REG - Serco Group PLC - Final Results <Origin Href="QuoteRef">SRP.L</Origin> - Part 2

SercoAnnouncement

12/03/2015 07:02

- Part 2: For the preceding part double click  ID:nRSL2478Ha 

                                    706           871           (201.6)  78.2     
 Of which, onerous contract provisions, asset impairments and other review items charged in 2014                              (237.1)           
 
 
Divisional revenue on a constant currency basis declined by 9%, though significant currency weakening against sterling,
particularly the Australian dollar, extended the decline on a reported currency basis to 19%.  The division's single
largest contract which provides Immigration Services in Australia saw revenues reduce by 35% to approximately £300m; this
reflected fewer people in our care following the significant changes to government policies addressing the issue of people
arriving by boat without a valid visa.  Other contract starts and ramp-ups provided good growth, including the Fiona
Stanley Hospital in Perth moving to the operational stage, a short-term contract providing private sector aviation support
services in the Australian natural resources industry; and new transport management services in Asia such as those for the
Hong Kong Tsing Sha Control Area. 
 
Divisional Trading Profit, before the impact of onerous contract provisions, asset impairments and other charges, reduced
much more significantly than revenue.  In Australian Immigration Services there was a greater impact on profitability from
the volume reductions together with changes to the mix of services provided and the types of centres remaining in
operation.  The loss of the Australian regional defence garrison support services contracts, operated in partnership with
Sodexo, has not reduced revenue as it was a joint venture operation, but reduced profits.  The Trading Profit for 2013
included a profit still being recognised on the Armidale Class Patrol Boats (ACPB) contract which was not repeated in 2014.
 Overheads also increased in the division, reflecting in particular increased bid costs on a number of unsuccessful large
tenders including a new-build prison and two rail operations in Australia. 
 
There was a significant impact from provisions, impairments and other review items in the AsPac division, with the vast
majority of this driven by the ACPB contract for Defence Materiel Organisation on behalf of the Royal Australian Navy. 
Detailed engineering reports have revealed major issues with the class of vessel, including those related to design,
manufacture, usage and maintenance practice, all of which have conspired to require maintenance expenditure far in excess
of that envisaged at the time the vessels first began service in 2005.  Until the second half of 2014, it was believed that
these issues could be fixed as part of a one-off maintenance cycle.  However, updated engineering assessments indicate far
greater costs over the remaining life of the vessels and therefore for our operation of the contract through to 2022.  An
onerous contract provision of £136m, together with a further £60m of related impairments and other balance sheet
adjustments, has therefore been required. 
 
The value of signed contracts totalled over £200m in 2014, however this was dominated by continuation of two existing
operations rather than new bids.  An extension to Serco's Traffic Camera Services contract in Australia is valued at
approximately £50m.  By far the largest award was successfully rebidding the provision of onshore immigration detention
services in Australia.  Whilst the five-year contract has a much larger potential value, since it is volume related, Serco
will initially only reflect in its order book an estimate of approximately £125m of revenue anticipated in relation to the
first year of the contract. 
 
Looking ahead, the estimate of lower immigration detention volumes is expected to reduce further the revenue for the AsPac
division in 2015.  There will also be a greater reduction in profitability than revenue following the rebid.  After
securing this important contract however, there are no other significant contracts that require extending or rebidding in
2015, though there will be attrition impact from the loss of the garrison support contracts and the end of the short-term
private sector aviation support services contract in the Australian natural resources industry.  Whilst progress on new
bids was weak in 2014, significant market opportunities remain in the region.  These include further opportunities in
Justice & Immigration, defence support and transport operations where Serco has strong presence in each of these local
markets.  Serco is also looking to develop opportunities in Citizen Services and build upon its skills in non-clinical
healthcare. 
 
Middle East 
 
Operations in the Middle East division include Transport, Defence, Healthcare and other Direct Services such as facilities
management. 
 
 Year ended 31 December                                                                           2014 Revenue  2013 Revenue  2014     2013     
 £m                                                                                                                           Profit   Profit   
 Revenue and Trading (Loss)/Profit                                                                260           268           (0.2)    24.5     
 Of which, onerous contract provisions, asset impairments and other review items charged in 2014                              (19.3)            
 
 
Divisional revenue on a constant currency basis increased by 3%, though the weakening of local currencies against sterling
resulted in a reported currency decline of 3%.  Growth was led by expanded transport operations including those in Dubai,
new health services in Abu Dhabi and defence training services in Qatar. 
 
Divisional Trading Profit, before the impact of onerous contract provisions, asset impairments and other charges, reduced
more than revenue.  The greater impact on profitability reflected lower margins on the Dubai Metro contract that was
extended in late 2013, the end of air traffic control operations in Kurdistan, together with delays in awards and lower
overall success rates on new bids. 
 
The impact of provisions, impairments and other review items was limited for the Middle East division compared to the other
divisions, and mainly reflects receivable and other impairments rather than any significant onerous contracts. 
 
The value of signed contracts during 2014 totalled approximately £135m.  This included the successful rebids of air
navigation services in Bahrain and Sharjah, and of our public facilities management contract for the Abu Dhabi
Municipality, the next phase of the new military college in Qatar and new contracts won for further healthcare support
services in Abu Dhabi and Saudi Arabia. 
 
Looking ahead, rebids to secure in 2015 include Sowwah Square facilities management, Baghdad air navigation services, Palm
Jumeirah Monorail operations and logistics and base support services provided to the Australian Defence Force (ADF) in the
region; these accounted in aggregate for 22% of 2014 divisional revenue.  Whilst new bid win rates have been lower in 2014,
there remains a vibrant public service outsourcing market in the region and Serco has strong references to continue
expanding.  Major opportunities include light rail across the region and other transport operations, as well as further
non-clinical healthcare and defence training support. 
 
Global Services 
 
Following the transfer of public sector BPO operations to our other divisions, the Global Services division now consists of
Serco's private sector BPO business, predominantly for customers in the UK, India and North America.  The operations
consist of middle and back office skills and capabilities across customer contact, transaction and financial processing,
and related consulting and technology services.  As previously described, Serco intends to dispose of the majority of the
private sector BPO business. 
 
 Year ended 31 December                                                                           2014 Revenue  2013 Revenue  2014     2013     
 £m                                                                                                                           Profit   Profit   
 Revenue and Trading (Loss)/Profit                                                                359           343           (23.4)   7.8      
 Of which, onerous contract provisions, asset impairments and other review items charged in 2014                              (30.3)            
 
 
Divisional revenue on a constant currency basis increased by 11%, though the weakening of local currencies against sterling
resulted in a reported currency growth of 5%.  Growth was led by new customers or expanded services in India and the Middle
East, the latter of which included the benefit of a small infill acquisition of a regional provider of BPO services;
organic growth was 9%.  Revenue in the UK declined, reflecting in particular the end of the additional work for the
transformation phase of the major Shop Direct contract as well as exits from certain loss-making contracts. 
 
Divisional Trading Profit, before the impact of onerous contract provisions, asset impairments and other charges, reduced
much more significantly than revenue.  Cost reduction activity announced last year has delivered savings in 2014, but these
were offset by profit decreases on certain contracts moving from transformation to full operational phase and an increase
in costs associated with internal systems.  The exit of low margin or loss-making work has also had the impact of a number
of delivery centres in the UK and India becoming underutilised in the short term. 
 
The impact of provisions, impairments and other review items reflects a number of onerous contract provisions required on
loss-making contracts, all of which are relatively small.  In addition to the £30.3m charged to Trading Profit, there is an
exceptional £39.2m impairment of Global Services assets transferred to held for sale; within this the largest
contract-related charge is for £8.7m for Shop Direct. 
 
The value of signed contracts during 2014 totalled approximately £250m.  The largest, with a value of approximately £140m
over 10 years was a new contract for multi-channel customer contact services for a major UK retailer.  Other similar
contracts have been awarded in the United States, Qatar and Australia, reflecting continued regional development of private
sector BPO operations. 
 
Looking ahead, there is no significant attrition anticipated from the ending of any individual contracts and there are also
no significant contracts that require extending or rebidding during 2015.  As always, existing customers are always seeking
to reduce costs, however our efficiency plans include a number of specific operational improvement initiatives in several
major contracts and delivery centres to improve profitability.  Currently there are a limited number of major new bid
opportunities to be decided, although the pipeline in this business tends to be generated over a shorter time period than
those for our frontline public service operations.  Reinvigorating business development efforts is a key focus of
management to recover the division from the consequential impact of challenges elsewhere in Serco, particularly some
residual brand issues in the UK market. 
 
Corporate costs 
 
 Year ended 31 December                                                                           2014 Revenue  2013 Revenue  2014     2013     
 £m                                                                                                                           Profit   Profit   
 Revenue and Trading (Loss)/Profit                                                                n/a           n/a           (90.2)   (50.6)   
 Of which, onerous contract provisions, asset impairments and other review items charged in 2014                              (37.3)            
 
 
Corporate costs relate to typical central function costs of running the Group including executive, governance and support
functions.  Where appropriate, these costs are stated after allocation of recharges to operating divisions.  The costs of
Group-wide programmes and initiatives are also incurred centrally, and these include the costs of the Corporate Renewal
Programme. 
 
There was a £37.3m charge to Trading Profit relating to the impairment of various intangible assets held at Group level,
property dilapidation provisions and balance sheet timing adjustments in recognition of employee-related costs. 
 
Finance Review 
 
Changes to non-statutory measures 
 
Our financial statement disclosure has been simplified, increasing the transparency of how we report and making it easier
for the reader of our Annual Report and Accounts to interpret the financial information.  The format and style of this
Finance Review has therefore changed with the use of newly defined non-statutory numbers and more explanation of what lies
behind the numbers.  The Finance Review is longer than usual as a result, but there is a lot to talk about and our
objective is to give our shareholders as clear an understanding as we can about what has happened from a financial
perspective in 2014. 
 
The simplification in the use of supplemental non-statutory measures used by the Board to assess the performance of the
business has involved moving to measures that are more closely aligned with IFRS and which are clearly and easily
reconciled to the numbers in the statutory financial statements.  A reconciliation to the former adjusted measures is
provided below to provide comparability from the old measures to these new ones. 
 
With respect to revenue, the former Adjusted Revenue measure included Serco's share of the revenue of joint ventures.  We
now exclude revenue from joint ventures in line with the statutory definition. 
 
In terms of profit, our new measure of Trading Profit more closely aligns to the statutory number, meaning fewer
reconciling items.  Trading Profit is defined as Operating Profit before i) amortisation and impairment costs of
intangibles arising on acquisitions, and ii) exceptional items.  A significant change from the former Adjusted Operating
Profit measure has been to present joint venture results on a statutory accounting basis which includes the share of joint
venture results after tax and interest instead of proportionally consolidating joint venture Adjusted Operating Profit.  In
addition, Trading Profit is now stated after transaction-related costs and no longer excludes any "Management Estimates". 
For example, during financial year 2013, management excluded from Adjusted Operating Profit the estimated impact of the
charges related to UK Government reviews on the business. From this set of Accounts onwards, no "Management Estimates" will
be included in the Trading Profit measure unless they are classified as exceptional items in the statutory consolidated
Income Statement. 
 
Trading cash flow is the net cash flow from operating activities before exceptional items as shown on the face of the
Group's Consolidated Cash Flow Statement and is stated after capital expenditure on tangible and intangible purchases less
proceeds of tangible and intangible disposals, adding dividends we receive from joint ventures and adjusting to remove tax
payments or receipts. Free Cash Flow is Trading Cash Flow after adjusting to add interest received, deduct interest paid,
deduct Tax payments, and add Tax received.  Free Cash Flow and Trading Cash Flow, consistent with Trading Profit, exclude
exceptional items which are considered to be non-recurring in nature and outside the normal operations of the Group. 
Consistent with Trading Profit these measures also no longer exclude transaction-related costs and "Management Estimate"
items. 
 
A new measure of pre-tax return on invested capital (ROIC) has been introduced in 2014 to measure how efficiently the Group
uses its capital in terms of the return it generates from its assets.  Pre-tax ROIC is calculated as Trading Profit divided
by the Invested Capital balance.  Invested Capital represents the assets and liabilities considered to be deployed in
delivering the trading performance of the business.  Of the total assets on the balance sheet, Invested Capital assets are:
goodwill and other intangible assets; property, plant and equipment; interests in joint ventures; trade and other
receivables; inventories; and assets classified as held for sale.  All other assets are excluded from Invested Capital,
being: retirement benefit assets; tax assets; derivative financial instruments; and cash and cash equivalents.  Of the
total liabilities on the balance sheet, Invested Capital liabilities are trade and other payables and liabilities
classified as held for sale.  All other liabilities are excluded from Invested Capital being: retirement benefit
obligations; tax liabilities; provisions; obligations under finance leases; derivative financial instruments; and loans. 
The calculation of ROIC is shown in a table presented later in this review. 
 
Overview of financial performance 
 
Serco faced an unprecedented set of challenges in 2014, and as a consequence our financial performance in 2014 was very
poor.  Some of these challenges arose in 2014 as a direct result of the issues we encountered in our relationship with the
UK Government in 2013 and other key customers, and there is little doubt that these difficulties had a substantial impact
in 2014 on our ability to win new business and to satisfactorily resolve contractual issues; others were due to some
valuable contracts being lost or taken back in house; while on certain other contracts the cost of providing services rose
- in some cases dramatically. 
 
·       The business encountered critical operational difficulties during the year on some large contracts (for example
COMPASS and ACPB) with a consequent and unexpected increase in costs to levels far above those seen in 2013 
 
·       Contracts which in 2013 had contributed significant amounts of profit were lost (e.g. Electronic Monitoring), had
reduced margins on re-bid (e.g. Northern Rail) or saw sharply lower profitability as a consequence of reduced volumes (e.g.
Australian Immigration) 
 
·       There has been a significant change in senior management, in particular in the Group leadership and the UK
business, together with a restructuring of the latter into two new divisions 
 
·       The business was operating for a number of months in a strategic vacuum as the new management team were actively
developing a new strategic direction for the Group 
 
These challenges had a significant adverse impa