Final Results

RNS Number : 2748Q

Serco Group PLC

25 February 2021

 

2020 full year results

25 February 2021

Serco Group plc

LEI: 549300PT2CIHYN5GWJ21

Year ended 31 December	2020	2019	Change at reported currency	Change at constant currency
Revenue(1)	£3,884.8m	£3,248.4m	+20%	+20%
Underlying Trading Profit (UTP)(2)	£163.1m	£120.2m	+36%	+37%
Reported Operating Profit (i.e. after exceptional items)(2)	£179.2m	£102.5m	+75%
Underlying Earnings Per Share (EPS), diluted(3)	8.43p	6.16p	+37%
Reported EPS (i.e. after exceptional items), diluted	10.67p	4.21p	+153%
Dividend Per Share (recommended re-instated)	1.4p
Free Cash Flow(4)	£134.9m	£62.0m	+118%
Adjusted Net Debt(5)	£57.8m	£214.5m	-73%
Reported Net Debt(6)	£460.4m	£584.4m	-21%

Very strong year across global business in 2020; guidance increased for 2021.

Highlights

·	Revenue : grew by 20% to £3.9bn, with organic growth of 16%, a 5% uplift from our US acquisition in August 2019 of NSBU and -1% from currency.
·	Underlying Trading Profit : increased by 36% to £163m, with NSBU adding 8%; net impact of Covid-19 around £2m, or ~1% of UTP.  Margin increased from 3.7% to 4.2%. Around three-quarters of our profit(7) is now from outside the UK.
·	Reported Operating Profit: increased by 75%, or £77m, to £179m, as a result of the 36% increase in underlying profit and an exceptional gain on disposal.
·	Earnings per Share: increased by 37% on an underlying basis and 153% on a reported basis.
·	Free Cash Flow: more than doubled, to £135m.
·	Adjusted Net Debt: reduced by £157m to £58m. Covenant leverage stands at 0.5x EBITDA.
·	Order Intake and Pipeline: some customer decisions slipped from Q4 2020 to Q1 2021, leading to order intake of £3.1bn (80% book-to-bill) and significant year-on-year increase in year-end qualified pipeline of new business to £6.4bn (2019: £4.9bn).
·	Government support & employee recognition: the Group has repaid all UK government employment and liquidity support, including £2m of furlough payments, and has made ex-gratia payments totalling £5m to around 50,000 front-line staff.
·	Dividends: the Board recommends restarting dividends, last paid to Serco shareholders in 2014, with a payment of 1.4p in respect of the 2020 financial year.
·	Acquisitions: in January 2021 we acquired Facilities First Australia (FFA), a leading Australian facilities management company for A$78m.  In February 2021 we announced the acquisition, subject to regulatory approval, of Whitney, Bradley & Brown Inc (WBB), a leading provider of technical and engineering services to the US military for a consideration of $295m.
·	Outlook for 2021(8) : having delivered compound annual growth in profits of 33% over the last three years, we expect revenues and trading profit to continue to grow in 2021, albeit at a slower rate than seen in recent years.  Reflecting a strong start to the year, we have increased our profit guidance for 2021 by 6%, which equates to year-on-year growth at constant currency of 10%.  This excludes the effect of the acquisition of WBB. Guidance will be updated for this following completion.

Rupert Soames, Serco Group Chief Executive, said: "In the coming months, every company's trading statement will pay glowing tributes to employees, and thank them for their resilience and courage.  I have struggled to think of words that are not trite or clichés and will not be repeated by a thousand other CEOs, so I will use instead the words of a colleague, whose job is escorting prisoners, who wrote to me in January: 

"Working as a Custody Officer is both challenging and rewarding, yes, the current situation with the virus has certainly changed the way in which we work and has made day to day life more challenging for everyone within Serco but also for the entire world.  My husband has cancer and also a disease which has caused him to have no immune system. People have asked me why I would continue to work knowing that every day when I go home to him, I am putting his health at risk.  The answer to this question is this: if everyone took that attitude then businesses would suffer more than they are already, people like myself and my colleagues are what keep the contract running, and without my work  to focus on I am sure I would have gone crazy by now.  Both my husband and I know that life throws us curve balls now and again and we have to get on and make the best of it and most importantly never give in!   My husband and I acknowledge how precious life is, we are as careful as we possibly can be in protecting ourselves and others and acknowledge that life has to go on. Serco has looked after its employees very well throughout this terrible time.  I am grateful to be able to work every day in a job that I love doing."

Around 90% of our 55,000 colleagues cannot work from home, because they work in places such as prisons, hospitals, ships, or trains.  They have turned up each day to enable us to deliver our promise of supporting the delivery of public services; many have suffered loss, either of colleagues, friends or family, and still turned up for work.  My respect and gratitude for them is unbound, and I want to extend our condolences to the families of those colleagues who have died from Covid-19 over the last year.  

Turning to our financial performance in 2020, growing Revenues by 20% (2019: +15%) and Underlying Trading Profit by 36% (2019: +29%), is all the more impressive as it follows strong growth in 2019 and underlines the momentum behind Serco's return to robust financial health.  This performance is particularly gratifying given the disruption caused to some parts of our business by Covid-19; despite approaching £400m of Covid-19 related revenues, the net impact of Covid-19 was around 1% of Underlying Trading Profit, and the balance of the 35% increase in profits came from the normal operations of the business. 

Our free cash flow, now released from the drag of recent years of Onerous Contract Provisions, was very strong at £135m, which, combined with strong growth in EBITDA brings our covenant leverage ratio down to 0.5x, which puts us in a very strong financial position.  This has enabled us to finance the recently announced acquisition of WBB from our existing debt facilities and still be around the middle of our target leverage range of 1-2 times Net Debt : EBITDA.

It is pleasing finally to be able to re-start paying dividends, last paid in 2014. The Board has thought carefully about this, particularly in the light of the current circumstances; in April 2020, we justified withdrawing the proposed Final Dividend in respect of 2019 saying: "At a time when the UK and other governments are helping Serco with its liquidity, it seems inappropriate to use that cash for anything other than its intended purpose of protecting the financial strength and resilience of our business".  Subsequently, and for the same reason, we did not propose a dividend at the half year in August 2020.  Four things have changed for us since the earlier decision-points in April and August.  First, any concerns we had about liquidity have proved groundless; we have successfully re-entered the long term private placement debt market (and at lower cost); we have been strongly cash-positive in 2020; leverage is below our target range at year end, and even after the WBB acquisition would sit comfortably within our target range.  Secondly, we have refunded all employment and liquidity support paid to Serco by governments, with the exception of £12m in the USA, for which there is no mechanism for early repayment, so will be repaid as scheduled in 2021 and 2022.  Thirdly, whilst the profits arising from our work on Covid-19 are ephemeral, they do not represent a material proportion of our profits in the year (net, around 1% of Underlying Trading Profit).  Finally, we have sought to recognise the intense pressure and extra work that Covid-19 has brought to our staff by making ex-gratia payments totalling £5m to 50,000 of our front line colleagues.  In the light of these four considerations, the Board feels it appropriate to recommend the payment of a final dividend in respect of 2020 of 1.4p per share, representing a 25% payout ratio assuming a notional 1/3^rd / 2/3^rd split between interim and full year dividends.

Looking ahead to 2021, guidance set out below is improved from that which we gave in December. It does not reflect the acquisition of WBB, announced on 16 February, which is subject to regulatory approval; guidance will be updated immediately after completion, which is expected to be during the course of Q2.  After the dramatic growth of the last three years - with 33% compound annual growth in Underlying Trading Profit -  we see 2021 as being a year of more normal rates of growth in revenues and profits; we will have some "drags" on our profitability, notably only having six months of the AWE contract, and we expect revenues related to Covid-19 services to be much stronger in the first half than in the second.  However, we have had a strong start to the year, and we are therefore increasing our profit guidance for 2021, with the revised guidance equating to 10% constant currency growth in the year.

Guidance for 2021 excluding the effect of the WBB acquisition, but including Facilities First Australia

	2020	2021
	Actual	Initial guidance	New guidance
Revenue	£3.9bn	~£4.1bn	~£4.2bn
Organic sales growth	16%	~2%	~4%
Underlying Trading Profit	£163m	~£165m	~£175m
Net finance costs	£26m	~£27m	~£27m
Underlying effective tax rate	23%	~25%	~25%
Free Cash Flow	£135m	~£75m	~£75m
Adjusted Net Debt	£58m	~£100m	~£100m

Notes to guidance: The guidance uses an average GBP:USD exchange rate of 1.37 in 2021 and GBP:AUD of 1.79.  If the WBB acquisition completes in Q2, we would expect our Net Debt : EBITDA to be around 1.6x at the half year and reduce thereafter.

For further information please contact Serco:

Paul Checketts, Head of Investor Relations, tel: [phone] or email: [e-mail]

Marcus De Ville, Head of Media Relations; tel [phone] or email: [e-mail]

Presentation:

A virtual presentation for institutional investors and analysts will be held today starting at 10.00am.  The presentation will be webcast live on www.serco.com and subsequently available on demand.  A dial-in facility is also available on [phone] (USA: [phone]) with participant pin code 5359253.

Notes to financial results summary table and highlights:

(1) Revenue is as defined under IFRS, which excludes Serco's share of revenue of its joint ventures and associates.  Organic revenue growth is the change at constant currency after adjusting to exclude the impact of relevant acquisitions or disposals.  Change at constant currency is calculated by translating non-sterling values for the year ended 31 December 2020 into sterling at the average exchange rates for the prior year.

(2) Trading Profit is defined as IFRS Operating Profit excluding amortisation of intangibles arising on acquisition as well as exceptional items.  Consistent with IFRS, it includes Serco's share of profit after interest and tax of its joint ventures and associates.  Underlying Trading Profit additionally excludes Contract & Balance Sheet Review adjustments (principally Onerous Contract Provision (OCP) releases or charges) and other material one-time items.  A reconciliation of Underlying Trading Profit to Trading Profit and Reported Operating Profit is as follows:

Year ended 31 December £m	2020	2019
Underlying Trading Profit	163.1	120.2
Include: non-underlying items
OCP charges and releases	5.8	0.8
Other Contract & Balance Sheet Review adjustments and one-time items	6.8	12.4
Trading Profit	175.7	133.4
Amortisation of intangibles arising on acquisition	(9.0)	(7.5)
Operating Profit before exceptional items	166.7	125.9
Operating exceptional items	12.5	(23.4)
Reported Operating Profit	179.2	102.5

(3) Underlying EPS reflects the Underlying Trading Profit measure after deducting net finance costs and related tax effects.

(4) Free 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, adding dividends we receive from joint ventures and associates, and deducting net interest and net capital expenditure on tangible and intangible asset purchases. 

(5) Adjusted Net Debt has been introduced by Serco as an additional non-IFRS Alternative Performance Measure (APM) used by the Group.  This measure more closely aligns with the covenant measure for the Group's financing facilities than Reported Net Debt because it excludes all lease liabilities including those newly recognised under IFRS16. 

(6) Reported Net Debt includes all lease liabilities, including those newly recognised under IFRS16.  A reconciliation of Adjusted Net Debt to Reported Net Debt is as follows:

As at 31 December £m	2020	2019
Adjusted Net Debt	57.8	214.5
Include: all lease liabilities accounted for in accordance with IFRS16	402.6	369.9
Reported Net Debt	460.4	584.4

(7) Refers to non-UK Underlying Trading Profit as a proportion of group Underlying Trading Profit before corporate costs. Our Underlying Trading Profit before corporate costs in 2020 was £204.3m.

(8) Our outlook for 2021 is based upon currency rates as at 31 January 2021.  The rates used, along with their estimated impact on revenue and UTP are as follows:

Year ended 31 December	2021 outlook	2020 actual	2019 actual
Average FX rates:
US Dollar	1.37	1.29	1.28
Australian Dollar	1.79	1.88	1.83
Euro	1.13	1.13	1.14
Year-on-year impact:
Revenue	~(£40m)	(£24m)	+£42m
UTP	~(£4m)	(£1m)	+£4m

Reconciliations and further detail of financial performance are included in the Finance Review on pages 22-38.  This includes full definitions and explanations of the purpose and usefulness of each non-IFRS Alternative Performance Measure (APM) used by the Group.  The Condensed Consolidated Financial Statements and accompanying notes are on pages 39-76. 
 

Chief Executive's Review

Summary of financial performance

Revenue and Trading Profit

Reported Revenue increased 20% to £3,885m (2019: £3,248m); in accordance with IFRS this measure excludes Serco's share of revenue from joint ventures and associates of £364m (2019: £395m).  Net currency movements reduced revenue by £22m or 1%, whilst the full-year effect of the acquisition of Naval Systems Business Unit (NSBU), which completed at the start of August 2019, added £151m or 5% to growth.  At constant currency, the organic revenue growth was £508m or 16%, accelerating from 15% in the first half of the year to 17% in the second half.  The very strong revenue growth rate was a consequence of Covid-19 related services, higher demand for our immigration services, a full year contribution from the AASC asylum accommodation and support contract in the UK and the AHSC defence garrison healthcare services contract in Australia, as well as the start of new work including Clarence Correctional Centre, Gatwick Immigration & Removal Centres and Prisoner Escorting.  This resulted in particularly strong organic growth in our UK&E and AsPac Divisions.

Underlying Trading Profit (UTP) increased by £43m or 36% to £163m (2019: £120m); excluding the £1m adverse impact of currency, the increase in UTP was £44m or 37%.  Profits increased in all our divisions, with our UK&E and Americas businesses seeing very strong improvement. The Group's Underlying Trading Profit margin was 4.2%, an increase of 50 basis points.

In every year, Serco's results are the aggregation of pluses and minuses, as some contracts grow their profits and others reduce them.  This year, some of the pluses and the minuses were extreme.  Contracts that went backwards included our business in the UK supporting Local Authority Leisure Centres, which were largely closed down during the various lockdowns; our Health business bore very significant additional costs as it worked to maintain service in the face of Covid-19; our Merseyrail joint venture saw passenger volumes at a fraction of normal levels; together, these three parts of our UK operations saw their contribution reduce year-on-year by around £35m; our contract to build an ice-breaker for the Australian Government suffered losses as we had to tow the ship from its shipyard in Romania, where there was a serious Covid-19 outbreak, to Holland in order to complete construction; many of our contracts bore additional costs as they worked to deliver services in the face of Covid-19.  And we also made the decision to recognise the extraordinary efforts of colleagues by making ex-gratia payments totalling £5m to 50,000 front-line staff. 

A large positive was we had a number of new and re-bid contracts contributing to profits.  Our Asylum Seeker (AASC) contract in the UK, which over the last five years lost around £15m-£20m on average per year, swung into profit under the new 10-year contract in 2020; there was strong demand for immigration services in Australia, which included mobilising quarantine hotels in Western Australia; our defence garrison healthcare services contract in Australia, won in 2019, made a full-year contribution in 2020; in the US, our contract with the Federal Emergency Management Agency (FEMA) saw strong growth.  And we benefitted from an entirely new source of business - NHS Test & Trace where we have provided more than 25% of the testing sites and half the Tier 3 tracing capacity; although these contracts are at lower margins than we would normally accept for this type of work, they generated nearly £350m of revenue, so made a material contribution and helped to reduce the impact of losses in Transport, Health and Leisure.  Together, contributions from these new and growing contracts combined to outweigh the losses and reduced profits of other parts of the business that were negatively impacted by Covid-19.  Importantly, of the £43m increase in UTP, the net impact on profits directly attributable to Covid-19, was £2m; the balance of £41m came from underlying growth in the business and the acquisition of NSBU.

Trading Profit was £176m (2019: £133m), £13m higher than UTP, which reflects a net £6m credit in Contract & Balance Sheet Review and one-time items (2019: net credit of £4m), and £7m of other one off items (2019: £12m) relating to the release of provisions that are no longer required.  The utilisation of Onerous Contract Provisions (OCPs) fell from £41m in 2019 (excluding IFRS16-related accelerated utilisation) to just £2m in 2020.  We have now very nearly completed our task of managing the £447m of loss-making onerous contracts identified in 2014; the closing balance of OCPs now stands at £15m, compared to £17m at the start of the year and the initial charge of £447m.

Reported operating profit and exceptional costs

Reported Operating Profit grew by £77m, or 75%, to £179m (2019: £103m) and was higher than Trading Profit as £9m (2019: £8m) of amortisation of intangibles arising on acquisition was more than offset by exceptional operating income of £13m (2019: costs of £23m), the largest portion of which related to our exit from the Viapath pathology services joint venture. There were no exceptional restructuring costs (2019: £13m).

 

Finance costs

Net finance costs were £26m (2019: £22m), with the increase driven by having a full year of property leases related to the AASC contract. The interest component of leases reported under Finance costs, as required under IFRS16, was £10m (2019: £7m).  Cash net interest paid was £25m (2019: £22m).

Pensions

Serco's pension schemes are in a strong funding position, resulting in a balance sheet accounting surplus, before tax, of £80m (31 December 2019: £54m) on scheme gross assets of £1.6bn and gross liabilities of £1.5bn.  The opening net asset position led to a net credit within net finance costs of £1m (2019: £2m).  For the Group's main scheme, the Serco Pension and Life Assurance Scheme (SPLAS), the purchase of a bulk annuity from an insurer has the effect of fully removing longevity, investment and accounting risks for around half of all scheme members; the gross liability remains recognised on our balance sheet, but there is an equal and opposite insurance asset reflecting the perfect hedge established by the annuity.

Tax

The underlying effective tax cost was £31m (2019: £24m), representing an underlying effective rate of 23% (2019: 25%) based upon Underlying Trading Profit less net finance costs, totalling £137m (2019: £98m).  The rate is higher than the UK statutory rate of corporation tax as the tax rates in our international divisions tend to be higher than the UK's rate. This is partially offset by consolidating our share of joint venture and associate earnings as, although included in profit before tax, the income has already been taxed.  The rate is lower than in 2019 due to an increase in the proportion of the Group's profits arising in the UK and a reduction in the proportion of our profits made by our joint ventures and associates. We expect the rate to increase to closer to 25% in 2021, although this is sensitive to the geographic mix of our profits.

Tax on non-underlying items was a net credit of £12m (2019: charge of £3m). The £12m credit, related to the tax impact of amortisation of intangibles arising on acquisition of £2m and £10m related to non-underlying items. Tax on exceptional items was £0.4m (2019: £3m).  The total tax charge was £19m (2019: £30m) and net cash tax paid was £36m (2019: £31m), which is higher than the current tax charge due to the effect of future expected cash tax deductions for which a current accounting credit is taken and due to timing differences on some tax receipts and payments, notably the cash from joint ventures and associates for losses transferred to them.

Reported result for the year

The reported result for 2020, as presented at the bottom of the Group's Consolidated Income Statement on page 39, is a profit of £134m (2019: £51m).  This comprises reported operating profit of £179m (2019: £103m), reported profit before tax of £153m (2019: £81m) and tax of £19m (2019: £30m). 

Earnings per share (EPS)

Diluted underlying EPS, which reflects the Underlying Trading Profit measure after deducting pre-exceptional net finance costs and related tax effects, increased by 37% to 8.43p (2019: 6.16p).  The improvement reflects the 36% increase in Underlying Trading Profit and the lower tax rate, partially offset by the increase in net finance costs and an increase in the weighted average number of shares in issue. The weighted average number of shares increased by 58m, or 5%, to 1,229m (2019: 1,171m), with the vast majority of this, 45m, the full-year effect of the May 2019 share placing.  Diluted reported EPS, which includes the impact of the other non-underlying items and exceptional costs, increased by 153% to 10.67p (2019: 4.21p).

Cash flow and Net Debt

Free Cash Flow showed sharp improvement, increasing by £73m to £135m (2019: £62m), representing cash conversion of 120%. The improvement was a result both of the £43m increase in underlying profits as well as improved debtors collection, with an almost complete catch up on delays in processing billings on our FEMA contract in the US and successful collection of some older receivables in our Middle East business.  We also benefited from £12m of Covid-19 tax deferrals in the USA, for which there is no mechanism to repay ahead of schedule.  Despite organic revenue growth of just over half a billion pounds, our working capital outflow was just £5m as governments, most notably the UK Government, made significant efforts to ensure that their suppliers were paid promptly, and for our part we ensured our suppliers were equally supported.  Average working capital days for the year were broadly unchanged, with creditor days reducing from 29 in 2019 to 23 in 2020; we are proud to say that 89% of UK supplier invoices were paid in under 30 days (2019: 86%) and 97% were paid in under 60 days (2019: 96%).  

The cash outflows related to loss-making contracts subject to OCPs reduced, reflected in the lower rate of provision utilisation of £2m (2019: £41m).  The Group did not utilise any working capital financing facilities in 2020 or the prior year, and has no such facilities in place.  Of other movements within Free Cash Flow to note, cash tax paid increased due to some timing effects and capital expenditure was higher, primarily a temporary consequence of the purchase of vehicles for our new prisoner escorting contract.

 

Adjusted Net Debt at the end of the year fell by £157m to £58m (2019: £215m). Our key measure of Adjusted Net Debt excludes all lease liabilities, which now total £403m (2019: £370m), including those leases now recognised under IFRS16. The adjusted measure of Net Debt aligns closely with the covenant on our financing facilities; our Net Debt for covenant purposes was £102m (2019: £235m).  The £157m reduction in 2020 includes the free cash inflow of £137m, proceeds from the sale of our stake in Viapath and £12m of favourable currency moves.  The closing Adjusted Net Debt of £58m compares to a daily average of £209m (2019: £231m) and a peak of £356m (2019: £357m). The unusually large difference between peak, average daily and period end Adjusted Net Debt was the result of two factors that occurred in the first half: first, in response to Covid-19 and government requests, we mobilised and paid for a large amount of additional resources from March onwards, and it took until June for the contractual paperwork and the payments to catch up, so we carried an unusually high amount of working capital for much of the first six months; second, there were delays in processing billings on our FEMA contract in the US in Q1, which saw improvement in Q2 and complete catch up in the second half.  Working capital normalised in the second half, with peak and average Adjusted Net Debt being £208m and £137m respectively, much closer to period end than in the first half. 

Reported Net Debt fell £124m to £460m (2019: £584m), notwithstanding a £33m increase in leases to £403m (2019: £370m), reflecting the continued expansion of our AASC contract.

At the closing balance sheet date, our leverage for debt covenant purposes was 0.5x EBITDA (2019: 1.2x), being Covenant Net Debt of £102m divided by EBITDA of £225m.  This compares with the covenant requirement to be less than 3.5x Net Debt : EBITDA.  Our target range is 1x-2x Covenant Net Debt to EBITDA.

At our pre-close update on 17 December we announced that we intended to buy £40m of shares over the coming months, and these shares would be either cancelled, held in Treasury and/or used to satisfy the requirements of employee share schemes.  As at 24 February 2021, 14.4m shares have been purchased at an average price of £1.23.  As stated below, it is now our intention to cancel around £20m of the purchased shares, and apply the balance to employee share schemes.  The effect of this share buyback, along with dividends and the anticipated purchase of WBB Inc, would result in our leverage for debt covenant purposes rising to around 1.6x EBITDA.

The Revenue and Trading Profit performances are discussed in more detail in the Divisional Reviews.  More detailed analysis of earnings, cash flow, financing and related matters are described further in the Finance Review.

Dividend recommendation

In the 2019 Annual Report, the Board recommended the payment of a final dividend with respect to 2019, the first time it had been able to make such a recommendation since 2014. It was a milestone in the recovery of the company.  Covid-19 then intervened and in April 2020, we withdrew the proposed Final Dividend in respect of 2019 saying: "At a time when the UK and other governments are helping Serco with its liquidity, it seems inappropriate to use that cash for anything other than its intended purpose of protecting the financial strength and resilience of our business". 

The Board has considered carefully the timing of the re-instatement of dividends, which, in the current circumstances is more than a simple financial calculation, given the importance of acting responsibly from a reputational perspective at this challenging time.  We have also been mindful of the views of some of the institutions and agencies whose opinion shareholders may value, as well as taking into account more broadly, to the extent that we can discern them, views of other stakeholders.  It would, perhaps, be the easiest thing to defer payments of dividends again, given that the pandemic is still very much with us.  On the other hand, Serco as a company has been saved by its shareholders and supported on its return to growth, with £850m of additional equity injected into the company since May 2014; the Board feels very strongly that shareholders should see cash returns on their investment at the earliest moment it is appropriate and prudent for them to do so.

Four things have changed for us since the earlier decision-points of our initial Covid-19 trading update in April and our half year results in August.  First, any concerns we had about liquidity have proved groundless; we have successfully re-financed our long-term debt (and at lower cost); we have been strongly cash-positive in 2020; leverage, even after the WBB acquisition, will be in the middle of our target range.  Secondly, we have refunded all employment and liquidity support paid to Serco by governments, with the exception of £12m in the USA, for which there is no mechanism for early repayment.  Thirdly, whilst the profits arising from our work on Covid-19 are ephemeral, they do not represent a disproportionate proportion of our profits in the year (net, around 1% of Underlying Trading Profit).  Finally, we have sought to recognise the intense pressure and extra work that Covid-19 has brought to our staff by making an ex-gratia payment of £5m to 50,000 of our front-line colleagues.

In the light of these four considerations, the Board feels it both appropriate and prudent to recommend the payment of a final dividend in respect of 2020 of 1.4p per share, which based on a policy of paying 1/3^rd / 2/3^rd split between interim and full year dividend, would represent 4x dividend cover, or a 25% payout ratio.  The dividend, if approved by shareholders at the AGM on 21 April 2021, would be paid on 4 June. We also intend to cancel £20m of the £40m of shares whose purchase we announced at our pre-close Trading Update in December; the £20m would be roughly equivalent to the cash value of the 2019 final and 2020 interim dividends foregone.

As we said in last year's report, the Board regards the 25% payout ratio as a prudent starting point for dividends, and will keep dividend policy under regular consideration as we continue to implement the growth stage of our strategy.  Future dividend decisions will take into account the Group's underlying earnings, cash flows and financial leverage, together with the prevailing market outlook.  The Board is mindful of the requirement to maintain an appropriate level of dividend cover, the potential alternative uses of capital to generate incremental value for shareholders, and the desire to maintain financial flexibility and a strong balance sheet that is considered appropriate for Serco's ability to deliver sustainable value for all of the Group's stakeholders.

Contract awards, order book, rebids and pipeline

Contract awards

We won £3.1bn of work in 2020, which represented a book-to-bill ratio (the relationship between orders received and revenue recognised) of around 80% (2019: 170%). We noted in last year's full year results that 2019's £5.4bn of order intake was an exceptional performance, and that we expected order intake in 2020 to be significantly lower; since 2017, our book-to-bill ratio has been approximately 115%. The natural lumpy flow of contract awards that led us to make this prediction was exaggerated in 2020 by the disruption caused by Covid-19 and, as a result, several large contract award decisions scheduled for Q4 were delayed to 2021; a consequence of this is that our reported year-end pipeline at £6.4bn was significantly larger than last year's £4.9bn.  Furthermore, whilst the average duration of a new contract in Serco is about five years - so a new or rebid contract win "books" at a multiple of this year's "billing" - more than half of the £636m increase in revenues in 2020 arose from Covid-19 related work where contracts are by their nature "booked" into the order book as they are "billed".  In the light of these factors, we are encouraged that our book-to-bill remained as high as 80%.

Of the order intake, approximately 60% was represented by the value of rebids and extensions of existing work and 40% comprised new business.  Our win rate by value for new work was around 35%, above the average over the last five years of approximately 25%.  Conversely, the win rate by value for securing existing work was around 70%, which is considerably lower than the 80-90% we typically see. The lower rate was a result of the Viapath joint venture, in which we had a 33% interest, not being selected as the preferred bidder for pathology services in London. We subsequently sold down our interest in the joint venture for a consideration of £11m.  In our wholly-owned operations, the win rate by value for existing work was over 90%.  The win rates by number of tenders were nearly 60% for new bids and over 90% for rebids and extensions.

Regionally, just under 50% of order intake came from the UK&E, slightly less than 30% from Asia Pacific, 20% from the Americas and the remaining proportion from customers of our Middle East business.

The largest award was our £450m contract to continue to operate the Northern Isles Ferry Services. First announced in September 2019, the contract was not included in our order intake until a procurement challenge from the unsuccessful bidder was resolved early in 2020.  In Australia, we signed a six-year A$730m (~£370m) extension to our contract to deliver support services at Fiona Stanley Hospital in Perth.  Also in Australia, we successfully rebid our contract to run Acacia Prison in Western Australia. The new contract has an estimated value of A$445m (£250m) over the initial five-year period and $A1.4bn (£790m) if two five-year extensions are exercised.  The UK business won an eight-year contract valued at just over £200m to manage the Gatwick Immigration Removal Centres.  We agreed and mobilised a range of work related to helping governments tackle Covid-19. This included contracts in the UK to support the NHS Test & Trace programme, testing facilities in the UK, temporary hospitals in the UK and the Middle East, and quarantine hotels in Western Australia. In total, the contracted value of the Covid-19 work was approaching £400m.  Other notable contract awards included a nine-year £116m environmental services contract with three councils in Norfolk, a new £52m, five-year agreement for deployment of secure services for the US Department of Defense, a new win worth £43m to provide deep space surveillance support in the USA and a 14-month extension to our contract to provide contact centre services for the Australian Tax Office, valued at £44m. We were also awarded a new contract to deliver front line customer services at Dubai Airport. However, as a result of the airport closing and subsequent lower passenger volumes due to Covid-19, the contract is yet to start, so we have not included it in our order intake in the period.  

Bids for new work that were unsuccessful in the period included Wellingborough Prison in the UK, Air Traffic Controller training for the Federal Aviation Administration in North America and support services for Kowloon West Cluster Hospital Authority in Hong Kong. 

Order book

As a result of the lower order intake, the Group's order book reduced from £14.1bn at the start of 2020 to £13.5bn at the year end. The order book reflects any required changes in assumptions for existing contracts, including currency movements.  This order book definition is therefore aligned with the IFRS15 disclosures of the future revenue expected to be recognised from the remaining performance obligations on existing contractual arrangements.  It is worth noting that, as it excludes unsigned extension periods, the £13.5bn would be £14.4bn if option periods on contracts in our US business were included.  As option periods have always tended to be exercised in our US business, we do include these in our assessment of order intake, but in accordance with IFRS15 we do not include them in the order book until they are exercised.  The order book definition also excludes our share of expected revenue from contractual arrangements of our joint ventures and associates. This would add a further £0.8bn if included within our order book, relating to the remaining period of the AWE operations and the Merseyrail franchise.

There is £2.9bn of revenue already secured in the order book for 2021, equivalent to around 70% visibility of our £4.2bn revenue guidance. The 'gap' in visibility is typically closed by our US business receiving the exercise of contract option periods and through short-term task order work on framework contracts, together with the necessary securing of contract extensions and rebids across the rest of the Group.

Rebids

As we look ahead the customary three years through to the end of 2023, across the Group there are around 75 contracts in our order book with annual revenue of over £5m where an extension or rebid will be required. Collectively these represent current annual revenue of around £1.9bn or 50% of the Group's 2021 revenue guidance.  At the start of 2018 the three-year forward rebid value was £1.4bn, at the start of 2019 it was £1.2bn and at the start of 2020 it was £1.5bn.  The proportion of revenue that requires securing at some point over the next three years is slightly higher than usual as the contracts related to the Covid-19 response are shorter-term in nature. Contracts that could potentially end at some point before the end of 2021 have aggregate annual revenue of around £1.1bn, which is higher than normal as it includes the Covid-19 work and our operations for the Dubai Metro, a rebid we consider to have been unsuccessful, and accounts for 3% of Group revenue and a minor profit impact.  In 2022, the aggregate annual revenue due for extension or recompete is around £400m. This includes the Australian immigration services contract due to end in December 2021 unless the option for a further extension is exercised or a rebid is won, and which currently accounts for over 5% of Group revenue.

Pipeline

Serco's measure of pipeline is probably more narrowly defined than is common in our industry; it was designed as an indicator of future growth and focuses on bids for new business only.  As a consequence, on average over the last five years, less than half of our achieved order intake has come from the pipeline.  It measures only opportunities for new business that have an estimated Annual Contract Value (ACV) greater than £10m, and which we expect to bid and to be awarded within a rolling 24-month timeframe; we cap the Total Contract Value (TCV) of individual opportunities at £1bn, to attenuate the impact of single large opportunities; the definition does not include rebids and extension opportunities; and in the case of framework, or call-off contracts such as Indefinite Delivery / Indefinite Quantity (ID/IQ) contracts, which are common in the US, we only take the individual task orders into account.  It is therefore a relatively small proportion of the total universe of opportunities as many of these have annual revenues less than £10m, are likely to be decided beyond the next 24 months, will be work from framework contracts, or are rebids and extensions.

On this definition our pipeline stood at £6.4bn at the close of 2020, significantly higher than the £4.9bn we reported at the start of the year and £4.2bn at the half year.  As well as the usual flow of wins and losses, 2020 was particularly unusual with Covid-19 leading to changing timings on work in the pipeline plus new work helping governments respond to the pandemic. The increase in the pipeline value reflects a combination of new opportunities and award decisions that were expected in 2020, being delayed to 2021, as our government customers' timelines were disrupted by Covid-19. The upwards shift in our pipeline can be seen as a natural consequence of our order intake being lower due to delayed award decisions. The pipeline at the end of 2020 consisted of around 30 bids that have an ACV averaging approximately £35m and a contract length averaging around seven years.  The UK & Europe division represents slightly more than half of the Group's pipeline, the Americas division around one-third, AsPac approximately 10% and the Middle East Division the balance.

Although excluded from our primary pipeline definition above, opportunities for new business that have an estimated ACV smaller than £10m are a significant component of the pipeline and potential growth. This is increasingly likely to be the case given the use of task orders under framework contracts. The pipeline of new business opportunities with an estimated ACV of less than £10m has increased from £1.6bn at the beginning of the year to £1.7bn. The pipeline including both large and smaller opportunities has increased from £6.5bn to £8.1bn.

As we have noted before, in the services industry in which Serco operates, pipelines are often lumpy, as individual opportunities can be very large, and when they come in and out of the pipeline they can have a material effect on reported values.  While the second half of 2020 did produce an increase in the pipeline, and market conditions may over time become more favourable, it is not necessarily strongly predictive of future revenues.

Operational progress, transformation, innovation and people

We have an ambition to be the best-managed business in our sector.  Achieving this will require investment in people, processes and systems.  We regularly update on progress, and each are described below, but Covid-19 has been hugely disruptive and has tested our systems, processes and people in unforeseen ways.

Our first trading statement on Covid-19, issued on 2 April, set out our operational priorities:

"Our priority in this crisis is to support the delivery of essential public services and, within that context, do all we can
to protect our employees from harm and our shareholders from loss. …. Our mettle is being tested as never before, and we are determined to rise to the level of events."

It turns out that many of the investments that we have made over the past five years have proven their worth during the crisis. In particular, I would point to three themes which have served us well.

The first is a management structure based on our "loose-tight" model. This means that we delegate authority and responsibility for day-to-day operational management to be as close to the customer as possible, but we maintain a tight control over risk management, bidding and cost control, and we have a well-established reporting regime, where transparency and reporting bad news as soon as it happens are the orders of the day.  During the crisis, we maintained the regimen of monthly reporting, and the Investment Committee, which is a standing committee of the most senior Group executives including the CEO, CFO, COO and Group General Counsel and which oversees bids and investments, met no fewer than 85 times between the 1^st April and 31^st December 2020.  Divisional Performance Reviews, and Business Unit Performance Reviews, continued their monthly rhythm.  Our cash performance was reported daily.

The second was cultural: over the past five years we have laid much emphasis on our values of Trust, Care, Innovation and Pride. These played a significant part in sustaining the ability of the business to deliver under extreme and unprecedent pressure. The levels of Trust built up across the management team allowed us to work seamlessly together across boundaries; the value of Care made it easy to connect company and personal interest with the astonishing efforts that people had to make to look after prisoners, patients, travellers, and hundreds of thousands of often frightened and confused citizens.  Innovation and loose-tight management allowed us to invent new services and business models almost overnight and to adapt our IT platforms to new ways of working.  Pride meant that people understood that the work we do delivering public services is incredibly important and that it is a privilege to be able to make a difference every day to people's lives. Pride and Trust also helped us maintain momentum and morale in the face of public criticism and comment about our work in the early days of NHS Test & Trace in the UK.  Needless to say, much of the criticism was wildly unfair and bore little relationship to the facts, but it was still unsettling to our colleagues to see their hard work being called into question.

What evidence do we have of the impact of our culture and organisational philosophy?  On the operational side, clearly we have the evidence of what has been delivered: quarantine hotels in Australia mobilised in a matter of days; 10,500 call handlers mobilised in four weeks for the UK Tracing programme, then reduced three months later to 5,000, then expanded two months later to approaching 10,000.  A network of test centres set up and operated which between May and December tested more than 5 million people.  Critical ship repairs performed under lock-down; train and metro services maintained transport services to move critical workers; multiple crews on rotating isolation to help support Navy movements; prisons adapted to 23-hour-day lockdowns and no visitors; hospital staff delivering cleaning, catering and portering with sickness absence rates of up to 25% in some contracts.  Operationally, Serco has performed really well during the crisis. 

But we also have the evidence of our trusty Viewpoint survey, to which 29,782 responded this year, slightly more than last year.  These surveys have been running since 2011, and the "Engagement Score" they produce has pretty accurately reflected the fortunes of the company and the state of morale in Serco.  Given the huge disruption experienced by so many of our colleagues; the immense changes they faced and adaptations they had to make in both their personal and working lives, I was braced for a sharp drop in response rates and scores.  To my immense surprise and pleasure, I was wrong and engagement scores increased over prior years', and continue their upward march.  There can be no greater tribute to the leadership shown by managers at all levels in the company that this has happened, and of all our operational and financial achievements in 2020, it is of this that I am the most proud.  Of particular note is the clear correlation between the scores of People Managers (+2 at 75) and the wider workforce (+2 at 73); clearly, the experience of the workforce as a whole, and their managers, is aligned to a rare degree. 

	2011	2012	2013	2014	2015	2016	2017	2018*	2019	2020
Leaders	65	56	51	38	55	72	71	69	77	83
Managers	54	51	49	n/a	59	62	65	70	73	75
All employees	45	45	42	42	53	54	56	67	71	73

*  in 2018, the methodology for calculating employee engagement changed, aligned to the new specialist third party provider of the survey.  As reported at the time, it is not possible to adjust historic data to restate to the new methodology, but analysis performed by the new provider in 2018 indicated that the engagement level for that year was broadly stable on the previous year's score.

One other fact worth mentioning: in 2019 we opened up the questionnaire to allow free-text answers to questions, with specific opportunities to make comments to the Board.  To our surprise, the 27,000 respondents made some 50,000 individual comments.  In 2020, we did the same, and this year there were 64,500 comments, of which we have picked a genuinely random sample - the good the bad and the ugly - of 1,000 and published them for public view on our website.  If anyone has any doubt as to the fact that Serco colleagues are a feisty, fearless and passionate lot who care deeply about their work delivering public services and about Serco, we need look no further than those comments.

One thing that has suffered badly is our management training.  Several years ago we designed and developed specific week long management training programmes with our partners at the Saïd Business School, Oxford; travel restrictions meant that we had to abandon these programmes because we believed the week long residential element was critical in being able to build networks across the company. We will reinstate these courses as soon as we can and catch up. On the other hand, we have been able to hold our commitment to recruiting graduates, and doubled our intake in 2020.

The third element that has stood us in good stead has been our investment in IT systems; over the past few years we have been migrating our key management and financial systems to the Cloud, and upgrading them at the same time. By the end of the first quarter of 2020 we had migrated the majority of our worldwide users on to Cloud-based implementations of Office 365, with the effect that, when the pandemic hit, we had an IT and support infrastructure which was able to adapt readily to remote and home working in a secure manner for most of our users.  Just in time, as it turns out.  Despite all the distractions of the crisis, we have not slackened off our rate of investment in new systems; we are in the process of a major upgrade of our back office systems in North America, which is almost complete at the time of writing, and we are also developing a custom-built system for the one process which we in Serco do on a truly industrial scale: recruit, manage, pay, train and organise people.  This will use our existing SAP back-end, but put a much more efficient and intuitive front-end onto it.  To give some idea of the scale at which Serco operates on the HR front: in 2020, including contingent labour, we recruited about 21,500 people, and created around 10,000 net new jobs.

We said at the beginning of the crisis that it would test our mettle; it has, and I am proud beyond words as to how well colleagues and the organisation as a whole have performed. For a very large business, we have shown surprising agility. For a business which sometimes looks like a collection of small businesses, we have demonstrated our ability to act with common purpose, and to maintain rigorous standards of reporting and control in confusing and difficult circumstances.  For a business of any size we have shown great resilience.  Perhaps the most remarkable thing is that whilst the management of some other companies, for example in travel, or hospitality, have had to manage disaster and seen their businesses going bust, and others for instance in on-line retailing may have seen the triumph of their model and their businesses boom, Serco has had to manage businesses booming and busting under the same roof.

Perhaps the biggest lesson we have learnt over the last year is encapsulated in the words of Rudyard Kipling:-

"If you can meet with Triumph and Disaster, and treat those two impostors just the same"

Easy to say, hard to do.

The Serco Institute

From March to June 2020, during the first few months of Covid-19, and acknowledging the world was rightly rather distracted with different priorities and focus areas, the Institute purposefully paused its work and instead lent its team to help fight the virus on the frontline of London hospitals, as well as to assist the Serco Foundation's Coronavirus Community Support Fund scheme that gave over £600k to local charities fighting the pandemic.  However, since restarting in the summer, the Institute has been publishing once again and making a thoughtful contribution and impact on public service thinking and our markets:

·	It has produced several volumes in its new "Policy People" series - interviews with key figures from across the international public sector landscape, who share their insight and reflections on their policy experiences.
·	Ahead of the Integrated Review in UK Defence, the Institute published a substantial report produced in conjunction with Kings College London's Centre for Defence Studies on the merits of the 'Whole Force' approach, including greater use of the private sector, which was launched at a roundtable hosted by the Institute with the Chief of Defence Personnel and the recent UK Minister for the Armed Forces speaking, amongst others.
·	At the time of writing, as the outputs of the Institute gain traction and attention, we are about to see the launch of the Serco Institute Middle East with two reports to be published based on polling residents of the UAE and KSA respectively for their views, hopes, and fears on the future of public services in their countries.
·	Last but not least, the Institute has also published numerous short-form articles reacting to day-to-day or more immediate events, such as the realities of NHS Test and Trace operations, Social Value models in the UK, vaccine policy, the likely impact of the Biden administration, and more.

In terms of work soon to be published, the report the Institute commissioned from the independent economic consultancy Capital Economics on the value of outsourcing is complete and simply awaiting publication. This has provided new and persuasive evidence and data in an area where there has been no new research in nearly ten years.  Some of the key conclusions are as follows:

·	"The evidence from areas that have been subject to competition suggests that it is possible to deliver services more cost efficiently without damaging service quality..."
·	"Our analysis on prison management, soft facilities management in healthcare and air traffic control suggests that potential average savings to the government of between five and fifteen per cent from introducing competitive markets is a relatively conservative estimate…"
·	And perhaps most importantly, that: "…the private sector typically delivers services to the same standard or better than the public sector."

Also, soon to be published is a piece of substantial research on 'Contestability' policy and the use of the private sector in delivering public services in Australia.

At a time when the role of the private sector in delivering public services has been questioned in some countries - particularly on the back of political controversies as to how well or not governments have dealt with the pandemic - and at a time when citizens' expectations of public services continue to increase and evolve, we feel the Serco Institute can continue to make an important contribution to understanding what works, and why, in policy delivery, and disseminating knowledge of innovations in public services.

Acquisitions

We regard acquisitions as an important part of our toolkit, which if deployed correctly, can add value and speed strategic progress; but they should be in addition to, and designed to deliver, new opportunities for organic growth.   They require discipline and process, and for M&A we follow our head office mantra of having a few good people rather than a lot of mediocre ones.  Much of our work we do in-house although we also use advisers where appropriate.  We look at an awful lot of opportunities, and reject most of them.  Generally speaking, we regard acquisitions as higher risk than organic growth, so any candidates have to meet our stringent criteria of being both financially and strategically compelling.  We also recognise that acquisition opportunities come in different shapes, sizes and sectors, and a small one can be strategically important to a region, but not necessarily significant at Group level.  But large or small, all acquisitions are centrally managed by Group and follow the same rigorous process. 

 

Since 2014 we have undertaken five acquisitions:

·	In 2017, we acquired BTP systems, a US defence engineering company, for $20m (£13m).
·	In 2018 we acquired parts of the Carillion Healthcare business, for £18m.
·	In 2019 we undertook a major acquisition in North America in the form of the Naval Systems Business Unit of Alion, a leading provider of naval design, systems engineering and acquisition & programme management, for a consideration of $225m (£186m).
·	In January 2021, we acquired FFA, a specialist provider of cleaning, facilities maintenance and management services to governments in Australia for A$78m (£44m) including working capital adjustments.
·	On 16 February 2021 we announced the acquisition, subject to regulatory approvals, of WBB, a leading provider of advisory, engineering, and technical services to the US military, for $295m (£215m).

The FFA acquisition was attractive because our Australian business wanted to extend its reach and capability in the government facilities maintenance and management market, for which there are numerous opportunities in the years ahead. FFA was a rare asset because of its focus on, and strong track record with, government, indeed it had originally been the management buyout of the New South Wales in-house FM operation.  The purchase price was 6.3x trailing EBITDA, which we believed was a fair price for a business with relatively low margins.  

The WBB acquisition, which is subject to regulatory approval, would be our largest to date.  It is highly complementary to our existing Serco business in North America: like Serco, WBB is a leading provider to the US Department of Defense of Systems Engineering and Technical Assistance (SETA) services focusing in the fields of Acquisition and Programme Management, Systems Design and Engineering, Through-Lifecycle Asset Management and Mission. 

It would add very significantly to the scale, breadth and capability of our North American defence business. In terms of scale, it adds around 20% to Serco's existing $0.9bn of North American defence revenues, and about 1,000 skilled people, reinforcing our position as a significant supplier in the US defence services market, with credible positions in all arms of the Department of Defense.  In terms of breadth the acquisition of WBB adds new market segments and reach within US defence. It will approximately double Serco's revenues across both the US Army and Air Force/Space Force, giving us ~$100m businesses in each. It will give us immediate access to markets that are difficult to enter organically including Air Force programme offices, the Missile Defense Agency, Space and Missile Defense Command, the Office of the Secretary of Defense, security agencies and others.  In terms of capability, WBB brings significant new areas of capability to Serco's global defence business, including Advanced Data Analytics, Organisation Design, Cyber, AI & Machine Learning, Natural Language Processing, Wargaming, Modelling, and technologies related to geo-location. Among its 1,000 employees, 80% of whom have security clearances, it has around 200 "Subject Matter Experts" many of whom are former senior US military officers who are recognised experts in their fields.

We will continue to keep our eyes and ears open for new opportunities, and focus in the meantime on delivering value from those acquisitions we have already done.

Market outlook

Our approach to strategy planning is to conduct annual planning exercises, updating five-year forward plans, using internal resources.  Every 4-5 years we conduct a root-and-branch review, with external help, of our markets.  The last such review was in 2018, and in our 2018 results announcement, we set out our views on our markets.  We had planned to conduct an annual update in 2020, but as soon as Covid-19 struck we told those people who would normally do this work to focus on managing the business.  We did, however, set all our Divisions to thinking how life might be different in a post-Covid-19 world.

It is our intention to give investors a Capital Markets Day in the second half of 2021, at which point the fog on what a post-Covid-19 world might look like will have thinned, and we will be able to give a more considered analysis.  In the Our Market section of the Annual Report we set out a lot of our thinking, but below are some of our reflections on how Covid-19 may impact our market:-

·	Covid-19 will probably amplify the underlying drivers of demand in our market - which in 2014 we described as the "Four Forces".  They are: relentlessly increasing demand for public services; expectations of higher service quality; structural fiscal deficits; electoral resistance to tax increases.  These forces will continue to encourage governments to seek innovative ways to deliver more services, of higher quality, and at lower cost (what we call 'More and Better for Less').  We believe that Covid-19 has reconnected hundreds of millions of people worldwide with government services and reminded them of the value of well organised service delivery. This will make government more confident in promoting services to citizens.  But the fact is that deficits and levels of government debt have increased to levels not seen outside World War, and governments will be sharply focused on delivering "More and Better for Less".  This is positive for our market.
·	When faced by Covid-19, governments worldwide were surprised by two things. First, how little resilience there was in many critical self-provided government services, and second by how well the private sector was able to respond to an existential crisis. From developing vaccines in previously undreamt-of timescales, to building vast new hospitals in weeks, to manufacturing tens of thousands of ventilators, to standing up test and tracing services on a scale never before seen, governments asked the private sector to respond, and has, I suggest, been pleasantly surprised at how broad and capable the private sector has proved to be.
·	We think that thoughtful governments will reflect that they need to be more diligent about how they plan for crises, and putting in place supply-chains and procurement processes that allow for the swift mobilisation of the private sector.
·	In the UK in particular, many companies have avoided doing business with government as they have seen the carnage that has been wrought, some by government, some by self-harm, on the sector over the past 10 years.  During the crisis, companies have seen that, particularly in crisis, government can be a good customer to have; they pay on time, and in times of trouble, demand increases.  This may attract more entrants into the market, which would be a good thing.  One of the greatest dangers for companies like Serco, whose very existence depends upon government being confident it can test value through competition, is if there is no competition.
·	Governments across the world were broadly able to maintain momentum on tender evaluation during the first six months of 2020, but in the second half many of the larger tender adjudications became delayed, and we suspect that it will take some time for backlogs to be cleared. This trend is exacerbated in the US where it is the habit of losers, particularly incumbent losers, to launch protests against procurement decisions, and Covid-19 is slowing up the process of dealing with these protests.
·	With hundreds of millions of people being made unemployed, we believe that governments will invest in services to get people back into work as soon as possible. This is an area in which we have deep experience.
·	We see demand for testing and contact tracing reducing during the course of 2021 and eventually being taken over by Local Authorities, with a reserve force from the private sector at the ready to deploy in case of significant outbreaks.
·	We believe the arrival of the Biden administration and its response to higher debt due to Covid-19 is likely to slow the rate of growth in US defence spending.  However, the need to respond to external military threats is supported across both parties and we therefore think the change of government is unlikely to have a dramatic impact on our US defence business.

Long term, we believe that the Covid-19 crisis will have an impact on the mix of demand for services provided by the private sector to governments, but we see no reason to change our view that in the years ahead Serco should be able to grow its revenues by, on average, around 5% a year, and deliver trading margins of 5%.

Guidance for 2021

At our Closed Period trading update on 17 December 2020, we provided our initial outlook for 2020 and remarked that we anticipated a year of stable revenue, UTP and earnings for the existing business, with a small uplift to reflect the acquisition of FFA.  We also noted that, in common with many other businesses, we face a lot of uncertainty in 2021, and the outlook has a wider-than-usual margin for error.  Since that date, and having had a very strong start to the year, we have revised upwards our view of Underlying Trading Profit.  We have also revised guidance to take account of currency rates and to take into account the impact of the resumption of dividend payments announced with our 2020 results.  With lower volumes expected from Covid-19-related work in the second half, along with the exit from our activities at the Atomic Weapons Establishment at the end of June 2021, we expect trading to be stronger in the first half than in the second. This guidance does not include the effect of the acquisition of WBB Inc, which is still subject to regulatory approval; guidance will be updated following completion, which we expect to achieve in Q2.  In our statement announcing the transaction, we stated that we expected WBB to generate revenue in calendar 2021 of around $230m (£168m), EBITDA of $29m (£21m) and UTP of $28m (£20m), before exceptional transaction and integration costs; naturally, the proportion of this that would accrue to Serco in 2021 would depend on the timing of completion.

Revenue: Revenue in 2021 is expected to be around £4.2bn, approximately 7% higher than the £3.9bn outturn for 2020.  This assumes 4% from the acquisition of FFA, organic growth of 4% and a 1% adverse impact from currency.  We will have an ongoing positive contribution from several of the contracts that have supported growth in the second half of 2020, including Prisoner Escorting and Custody Services, Gatwick IRC and Clarence Correctional Centre.  Predicting the outcome for our Covid-19 related work is difficult due to the speed of change with the pandemic and the potential for rapid changes in demand from our government customers. Our current expectation is that the level of work will be lower in 2021 but the range of potential outcomes is wide.

Underlying Trading Profit: UTP is expected to be around £175m, including approximately £6m from FFA and a currency headwind of £4m, based on recent exchange rates.  The year will benefit from the annualisation of our new contracts from 2020 and we anticipate some improvement in the parts of our business negatively impacted by Covid-19 in 2020. These should offset the cessation of our involvement in the Atomic Weapons Establishment at the end of June 2021, higher insurance costs and a lower level of profit on our Center for Medicare & Medicaid Services (CMS) contract as the high volumes we saw in 2020 fall away; we also expect to see a reduced contribution from our Anti-Terrorism / Force Protection (ATFP) framework contract for US Naval Facilities due to the typical phasing of work over the contract life.

Net finance costs and tax: Net finance costs are expected to be around £27m. This is similar to 2020 as the lower level of debt is temporarily offset by us paying interest on both our new US private placement notes and the existing notes that will mature in May and October 2021 as well as the acquisition of FFA.  The underlying effective tax rate is expected to continue at around 25%, although this is sensitive to the geographic mix of our profit and any changes to current corporate tax rates. 

Financial position: We expect Adjusted Net Debt to be to approximately £100m. Strong cash generation will be balanced by us repaying about half the of the £12m in US employment tax deferrals in 2020, the acquisition of FFA and the £40m of our own shares being purchased. Free Cash Flow is expected to reduce in 2021 due to the repayment of US tax deferrals, the purchase of shares for employee share schemes and because 2020 benefitted from catch up on delays in processing billings on our FEMA contract in the US.

Our outlook for 2021 is based upon recent currency rates.  The rates used, along with their estimated impact on revenue and UTP, are shown in the table on page 4.

Board

There have been numerous changes to the Board during the year, which will be described in the Chairman's letter in our annual report.  There are two in particular I would like to comment on. The first is the departure of Serco's Chairman, Sir Roy Gardner who had the courage to join Serco in 2015, at a time when few others would.  He has been immensely supportive of the executive and has been a font of wise advice, for which I and my colleagues are enormously grateful.  I greatly look forward to working with new incoming Chairman, John Rishton, who has been on the Serco Board since 2016.  The second is the departure of my longstanding colleague Angus Cockburn, who is to step down from the Board at the AGM.  Angus was instrumental in persuading me to join Aggreko in 2003, and we have worked together, with only a six-month break, since then.  He is a prince amongst men, and a giant amongst CFOs.  Fortunately, in 2014 he took the trouble to recruit and groom a brilliant successor, Nigel Crossley, who will seamlessly take on Angus's work.

Summary and concluding thoughts

In this section of my report last year, the preoccupation was how we should adapt to being a "normal" company after four turbulent years and how we should respond to the increased focus of stakeholders on Environmental, Social and Governance (ESG) issues.

On ESG, we have tried hard to respond in a thoughtful way to the need for continuous improvement.  We think that our reporting has much improved, and although it will have negative consequences for our profits, the loss of our contracts at AWE will allay the concerns of those stakeholders who felt uncomfortable with us being centrally involved with the production of nuclear weapons.  However, there will always be certain parts of our business which will cause concern to some.  Most notably the fact that we do on governments' behalf some of the hard things that citizens expect their governments to do, like deport some people and hold others in prison; all on behalf of democratically elected governments, but unpalatable to some.

In terms of business operations, 2020 was a salutary example that, in the words of Robert Burns, "the best laid schemes o' mice an' men gang aft a-gley." Covid-19 upended the best-laid plans of CEOs, let alone of mice.  I am beyond proud of the way colleagues managed their way through this crisis, and beyond pleased with the way our "loose-tight" management structure, our reporting, our processes and our IT systems were able to react with agility, pace and precision to an existential, and completely unexpected, crisis and deliver an outstanding financial outcome.

So, what does this say of the future?  Naturally we will want to point to the wisdom of our investment in management, systems, processes, and the creation of an operating platform that is able to work across different geographies and segments of the government services marketplace.  But we have been lucky, too.  Lucky to have had our balance sheet crisis before most of our peers, and been able to learn the salutary lessons and disciplines that brought with it; lucky that when Covid-19 struck, our balance sheet was repaired and our operating platform was well invested; lucky that when governments needed us, we had earned our right to be "in the room".  And that combination of skill and luck has enabled us to deliver 33% compound growth in profits over the last three years, even in the teeth of a crisis as grave as Covid-19.

Maybe now, in 2021, we can think once again of the ambition we set ourselves a year ago of being a more "normal" company.  That we can grow our margins to 5% and our revenues at 5%, quietly and diligently serving governments, avoiding risk and losses, and repeating to ourselves the mantra that "no deal is better than a bad deal".  All the while paddling furiously below the surface trying to do better than that; investing in our people and systems as well as searching for value-enhancing acquisition such as NSBU, FFA and WBB.  And holding fast to our ambition to be thought of as the best-managed business in our sector.

And we intend to stick with the strategy we developed in 2014:

What we do: we are an international business providing people-enabled services, supported by best-in-class systems and processes, to governments.

How we do it: we use a management framework, as set out below.

Our Values: Trust, Care, Innovation, Pride

Our Purpose: to be a trusted partner of governments, delivering superb public services, that transform outcomes and make a positive difference for our fellow citizens.

Our Organising Principles: loose-tight, disciplined entrepreneurialism

Our Method: being the best-managed business in the sector.

Our Deliverables: high and rising employee engagement, margins of ~5%, growing revenues at ~5%.

We intend to continue working hard to deliver this strategy.

Rupert Soames

Group Chief Executive

Serco - and proud of it.
 

Divisional Reviews

Serco's operations are reported as four regional Divisions: UK & Europe (UK&E); the Americas; the Asia Pacific region (AsPac); and the Middle East.  Reflecting statutory reporting requirements, Serco's share of revenue from its joint ventures and associates is not included in revenue, while Serco's share of joint ventures and associates' profit after interest and tax is included in Underlying Trading Profit (UTP).  As previously disclosed and for consistency with guidance, Serco's Underlying Trading Profit measure excludes Contract & Balance Sheet Review adjustments (principally OCP releases or charges).

Year ended 31 December 2020 £m	UK&E	Americas	AsPac	Middle East	Corporate costs	Total
Revenue	1,777.4	1,064.3	718.9	324.2	-	3,884.8
Change	+31%	+16%	+16%	(7%)		+19.6%
Change at constant currency	+31%	+17%	+18%	(7%)		+20.3%
Organic change at constant currency	+31%	+1%	+18%	(7%)		+16.2%
UTP	57.0	100.8	32.6	13.9	(41.2)	163.1
Margin	3.2%	9.5%	4.5%	4.3%	(1.1%)	4.2%
Change	39bps	51bps	-50bps	31bps	34bps	50bps
Contract & Balance Sheet Review adjustments	5.8	-	-	-	-	5.8
Other one-time items	6.8	-	-	-	-	6.8
Trading Profit/(Loss)	69.6	100.8	32.6	13.9	(41.2)	175.7
Amortisation of intangibles arising on acquisition	(2.0)	(7.0)	-	-	-	(9.0)
Operating profit/(loss) before exceptionals	67.6	93.8	32.6	13.9	(41.2)	166.7

Year ended 31 December 2019 £m	UK&E	Americas	AsPac	Middle East	Corporate costs	Total
Revenue	1,361.7	915.7	621.4	349.6	-	3,248.4
UTP	38.4	82.1	31.3	13.9	(45.5)	120.2
Margin	2.8%	9.0%	5.0%	4.0%	(1.4%)	3.7%
Contract & Balance Sheet Review adjustments	0.3	9.5	-	-	(6.2)	3.6
Other one-time items	9.6	-	-	-	-	9.6
Trading Profit/(Loss)	48.3	91.6	31.3	13.9	(51.7)	133.4
Amortisation of intangibles arising on acquisition	(1.2)	(6.2)	(0.1)	-	-	(7.5)
Operating profit/(loss) before exceptionals	47.1	85.4	31.2	13.9	(51.7)	125.9

The trading performance and outlook for each Division are described on the following pages.  Reconciliations and further detail of financial performance are included in the Finance Review on pages 22-38.  This includes full definitions and explanations of the purpose of each non-IFRS Alternative Performance Measure (APM) used by the Group.  The Condensed Consolidated Financial Statements and accompanying notes are on pages 39-76.  Included in note 2 to the Group's Consolidated Financial Statements are the Group's policies on recognising revenue across the various revenue streams associated with the diverse range of goods and services discussed within the Divisional Reviews.  The various revenue recognition policies are applied to each individual circumstance as relevant, taking into account the nature of the Group's obligations under the contract with the customer and the method of delivering value to the customer in line with the terms of the contract.
 

UK & Europe

Serco's UK & Europe Division supports public service delivery across all five of the Group's chosen sectors: our Justice & Immigration business provides a wide range of services to support the safeguarding of society, the reduction of reoffending, and the effective management of the UK's immigration system, and includes prison management as well as the provision of housing and welfare services for asylum seekers; in Defence, we are trusted to deliver critical support services and operate highly sensitive facilities of national strategic importance; we operate complex public Transport systems and services; our Health business provides primarily non-clinical support services to hospitals; and our Citizen Services business provides environmental and leisure services, as well as a wide range of other front, middle and back-office services to support public sector customers in the UK and international organisations across Europe, including the European Patent Organisation and the European Space Agency.  On a Reported Revenue basis, Serco's operations in the UK represent approximately 43% of the Group's reported revenue, and those across the rest of Europe approximately 3%.

The division had a very strong year, and the UK had the most to cope with in terms of Covid-19, with some businesses going backwards and others growing strongly.  Revenue for 2020 was £1,777m (2019: £1,362m), an increase of 31%.  Reported revenue excludes that from our joint venture and associate holdings which largely comprise the operations of AWE and Merseyrail.  At constant currency, the growth in revenue was also 31%, or £415m.  The high organic growth resulted from a combination of additional work related to Covid-19, our Asylum Accommodation and Support Services Contracts (AASC) contracts, the start of our agreement to manage the Gatwick Immigration Removal Centres and mobilisation of our new Prisoner Escorting contract. Work supporting our customers' response to Covid-19 included the NHS Testing and Contact Tracing programmes, and increased customer service work, including NHS 111. At the same time, Covid-19 caused an abrupt reduction in demand in our Leisure business and on our contract to operate the Northern Isles Ferries. The Caledonian Sleepers contract saw a sharp reduction in passenger volumes and services as a result of Government limitations on travel, but alongside these service changes, Emergency Measures Arrangements were agreed with the customer. The current EMA comes to an end in March 2021 and we have commenced discussions with the customer about the future trading arrangement, including the possibility of an extension or new EMA.

Underlying Trading Profit (UTP) was £57m (2019: £38m), representing a margin of 3.2% (2019: 2.8%) and growth of 48% at constant currency.  The increase in our profit was driven, in large part, by our AASC contracts moving from losing money in 2019, as mobilisation costs were incurred, to profitability, and by our additional Covid-19 work. There was a £2m non-recurring benefit to UTP as we exited the Viapath pathology services joint venture. Trading Profit includes the profit contribution (from which interest and tax have already been deducted) of joint ventures and associates. If the £365m (2019: £395m) proportional share of revenue from joint ventures and associates was included and the £3m (2019: £6m) share of interest and tax cost was excluded, the overall Divisional margin would have been 2.8% (2019: 2.7%).  The joint venture and associate profit contribution was lower at £13m (2019: £27m), due to the impact of Covid-19 on Merseyrail passenger numbers and lower pricing on AWE. 

Within UTP there was a reduced rate of OCP utilisation of £1m (2019: £33m excluding IFRS16-related accelerated utilisation), as we draw towards the end of our efforts over the last six years to reduce these large loss-making contracts.  Trading Profit of £70m (2019: £48m) was above UTP due to a £6.8m credit, relating to a settlement in favour of the Group included within other one time items (2019: £9.6m net credit) and a £5.8m credit in Contract & Balance Sheet Review adjustments (2019: £0.3m net credit).

The UK & Europe Division's order intake was £1.5bn, or 48% of that for the whole Group.  The largest award was our £450m contract to continue to operate the Northern Isles Ferry Services. First announced in September 2019, the contract was not included in our order intake until a procurement challenge from the unsuccessful bidder was resolved earlier this year. The second largest contract award in the period was a new agreement to manage the Gatwick Immigration Centres, valued at approximately £200m. We also agreed various shorter-term contracts with the government to provide services in response to Covid-19.

Of existing work where an extension or rebid will be required at some point before the end of 2023, there are less than 30 contracts with annual revenue of £5m or more within the division. In aggregate, these represent around 40% of the current level of annual revenue for the division.  The largest is the NHS Test & Trace contract, which, due to its nature, we don't expect to continue, at least at its current level.  The larger contracts to rebid include, in 2021, our contract with the Department for Work and Pensions and, in 2022, our Royal Navy fleet support contract known as Future Provision of Marine Services (FPMS) and our UK MOD Skynet satellite support operations.

The UK & Europe pipeline has increased materially in 2020 as a result of new opportunities and awards that were expected in 2020 being delayed to 2021. Opportunities in the new bid pipeline include several defence support opportunities, justice tenders including the new build prison manage and operate contracts, and environmental services work in Citizen Services.  A significant proportion of the UK pipeline relates to work for the Defence
 

Infrastructure Organisation (DIO). We are bidding this in a joint venture and, if successful, we would recognise only Serco's share of profit after interest and tax, not revenue.

The announcement in early November that the Ministry of Defence intended to take back in-house the management of the Atomic Weapons Establishment as from the end of June 2021, was clearly a major disappointment as we have been involved with the management of AWE for over 20 years.  The contract contributed £15m to UTP in 2020, and the financial consequences of losing the contract will be split between 2021 and 2022.

Americas

Our Americas Division accounts for 27% of Serco's reported revenue, and provides professional, technology and management services focused on Defence, Transport, and Citizen Services.  The US Federal Government, including the military, civilian agencies and the national intelligence community, are our largest customers.  We also provide services to the Canadian Government and to some US state and municipal governments.

Revenue for 2020 was £1,064m (2019: £916m), an increase of 16% in reported currency.  In US dollars, the main currency for operations of the Division, revenue for the year was equivalent to approximately US$1,369m (2019: US$1,172m).  The Naval Systems Business Unit (NSBU) acquisition, completed at the start of August 2019, drove growth from acquisitions of 17%, while the strengthening of the pound against the dollar decreased revenue by £8m or 1%. Organically, revenue was stable as growth in the US Federal Emergency Management Agency (FEMA) contract framework and the US Pension Benefit Guaranty Corporation (PBGC) contract was offset by the loss in 2019 of our contract to provide traffic management services to the US state of Georgia Department of Transportation (GDOT) and lower volumes on our Consolidated Afloat Networks Enterprise Services (CANES) contract, which was coming off strong demand and task order processing in 2019. CANES had seen particularly strong demand and new task order wins in 2019; it is a contract to assemble off-the-shelf components for the US Navy and attracts with relatively low margins and by its nature has volumes which vary by significant amounts from quarter to quarter.

Underlying Trading Profit grew strongly to £101m (2019: £82m), representing a margin of 9.5% (2019: 9.0%) and growth of £19m or 23%. Constant currency growth, after an adverse currency movement of less than £1m, was 24%.  Around half of the growth came from the NSBU acquisition and half was organic.  Despite revenue being flat organically, profit improved as the additional FEMA and PBGC work more than offset the reduced contribution from CANES and GDOT, and due to a step up in profit on our Anti-Terrorism / Force Protection (ATFP) framework contract for US Naval Facilities. The ATFP contract has been successfully rebid in 2021 but the typical phasing of this work over the contract life means we anticipate a lower level of revenue and profit at the beginning of the new agreement.  Following a strong 2019, profit was broadly flat on our health insurance eligibility support contract for the Center for Medicare & Medicaid Services (CMS). The temporary uplift in volume related work experienced in 2019 continued into the first half of 2020 before stepping down in the second half, as expected, once the circumstances that led to the extra activity were resolved.

Within Underlying Trading Profit there was no OCP utilisation (2019: £4m), as the Ontario Driver Examination Services (DES) contract is no longer an onerous contract.  There were no Contract & Balance Sheet Review adjustments (2019: £9.5m net credit), so Trading Profit was £101m (2019: £92m).

Americas represented around £0.6bn ($0.8bn) or 19% of the Group's order intake.  The largest award for new work was from the U.S. Space Force to manage, operate and maintain the Ground-Based Electro-Optical Deep Space Surveillance (GEODSS) system.  The contract has an eight-month base period and six one-year option years with a total value of $57m. We also secured additional field office support services work for the Pension Benefit Guaranty Corporation, following our initial contract win in 2019.

Our rebid and extended win rate was in excess of 90% in the year. This included the rebid of our contract to support the US Army's civilian readiness training and talent management efforts. We also resecured places on the ID/IQ frameworks for both ship and shore-based C4ISR systems modernisation services over the next ten years that replace the previous GIC frameworks. 

Of existing work where an extension or rebid will be required at some point before the end of 2023, there are around 25 contracts with annual revenue of over £5m within the Americas division; in aggregate, these represent around 60% of the current level of annual revenue for the division.  Those coming up for rebid or extension in 2021 include our SEA 21 contract for managing lifecycle maintenance of US Navy surface ships and our support services at the 5 Wing Canadian Forces Base in Goose Bay; and in 2022, the Federal Aviation Administration's (FAA) Contract Tower (FCT) Program and resecuring a position on the successor framework for CANES.  In 2023, our CMS contract is scheduled to be retendered.

Our pipeline of major new bid opportunities due for decision within the next 24 months includes a broad spread of defence support functions, including those added with the NSBU acquisition.  Our Citizen Services business unit also had a number of wins during the year, and building further the pipeline in this area remains a target.

AsPac

Serco operates in Australia, New Zealand and Hong Kong in the Asia Pacific region, providing services in each of the Justice, Immigration, Defence, Health, Transport and Citizen Services sectors.  The AsPac Division accounts for 19% of the reported revenue for the Group.

Revenue for 2020 was £719m (2019: £621m), an increase of 16% in reported currency.  In Australian dollars, the main currency for operations of the Division, revenue for the year was equivalent to approximately A$1,343m (2019: A$1,137m).  The weakening of local currencies against sterling reduced revenue by £14m or 2%; the organic change at constant currency was therefore growth of 18%, or £112m.  The largest contributor to this growth was the AHSC defence garrison healthcare services contract in Australia, which started operations on 1 July 2019.  Other notable drivers of growth were Clarence Correctional Centre, where operations commenced in July, increased activity for our immigration business and additional work with Services Australia (formerly the Department of Human Services), where increased business resulted indirectly from the impact of Covid-19.

Underlying Trading Profit was £33m (2019: £31m), representing a margin of 4.5% (2019: 5.0%) and an increase of 4%. Excluding the adverse currency movement of £0.4m, the increase at constant currency was 6%.  We saw good profit growth from the AHSC contract, this being its first full year of operation, as well as the additional work with Services Australia. The margin reduced by around 50 basis points due to a drag from Clarence Correctional Centre, which was break even, construction delays on Australia's new Antarctic research icebreaker vessel, as a result of Covid-19, and additional overheads of around £3m, including £1m of front-line worker bonuses.

There was OCP utilisation of £0.8m (2019: £3m) within Underlying Trading Profit. There were no Contract & Balance Sheet Review adjustments (2019: £nil), so trading profit was therefore £33m (2019: £31m), the same as Underlying Trading Profit.

AsPac represented around £0.9bn or 29% of the Group's order intake.  Having had significant success in winning in recent years, it was a relatively quiet year for new work. We did however have a very strong year on rebids and extensions, with our win rate by value approaching 100%. Our contract to deliver prison services at Acacia Prison for the Government of Western Australia was successfully rebid. Serco has managed operations at the prison, which is Western Australia's largest prison and the second largest in Australia, since 2006.  The initial 5-year period has an estimated value of A$445m or approximately £250m.  The contract has provision for two further 5-year extensions with potential value to Serco over the full 15 years, including indexation, of approximately A$1.4bn (£790m).  We signed a variation and extension contract with the government of Western Australia for the Fiona Stanley Hospital in Perth.  The new contract will see continued delivery of support services at the hospital, albeit with a reduced number of service lines.  The contract has an estimated value of approximately $730m (~£370m) over its six-year term, including indexation. We also extended our contract to provide contact centre services to the Australian Tax Office to April 2021 and to Services Australia to June 2021. Related to Covid-19, we agreed work with the government for services, including to provide accommodation in mid-2020 for more than 1,300 quarantined travellers in Western Australia and additional contact centre work.

Of existing work where an extension or rebid will be required at some point before the end of 2023, there are 10 contracts with annual revenue of over £5m within the AsPac division. In aggregate, these represent just over half of the current level of annual revenue for the division. This high proportion reflects that the Australia onshore immigration services contract requires further extension or rebid again at the end of 2021, with this accounting for around 25% of divisional revenue.  Others that will require extending or rebidding include, in 2021, the Services Australia framework contract, the Australian Tax Office framework contract and the Fleet Marine Service Contract.

Our pipeline of new bid opportunities is currently weighted towards the health segment. The largest is to provide health services as part of the redevelopment and expansion project of the existing Frankston Hospital in Victoria.  Rebuilding the pipeline across the Justice & Immigration, Defence, Citizen Services, Transport and Health sectors remains a target, and we are expecting further opportunities in the coming years.

The AsPac pipeline is in a rebuilding phase, with the growth team looking to scope future opportunities over the short to medium term.  Our pipeline of new bid opportunities is currently weighted towards health facilities management. We are expecting further opportunities to join the pipeline in the Justice and Defence segments.  AsPac will be working with its newly acquired subsidiary, FFA, to develop and execute a strong pipeline in the facilities management and cleaning sectors.

Middle East

Operations in the Middle East Division include Transport, Defence, Health and Citizen Services, with the region accounting for approximately 8% of the Group's reported revenue.

Revenue for 2020 was £324m (2019: £350m), a decrease of 7% in reported currency.  The weakening of local currency against sterling decreased revenue by £3m or less than 1%; the organic change at constant currency was also a decline of 7%.  The Middle East segment has faced the largest negative impact from Covid-19 as there has been a sudden reduction in activity in parts of the transport portfolio and, unlike in the UK, limited Covid-19 response work to act as a counterbalance. There was growth in revenue from expanded services to Mashroat in Saudi Arabia and the Dubai Metro. These were outweighed by Covid-19 leading to reduced revenue on various contracts including Baghdad Air Traffic Control, health FM in Saudi Arabia and Dubai Airport facilities management. There was also a drag from the Cleveland Clinic contract, which was lost in 2019.

Underlying Trading Profit of £14m (2019: £14m) was stable year-on-year, representing a margin of 4.3% (2019: 4.0%). Excluding the adverse currency movement of £0.6m, the increase at constant currency was 1%.  Although the reduction in revenue on our air traffic control work and health FM contracts in Saudi Arabia negatively impacted profit, this was offset by improved profitability on some of our work in Saudi Arabia.  There are no OCP contracts in the Division and therefore no OCP utilisation within Underlying Trading Profit.  There were no Contract & Balance Sheet Review adjustments in the latest or prior year.  Trading Profit was therefore £14m (2019: £14m).

The Middle East represented £0.2bn, or 6%, of the Group's order intake, not helped by disruption from Covid-19. We were awarded a new contract to deliver front line hospitality customer services at Dubai Airport. However, as a result of the airport closing and subsequent lower passenger volumes due to Covid-19, the contract start was delayed. It began in January 2021 at a lower level than originally anticipated. As a result, we have included it in our order intake at a reduced amount. We did, however, secure a five-year contract to continue running the monorail for Nakheel on the Palm Jumeirah and successfully rebid our contract for the delivery of air navigation services at Sharjah Airport.

Of existing work where an extension or rebid will be required at some point before the end of 2023, there are around 10 contracts with annual revenue of over £5m within the Middle East division. In aggregate, these represent around 65% of the current level of annual revenue for the division.  The high proportion reflects that the Dubai Metro contract is due for rebid in 2021, with this accounting for around 30% of current divisional revenue.  We consider this rebid to have been unsuccessful.  Further extensions or rebids include the Dubai and Baghdad ANS contracts, the Middle East Logistics and Base Support Services (MELABS) contract and Saudi rail operations.

Corporate costs

Corporate costs relate to typical central function costs of running the Group, including executive, governance and support functions such as HR, finance and IT.  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.

Corporate costs at the Underlying Trading Profit level reduced by £4m to £41.2m (2019: £45.5m).

Corporate costs at a UTP level have reduced due to lower travel, lower LTIP costs as the issue of awards was delayed in the year, and favourable estimates in provisions for disputes held centrally which do not relate to specific contracts or operation.

Dividend calendar, if approved at the AGM

Ex-dividend date 13 May 2021

Record date 14 May 2021

Final dividend payable 4 June 2021

 

Finance Review

For the year ended 31 December 2020	Underlying £m	Non underlying items £m	Trading £m	Amortisation and impairment of intangibles arising on acquisition £m	Statutory pre exceptional £m	Exceptional items £m	Statutory £m
Revenue	3,884.8	-	3,884.8	-	3,884.8	-	3,884.8
Cost of sales	(3,514.4)	12.6	(3,501.8)	-	(3,501.8)	-	(3,501.8)
Gross profit	370.4	12.6	383.0	-	383.0	-	383.0
Administrative expenses	(220.0)	-	(220.0)	-	(220.0)	-	(220.0)
Exceptional profit on disposal of subsidiaries and operations	-	-	-	-	-	11.0	11.0
Other exceptional operating items	-	-	-	-	-	1.5	1.5
Other expenses	-	-	-	(9.0)	(9.0)	-	(9.0)
Share of profits in joint ventures and associates, net of interest and tax	12.7	-	12.7	-	12.7	-	12.7
Profit before interest and tax	163.1	12.6	175.7	(9.0)	166.7	12.5	179.2
Margin	4.2%		4.5%		4.3%		4.6%
Net finance costs	(25.9)	-	(25.9)	-	(25.9)	-	(25.9)
Profit before tax	137.2	12.6	149.8	(9.0)	140.8	12.5	153.3
Tax charge	(31.2)	10.5	(20.7)	1.8	(18.9)	(0.4)	(19.3)
Effective tax rate	22.7%		13.8%		13.4%		12.6%
Profit for the period	106.0	23.1	129.1	(7.2)	121.9	12.1	134.0
Minority interest	0.2		0.2		0.2		0.2
Earnings per share - basic (pence)	8.61		10.49		9.90		10.89
Earnings per share - diluted (pence)	8.43		10.28		9.70		10.67

For the year ended 31 December 2019	Underlying £m	Non underlying items £m	Trading £m	Amortisation and impairment of intangibles arising on acquisition £m	Statutory pre exceptional £m	Exceptional items £m	Statutory £m
Revenue	3,248.4	-	3,248.4	-	3,248.4	-	3,248.4
Cost of sales	(2,941.5)	13.2	(2,928.3)	-	(2,928.3)	-	(2,928.3)
Gross profit	306.9	13.2	320.1	-	320.1	-	320.1
Administrative expenses	(214.2)	-	(214.2)	-	(214.2)	-	(214.2)
Other exceptional operating items	-	-	-	-	-	(23.4)	(23.4)
Other expenses	-	-	-	(7.5)	(7.5)	-	(7.5)
Share of profits in joint ventures and associates, net of interest and tax	27.5	-	27.5	-	27.5	-	27.5
Profit before interest and tax	120.2	13.2	133.4	(7.5)	125.9	(23.4)	102.5
Margin	3.7%		4.1%		3.9%		3.2%
Net finance costs	(21.8)	-	(21.8)	-	(21.8)	-	(21.8)
Profit before tax	98.4	13.2	111.6	(7.5)	104.1	(23.4)	80.7
Tax charge	(24.4)	(4.5)	(28.9)	1.5	(27.4)	(2.7)	(30.1)
Effective tax rate	24.8%		25.9%		26.3%		37.3%
Profit for the period	74.0	8.7	82.7	(6.0)	76.7	(26.1)	50.6
Minority interest	0.2		0.2		0.2		0.2
Earnings per share - basic (pence)	6.31		7.05		6.54		4.31
Earnings per share - diluted (pence)	6.16		6.89		6.39		4.21

 

Alternative Performance Measures (APMs) and other related definitions

Overview

APMs used by the Group are reviewed below to provide a definition and reconciliation from each non-IFRS APM to its IFRS equivalent and to explain the purpose and usefulness of each APM.

In general, APMs are presented externally to meet investors' requirements for further clarity and transparency of the Group's financial performance. The APMs are also used internally in the management of our business performance, budgeting and forecasting and for determining Executive Directors' remuneration and that of other Management throughout the business.

APMs are non-IFRS measures. Where additional revenue is being included in an APM, this reflects revenues presented elsewhere within the reported financial information, except where amounts are recalculated to reflect constant currency. Where items of profits or costs are being excluded in an APM, these are included elsewhere in our reported financial information as they represent actual profits or costs of the Group, except where amounts are recalculated to reflect constant currency. As a result, APMs allow investors and other readers to review different kinds of revenue, profits and costs and should not be used in isolation. Other commentary within the Strategic Report within the Annual Report and Accounts, including the other sections of the Finance Review, as well as the Consolidated Financial Statements and their accompanying notes, should be referred to in order to fully appreciate all the factors that affect our business. We strongly encourage readers not to rely on any single financial measure, but to carefully review our reporting in its entirety.

The methodology applied to calculating the APMs has not changed during the year.

Alternative revenue measures

Reported revenue at constant currency

Reported revenue, as shown on the Group's Consolidated Income Statement on page 39, reflects revenue translated at the average exchange rates for the period. In order to provide a comparable movement on the previous year's results, reported revenue is recalculated by translating non-Sterling values for the year to 31 December 2020 into Sterling at the average exchange rate for the year ended 31 December 2019.

For the year ended 31 December	2020 £m
Reported revenue at constant currency	3,908.8
Foreign exchange differences	(24.0)
Reported revenue at reported currency	3,884.8

Organic Revenue at constant currency

Reported revenue may include revenue generated by businesses acquired during a particular year from the date of acquisition and/or generated by businesses sold during a particular year up to the date of disposal. In order to provide a comparable movement which ignores the effect of both acquisitions and disposals on the previous year's results, Organic Revenue at constant currency is recalculated by excluding the impact of any relevant acquisitions or disposals.

There is one acquisition excluded for the calculation of Organic Revenue in the year to 31 December 2020, which is the acquisition of the Naval Systems Business Unit ("NSBU") from Alion Science and Technology Corporation on 1 August 2019.

The Group also disposed of its interest in its Viapath joint venture on 31 May 2020, however no adjustment is required to Organic Revenue growth since the joint venture results were accounted for on an equity basis and therefore had no impact Group revenue.

Organic Revenue growth is calculated by comparing the current year Organic Revenue at constant currency exchange rates with the prior year Organic Revenue at reported currency exchange rates.

For the year ended 31 December	2020 £m
Organic Revenue at constant currency	3,646.1
Foreign exchange differences	(21.8)
Organic Revenue at reported currency	3,624.3
Impact of any relevant acquisitions or disposals	260.5
Reported revenue at reported currency	3,884.8

For the year ended 31 December	2019 £m
Organic Revenue at reported currency	3,138.4
Impact of any relevant acquisitions or disposals	110.0
Reported revenue at reported currency	3,248.4

Revenue plus share of joint ventures and associates

Reported revenue, as shown on the Group's Consolidated Income Statement on page 39, excludes the Group's share of revenue from joint ventures and associates, with Serco's share of profits in joint ventures and associates (net of interest and tax) consolidated within reported operating profit as a single line in the Consolidated Income Statement. The alternative measure includes the share of joint ventures and associates for the benefit of reflecting the overall change in scale of the Group's ongoing operations, which is particularly relevant for evaluating Serco's presence in market sectors such as Defence and Transport. The alternative measure allows the performance of the joint venture and associate operations themselves, and their impact on the Group as a whole, to be evaluated on measures other than just the post-tax result.

For the year ended 31 December	2020 £m	2019 £m
Revenue plus share of joint ventures and associates	4,249.9	3,643.0
Exclude share of revenue from joint ventures and associates	(365.1)	(394.6)
Reported revenue	3,884.8	3,248.4

Alternative profit measures

For the year ended 31 December	2020 £m	2019 £m
Underlying Trading Profit	163.1	120.2
Non-underlying items:
OCP charges and releases	5.8	0.8
Other Contract & Balance Sheet Review adjustments and one-time items	6.8	12.4
Total non-underlying items	12.6	13.2
Trading Profit	175.7	133.4
Operating exceptional items	12.5	(23.4)
Amortisation and impairment of intangibles arising on acquisition	(9.0)	(7.5)
Operating profit	179.2	102.5

Underlying Trading Profit (UTP)

The Group uses an alternative measure, Underlying Trading Profit, to make adjustments for unusual items that occur and to remove the impact of historical issues. UTP therefore provides a measure of the underlying performance of the business in the current year.

Charges and releases on all Onerous Contract Provisions (OCPs) that arose during the 2014 Contract & Balance Sheet Review are excluded from UTP in the current and prior years. Charges associated with the creation of new OCPs identified are included within UTP to the extent that they are not considered sufficiently material to require separate disclosure on an individual basis. OCPs reflect the future multiple year cost of delivering onerous contracts and do not reflect only the current cost of operating the contract in the latest individual year. It should be noted that, as for operating profit, UTP benefits from OCP utilisation of £1.8m in 2020 (2019: £53.6m).  The utilisation, which neutralises the in-year losses on previously identified onerous contracts, is significantly lower than the prior year as the number of onerous contracts within the Group have significantly reduced, as many have come to an end or have ceased to be onerous.

Revisions to accounting estimates and judgements which arose during the 2014 Contract & Balance Sheet Review are reported alongside other one-time items where the impact of an individual item is material. Items recorded within this category during 2020 include the settlement of contractual disputes arising on one of the Group's ongoing contracts which represents final settlement of the issues under discussion.

Both OCP adjustments and other Contract & Balance Sheet Review and one-time items are identified and separated from the APM in order to give clarity of the underlying performance of the Group and to separately disclose the progress made on these items.

Underlying trading margin is calculated as UTP divided by statutory revenue.

The non-underlying column in the summary income statement on page 22 includes the tax impact of the above items and tax items that, in themselves, are considered to be non-underlying. Further detail of such items is provided in the tax section below.

Trading Profit

The Group uses Trading Profit as an alternative measure to operating profit, as shown on the Group's Consolidated Income Statement on page 39, by making two adjustments.

Firstly, Trading Profit excludes exceptional items, being those considered material and outside of the normal operating practices of the Group to be suitable for separate presentation and detailed explanation.

Secondly, amortisation and impairment of intangibles arising on acquisitions are excluded, because these charges are based on judgements about the value and economic life of assets that, in the case of items such as customer relationships, would not be capitalised in normal operating practice.

UTP at constant currency

UTP disclosed above has been translated at the average foreign exchange rates for the year. In order to provide a comparable movement on the previous year's results, UTP is recalculated by translating non-Sterling values for the year to 31 December 2020 into Sterling at the average exchange rate for the year ended 31 December 2019.

For the year ended 31 December	2020 £m
Underlying Trading Profit at constant currency	164.5
Foreign exchange differences	(1.4)
Underlying Trading Profit at reported currency	163.1

Alternative Earnings Per Share (EPS) measures

For the year ended 31 December	2020 pence	2019 pence
Underlying EPS, basic	8.61	6.31
Net impact of non-underlying items and amortisation and impairment of intangibles arising on acquisition	1.29	0.23
EPS before exceptional items, basic	9.90	6.54
Impact of exceptional items	0.99	(2.23)
Reported EPS, basic	10.89	4.31

For the year ended 31 December	2020 pence	2019 pence
Underlying EPS, diluted	8.43	6.16
Net impact of non-underlying items and amortisation and impairment of intangibles arising on acquisition	1.27	0.23
EPS before exceptional items, diluted	9.70	6.39
Impact of exceptional items	0.97	(2.18)
Reported EPS, diluted	10.67	4.21

EPS before exceptional items

EPS, as shown on the Group's Consolidated Income Statement on page 39, includes exceptional items charged or credited to the income statement in the year. EPS before exceptional items aids consistency with historical operating performance.

Underlying EPS

Reflecting the same adjustments made to operating profit to calculate UTP as described above and including the related tax effects of each adjustment and any other non-underlying tax adjustments as described in the tax charge section below, an alternative measure of EPS is presented. This aids consistency with historical results and enables performance to be evaluated before the unusual or one-time effects described above. The full reconciliation between statutory EPS and Underlying EPS is provided in the summary income statement on page 22.

 

Alternative cash flow and Net Debt measures

Free Cash Flow (FCF)

We present an alternative measure for cash flow to reflect cash flow from operating activities before exceptional items, which is the measure shown on the Consolidated Cash Flow Statement on page 43. This IFRS measure is adjusted to include dividends we receive from joint ventures and associates and exclude net interest paid, the capital element of lease payments and net capital expenditure on tangible and intangible asset purchases.

For the year ended 31 December	2020 £m	2019 £m
Free Cash Flow	134.9	62.0
Exclude dividends from joint ventures and associates	(19.8)	(25.4)
Exclude net interest paid	24.6	21.0
Exclude capitalised finance costs paid	0.9	1.2
Exclude capital element of lease repayments	100.8	70.2
Exclude proceeds received from exercise of share options	(0.1)	(0.2)
Exclude purchase of intangible and tangible assets net of proceeds from disposal	29.2	23.3
Cash flow from operating activities before exceptional items	270.5	152.1
Exceptional operating cash flows	(2.0)	(49.2)
Cash flow from operating activities	268.5	102.9

UTP cash conversion

FCF as defined above, includes interest and tax cash flows. In order to calculate an appropriate cash conversion metric equivalent to UTP, Trading Cash Flow is derived from FCF by excluding tax and interest items. UTP cash conversion therefore provides a measure of the efficiency of the business in terms of converting profit into cash before taking account of the impact of interest, tax and exceptional items.

For the year ended 31 December	2020 £m	2019 £m
Free Cash Flow	134.9	62.0
Add back:
Tax paid	35.9	31.2
Non-cash R&D expenditure	0.1	0.1
Net interest paid	24.6	21.0
Capitalised finance costs paid	0.9	1.2
Trading Cash Flow	196.4	115.5
Underlying Trading Profit	163.1	120.2
Underlying Trading Profit cash conversion	120%	96%

Net Debt and Adjusted Net Debt

We present an alternative measure to bring together the various funding sources that are included on the Group's Consolidated Balance Sheet on page 42 and the accompanying notes. Net Debt is a measure to reflect the net indebtedness of the Group and includes all cash and cash equivalents and any debt or debt-like items, including any derivatives entered into in order to manage risk exposures on these items.  Net Debt includes all lease liabilities, whilst Adjusted Net Debt is derived from Net Debt by excluding liabilities associated with leases.

The Adjusted Net Debt measure was introduced because it more closely aligns to the Consolidated Total Net Borrowings measure used for the Group's debt covenants, which is prepared under accounting standards applicable prior to the adoption of IFRS16 Leases.  Principally as a result of the Asylum Accommodation and Support Services Contract ("AASC"), the Group has entered into a significant number of leases which contain a termination option.  The use of Adjusted Net Debt removes the volatility that would result from estimations of lease periods and the recognition of liabilities associated with such leases where the Group has the right to cancel the lease and hence the corresponding obligation.  Though the intention is not to exercise the options to cancel the leases, it is available, unlike other debt obligations.

 

For the year ended 31 December	2020 £m	2019 £m
Cash and cash equivalents	335.7	89.5
Loans payable	(388.8)	(305.0)
Lease liabilities	(402.6)	(369.9)
Derivatives relating to Net Debt	(4.7)	1.0
Net Debt	(460.4)	(584.4)
Add back: Lease liabilities	402.6	369.9
Adjusted Net Debt	(57.8)	(214.5)

Pre-tax Return on Invested Capital (ROIC)

ROIC is a measure to assess the efficiency of the resources used by the Group and is one of the metrics used to determine the performance and remuneration of the Executive Directors. ROIC is calculated based on UTP and Trading Profit using the Group's Consolidated Income Statement for the year and a two-point average of the opening and closing balance sheets. The composition of Invested Capital and calculation of ROIC are summarised in the table below.

Invested Capital excludes right of use assets recognised under IFRS16 Leases.  This is because the Invested Capital of the Group are those items within which resources are, or have been, committed, which is not the case for many leases which would previously have been classified as operating leases under IAS17 Leases where termination options exist and commitments for expenditure are in future years.

For the year ended 31 December	2020 £m	2019* £m
ROIC excluding right of use assets
Non current assets
Goodwill	669.6	674.2
Other intangible assets - owned	80.6	96.5
Property, plant and equipment - owned	54.2	47.3
Interest in joint ventures and associates	19.2	23.6
Trade and other receivables	25.3	26.5
Current assets
Inventory	21.4	18.3
Contract assets, trade and other receivables	609.6	607.4
Total invested capital assets	1,479.9	1,493.8
Current liabilities
Contract liabilities, trade and other payables	(576.2)	(557.0)
Non current liabilities
Contract liabilities, trade and other payables	(56.9)	(72.7)
Total invested capital liabilities	(633.1)	(629.7)
Invested Capital	846.8	864.1
Two-point average of opening and closing Invested Capital	855.5	782.7
Trading Profit	175.7	133.4
ROIC%	20.5%	17.0%
Underlying Trading Profit	163.1	120.2
Underlying ROIC%	19.1%	15.4%

*  During the year ended 31 December 2020, the Group finalised fair value measurements for a number of contracts which had previously been provisionally valued associated with the acquisition of Naval Systems Business Unit which was completed 1 August 2019.  As a result, in accordance with IFRS3 Business Combinations, goodwill has been revised and the fair value of acquired assets and liabilities have been adjusted, resulting in an amendment to their carrying value as presented as at 31 December 2019.  Further information on the fair value can be found in Note 5 to the Condensed Consolidated Financial Statements.

 

Overview of financial performance

Revenue

Reported revenue increased by 19.6% in the year to £3,884.8m (2019: £3,248.4m), a 20.3% increase in constant currency. Organic revenue growth at constant currency was 16.2%. This is in line with the trading update issued on 17 December 2020 where revenue was expected to be £3.9bn for the year ended 31 December 2020.

Commentary on the revenue performance of the Group is provided in the Chief Executive's Review and the Divisional Reviews sections.

Trading Profit

Trading Profit for the year was £175.7m (2019: £133.4m).

Commentary on the trading performance of the Group is provided in the Chief Executive's Review and the Divisional Reviews sections.

Underlying Trading Profit

UTP was £163.1m (2019: £120.2m), up 35.7%. At constant currency, UTP was £164.5m, up 36.9%. This is in line with the trading update issued on 17 December 2020 where UTP was expected to be between £160m and £165m for the year ended 31 December 2020.

Commentary on the underlying performance of the Group is provided in the Chief Executive's Review and the Divisional Reviews sections.

Excluded from UTP were net releases from OCPs of £5.8m (2019: net releases of £0.8m) following the detailed reassessment undertaken as part of the budgeting process. Also excluded from UTP were net releases and additional profits of £6.8m (2019: net releases and additional profits of £12.4m) relating to items identified during the 2014 Contract & Balance Sheet Review and other one-time items.

The tax impact of items in UTP and other non-underlying tax items is discussed in the tax section of this Finance Review.

Joint ventures and associates - share of results

In 2020, the most significant joint ventures and associates in terms of scale of operations were AWE Management Limited ("AWE") and Merseyrail Services Holding Company Limited ("Merseyrail"), with dividends received of £15.5m (2019: £17.6m) and £1.5m (2019: £7.8m) respectively. Total revenues generated by these businesses were £1,106.8m (2019: £1,065.4m) and £150.7m (2019: £177.9m) respectively.

As announced on 2 November 2020, the Ministry of Defence notified the Group that it would be exercising its ability to terminate services provided by the Group through AWE on 30 June 2021.  The terms of the exit are in the process of being negotiated and since the full services under the contract have not been completed, judgement has been taken in relation to the milestone achievements which are to be agreed and an estimate of costs incurred in delivering services which cannot be recovered.  The agreement in respect of both of these items are to be finalised, however the final outcome is not expected to have a material impact on the Group's Financial Statements.

While the revenues and individual line items are not consolidated in the Group's Consolidated Income Statement, summary financial performance measures for the Group's proportion of the aggregate of all joint ventures and associates are set out below for information purposes.

For the year ended 31 December	2020 £m	2019 £m
Revenue	365.1	394.6
Operating profit	15.4	33.8
Net investment revenue	-	0.3
Income tax charge	(2.7)	(6.6)
Profit after tax	12.7	27.5
Dividends received from joint ventures and associates	19.8	25.4

The change in revenue and profits on the prior year is due to changes in the underlying operating performance of the Group's material joint ventures particularly with respect to the impact of Covid-19 on the Merseyrail joint venture, as well as the disposal, on 31 May 2020, of the Group's 33% interest in Viapath Analytics LLP, Viapath Services LLP and Viapath Group LLP (together "Viapath"). The decrease in dividends received is mainly due to reduced profits, most notably in respect of the Merseyrail joint venture, where passenger volumes were impacted by Covid-19.

 

Exceptional items

Exceptional items are items of financial performance that are outside normal operations and are material to the results of the Group either by virtue of size or nature. As such, the items set out below require separate disclosure on the face of the income statement to assist in the understanding of the performance of the Group.

For the year ended 31 December	2020 £m	2019 £m
Exceptional items arising
Exceptional profit on disposal of subsidiaries and operations	11.0	-
Other exceptional operating items
Restructuring costs	0.1	(12.8)
Costs associated with UK Government review	(1.3)	(25.2)
Movement in other provisions and other items	2.6	19.3
Reversal of impairment in interest in joint venture and related loan balances	2.5	-
Costs associated with the acquisition of Naval Systems Business Unit	(1.5)	(4.7)
Costs associated with the acquisition of Facilities First Australia	(0.9)	-
Other exceptional operating items	1.5	(23.4)
Exceptional operating items	12.5	(23.4)
Exceptional tax	(0.4)	(2.7)
Total exceptional operating items net of tax	12.1	(26.1)

Exceptional items arising

The Group disposed of its interest in Viapath with effect from 31 May 2020. The Group had historically impaired its investment in Viapath as it was not receiving any returns from this joint venture due to the level of investment being made back into the business, therefore the carrying value of the Group's investment in Viapath was nil. Following the announcement during the first half of 2020 that Viapath had been unsuccessful in the tender process to provide pathology services to five South East London hospitals as well as associated GP surgeries, the Group exited the joint venture, selling its stake to the remaining two investors. In May 2020, the proceeds received by the Group in exchange for its holding in the joint venture represents the profit on disposal of £11.0m.

At the same time as disposing of the Group's interest in Viapath, certain historical balances were recovered which had previously been impaired. Since the impairments associated with those balances were historically treated as exceptional items, the reversals of these impairments have been treated consistently. The exceptional credit of £2.5m consists of the recovery of a loan from the Group into the joint venture of £1.2m, the exceptional element of the recovery of profit share which was previously considered to be irrecoverable and the reversal of impairment.

Other exceptional operating items

The Group recognised the final costs associated with the Strategy Review during 2019 and, on review, certain costs which had been accrued but were not incurred were released back to exceptional operating items resulting in a credit to exceptional items of £0.1m during 2020 (2019: exceptional restructuring costs of £12.8m). Non-exceptional restructuring charges are incurred by the business as part of normal operational activity, which in the year totalled £7.2m (2019: £8.9m) and were included within operating profit before exceptional items.

There were exceptional costs totalling £1.3m (2019: £25.2m) associated with the UK Government reviews and the programme of Corporate Renewal. These costs have historically been treated as exceptional and consistent treatment is applied in 2020. The 2019 costs included £22.9m for the fine and associated costs which resulted from the SFO's investigation into Serco companies.

During 2019, the Group reached a legal settlement in relation to a commercial dispute which resulted in the release of a provision which accounted for the majority of the £19.3m exceptional credit. The treatment of the release as exceptional was consistent with the recognition of the charge associated with the same legal matter in 2014. During 2020, the Group reached an agreement with its insurer for the reimbursement of £2.6m of legal fees associated with the matter and, consistent with the treatment of other associated amounts, this has been treated as an exceptional credit.

The Group completed the acquisition of Naval Systems Business Unit ("NSBU") from Alion Science and Technology in 2019. The transaction and implementation costs incurred during 2020 of £1.5m (2019: £4.7m) have been treated as exceptional costs in line with the Group's accounting policy and the treatment of similar costs incurred during the year ended 31 December 2019. No further costs associated with this acquisition are anticipated to be recognised as exceptional. 

 

On 17 December 2020, the Group announced it had reached an agreement to acquire Facilities First Australia Holdings Pty Limited ("FFA" or "Facilities First Australia") and the acquisition was completed on 4 January 2021. Acquisition costs totalling £0.9m have been incurred during 2020 in respect of the FFA acquisition and have been treated as exceptional in accordance with the Group's accounting policies.  Further details on this post year end transaction are provided in Note 24 to the Consolidated Financial Statements.

Exceptional tax

Exceptional tax for the year was a charge of £0.4m (2019: charge of £2.7m) which arises on exceptional items within operating profit. This charge arises mainly in connection with the reimbursement of legal fees from our insurer. The charge is partially offset by tax deductions related to the acquisition of Naval Systems Business Unit.

Finance costs and investment revenue

Investment revenue of £1.9m (2019: £2.7m) consists primarily of interest accruing on net retirement benefit assets of £1.2m (2019: £2.1m).  The finance costs of £27.8m (2019: £24.5m) include interest incurred on the US private placement loan notes and the revolving credit facility of £15.3m (2019: £13.9m) and lease interest payable of £9.5m (2019: £6.9m) as well as other financing related costs including the impact of foreign exchange on financing activities.

Of the increase in lease interest paid, the majority relates to the Group's Asylum Accommodation and Support Services contract ("AASC").  The lease costs on the COMPASS contract (the predecessor contract to AASC) in 2019 were recorded as operating lease costs due to the short-term transitional arrangement under IFRS16 Leases. Leases under the AASC contract were accounted for in accordance with IFRS16 from the point at which service users moved to AASC, typically 1 July 2019 for the North West region and 1 September 2019 for the Midlands and East of England region.

Tax

Tax charge

Underlying tax

In 2020 we recognised a tax charge of £31.2m on underlying trading profits after finance costs. The effective tax rate (22.7%) is slightly lower than in 2019 (24.8%).  This reduction compared to 2019 is largely due to the utilisation of previously unrecognised deferred tax in the UK used to offset current UK taxable profits. The impact is partially offset by disallowable items in the current year being higher than in 2019 and also the impact of reduced profits from our joint ventures whose post tax profits are included in our pre-tax results.

Pre-exceptional tax

We recognised a tax charge of £18.9m (2019: £27.4m) on pre-exceptional profits which includes underlying tax (£31.2m), tax credit from amortisation of intangibles arising on acquisition of £1.8m and a £10.5m credit arising on non-underlying items.  This £10.5m credit consists of tax items that are in themselves considered to be non-underlying:

·	During the current year we have recognised an additional £9.5m (2019: £0.8m) of deferred tax asset in relation to the increase in expected UK future tax rate from 17% to 19% and anticipated additional utilisation of UK losses to reflect the improved forecast for taxable income of our UK operations.
·	Generally, movements in the valuation of the Group's defined benefit pension schemes and the associated deferred tax impact are reported in the Statement of Comprehensive Income (SOCI) and do not flow through the income statement, therefore do not impact profit before tax or the tax charge.  However, the net amount of deferred tax recognised in the balance sheet relates to both the pension accounting and other timing differences, such as recoverable losses.  As the net deferred tax balance sheet position is at the maximum level supported by future profit forecasts, the increase in the deferred tax liability associated with the pension scheme (with the benefit reported in the SOCI) leads to a corresponding increase in the deferred tax asset to match the future profit forecasts.  Such an increase in the deferred tax asset therefore leads to a credit to tax in the income statement.  Where deferred tax charges or releases are the result of movements in the pension scheme valuations rather than trading activity, these are excluded from the calculation of tax on underlying profit and the underlying effective tax rate.  These amounted to a £5.9m credit for 2020 (2019: £2.7m charge).
·	An amount of £4.9m has been charged to non-underlying tax in respect of the derecognition of balance sheet liabilities following the implementation of IFRS16 Leases in 2019, a portion of which was not tax effected. Since the adjustment does not relate to the current year, it is considered to be non-underlying

The tax rate on profits before exceptional items, at 13.4%, is lower than the UK standard corporation tax rate of 19%.  This is due mainly to the impact of the non-underlying tax items noted above together with the impact of utilising previously unvalued deferred tax in the UK to offset current year profits (reducing rate by 3.6%) and the impact of our joint ventures whose post-tax results are included in our pre-tax profits (reducing rate by 1.8%). This is only partially offset by higher tax being suffered on overseas profits due to their higher statutory tax rates (increasing rate by 5.1%).  To the extent that the UK generates significant taxable profits or losses, our tax charge in future years could continue to be materially impacted by our accounting for UK deferred taxes. 

 

Exceptional tax

Analysis of exceptional tax is provided in the Exceptional items section above.

Contingent tax assets

At 31 December 2020, the Group has gross estimated unrecognised deferred tax assets of £1.0bn (tax effected: £198m), which are potentially available to offset against future taxable income.  These principally relate to tax trading losses of £846m.  Of these tax losses, £698m have arisen in the UK business (tax effected: £133m). £558m (tax effected £106m) of the unrecognised deferred tax asset would be expected to be brought onto the balance sheet as the UK trading profits improve.

A £30.6m UK tax asset has been recognised at 31 December 2020 (2019: £21.1m) on the basis of forecast utilisation against future taxable income.

Taxes paid

Net corporate income tax of £35.9m (2019: £31.2m) was paid during the year, relating primarily to our operations in AsPac of £21.2m (2019: £19.4m), North America of £14.7m (2019: £12.1), Europe of £1.3m (2019: £1.1m) and Middle East of £0.8m (2019: £1.1m). The Group's UK operations have transferred tax losses to its profitable joint ventures and associates giving a cash tax inflow in the UK of £2.1m (2019: £2.5m).

The amount of tax paid (£35.9m) differs from the tax charge in the period (£19.3m) mainly due to the effect of deferred tax credits on costs incurred in the current year which will lead to tax deductions in future years.  In addition, taxes paid to/received from Tax Authorities can arise in different periods to the associated tax charge/credit and there is also a time lag on receipts of cash from joint ventures and associates for losses transferred to them.

Further detail is shown below of taxes that have been paid during the year. Amounts below categorised as corporation tax paid differs from the above as it only includes amounts paid to and received from Tax Authorities, therefore excludes amounts received from our joint ventures and associates. Withholding taxes, which form part of the net income tax paid, are shown within other taxes.

Total tax contribution

Our tax strategy of paying the appropriate amount of tax as determined by local legislation in the countries in which we operate, means that we pay a variety of taxes across the Group.  In order to increase the transparency of our tax profile, we have shown below the cash taxes that we have paid across our regional markets.

In total during 2020, Serco globally contributed £686.1m of tax to governments in the jurisdictions in which we operate.

Taxes by category

For the year ended 31 December 2020	Taxes borne £m	Taxes collected £m	Total £m
Corporation tax	37.9	-	37.9
VAT and similar	10.0	185.1	195.1
People taxes	119.2	328.5	447.7
Other taxes	5.1	0.3	5.4
Total	172.2	513.9	686.1

 Taxes by region

For the year ended 31 December 2020	Taxes borne £m	Taxes collected £m	Total £m
UK & Europe	80.8	263.2	344.0
AsPac	42.2	154.8	197.0
Americas	47.0	93.2	140.2
Middle East	2.2	2.7	4.9
Total	172.2	513.9	686.1

Corporation tax, which is the only cost to be separately disclosed in our Consolidated Financial Statements, is only one element of our tax contribution.  For every £1 of corporate tax paid directly by the Group (tax borne), we bear a further £3.54 in other business taxes.  The largest proportion of these is in connection with employing our people.

In addition, for every £1 of tax that we bear, we collect £2.98 on behalf of national governments (taxes collected).  This amount is directly impacted by the people that we employ and the sales that we make.

 

Dividends

When dividend payments were suspended in 2014, the Board committed to resuming dividend payments to Serco's shareholders as soon as it judged it prudent to do so.  During 2020, a final dividend was proposed in respect of the year ended 31 December 2019, however this was withdrawn in April 2020 as the potential impact on the Group of the Covid-19 pandemic was unknown. This remained the case when the Group announced its half year results during August 2020.

After reassessing the Group's liquidity and repaying all direct Government support the Group received in respect of the pandemic where there was a mechanism to do so, combined with the strength of the balance sheet at the end of 2020 and positive forecast performance into 2021 and beyond, the Board is recommending the payment of a final dividend in respect of the 2020 financial year of 1.4p, aligned to the recommended dividend and outlook as described in the Chief Executive's Review. The Group has also announced its intention to repurchase shares equivalent to an amount of £40m in 2021, of which £20m will be cancelled and the remainder used for existing share schemes. The dividend, subject to shareholder approval at the Annual General Meeting on 21 April 2021, would be paid on 4 June 2021.

Share count and EPS

The weighted average number of shares for EPS purposes was 1,229.1m for the year ended 31 December 2020 (2019: 1,171.4m) and diluted weighted average number of shares was 1,254.3m (2019: 1,199.0m).

In the year, 10,000,000 (2019: 13,600,000) shares were issued to the Employee Share Ownership Trust to satisfy awards under the Group's share plan schemes.

In May 2019, the company completed a placement of 111,216,400 new ordinary shares of 2p each raising net proceeds of £138.7m.  There were no such placements in 2020.

Basic EPS before exceptional items was 9.90p per share (2019: 6.54p); including the impact of exceptional items, Basic EPS was 10.89p (2019: 4.31p). Basic Underlying EPS was 8.61p per share (2019: 6.31p).

Diluted EPS before exceptional items was 9.70p per share (2019: 6.39p); including the impact of exceptional items, Diluted EPS was 10.67p (2019: 4.21p). Diluted Underlying EPS was 8.43p per share (2019: 6.16p).

Cash flows

The UTP of £163.1m (2019: £120.2m) converts into a trading cash inflow of £196.4m (2019: £115.5m).  The improvement in 2020 cash generation reflects the increase in profitability from revenue growth, delivery of cost efficiencies and improvements made in managing working capital within the Group throughout the year. The improvement in Trading Cash Flow is driven by operating profit before exceptional items increasing by £40.8m, a marginal increase in working capital outflow to £5.3m (2019: £0.1m) and a reduction in OCP utilisation to £1.8m (2019: £53.6m), although in 2019, £12.7m of the utilisation was not related to a cash cost but rather was related to the impairment of right of use assets created on adoption of IFRS16 within onerous contracts. The working capital outflow of £5.3m is considered to be low given the fact that the Group experienced significant organic growth year on year. The improvement is a result of improved collections, particularly in the US and Middle East where there was a significant increase in receivables on certain contracts at the end of 2019, and better management of debtor days across the Group. The movement in working capital also benefits from £12.4m of tax deferrals in the US as a result of Covid-19. This amount is currently planned to be paid in equal instalments in 2021 and 2022. The amount has not been repaid early in a manner consistent with deferrals received in other jurisdictions, owing to the absence of a mechanism to do so. 

The table below shows the operating profit and FCF reconciled to movements in Net Debt. FCF for the year was an inflow of £134.9m compared to £62.0m in 2019.  The improvement in FCF is largely as a result of improved trading cash inflows as discussed above.

The movement in Adjusted Net Debt is a reduction of £156.7m in 2020, a reconciliation of which is provided at the bottom of the following table.

The net cash inflow on acquisition and disposal of subsidiaries of £6.1m (2019: outflow £183.9m acquisition and £9.3m deferred consideration) includes £11.0m of consideration received by the Group for its share of the Viapath joint venture.  Offsetting this are costs associated with the acquisition of Naval Systems Business Unit including deferred consideration and working capital adjustments as well as costs associated with the acquisition of Facilities First Australia Holdings Pty Limited.

Exceptional cash outflows of £2.0m as shown below differ to the net exceptional credit on other exceptional operating items of £1.5m due to cash payments associated with costs provided for in 2019.
 

For the year ended 31 December	2020 £m	2019 £m
Operating profit	179.2	102.5
Remove exceptional items	(12.5)	23.4
Operating profit before exceptional items	166.7	125.9
Less: share of profit from joint ventures and associates	(12.7)	(27.5)
Movement in provisions	16.2	(43.1)
Depreciation, amortisation and impairment of owned property, plant and equipment and intangible assets	39.2	43.3
Depreciation, amortisation and impairment of leased property, plant and equipment and intangible assets	93.9	75.6
Other non-cash movements	8.5	9.3
Operating cash inflow before movements in working capital, exceptional items and tax	311.8	183.5
Working capital movements	(5.3)	(0.1)
Tax paid	(35.9)	(31.2)
Non-cash R&D expenditure	(0.1)	(0.1)
Cash flow from operating activities before exceptional items	270.5	152.1
Dividends from joint ventures and associates	19.8	25.4
Interest received	0.3	0.4
Interest paid	(24.9)	(21.4)
Capital element of lease repayments	(100.8)	(70.2)
Capitalised finance costs paid	(0.9)	(1.2)
Purchase of intangible and tangible assets net of proceeds from disposals	(29.2)	(23.3)
Proceeds received from exercise of share options	0.1	0.2
Free Cash Flow	134.9	62.0
Net cash inflow/(outflow) on acquisition and disposal of subsidiaries, joint ventures and associates	6.1	(193.2)
Issue of share capital	-	138.7
Movements on other investment balances	0.5	0.2
Capitalisation and amortisation of loan costs	-	0.1
Exceptional items	(2.0)	(49.2)
Exceptional proceeds from loans receivable	1.2	-
Exceptional distribution from joint venture	1.9	-
Cash movements on hedging instruments	2.4	(2.0)
Foreign exchange gain on Adjusted Net Debt	11.7	2.1
Movement in Adjusted Net Debt	156.7	(41.3)
Opening Adjusted Net Debt	(214.5)	(173.2)
Closing Adjusted Net Debt	(57.8)	(214.5)
Lease liabilities	(402.6)	(369.9)
Closing Net Debt at 31 December	(460.4)	(584.4)

 

Net Debt

As at 31 December	2020 £m	2019 £m
Cash and cash equivalents	335.7	89.5
Loans payable	(388.8)	(305.0)
Lease liabilities	(402.6)	(369.9)
Derivatives relating to Net Debt	(4.7)	1.0
Net Debt	(460.4)	(584.4)
Exclude lease liabilities	402.6	369.9
Adjusted Net Debt	(57.8)	(214.5)

Average Adjusted Net Debt as calculated on a daily basis for the year ended 31 December 2020 was £209.2m (2019: £231.0m).  Peak Adjusted Net Debt was £355.7m (2019: £356.8m).

Treasury operations and risk management

The Group's operations expose it to a variety of financial risks that include liquidity, the effects of changes in foreign currency exchange rates, interest rates and credit risk. The Group has a centralised Treasury function whose principal role is to ensure that adequate liquidity is available to meet the Group's funding requirements as they arise and that the financial risk arising from the Group's underlying operations is effectively identified and managed.

Treasury operations are conducted in accordance with policies and procedures approved by the Board and are reviewed annually. Financial instruments are only executed for hedging purposes and speculation is not permitted. A monthly report is provided to senior Management outlining performance against the Treasury Policy and the Treasury function is subject to periodic internal audit review.

Liquidity and funding

As at 31 December 2020, the Group had committed funding of £642m (2019: £508m), comprising £347m of US private placement notes, a £45m term loan facility which was fully drawn and a £250m revolving credit facility (RCF) which was undrawn in its entirety. The Group does not engage in any external financing arrangements associated with either receivables or payables.

The Group's RCF provides £250m of committed funding for five years from the arrangement date in December 2018. The US private placement notes are repayable in bullet payments between 2021 and 2032.

Interest rate risk

Given the nature of the Group's business, we have a preference for fixed rate debt to reduce the volatility of net finance costs. Our Treasury Policy requires us to maintain a minimum proportion of fixed rate debt as a proportion of overall Adjusted Net Debt and for this proportion to increase as the ratio of EBITDA to interest expense falls. As at 31 December 2020, £346.7m of debt was held at fixed rates and Adjusted Net Debt was £57.8m.

Foreign exchange risk

The Group is subject to currency exposure on the translation to Sterling of its net investments in overseas subsidiaries. The Group manages this risk where appropriate, by borrowing in the same currency as those investments. Group borrowings are predominantly denominated in Sterling and US Dollar. The Group manages its currency flows to minimise foreign exchange risk arising on transactions denominated in foreign currencies and uses forward contracts where appropriate to hedge net currency flows.

Credit risk

Cash deposits and in-the-money financial instruments give rise to credit risk on the amounts due from counterparties. The Group manages this risk by adhering to counterparty exposure limits based on external credit ratings of the relevant counterparty.

 

Debt covenants

The principal financial covenant ratios are consistent across the private placement loan notes and revolving credit facility, with a maximum Consolidated Total Net Borrowings (CTNB) to covenant EBITDA of 3.5 times and minimum covenant EBITDA to net finance costs of 3.0 times, tested semi-annually. A reconciliation of the basis of calculation is set out in the table below.

Following the refinancing in December 2018, the debt covenants were amended to include the impact of IFRS15 Revenue from Contracts with Customers. The covenants continue to exclude the impact of IFRS16 Leases on the Group's results.

For the year ended 31 December	2020 £m	2019 £m
Operating profit before exceptional items	166.7	125.9
Remove: Amortisation and impairment of intangibles arising on acquisition	9.0	7.5
Trading Profit	175.7	133.4
Exclude: Share of joint venture post-tax profits	(12.7)	(27.5)
Include: Dividends from joint ventures	19.8	25.4
Add back: Net non-exceptional charges to covenant OCPs	4.9	7.2
Add back: Net covenant OCP utilisation	(0.7)	-
Add back: Depreciation, amortisation and impairment of owned property, plant and equipment and non-acquisition intangible assets	30.2	35.8
Add back: Depreciation, amortisation and impairment of property, plant and equipment and non-acquisition intangible assets held under finance leases - in accordance with IAS17 Leases	4.3	5.8
Add back: Foreign exchange credit on investing and financing arrangements	(0.7)	(0.8)
Add back: Share based payment expense	11.2	11.6
Other covenant adjustments to EBITDA	(7.2)	9.8
Covenant EBITDA	224.8	200.7
Net finance costs	25.9	21.8
Exclude: Net interest receivable on retirement benefit obligations	1.2	2.1
Exclude: Movement in discount on other debtors	0.1	0.1
Exclude: Other dividends received	0.4	-
Exclude: Foreign exchange on investing and financing arrangements	(0.7)	(0.8)
Add back: Movement in discount on provisions	(0.2)	(1.2)
Other covenant adjustments to net finance costs resulting from IFRS16 Leases	(9.1)	(6.6)
Covenant net finance costs	17.6	15.4
Adjusted Net Debt	57.8	214.5
Obligations under finance leases - in accordance with IAS17 Leases	24.1	8.9
Recourse Net Debt	81.9	223.4
Exclude: Disposal vendor loan note, encumbered cash and other adjustments	(1.7)	4.1
Covenant adjustment for average FX rates	21.3	7.6
CTNB	101.5	235.1
CTNB / covenant EBITDA (not to exceed 3.5x)	0.45x	1.17x
Covenant EBITDA / covenant net finance costs (at least 3.0x)	12.8x	13.0x

 

Net assets summary

As at 31 December	2020 £m	2019* £m
Non current assets
Goodwill	669.6	674.2
Other intangible assets	80.6	96.5
Property, plant and equipment	441.7	392.6
Other non current assets	44.5	50.1
Deferred tax assets	83.2	63.9
Retirement benefit assets	114.6	78.3
Total non current assets	1,434.2	1,355.6
Current assets
Inventories	21.4	18.3
Contract assets, trade receivables and other current assets	614.1	610.4
Current tax assets	4.9	6.8
Cash and cash equivalents	335.7	89.5
Total current assets	976.1	725.0
Total assets	2,410.3	2,080.6
Current liabilities
Contract liabilities, trade payables and other current liabilities	(585.5)	(558.9)
Current tax liabilities	(21.6)	(18.7)
Provisions	(62.1)	(58.4)
Lease obligations	(109.3)	(84.6)
Loans	(89.7)	(56.1)
Total current liabilities	(868.2)	(776.7)
Non current liabilities
Contract liabilities, trade payables and other non current liabilities	(57.0)	(72.7)
Deferred tax liabilities	(26.9)	(26.7)
Provisions	(115.9)	(103.4)
Lease obligations	(293.3)	(285.3)
Loans	(299.1)	(248.9)
Retirement benefit obligations	(34.9)	(24.0)
Total non current liabilities	(827.1)	(761.0)
Total liabilities	(1,695.3)	(1,537.7)
Net assets	715.0	542.9

*  During the year ended 31 December 2020, the Group finalised fair value measurements for a number of contracts which had previously been provisionally valued associated with the acquisition of Naval Systems Business Unit which was completed 1 August 2019.  As a result, in accordance with IFRS3 Business Combinations, goodwill has been revised and the fair value of acquired assets and liabilities have been adjusted, resulting in an amendment to their carrying value as presented as at 31 December 2019.  Further information on the fair value can be found in Note 5 to the Condensed Consolidated Financial Statements.

At 31 December 2020 the Group had net assets of £715.0m, a movement of £172.1m from the closing net asset position of £542.9m as at 31 December 2019. The increase in net assets is mainly due to the following movements:

·

An increase in property, plant and equipment of £49.1m, which includes an increase in right of use assets of £42.2m.  This is matched by a corresponding increase in lease liabilities net of repayments made of £32.7m. The increase in leases is primarily due to the Group's Asylum Accommodation and Support Services Contract ("AASC") contract.

·

An increase in the net retirement benefit asset of £25.4m. Market volatility seen throughout 2020 meant a decrease in risk free rates and a corresponding decrease in the discount rate applied to the defined benefit obligation associated with the Group's most significant pension scheme. Whilst this increased the liability associated with the scheme, it also served to increase the rates of return on more secure assets, such as government bonds, meaning the buy and hold approach adopted by the scheme saw favourable net returns during the year.

 

·

Cash and cash equivalents have increased by £246.2m which includes a net exchange gain of £1.8m.  In the year the Group has generated cash inflows of £270.5m from operations before exceptionals as well as raising $200.0m (£155.9m) through an additional US private placement.  The net spend on tangible and intangible assets was £29.2m and the capital element of lease repayments in the year was £100.8m.

·

Net loan balances have increased by £83.8m due to the offsetting impacts of the Group obtaining an additional £155.9m through a US private placement but repaying £50.0m of the revolving credit facility that was drawn at the end of 2019. Other movements on the loan balances are predominantly favourable foreign exchange gains.

Provisions

The total of current and non current provisions has increased by £16.2m since 31 December 2019. The movement is predominantly due to:

·	An increase in restructuring and other employee provisions of £15.7m.
·	An increase of £5.4m across employee terminal gratuity and long service award provisions.
·	A decrease of £2.0m in onerous contract provisions to £14.5m (2019: £16.5m).  OCP balances are subject to ongoing review and a full bottom-up assessment of the forecasts that form the basis of the OCPs is conducted as part of the annual budgeting process.  The net release to OCPs was £0.2m in 2020 (2019: £1.0m charge) and utilisation was £1.8m (2019: £53.6m).

In 2020, the release from OCPs is reflective of the Group's ability to forecast the final years of contracts which are nearing completion. Additional charges of £5.7m (2019: £10.6m) have been made in respect of future losses on new and existing onerous contract provisions to reflect the updated forecasts and releases of £5.9m (2019: £9.6m) as settlements are agreed and contracts near completion. The additional charges represent certain operational issues and the associated risks which are resulting in charges to existing onerous contract provisions.

The Group undertakes a robust assessment at each reporting date to determine whether any individual customer contracts, which the Group has entered into, are onerous and require a provision to be recognised in accordance with IAS37 Provisions, Contingent Liabilities & Contingent Assets. The Group operates a large number of long-term contracts at different phases of their contract life cycle. Within the Group's portfolio, there are a small number of contracts where the balance of risks and opportunities indicates that they might be onerous if transformation initiatives or contract changes are not successful. The Group has concluded that these contracts do not require an onerous contract provision on an individual basis. Following the individual contract reviews, the Group has also undertaken a top down assessment which assumes that, whilst the contracts may not be onerous on an individual basis, as a portfolio there is a risk that at least some of the transformation programmes or customer negotiations required to avoid a contract loss, will not be fully successful, and it is more likely than not that one or more of these contracts will be onerous. Therefore, in considering the Group's overall onerous contract provision, the Group has made a best estimate of the provision required to take into consideration this portfolio risk. As a result, the risk of OCPs and the monitoring of individual contracts for indicators remains a critical estimate for the Group. As at 31 December 2020, the provision recognised in respect of this portfolio of contracts is £8.5m (2019: £6.2m).

Acquisitions

On 4 January 2021, the Group acquired 100% of the issued share capital of Facilities First Australia Holdings Pty Limited ("FFA" or "Facilities First Australia"), for consideration of A$52.6m, subject to standard net working capital adjustments. Further details on this post year end transaction are provided in note 24 to the Condensed Consolidated Financial Statements.

On 16 February 2021, the Group announced that it had agreed to acquire Whitney, Bradley & Brown, Inc ("WBB"), a leading provider of advisory, engineering and technical services to the US Military, for $295m from an affiliate of H.I.G. Capital.  The acquisition will increase the scale, breadth and capability of Serco's North American defence business and will give Serco a strong platform from which to address all major segments of the US defence services market.  The acquisition will be immediately accretive to earnings and will be funded through existing debt facilities; it is expected to complete in the second quarter of 2021, subject to regulatory approvals. As the transaction is yet to complete, the financial results and impact of the transaction have not been recognised in these Consolidated Financial Statements.

Disposals

On 31 May 2020, the Group disposed of its 33% interest in Viapath Analytics LLP, Viapath Services LLP and Viapath Group LLP (together "Viapath").

The Group had historically impaired its investment in Viapath as it was not receiving any returns from this joint venture due to the level of investment being made back into the business, therefore the carrying value of the Group's investment in Viapath was nil. Following the announcement during the first half of 2020 that Viapath had been unsuccessful in the tender process to provide pathology services to five South East London hospitals as well as associated GP surgeries, the Group exited the joint venture, selling its stake to the remaining two investors. Total cash receipts on the date of the disposal were £15.1m. Of the £15.1m, £1.2m was in respect of a loan that had previously been impaired through exceptional costs and so the reversal has been recognised as an exceptional gain. An additional amount of £2.9m was received as a profit share which, because the Group's investment in Viapath was fully impaired, resulted in a profit being recognised. Since £1.0m of the impairment was recorded within exceptional items in prior years, the associated profit was treated as exceptional with the remainder being recognised within Underlying Trading Profit. The remaining £11.0m was received in respect of the Group's interest in Viapath and so, with no carrying value attributed to Viapath, this has been recognised as a gain on disposal of the investment in the joint venture.

Covid-19

The impact of Covid-19 on the Group during the year at a profit level has been broadly neutral, however this includes significant gross impacts. Whilst the Group has been successful in providing support to governments in the majority of the locations in which it operates, there are areas of the Group that have fared less favourably. Our assistance with the UK testing programme, NHS Test and Trace, and Immigration contracts in AsPac and the UK have resulted in positive contributions to the Group's profit. Offsetting these are higher costs within the Group's Health contracts, the Group's Leisure business in the UK which has seen significant adverse profit impacts from the lockdowns, both local and national, and the Group's Transport contracts both in the UK and the Middle East which have seen significant reductions in volumes; these include the Merseyrail joint venture and Caledonian Sleepers contract in the UK and Aviation businesses in the Middle East. Some of these adverse impacts have been mitigated with commercial customer support to offset the impact of the pandemic on costs and volumes. The Group has also paid every member of front-line staff an ex-gratia bonus of £100 resulting in a total cost of c.£5m.

The Group's cash flow has benefitted from £12.4m of tax deferrals in the North America division owing to the absence of a mechanism to repay these early, but all other deferrals of taxes have been repaid. Additionally, the Group has returned all furlough amounts received in respect of Group's employees in the UK, meaning the Group has not received any government assistance in respect of Covid-19 and the US tax deferrals will be repaid early as soon as there is a mechanism to do so.

Claim for losses in respect of the 2013 share price reduction

Following the announcement during 2020 that the Group has received a claim seeking damages for alleged losses as a result of the reduction in Serco's share price in 2013, the Group has continued to assess the merit, likely outcome and potential impact on the Group of any such litigation that either has been or might potentially be brought against the Group. Any outcome is subject to a number of significant uncertainties and, therefore, it is not possible to assess the quantum of any such litigation as at the date of this disclosure.

Information on other contingent liabilities can be found in note 20 to the Condensed Consolidated Financial Statements.

 

Condensed Consolidated Financial Statements

Consolidated Income Statement

For the year ended 31 December

	Note	2020 £m	2019 £m
Revenue	7	3,884.8	3,248.4
Cost of sales		(3,501.8)	(2,928.3)
Gross profit		383.0	320.1
Administrative expenses		(220.0)	(214.2)
Exceptional profit on disposal of subsidiaries and operations	6	11.0	-
Other exceptional operating items	8	1.5	(23.4)
Other expenses - amortisation and impairment of intangibles arising on acquisition		(9.0)	(7.5)
Share of profits in joint ventures and associates, net of interest and tax	4	12.7	27.5
Operating profit		179.2	102.5
Operating profit before exceptional items		166.7	125.9
Investment revenue	9	1.9	2.7
Finance costs	10	(27.8)	(24.5)
Total net finance costs		(25.9)	(21.8)
Profit before tax		153.3	80.7
Profit before tax and exceptional items		140.8	104.1
Tax on profit before exceptional items	11	(18.9)	(27.4)
Exceptional tax	11	(0.4)	(2.7)
Tax charge		(19.3)	(30.1)
Profit for the year		134.0	50.6
Attributable to:
Equity owners of the Company		133.8	50.4
Non controlling interests		0.2	0.2
Earnings per share (EPS)
Basic EPS	13	10.89p	4.31p
Diluted EPS	13	10.67p	4.21p

The accompanying notes form an integral part of the financial statements.

 

Consolidated Statement of Comprehensive Income

For the year ended 31 December

	Note	2020 £m	2019 £m
Profit for the year		134.0	50.6
Other comprehensive income for the year:
Items that will not be reclassified subsequently to profit or loss:
Share of other comprehensive income in joint ventures and associates	4	2.7	1.3
Remeasurements of post-employment benefit obligations*	21	18.2	(20.3)
Actuarial gain on reimbursable rights*	21	3.9	3.2
Income tax relating to these items*	11	(5.9)	2.7
Items that may be reclassified subsequently to profit or loss:
Net exchange gain/(loss) on translation of foreign operations**		7.9	(33.3)
Fair value loss on cash flow hedges during the year**		(0.2)	(0.1)
Total other comprehensive income/(expense) for the year		26.6	(46.5)
Total comprehensive income for the year		160.6	4.1
Attributable to:
Equity owners of the Company		160.4	4.0
Non controlling interest		0.2	0.1

*  Recorded in retirement benefit obligations reserve in the Consolidated Statement of Changes in Equity.

**  Recorded in hedging and translation reserve in the Consolidated Statement of Changes in Equity.

The accompanying notes form an integral part of the financial statements.

 

Consolidated Statement of Changes in Equity

	Share capital £m	Share premium account £m	Capital redemption reserve £m	Retained earnings £m	Retirement benefit obligations reserve £m	Share based payment reserve £m	Own shares reserve £m	Hedging and translation reserve £m	Total shareholders' equity £m	Non controlling interest £m
At 1 January 2019	22.0	327.9	0.1	111.1	(137.4)	75.0	(18.7)	5.4	385.4	1.4
Opening balance adjustment - IFRS16	-	-	-	3.0	-	-	-	-	3.0	-
Total comprehensive income for the year	-	-	-	51.8	(14.4)	-	-	(33.4)	4.0	0.1
Issue of share capital	2.5	135.0	-	-	-	-	(0.3)	-	137.2	-
Shares transferred to award holders on exercise of share awards	-	-	-	-	-	(14.4)	14.6	-	0.2	-
Expense in relation to share based payments	-	-	-	-	-	11.6	-	-	11.6	-
At 1 January 2020	24.5	462.9	0.1	165.9	(151.8)	72.2	(4.4)	(28.0)	541.4	1.5
Total comprehensive income for the year	-	-	-	136.5	16.2	-	-	7.7	160.4	0.2
Issue of share capital	0.2	0.2	-	-	-	-	(0.2)	-	0.2	-
Shares transferred to award holders on exercise of share awards	-	-	-	-	-	(2.4)	2.5	-	0.1	-
Expense in relation to share based payments	-	-	-	-	-	11.2	-	-	11.2	-
At 31 December 2020	24.7	463.1	0.1	302.4	(135.6)	81.0	(2.1)	(20.3)	713.3	1.7

The accompanying notes form an integral part of the financial statements.

 

Consolidated Balance Sheet

	Note	At 31 December 2020 £m	At 31 December 2019* £m
Non current assets
Goodwill	14	669.6	674.2
Other intangible assets		80.6	96.5
Property, plant and equipment		441.7	392.6
Interests in joint ventures and associates	4	19.2	23.6
Trade and other receivables	15	25.3	26.5
Deferred tax assets	12	83.2	63.9
Retirement benefit assets	21	114.6	78.3
		1,434.2	1,355.6
Current assets
Inventories		21.4	18.3
Contract assets	15	296.1	287.5
Trade and other receivables	15	313.5	319.9
Current tax assets		4.9	6.8
Cash and cash equivalents		335.7	89.5
Derivative financial instruments		4.5	3.0
		976.1	725.0
Total assets		2,410.3	2,080.6
Current liabilities
Contract liabilities	16	(42.3)	(66.8)
Trade and other payables	16	(533.9)	(490.2)
Derivative financial instruments		(9.3)	(1.9)
Current tax liabilities		(21.6)	(18.7)
Provisions	19	(62.1)	(58.4)
Lease obligations	17	(109.3)	(84.6)
Loans		(89.7)	(56.1)
		(868.2)	(776.7)
Non current liabilities
Contract liabilities	16	(47.5)	(58.2)
Trade and other payables	16	(9.4)	(14.5)
Derivative financial instruments		(0.1)	-
Deferred tax liabilities	12	(26.9)	(26.7)
Provisions	19	(115.9)	(103.4)
Lease obligations	17	(293.3)	(285.3)
Loans		(299.1)	(248.9)
Retirement benefit obligations	21	(34.9)	(24.0)
		(827.1)	(761.0)
Total liabilities		(1,695.3)	(1,537.7)
Net assets		715.0	542.9
Equity
Share capital		24.7	24.5
Share premium account		463.1	462.9
Capital redemption reserve		0.1	0.1
Retained earnings		302.4	165.9
Retirement benefit obligations reserve		(135.6)	(151.8)
Share based payment reserve		81.0	72.2
Own shares reserve		(2.1)	(4.4)
Hedging and translation reserve		(20.3)	(28.0)
Equity attributable to owners of the Company		713.3	541.4
Non controlling interest		1.7	1.5
Total equity		715.0	542.9

*  During the year ended 31 December 2020, but within twelve months of the date of the acquisition, the Group finalised fair value measurements for a number of contracts, which had previously been provisionally valued, associated with the acquisition of Naval Systems Business Unit which was completed 1 August 2019.  As a result, in accordance with IFRS3 Business Combinations, goodwill has been revised and the fair value of acquired assets and liabilities have been adjusted, resulting in an amendment to their carrying value as presented as at 31 December 2019.  Further information on the fair value can be found in Note 5.

The accompanying notes form an integral part of the financial statements.

The financial statements were approved by the Board of Directors on 24 February 2021 and signed on its behalf by:

Rupert Soames  Angus Cockburn
Group Chief Executive Officer  Group Chief Financial Officer
 

Consolidated Cash Flow Statement

For the year ended 31 December

	Note	2020  m	2019 £m
Net cash inflow from operating activities before exceptional items		270.5	152.1
Exceptional items		(2.0)	(49.2)
Net cash inflow from operating activities	3	268.5	102.9
Investing activities
Interest received		0.3	0.4
Decrease in security deposits		0.1	0.2
Dividends received from joint ventures and associates		19.8	25.4
Exceptional distribution from joint ventures		1.9	-
Other dividends received		0.4	-
Proceeds from disposal of property, plant and equipment		20.9	1.0
Net cash inflow on disposal of subsidiaries and operations	6	11.0	-
Acquisition of subsidiaries, net of cash acquired	5	(4.9)	(193.2)
Proceeds from loans receivable		1.2	-
Purchase of other intangible assets		(8.3)	(6.8)
Purchase of property, plant and equipment		(41.8)	(17.5)
Net cash inflow/(outflow) from investing activities		0.6	(190.5)
Financing activities
Interest paid		(24.9)	(21.4)
Capitalised finance costs paid		(0.9)	(1.2)
Net advances/repayments of loans		99.4	72.3
Capital element of lease repayments		(100.8)	(70.2)
Cash movements on hedging instruments		2.4	(2.0)
Issue of share capital		-	138.7
Proceeds received from exercise of share options		0.1	0.2
Net cash (outflow)/inflow from financing activities		(24.7)	116.4
Net increase in cash and cash equivalents		244.4	28.8
Cash and cash equivalents at beginning of year		89.5	62.5
Net exchange gain/(loss)		1.8	(1.8)
Cash and cash equivalents at end of year		335.7	89.5

The accompanying notes form an integral part of the financial statements.

 

Notes to the Condensed Consolidated Financial Statements

1. General information, going concern and changes in accounting standards

The basis of preparation in this preliminary announcement is set out below.

The financial information in this announcement does not constitute the Group's or the Company's statutory accounts as defined in section 434 of the Companies Act 2006 for the years ended 31 December 2020 or 2019, but is derived from those accounts. Statutory accounts for 2019 have been delivered to the registrar of companies, and those for 2020 will be delivered in due course. The auditor has reported on those accounts; their reports were (i) unqualified, (ii) did not include a reference to any matters to which the auditor drew attention by way of emphasis without qualifying their report and (iii) did not contain a statement under section 498 (2) or (3) of the Companies Act 2006.

The preliminary announcement has been prepared in accordance with international accounting standards in conformity with the requirements of the Companies Act 2006 ("Adopted IFRS") and are prepared in accordance with international financial reporting standards adopted pursuant to Regulation (EC) No 1606/2002 as it applies to the European Union. Whilst the financial information included in this preliminary announcement has been computed in accordance with IFRS, this announcement does not itself contain sufficient information to comply with IFRS. The Company expects to publish full Group and parent company only financial statements that comply with IFRS and FRS101 respectively, in March 2021 and this includes the Group's and parent company's accounting policies.

The financial statements have been prepared on the historical cost basis, except for the revaluation of financial instruments. Historical cost is generally based on the fair value of the consideration given in exchange for goods and services. The following principal accounting policies adopted have been applied consistently in the current and preceding financial year except as stated below.

Going concern

In assessing the basis of preparation of the financial statements for the year ended 31 December 2020, the Directors have considered the principles of the Financial Reporting Council's 'Guidance on Risk Management, Internal Control and Related Financial and Business Reporting, 2014'; particularly in assessing the applicability of the going concern basis, the review period and disclosures. The period of assessment is considered to be at least 12 months from the date of approval of these financial statements.

At 31 December 2020, the Group's principal debt facilities comprised a £250m revolving credit facility, an acquisition facility of £45m and £347m of US private placement notes, giving £642m of committed credit facilities and committed headroom of £582m. As at December 2020, the Group's leverage ratio is below its covenant of 3.5x and below the Group's target range of 1x-2x at 0.45x.

The Directors have undertaken a rigorous assessment of going concern and liquidity taking into account key uncertainties and sensitivities, including the potential impact of Covid-19 on the future performance of the Group. In making this assessment the Directors have considered the Group's existing debt levels, the committed funding and liquidity positions under its debt covenants, its ability to generate cash from trading activities and its working capital requirements. The Directors have also identified a series of mitigating actions that could be used to preserve cash in the business should the need arise.

The basis of the assessment is the Board-approved budget, which is prepared annually for the next two-year period and is based on a bottom-up approach to all of the Group's existing contracts, potential new contracts and administrative functions. In setting the Group's budgets for 2021 and 2022, consideration has been given to the known impacts of Covid-19, though most of the Group's contracts deliver critical services to Governments and the delivery requirements of these have not been materially impacted.

The Directors have considered various downside scenarios, including the anticipated impact of Covid-19 on the Group's operations, and have excluded the positive impacts on profitability experienced to date as a result of the virus. The key assumptions considered in these downside scenarios include a range of lower passenger volumes on the Group's train operating contracts, higher costs within the Health portfolio and slower recovery in usage of leisure centres in the UK through to the end of 2021. In a more severe downside scenario, the Directors have modelled the negative financial impact of Covid-19 as experienced during the year to 31 December 2020 through another two three-month lockdowns during the assessment period. In these different downside scenarios, the Group continues to have sufficient covenant and liquidity headroom.

Due to the limited impact of Covid-19 on the Group's profitability, the Directors believe that appropriate sensitivities in assessing the Group and Company's ability to continue as a going concern are to model reductions in the Group's win rates for new business and rebids, and reductions in profit margins. Due to the diversity in the Group's operations, the Directors believe that a reverse stress test of these sensitivities to assess the headroom available under the Group's debt covenants and available liquidity, provides meaningful analysis of the Group's ability to continue as a going concern. Based on the headroom available, the Directors are then able to assess whether the reductions required to breach the Group's financial covenants, or exhaust available liquidity, are plausible.

This reverse stress test shows that, even after assuming that the US private placement loans of $152m due to mature before 30 June 2022 are repaid, and that no additional refinancing occurs, the Group can afford to be unsuccessful on 50% of its target new business and rebid wins, combined with a profit margin 50 basis points below the Group's forecast, and still retain sufficient liquidity to meet all liabilities as they fall due and remain compliant with the Group's financial covenants.

In respect of win rates, rebids have a more significant impact on the Group's revenue than new business wins during the assessment period, as contracts accounting for c.62% of total revenues are expected to be rebid in the next three years. The Group's rebid win rate excluding COMPASS SNI and Viapath, neither of which contributed to the Group's profitability, has been in excess of 85% over the last two years, therefore a reduction of 50% to the budgeted win rates and rebid rates is not considered plausible. The Group does not bid for contracts at margins below its target range.

In respect to margin reduction, due to the diversified nature of the Group's portfolio of long term contracts and the fact that the Group has met or exceeded its full year guidance for the last five years, a reduction in margin of 50bps (c£20m) versus the Group's budget is not considered plausible within the assessment period combined with a 50% reduction in win rates for new business and rebids.

Consequently, the Directors are confident that the Group and Company will have sufficient funds to continue to meet its liabilities as they fall due for at least 12 months from the date of approval of the financial statements and therefore have prepared the financial statements on a going concern basis.

Adoption of new and revised standards

There have been no new accounting standards implemented by the Group during the year and no revisions to accounting standards have had a material impact on the Group's Financial Statements.

Amendments to IFRS16 Covid-19 Related Rent Concessions

On 28 May 2020, the IASB issued Covid-19 Related Rent Concessions - amendment to IFRS16 Leases. The amendments provide relief to lessees from applying IFRS16 guidance on lease modification accounting for rent concessions arising as a direct consequence of the Covid-19 pandemic. As a practical expedient, a lessee may elect not to assess whether a Covid-19 related rent concession from a lessor is a lease modification. A lessee that makes this election accounts for any change in lease payments resulting from the Covid-19 related rent concession the same way it would account for the change under IFRS16, if the change were not a lease modification.

Whilst the amendment applies to annual reporting periods beginning on or after 1 June 2020, earlier application is permitted. The impact of applying the amendment to the Group's Financial Statements was immaterial.

2. Critical accounting judgements and key sources of estimation uncertainty

In the process of applying the Group's accounting policies, which are described in note 2 to the Group's Consolidated Financial Statements, Management has made the following judgements that have the most significant effect on the amounts recognised in the Consolidated Financial Statements. As described below, many of these areas of judgement also involve a high level of estimation uncertainty.

Key sources of estimation uncertainty

Provisions for onerous contracts

Determining the carrying value of onerous contract provisions requires assumptions and complex judgements to be made about the future performance of the Group's contracts. The level of uncertainty in the estimates made, either in determining whether a provision is required, or in the measurement of a provision booked, is linked to the complexity of the underlying contract and the form of service delivery. Due to the level of uncertainty and combination of variables associated with those estimates there is a significant risk that there could be material adjustment to the carrying amounts of onerous contract provisions within the next financial year for contracts which the Directors have assessed do not require a provision as at 31 December 2020. The estimates made in relation to onerous contracts differ according to whether an existing provision is recognised or not.

Major sources of uncertainty within existing onerous contract provisions, which could result in a material adjustment within the next financial year, are:

·	The ability of the Company to maintain or improve operational performance to ensure costs or performance related penalties are in line with expected levels;
·	Volume driven revenue and costs being within the expected ranges;
·	The outcome of open claims made by or against a customer regarding contractual performance or contractual negotiations taking place where there is expected to be a positive outcome from the Group's perspective;
·	The ability of suppliers to deliver their contractual obligations on time and on budget; and
·	The longer term impact of Covid-19 on contract performance such as the performance and usage of leisure centres or passenger volumes in the UK and the risk that this may be impacted by any future wave of the virus which requires a subsequent lock down period, in the absence of any customer support.

In the current year, an amount of £0.1m was charged to historic provisions, and releases of £5.9m have been made. One new OCP was recognised during the year with the charge being £3.3m within Underlying Trading Profit. All of these revisions have resulted from triggering events in the current year, either through changes in contractual positions or changes in circumstances which could not have been reasonably foreseen at the previous balance sheet date such as the impact of Covid-19. To mitigate the level of uncertainty in making these estimates, Management regularly compares actual performance of the contracts against previous forecasts and considers whether there have been any changes to significant judgements. A detailed bottom up review of the provisions is performed as part of the Group's formal annual budgeting process.

The future range of possible outcomes in respect of those assumptions and significant judgements made to determine the carrying value of onerous contracts could result in either a material increase or decrease in the value of onerous contract provisions in the next financial year.  The extent to which actual results differ from estimates made at the reporting date depends on the combined outcome and timing of a large number of variables associated with performance across multiple contracts.

The individual provisions are discounted where the impact is assessed to be significant.  Discount rates used are calculated based on the estimated risk-free rate of interest for the region in which the provision is located and matched against the ageing profile of the provision.

The Group undertakes a robust assessment at each reporting date to determine whether any individual customer contracts, which the Group has entered into, are onerous and require a provision to be recognised in accordance with IAS37 Provisions, Contingent Liabilities & Contingent Assets. The Group operates a large number of long-term contracts at different phases of their contract life cycle. Within the Group's portfolio, there are a small number of contracts where the balance of risks and opportunities indicates that they might be onerous if transformation initiatives or contract changes are not successful. The Group has concluded that these contracts do not require an onerous contract provision on an individual basis. Following the individual contract reviews, the Group has also undertaken a top down assessment which assumes that, whilst the contracts may not be onerous on an individual basis, as a portfolio there is a risk that at least some of the transformation programmes or customer negotiations required to avoid a contract loss, will not be fully successful, and it is more likely than not that one or more of these contracts will be onerous. Therefore, in considering the Group's overall onerous contract provision, the Group has made a best estimate of the provision required to take into consideration this portfolio risk. As a result, the risk of OCPs and the monitoring of individual contracts for indicators remains a critical estimate for the Group. As at 31 December 2020, the provision recognised in respect of this portfolio of contracts is £8.5m (2019: £6.2m).

The Group operates a large number of long-term contracts. Onerous contract provisions totalling £6.0m are estimated for individual contracts, based on the specific characteristics of the contract including possible contract extensions or variations, estimates of transaction price such as variable revenues and forecast costs to fulfil those contracts. As noted above, the Group also holds a balance of £8.5m in respect of the portfolio risk associated with operating a large number of long-term contracts, giving a total onerous contract provision of £14.5m (see note 19). Management has considered the nature of the estimate for onerous contract provisions and concluded that it is reasonably possible that outcomes within the next financial year may be different from management's assumptions and could, in aggregate, require a material adjustment to the onerous contract provision. However, due to the estimation uncertainty across numerous contracts each with different characteristics, it is not practical to provide a quantitative analysis of the aggregated judgements that are applied, and management do not believe that disclosing a potential range of outcomes on a consolidated basis would provide meaningful information to a reader of the accounts.

Impairment of assets

Identifying whether there are indicators of impairment for assets involves a high level of judgement and a good understanding of the drivers of value behind the asset. At each reporting period an assessment is performed in order to determine whether there are any such indicators, which involves considering the performance of our business and any significant changes to the markets in which we operate.

We seek to mitigate the risk associated with this judgement by putting in place processes and guidance for the finance community and internal review procedures.

Determining whether assets with impairment indicators require an actual impairment involves an estimation of the expected value in use of the asset (or CGU to which the asset relates). The value in use calculation involves an estimation of future cash flows and also the selection of appropriate discount rates, both of which involve considerable judgement. The future cash flows are derived from approved forecasts, with the key assumptions being revenue growth, margins and cash conversion rates. During the current year, the process for setting future budgets and longer-term business planning, has required an assessment of the likely future impact of Covid-19 on the Group's operations and its future activities. As noted above, in relation to both going concern and onerous contract provisions, the potential impact of Covid-19 in the future is uncertain. Management, as part of the budgeting process, have included an estimate of the potential future impact, and as a result, no specific adjustment has been made in relation to the cash flows used in the assessment of the value in use of assets.

Discount rates are calculated with reference to the specific risks associated with the assets and are based on advice provided by external experts. Our calculation of discount rates are performed based on a risk free rate of interest appropriate to the geographic location of the cash flows related to the asset being tested, which is subsequently adjusted to factor in local market risks and risks specific to Serco and the asset itself.  Discount rates used for internal purposes are post tax rates, however for the purpose of impairment testing in accordance with IAS36 Impairment of Assets we calculate a pre tax rate based on post tax targets.

A key area of focus in recent years has been in the impairment testing of goodwill as a result of the pressure on the results of the Group. However, no impairment of goodwill was noted in the year ended 31 December 2020.

Current tax

Liabilities for tax contingencies require Management judgement and estimates in respect of tax audits and also tax exposures in each of the jurisdictions in which we operate. Management is also required to make an estimate of the current tax liability together with an assessment of the temporary differences that arise as a consequence of different accounting and tax treatments. Key judgement areas for the Group include the correct allocation of profits and losses between the countries in which we operate and the pricing of intercompany services. Where Management conclude that a tax position is uncertain, a current tax liability is held for anticipated taxes that are considered probable based on the current information available including the specific circumstances of each case and external advice, where appropriate.

These liabilities can be built up over a long period of time, but the ultimate resolution of tax exposures usually occurs at a point in time and, given the inherent uncertainties in assessing the outcomes of these exposures, these estimates are prone to change in future periods. It is not currently possible to estimate the timing of potential cash outflow, but on resolution, to the extent this differs from the liability held, this will be reflected through the tax charge or credit, which could be material for that period to the extent that the outcomes differ from the current estimates. Each potential liability and contingency is revisited on an annual basis and adjusted to reflect any changes in positions taken by the Group, local tax audits, the expiry of the statute of limitations following the passage of time and any change in the broader tax environment.

Retirement benefit obligations

Identifying whether the Group has a retirement benefit obligation as a result of contractual arrangements entered into requires a level of judgement, largely driven by the legal position held between the Group, the customer and the relevant pension scheme. The Group's retirement benefit obligations and other pension scheme arrangements are covered in note 21.

The calculation of retirement benefit obligations is dependent on material key assumptions including discount rates, mortality rates, inflation rates and future contribution rates.

In accounting for the defined benefit schemes, the Group has applied the following principles:

·	The asset recognised for the Serco Pension and Life Assurance Scheme is equal to the full surplus that will ultimately be available to the Group as a future refund.
·	No foreign exchange item is shown in the disclosures as the non UK liabilities are not material.

No pension assets are invested in the Group's own financial instruments or property.

Pension annuity assets are remeasured to fair value at each reporting date based on the share of the defined benefit obligation covered by the insurance contract.

Critical accounting judgements

Covid-19 related impacts

During the year ended 31 December 2020, the Group's results have been impacted by Covid-19, and in a number of instances, the recognition and measurement of amounts as at 31 December 2020 has required judgements to be made about the impact of Covid-19. Management assessed each balance on the balance sheet for the impact of Covid-19 as at 31 December 2020, as well as a number of other critical judgements which could also reasonably be considered to be impacted by the ongoing effects of Covid-19. Those items for which Covid-19 was considered to be a critical element of the judgements made, are summarised below. In reviewing areas of the financial statements that could be impacted by Covid-19, Management identified a number of areas subject to judgement, but where it was considered unlikely that a material difference would result from the judgements made. These areas included:

·	Compliance with banking covenants due to the headroom levels available under the current facilities;
·	The impact of changes in cash flows on financing arrangements and hedging effectiveness due to the assumption that current financing arrangements are sufficient and will continue unchanged for the duration of the arrangements;
·	Dividends and capital management restrictions, owing to the limited impact of Covid-19 on the Group's financial results and considerations disclosed in the Chief Executive's Review around the proposed dividend in relation to the year ended 31 December 2020;
·	Alternative Performance Measures (APMs), as the impact of Covid-19 was considered too subjective to require a change to the Group's APMs, and the APMs continue to be appropriate to meet investors' requirements and for further clarity and transparency of the Group's financial performance; and
·	Post balance sheet events, owing to the fact that Covid-19 has been factored into other assumptions and judgements around forecast performance into 2021, and in the absence of material events subsequent to 31 December 2020, no additional judgements were required to be made.

 

Going concern

As noted on page 44, the impact of Covid-19 on the ability of the Group to continue as a going concern has been considered by Management. The critical judgements are focused on the economic recovery of certain sectors in which the Group operates, as well as the potential impacts of future actions taken by governments globally. The judgements made represent severe but plausible scenarios that could occur within the going concern assessment period. The conclusion drawn by Management based on these judgements is that no material uncertainties exist in respect of the ability for the Group to continue as a going concern.

Onerous contract provisions

The calculation of onerous contract provisions is a key source of estimation uncertainty. Within the calculation of onerous contract provisions judgements have been made by Management regarding the recovery of global economies from the impacts of Covid-19, particularly in the sectors in which the Group operates. In particular, the short-term impacts of Covid-19 have been estimated specific to each of the Group's contracts and these impacts have been included in budgets used to identify any contracts which require an onerous contract provision to be recognised. Judgements related to Covid-19 include the potential for further lock-downs, the length of any such lock-downs and the scale and speed of future recoveries. Should this be incorrect then this could lead to onerous contract provisions being recognised in future periods.

Impairment of assets

The impairment of assets is a key source of estimation uncertainty. In calculating the value in use of CGUs, Management are required to form an estimate of the future cash flows which inherently includes a degree of estimation uncertainty. Moreover, when looking at future cash flows as at 31 December 2020, Management has made judgements regarding the impact of Covid-19 over the same timeframe as the cash flows used to calculate value in use. During this timeframe, Management has considered the impact of Covid-19 specific to each existing contract, as well as opportunities in the Group's pipeline and this judgement is included in budgeted cash flows. Should this be incorrect then this could lead to impairments being recognised in future periods.

Recoverability of trade receivables

At 31 December 2020, the Group's trade receivables balance is recorded at the carrying value of trade receivables less an allowance for bad or doubtful debts. Due to the global impact of the Covid-19 pandemic, Management has reassessed the judgement made in previous periods that any expected credit losses associated with trade receivables is immaterial. Management remain confident that as the Group's customers are predominantly sovereign in nature, there remains limited risk to the recoverability of the trade receivables balances at the end of the year as a result of expected credit losses. Should this be incorrect, a charge associated with irrecoverable debts could be recognised in future periods.

Retirement benefit obligations

The net position on defined benefit pension schemes is a key source of estimation uncertainty. Covid-19 could have a material impact on any number of judgements used in valuing the Group's pension schemes as at 31 December 2020, including, but not necessarily limited to, the discount rate used, future inflation rates and the mortality assumptions in place. To ensure appropriate judgements are taken based on the most relevant information available, Management has continued to engage with third-party advisors in assessing each of these judgements. The discount rate is derived from the return on corporate bond yields, and whilst this is largely observable, any change in discount rates in the future could have a material impact on the carrying value of the defined benefit obligation. Similarly, inflation rates and mortality assumptions impact the defined benefit obligation as they are used to model future salary increases and the duration of pension payments. Whilst current assumptions use projected future inflation rates and the most up to date information available on mortality, if these judgements change, the defined benefit obligation could also change materially in future periods.

Management also considered whether an allowance was required for assets held in pension schemes owing to the impact of Covid-19 on the carrying value of assets. In concluding that such an adjustment was not required, Management's judgement focused on the fact that a significant proportion of the assets are either quoted or have market observable prices and for those which are not directly observable, sufficient assurance has been received from asset managers regarding the appropriateness of the carrying values of the underlying assets.

Going concern

Whilst there are no material uncertainties over the ability of the Group to continue as a going concern, in preparing the going concern assessment the Directors are required to make a number of judgements to reach such a conclusion. In particular, when forming an opinion for the current year, the ongoing impact of Covid-19 and the impact on headroom in the Group's financing facilities has been the most critical area of judgement.

In order to model severe but plausible scenarios to stress test the potential impact of Covid-19 on the Group's forecast, the Directors have considered, amongst other scenarios, lower passenger volumes on the Group's train operating contracts, higher costs within the Health portfolio and slower recovery in usage of leisure centres in the UK through to the end of 2021, without mitigations that are outside of the Group's control. The Directors have also considered, for the plausible downside scenario, the absence of any repeat of contracts associated with the UK Government's response to the pandemic. The Directors have reviewed the impact on overseas operations and considered the impact of a future wave in Australia which may impact the ability to deliver operations within contact centres, or drive higher absenteeism in the delivery of its larger operations such as the Fiona Stanley Hospital or Department of Immigration and Border Protection contracts. In the United States, the recent change in administration and escalation of Covid-19 cases has made an assessment of the impact of the response to the pandemic difficult to estimate, as the response could take a different approach to that seen under the previous administration. In an extreme case, the Directors have modelled the negative financial impact of Covid-19 as experienced during the year to 31 December 2020, without the mitigations outlined above, through another two three-month lockdown periods during the assessment period and allowed for the impact of a change in direction of the response in the United States. The scenario indicates that the Group has sufficient liquidity to withstand a potential future wave of the virus if the impact is consistent with that experienced during the first wave.

After considering these severe but plausible scenarios, the forecasts indicate sufficient capacity in the Group's financing facilities and associated covenants to support the Group. In order to satisfy themselves that they have adequate resources for the future, the Directors have reviewed the Group's existing debt levels, the committed funding and liquidity positions under its debt covenants and its ability to generate cash from trading activities and working capital requirements, as well as a series of identified mitigating actions that could be used to preserve cash in the business. In order to reverse stress test the headroom available on the Group's debt covenants and liquidity available, the Directors have considered the impact of reductions to expected win rates for new contracts and rebid contracts combined with lower margins in the period of assessment and concluded that, given the headroom available, these do not present a material risk in its ability to continue as a going concern.

In making the going concern assessment, the Directors have assumed that the US private placement loans of $152m due to mature before 30 June 2022 are repaid without any additional refinancing occurring.

Leases

The Group makes use of leases both in assisting with the operational delivery of contracts and within support functions. Operational leases include, but are not limited to, accommodation for asylum seekers, vehicles used in the transport of service users and properties used to deliver services or administrative functions. Within the Group's support functions, the most prevalent leases are those associated with properties and the company car fleet.

The majority of the Group's operational leases are entered into either for the duration of the contract to which they relate, or with a termination option included, allowing the Group the option to exit the lease if it so desires. As a result, the most significant judgement that is made in relation to leases, is the derivation of the lease term at the outset of the lease. Extension and cancellation options included in leases, where the Group has the unilateral option to exercise, are included when assessing the lease term only to the extent that it is more likely than not they will be exercised. This assessment is revisited whenever the circumstances of a contract change, or more frequently if Management become aware of a change in the probability of exercising such options.

Use of Alternative Performance Measures: Operating profit before exceptional items

IAS1 Presentation of Financial Statements requires material items to be disclosed separately in a way that enables users to assess the quality of a company's profitability. In practice, these are commonly referred to as 'exceptional' items, but this is not a concept defined by IFRS and therefore there is a level of judgement involved in arriving at an Alternative Performance Measure which excludes such exceptional items. We consider items which are material and outside of the normal operating practice of the company to be suitable for separate presentation. There is a level of judgement required in determining which items are exceptional on a consistent basis and require separate disclosure. Further details can be seen in note 8.

The segmental analysis of operations in note 3 includes the additional performance measure of Trading Profit on operations which is reconciled to reported operating profit in that note. The Group uses Trading Profit as an alternative measure to reported operating profit by making several adjustments. Firstly, Trading Profit excludes exceptional items, being those we consider material and outside of the normal operating practice of the Company to be suitable of separate presentation and detailed explanation. Secondly, amortisation and impairment of intangibles arising on acquisitions are excluded, because these charges are based on judgments about the value and economic life of assets that, in the case of items such as customer relationships, would not be capitalised in normal operating practice. The CODM reviews the segmental analysis for operations.

Claim for losses in respect of the 2013 share price reduction

Following the announcement during 2020 that the Group has received a claim seeking damages for alleged losses as a result of the reduction in Serco's share price in 2013, the Group has continued to assess the merit, likely outcome and potential impact on the Group of any such litigation that either has been or might potentially be brought against the Group. Any outcome is subject to a number of significant uncertainties and therefore, it is not possible to assess the quantum of any such litigation as at the date of this disclosure.

Deferred tax

Deferred tax assets are recognised for unused tax losses to the extent that it is probable that taxable profit will be available against which the losses can be utilised. Significant Management judgement is required to determine the amount of deferred tax assets that can be recognised, based upon the likely timing and the level of future taxable profits. Recognition has been based on forecast future taxable profits. 

Further details on deferred taxes are disclosed in note 12.

3. Segmental information

The Group's operating segments reflecting the information reported to the Board in 2020 under IFRS8 Operating Segments are as set out below.

Reportable segments	Operating segments
UK & Europe	Services for sectors including Citizen Services, Defence, Health, Justice & Immigration and Transport delivered to UK Government, UK devolved authorities and other public sector customers in the UK and Europe
Americas	Services for sectors including Citizen Services, Defence and Transport delivered to US federal and civilian agencies, selected state and municipal governments and the Canadian Government
AsPac	Services for sectors including Citizen Services, Defence, Health, Justice & Immigration and Transport in the Asia Pacific region including Australia, New Zealand and Hong Kong
Middle East	Services for sectors including Citizen Services, Defence, Health and Transport in the Middle East region
Corporate	Central and head office costs

Each operating segment is focused on a narrow group of customers in a specific geographic region and is run by a local Management team which report directly to the CODM on a regular basis. As a result of this focus, the sectors in each region have similar economic characteristics and are aggregated at the operating segment level in these financial statements.

The accounting policies of the reportable segments are the same as the Group's accounting policies described in note 2 to the Group's Consolidated Financial Statements.

Information about major customers

The Group has four major governmental customers which each represent more than 5% of Group revenues. The customers' revenues were £1,517.0m (2019: £1,043.3m) for the UK Government within the UK & Europe segment, £913.1m (2019: £734.9m) for the US Government within the Americas segment, £703.8m (2019: £597.5m) for the Australian Government within the AsPac segment and £237.2m (2019: £255.5m) for the Government of the United Arab Emirates within the Middle East segment.

Segmental information

Segmental revenue is analysed on an external basis. Inter-segment revenue is not presented as it is not significant in the context of revenue as a whole. Net finance costs are not presented for each operating segment as they are reviewed on a consolidated basis by the CODM.

Specific corporate expenses are allocated to the corresponding segments. Segment assets comprise goodwill, other intangible assets, property, plant and equipment including right of use assets, inventories, trade and other receivables (excluding corporation tax recoverable) and any retirement benefit asset. Segment liabilities comprise trade and other payables, lease liabilities, provisions and retirement benefit obligations.

The following is an analysis of the Group's revenue, results, assets and liabilities by reportable segment:

Year ended 31 December 2020	UK&E  m	Americas £m	AsPac  m	Middle East £m	Corporate £m	Total £m
Revenue	1,777.4	1,064.3	718.9	324.2	-	3,884.8
Result
Trading Profit/(loss) from operations*	69.6	100.8	32.6	13.9	(41.2)	175.7
Amortisation and impairment of intangibles arising on acquisition	(2.0)	(7.0)	-	-	-	(9.0)
Operating profit/(loss) before exceptional items	67.6	93.8	32.6	13.9	(41.2)	166.7
Exceptional profit on disposal of subsidiaries and operations	11.0	-	-	-	-	11.0
Other exceptional operating items**	1.0	1.4	(0.8)	-	(0.1)	1.5
Operating profit/(loss)	79.6	95.2	31.8	13.9	(41.3)	179.2
Investment revenue						1.9
Finance costs						(27.8)
Profit before tax						153.3
Tax charge						(18.9)
Tax on exceptional items						(0.4)
Profit for the year from operations						134.0

*  Trading Profit/(loss) is defined as operating profit/(loss) before exceptional items and amortisation and impairment of intangible assets arising on acquisition.

**  Exceptional restructuring costs incurred by the Corporate segment are not allocated to other segments.  Such items may represent costs that will benefit the wider business. Included within Other exceptional operating items are total acquisition related costs of £2.4m. 

Year ended 31 December 2020	UK&E  m	Americas £m	AsPac  m	Middle East £m	Corporate £m	Total £m
Supplementary information
Share of profits in joint ventures and associates, net of interest and tax	12.7	-	-	-	-	12.7
Depreciation of plant, property and equipment	(61.6)	(22.5)	(9.6)	(7.6)	(8.1)	(109.4)
Impairment of plant, property and equipment	(0.7)	-	-	-	-	(0.7)
Total depreciation and impairment of plant, property and equipment	(62.3)	(22.5)	(9.6)	(7.6)	(8.1)	(110.1)
Amortisation of intangible assets arising on acquisition	(2.0)	(7.0)	-	-	-	(9.0)
Amortisation of other intangible assets	(0.7)	(0.6)	(3.0)	(0.4)	(9.3)	(14.0)
Total amortisation and impairment of intangible assets	(2.7)	(7.6)	(3.0)	(0.4)	(9.3)	(23.0)
Segment assets
Interests in joint ventures and associates	18.7	-	0.1	0.4	-	19.2
Other segment assets***	750.9	675.3	274.4	87.9	174.3	1,962.8
Total segment assets	769.6	675.3	274.5	88.3	174.3	1,982.0
Unallocated assets						428.3
Consolidated total assets						2,410.3
Segment liabilities
Segment liabilities***	(626.6)	(185.0)	(200.0)	(66.7)	(170.3)	(1,248.6)
Unallocated liabilities						(446.7)
Consolidated total liabilities						(1,695.3)

*** The Corporate segment assets and liabilities include balance sheet items which provide benefit to the wider Group, including defined benefit pension schemes and corporate intangible assets.

Year ended 31 December 2019	UK&E  m	Americas £m	AsPac  m	Middle East £m	Corporate £m	Total £m
Revenue	1,361.7	915.7	621.4	349.6	-	3,248.4
Result
Trading Profit/(loss) from operations*	48.2	91.7	31.2	13.9	(51.6)	133.4
Amortisation and impairment of intangibles arising on acquisition	(1.2)	(6.2)	(0.1)	-	-	(7.5)
Operating profit/(loss) before exceptional items	47.0	85.5	31.1	13.9	(51.6)	125.9
Other exceptional operating items**	(24.8)	15.3	(3.0)	-	(10.9)	(23.4)
Operating profit/(loss)	22.2	100.8	28.1	13.9	(62.5)	102.5
Investment revenue						2.7
Finance costs						(24.5)
Profit before tax						80.7
Tax charge						(27.4)
Tax on exceptional items						(2.7)
Profit for the year from operations						50.6

*  Trading Profit/(loss) is defined as operating profit/(loss) before exceptional items and amortisation and impairment of intangible assets arising on acquisition.

**  Exceptional restructuring costs incurred by the Corporate segment are not allocated to other segments.  Such items may represent costs that will benefit the wider business.

 

Year ended 31 December 2019	UK&E  m	Americas £m	AsPac  m	Middle East £m	Corporate £m	Total £m
Supplementary information
Share of profits in joint ventures and associates, net of interest and tax	27.3	-	0.2	-	-	27.5
Depreciation of plant, property and equipment	(37.3)	(17.4)	(9.0)	(4.7)	(6.0)	(74.4)
Impairment of plant, property and equipment	(18.9)	-	-	-	-	(18.9)
Total depreciation and impairment of plant, property and equipment	(56.2)	(17.4)	(9.0)	(4.7)	(6.0)	(93.3)
Amortisation of intangible assets arising on acquisition	(1.2)	(6.2)	(0.1)	-	-	(7.5)
Amortisation of other intangible assets	(0.3)	(1.2)	(4.8)	(0.4)	(11.4)	(18.1)
Total amortisation and impairment of intangible assets	(1.5)	(7.4)	(4.9)	(0.4)	(11.4)	(25.6)
Segment assets****
Interests in joint ventures and associates	22.4	-	0.8	0.4	-	23.6
Other segment assets***	645.4	757.5	227.3	132.0	131.6	1,893.8
Total segment assets	667.8	757.5	228.1	132.4	131.6	1,917.4
Unallocated assets						163.2
Consolidated total assets						2,080.6
Segment liabilities****
Segment liabilities***/****	(536.3)	(234.0)	(151.8)	(103.0)	(160.3)	(1,185.4)
Unallocated liabilities						(352.3)
Consolidated total liabilities						(1,537.7)

*** The Corporate segment assets and liabilities include balance sheet items which provide benefit to the wider Group, including defined benefit pension schemes and corporate intangible assets.

**** During the year ended 31 December 2020, but within twelve months of the date of the acquisition, the Group finalised fair value measurements for a number of contracts, which had previously been provisionally valued, associated with the acquisition of Naval Systems Business Unit which was completed 1 August 2019.  As a result, in accordance with IFRS3 Business Combinations, goodwill has been revised and the fair value of acquired assets and liabilities have been adjusted, resulting in an amendment to their carrying value as presented as at 31 December 2019.  Further information on the fair value can be found in Note 5.

4. Joint ventures and associates

AWE Management Limited ("AWEML") and Merseyrail Services Holding Company Limited ("MSHCL") were the only equity accounted entities which were material to the Group during the year or prior year. Dividends of £15.5m (2019: £17.6m) and £1.5m (2019: £7.8m) respectively were received from these companies in the year.  The decrease in dividends received is mainly due to reduced profits from joint ventures, most notably in respect of MSHCL, where passenger volumes in particular were negatively impacted by Covid-19.

On 31 May 2020, the Group disposed of its 33% interest in Viapath Analytics LLP, Viapath Services LLP and Viapath Group LLP (together "Viapath").  As part of the transaction, the Group received an amount of £11.0m for its share in the net assets of the joint venture.  At the same time as disposing of the Group's interest in Viapath, the Group recovered a loan into the joint venture of £1.2m and £2.9m of profit share which was previously considered to be irrecoverable.

As announced on 2 November 2020, the Ministry of Defence notified the Group that it would be exercising its ability to terminate services provided by the Group through AWEML on 30 June 2021.  The terms of the exit are in the process of being negotiated and since the full services under the contract have not been completed, judgement has been taken in relation to the milestone achievements which are to be agreed and an estimate of the costs incurred in delivering services which cannot be recovered.  The agreement in respect of both of these items are to be finalised, however the final outcome is not expected to have a material impact on the Group's Financial Statements.

Summarised financial information of AWEML and MSHCL and an aggregation of the other equity accounted entities in which the Group has an interest is as follows:

 

31 December 2020

Summarised financial information	AWEML (100% of results)  m	MSHCL (100% of results) £m	Group portion of material joint ventures and associates* £m	Group portion of other joint venture arrangements and associates* £m	Total £m
Revenue	1,106.8	150.7	346.5	18.6	365.1
Operating profit/(loss)	75.0	(5.7)	15.5	(0.1)	15.4
Net investment revenue/(finance cost)	0.3	(0.1)	-	-	-
Income tax (charge)/credit	(14.0)	1.5	(2.7)	-	(2.7)
Profit/(loss) from operations	61.3	(4.3)	12.8	(0.1)	12.7
Other comprehensive income	-	5.3	2.7	-	2.7
Total comprehensive income/(expense)	61.3	1.0	15.5	(0.1)	15.4
Non current assets	668.1	19.1	173.3	0.1	173.4
Current assets	191.4	43.2	68.5	1.8	70.3
Current liabilities	(169.2)	(29.6)	(56.3)	(0.8)	(57.1)
Non current liabilities	(665.9)	(8.5)	(167.4)	-	(167.4)
Net assets	24.4	24.2	18.1	1.1	19.2
Proportion of group ownership	24.5%	50.0%	-	-	-
Carrying amount of investment	6.0	12.1	18.1	1.1	19.2

*  Total results of the entity multiplied by the respective proportion of Group ownership.

	AWEML (100% of results)  m	MSHCL (100% of results) £m	Group portion of material joint ventures and associates* £m	Group portion of other joint venture arrangements and associates* £m	Total £m
Cash and cash equivalents	119.8	22.5	40.6	0.8	41.4
Current financial liabilities excluding trade and other payables and provisions	(0.6)	(5.5)	(2.9)	0.1	(2.8)
Non current financial liabilities excluding trade and other payables and provisions	-	(7.7)	(3.8)	-	(3.8)
Depreciation and amortisation	-	(6.1)	(3.1)	(0.4)	(3.5)
Interest income	0.3	0.1	0.1	-	0.1
Interest expense	-	(0.2)	(0.1)	-	(0.1)

*  Total results of the entity multiplied by the respective proportion of Group ownership.

The Group's share of liabilities within joint ventures is £224.5m.  Of this, an amount of £163.1m relates to a defined benefit pension obligation, against which Serco is fully indemnified, and a further £49.7m is trade and other payables which arise as part of the day to day operations carried out by those entities.  Other than liabilities associated with leases, the Group has no material exposure to third party debt or other financing arrangements within any of its joint ventures and associates.

The financial statements of MSHCL are for a period which is different from that of the Group, being for the 52 week period ended 9 January 2021 (2019: 52 week period ended 4 January 2020). The 52 week period reflects the joint venture's internal reporting structure and is sufficiently close so as to not require adjustment to match that of the Group.

Certain employees of the groups headed by AWEML and MSHCL are members of sponsored defined benefit pension schemes. Given the significance of the schemes to understanding the position of the entities, the following key disclosures are made:

Main assumptions: 2020	AWEML	MSHCL
Rate of salary increases (%)	1.9%	2.8%
Inflation assumption (CPI %)	1.9%	1.9%
Discount rate (%)	1.5%	2.4%
Post-retirement mortality:
Current male industrial pensioners at 65 (years)	23.0	N/A
Future male industrial pensioners at 65 (years)	25.1	N/A

Retirement benefit funding position (100% of results)	£m	£m
Present value of scheme liabilities	(2,597.7)	(450.5)
Fair value of scheme assets	1,931.8	233.8
Net amount recognised	(665.9)	(216.7)
Members' share of deficit	-	86.7
Franchise adjustment*	-	130.0
Related asset, right to reimbursement	665.9	-
Net retirement benefit obligation	-	-

*   The franchise adjustment represents the amount of scheme deficit that is expected to be funded outside the contract period.

AWEML is not liable for any deficiency in the defined benefit pension scheme under current contractual arrangements. The deficit reflected in the financial statements of MSHCL covers only that portion of the deficit that is expected to be funded over the term of the franchise arrangement the entity operates under. In addition, the defined benefit position reflects an adjustment in respect of funding required to be provided by employees.

31 December 2019

Summarised financial information	AWEML (100% of results)  m	MSHCL (100% of results) £m	Group portion of material joint ventures and associates* £m	Group portion of other joint venture arrangements and associates* £m	Total £m
Revenue	1,065.4	177.9	350.0	44.6	394.6
Operating profit	95.4	18.9	32.7	1.1	33.8
Net investment revenue	0.8	0.2	0.3	-	0.3
Income tax charge	(18.8)	(3.8)	(6.4)	(0.2)	(6.6)
Profit from operations	77.4	15.3	26.6	0.9	27.5
Other comprehensive income	-	2.5	1.3	-	1.3
Total comprehensive income	77.4	17.8	27.9	0.9	28.8
Non current assets	510.0	23.2	136.6	2.4	139.0
Current assets	186.8	64.6	78.1	18.7	96.8
Current liabilities	(163.0)	(48.4)	(64.1)	(14.7)	(78.8)
Non current liabilities	(509.3)	(12.7)	(131.2)	(2.2)	(133.4)
Net assets	24.5	26.7	19.4	4.2	23.6
Proportion of group ownership	24.5%	50.0%	-	-	-
Carrying amount of investment	6.0	13.4	19.4	4.2	23.6

*  Total results of the entity multiplied by the respective proportion of Group ownership.

	AWEML (100% of results)  m	MSHCL (100% of results) £m	Group portion of material joint ventures and associates* £m	Group portion of other joint venture arrangements and associates* £m	Total £m
Cash and cash equivalents	101.3	39.9	44.8	7.4	52.2
Current financial liabilities excluding trade and other payables and provisions	(7.6)	(7.3)	(5.6)	(0.2)	(5.8)
Non current financial liabilities excluding trade and other payables and provisions	(0.1)	(12.5)	(6.3)	(2.3)	(8.6)
Depreciation and amortisation	-	(1.6)	(0.8)	(0.9)	(1.7)
Interest income	0.8	0.2	0.3	-	0.3

*  Total results of the entity multiplied by the respective proportion of Group ownership. 

 

Key disclosures with respect of the defined benefit pension schemes of material joint ventures and associates: 

Main assumptions: 2019	AWEML	MSHCL
Rate of salary increases (%)	2.1%	3.1%
Inflation assumption (CPI %)	2.1%	2.2%
Discount rate (%)	2.1%	2.1%
Post-retirement mortality:
Current male industrial pensioners at 65 (years)	22.9	N/A
Future male industrial pensioners at 65 (years)	25.0	N/A

Retirement benefit funding position (100% of results)	£m	£m
Present value of scheme liabilities	(2,213.6)	(374.5)
Fair value of scheme assets	1,716.6	218.5
Net amount recognised	(497.0)	(156.0)
Members' share of deficit	-	62.4
Franchise adjustment*	-	93.6
Related asset, right to reimbursement	497.0	-
Net retirement benefit obligation	-	-

*   The franchise adjustment represents the amount of scheme deficit that is expected to be funded outside the contract period.

AWEML is not liable for any deficiency in the defined benefit pension scheme under current contractual arrangements. The deficit reflected in the financial statements of MSHCL covers only that portion of the deficit that is expected to be funded over the term of the franchise arrangement the entity operates under. In addition, the defined benefit position reflects an adjustment in respect of funding required to be provided by employees.

5. Acquisitions

The Group made no acquisitions during the period. On 17 December 2020, the Group announced it had reached an agreement to acquire Facilities First Australia Holdings Pty Limited ("FFA") and the acquisition was completed on 4 January 2021 for consideration of A$52.6m, subject to standard net working capital adjustments. Acquisition costs totalling £0.9m have been incurred during 2020 in respect of the FFA acquisition and have been treated as exceptional in accordance with the Group's accounting policies. Further details on this post year end transaction are provided in Note 24.

On 16 February 2021, the Group announced that it had agreed to acquire Whitney, Bradley & Brown, Inc ("WBB"), a leading provider of advisory, engineering and technical services to the US Military, for $295m from an affiliate of H.I.G. Capital.  The acquisition will increase the scale, breadth and capability of Serco's North American defence business and will give Serco a strong platform from which to address all major segments of the US defence services market.  The acquisition will be immediately accretive to earnings and will be funded through existing debt facilities; it is expected to complete in the second quarter of 2021, subject to regulatory approvals. As the transaction is yet to complete, the financial results and impact of the transaction have not been recognised in these Condensed Consolidated Financial Statements.

During the period the Group finalised the integration of Naval Systems Business Unit ("NSBU"), completed the analysis of balances acquired as part of the transaction and made closing net working capital settlements with the vendor. Two main activities were undertaken that resulted in adjustments to the fair value of acquired assets and liabilities. There were no material impacts to the post-acquisition income statement. Firstly, the Group finalised its review of provisional working capital balances which resulted in fair value changes to both receivables and payables. Secondly, one of the acquired fixed price contracts required a revision to the provisional estimate of the costs required to complete the contract. The estimated cost of completion was increased as a result of a technical defect relating to machine parts that had been in place at the acquisition date and which became known through initial testing that completed during the first six months of 2020. As a result of these activities, the Group revised the fair values of the acquired assets and liabilities as at the transaction date as follows:

 

	Fair value as originally stated £m	Fair value adjustment* £m	Revised fair value £m
Goodwill	115.3	3.0	118.3
Acquisition related intangible assets	52.6	-	52.6
Property, plant and equipment	3.6	-	3.6
Trade and other receivables	46.6	(1.8)	44.8
Cash and cash equivalents	0.4	-	0.4
Deferred tax asset	0.9	-	0.9
Trade and other payables	(30.7)	(0.5)	(31.2)
Deferred tax liability	(2.4)	-	(2.4)
Acquisition date fair value of consideration transferred	186.3	0.7	187.0
Satisfied by:
Cash	184.3	-	184.3
Deferred consideration	2.0	0.7	2.7
Total consideration	186.3	0.7	187.0

* The fair value adjustments recorded represent items that were in existence at the acquisition date and therefore have no material impact on profits or losses subsequent to acquisition.

The total impact of acquisitions to the Group's cash flow position during the current period was as follows:

	£m
Deferred consideration paid in respect of historic acquisition:
Carillion health contracts	0.9
NSBU	2.7
Anglia Support Partnership	1.3
Net cash outflow in relation to acquisitions	4.9
Exceptional acquisition related costs:
NSBU	1.5
Facilities First	0.2
Net cash outflow related to acquisition costs	1.7
Net cash impact in the period on acquisitions	6.6

Costs associated with the acquisition of NSBU which were not directly related to the issue of shares or arrangement of the acquisition facility and costs associated with the acquisition of FFA are shown as exceptional costs in the Group's Consolidated Income Statement for the year. The total acquisition related costs recognised in exceptional items for the year ended 31 December 2020 was £2.4m, of which, as noted above, £1.7m were paid during the year.

6. Disposals

On 31 May 2020, the Group disposed of its 33% interest in Viapath Analytics LLP, Viapath Services LLP and Viapath Group LLP (together "Viapath"). As part of the transaction, the Group received an amount of £11.0m for its share in the net assets of the joint venture. A summary of the disposal is as follows:

	Viapath £m
Consideration	11.0
Less: Investment in joint venture disposed of	-
Profit on disposal	11.0

The net cash inflow arising on disposal and the impact on both Net Debt and Adjusted Net Debt is:

 

	Viapath £m
Consideration	11.0
Less: Costs associated with the disposal	-
Net cash flow on disposal	11.0

As well as consideration for its share of the net assets of Viapath, the Group also received £2.9m for the Group's share of profits and £1.2m for loans due from Viapath.

7. Revenue from contracts with customers

Revenue

Information regarding the Group's major customers and a segmental analysis of revenue is provided in note 3.

An analysis of the Group's revenue from its key market sectors, together with the timing of revenue recognition across the Group's revenue from contracts with customers, is as follows:

Year ended 31 December 2020	UK&E  m	Americas £m	AsPac  m	Middle East £m	Total £m
Key sectors
Defence	196.6	725.2	133.3	27.0	1,082.1
Justice & Immigration	393.7	-	328.1	-	721.8
Transport	143.6	84.7	7.7	194.2	430.2
Health	245.9	-	101.4	10.0	357.3
Citizen Services	797.6	254.4	148.4	93.0	1,293.4
	1,777.4	1,064.3	718.9	324.2	3,884.8
Timing of revenue recognition
Revenue recognised from performance obligations satisfied in previous periods	1.1	-	(0.8)	-	0.3
Revenue recognised at a point in time	14.2	-	0.8	-	15.0
Products and services transferred over time	1,762.1	1,064.3	718.9	324.2	3,869.5
	1,777.4	1,064.3	718.9	324.2	3,884.8

Yar ended 31 December 2019	UK&E  m	Americas £m	AsPac  m	Middle East £m	Total £m
Key sectors
Defence	215.9	575.5	89.5	28.1	909.0
Justice & Immigration	311.9	-	279.6	-	591.5
Transport	143.5	99.7	19.7	215.3	478.2
Health	259.9	-	94.8	30.2	384.9
Citizen Services	430.5	240.5	137.8	76.0	884.8
	1,361.7	915.7	621.4	349.6	3,248.4
Timing of revenue recognition
Revenue recognised from performance obligations satisfied in previous periods	3.3	-	(0.4)	-	2.9
Revenue recognised at a point in time	19.0	-	2.6	-	21.6
Products and services transferred over time	1,339.4	915.7	619.2	349.6	3,223.9
	1,361.7	915.7	621.4	349.6	3,248.4

Transaction price allocated to remaining performance obligations

 

The following table shows the transaction price allocated to remaining performance obligations. This represents revenue expected to be recognised in subsequent periods arising on existing contractual arrangements. The Group has not taken the practical expedient in IFRS15.121 not to disclose information about performance obligations that have original expected durations of one year or less and therefore no consideration from contracts with customers is excluded from the amounts included below.

In assessing the future transaction price, the judgements of most relevance are the future term over which the transaction price is calculated and the estimation of variable revenue to be included.

Where a contract with a customer includes, within the term of the committed contract, provisions for price-rebasing or a provision for market testing, revenue beyond these is included to the extent that there are no indicators which suggest that the contract will not continue past this point and it is highly probable that a significant reduction will not occur. Where there is a requirement for the Group, or a customer, to enter into to a new contract, rather than continuing an existing contract, such an extension is not included for the purposes of calculating future transaction price.

Additionally, the Group has a small subset of contracts that contain a termination for convenience clause, for example due to national security considerations which are assumed by the Group not to be without cause. These contracts are considered to run for the full intended term for the purpose of calculating the transaction price allocated to remaining performance obligations, other than instances where the Group believes that termination will occur before the original contract end date.

Under the terms of certain contracts which the Group has with its customers, the Group's compensation for providing those services is based on volumes or other drivers of variable activity, such as additional activities awarded under existing contracts. These volumes are not guaranteed, however based on historic volumes and the nature of the contracts in operation, such as the provision of asylum seeker accommodation or passenger transport, Management are able to prepare a sufficiently reliable estimate of the minimum level of variable revenue that is likely to be earned. As a result, variable revenue is included only to the level at which Management remain confident that a significant reduction will not occur.

As part of the considerations around variable revenue, Management consider the impact that factors such as contractual performance, anticipated demand and pricing (including indexation) may have on future revenue recognised. Management also considers whether there are possible impacts from climate change and other environmental related risks, with certain sectors considered to be more at risk than others, however no adjustment was identified in relation to existing contracts' future revenue forecasts.

	UK&E  m	Americas £m	AsPac  m	Middle East £m	Total £m
Within 1 year (2021)	1,296.0	507.0	673.3	223.1	2,699.4
Between 2 - 5 years (2022 - 2025)	3,624.2	140.1	1,394.5	139.6	5,298.4
5 years and beyond (2026+)	3,751.5	0.2	1,647.6	145.1	5,544.4
	8,671.7	647.3	3,715.4	507.8	13,542.2

8. Exceptional items

Exceptional items are items of financial performance that are outside normal operations and are material to the results of the Group either by virtue of size or nature. As such, the items set out below require separate disclosure on the face of the income statement to assist in the understanding of the underlying performance of the Group.

Other exceptional operating items

For the year ended 31 December	2020 £m	2019 £m
Exceptional items arising
Exceptional profit on disposal of subsidiaries and operations	11.0	-
Other exceptional operating items
Restructuring costs	0.1	(12.8)
Costs associated with UK Government review	(1.3)	(25.2)
Movement in other provisions and other items	2.6	19.3
Reversal of impairment in interest in joint venture and related loan balances	2.5	-
Costs associated with the acquisition of Naval Systems Business Unit	(1.5)	(4.7)
Costs associated with the acquisition of Facilities First Australia	(0.9)	-
Other exceptional operating items	1.5	(23.4)
Exceptional operating items	12.5	(23.4)
Exceptional tax	(0.4)	(2.7)
Total exceptional operating items net of tax	12.1	(26.1)

Exceptional items arising

As explained in note 6, the Group disposed of its interest in Viapath with effect from 31 May 2020. The Group had historically impaired its investment in Viapath as it was not receiving any returns from this joint venture due to the level of investment being made back into the business, therefore the carrying value of the Group's investment in Viapath was nil. Following the announcement during the first half of 2020 that Viapath had been unsuccessful in the tender process to provide pathology services to five South East London hospitals as well as associated GP surgeries, the Group exited the joint venture, selling its stake to the remaining two investors. In May 2020, the proceeds received by the Group in exchange for its holding in the joint venture represents the profit on disposal of £11.0m.

At the same time as disposing of the Group's interest in Viapath, certain historical balances were recovered which had previously been impaired. Since the impairments associated with those balances were historically treated as exceptional items, the reversals of these impairments have been treated consistently. The exceptional credit of £2.5m consists of the recovery of a loan from the Group into the joint venture of £1.2m, the exceptional element of the recovery of profit share which was previously considered to be irrecoverable and the reversal of impairment.

Other exceptional operating items

The Group recognised the final costs associated with the Strategy Review during 2019 and, on review, certain costs which had been accrued but were not incurred were released back to exceptional operating items resulting in a credit to exceptional items of £0.1m during 2020 (2019: exceptional restructuring costs of £12.8m). Non-exceptional restructuring charges are incurred by the business as part of normal operational activity, which in the year totalled £7.2m (2019: £8.9m) and were included within operating profit before exceptional items.

There were exceptional costs totalling £1.3m (2019: £25.2m) associated with the UK Government reviews and the programme of Corporate Renewal. These costs have historically been treated as exceptional and consistent treatment is applied in 2020. The 2019 costs included £22.9m for the fine and associated costs which resulted from the SFO's investigation into Serco companies.

During 2019, the Group reached a legal settlement in relation to a commercial dispute which resulted in the release of a provision which accounted for the majority of the £19.3m exceptional credit. The treatment of the release as exceptional was consistent with the recognition of the charge associated with the same legal matter in 2014. During 2020, the Group reached an agreement with its insurer for the reimbursement of £2.6m of legal fees associated with the matter and, consistent with the treatment of other associated amounts, this has been treated as an exceptional credit.

The Group completed the acquisition of Naval Systems Business Unit ("NSBU") from Alion Science and Technology in 2019. The transaction and implementation costs incurred during 2020 of £1.5m (2019: £4.7m) have been treated as exceptional costs in line with the Group's accounting policy and the treatment of similar costs incurred during the year ended 31 December 2019. No further costs associated with this acquisition are anticipated to be recognised as exceptional.

On 17 December 2020, the Group announced it has reached an agreement to acquire Facilities First Australia Holdings Pty Limited ("FFA" or "Facilities First Australia") and the acquisition was completed on 4 January 2021. Acquisition costs totalling £0.9m have been incurred during 2020 in respect of the FFA acquisition and have been treated as exceptional in accordance with the Group's accounting policies. 

Exceptional tax

Exceptional tax for the year was a charge of £0.4m (2019: £2.7m charge) which arises on exceptional items within operating profit.  This charge arises mainly in connection the reimbursement of legal fees from our insurer. The charge is partially offset by tax deductions related to the acquisition of Naval Systems Business Unit.

9. Investment revenue

Year ended 31 December	2020  m	2019 £m
Interest receivable on other loans and deposits	0.2	0.5
Net interest receivable on retirement benefit obligations (note 21)	1.2	2.1
Other dividends received	0.4	-
Movement in discount on other debtors	0.1	0.1
	1.9	2.7

 

10. Finance costs

Year ended 31 December	2020  m	2019 £m
Interest payable on lease liabilities	9.5	6.9
Interest payable on other loans	15.3	13.9
Facility fees and other charges	2.1	1.7
Movement in discount on provisions	0.2	1.2
	27.1	23.7
Foreign exchange on financing activities	0.7	0.8
	27.8	24.5

11. Tax

11 (a) Income tax recognised in the income statement

Year ended 31 December	Before exceptional items  2020  m	Exceptional items  2020 £m	Total 2020 £m	Before exceptional items  2019  m	Exceptional items  2019 £m	Total 2019 £m
Current income tax
Current income tax charge/(credit)	41.8	0.4	42.2	22.7	(1.1)	21.6
Adjustments in respect of prior years	(1.3)	-	(1.3)	(0.2)	-	(0.2)
Deferred tax
Current year (credit)/charge	(23.5)	-	(23.5)	4.7	3.8	8.5
Adjustments in respect of prior years	1.9	-	1.9	0.2	-	0.2
	18.9	0.4	19.3	27.4	2.7	30.1

The tax expense for the year can be reconciled to the profit in the Consolidated Income Statement as follows:

Year ended 31 December	Before exceptional items 2020 £m	Exceptional items 2020 £m	Total 2020 £m	Before exceptional items 2019 £m	Exceptional items 2019 £m	Total 2019 £m
Profit before tax	140.8	12.5	153.3	104.1	(23.4)	80.7
Tax calculated at a rate of 19.00% (2019: 19.00%)	26.7	2.4	29.1	19.7	(4.4)	15.3
Expenses not deductible for tax purposes*	6.5	(0.2)	6.3	0.9	4.4	5.3
UK unprovided deferred tax**	(4.2)	(1.9)	(6.1)	4.4	2.1	6.5
Other unprovided deferred tax	2.5	-	2.5	3.0	-	3.0
Effect of the use of unrecognised tax losses	(1.1)	-	(1.1)	-	-	-
Recognition of previously unrecognised UK tax losses	(9.5)	-	(9.5)	(0.9)	-	(0.9)
Impact of changes in statutory tax rates on current income tax	-	-	-	(0.2)	-	(0.2)
Overseas rate differences	7.2	0.1	7.3	5.9	0.6	6.5
Statutory tax benefits	-	-	-	(0.2)	-	(0.2)
Other non taxable income	(1.4)	-	(1.4)	(3.1)	-	(3.1)
Adjustments in respect of prior years***	0.6	-	0.6	-	-	-
Adjustments in respect of deferred tax on pensions	(5.9)	-	(5.9)	3.0	-	3.0
Adjustments in respect of equity accounted investments	(2.5)	-	(2.5)	(5.1)	-	(5.1)
Tax charge	18.9	0.4	19.3	27.4	2.7	30.1

*  Relates to costs that are not allowable for tax deduction under local tax law.

**  Arises due to timing differences between when an amount is recognised in the income statement and when the amount is subject to UK tax. In the current year, the Group has received tax credits for amounts which have been charged to the income statement in previous periods in connection with items such as fixed assets.

*** Included within adjustments in respect of prior years is a charge of £4.9m being an immaterial adjustment in the current year related to the deferred tax impact of the derecognition of balance sheet liabilities recognised in retained earnings on implementation of IFRS16 Leases in 2019.

 

The income tax charge for the year is based on the UK statutory rate of corporation tax for the period of 19.00% (2019: 19.00%). Taxation for other jurisdictions is calculated at the rates prevailing in the respective jurisdictions.

11 (b) Income tax recognised in the SOCI

Year ended 31 December	2020 £m	2019 £m
Deferred tax
Relating to cash flow hedges	-	0.1
Taken to retirement benefit obligations reserve	(5.9)	2.7
	(5.9)	2.8

12. Deferred tax

Deferred income taxes are calculated in full on temporary differences under the liability method using local substantively enacted tax rates.

The movement in net deferred tax assets during the year was as follows:

	2020 £m	2019  £m
At 1 January - asset	(37.2)	(39.5)
IFRS16 restatement	-	(5.1)
Opening asset restated	(37.2)	(44.6)
Income statement (credit)/charge*	(21.6)	8.7
Items recognised in equity and in other comprehensive income	5.9	(2.8)
Arising on acquisition	-	1.5
Exchange differences	(3.4)	-
At 31 December - asset	(56.3)	(37.2)

* Included within the income statement (credit)/charge is a charge of £4.9m being an immaterial adjustment in the current year related to the deferred tax impact of the derecognition of balance sheet liabilities recognised in retained earnings on implementation of IFRS16 Leases in 2019.

The movement in deferred tax assets and liabilities during the year was as follows:

	Temporary differences on assets/intangibles  m	Share based payment and employee benefits £m	Retirement benefit schemes £m	OCPs  m	Tax losses £m	Other temporary differences £m	Total £m
At 1 January 2020	24.4	(15.6)	6.8	(1.9)	(21.0)	(29.9)	(37.2)
Charged/(credited) to income statement (note 11a)*	2.8	(6.2)	-	1.3	(10.1)	(9.4)	(21.6)
Items recognised in equity and in other comprehensive income (note 11b)	-	-	5.9	-	-	-	5.9
Reclassification	-	(2.0)	2.0	-	-	-	-
Exchange differences	(1.7)	(0.9)	0.1	0.1	-	(1.0)	(3.4)
At 31 December 2020	25.5	(24.7)	14.8	(0.5)	(31.1)	(40.3)	(56.3)

* Included within other temporary differences is a charge of £4.9m being an immaterial adjustment in the current year related to the deferred tax impact of the derecognition of balance sheet liabilities recognised in retained earnings on implementation of IFRS16 Leases in 2019.

Other temporary differences include amounts such as provisions and accruals which, under certain tax laws, are only allowable when expended.

The reclassification between categories in the year reflects payments in connection with employees which are considered more akin to employee benefits than retirement benefit schemes.

 

The movement in deferred tax assets and liabilities during the previous year was as follows:

	Temporary differences on assets/ intangibles  m	Share based payment and employee benefits £m	Retirement benefit schemes £m	OCPs  m	Derivative financial instruments £m	Tax losses £m	Other temporary differences £m	Total £m
At 1 January 2019	24.6	(13.7)	9.9	(7.4)	-	(20.6)	(32.3)	(39.5)
IFRS16 restatement	(5.1)	-	-	-	-	-	-	(5.1)
Opening asset restated	19.5	(13.7)	9.9	(7.4)	-	(20.6)	(32.3)	(44.6)
Charged/(credited) to income statement (note 11a)	4.1	(1.6)	(0.4)	5.4	-	(0.4)	1.6	8.7
Items recognised in equity and in other comprehensive income (note 11b)	-	-	(2.7)	-	(0.1)	-	-	(2.8)
Arising on acquisition	2.4	(0.9)	-	-		-	-	1.5
Exchange differences	(1.6)	0.6	-	0.1	0.1	-	0.8	-
At 31 December 2019	24.4	(15.6)	6.8	(1.9)	-	(21.0)	(29.9)	(37.2)

Deferred income tax assets and liabilities are offset when there is a legally enforceable right to set off current tax assets against current tax liabilities and when the deferred income taxes relate to the same fiscal authority. The following is the analysis of the deferred tax balances (after offset) for financial reporting purposes:

	2020 £m	2019 £m
Deferred tax liabilities	26.9	26.7
Deferred tax assets	(83.2)	(63.9)
	(56.3)	(37.2)

As at the balance sheet date, the UK has a potential deferred tax asset of £189.9m (2019: £180.8m) available for offset against future profits. A deferred tax asset has currently been recognised of £30.6m (2019: £21.1m). Recognition has been based on forecast future taxable profits. Due to the history of tax losses within the UK, no deferred tax asset has been recognised in respect of the remaining asset (net £159.3m) due to the current absence of sufficient convincing evidence of further improvements in the UK profit forecast. Measures enacted during 2016 cut the future tax rate from April 2020 from 19% to 17%. However, the March 2020 Budget announced that a rate of 19% would continue to apply with effect from 1 April 2020 and this change was substantially enacted on 17 March 2020.  These measures increase the Group's future current tax charge accordingly. The deferred tax balance at 31 December 2020 has been calculated reflecting the increased rate of 19%.

Losses of £0.1m (2019: £0.1m) expire within 5 years, losses of £0.5m (2019: £0.1m) expire within 6-10 years, losses of £0.7m (2019: £0.7m) expire within 20 years and losses of £1,052.3m (2019: £1,063.9m) may be carried forward indefinitely.

13. Earnings per share

Basic and diluted earnings per ordinary share (EPS) have been calculated in accordance with IAS33 Earnings per Share.

The calculation of the basic and diluted EPS is based on the following data:

Number of shares	2020 millions	2019 millions
Weighted average number of ordinary shares for the purpose of basic EPS	1,229.1	1,171.4
Effect of dilutive potential ordinary shares: Shares under award	25.2	27.6
Weighted average number of ordinary shares for the purpose of diluted EPS	1,254.3	1,199.0

 

Earnings per share

Basic EPS	Earnings 2020 £m	Per share amount 2020 pence	Earnings 2019 £m	Per share amount 2019 pence
Earnings for the purpose of basic EPS	133.8	10.89	50.4	4.31
Effect of dilutive potential ordinary shares	-	(0.22)	-	(0.10)
Diluted EPS	133.8	10.67	50.4	4.21
Basic EPS excluding exceptional items
Earnings for the purpose of basic EPS	133.8	10.89	50.4	4.31
Add back exceptional items	(12.5)	(1.02)	23.4	2.00
Add back tax on exceptional items	0.4	0.03	2.7	0.23
Earnings excluding exceptional items for the purpose of basic EPS	121.7	9.90	76.5	6.54
Effect of dilutive potential ordinary shares	-	(0.20)	-	(0.15)
Excluding exceptional items, diluted	121.7	9.70	76.5	6.39

14. Goodwill

	Cost £m	Accumulated impairment losses  m	Carrying amount £m
At 1 January 2019	919.2	(339.6)	579.6
Exchange differences	(31.5)	7.8	(23.7)
Acquisitions	115.3	-	115.3
Fair value adjustment*	3.0	-	3.0
At 31 December 2019*	1,006.0	(331.8)	674.2
Exchange differences	(11.6)	7.0	(4.6)
At 31 December 2020	994.4	(324.8)	669.6

Movements in the balance since the prior year end can be seen as follows:

		Goodwill balance 1 January 2020* £m	Exchange differences 2020  m	Goodwill balance 31 December 2020 £m	Headroom on impairment analysis 2020  m	Headroom on impairment analysis 2019* £m
UK & Europe		183.2	1.2	184.4	688.5	799.2
Americas		379.1	(12.4)	366.7	658.3	417.3
AsPac		101.7	6.9	108.6	328.0	162.7
Middle East		10.2	(0.3)	9.9	103.2	63.3
		674.2	(4.6)	669.6	1,778.0	1,442.5

 * During the year ended 31 December 2020, but within twelve months of the date of the acquisition, the Group finalised fair value measurements for a number of contracts, which had previously been provisionally valued, associated with the acquisition of Naval Systems Business Unit which was completed 1 August 2019.  As a result, in accordance with IFRS3 Business Combinations, goodwill has been revised and the fair value of acquired assets and liabilities have been adjusted, resulting in an amendment to their carrying value as presented as at 31 December 2019.  Further information on the fair value can be found in Note 5.

Included above is the detail of the headroom on the CGUs existing at the year end which reflects where future discounted cash flows are greater than the underlying assets and includes all relevant cash flows, including where provisions have been made for future costs and losses. The increase in headroom compared to 2019 is predominantly due to higher forecast cashflows as the Group continues to forecast growth across all divisions which in most instances outweighs the increase in discount rates. This is not the case in the UK & Europe CGU, where rising discount rates have meant a reduction in headroom, whilst the impact of increased future cash flows in the AsPac CGU is enhanced by a marginal reduction in discount rates.

The key quantifiable assumptions applied in the impairment review are set out below:

	Discount rate 2020 %	Discount rate 2019  %	Terminal growth rates 2020 %	Terminal growth  rates 2019 %
UK & Europe	10.2	9.4	1.9	1.7
Americas	10.7	10.4	2.5	2.2
AsPac	9.4	9.7	2.2	2.3
Middle East	12.1	11.9	1.6	1.8

Discount rate

Pre-tax discount rates derived from the Group's post-tax weighted average cost of capital have been used in discounting the projected cash flows. These rates are reviewed annually with external advisers and are adjusted for risks specific to the market in which the CGU operates.

Terminal growth rates

The calculations include a terminal value based on the projections for the fifth year of the short-term plan, with a growth rate assumption applied which extrapolates the business into perpetuity. The terminal growth rates are based on long term inflation rates of the geographic market in which the CGUs operate and therefore do not exceed the average long-term growth rates forecast for the individual markets. These are provided by external sources.

Short term growth rates

The annual impairment test is performed immediately prior to the year end, based initially on five-year cash flow forecasts approved by senior Management. Short term revenue growth rates used in each CGU five-year plan are based on internal data regarding our current contracted position, the pipeline of opportunities and forecast growth for the relevant market.

Short term profitability and cash conversion is based on our historic experiences and a level of judgement is applied to expected changes in both. Where businesses have been poor performers in recent history, turnaround has only been assumed where a detailed and achievable plan is in place and all forecasts include cash flows relating to contracts where onerous contract provisions have been made.

As explained in Note 7, Management consider certain sectors in which the Group operates to be more exposed to environmental risks than others. For example, changes in consumer attitudes to aviation or the use of private vehicles, may have an impact on the Group's Transport contracts. Currently, no adjustment to existing contracts is required, although Management will continue to monitor the potential impact of environmental risks and will include these in future analysis as required.

Sensitivity analysis

Sensitivity analysis has been performed for each key assumption, a 1% movement in discount rates and a 1% movement in terminal growth rates are considered to be reasonably possible, as has a degree of estimation uncertainty in the cash flows associated with each CGU of up to 10% in the final year of the plan. Performing a sensitivity analysis on short term growth rates is not a numerical exercise, as growth rates are based on known opportunities and the likelihood of those opportunities being won and turned into resulting cash flows. In order to model a sensitivity scenario for short term growth rates, Management have calculated the growth rates over the five years of cash flows, restricted these to be equivalent to the long term growth rate, and assessed what change in discount rate would be required to have resulted in the same reduction in value in use. In doing so, Management have identified increases in discount rates of between 1.0% and 3.5% across CGUs. No impairment results from these changes even when these increases in discount rates, which reflect a reduction in short term growth rates, are combined with the additional 1% increase in discount rates and 1% reduction in terminal growth rates.

15. Contract assets, trade and other receivables

 

Contract assets: Current	2020  m	2019* £m
Accrued income and other unbilled receivables	278.0	264.5
Capitalised bid costs	2.8	3.8
Capitalised mobilisation and phase in costs	15.3	19.2
	296.1	287.5

*  During the year ended 31 December 2020, but within twelve months of the date of the acquisition, the Group finalised fair value measurements for a number of contracts, which had previously been provisionally valued, associated with the acquisition of Naval Systems Business Unit which was completed 1 August 2019.  As a result, in accordance with IFRS3 Business Combinations, goodwill has been revised and the fair value of acquired assets and liabilities have been adjusted, resulting in an amendment to their carrying value as presented as at 31 December 2019.  Further information on the fair value can be found in Note 5.

The Group's Consolidated Balance Sheet includes capitalised bid and phase in costs that are realised as a part of the normal operating cycle of the Group. These assets represent up-front investment in contracts which are recoverable and expected to provide benefits over the life of those contracts. Bid costs are capitalised only when they relate directly to a contract and are incremental to securing the contract. Any costs which would have been incurred whether or not the contract is actually won are not considered to be capitalised bid costs. 

Contract costs can only be capitalised when the expenditure meets all three criteria identified in note 2 to the Group's Consolidated Financial Statements.

An Expected Credit Loss (ECL) is recognised against contract assets only when it is considered to be material and there is evidence that the credit worthiness of a counterparty may render balances irrecoverable.

Movements in the period were as follows:

Capitalised bid and phase in costs	2020  m	2019 £m
At 1 January	23.0	22.1
Additions	1.3	7.1
Amortisation	(6.8)	(6.7)
Reclassified from contract asset	-	0.9
Exchange differences	0.6	(0.4)
At 31 December	18.1	23.0

Total trade and other receivables held by the Group at 31 December 2020 amount to £338.8m (2019*: £346.4m).

Trade and other receivables: Non current	2020  m	2019 £m
Trade receivables	3.1	7.3
Other investments	9.4	8.9
Prepayments	1.7	0.3
Security deposits	0.5	0.5
Other receivables	10.6	9.5
	25.3	26.5

Other non current receivables include long term employee compensation plans, advances and other non-trade receivables.

Trade and other receivables: Current	2020  m	2019* £m
Trade receivables	244.3	254.2
Prepayments	45.5	42.1
Amounts owed by joint ventures and associates	0.2	0.6
Security deposits	0.2	0.2
Other receivables	23.3	22.8
	313.5	319.9

*  During the year ended 31 December 2020, but within twelve months of the date of the acquisition, the Group finalised fair value measurements for a number of contracts, which had previously been provisionally valued, associated with the acquisition of Naval Systems Business Unit which was completed 1 August 2019.  As a result, in accordance with IFRS3 Business Combinations, goodwill has been revised and the fair value of acquired assets and liabilities have been adjusted, resulting in an amendment to their carrying value as presented as at 31 December 2019.  Further information on the fair value can be found in Note 5.

 

Other receivables include amounts due from third parties, advances paid to suppliers, employee benefit schemes and other non-trade receivables.

The management of trade receivables is the responsibility of the operating segments, although they report to Group on a monthly basis on debtor days, debtor ageing and significant outstanding debts. The average credit period taken by customers is 23 days (2019*: 29 days) and no interest was charged on overdue amounts in the current or prior reporting period.

Each customer has an external credit score which determines the level of credit provided. However, the majority of our customers have a sovereign credit rating as a result of being government organisations. Of the trade receivables balance at the end of the year, £63.5m is due from agencies of the UK Government, the Group's largest customer, £57.1m from the Australian Government, £42.7m from the Government of the United Arab Emirates and £27.8m from the US Government. There are no other customers who represent more than 5% of the total balance of trade receivables. Of the trade receivables balance at the end of 2019, £51.8m was due from agencies of the UK Government. The maximum potential exposure to credit risk in relation to trade receivables at the reporting date is equal to their carrying value. The Group does not hold any collateral as security.

The Group does not have any material impairments associated with expected credit losses due to the sovereign credit rating of most customers. Further specific impairments to trade receivables are based on estimated irrecoverable amounts and provisions on outstanding balances greater than a year old unless there is firm evidence that the balance is recoverable. The total amount of these impairments for the Group was £7.0m as of 31 December 2020 (2019: £5.5m).

Ageing of trade receivables	2020  m	2019* £m
Not due	175.5	188.7
Overdue by less than 30 days	49.1	43.7
Overdue by between 30 and 60 days	5.5	6.4
Overdue by more than 60 days	21.2	20.9
Allowance for doubtful debts	(7.0)	(5.5)
	244.3	254.2

*  During the year ended 31 December 2020, but within twelve months of the date of the acquisition, the Group finalised fair value measurements for a number of contracts, which had previously been provisionally valued, associated with the acquisition of Naval Systems Business Unit which was completed 1 August 2019.  As a result, in accordance with IFRS3 Business Combinations, goodwill has been revised and the fair value of acquired assets and liabilities have been adjusted, resulting in an amendment to their carrying value as presented as at 31 December 2019.  Further information on the fair value can be found in Note 5.

Of the total overdue trade receivable balance, 73% (2019: 70%) relates to the Group's four major governmental customers (being the governments of the UK, US, Australia and the United Arab Emirates).

Movements on the Group allowance for doubtful debts	2020  m	2019 £m
At 1 January	5.5	2.8
Net charges and releases to income statement	1.9	2.9
Utilised	(0.2)	(0.1)
Exchange differences	(0.2)	(0.1)
At 31 December	7.0	5.5

Included in the current other receivables balance is a further £0.2m (2019: £1.0m) due from agencies of the UK Government.

16. Contract liabilities, trade and other payables

Contract liabilities: Current	2020  m	2019  £m
Deferred income	42.3	66.8

Contract liabilities: Non current	2020  m	2019  £m
Deferred income	47.5	58.2

The allocation of deferred income between current and non current is presented on the basis that the current portion will unwind in the following twelve months through revenue.  There were no material items in the current portion of deferred income in 2019 which did not unwind during the year.

Total trade and other payables held by the Group at 31 December 2020 amount to £543.3m (2019: £504.7m).

 

Trade and other payables: Current	2020  m	2019* £m
Trade payables	99.6	100.8
Other payables	134.5	94.6
Accruals	299.8	294.8
	533.9	490.2

*  During the year ended 31 December 2020, but within twelve months of the date of the acquisition, the Group finalised fair value measurements for a number of contracts, which had previously been provisionally valued, associated with the acquisition of Naval Systems Business Unit which was completed 1 August 2019.  As a result, in accordance with IFRS3 Business Combinations, goodwill has been revised and the fair value of acquired assets and liabilities have been adjusted, resulting in an amendment to their carrying value as presented as at 31 December 2019.  Further information on the fair value can be found in Note 5.

The average credit period taken for trade purchases is 25 days (2019: 26 days).

The range of costs included in the calculation of the average credit period taken has been updated in 2020 to better reflect the nature of the Group's purchases.  The average credit period for 2019 has been adjusted to ensure that the calculation is consistent with the method used for the current year.  Using the prior year calculation method, the average credit period in 2020 would be 32 days (2019: 36 days).

Trade and other payables: Non current	2020  m	2019 £m
Other payables	9.4	14.5

17. Leases

The Directors estimate that the fair value of the Group's lease obligations approximates their carrying amount. The Group uses leases in the delivery of its contractual obligations and the services required to support the delivery of those contracts, including administrative functions. There are no material future cash flows relating to leases in place as at 31 December 2020 that are not reflected in the minimum lease payments disclosed above and the Group does not have any leases to which it is contracted but which are not yet reflected in the minimum lease payments. Additionally, the Group does not have any leases where payments are variable. As explained in note 2 to the Consolidated Financial Statements, the Group has a significant number of leases which include either termination or extension options, or both. The amounts included in amounts payable under leases below represents Management's best estimate of the mix of options likely to be exercised in line with current operational requirements.

No lease liability is recognised in respect of leases which have a lease term of less than twelve months in duration at the point of entering into the lease, or where the purchase price of the underlying right of use asset is less than £5,000.

The Group has not materially benefitted from the amendment to IFRS16 issued during the year which allows rent concessions to be recognised directly in the income statement.

Amounts payable under leases	Minimum lease payments 2020 £m	Minimum lease payments  2019 £m
Within one year	115.3	93.3
Between one and five years	228.9	226.5
After five years	90.5	69.7
	434.7	389.5
Less: future finance charges	(32.1)	(19.6)
Present value of lease obligations	402.6	369.9
Less: amount due for settlement within one year (shown within current liabilities)	(109.3)	(84.6)
Amount due for settlement after one year	293.3	285.3

 

The following amounts are included in the Group's Condensed Consolidated Financial Statements in respect of its leases:

		2020  m	2019 £m
Additions to right of use assets (including transitional adjustments)		159.1	516.5
Depreciation charge on right of use assets (including transitional adjustments)		(93.5)	(167.1)
Impairment of right of use assets		(0.4)	(16.5)
Net disposals of right of use assets		(20.7)	(2.3)
Net reclassifications (from)/to right of use assets		(2.0)	(1.0)
Net exchange differences on right of use assets		(0.3)	(4.8)
Carrying amount of right of use assets		387.5	345.3
Current lease liabilities		109.3	84.6
Non current lease liabilities		293.3	285.3
Capital element of lease repayments		(100.8)	(70.2)
Interest expense on lease liabilities		(9.5)	(6.9)
Profit on early termination of leases		2.9	0.9
Expenses relating to short-term or low value leases		(5.6)	(5.5)

18. Analysis of Net Debt

The analysis below provides a reconciliation between the opening and closing positions in the balance sheet for liabilities arising from financing activities together with movements in derivatives relating to the items included in Net Debt.  There were no changes in fair value noted in either the current or prior year.

		At 1 January 2020 £m	Cash flow £m	Exchange differences £m	Non cash movements £m	At 31 December 2020  m
Loans payable		(305.0)	(99.4)	15.6	-	(388.8)
Lease obligations		(369.9)	100.8	0.9	(134.4)	(402.6)
Liabilities arising from financing activities		(674.9)	1.4	16.5	(134.4)	(791.4)
Cash and cash equivalents		89.5	244.4	1.8	-	335.7
Derivatives relating to Net Debt		1.0	-	(5.7)	-	(4.7)
Net Debt		(584.4)	245.8	12.6	(134.4)	(460.4)

	At 1 January 2019 £m	Opening adjustment - IFRS16 £m	Cash flow £m	Acquisitions* £m	Exchange differences £m	Non cash movements £m	At 31 December 2019  m
Loans payable	(239.5)	-	(72.3)	-	6.7	0.1	(305.0)
Lease obligations	(14.8)	(129.1)	70.2	-	4.7	(300.9)	(369.9)
Liabilities arising from financing activities	(254.3)	(129.1)	(2.1)	-	11.4	(300.8)	(674.9)
Cash and cash equivalents	62.5	-	28.4	0.4	(1.8)	-	89.5
Derivatives relating to Net Debt	3.8	-	-	-	(2.8)	-	1.0
Net Debt	(188.0)	(129.1)	26.3	0.4	6.8	(300.8)	(584.4)

*  Acquisitions represent the net cash/(debt) acquired on acquisition.

 

19. Provisions

	Employee related £m	Property  m	Contract £m	Other  m	Total £m
At 1 January 2020	62.1	13.3	16.5	69.9	161.8
Charged to income statement - exceptional	0.1	-	-	1.0	1.1
Charged to income statement - other	25.5	5.5	5.7	6.0	42.7
Released to income statement - exceptional	(0.2)	-	-	-	(0.2)
Released to income statement - other	(0.7)	(3.1)	(5.9)	(6.2)	(15.9)
Included in the valuation of right of use asset	-	1.3	-	-	1.3
Utilised during the year	(5.8)	(1.7)	(1.8)	(6.2)	(15.5)
Unwinding of discount	-	0.2	-	-	0.2
Exchange differences	2.2	0.2	-	0.1	2.5
At 31 December 2020	83.2	15.7	14.5	64.6	178.0
Analysed as:
Current	20.9	5.8	13.8	21.6	62.1
Non current	62.3	9.9	0.7	43.0	115.9
	83.2	15.7	14.5	64.6	178.0

Employee related provisions are for long-term service awards and terminal gratuity liabilities which have been accrued and are based on contractual entitlement, together with an estimate of the probabilities that employees will stay until rewards fall due and receive all relevant amounts. There are also amounts included in relation to restructuring. The provisions will be utilised over various periods driven by local legal or regulatory requirements, the timing of which is not certain.

The majority of property provisions relate to leased properties and are associated with the requirement to return properties to either their original condition, or to enact specific improvement activities in advance of exiting the lease. Dilapidations associated with leased properties are held as a provision until such time as they fall due, with the longest running lease ending in June 2039.

The present value of the estimated future cash outflow required to settle the contract obligations as they fall due over the respective contracts has been used in determining the provision. Individual provisions are only discounted where the impact is assessed to be significant. Currently, no contract provisions are discounted. Discount rates are calculated based on the estimate risk-free rate of interest for the region in which the provision is located and matched against the ageing profit of the provision.

Other provisions are held for indemnities given on disposed businesses, legal and other costs that the Company expects to incur over an extended period, in respect of past events, for which a provision has been recorded. These costs are based on past experience of similar items and other known factors and represent Management's best estimate of the likely outcome and will be utilised with reference to the specific facts and circumstances. The timing of utilisation is dependent on future events which could occur within the next twelve months or over a longer period with the majority expected to be settled by 31 December 2023.

20. Contingent liabilities

The Company has guaranteed overdrafts, leases, and bonding facilities of its joint ventures and associates up to a maximum value of £3.8m (2019: £4.3m). The actual commitment outstanding at 31 December 2020 was £3.8m (2019: £4.3m).

The Company and its subsidiaries have provided certain guarantees and indemnities in respect of performance and other bonds, issued by its banks on its behalf in the ordinary course of business. The total commitment outstanding as at 31 December 2020 was £247.9m (2019: £257.5m).

Following the announcement during 2020 that the Group has received a claim seeking damages for alleged losses as a result of the reduction in Serco's share price in 2013, the Group has continued to assess the merit, likely outcome and potential impact on the Group of any such litigation that either has been or might potentially be brought against the Group. Any outcome is subject to a number of significant uncertainties and therefore, it is not possible to assess the quantum of any such litigation as at the date of this disclosure.

The Group is in discussion with HMRC regarding the application of certain employer duties from April 2017. The Group has received strong legal opinion that a court is likely to find in the Group's favour and therefore no provision has been recorded on the balance sheet in respect of the matter. Due to the range of subjective outcomes it is not possible to disclose any meaningful quantitative amount associated with any liability where a cost to the Group of nil continues to be the most likely outcome.

The Group is also aware of other claims and potential claims which involve or may involve legal proceedings against the Group although the timing of settlement of these claims remains uncertain. The Directors are of the opinion, having regard to legal advice received and the Group's insurance arrangements, that it is unlikely that these matters will, in aggregate, have a material effect on the Group's financial position.

21. Retirement benefit schemes

Characteristics

The Group contributes to defined benefit schemes for qualifying employees of its subsidiaries in the UK and Europe. The normal contributions expected to be paid during the financial year ending 31 December 2021 are £8.0m (2020: £12.7m).

Among our non-contract specific schemes, the largest is the Serco Pension and Life Assurance Scheme (SPLAS). The most recent full actuarial valuation of this scheme was undertaken as at 5 April 2018 and resulted in an actuarially assessed deficit of £26.0m for funding purposes. Pension obligations are valued separately for accounting and funding purposes and there is often a material difference between these valuations. As at 31 December 2020 the estimated actuarial deficit of SPLAS was £20.0m (2019: £27.0m) based on the actuarial assessment on the funding basis whereas the accounting valuation resulted in an asset of £114.6m (2019: £78.3m). The primary reason a difference arises is that pension scheme accounting requires the valuation to be performed on the basis of a best estimate whereas the funding valuation used by the trustees makes more prudent assumptions.

The scheme was comfortably on track to achieve full funding on the funding basis by March 2028 as planned in the 2018 valuation. As a scheme well hedged for inflation risk, the impact of RPI reform is significant at a £65m increase to liabilities. This will be partially offset by changes to mortality assumptions and the scheme will work with the Trustees during the 2021 valuation process to address the impact on the funding level.

A revised schedule of contributions for SPLAS was agreed during 2019, with 30.8% of pensionable salaries due to be paid from 1 November 2019, changing to 30.3% from 1 November 2020. The schedule of contributions also determined that additional shortfall contributions were required. A total of £9.2m of these have already been made, with further amounts of £4m due in March 2021 then £1.7m for the years 2022 to 2028.  

Events in the year

The Group agreed with the Trustees of SPLAS a staggered schedule for the £4.0m deficit recovery payment which originally fell due in March 2020 during the period when the impact of Covid-19 on the Group's cash flows was being evaluated.  Following that review, the outstanding instalments were paid in June 2020. A further £4m due for payment in March 2021 will be paid in tranches from January 2021 to March 2021 as a gesture of goodwill for the Trustees agreeing to the delayed payments in 2020.

Values recognised in total comprehensive income in the year

The amounts recognised in the Consolidated Financial Statements for the year are analysed as follows:

Recognised in the income statement	Contract specific 2020 £m	Non contract specific 2020 £m	Total 2020 £m
Current service cost - employer	1.2	3.5	4.7
Administrative expenses and taxes	0.1	1.5	1.6
Recognised in arriving at operating profit after exceptionals	1.3	5.0	6.3
Interest income on scheme assets - employer	(0.2)	(29.1)	(29.3)
Interest on franchise adjustment	(0.1)	-	(0.1)
Interest cost on scheme liabilities - employer	0.4	27.8	28.2
Finance cost/(income)	0.1	(1.3)	(1.2)

Included within the SOCI	Contract specific 2020 £m	Non contract specific 2020 £m	Total 2020 £m
Actual return on scheme assets	0.1	216.7	216.8
Less: interest income on scheme assets	(0.3)	(29.1)	(29.4)
	(0.2)	187.6	187.4
Effect of changes in demographic assumptions	0.4	-	0.4
Effect of changes in financial assumptions	(3.6)	(170.0)	(173.6)
Effect of experience adjustments	(0.6)	4.6	4.0
Remeasurements	(4.0)	22.2	18.2
Change in franchise adjustment	2.5	-	2.5
Change in members' share	1.3	0.1	1.4
Actuarial profit on reimbursable rights	3.8	0.1	3.9
Total pension (loss)/gain recognised in the SOCI	(0.2)	22.3	22.1

Recognised in the income statement	Contract specific 2019 £m	Non contract specific 2019 £m	Total 2019 £m
Current service cost - employer	1.1	3.2	4.3
Past service cost	0.2	1.2	1.4
Administrative expenses and taxes	-	2.0	2.0
Recognised in arriving at operating profit after exceptionals	1.3	6.4	7.7
Interest income on scheme assets - employer	(0.4)	(37.5)	(37.9)
Interest on franchise adjustment	(0.1)	-	(0.1)
Interest cost on scheme liabilities - employer	0.5	35.4	35.9
Finance income	-	(2.1)	(2.1)

Included within the SOCI	Contract specific 2019 £m	Non contract specific 2019 £m	Total 2019 £m
Actual return on scheme assets	2.8	125.3	128.1
Less: interest income on scheme assets	(0.5)	(37.6)	(38.1)
	2.3	87.7	90.0
Effect of changes in demographic assumptions	(0.7)	40.6	39.9
Effect of changes in financial assumptions	(4.8)	(143.8)	(148.6)
Effect of experience adjustments	-	(1.6)	(1.6)
Remeasurements	(3.2)	(17.1)	(20.3)
Change in franchise adjustment	2.0	-	2.0
Change in members' share	1.1	0.1	1.2
Actuarial profit on reimbursable rights	3.1	0.1	3.2
Total pension loss recognised in the SOCI	(0.1)	(17.0)	(17.1)

Balance sheet values

The assets and liabilities of the schemes at 31 December are:

Scheme assets at fair value	Contract specific 2020 £m	Non contract specific 2020 £m	Total 2020 £m
Equities	11.3	44.3	55.6
Bonds except LDIs	4.1	363.2	367.3
Pooled investment funds	-	62.8	62.8
LDIs	-	408.3	408.3
Property	1.6	-	1.6
Cash and other	4.1	10.6	14.7
Annuity policies	-	690.2	690.2
Fair value of scheme assets	21.1	1,579.4	1,600.5
Present value of scheme liabilities	(37.0)	(1,497.8)	(1,534.8)
Net amount recognised	(15.9)	81.6	65.7
Franchise adjustment*	8.4	-	8.4
Members' share of deficit	5.6	-	5.6
Net retirement benefit asset	(1.9)	81.6	79.7
Net pension liability	(1.9)	(33.0)	(34.9)
Net pension asset	-	114.6	114.6
Net retirement benefit asset	(1.9)	81.6	79.7
Deferred tax liabilities	-	(15.2)	(15.2)
Net retirement benefit asset (after tax)	(1.9)	66.4	64.5

*   The franchise adjustment represents the amount of scheme deficit that is expected to be funded outside the contract period.

Scheme assets at fair value	Contract specific 2019 £m	Non contract specific 2019 £m	Total 2019 £m
Equities	10.8	43.9	54.7
Bonds except LDIs	4.1	298.1	302.2
LDIs	-	447.4	447.4
Property	1.7	-	1.7
Cash and other	4.1	5.1	9.2
Annuity policies	-	614.0	614.0
Fair value of scheme assets	20.7	1,408.5	1,429.2
Present value of scheme liabilities	(31.1)	(1,353.4)	(1,384.5)
Net amount recognised	(10.4)	55.1	44.7
Franchise adjustment*	5.8	-	5.8
Members' share of deficit	3.8	-	3.8
Net retirement benefit asset	(0.8)	55.1	54.3
Net pension liability	(0.8)	(23.2)	(24.0)
Net pension asset	-	78.3	78.3
Net retirement benefit asset	(0.8)	55.1	54.3
Deferred tax liabilities	-	(9.2)	(9.2)
Net retirement benefit asset (after tax)	(0.8)	45.9	45.1

*   The franchise adjustment represents the amount of scheme deficit that is expected to be funded outside the contract period.

The SPLAS Trust Deed gives the Group an unconditional right to a refund of surplus assets, assuming the full settlement of plan liabilities in the event of a plan wind-up. Pension assets are deemed to be recoverable and there are no adjustments in respect of minimum funding requirements as economic benefits are available to the Group either in the form of future refunds or, for plans still open to benefit accrual, in the form of possible reductions in future contributions.

As required by IAS19 Employee Benefits, the Group has considered the extent to which the pension plan assets should be classified in accordance with the fair value hierarchy of IFRS13 Fair Value Measurement. Virtually all equity and debt instruments have quoted prices in active markets. Annuity policies, private debt mandates and property assets can be classified as Level 3 instruments, and LDIs are classified as Level 2.

Actuarial assumptions:  SPLAS

The assumptions set out below are for SPLAS, which reflects 91% of total liabilities and 94% of total assets of the defined benefit pension scheme in which the Group participates. The significant actuarial assumptions with regards to the determination of the defined benefit obligation are set out below.

The Group continued to set RPI inflation in line with the market break even expectations less an inflation risk premium. The inflation risk premium has been decreased from 0.4% at 31 December 2019 to 0.3% at 31 December 2020, reflecting a decrease in potential market distortions caused by the RPI reform proposals. For CPI, the Group increased the assumed difference between the RPI and CPI by 0.3% to an average of 0.9% per annum for pre-retirement scheme participants.

The average duration of the benefit obligation at the end of the reporting period is 17.4 years (2019: 16.8 years).

Main assumptions	2020  %	2019  %
Rate of salary increases	2.50	2.70
Rate of increase in pensions in payment	2.40 (CPI) and 2.75 (RPI)	2.20 (CPI) and 3.00 (RPI)
Rate of increase in deferred pensions	2.20 (CPI) and 2.80 (RPI)	2.30 (CPI) and 3.30 (RPI)
Inflation assumption - pre-retirement	2.00 (CPI) and 2.90 (RPI)	2.20 (CPI) and 3.20 (RPI)
Inflation assumption - post-retirement	2.40 (CPI) and 2.75 (RPI)	2.20 (CPI) and 2.70 (RPI)
Discount rate	1.40	2.10

 

Post retirement mortality	2020 years	2019 years
Current pensioners at 65 - male	21.6	21.6
Current pensioners at 65 - female	24.2	24.1
Future pensioners at 65 - male	23.9	23.8
Future pensioners at 65 - female	26.3	26.2

Sensitivity analysis is provided below, based on reasonably possible changes of the assumptions occurring at the end of the reporting period, assuming all other assumptions are held constant. The sensitivities have been derived in the same manner as the defined benefit obligation as at 31 December 2020 where the defined benefit obligation is estimated using the Projected Unit Credit method. Under this method each participant's benefits are attributed to years of service, taking into consideration future salary increases and the scheme's benefit allocation formula. Thus, the estimated total pension to which each participant is expected to become entitled at retirement is broken down into units, each associated with a year of past or future credited service. The defined benefit obligation as at 31 December 2020 is calculated on the actuarial assumptions agreed as at that date. The sensitivities are calculated by changing each assumption in turn following the methodology above with all other things held constant. The change in the defined benefit obligation from updating the single assumption represents the impact of that assumption on the calculation of the defined benefit obligation.

(Increase)/decrease in defined benefit obligation	2020 £m	2019 £m
Discount rate - 0.5% increase	(125.3)	(108.5)
Discount rate - 0.5% decrease	142.4	122.9
Inflation - 0.5% increase	103.7	88.9
Inflation - 0.5% decrease	(96.6)	(83.3)
Rate of salary increase - 0.5% increase	3.7	3.2
Rate of salary increase - 0.5% decrease	(3.5)	(3.1)
Mortality - one-year age rating	59.8	48.6

Management acknowledges that the method used of presuming that all other assumptions remaining constant has inherent limitation given that it is more likely for a combination of changes but highlights the value of each individual risk and is therefore a suitable basis for providing this analysis.

Assumptions in respect of the expected return on scheme assets are required when calculating the franchise adjustment for the contract-specific plans. These assumptions are based on market expectations of returns over the life of the related obligation. Due consideration has been given to current market conditions as at 31 December 2020 in respect to inflation, interest, bond yields and equity performance when selecting the expected return on assets assumptions.

The expected yield on bond investments with fixed interest rates is derived from their market value. The yield on equity investments contains an additional premium (an 'equity risk premium') to compensate investors for the additional anticipated risks of holding this type of investment, when compared to bond yields. The Group applies an equity risk premium of 4.6% (2019: 4.6%).

The overall expected return on assets is calculated as the weighted average of the expected returns for the principal asset categories held by the scheme.

 

22. Related party transactions

Transactions between the Company and its wholly owned subsidiaries, which are related parties, have been eliminated on consolidation and are not disclosed in this note. Transactions between the Group and its joint venture undertakings and associates are disclosed below.

Transactions

During the year, Group companies entered into the following transactions with joint ventures and associates:

	Transactions 2020  m	Current outstanding at 31 December 2020  m	Non current outstanding at 31 December 2020  m
Sale of goods and services
Joint ventures	0.1	-	-
Associates	2.3	0.2	-
Other			-
Dividends received - joint ventures	4.3	-	-
Dividends received - associates	15.5	-	-
Receivable from consortium for tax - joint ventures	(0.1)	2.0	0.1
Total	22.1	2.2	0.1

Joint venture receivable and loan amounts outstanding have arisen from transactions undertaken during the general course of trading, are unsecured, and will be settled in cash. No guarantees have been given or received.

	Transactions 2019  m	Outstanding at 31 December 2019*  m
Sale of goods and services
Joint ventures	1.3	0.1
Associates	8.4	0.5
Other
Dividends received - joint ventures	7.8	-
Dividends received - associates	17.6	-
Receivable from consortium for tax - joint ventures	4.4	4.8
Total	39.5	5.4

*  All amounts outstanding as at 31 December 2019 are due within 12 months of the balance sheet date.

On 31 May 2020, the Group disposed of its 33% interest in Viapath Analytics LLP, Viapath Services LLP and Viapath Group LLP (together "Viapath").  As part of the transaction, the Group received an amount of £11.0m for its share in the net assets of the joint venture.  At the same time as disposing of the Group's interest in Viapath, the Group recovered a loan into the joint venture of £1.2m and £2.9m of profit share which was previously considered to be irrecoverable.

Remuneration of key Management personnel

The Directors of Serco Group plc had no material transactions with the Group during the year other than service contracts and Directors' liability insurance.

The remuneration of the key Management personnel of the Group is set out below in aggregate for each of the categories specified in IAS24 Related Party Disclosures:

	2020  m	2019 £m
Short-term employee benefits	9.3	8.9
Share based payment expense	5.4	5.3
	14.7	14.2

The key Management personnel comprise the Executive Directors, Non-Executive Directors and members of the Executive Committee (2020: 18 individuals, 2019: 17 individuals).

 

Aggregate Directors' remuneration

The total amounts for Directors' remuneration in accordance with Schedule 5 to the Accounting Regulations were as follows:

	2020  m	2019 £m
Salaries, fees, bonuses and benefits in kind	3.6	3.9
Amounts receivable under long-term incentive schemes	3.4	3.0
Gains on exercise of share awards	3.6	5.1
	10.6	12.0

None of the Directors are members of the Company's defined benefit or money purchase pension schemes.

23. Notes to the Consolidated Cash Flow statement

Year ended 31 December	2020 Before exceptional items £m	2020 Exceptional items £m	2020  Total  m	2019 Before exceptional items £m	2019 Exceptional items £m	2019  Total  m
Operating profit for the year	166.7	12.5	179.2	125.9	(23.4)	102.5
Adjustments for:
Share of profits in joint ventures and associates	(12.7)	-	(12.7)	(27.5)	-	(27.5)
Exceptional distribution from joint venture	-	(1.9)	(1.9)	-	-	-
Share based payment expense	11.2	-	11.2	11.6	-	11.6
Impairment of property, plant and equipment - owned	0.3	-	0.3	2.4	-	2.4
Impairment of property, plant and equipment - leased	0.4	-	0.4	16.5	-	16.5
Depreciation of property, plant and equipment - owned	15.9	-	15.9	15.3	-	15.3
Depreciation of property, plant and equipment - leased	93.5	-	93.5	59.1	-	59.1
Amortisation of intangible assets - owned	23.0	-	23.0	25.6	-	25.6
Exceptional profit on disposal of subsidiaries and operations	-	(11.0)	(11.0)	-	-	-
Reversal of impairment on loans to JVs	-	(1.2)	(1.2)	-	-	-
Profit on early termination of leases	(2.9)	-	(2.9)	(0.9)	-	(0.9)
Profit on disposal of property, plant and equipment	(0.4)	-	(0.4)	(0.6)	-	(0.6)
Loss on disposal of intangible assets	0.6	-	0.6	0.4	-	0.4
Increase/(decrease) in provisions	16.2	(4.0)	12.2	(43.1)	(20.5)	(63.6)
Other non cash movements	-	-	-	(1.2)	-	(1.2)
Total non cash items	145.1	(18.1)	127.0	57.6	(20.5)	37.1
Operating cash inflow/(outflow) before movements in working capital	311.8	(5.6)	306.2	183.5	(43.9)	139.6
(Increase)/decrease in inventories	(2.9)	-	(2.9)	4.4	-	4.4
Increase in receivables	(0.1)	-	(0.1)	(36.7)	-	(36.7)
(Decrease)/increase in payables	(2.3)	3.6	1.3	32.2	(5.3)	26.9
Movements in working capital	(5.3)	3.6	(1.7)	(0.1)	(5.3)	(5.4)
Cash generated by operations	306.5	(2.0)	304.5	183.4	(49.2)	134.2
Tax paid	(35.9)	-	(35.9)	(31.2)	-	(31.2)
Non cash R&D expenditure	(0.1)	-	(0.1)	(0.1)	-	(0.1)
Net cash inflow/(outflow) from operating activities	270.5	(2.0)	268.5	152.1	(49.2)	102.9

 

24. Post balance sheet events

Facilities First Australia

On 4 January 2021, the Group acquired 100% of the issued share capital of Facilities First Australia Holdings Pty Limited ("FFA"), for consideration of AU Dollars $52.6m (£29.8m) in cash, on a cash free, debt free basis, subject to standard working capital and completion adjustments. At the same time, the Group transferred AU Dollars $25.2m (£14.3m) to allow FFA to settle existing debt and debt-like balances.  FFA is a specialist provider of cleaning, facility maintenance and management services in Australia. The financial results and impact of this transaction have not been recognised in these Consolidated Financial Statements, the operating results, assets and liabilities will be recognised with effect from 4 January 2021. The amounts shown below in respect of the assets and liabilities acquired remain provisional until the Group has finalised the associated acquisition accounting.

		Provisional fair value AU Dollars $m	Provisional fair value £m
Acquisition related intangibles		78.0	44.2
Property, plant and equipment		7.0	4.0
Deferred tax asset		3.3	1.9
Trade and other receivables		28.3	16.0
Cash and cash equivalents		3.6	2.0
Trade and other payables		(42.9)	(24.3)
Borrowings		(16.5)	(9.4)
Current tax liabilities		(1.3)	(0.7)
Non current payables		(6.9)	(3.9)
Acquisition date fair value of consideration transferred		52.6	29.8

Acquisition of shares		52.6	29.8
Total Cash Consideration		52.6	29.8

Whitney, Bradley & Brown, Inc

On 16 February 2021, the Group announced that it had agreed to acquire Whitney, Bradley & Brown, Inc ("WBB"), a leading provider of advisory, engineering and technical services to the US Military, for $295m from an affiliate of H.I.G. Capital.  The acquisition will increase the scale, breadth and capability of Serco's North American defence business and will give Serco a strong platform from which to address all major segments of the US defence services market.  The acquisition will be immediately accretive to earnings and will be funded through existing debt facilities; it is expected to complete in the second quarter of 2021, subject to regulatory approvals. As the transaction is yet to complete, the financial results and impact of the transaction have not been recognised in these Consolidated Financial Statements.

Serco share repurchase programme

On 31 December 2020, the Group announced that with effect from 4 January 2021, it was commencing a programme to purchase its own shares with a value of up to £40m over the period to 11 June 2021, subject to a maximum number of shares of 122,338,063 being purchased. These shares will subsequently be transferred into treasury, either to be used for existing employee share schemes or to be cancelled.

Dividends

Subsequent to the year end, the Board has recommended the payment of a final dividend in respect of the year ended 31 December 2020 of 1.4p. The dividend remains subject to shareholder approval at the Annual General Meeting and therefore no amounts have been recognised in respect of a dividend in these Consolidated Financial Statements.

Financing facility

On 24 February 2021, the Group entered into a new financing facility totalling £75m with a syndicate of banks. The three year facility is undrawn, but it is anticipated that it will be drawn at completion of the acquisition of WBB, currently expected to be during the second quarter of 2021.

 

REPORT OF KPMG LLP TO SERCO GROUP PLC ("THE COMPANY") IN RELATION TO THE COMPANY'S PRELIMINARY ANNOUNCEMENT OF RESULTS FOR THE YEAR ENDED 31 DECEMBER 2020

The UK Listing Rules require that we, as independent auditor, agree to the publication of the Company's preliminary announcement of results for the year ended 31 December 2020 which comprises the Condensed Consolidated Income Statement, the Condensed Consolidated Statement of Comprehensive Income, the Condensed Consolidated Statement of Changes in Equity, the Condensed Consolidated Cash Flow Statement and the Notes to the Condensed Consolidated Financial Statements as well as the Stock Exchange Announcement including the Chief Executive's Review, the Divisional Reviews and the Finance Review. 

At your request we have provided this report to set out the procedures performed by us to agree to the publication, the status of the audit report on the statutory financial statements, and the key audit matters addressed in that audit report in respect of the consolidated financial statements of the group.

Our audit of the statutory financial statements is complete and we have issued an unmodified audit opinion

The annual report and statutory financial statements of Serco Group plc for the year ended 31 December 2020 were approved by the board on 24 February 2021.

Our audit of those financial statements is complete and we signed our auditor's report on 24 February 2021.  Our opinion in that report is not modified and does not include a material uncertainty related to going concern, or emphasis of matter, paragraph.

This report is in addition to, should not be regarded as a substitute for, our auditor's report on the statutory financial statements, which has been released to the Company and will be available when the Company publishes its annual report. 

Key audit matters

Key audit matters are those matters that, in our professional judgement, were of most significance in the audit of the consolidated financial statements and include the most significant assessed risks of material misstatement (whether or not due to fraud) identified by us, including those which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team. 

Key audit matters were addressed, and our findings are based on procedures undertaken, in the context of, and solely for the purpose of, our audit of the consolidated financial statements as a whole, and in forming our opinion thereon, and consequently are incidental to that opinion, and we do not provide a separate opinion on these matters.  The overall materiality applied in the audit of the consolidated financial statements as a whole was £6.2 million.

In our auditor's report on the statutory financial statements of the Company, we reported on the key audit matters in respect of the consolidated financial statements of the group described below.  No additional work in relation to key audit matters has been undertaken for the purpose of this report.

Revenue and margin recognition

Revenue £3,884.8m (2019: £3,248.4m), Operating Profit £179.2m (2019: £102.5m), Onerous Contract Provisions of £14.5m (2019: £16.5m) and Contract Assets £296.1m (2019: £287.5m)

Assessment of risk vs. prior year: Unchanged

Refer to note 2 Critical accounting judgements and key sources of estimation uncertainty, note 7 Revenue from contracts with customers, note 15 Contract assets, trade and other receivables and note 19 Provisions.

The risk

Accounting application

The contractual arrangements that underpin the measurement and recognition of revenue by the group can be complex, with significant judgement involved in the assessment of current and future financial performance. The key judgements impacting the recognition of revenue and resulting operating profit include:

·	Interpretations of terms and conditions in relation to the required service obligations in accordance with contractual arrangements;
·	The allocation of revenue and costs to performance obligations where multiple deliverables exist;
·	Assessment of stage of completion and cost to complete, where percentage completion accounting is used;
·	Consideration of the Group's performance against contractual obligations and the impact on revenue and costs of delivery;
·	The recognition and recoverability assessments of contract related assets, including those recognised as direct incremental costs prior to service commencement.

Subjective estimate

Judgement is required to determine whether a contract is onerous, based upon the estimated future performance of the contract. Where a contract is determined to be loss-making, an onerous contract provision is required, which requires further judgement in assessing the level of provision, based on estimated income and cost to complete, taking into account contractual obligations to the end of the contract, extension periods and customer negotiations.

The effect of these matters is that, as part of our risk assessment, we determined that the onerous contract provision has a high degree of estimation uncertainty, with a potential range of reasonable outcomes greater than our materiality for the financial statements as a whole, and possibly many times that amount.

Our response

Our audit procedures included:

Contracts were selected for substantive audit procedures based on qualitative factors, such as commercial complexity, and quantitative factors, such as financial significance and profitability that we considered to be indicative of risk. Our audit testing for the contracts selected included the following:

Assessing policy application

We inspected customer contracts to assess the method of revenue recognition to determine that it was in accordance with the Group's accounting policy and relevant accounting standards, including the appropriate recognition of revenue as the performance obligation is satisfied on service contracts.

Accounting analysis

We inspected and challenged accounting papers prepared by the Group to explain the positions taken in respect of key contract judgements including contract modifications (such as those arising due to COVID-19). We also challenged whether it is highly probable that the variable revenue recognised will not be reversed in future periods as required by the application of the revenue constraint in accordance with the Group's accounting policy and relevant accounting standards.

Tests of details

To assess whether the revenue constraint was appropriately applied in accordance with the Group's accounting policy and relevant accounting standards:

·	we vouched a sample of unbilled revenue to documents such as post year end invoices or purchase orders, or customer agreements for the work performed;
·	we inspected a sample of customer contracts to identify contractual KPI requirements and assessed the contracts operational performance against those requirements; and
·	we inspected a sample of customer contracts to identify contractual variations and claims and where these arose, obtained evidence of correspondence with customers and third parties.

Site visits

For contracts selected for testing:

·	we attended a selection of monthly Divisional and Business Unit Performance Reviews used to assess business performance in order to inform our assessment of operational and financial performance of the contracts; and
·	we performed virtual site visits and enquired with contract and Business Unit management teams as to matters related to operational and financial performance in order to assess whether indicators of an onerous contract exist.

For selected contract related assets, representing capitalised bid and phase in costs, our procedures included:

Assessing application: We assessed whether contract related assets have been recognised in accordance with the Group's accounting policy and relevant accounting standards.

Historical comparisons: We compared forecast contract cash flows and profits with historical actuals and assessed whether the forecasts supported the carrying value of the assets.

Independent reperformance: We compared the amortisation period with the duration of the contract and checked that the amortisation had been calculated correctly.

For onerous and potentially onerous contracts identified through application of quantitative selection criteria, our procedures to address the subjective estimate risk included:

Benchmarking assumptions

We compared contract level forecast revenues and costs to the Group's annual budgets and longer-term forecasts approved by the directors. We challenged key assumptions made by the Group in preparing these forecasts, including those in relation to revenue growth and cost reductions, by comparing them to external evidence (for example customer correspondence) where possible, and assessing against business plans.

Our sector experience

We assessed the contractual terms and conditions to identify the key obligations of the contract and compared these with common industry risk factors to inform our challenge of completeness of forecast costs.

Our major projects expertise

For a specific contract we used our own major project specialists to assess the reasonableness of the cost estimates where there was material estimation uncertainty.

Historical comparisons

We compared the contract forecasts to historic and in year performance to assess the historical accuracy of the forecasts.

Tests of details

For contracts we assessed as being potentially onerous, we compared the allocation of central functional costs to the group's policy and challenged the underlying assumptions using our understanding of the contract operations.

Assessing transparency

We also assessed whether the Group's disclosures about the estimates and judgements applied reflected the risks related to the estimation of onerous contracts.

Our findings

We found no material errors in the group's application of its revenue accounting policy (2019: no material errors). We found the resulting estimate of onerous contract provision to be balanced (2019: balanced).

Recoverability of group goodwill

Group: £669.6m (2019: £674.2m);

Assessment of risk vs. prior year: Unchanged

Refer to note 14 Goodwill

The risk

Goodwill in the group is significant and at risk of irrecoverability due to estimation uncertainty in valuing the recoverable amounts of the Group's cash generating units. The estimated recoverable amount of these balances through value in use calculations is subjective due to the inherent uncertainty involved in forecasting and discounting future cash flows.

The CGUs which were most sensitive to a deterioration in the division's cash flow projections or an increase in discount rate were the AsPac CGU and Middle East CGU. As at year end 31 December 2020, the AsPac CGU was estimated to have headroom of £328.0m and Middle East has headroom of £103.2m.

The effect of these matters is that, as part of our risk assessment, we determined that the value in use of CGUs has a high degree of estimation uncertainty, with a potential range of reasonable outcomes greater than our materiality for the financial statements as a whole, and possibly many times that amount. The financial statements (note 14) disclose the sensitivity for goodwill estimated by the Group.

Our response

Our audit procedures included:

Benchmarking assumptions: With the assistance of our valuation specialists, we challenged the growth rate and discount rate used in the value in use calculation by comparing the Group's assumptions to external data. We challenged the implied cumulative annual growth rate within the five year forecasts and assessed this against past performance and the terminal growth rate. We challenged forecast assumptions around new contract wins or extensions, contract attrition and the profitability of existing contracts.

Historical comparisons

We compared current year actual cash flows to historic forecasts to assess the historical accuracy of the forecasts used in the impairment model.

Sensitivity analysis

We tested the sensitivity of impairment calculations to changes in key underlying assumptions, which were the short term cash-flow projections, the discount rate and terminal growth rates. We assessed the impact on headroom with the inclusion of an alpha factor in the discount rate in order to reflect any country specific and forecasting risks we considered might be present in each division. We challenged the projected win probabilities (including contract extensions) on key contracts and sensitised the five year cash flow forecasts by reducing new wins and extensions within the pipeline. We specifically considered the impact of COVID-19 on trading and compared the forecasts against the company's experience to date during the pandemic.

Comparing valuations

We considered whether the forecast cash flow assumptions used in the value in use calculation were consistent with the assumptions used to calculate the expected loss on onerous contract provisions, the recognition of deferred tax assets and the Directors' assessment of going concern and viability.

Assessing transparency

We also assessed whether the Group's disclosure about the sensitivity of outcomes reflects the risks inherent in the valuation of goodwill.

Our findings:

We found the Group's assessment that there is no impairment of the carrying amount of Group's goodwill to be balanced (2019: balanced) and the related sensitivity disclosures to be proportionate (2019: proportionate).

Procedures performed to agree to the preliminary announcement of annual results

In order to agree to the publication of the preliminary announcement, we conducted procedures having regard to the Financial Reporting Council's Bulletin: The auditors' association with preliminary announcements made in accordance with the requirements of the UK Listing Rules.  Our work included considering whether:

·	the financial information included in the preliminary announcement has been accurately extracted from the audited statutory financial statements, and that it reflects the presentation adopted in the audited statutory financial statements;
·	based on our statutory financial statements audit work, the financial information included in the preliminary announcement is materially misstated;
·	the information included in the preliminary announcement (including the management commentary) is materially consistent with the content of the annual report;
·	based on our statutory financial statements audit work, the assessment of the Company's position and prospects in the preliminary announcement is fair, balanced and understandable; and
·	the preliminary announcement includes the disclosures required under the UK Listing Rules and s435 of the Companies Act 2006.

Directors' responsibilities 

The preliminary announcement is the responsibility of, and has been approved by, the directors.  The directors are responsible for: preparing, presenting and publishing the preliminary announcement in accordance with the Listing Rules of the UK FCA; ensuring that its content is consistent with the information included in the annual report and audited statutory financial statements; and, as required under the UK Corporate Governance Code, for ensuring that the assessment of the Company's position and prospects in the preliminary announcement is fair, balanced and understandable. 

Our responsibility 

Our responsibility under the Listing Rules is to agree to the publication of the preliminary announcement based on our work.  In addition, under the terms of our engagement our responsibility is to report to the Company setting out the procedures performed by us to agree to the publication, the status of the audit report on the statutory financial statements, and the key audit matters addressed in that audit report.

We do not express an audit opinion on the preliminary announcement. 

We are not required to agree to the publication of presentations to analysts or webcasts.

This report is made solely to the Company in accordance with the terms of our engagement.  Our work has been undertaken so that we might state to the Company those matters we have agreed to state to it in this report and for no other purpose.  To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company for our work, for this report, or for the conclusions we have reached. 

This report is not the auditor's report on the Company's statutory financial statements. It relates only to the matters specified and does not extend to the Company's statutory financial statements taken as a whole. 

John Luke

for and on behalf of KPMG LLP

Chartered Accountants 

15 Canada Square

London

E14 5GL

24 February 2021

 

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