Final Results
1 March 2006
Serco Group plc - 2005 Preliminary Results
Outstanding year with firm foundations for revenue and margin increases going
forward
2005 2004
Revenue £2,260.3m £1,636.9m up 38.1%
Profit before tax and amortisation £91.5m £71.2m up 28.5%
Earnings per share before amortisation 14.09p 11.46p up 22.9%
Profit before tax £77.9m £64.0m up 21.7%
Earnings per share 11.66p 10.11p up 15.3%
Dividend per share 2.97p 2.63p up 12.9%
Further strong growth
* Organic revenue growth of 19.4% and organic PBTA growth of 13.1%
* In 2005, contract wins and extensions of £2.6bn secured and appointed
preferred bidder on contracts valued at a further £2.4bn
* Continued win rates of over 90% of rebids and over 50% of new bids
* Acquisitions of ITNET and RCI added £333.9m to revenue and £23.6m to PBTA
(£10.3m after funding costs)
* Group EBITDA to cash conversion of 90% contributing to Group free cash flow
of £73.8m (2004: £55.8m)
Rapidly developing capabilities and markets
* ITNET and RCI have added new skills and capabilities and taken us into new
and growing markets
* Leveraging Group-wide capabilities to win large and technical contracts -
Cyclamen (£100m) and Small Business Service (£125m)
* Increasing range of drivers expanding our markets around the world
High visibility of future revenue
* Forward order book at a record £13.4bn at 31 December 2005
* 91% of planned revenue for 2006, 77% for 2007, 64% for 2008
* None of our ten largest contracts due for rebid before end of 2010
* Encouraging start to 2006 - appointed preferred bidder for £1.0bn Marine
Services rebid
Continuing positive outlook
* Unprecedented range of market opportunities
* In excess of £21bn of opportunities identified across our markets
* Selective bidding, portfolio management and efficiency will contribute to
increasing margins
* Confident of double-digit growth for the foreseeable future
Note: Organic growth excludes the impact of acquisitions and disposals, as
included in the Finance Review.PBTA is profit before tax and intangible
amortisation. Group EBITDA is earnings from subsidiaries before interest, tax,
depreciation and intangible amortisation. Cash conversion is the ratio of Group
operating cash flow to Group EBITDA. Group free cash flow is from subsidiaries
and joint venture dividends and is reconciled in Section 4 of the Finance
Review.
Commenting on the results, Kevin Beeston, Executive Chairman of Serco, said:
'2005 was an outstanding year for Serco. Markets continue to grow, primarily
driven by governments' needs to control spending and improve the quality of
public services. Our public service ethos and commitment to partnership enable
us to win more than 90% of rebids and 50% of new bids. This success is built on
a firm foundation: consistent, high quality service to satisfied customers. Our
balanced portfolio, spread across our chosen sectors and international markets,
allows us to target the best opportunities. The forward order book stands at a
record level and none of our ten highest revenue contracts are due for rebid
before the end of 2010. We remain confident of continuing double-digit growth
and increasing margins.'
- Ends -
For further information please contact Serco Group plc: +44 (0) 1256 745 900
Richard Hollins, Head of Investor Relations
Graham Capper, Head of Media and Public Relations
Dominic Cheetham, Corporate Communications Director
www.serco.com
Presentation and Conference Call
A presentation for investors and analysts will be held at JP Morgan Cazenove,
20 Moorgate, London EC2R 6DA, at 9.30am.
A conference call for investors and analysts will be held today at 14.30 UK
time.
Participants outside the US should call: +44 (20) 7019 0810
US participants should call: +1 210 795 0466
The passcode for the conference call is `Serco'
Copies of the presentation slides will be available from 12.00 UK time from
www.serco.com.
Outstanding year with firm foundations for revenue and margin increases going
forward
2005 was an outstanding year for Serco. We grew revenue by 38.1% to £2,260m,
with organic growth of 19.4%.
Profit before tax and intangible amortisation (PBTA) also increased strongly,
by 28.5% to £91.5m, with organic PBTA growth of 13.1%. Earnings per share
before intangible amortisation grew 22.9% to 14.09p. After intangible
amortisation, profit before tax grew 21.7% to £77.9m and earnings per share
increased by 15.3% to 11.66p.
The recommended final dividend of 2.06p per share gives a total for the year of
2.97p, an increase of 12.9%.
Our cash performance remains strong, with Group EBITDA to cash conversion of
90% (2004: 93%) contributing to a Group free cash flow of £73.8m for the year
(2004: £55.8m).
We have continued to retain existing contracts and win new work. We maintained
our win rate at more than 90% on rebids, demonstrating the quality of service
we deliver to satisfied customers. With the Docklands Light Railway and Marine
Services rebids at preferred bidder, none of our ten largest contracts by
annual revenue are due for rebid before the end of 2010.
As in previous years, in 2005 we won more than 50% of new bids, showing the
strength of our reputation, our ability to be selective in targeting new work
and our innovative solutions. In total during 2005, contract wins and
extensions were valued at £2.6bn and we were appointed preferred bidder for
contracts totalling £2.4bn.
Our two largest acquisitions - ITNET (now Serco Solutions) and RCI (now part of
Serco Inc) - had the anticipated positive impact, adding £333.9m to revenue and
£23.6m (£10.3m after funding costs) to PBTA. The new skills and capabilities
they have brought to the Group are already delivering benefits. For example,
Serco Solutions was instrumental in winning the £125m Small Business Service
contract from the UK Department of Trade and Industry.
We are leveraging the benefits of our increasing scale and achieving
efficiencies by centralising the purchasing of materials and developing a
shared services facility for our back office functions such as finance and
administration. We have streamlined our management structure, removed
unnecessary bureaucracy and begun the implementation of a SAP financial system.
These initiatives - together with selective bidding and continued management of
our business portfolio - will benefit our PBTA margins in 2006 and beyond.
Visibility of future revenue remains excellent. At 31 December 2005, our
forward order book stood at a record £13.4bn and we had visibility of 91% of
our planned revenue for 2006, 77% for 2007 and 64% for 2008.
At the same date we had contracts valued at £2.6bn at the preferred bidder
stage and a further £2.7bn of bids where we were shortlisted to the final two
or three bidders. None of our ten largest contracts by annual revenue are due
for rebid before the end of the decade.
Our identified pipeline of further opportunities exceeds £21bn.
Balanced portfolio and service excellence deliver strong growth
We have seen excellent growth across the Group during the year, both in the UK
and internationally.
The key developments in each of our markets are discussed below.
Civil Government
Revenue increased by 28% to £803.6m, representing 36% of Group revenue in 2005
and making it our largest segment, encompassing home affairs, health, regional
and local government, education and consulting. Growth benefited from the
inclusion of Serco Solutions from 3 February 2005.
In home affairs we secured our first major civil resilience contract win - a
ten-year contract valued at around £100m to provide solutions that detect the
illicit importation of radiological substances at UK borders. This programme,
known as Cyclamen, is central to the UK Government's counter-terrorism
strategy. In October we won a five-year contract valued at around £30m to
provide electronic monitoring of offenders across Scotland. We now manage three
of the six electronic monitoring contracts in the UK.
Among notable developments in health, our joint venture with Equion Ltd, a
division of John Laing plc, was appointed preferred bidder for a 35-year
agreement worth around £1.2bn to support three Leicester hospitals as part of
the Pathway private finance initiative. In managed healthcare, we acquired a
doctors `out of hours' business in Cardiff and we have since won other
contracts in Oxford and Cornwall. The acquisition has provided a platform from
which we have won contracts to provide healthcare services to Feltham Young
Offenders Institute & Remand Centre and HMP Cardiff, and to improve care for
patients with long term-illnesses in the London Borough of Newham.
In local government, the expertise gained in our long-term strategic contracts
with councils in Winchester, Canterbury and Woking led to us being appointed
preferred bidder for a ten-year streetscene contract valued at around £45m with
Restormel Borough Council, and to our securing an environmental services
contract with Welwyn Hatfield Council.
We work in partnership with two local education authorities in the UK - Walsall
and Bradford. In January 2005 the Office for Standards in Education (Ofsted)
declared Bradford's services to be `satisfactory', and Walsall's to be `highly
satisfactory', significant turnarounds for what were once two of the poorest
performing authorities in the country. While there is still a considerable
amount of work to be done, both Walsall and Bradford have continued to improve
at rates faster than national trends in all indicators.
Since its formation in 2003, our consulting business has grown rapidly and now
employs around 80 consultants. It aims to raise awareness of Serco and enhance
our reputation by providing high-value advisory services. During 2005, we won
new contracts with customers such as the Department of Health, the Home Office,
and the Environment Agency, as well as two global investment banks and one
major UK retail bank.
Defence
Revenue grew strongly during the year, increasing by 52% to £565.6m,
representing 25% of Group revenue. Growth in the year was both organic and
through acquisition, with the RCI element of Serco Inc included from 21 March
2005.
Significant wins in the year included the 23-year Defence Academy Campus
Integrator contract, valued at around £400m, to deliver a world-class academic
centre of excellence for senior military and civilian personnel for the UK
Ministry of Defence (MoD). Serco will manage the existing buildings, integrate
the design and building of new premises and integrate IT systems. The contract
builds upon the Joint Services Command and Staff College contract, which we
also manage at the same site.
Serco was also appointed preferred bidder for a strategic partnership with the
UK Defence Science and Technology Laboratories (Dstl). This contract, worth
around £400m over 15 years, will see us manage the design and build of new
facilities and provide IT and support services across the Dstl estate.
In August 2005, Serco Sodexho Defence Services - our joint venture with Sodexho
Alliance - renewed and expanded its contract with the Australian Defence Force
to provide garrison support services in the Sydney West South region of New
South Wales. The contract is valued at around AUS$200m to Serco over a term of
up to nine years.
In February 2006, we became preferred bidder for the MoD's Future Provision of
Marine Services contract. This 15-year contract, valued at around £1bn, is to
deliver marine support at major UK naval bases.
Transport
Revenue increased by 59% to £548.7m, representing 24% of Group revenue. Growth
was driven primarily by the first full year of Northern Rail, our largest
contract to date, which we run as a joint venture with NedRailways.
Since we began operating Northern Rail, passengers have benefited from
significant enhancements to performance, with train punctuality improving in
all but one of the reporting periods during the year. Punctuality is now at its
highest level for four years.
Our Merseyrail service, also run as a joint venture with NedRailways, continues
to prove itself to be one of the UK's best performing train operating
companies. In the January 2006 National Passenger Survey, Merseyrail's overall
satisfaction rating was 86%, 6% above the national average, with its
punctuality consistently over 92%.
In urban transportation, the key development was our appointment as preferred
bidder to continue operating the Docklands Light Railway (DLR). The new
contract is valued at around £400m over a period of up to nine years. Serco has
operated the DLR since 1997, winning National Rail Awards for six consecutive
years including an award for Outstanding Achievement in the rail industry in
September 2005. In the last seven years, Serco has consistently improved DLR's
performance and it is currently achieving passenger satisfaction scores close
to 95% and reliability scores of over 97%.
We operate the National Traffic Control Centre, which helps travellers in
England plan and complete their journeys by providing real-time traffic
information, including alternative routing advice, direct to the media and the
public via a website and interactive phone service. Achieving full
implementation has taken longer than envisaged and we are now finalising the
implementation phase with our client, the Highways Agency.
Science
Revenue increased by 18% to £342.4m, representing 15% of Group revenue.
The key development in our science business was the expansion of work at the
Atomic Weapons Establishment (AWE) sites at Aldermaston and Burghfield in the
UK, which we operate as a joint venture with BNFL and Lockheed Martin.
In July 2005, the MoD announced plans for a necessary upgrade to skills and
facilities at AWE, in order to provide continued reliability and safety
assurance. As a result, the MoD signed an amendment which increased its funding
for the project. The additional investment organically grows our business and
is valued at around £350m to Serco over three years, further enhancing our
position as a key player in the nuclear industry.
Our track record with the MoD means that we are in a good position to bid for
new business. We secured a £13m contract to supply the MoD's Integrated Sensor
Management System. This intelligent network is designed to detect nuclear,
chemical or biological attacks. The technology behind it gives us transferable
opportunities to other sectors.
We see potential for strong growth in the nuclear market, in particular
following the formation of the Nuclear Decommissioning Authority in the UK. Our
position here has been further strengthened by the transfer of around 60 staff,
together with an associated income stream, from BNFL Magnox Electric to Serco.
The staff are predominantly highly qualified experts in the nuclear field.
The European Space Agency (ESA) provided us with two successful rebids in 2005,
for ESA's Earth observation programme - a contract worth €14m over three years
- and for engineering support at ESA's technical centre in the Netherlands,
worth around €20m over an expected five-year period.
Acquisitions delivering
The acquisitions of ITNET (now Serco Solutions) and RCI (now part of Serco Inc)
are delivering the benefits we expected.
The additional skills, capabilities and customer relationships of ITNET and RCI
are providing significant opportunities for the Group in new markets and
enabling us to compete for larger and higher value contracts in markets where
we are well established.
Since its February 2005 acquisition, Serco Solutions has contributed £190.6m to
revenue and £14.3m to PBTA, at a margin of 7.5%.
Throughout the year, Serco Solutions secured important contract extensions and
additional work with local government and commercial clients. We were delighted
to win a place in a consortium shortlisted to bid for the UK Government's
e-borders project, which, if successful, could be worth around £360m to us. As
well as being instrumental in our securing a contract worth up to £125m to
provide web-based information services to the UK's small businesses on behalf
of the government, Serco Solutions was chosen by IBM as a sub-contractor to
implement Bradford Council's IT platforms and services. The ten-year programme
is worth £158m to the consortium.
However one of the key opportunities in this area is the outsourcing of UK
local and central government shared services. This has been slower than
anticipated in coming to market. We have invested in enhanced capacity and
capability to prepare for the expected rapid expansion in this market.
RCI expanded our position in the world's largest service contracting market,
the US federal government. Since the acquisition was completed in March 2005,
RCI has contributed £143.3m to Serco Inc's revenue and £9.3m to PBTA, at a
margin of 6.5%.
The RCI business continues to grow strongly, receiving numerous new task orders
and expanding or extending existing contracts. Among its key wins was the rebid
for the US Army's Career and Alumni Program. Valued at around $16m per year, we
have held this contract for 17 years - an exceptional achievement in US defence
contracting. In November 2005, we were awarded a contract to provide 102
embedded recruiters for the US Army Recruiting Command (USAREC). The base
contract is for one year, with two one-year options. Each contract year could
be worth up to $5m.
There are significant opportunities for further growth, as the US Department of
Defense continues to turn to the private sector for support, and as over time
we extend our skills in other markets, such as transport, into North America.
Market development
Our opportunities for growth are created by two principal drivers: the
necessity for central and local governments to control their spending and their
need to respond to social pressures for improved public services.
Our balanced portfolio, spread across different sectors and geographic markets
around the world, allows us to target our resources towards the best
opportunities.
In the UK, the home affairs market is driven by the change in government focus
from implementing initiatives to the delivery of outcomes - reducing crime and
the fear of crime. We estimate that this market is worth £2.5bn per annum and
growing fast.
We have created a new position in healthcare, which is among the largest and
fastest growing areas of UK Government spending - some £89bn in 2005/6. The
Government spends £70bn on education and we see opportunities in children's
services and information and communications technology after the recent
Education Bill. In science, the formation of the UK's Nuclear Decommissioning
Authority has created a market worth around £2bn per annum. Most areas of the
public sector are experiencing budget pressure and in response are changing the
way they work. In UK defence, we expect our addressable market to double to £
8bn per annum by 2010, as the MoD focuses resources, continues to civilianise
and seeks cost savings.
A similar pattern is emerging in North America. The market is estimated at
$2,000bn per annum, of which around one third is at the federal level and the
remainder with state and local governments. The annual US defence budget is
nearly $400bn and rising. Some market segments are looking at private sector
service provision for the first time and more established markets such as
municipal services and transportation are moving to more sophisticated,
performance-based contracting, as the emphasis shifts from lowest cost to best
value, a trend which plays to our strengths.
We also see exciting prospects in parts of Europe - notably Germany, where
economic and political conditions are accelerating the trend towards public
private partnerships - and the Middle East, in particular the United Arab
Emirates. In Asia Pacific, the Australian defence and transport markets
continue to offer good potential, while the opening of our Shanghai, China
office in May 2005 positions us to explore opportunities as the regional
government pursues its ambitious public service objectives.
Dedicated professionals
People are at the heart of our business. Throughout 2005, the dedication,
expertise and professionalism of Serco colleagues around the world were
critical to our performance. Notwithstanding their daily achievements in
bringing service to life, their wholehearted response to the tsunami in
south-east Asia, the London bombings, the hurricanes in the Gulf of Mexico and
the Pakistan earthquake, epitomised the spirit that defines Serco.
Board
Since his appointment as a non-executive director in April 2000, Ralph Hodge
has played a vital role in shaping the direction of our business. As he
prepares to step down from the Board, we would like to place on record our
gratitude for his contribution. We wish him a long and healthy retirement.
We are in the advanced stages of discussions in appointing a successor to
Ralph.
Continuing positive outlook
Governments around the world are continuing to face significant pressures to
provide better public services at lower cost and our market opportunities are
unprecedented. In the UK, our growth is being fuelled by the development of a
mixed economy, which incorporates the private sector in the delivery of public
services, and our ability to deliver customers' desired outcomes, which enable
us to develop long-term relationships which in turn drive our organic growth.
The Group has identified in excess of £21bn of opportunities across our
markets. The breadth of these opportunities together with our approach to
selective bidding, portfolio management and efficiency will contribute to
increasing margins. We are confident of achieving double-digit growth for the
foreseeable future.
Finance Review
1. Introduction
2005 is the first year the Group has reported its results under International
Financial Reporting Standards (IFRS). Explanation of the impact of adopting
IFRS was provided in the Group's announcement `Transition to International
Financial Reporting Standards', which was released on 31 August 2005. All
comparatives throughout this report have been restated under IFRS. Effective
from 1 January 2005, the Group adopted IAS 32 `Financial Instruments:
Disclosure and Presentation' and IAS 39 `Financial Instruments: Recognition and
Measurement'.
2. Financial performance
The Group continued to generate strong organic growth during 2005. We also
benefited from the contributions of ITNET plc (ITNET) and RCI Holding Corp
(RCI), which we acquired in February 2005 and March 2005 respectively.
The Group's income statement for 2005 is shown in Figure 1. This includes the
results of our joint ventures, which have been proportionately consolidated.
Figure 1: Income statement
2005 2004 Increase
£m £m
Revenue 2,260.3 1,636.9 38.1%
Gross profit 325.0 242.6 34.0%
Administrative expenses before (214.3) (166.2) 28.9%
amortisation
Investment revenue and finance costs (19.2) (5.2)
Profit before tax and intangible 91.5 71.2 28.5%
amortisation
Intangible amortisation (13.6) (7.2)
Profit before tax 77.9 64.0 21.7%
Tax (23.5) (19.5)
Profit for the year 54.4 44.5 22.2%
Minority interest (1.0) (1.0) -
Retained earnings 53.4 43.5 22.8%
Effective tax rate 30.2% 30.5%
Basic earnings per share before 14.09p 11.46p 22.9%
intangible amortisation
Basic earnings per share 11.66p 10.11p 15.3 %
Dividend per share 2.97p 2.63p 12.9%
2.1 Revenue
Revenue increased by 38.1% to £2,260.3m. Excluding the effect of £337.2m of
revenue from our acquisitions in 2005 and £26.0m of disposals in 2004, our
organic revenue growth was 19.4%.
Joint venture revenue increased by 109.8% to £536.1m, primarily reflecting a
full year of operation of the Northern Rail franchise, which began in December
2004, and continued growth at AWE.
2.2 Gross margin
Gross margin - the average contract margin across our portfolio - was 14.4% in
2005.
2.3 Investment revenue and finance costs
Investment revenue and finance costs totalled a net cost of £19.2m (2004: £
5.2m). Included within finance costs was £13.4m of interest on the debt used to
fund our acquisitions, the net interest on the assets and liabilities of our
defined benefit pension schemes and interest on our underlying net debt, which
has reduced compared with 2004.
2.4 Profit before tax and intangible amortisation (PBTA)
PBTA increased 28.5% to £91.5m (2004: £71.2m), representing a net margin of
4.0% (2004: 4.3%). Excluding the profits generated by the acquisitions and
their associated funding costs, organic PBTA increased by 13.1%.
2.5 Intangible amortisation
Intangible amortisation was £13.6m (2004: £7.2m). The increase results
principally from the amortisation of intangible assets acquired with ITNET and
RCI, together with the additional amortisation of pension-related intangible
assets arising from the rights to manage and operate certain of our contracts
and franchises.
2.6 Profit before tax
Profit before tax increased by 21.7% to £77.9m (2004: £64.0m).
2.7 Tax
The tax charge of £23.5m (2004: £19.5m) represents an effective rate of 30.2%,
broadly similar to 2004.
2.8 Earnings per share (EPS)
Basic EPS before intangible amortisation increased by 22.9% to 14.09p. Basic
EPS increased by 15.3% to 11.66p.
EPS before intangible amortisation and the effect of acquisitions increased by
15.6% to 13.25p, and on a post-amortisation basis increased by 10.4% to 11.16p.
EPS is calculated on an average share base of 458.1m during the year (2004:
430.1m). The majority of the increase resulted from the issue of 30.4m shares
in part consideration for the acquisition of ITNET.
3. Dividends
Our policy is to increase the total dividend per share each year broadly in
line with the increase in underlying earnings. The proposed final dividend of
2.06p per share represents a 13.2% increase on 2004. The total dividend for the
year is 2.97p, an increase of 12.9%. The dividend will be paid on 17 May 2006
to shareholders on the register at 10 March 2006.
4. Cash flow
Our cash performance in 2005 was strong, with a Group free cash inflow of £
73.8m, an increase of £18.0m compared with 2004.
The Group's cash flow is analysed in Figure 2. The presentation is consistent
with our analysis in previous years and is designed to show the true cash
performance of the Group - the cash flows generated by Serco's subsidiaries,
plus dividends received from joint ventures. It therefore differs from the
consolidated cash flow presented on page 22, in which the cash flows of joint
ventures have been proportionately consolidated. The adjustment line in Figure
2 reconciles the movement in Group cash to the consolidated cash flow.
Figure 2: Cash flow
2005 2004
£m £m
Operating profit excluding joint ventures 62.4 43.5
Non cash items 45.2 32.1
Group EBITDA 107.6 75.6
Working capital movement (11.2) (5.3)
Group operating cash flow 96.4 70.3
Interest (15.7) (3.8)
Tax (1.0) (1.5)
Expenditure on tangible and intangible assets (31.6) (23.4)
Dividends from joint ventures 25.7 14.2
Group free cash flow 73.8 55.8
Acquisitions (281.7) (9.1)
Other financing 269.4 (7.6)
Dividends paid (12.5) (10.4)
Group non recourse debt financed assets (15.6) (25.2)
Group net increase in cash and cash equivalents 33.4 3.5
Adjustment to include joint venture cash impacts 4.1 12.8
Net increase in cash and cash equivalents 37.5 16.3
Note: Group EBITDA is earnings from subsidiaries before interest, tax,
depreciation and intangible amortisation.
4.1 Group operating cash flow
The Group operating cash inflow for the year was £96.4m (2004: £70.3m), an
increase of 37.1%. This represents a conversion of Group EBITDA into cash of
90% (2004: 93%). The Group's cash conversion is particularly notable given the
level of organic growth, which typically results in a working capital outflow
equivalent to one month's incremental revenue.
4.2 Tax
Tax paid in 2005 was £1.0m, compared with £1.5m in the previous year. The level
of tax paid in 2005 reflects a number of factors, including our continued
progress in closing previous years' tax returns, with a refund of £8m in the
year, as well as residual accelerated capital allowances and other timing
differences. Tax paid in 2004 benefited from a repayment of nearly £7m, as we
were able to utilise tax losses in subsidiaries which were previously joint
ventures. From 2006, we expect our tax paid to be close to the tax charge in
our income statement.
4.3 Expenditure on tangible and intangible assets
Expenditure on tangible and intangible assets was £31.6m (2004: £23.4m). This
represents around 1.8% of revenue excluding joint ventures. Included within
this is £7m of cash spent on designing and building our new SAP accounting
system and shared service centre. This programme of expenditure will continue
through 2006 and 2007.
4.4 Dividends from joint ventures
Dividends received from joint ventures during 2005 were £25.7m (2004: £14.2m).
This is equivalent to 101% (2004: 78%) of our share of joint ventures' profit
after tax. The high level of conversion reflects dividend payments made by
joint ventures from reserves retained in previous years. We expect a conversion
rate in the range of 70% to 80% going forward.
4.5 Acquisitions
The cash outflow in 2005 of £281.7m primarily relates to the acquisitions of
ITNET and RCI. The other significant acquisition during the year was our
purchase of the outstanding 50% of Defence Management Holdings Limited (DMHL)
for £5.9m. DMHL, which owns the special purpose company for the Joint Services
Command and Staff College PFI, was previously a joint venture.
4.6 Other financing
Other financing of £269.4m primarily relates to the net draw down of loans to
fund the acquisitions of ITNET and RCI.
4.7 Group non recourse debt financed assets
The £15.6m outflow is the net of expenditure on PFI assets under construction,
the movement on non recourse loans and changes in other PFI balances.
Over the life of each PFI contract, we expect these movements to offset each
other.
5. Net debt
At 31 December 2005, Group recourse net debt was £264.0m (31 December 2004: £
15.3m). Further analysis is provided in Figure 3.
Figure 3: Net debt
As at 31 December 2005 2004
£m £m
Group - cash and cash equivalents 210.0 173.9
Group - recourse debt (453.1) (168.4)
Group - obligations under finance leases (20.9) (20.8)
Group recourse net debt (264.0) (15.3)
Joint venture recourse net cash/(debt) 18.0 (4.6)
Total recourse net debt (246.0) (19.9)
Group non recourse debt (326.8) (256.5)
Joint venture non recourse debt (22.4) (47.1)
Total non recourse debt (349.2) (303.6)
Total net debt (595.2) (323.5)
Included within Group recourse net debt is £16.8m (2004: £15.3m) of cash
securing credit obligations in relation to PFI and other project companies.
5.1 Group recourse net debt
The strength of our cash flow resulted in a reduction in Group recourse net
debt in the second half of the year, from £315.2m at 30 June 2005 to £264.0m at
the year end.
The net increase in the Group's other loans during the year reflects the debt
funding for the acquisitions of ITNET and RCI. These loans have covenants
consistent with our private placements and allow sufficient headroom to fund
known commitments and working capital requirements.
5.2 Group non recourse debt
Group non recourse debt, which we have utilised to fund PFI assets and the
acquisition of the DES franchise, increased during the year to £326.8m (31
December 2004: £256.5m). This was the result of our acquisition of the
remaining 50% share of DMHL. Since the acquisition, we have consolidated 100%
of DMHL's non recourse debt in our balance sheet. The increase was partly
offset by the scheduled repayments of debt across all our non recourse debt
funded projects.
The Group's debt is non recourse if no Group company other than the relevant
borrower - typically a special purpose company for a PFI - has an obligation to
repay the debt under a guarantee or other arrangement. The debt is excluded
from all of our credit agreements and other covenant calculations, and
therefore has no impact on the Group's ability to borrow.
6. Pensions
To assist understanding of the complexities of accounting for pension schemes
under IFRS, we have provided an overview. Further detail was provided in our
announcement `Transition to International Financial Reporting Standards', on 31
August 2005.
The total pension cost included within PBTA for 2005 was £55.6m (2004: £39.5m).
At the year end, the net amount included in the balance sheet arising from our
obligations in respect of defined benefit pension schemes was £149.9m (31
December 2004: £124.7m). Further analysis is provided in Figure 4.
Figure 4: Defined benefit pension schemes
As at 31 December 2005 2004
£m £m
Group schemes - non contract specific (200.4) (164.6)
Contract specific schemes
- reimbursable (84.9) (56.0)
- not certain to be reimbursable (21.3) (22.3)
Net retirement benefit liabilities (306.6) (242.9)
Intangible asset arising from rights to 19.0 21.2
operate franchises and contracts
Reimbursable rights debtor 84.9 56.0
Deferred tax asset 52.8 41.0
Net balance sheet position (149.9) (124.7)
Under IFRS, Serco has three main types of scheme which are accounted for as
defined benefit pension schemes. Each type has its own accounting treatment
under IAS 19 `Employee Benefits'. These are:
* Schemes which do not relate to specific contracts or franchises -
principally the Group scheme. For these schemes, the actuarial gain or loss
for the period is charged to the consolidated statement of recognised
income and expense (the SORIE)
* Schemes relating to specific contracts or franchises, where the deficit
will pass back to the customer or to the next contractor at the end of the
relevant contract. For these schemes, the actuarial gain or loss for the
period is charged to the SORIE, and a recoverable intangible asset is
recognised on the balance sheet and amortised to the income statement over
the contract or franchise life, and
* The AWE contract, where there is a right of cost reimbursement, and where
the pension scheme deficit and offsetting debtor are both included the
balance sheet.
The increase in net liabilities during the year resulted primarily from the
reduction in the AA bond rate, which increased the liabilities on all defined
benefit pensions. These increases, together with the related deferred tax
movement, have been reflected in the SORIE.
Figure 5 shows the approximate sensitivities of the liabilities on our defined
benefit pension schemes to movements in the discount rate, and to changes in
our actuarial assumptions regarding the rate of inflation, the rate of increase
of scheme members' salaries and life expectancies.
Figure 5: Pension assumption sensitivities
Change in assumption Change in liability
Discount rate +0.5% (10)%
(0.5)% +11%
Price inflation +0.5% +8%
(0.5)% (7)%
Salary +0.5% +3%
(0.5)% (3)%
Longevity Increase by one year +2.5%
The main Group defined benefit pension scheme accounts for around two thirds of
our net balance sheet position. In recent years, we have taken action to manage
the liabilities of the Group scheme. We have closed the scheme to new members,
other than those joining the Group as a result of TUPE transfers. We increased
employer contributions to the scheme from 2003, and employee contributions from
2004. We have also introduced annual actuarial valuations, which ensure that we
have up-to-date information on the position of the scheme.
During 2006, in conjunction with the scheme's trustees, we will further
consider the funding and risk profile of the Group scheme.
7. Acquisitions
We completed the acquisition of ITNET on 3 February 2005. The consideration of
£245.5m comprised £171.3m of cash and 30.4m shares worth £74.2m. The
acquisition gave rise to goodwill of £260.9m, including fair value adjustments
and acquisition costs of £28.1m. Intangible assets arising on the acquisition
have been recognised at £20.6m and will be amortised on a straight-line basis
over their expected life of eight years. From the date of ownership ITNET
contributed £190.6m to revenue and £14.3m to PBTA.
Our acquisition of RCI was completed on 21 March 2005 for consideration of £
116.3m in cash. The acquisition gave rise to goodwill of £93.7m, including fair
value adjustments and acquisition costs of £7.0m. Intangible assets arising on
the acquisition have been recognised at £2.2m and will be amortised on a
straight-line basis over their expected life of five years. From the date of
ownership, RCI contributed £143.3m to revenue and £9.3m to PBTA.
Our other acquisitions during the year, principally the 50% of DMHL,
contributed £3.3m to revenue and £0.8m to PBTA.
8. PFIs
8.1 PFI portfolio
The Group has a portfolio of 11 PFI projects. We have operating contracts for
all our PFIs, and equity investments in ten. Following our purchase of 50% of
DMHL, we now own 100% of eight of our PFI projects.
8.2 Accounting for PFI contracts
In March 2005, the International Financial Reporting Interpretations Committee
(IFRIC) issued a draft interpretation on accounting for service concession
arrangements. These are arrangements such as PFIs, under which a government or
other body grants contracts for the supply of public services - such as prisons
or hospitals - to private operators. The IFRIC is still working towards a final
interpretation, which it expects to publish in the second half of 2006.
In the absence of specific guidance within IFRS, from 1 January 2005 we have
recognised our PFI debtors at amortised cost, as defined by IAS 39. This
maintains an accounting treatment consistent with UK GAAP and existing IFRS.
The draft guidance from IFRIC, if it were issued in final form, could require a
number of changes to the accounting treatment of service concession
arrangements. This could result in a significant increase in the carrying value
of the Group's PFI debtors.
9. Treasury
9.1 Credit facilities and liquidity management
The £420m bank credit facility we used to provide funding for the acquisitions
of ITNET and RCI comprises a term loan facility and a revolving credit
facility. As at 31 December 2005, term loans totalling £279m were outstanding
and the revolving credit facility was undrawn. The bank facility has covenants
and obligations typical of these types of arrangement, is unsecured and expires
in December 2009. Loans drawn under the bank facility accrue interest at a rate
of 50 basis points over LIBOR.
Serco has also issued loan notes under two private placements. The first, for £
43.2m, matures in December 2007. The second, for £117m, amortises evenly from
2011 to 2015.
9.2 Impact of IAS 32 and IAS 39
The Group adopted IAS 32 and IAS 39 effective from 1 January 2005. Adopting IAS
39 resulted in a reduction in our opening net assets of £27.1m. This
principally represents a fair value loss from marking to market the interest
rate swaps we use to hedge the interest obligations of PFI special purpose
companies into fixed rate obligations, and the cross-currency swaps used to
hedge long term loan notes.
All designated hedges are highly effective and, as a result, the impact on the
income statement for the period was immaterial. Further details of the effect
of applying IAS 32 and IAS 39 can be found in our announcement of 31 August
2005, 'Transition to International Financial Reporting Standards'.
Consolidated income statement
For the year ended 31 December
Note 2005 2004
£m £m
Continuing operations
Revenue 2 2,260.3 1,636.9
Cost of sales (1,935.3) (1,394.3)
Gross profit 325.0 242.6
Administrative expenses (214.3) (166.2)
Other operating expenses - amortisation (13.6) (7.2)
of intangibles
Total administrative expenses (227.9) (173.4)
Operating profit 2 97.1 69.2
Investment revenue 3 33.6 35.3
Finance costs 3 (52.8) (40.5)
Profit before tax 77.9 64.0
Tax (23.5) (19.5)
Profit for the year 54.4 44.5
Attributable to:
Equity holders of the parent 53.4 43.5
Minority interest 1.0 1.0
Earnings per ordinary share (EPS)
Basic EPS 4 11.66p 10.11p
Diluted EPS 4 11.46p 9.99p
Consolidated statement of recognised income and expense
For the year ended 31 December
Note 2005 2004
£m £m
Net actuarial loss on defined benefit 8 (58.4) (29.4)
pension schemes
Actuarial gain on reimbursable rights 8 35.6 13.0
Goodwill previously written off, released - 0.2
on sale of subsidiary
Net exchange gain/(loss) on translation of 8 6.9 (3.3)
foreign operations
Fair value gain on cash flow hedges during 8 6.1 -
the year
Tax credit on items taken directly to 8 2.0 5.6
equity
Net expense recognised directly in equity (7.8) (13.9)
Profit for the year 54.4 44.5
Total recognised income and expense for 46.6 30.6
the year
Attributable to:
Equity holders of the parent 45.6 29.6
Minority interest 1.0 1.0
46.6 30.6
Consolidated balance sheet
At 31 December
Note 2005 2004
£m £m
Non-current assets
Goodwill 544.5 177.4
Other intangible assets 107.8 75.0
Property, plant and equipment 103.0 96.2
Investments - 13.7
Trade and other receivables 459.8 390.6
Deferred tax assets 91.2 50.1
1,306.3 803.0
Current assets
Inventories 36.4 26.9
Trade and other receivables 528.8 390.1
Cash and cash equivalents 240.7 200.5
805.9 617.5
Total assets 2,112.2 1,420.5
Current liabilities
Trade and other payables (531.1) (417.0)
Current tax liabilities (19.5) (5.8)
Obligations under finance leases (8.2) (8.1)
Loans (64.8) (46.4)
Financial instruments (4.9) -
(628.5) (477.3)
Non-current liabilities
Trade and other payables (5.0) (0.6)
Obligations under finance leases (18.2) (18.2)
Loans (744.7) (451.3)
Financial instruments (30.8) -
Retirement benefit obligations (306.6) (242.9)
Provisions (26.3) (6.0)
Deferred tax liabilities (92.1) (55.0)
(1,223.7) (774.0)
Total liabilities (1,852.2) (1,251.3)
Net assets 260.0 169.2
Equity
Share capital 9.4 8.7
Share premium account 269.5 191.5
Capital redemption reserve 0.1 0.1
Retained earnings 8 132.8 104.4
Retirement benefit obligations 8 (139.0) (124.4)
reserve
Share-based payment reserve 8 16.6 6.2
Own shares reserve 8 (16.4) (16.4)
Hedging and translation reserve 8 (15.1) (2.6)
Equity attributable to equity 257.9 167.5
holders of the parent
Minority interest 2.1 1.7
Total equity 260.0 169.2
Consolidated cash flow statement
For the year ended 31 December
Note 2005 2004
£m £m
Net cash inflow from operating 6 140.8 87.6
activities
Investing activities
Interest paid (47.6) (39.4)
Interest received 32.8 35.0
Disposal of subsidiary and business - 3.2
undertakings
Proceeds from disposal of property, 0.4 0.4
plant and equipment
Proceeds from reduction in investment in - 1.8
joint venture
Acquisition of franchise - (4.1)
Acquisition of subsidiaries, net of cash (281.7) (13.7)
acquired
Purchase of other intangible assets (13.1) (4.1)
Purchase of property, plant and (22.3) (21.9)
equipment
Net cash outflow from investing (331.5) (42.8)
activities
Financing activities
Dividends paid (12.5) (10.4)
Repayment of borrowings (5.8) (0.8)
New loan advances 272.0 10.2
Capital element of finance lease (8.4) (9.0)
repayments
Proceeds from issue of share capital 4.4 0.7
Decrease in non recourse loans (21.5) (19.2)
Net cash inflow/(outflow) from financing 228.2 (28.5)
activities
Net increase in cash and cash 37.5 16.3
equivalents
Cash and cash equivalents at beginning 200.5 184.6
of year
Net exchange gain/(loss) 2.7 (0.4)
Cash and cash equivalents at end of year 240.7 200.5
Notes to the preliminary announcement
1. General information
The basis of preparation of this preliminary announcement is set out below.
The financial information in this announcement, which was approved by the Board
of Directors on
1 March 2006, does not constitute the Company's statutory accounts for the
years ended
31 December 2005 or 2004, but is derived from these accounts.
Statutory accounts for 2004 have been delivered to the Register of Companies
and those for 2005 will be delivered following the Company's annual general
meeting. The auditors have reported on these accounts; their reports were
unqualified and did not contain statements under S237 (2) or (3) of the
Companies Act 1985.
The preliminary announcement has been prepared in accordance with the
accounting policies adopted under IFRS for the first time with a transition
date of 1 January 2004. The disclosures required by IFRS 1 `First-time Adoption
of International Financial Reporting Standards' concerning the transition from
UK GAAP to IFRS can be found in our announcement of 31 August 2005, `Transition
to International Financial Reporting Standards'.
The financial statements have been prepared on the historical cost basis.
The Group has adopted IAS 32 `Financial Instruments : Disclosure and
Presentation' and IAS 39 `Financial Instruments: Recognition and Measurement'
with effect from 1 January 2005. Derivatives are initially accounted for and
measured at fair value on the date a derivative contract is entered into and
subsequently measured at fair value. The gain or loss on re-measurement is
taken to the income statement except where the derivative is a designated cash
flow hedging instrument.
2. Segmental information
This Group manages its business on a market segment basis and these segments
are the basis on which the Group reports its primary segment information.
Business segments Civil Defence Transport Science Total
Government
Year ended 31 December 2005 £m £m £m £m
£m
Revenue 803.6 565.6 548.7 342.4 2,260.3
Result
Segment result 37.5 33.3 25.0 31.4 127.2
Unallocated expenses (30.1)
Operating profit 97.1
Investment revenue 33.6
Finance costs (52.8)
Profit before tax 77.9
Tax (23.5)
Profit for the year 54.4Year ended 31 December 2004 Civil Defence Transport Science Total
Government
£m £m £m £m
£m
Revenue 629.1 372.3 345.8 289.7 1,636.9
Result
Segment result 26.6 21.6 20.7 26.5 95.4
Unallocated expenses (26.2)
Operating profit 69.2
Investment revenue 35.3
Finance costs (40.5)
Profit before tax 64.0
Tax (19.5)
Profit for the year 44.5
Geographical segments United North Europe and Asia Total
Kingdom America Middle Pacific
Year ended 31 December 2005 East £m
£m £m £m
£m
Revenue 1,661.7 254.5 205.2 138.9 2,260.3
Year ended 31 December 2004 United North Europe and Asia Total
Kingdom America Middle Pacific
East £m
£m £m £m
£m
Revenue 1,202.3 94.6 186.7 153.3 1,636.9
3. Investment revenue and finance costs
2005 2004
£m £m
Interest receivable by PFI companies 26.7 31.8
Interest receivable on other loans and deposits 6.9 3.5
Investment revenue 33.6 35.3
Interest payable on non recourse loans (19.9) (23.6)
Interest payable on obligations under finance leases (0.8) (0.7)
Fair value adjustment on fair value hedges and non IAS 0.4 -
39 designated hedges
Interest payable on other loans (27.8) (13.8)
Net interest payable on retirement benefit obligations (4.7) (2.4)
Finance costs (52.8) (40.5)
4. Earnings per share
Basic and diluted earnings per ordinary share (EPS) have been calculated in
accordance with IAS 33 `Earnings Per Share'. EPS is shown both before and after
amortisation of intangible assets to assist in the understanding of the impact
of IAS 38 `Intangible Assets' on the Group financial statements.
The calculation of the basic and diluted EPS is based on the following data:
Number of shares
2005 2004
millions millions
Weighted average number of ordinary shares for the 458.1 430.1
purpose of basic EPS
Effect of dilutive potential ordinary shares: share 8.0 5.3
options
Weighted average number of ordinary shares for the 466.1 435.4
purpose of diluted EPS
Earnings 2005 2004
Earnings Per Earnings Per
share share
amount amount
£m Pence £m Pence
Earnings for the purpose of basic 53.4 11.66 43.5 10.11
EPS being net profit attributable to
the equity holders of the parent
Add back :
Amortisation of intangible assets, 11.2 2.43 5.8 1.35
net of tax
Basic earnings before amortisation 64.6 14.09 49.3 11.46
of intangible assets
Earnings for the purpose of basic 53.4 11.66 43.5 10.11
EPS
Effect of dilutive potential - (0.20) - (0.12)
ordinary shares
Diluted EPS 53.4 11.46 43.5 9.99
5. Acquisitions
a) Acquisition of ITNET plc
On 3 February 2005 the Group acquired all of the issued share capital of ITNET
plc for purchase consideration of £245.5m comprising cash and the issue of
shares. ITNET plc is the parent company of a group of companies involved in
information technology solutions. This transaction has been accounted for by
the purchase method of accounting. The goodwill arising is attributable to the
anticipated profitability arising from new business and the anticipated future
operating synergies from the combination.
Book Fair value Fair
adjustments value
value
£m £m
£m
Net assets acquired
Goodwill 12.8 (12.8) -
Other intangible assets 0.6 20.0 20.6
Property, plant and equipment 9.4 (1.4) 8.0
Deferred tax assets 6.3 3.2 9.5
Inventories 6.0 - 6.0
Trade and other receivables 43.6 (4.1) 39.5
Trade and other payables (39.9) (7.4) (47.3)
Current tax liabilities (0.4) (1.0) (1.4)
Provisions (4.4) (19.2) (23.6)
Loans (4.0) - (4.0)
Retirement benefit obligations (11.5) - (11.5)
Obligations under finance leases (5.8) - (5.8)
12.7 (22.7) (10.0)
Goodwill 260.9
Total consideration 250.9
Satisfied by:
Issue of Serco Group plc ordinary shares 74.2
Cash 171.3
Purchase consideration 245.5
Directly attributable costs 5.4
250.9
Net cash outflow arising on acquisition:
Cash consideration paid in 2004 13.7
Cash consideration paid in 2005 163.0
176.7
ITNET plc contributed £190.6m to revenue and £14.3m to the Group's profit
before tax and intangible amortisation for the period between the date of
acquisition and the balance sheet date.
5. Acquisitions (continued)
b) Acquisition of RCI Holding Corp (`RCI')
On 21 March 2005, the Group acquired all of the issued share capital of RCI for
cash consideration of £116.3m. RCI is the parent company of a group of
companies involved in business process management for the US Federal
Government. This transaction has been accounted for by the purchase method of
accounting. The goodwill arising is attributable to the anticipated
profitability arising from new business.
Book Fair value Fair
value adjustments
value
£m £m
£m
Net assets acquired
Goodwill 4.3 (4.3) -
Other intangible assets 0.1 2.1 2.2
Property, plant and equipment 1.9 - 1.9
Deferred tax assets 1.0 0.1 1.1
Inventories 0.7 - 0.7
Trade and other receivables 35.3 - 35.3
Trade and other payables (13.7) (2.8) (16.5)
29.6 (4.9) 24.7
Goodwill 93.7
Total consideration 118.4
Satisfied by:
Cash 116.3
Directly attributable costs 2.1
Net cash outflow arising on 118.4
acquisition
RCI contributed £143.3m to revenue and £9.3m to the Group's profit before tax
and intangible amortisation for the period between the date of acquisition and
the balance sheet date.
6. Reconciliation of operating profit to net cash from operating activities
2005 2004
£m £m
Operating profit for the year 97.1 69.2
Adjustments for:
Share-based payments 5.7 4.5
Depreciation of property, plant and equipment 30.3 22.2
Amortisation of intangible assets 13.6 7.2
Loss on disposal of property, plant and equipment 0.4 0.8
Loss on disposal of intangible assets 0.1 -
Loss on sale of subsidiary undertakings - 0.1
Operating cash inflows before movements in 147.2 104.0
working capital
(Increase)/decrease in inventories (1.9) 2.3
Increase in receivables (47.2) (34.4)
Increase in payables 44.6 31.7
Cash generated by operations before PFI asset 142.7 103.6
expenditure
Movement on PFI debtor 15.3 7.6
Expenditure on PFI assets in the course of (7.8) (16.3)
construction
Cash generated by operations after PFI asset 150.2 94.9
expenditure
Tax paid (9.4) (7.3)
Net cash inflow from operating activities 140.8 87.6
7. Analysis of net debt
At Cash Acquisitions Exchange Non-cash At
flow / differences movements
1 £m 31
January £m disposals £m December
2005 2005
£m
£m £m
Cash and cash 200.5 32.5 5.0 2.7 - 240.7
equivalents
Non recourse loans (256.0) 20.5 (43.1) - 0.4 (278.2)
(related to PFI
assets)
Other non recourse (47.6) 1.0 - (6.9) (17.5) (71.0)
loans
Other loans (194.1) (266.2) (4.0) (12.2) 16.2 (460.3)
Obligations under (26.3) 8.4 (5.8) (0.2) (2.5) (26.4)
finance leases
(323.5) (203.8) (47.9) (16.6) (3.4) (595.2)
8. Reserves
Retained Retirement Share-based Own Hedging and Total
earnings benefit payment translation
obligations reserve shares reserve £m
£m reserve reserve
£m £m
£m £m
At 1 January 2005 104.4 (124.4) 6.2 (16.4) (2.6) (32.8)
Fair value loss on (3.5) - - - (34.4) (37.9)
hedges on adoption of
IAS 39
Tax credit on hedges 0.5 - - - 10.3 10.8
Restated at 1 January 101.4 (124.4) 6.2 (16.4) (26.7) (59.9)
2005
Dividends paid (12.5) - - - - (12.5)
Net profit for the year 53.4 - - - - 53.4
Net actuarial loss on - (58.4) - - - (58.4)
defined benefit pension
schemes
Actuarial gain on - 35.6 - - - 35.6
reimbursable rights
Credit in relation to - - 5.7 - - 5.7
share-based payment
Fair value gain on cash - - - - 6.1 6.1
flow hedges during the
year
Net exchange gain on - - - - 6.9 6.9
translation of foreign
operations
Tax charge on cash flow - - - - (1.4) (1.4)
hedges
Tax (charge)/credit on (9.5) 8.2 4.7 - - 3.4
items taken directly to
equity
At 31 December 2005 132.8 (139.0) 16.6 (16.4) (15.1) (21.1)
9. Joint ventures
The Group's interests in joint ventures are reported in the consolidated
financial statements using the proportionate consolidation method. The effect
of the Group's joint ventures on the consolidated income statement is as
follows:
2005 2004
£m £m
Revenue 536.1 255.5
Operating profit 34.7 25.7
Profit before tax 36.4 25.2
Tax (10.4) (6.3)
Profit for the year 26.0 18.9
Minority interest (0.5) (0.6)
Share of post-tax results from joint ventures 25.5 18.3
Operating profit includes £6.6m (2004 : £nil) of costs incurred by Group.
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