Serco : half year results 2021

Stock Exchange Announcement

2021 half year results

5 August 2021

Very strong trading and cash. £4bn of order intake. Order book increases to £14bn. First interim dividend since 2014.

			Change at	Change at
			reported	constant
Six months ended 30 June	2021	2020	currency	currency
Revenue(1)	£2,168m	£1,822m	+19%	+20%
Underlying Trading Profit (UTP)(2)	£123m	£78m	+58%	+62%
Reported Operating Profit (i.e. after exceptional items)(2)	£116m	£89m	+31%
Underlying Earnings Per Share (EPS), diluted(3)	6.75p	3.86p	+75%
Reported EPS (i.e. after exceptional items), diluted	18.77p	5.66p	+232%
Dividend Per Share	0.8p	-
Free Cash Flow(4)	£130m	£81m	+61%
Adjusted Net Debt(5)	£225m	£143m	+58%
Reported Net Debt(6)	£651m	£503m	+29%

Highlights

• Revenue(1) grew by 19% to £2.2bn, with organic growth of 15%, a 5% uplift from acquisitions and a 1% FX drag.
• Underlying Trading Profit(2) increased by 58% to £123m; 8%, or £6m, contributed by acquisitions of Facilities First in Australia and WBB in North America.
• Group Margin strengthened from 4.3% to 5.7%.
• Reported Operating Profit increased by 31%.
• Diluted Underlying EPS increased by 75%, reflecting the growth in Underlying Trading Profit, unchanged finance costs and a lower effective tax rate. Reported EPS benefits from one-off credit of £155m on recognition of an increased UK tax asset.
• Free Cash Flow(4) up 61% to £130m, supported by strong cash collections and some favourable timing effects.
• Adjusted Net Debt(5) increased by £82m to £225m in the last 12 months, despite spend of £249m on acquisitions and £40m on share buy-backs. Covenant leverage 1.0x EBITDA (2020: 0.7x).
• Interim dividend of 0.8p per share, the first interim dividend since 2014.
• Order Intake was extremely strong at £4.1bn, 190% book-to-bill. Approximately 60% of the order intake related to new work and 40% contracts being rebid. Pipeline of £5.8bn up 40% year-on-year, and largely rebuilt since the start of the year despite exceptionally strong order intake.
• Order Book increased from £13.5bn at the end of 2020 to £14.1bn.

Rupert Soames, Serco Group Chief Executive, said:

"These are very strong results, with revenue up 19%, Underlying Trading Profit up 58%, and Free Cash Flow up 61%. We have had extremely strong order intake, and the book-to-bill ratio was 190%, which bodes well for the future. Our three largest divisions - Asia Pacific, North America and UK & Europe - all delivered good growth, and this reflects both the trust our government customers have shown in us during the pandemic, and Serco's ability to respond to their requirements with speed and at scale.

Serco has grown very rapidly in the past two years, made possible by the investment we have made since 2014 in transforming our culture, systems and processes, re-gaining the trust of our customers, and building a strong and experienced management team. Over 60% of our profits now come from outside the UK, which reflects the success we have had in developing our businesses around the world. We now employ 83,000 people, which is around 21,000, or a third, more than we did a year ago; notwithstanding this rapid expansion, we have delivered an extremely strong operational performance. In the last six months we have completed two acquisitions, mobilised and trained thousands of people for new contracts, de-mobilised others, and responded with agility to constantly changing customer requirements. At the same time colleagues have had to deal with challenges and sometimes tragedies in their personal lives. For too many, home-life has provided little respite from the pressures of work-life. My respect and admiration for them all is unbounded.

About 17% of our first half revenues were directly associated with the critical work of supporting governments in their response to Covid-19. These revenues will fall away as the pandemic fades; for all our sakes, the sooner the better.

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In the meantime, our job is to deliver great service and value to governments on these contracts while they are needed, and to wind them down in an orderly manner when they are not. This work, whilst temporary in nature, will leave an enduring legacy for Serco and make it an even stronger company. It has shown our customers that they can trust us to respond at speed and scale to extremely demanding requirements; it has enabled us to invest in the development of systems, processes and skills which will further strengthen what is already a powerful proprietary platform for delivering complex government services. We believe that as a result of Covid-19 related contracts our skills and capabilities will be greater and our reputation with governments will be enhanced. We take the £4bn of order intake we have won in the first half as encouraging early evidence of this, and it will certainly help to cushion the impact of the inevitable wind-down of Covid-19 related work.

For the year as a whole, we expect to deliver Underlying Trading Profit of around £200m, or nearly 30% growth in constant currency. Profits in the year will be weighted to the first half, and will include contributions from the WBB and FFA acquisitions, which will enable us to partially offset the impact of the end of the AWE contract in June, the mobilisation costs of the recently-signed DWP contract, an expected reduction in Covid-19 related activities, and investments in our operating platform."

Our guidance for 2021 remains unchanged from that stated in our Pre-Close Update on 30 June 2021, except for cash and net debt, which has been updated following the very strong first half performance.

	Prior guidance	Latest guidance
Revenue	~£4.3bn	~£4.3bn
Organic sales growth	~6%	~6%
Underlying Trading Profit	~£200m	~£200m
Net Finance Costs	~£28m	~£28m
Underlying effective tax rate	~25%	~25%
Free Cash Flow	~£100m	~£120m
Adjusted Net Debt	~£275m	~£250m

Notes: The guidance uses an average GBP:USD exchange rate of 1.39 in 2021 and GBP:AUD of 1.82.

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.comand subsequently available on demand. A dial-in facility is also available on [phone] (USA: [phone]) with participant pin code 3376269.

Notes to summary table of financial results:

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 six months ended 30 June 2021 into sterling at the average exchange rates for the six months ended 30 June 2020.
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 historic Contract & Balance Sheet Review adjustments and other material one-time items. A reconciliation of Underlying Trading Profit to Trading Profit and Reported Operating Profit is as follows:

Six months ended 30 June	2021	2020
£m
Underlying Trading Profit	122.7	77.6
Include: non-underlying items
Contract & Balance Sheet Review adjustments	2.9	2.9
Trading Profit	125.6	80.5
Amortisation of intangibles arising on acquisition	(6.6)	(5.0)
Operating Profit Before Exceptional Items	119.0	75.5
Operating Exceptional Items	(2.7)	13.6
Reported Operating Profit (after exceptional items)	116.3	89.1

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

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1. Free Cash Flow is the net cash flow from operating activities before exceptional items as shown on the face of the Group's Condensed Consolidated Cash Flow Statement, adding dividends we receive from joint ventures and associates, and deducting net interest paid, the capital element of lease payments, net capital expenditure on tangible and intangible asset purchases and share purchases used to satisfy share awards.
2. Adjusted Net Debt is 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.
3. Reported Net Debt includes all lease liabilities. A reconciliation of Adjusted Net Debt to Reported Net Debt is as follows:

As at	30 June	30 June	31 Dec
£m	2021	2020	2020
Adjusted Net Debt	225.2	142.9	57.8
Include: all lease liabilities	425.7	359.9	402.6
Reported Net Debt	650.9	502.8	460.4

1. Represents percentage of Group Underlying Trading Profit before corporate costs. Underlying Trading Profit before corporate costs in the first half of 2021 was £145.4m.

Forward looking statements:

This announcement contains statements which are, or may be deemed to be, "forward looking statements" which are prospective in nature. All statements other than statements of historical fact are forward looking statements. Generally, words such as "expect", "anticipate", "may", "could", "should", "will", "aspire", "aim", "plan", "target", "goal", "ambition", "intend" and similar ex pressions identify forward looking-statements. By their nature, these forward looking statements are subject to a number of known and unknown risks, uncertainties and contingencies, and actual results and events could differ materially from those currently being anticipated as reflected in such statements. Factors which may cause future outcomes to differ from those foreseen or implied in forward looking statements include, but are not limited to: general economic conditions and business conditions in Serco's markets; contracts awarded to Serco; customers' acceptance of Serco's products and services; operational problems; the actions of competitors, trading partners, creditors, rating agencies and others; the success or otherwise of partnering; changes in laws and governmental regulations; regulatory or legal actions, including the types of enforcement action pursued and the nature of remedies sought or imposed; the receipt of relevant third party and/or regulatory approvals; exchange rate fluctuations; the development and use of new technology; changes in public expectations and other changes to business conditions; wars and acts of terrorism; cyber-attacks; and pandemics, epidemics or natural disasters. Many of these factors are beyond Serco's control or influence. These forward looking statements speak only as of the date of this announcement and have not been audited or otherwise independently verified. Past performance should not be taken as an indication or guarantee of future results and no representation or warranty, express or implied, is made regarding future performance. Except as required by any applicable law or regulation, Serco expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward looking statements contained in this announcement to reflect any change in Serco's expectations or any change in events, conditions or circumstances on which any such statement is based after the date of this announcement, or to keep current any other information contained in this announcement. Accordingly, undue reliance should not be placed on the forward looking statements.

LEI code: 549300PT2CIHYN5GWJ21

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Chief Executive's Review

Summary of financial performance

Revenue, Underlying Trading Profit and Underlying Earnings Per Share

Revenue increased by 19%, or £345m, to £2,168m (2020: £1,822m). Of the growth, 15% (£282m) was organic, acquisitions contributed 5% (£86m) and currency movements were a drag of 1% (-£23m). The high level of organic growth was driven by very strong performances from our UK and Australian businesses. About £365m of our global revenues were from services supporting governments' response to Covid-19, which compares to £130m in the first half of 2020.

Underlying Trading Profit (UTP) increased by 58%, or £45m, to £123m (2020: £78m). Excluding the adverse currency movement of £3m, growth at constant currency was 62%. Acquisitions added 8%, or £6m, of the growth, with the rest being organic. The organic growth arose from continued strong demand for our Covid-19 work and growth in a range of other contracts, notably in Justice & Immigration and Citizens Services. Our core operating platform was able to respond efficiently to the additional demand, illustrated by the fact that Group administrative expenses increased year-on-year by 8%, whilst revenues increased by 19%. As a consequence, most of our regions improved their Underlying Trading Profit margins as revenues increased, and this helped drive our UTP margin from 4.3% to 5.7%.

Diluted Underlying Earnings Per Share increased by 75% to 6.75p (2020: 3.86p). The percentage improvement was higher than the increase in UTP due to a broadly unchanged finance cost and a lower effective tax rate.

Cash flow and net debt

Free Cash Flow was very strong in the half at £130m (2020: £81m). The improvement was a result of the £45m increase in underlying profits and a working capital inflow of £44m, despite revenue growth of £345m. The working capital inflow was helped by the successful collection of some older receivables, efforts by governments to support their supply chains by ensuring prompt payments and favourable timing of receipts round the period end. Average working capital days were broadly unchanged with debtor days of 23 and creditor days of 24. We are proud to say that 89% of UK supplier invoices were paid in under 30 days (2020: 87%) and 95% were paid in under 60 days (2020: 96%). No working capital financing facilities were utilised in this or the prior year.

The closing Adjusted Net Debt of £225m (2020: £143m) compares to a daily average of £178m (2020: £283m) and

a peak of £346m (2020: £356m). The relatively large range for these reflects the acquisition of WBB in May and the favourable timing of receipts and payments at the end of the period. We have not used any financing or efforts out of the ordinary to reduce period end net debt.

Our measure of Adjusted Net Debt excludes all lease liabilities, which now total £426m (31 December 2020: £403m) the majority relating to the AASC contract and aligns more closely with the measure used for covenants on our financing facilities. Adjusted Net Debt at 30 June 2021 increased to £225m (31 December 2020: £58m, 30 June 2020: £143m). The £167m increase since the year end includes spend on acquisitions of £249m, £17m of dividend payments and £40m of share purchases.

At the closing balance sheet date, our leverage for debt covenant purposes was 1.0x EBITDA (2020: 0.7x). This compares with the covenant requirement for net debt to be less than 3.5x EBITDA and our target range of 1-2x.

Dividends

The Board has decided to declare an interim dividend of 0.8p in respect of the first half of 2021. To put this into context, the Board decided, given the uncertainties last year, not to declare an interim dividend in 2020. We did, however, pay a final dividend of 1.4p per share in respect of 2020, and if the normal approach of paying about one- third of an expected annual dividend at the interim stage and two-thirds at the Final stage had been followed, it would have implied an interim in 2020 of about 0.7p. Indeed, an amount roughly equivalent to this was included in the calculation of the quantum of the share buyback programme announced in December 2020. In this context an interim dividend of 0.8p would represent an increase of around 15% on the 0.7p that was notionally foregone in 2020.

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

Contract awards, order book, rebids and pipeline

Contract awards

Order intake has been extremely strong in the first half of 2021 with £4.1bn of work won, moving our book-to-bill to 190% for the half, and approaching 130% for the rolling 12-months; since January 2017 and June 2021, we have had

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revenues of £15bn, and booked orders of £19bn - a book-to-bill ratio of 126%. There were 33 contract awards worth more than £10m each and 4 with a total contract value of more than £200m. Around 70% of order intake came from the UK & Europe, 25% from the Americas and the remaining 5% from customers of our AsPac and Middle East operations.

Of the order intake, approximately 60% was represented by the value of new business and 40% was rebids and extensions of existing work. This is the opposite of the position in the same period last year. The win rate by value for new work, which has averaged slightly less than 30% over the last five years, was unusually high at almost 70%. The win rate by value for securing existing work was approximately 70%, which is lower than the 80-90% we typically see, as a result of the loss of our Dubai Metro contract. Win rates by number of tenders were approximately 65% for new bids and over 90% for rebids and extensions.

VIVO Defence Services, our 50/50 joint venture with Engie, was successful in securing several contracts from the UK Ministry of Defence (MOD) Defence Infrastructure Organisation (DIO) as part of the Future Defence Infrastructure Services (FDIS) programme, the largest facilities management procurement currently running across Europe. In Lot 3, which awarded contracts to provide asset and facilities management services for the UK defence built estate, VIVO won the largest two regions of the four that were competed. These have an estimated total potential value to Serco of around £1.7bn over the initial seven-year period. VIVO also secured the largest two regions in Lot 2B, which provides repairs and maintenance work for Service Family Accommodation, with an estimated total potential value to Serco of around £200m. Also in the UK, we were awarded contracts by the Department of Work and Pensions as part of their Restart programme, which will help unemployed people back into work. We estimate that the combined value over the initial four and a half-year contract period will be around £350m, with the amount dependent on the number of people who find employment. The order intake also includes the £400m contract renewal to provide support services at the Canadian Forces Base in Goose Bay, Canada and our award to continue to provide services at Covid- 19 testing centre locations in the UK.

Order book

The order book increased from £13.5bn at the start of the year to £14.1bn at the end of June. This is lower than might be expected when order intake has been so high as, consistent with our usual treatment of joint ventures, our order intake includes Serco's £1.9bn share of our VIVO joint venture with Engie but our order book does not. More widely, our order book definition gives our assessment of the future revenue expected to be recognised from the remaining performance obligations on existing contractual arrangements. This excludes unsigned extension periods and the order book would be £1.2bn higher if option periods in our US business, which always tend to be exercised, were included.

Rebids

In our portfolio of existing work, we have around 70 contracts with annual revenue of £5m or more where an extension or rebid will be required before the end of 2023. Excluding our NHS Test & Trace contracts, which are short-term in nature and we expect the work to come to a natural finish, contracts which will either end or need to be extended in 2021 have an annual contract value of around £400m. A significant part of this is the Australian Immigration services contract, where the customer has recently informed us they propose extending for the maximum two years to December 2023 and will enter into discussions to finalise the terms of this. In each of 2022 and 2023 the annual value of contracts ending or requiring extension is approximately £500m.

Pipeline

Our measure of pipeline is probably more narrowly defined than is common in our industry. It includes only opportunities for new business that have an estimated annual contract value (ACV) of at least £10m and which we expect to bid and to be adjudicated within a rolling 24-month timeframe. We cap the total contract value (TCV) of individual opportunities at £1bn, to lessen 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 'ID/IQ' (Indefinite Delivery / Indefinite Quantity contracts), which are common in the US, we only take the value of individual task orders into our Pipeline as the customer confirms them. Our published Pipeline is thus a relatively small proportion of the total universe of opportunities, many of which have annual revenues less than £10m, are likely to be decided beyond the next 24 months, or are rebids and extensions.

Our Pipeline was £6.4bn at the end of 2020. We have seen £4.1bn of orders secured in the half, and we are pleased that, despite this, we have managed to largely replenish the Pipeline, which stood at £5.8bn at 30 June. The Pipeline currently consists of just over 25 bids that have an ACV averaging approximately £30m and a contract length averaging seven years. The pipeline of opportunities for new business that have an estimated ACV of less than £10m has remained stable at £1.7bn.

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