mobile operators begin to roll-out their 3G products, we are beginning to see a positive impact on revenue.

Commercial

Turnover in the sector for the six months to 31 December 2004 was £59.3 million, an increase of 43% on the same period last year (2003: £41.5 million).

Morse's commercial sector includes industries such as media, pharmaceuticals, retail, manufacturing, professional services organisations and utilities. The addition of Diagonal has had a significant positive impact on revenues from this sector due to its strengths in areas such as retail and manufacturing. Its customers are typically both sizeable and international, but they do not traditionally have substantial in-house IT capability. We continue to see good opportunities to develop our relationships with businesses demonstrating these characteristics.

Public sector

Turnover in the sector for the six months to 31 December 2004 was £11.6 million, down from £13.2 million in the corresponding period in 2003. However, this is an improvement over the second six months of last year following our decision to expand our business with existing customers. We are also seeing considerable interest from the public sector in Diagonal's Wisdom product, as referred to above.

Processes and people

We continually look to improve and streamline processes across the Group. Following our review of duplication within Morse and Diagonal, we have successfully blended certain head office functions, resulting in the anticipated total annualised savings of £1.5 million being realised. The opportunities for further consolidation and cost savings remain considerable, particularly within our property portfolio, and we are now looking at finding ways to improve the efficiency of both front office and back office functions.

At 31 December 2004, Group headcount stood at 1,757. As our pipeline builds, we are focusing recruitment on revenue-generating consulting staff to ensure our capacity is in line with the requirements of our clients.

Maintaining uninterrupted operations while undertaking an integration project as large as that of Morse and Diagonal has been challenging, particularly in view of the aggressive timescales we set ourselves. It was the sheer determination and drive of our people that allowed us to carry this out successfully and they should be rightly proud of their achievements.


Current trading and outlook

We expect overall revenues to continue to grow this year. Taken as a whole, business in Continental Europe appears to have normalised, although there are clear regional variations in trading conditions.

We are confident that, given current trading conditions and with our portfolio of solutions to build upon, the Group can look forward to accelerated development in the second half of this year and we are targeting increased gross margins and profitability over the coming years.


Richard Lapthorne
Chairman