2015 full year results

Serco Group plc - 2015 full year results

25 February 2016

·    Underlying Trading Profit of £96m, ahead of our guidance provided at the time of the Rights Issue of £90m.

·    Reported Trading Profit of £138m, significantly higher than Underlying Trading Profit, benefiting from £21m net release of Onerous Contract Provisions and Contract and Balance Sheet Review items, £9m one-off profit on a contract termination and £12m beneficial impact of assets held for sale.

·    Exceptional operating charge of £188m, of which £166m are non-cash losses on disposals and impairments.

·    Free Cash Outflow of £16m, better than previously anticipated.

·    Net Debt reduced by £605m to £78m, as a result of the Rights Issue and offshore BPO disposal proceeds.  Net Debt:EBITDA around 0.5x.

·    £1.8bn total value of signed contracts, representing more than 700 individual customer orders of which 10 are worth more than £50m each.

·    Pipeline of larger new bid opportunities increases by approximately £1.5bn to £6.5bn.

·    Operating costs reduced by over £330m, broadly in proportion with revenue reduction.

·    Guidance for 2016 reiterated - Revenue expected to reduce to approximately £2.8bn and Underlying Trading Profit to around £50m as a result of BPO disposal and contract attrition.

Rupert Soames, Serco Group Chief Executive, said: "The business has delivered a much better performance than we expected at the start of the year, which reflects the fact that we are making good progress in the first year of the implementation of our strategy.

"Serco has achieved a great deal in 2015: we have a significantly stronger balance sheet with materially less debt, we have successfully disposed of the majority of our offshore BPO business, reduced costs, improved our internal reporting processes, recruited new management, improved the position on several of our largest loss-making contracts, and strengthened our pipeline.  Our plan has survived first contact with the enemy.

"Looking ahead, and in line with our plan, we expect revenues and profits to decline in 2016, as a result of the disposal of our private sector BPO business and contract attrition.  We have four priorities this year: further improve the operational and financial performance of our contracts; build our new business pipeline; reduce our costs; and improve and embed our new management information systems."

Sir Roy Gardner, Serco Group Chairman, commented: "Since joining Serco in June, I have seen first-hand the strong commitment of our people to delivering excellent public services.  Much has been done in 2015 to implement Serco's new strategy and strengthen the business, and we now have a good foundation upon which to build a successful future.  There is much still to do to complete our transformation and restore Serco to appropriate growth and returns, and doing so whilst ensuring we meet the highest standards of operational performance, corporate governance, integrity and business ethics."
 

For further information please contact Serco:

Stuart Ford, Head of Investor Relations T +44 (0) 1256 386 227

Presentation

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.  Revenue including that from discontinued operations is shown for consistency with previous guidance.

(2)      Reported Trading Profit is defined as IFRS Operating Profit adjusted for (i) amortisation and impairment of intangibles arising on acquisition and (ii) exceptional items.  Consistent with IFRS, it includes Serco's share of profit after tax of its joint ventures.  Underlying Trading Profit excludes Contract and Balance Sheet Review adjustments (principally OCP releases or charges), the beneficial treatment of depreciation and amortisation of assets held for sale, and other material one-time items such as the profit on early termination of a UK local authority contract that occurred in 2015.  Trading Profit measures include that from discontinued operations for consistency with previous guidance.

(3)      Underlying EPS reflects the Underlying Trading Profit measure after deducting pre-exceptional net finance costs (including those for discontinued operations) and related tax effects.

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", "should", "will" and similar expressions 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; and cyber-attacks.  Many of these factors are beyond Serco's control or influence.  These forward looking statements speak only as of the date of this announcement.  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.

Chief Executive's Review

Introduction

The financial results for 2015 were much better than we expected both at the start of the year and at the time of the March 2015 Rights Issue.  Underlying Trading Profit at £96m was ahead of the £90m we had forecast, and Reported Trading Profit was much higher still at £138m.  Closing net debt of £78m was significantly lower than expected, and represented a year-on-year reduction of £605m.  Revenue including discontinued operations was around the level we expected at £3.5bn; the discontinued operations comprise the private sector BPO division, the majority of which was disposed of at the end of December 2015.  Not included in Underlying Trading Profit was a net positive movement of £21m in provisions for future losses on onerous contracts and other liabilities recognised at the end of 2014; although it has no impact on Underlying Trading Profit, it was also pleasing that Onerous Contract Provision (OCP) utilisation was £14m lower than expected at the beginning of the year.  Looking ahead to 2016, and in line with our plan, we expect a further reduction in revenues and profits as we feel the impact of the disposal of our private sector Business Process Outsourcing (BPO) business, as well as further contract attrition.

To give some context to our performance in 2015, it is worth reflecting on where we have come from, and are going to.  After a difficult period during which the business suffered a series of major setbacks, I joined the business in May 2014, and my colleague Angus Cockburn joined as Chief Financial Officer in October 2014.  A thorough review of contracts in the business (the Contract and Balance Sheet Review) was carried out, resulting in an announcement in November 2014 that we anticipated a write-down of around £1.5bn, which included asset impairments, goodwill write-offs, and provisions against future losses on onerous contracts.  This led to the requirement to refinance the business, which was completed by way of a Rights Issue and a renegotiation of our debt facilities in early 2015.  In parallel with the Contract and Balance Sheet Review, we carried out a Strategy Review, which concluded that we should focus on being a leading supplier of public services to governments, and that the private sector outsourcing activities should be disposed of.  At the same time as the Strategy Review, the business also undertook a thorough Corporate Renewal programme, in which new systems and processes were implemented to ensure that there would be no repeat of previous issues.

The Strategy Review, presented to investors in March 2015, identified three distinct phases in the turnaround of our business.  The first phase, 'Stabilisation', involved developing a plan to take the business forward, refinancing the business, putting in place a new management team, and implementing new reporting processes.  The end of this phase was marked by the successful completion of our Rights Issue and refinancing in April 2015.  Since then we have been working hard on the second phase: 'Transformation'.  This will take us through to 2018, when we expect to see the business starting the third phase: 'Growth'.

Within this context, significant progress has been made in 2015 against our plan.  We now have a firm financial platform; our strategy - to be a leading international provider of public services operating in Defence, Justice & Immigration, Transport, Health and Citizen Services - has been well received by customers; our risk management and reporting processes have been hugely improved; we have made good progress mitigating the losses and improving service delivery on some of the largest onerous contracts; morale in the business, and most particularly amongst the management team, is much better; relationships with key customers are healthier; our pipeline of new business has started to grow again, and we have established our first Centres of Excellence; we have reduced the costs in the business by over £330m; and we have disposed of non-core businesses. 

In summary, in 2015 we delivered on our promises, our plan has survived first contact with the enemy, and we go into 2016 in much better shape than we entered 2015.  However, to paraphrase the Duke of Wellington at Waterloo, we know that much hard pounding lies ahead.

Summary of financial performance

Revenue and Trading Profit

Reported Revenue was £3,177m (2014: £3,596m); this measure excludes revenue from discontinued operations (our private sector BPO division) of £338m as well as Serco's share of revenue from joint ventures of £737m.  Revenue including discontinued operations was £3,515m (2014: £3,955m).  At constant currency and adjusting for disposals and acquisitions, revenue including discontinued operations declined by 10%, largely as a result of the ending of contracts such as the Docklands Light Railway and National Physical Laboratory, as well as certain US intelligence agency support services and visa processing work; it also reflected the reduced volumes and rates in Australian immigration services.  Partially offsetting these declines were the start of new contracts such as the Caledonian Sleeper and the start of full operations at Fiona Stanley Hospital in Australia.

Reported Trading Profit for the year was £137.6m (2014: loss of £632.1m).  The difference between Reported Trading Profit of £137.6m and Underlying Trading Profit of £96.0m, is accounted for by three items.  First, we have not included in Underlying Trading Profit £9.0m of profit arising from the early termination of a contract with Thurrock Council, on the basis that it is one-off in nature.  Second, and in accordance with the accounting treatment of assets held for sale, depreciation and amortisation charges related to assets held for sale at 31 December 2014 are required to be excluded from the Group accounts; this had the effect of increasing Reported Trading Profit by £11.7m, but has been excluded from Underlying Trading Profit.  Third, we have also excluded from Underlying Trading Profit a net benefit of £20.9m arising from our year-end review of OCPs and other Contract and Balance Sheet Review items.

In 2014, it became clear that a number of contracts would be unprofitable during their life and required OCPs, and numerous future liabilities needed to be reflected in our Balance Sheet; together, these led to a charge of £745.3m to Reported Trading Profit in 2014.  We said at the time we created these provisions that they should be viewed as a portfolio of liabilities and charges, and that as subsequent events interfered with the hundreds of judgements we made at the end of 2014, we expected that individual items would vary from our original estimates; however, we believed that in aggregate, the charge was a reasonable and prudent estimation of the likely total value of future liabilities.  Whilst there have been numerous charges and releases against individual contracts and provisions, the overall net release of £20.9m against the £745.3m charged last year indicates that our overall judgement at the end of 2014 was broadly correct.  Within the net release of £20.9m, OCP releases totalled £88.8m, additional OCP charges totalled £91.8m, and a net total benefit of £23.9m arose from movements in other balance sheet provisions and charges related to contracts taken in 2014.  The single largest OCP release was £63m related to the Armidale Class Patrol Boat (ACPB) contract; this followed the agreement we reached in 2015 with the Australian Government to amend the terms of the ACPB contract.  The largest OCP charge related to a new provision of £34m in respect of our contract with Lincolnshire County Council; in addition, we judged it necessary to increase the existing OCP against our UK Prisoner Escorting Contract (PECS) by £11m.

Underlying Trading Profit includes £114m of OCP utilisation, which reflects the neutralisation of the losses on contracts identified in the 2014 Contract and Balance Sheet Review.  A further £11m of OCP utilisation was applied to items classified in 2014 as exceptional.  Total OCP utilisation during 2015 of £125m was £14m less than the £139m we had expected at the start of the year.  Currency movements during the year had no material impact on Underlying Trading Profit.

Underlying Trading Profit of £113m in 2014 included losses of £54m incurred in 2014 on contracts that were subsequently provided for and had their equivalent losses in 2015 neutralised by OCP utilisation.  Therefore Underlying Trading Profit of £96m for 2015 is best compared to £167m in 2014.  The significant drop in profits is driven by contract attrition, volume and rate reductions on some contracts and the challenge of reducing costs in line with revenues that were £440m lower in 2015 than in 2014.

Finance, tax and exceptional costs

Pre-exceptional net finance costs, including discontinued operations, were £32.0m (2014: £36.7m).  The reduction in average net debt over the year reduced the Group's net interest payable, but this was partially offset by the movement in the discount on provisions which, although a non-cash item, is recorded within overall finance costs.  Cash net interest paid in the year was £32.7m (2014: £39.6m).

Pre-exceptional tax costs, including discontinued operations, were £36.6m (2014: £11.1m); on an underlying basis, tax costs were £30.5m and the effective rate was 47.7%; this rate reflects the combination of the current lack of a deferred tax credit in the UK to offset tax charges at locally prevailing rates in the international divisions (which tend to be higher than the UK's rate).  When we are able to show sufficient profits in our UK business, we will be able to reflect the value of a tax asset in the UK, and we would therefore expect that at some point our effective tax rate will drop substantially.  Net cash tax paid in the year, at £2.7m (2014: net repayment of £0.6m), was much lower than the accounting charge.

The Group incurred a £187.5m net exceptional operating charge for the year, of which £165.5m relates to non-cash losses on disposals and impairments.  There was a £77.6m charge on discontinued operations reflecting the impairment in the carrying value of businesses held for sale prior to disposal.  There was an £87.5m goodwill impairment related to the updated assessment for the Americas division.  Exceptional restructuring and other incremental costs related to the development and implementation of the Strategy Review amounted to £21.9m.  In addition to operating exceptionals, there was £32.8m of exceptional finance costs relating to the Rights Issue and debt refinancing, which included charges related to the early repayment of debt.

Earnings per share

Underlying Earnings Per Share, which reflects the Underlying Trading Profit measure after deducting pre-exceptional finance costs (including those for discontinued operations) and related tax effects, was 3.44p (2014: 4.73p); the reduction also reflects the movement in the weighted average number of shares in issue which increased to 986.5m shares (2014: 655.1m shares) as a consequence of the Rights Issue.  Earnings before exceptional items, including those for discontinued operations, were 6.55p per share; including the impact of exceptional items, there was a loss of 15.47p per share.

Cash flow and net debt

In 2015 our ability to manage monthly cash flow far outstripped our ability to forecast it accurately, as we managed around poor cash forecasting systems and the unpredictable impact of our campaign to normalise working capital management.  In previous years the focus was on optimising the net debt position at the end of reporting periods.  The consequence of this was significant volatility in monthly cash flows, with large net inflows in December and June, followed by equally large net outflows in January and July, with the result that average net debt over the year was often much higher than that reported at period ends.  In 2013 this difference between reported and average net debt amounted to £149m; in 2014 and 2015, we worked to progressively reduce this difference; in 2015 it had dropped to £59m across the year, and was a mere £34m in the second half of 2015.

As a consequence, our estimates of cash flow at the start of the year were less than perfect, and the reported result - a Free Cash outflow of £16m - was significantly better than we forecast at the beginning of the year.  Admittedly, there were numerous items which could not have been foreseen at the beginning of the year, such as the inflows from the ending of the Thurrock and Shop Direct contracts, lower-than-expected cash outflow from OCPs, and the quantum of other working capital movements as we normalised debtor and creditor cycles.

As a result of better-than-expected Free Cash outflow, net debt, including that for assets and liabilities held for sale, was also better than we expected, and stood at £77.5m at the end of the year.  This represented a reduction of £605m from the £682.2m at 31 December 2014.  The main drivers of this reduction were the net proceeds of approximately £530m from the April 2015 Rights Issue, together with the approximate £200m received following the completion of the BPO disposal at the end of December 2015.  Offsetting these inflows, there was an outflow of £88m related to exceptional items, £33m adverse currency impact and the £16m Free Cash outflow related to trading.  The reduction in net debt results in our leverage for covenant purposes being 0.4x EBITDA; on a pro forma basis, removing the £35m of EBITDA associated with the BPO disposal, it would have been 0.5x, which compares with the requirement in our debt covenants to be lower than 3.5x.

Dividends

As indicated in March 2015, the Board is not recommending the payment of a dividend for 2015.  The Board is committed to resuming dividend payments when it is prudent to do so.  The decision as to when to declare a dividend and the amount to be paid will take into account the Group's underlying earnings, cash flows and financial leverage, together with the requirement to maintain an appropriate level of dividend cover and the market outlook at the time.

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

Contract awards, pipeline, order book and rebids

Contract awards

The Group signed contracts with an aggregate total value of £1.8bn during the year; this excludes £0.3bn signed by the private sector BPO business that was sold in December 2015.  As anticipated, the year was relatively quiet with few major bidding outcomes announced.  The value of new business won was £0.5bn, or approximately 30% of the total value signed, with the bulk of order intake represented by securing extensions or successfully rebidding existing work.  Win rates by volume were around 50% for new bids and around 90% for rebids and extensions, but by value the win rates were around 20% and 75% respectively.

The largest new contracts signed were those to operate the North-South line for the Saudi Railway Company and to support the US Naval Facilities Engineering Command; these two were wins from our £5bn major opportunities pipeline at the start of the year.  We were however unsuccessful on two larger new bids, one for Australian offshore immigration services and the other for Wellington metro rail service.  It should be noted that in early February 2016, the Australian Government decided to re-tender the offshore immigration services contract, and as Reserve Bidder in the original tender, has invited Serco and the originally selected Preferred Bidder to re-tender for this opportunity, though we have not included the opportunity in our pipeline as at the time of reporting we have not decided whether to participate in the process.  A third opportunity in the pipeline, the Icebreaker vessel to be used by the Australian Antarctic Division (AAD), saw Serco selected as Preferred Tenderer, but, as this contract is yet to be signed, it has not been included in the value of signed contracts and remains in the Group's major bids pipeline.  Smaller new bids won included facilities management for the new district general hospital for NHS Dumfries and Galloway, supply chain support for the US Navy, and several contracts for our European Agencies business, including the provision of a multi-lingual call centre based in Brussels offering support in 24 languages.

Major rebids and extensions secured during 2015 included: facilities management services to Wishaw and Norfolk & Norwich University Hospitals; IT and contact centre support for European Agencies; air traffic control services for the Federal Aviation Administration and classification services for the US Patent and Trademark Office; cost analysis support to the US military and personnel identification support to the US Navy; traffic camera services in Victoria, Australia; defence logistics and base support services in the Middle East; Baghdad Air Navigation Services; and operating the Palm Jumeirah Monorail System in Dubai.  Major rebids lost during 2015 included two defence support contracts in the UK and the National Benefits Center contract in the US.  We will also experience attrition in 2016 from contracts where we have either decided not to rebid at the end of the contract because they were losing money (examples being Suffolk Community Healthcare and National Citizen Service) or where the customer has decided to take the work back in house (for instance MoD Defence Business Services, Thurrock Council and Virginia Department of Transport).

Order book

The Group's order book, excluding the discontinued Global Services division, now stands at £10.0bn, a reduction of £1.6bn over the year.  The value of signed contracts in the year increased the order book, but this was outweighed by the reductions to the order book due to revenue delivered in 2015 and adjustments for contracts ending early.  There is £2.5bn of revenue already secured in the order book for 2016, equivalent to approximately 90% revenue visibility of our £2.8bn revenue guidance.  The secured order book is £1.6bn for 2017 and £1.2bn for 2018.

Rebids

In terms of contracts potentially ending during 2016, there is an unusually small number subject to a rebid or extension decision; in aggregate these have annual revenue totalling around £90m, with an in-year 'revenue at risk' of approximately £60m.  In 2017, there are a larger number of contracts that will potentially end or need to be re-bid or extended, with these having aggregate annual revenue of around £240m.  In 2018, there is a further £460m.  In total over the next three years therefore, there are around 40 contracts in our order book with annual revenue of over £5m across the Group where an extension or rebid will be required, representing annual revenue of approximately £790m or around 30% of the Group's forecast revenue for 2016 of £2.8bn.

Pipeline

The definition we use for our reported pipeline is new bid opportunities with annual revenue of at least £10m, and which we expect to bid and to be decided within the next 24 months.  The definition does not include rebids and extension opportunities.  It is therefore a relatively small proportion of the total universe of opportunities we have in our prospect list, many of which either have annual revenues less than £10m, or are likely to be decided beyond the next 24 months, or are rebids and extensions.  It should also be remembered that in the Americas in particular, we have numerous contracts which are classed as 'IDIQ' - Indefinite Delivery / Indefinite Quantity - which are essentially framework contracts under which the customer issues task orders one at a time; whilst the ultimate value of such a contract may be very large and run over many years, the value of it is only recorded in our order book as individual task orders are contracted, and few of them would appear in the pipeline as they tend to be contracted on short lead times.

The reported pipeline has seen significant declines over recent years - from around £12bn at the end of 2013 to around £5bn at the end of 2014.  It is encouraging that for the first time in several years, it has shown an increase to around £6.5bn as at the end of 2015.  There continues to be around 20-30 opportunities, with the annual contract value averaging around £30m and a typical length of contract being 5-10 years.

Guidance for 2016 and outlook beyond

Serco provided initial guidance in December 2015 for the 2016 financial year, and that guidance is unchanged at the date of reporting the results for the 2015 financial year.  For 2016, we anticipate Revenue of approximately £2.8bn and Underlying Trading Profit of approximately £50m.  This view of Underlying Trading Profit is before any future adjustments to OCPs should these arise during the year.

The exit of the private sector BPO operations is forecast to reduce Revenue by over £300m and Underlying Trading Profit by over £20m, driven by the absence of the £23m contribution from the offshore BPO operations which were disposed of at the very end of 2015.  The Underlying Trading Loss from the residual UK private sector BPO operations up to the point of their assumed exit is forecast to be approximately £10m in 2016, which is broadly unchanged from the loss in 2015, given the effect of 'stranded' costs, which will take some time to work out of the business.

Revenue attrition across the rest of the Group is estimated to be up to £500m.  As previously described, and covered in more detail in the Divisional Reviews, the greatest attrition is in the Local and Regional Government division, and in the Americas division.  In the Central Government division, the end of the Northern Rail franchise in early 2016 will also reduce the profit contribution, although, being a joint venture, will have no impact on revenues.  In total, the impact of the profit contribution associated with contract attrition is approximately £40m, in addition to the £20m impact of the BPO disposal and wind-down of the private-sector BPO operations in the UK described above.

Our forecast for 2016 includes around £100m of incremental Revenue from already secured or potential new business.  Limited progress on new growth in 2016 reflects the weakness in the bid pipeline during the last two years.  The incremental profit contribution from this growth, together with retained cost efficiencies, will only partially mitigate the profit reductions from the BPO disposal and the significant amount of contract attrition.

In terms of cash flow and net debt movement, we anticipate an increased level of Free Cash outflow, as Underlying Trading Profit is expected to be significantly lower than in 2015, and we do not expect any one-off benefits such as the cash in-flows resulting from the end of the Shop Direct and Thurrock contracts.  We also expect to see continued outflow related to the utilisation of OCPs and previously booked exceptional items.  We therefore estimate that closing net debt at the end of 2016 could be around £200m, equivalent to leverage for covenant purposes of approximately 2x EBITDA.

For 2017, conditions remain uncertain and we do not expect anything more than limited financial progress.  Rebuilding and ultimately converting our pipeline of new contract opportunities will take some time, as will delivering incremental net benefits of cost efficiency programmes.  Our view of 2017 will clearly come more into focus as we progress through 2016.

Strategy implementation progress

In March 2015, we set out our new strategy, which is to focus on the public sector market and be a leading provider of public services to governments.  Specifically, we intend to focus on five market sectors: Defence, Justice & Immigration, Transport, Health and Citizen Services; and to do so across four geographies: UK & Europe, North America, Asia Pacific and the Middle East.  The strategy builds upon Serco's long track record and expertise in the transformation and management of complex public services, and in supporting critical and sensitive activities central to the work of governments.  We believe our chosen markets have long-term structural growth drivers and that Serco can play a central role in helping governments respond to the challenge of improving the quality and reducing the cost of public services, whilst earning for our shareholders sustainable and attractive risk-adjusted returns.

In our strategy presentation in March 2015, we identified three distinct phases in the turnaround of our business.  The first phase - Stabilisation - involved identifying all the issues which had impacted the company, changing management, setting a new strategy, reducing net debt, disposing of non-core businesses, and repairing relations with our customers, most particularly the UK Government.  This phase is now complete.  The next phase - Transformation - is now in full swing as we navigate a path towards our ambition of becoming one of the best managed businesses in our sector.  Whilst achieving this ambition will take many years, we expect it to enter the final phase - Growth - in 2018-2020; the precise moment the business starts to grow again in a meaningful way is hard to predict, and will depend on both our performance and external events.  Some, such as the speed with which we can reduce costs without prejudicing service quality, and building compelling service propositions are in our control; others, such as the timing of contract awards, the behaviour of competitors and the macro-economic environment, are not.  But with any plan, it is very helpful if it can deliver on early promises, and we feel that, with our performance in 2015, in which we have outperformed on almost every metric we set ourselves, we have done that.

Strengthening our balance sheet

Our strategy has to be properly funded, and a firm foundation is required to allow the Group to grow and flourish in the future as well as being an absolute necessity to retain customers' confidence.  To achieve a sustainable balance sheet with a prudent level of financial gearing, we therefore launched a Rights Issue during the year, which was successfully completed raising net proceeds of £530m.  We subsequently reached agreement with our lending banks and US private placement noteholders to refinance our debt facilities; we have therefore achieved the necessary reduction in our borrowing, extended the time period of our Revolving Credit Facility and put in place more flexible financial covenants.

Disposing of non-core businesses

As a major part of reshaping our portfolio, we have concluded our programme of targeted disposals.  In the first half of 2015, we sold the Great Southern Rail luxury tourist travel operation in Australia, which was losing money and could neither gain, nor deliver, synergies to the rest of the Group.  Likewise, in September 2015, we reached agreement on the sale of our offshore private sector BPO operations for a gross consideration of approximately £250m.  This business was acquired by Serco in 2011 on the premise that there were synergies between private and public outsourcing businesses; whilst in some parts of public sector operations such as IT and back office systems this may be true, however, for the majority of our business, which is heavily biased towards frontline services, often of a highly sensitive nature, using low-cost labour in emerging markets is not a palatable or practical option for our customers, and we determined that these synergies could not in reality be achieved.

We had previously stated our intention to dispose of our Environmental and Leisure businesses; this was prompted by our urgent need to reduce our debt burden rather than any strategic necessity.  These businesses provide frontline services to UK Local Authorities, are profitable, and align with our strategy of providing public services; they also give added breadth and depth to our offering to Local Authorities, which is an important business for us in the UK.  Once we had certainty around the disposal of our Private Sector BPO business and the proceeds of the Rights Issue, we were able to review the decision to dispose of these businesses, and we concluded that for both strategic and financial reasons these businesses should be retained within Serco's portfolio.

Mitigating loss-making contracts

We are working hard to mitigate our loss-making contracts throughout the Group in order to improve profitability and cash performance whilst meeting our contractual service obligations.  The adjustments required to the Contract and Balance Sheet Review charges taken last year were a net positive in 2015, and we will maintain an intense focus on each and every onerous contract to make further progress.  During the year, the major improvement was the agreement reached on the ACPB contract to improve the scope of work, the service regime and, very importantly, to bring an earlier end (2017 rather than 2022) to this highly onerous contract.  Other operational or negotiated improvements included the Future Provision of Marine Services (FPMS) and HMP Ashfield contracts; we have also successfully exited onerous contracts such as Suffolk Community Healthcare and the National Citizen Service, in both these cases at significantly lower cost than we initially expected.  A small number of other contracts have had new provisions or increases to reflect the latest operational performance and trading conditions, but overall, and with the total OCP balance reducing to £300m from £447m a year earlier, we have made pleasing progress on one of our biggest challenges.

Reducing our costs

We have also made good progress reducing costs.  In 2015, our operating costs were reduced by over £330m, broadly in proportion with the revenue reduction.  Much of this was direct cost reduction resulting from contracts which we exited, or where volumes reduced or businesses were sold; but we are also driving out cost to offset the effect of negative operating leverage as the Group becomes smaller.  Our previously announced plans to extract £20m of overhead and procurement savings in 2015 from specific initiatives were soundly beaten.

Improving management information                                             

Management information has improved noticeably, increasing our visibility of performance and strengthening our controls and governance.  Additionally, the strengthening of our bid risk management through tightened procedures and more thorough commercial reviews is becoming more deeply embedded in the business.  We now have high-quality monthly management accounts, which have become fundamental to the way in which monthly Divisional Performance Reviews now function, and the structure of these management accounts has been flowed down through the business units and to contract level.  Our core SAP accounting platform has been both upgraded and better integrated with related systems.  Further improvements will come in 2016 as we begin the year with new finance data structures and chart of accounts which have been reviewed, rationalised and standardised, and as we begin to fully utilise the power of new reporting tools.  In addition, we have made significant investment in new Procurement and HR systems, which will go live during 2016, and we plan to continue our investment in new systems to improve the efficiency of the business.

Rebuilding our pipeline and leveraging Centres of Excellence

The Strategy Review led us to conclude that we needed to focus on sectors of government expenditure which had applicability across a number of our regional operations, so we could leverage our international scale to provide customers innovation and operational excellence.  Historically, Serco has not been great at sharing skills, best practice and intellectual property across our businesses.  To tackle this, in 2015 we started to build Centres of Excellence in Health, Justice & Immigration and Transport.  These Centres of Excellence comprise small teams of world-class people seconded from our businesses whose job it is to take a global view of opportunities, recommend resource allocation and bid prioritisation, build compelling propositions and support our regional operations in their bids.  In time, as these Centres of Excellence become increasingly effective, we see us expanding the number of them to encompass a number of core operational, as well as market-centric, capabilities such as Workforce Management and Continuous Improvement.  In all their activities, the principle behind the Centres of Excellence is to use a small number of high quality people, along with building a culture of sharing best practice around the world to enable us to excel at proposition development, bidding and operations.

Delivering greater cost efficiency

Serco over-achieved against our target of £20m in overhead and procurement savings in 2015.  Whilst these will annualise to a higher figure in 2016, they will be offset in part by inflationary pressure on our labour costs, including the impact of the new National Living Wage, as well as further pressure from negative operating cost leverage as revenues decline.  Across the business we are reducing the number of management layers, rolling out Continuous Improvement initiatives in our contract base, and making better use of our scale in procurement and the operation of shared services.

The total net Revenue reduction in 2016 is however expected to be approximately 20%, resulting from the exit of private sector BPO operations and the substantial amount of contract attrition.  In the light of the associated reduction in profit contribution, we are targeting more significant cost reductions in both central support functions and other overheads.  In our budgets we have set ourselves an increased target of achieving over £50m in further savings in 2016; this is to be delivered from a combined overhead and shared service centre cost base that in 2015 was approaching £500m.  This cost base includes elements that are fixed or semi-fixed in the short term, or are areas of cost, such as business development and bidding, where we want to protect or even increase our spend in order to deliver a strategy for future growth.

Achieving over £50m in further cost savings is the level required to achieve our forecast of approximately £50m of Underlying Trading Profit.  Even at this level, our cost base would not have reduced fully in line with the greater rate of revenue reduction, resulting in a further year of margin pressure.  However, at the same time, we will be focused on developing a more efficient cost model for the longer term; with an overarching plan to stabilise revenues and move back to growth, our aim is to ensure positive operating cost leverage which contributes strongly to our planned outcome of Serco achieving margins at least in line with our industry by the end of our 2020 Strategy Review time horizon.

Concluding thoughts

Having completed the Stabilisation phase of our plan in good order, and delivered on our promises for 2015, we are now focused on the hard work of Transformation.  We are as serious about turning Serco into the best managed business in our sector, as we are about repaying our investors, customers and colleagues for the confidence and support they have shown us over the recent difficult times.  It will take years to achieve all we aspire to, and as we have consistently said there will bumps and mis-steps along the way.  We are rightly cautious on the prospects for 2016 given further revenue attrition and profit pressure, but I am confident we are taking the necessary actions, and have the strategic plan, management team and stabilised financial position in place to succeed.

Rupert Soames OBE

Group Chief Executive Officer

Serco - and proud of it.
 

Divisional Reviews

Consistent with the reporting of the year ended 31 December 2014, this section is presented according to the management structure and internal reporting that Serco put in place for 2015 as a result of actions from the Corporate Renewal Programme and the Strategy Review.  The UK Central Government division ('CG') brings together Serco's work for the UK Central Government, which is principally in the Defence, Justice & Immigration and Transport sectors, with the latter including that for devolved authorities.  The UK and Europe Local and Regional Government ('LRG') division comprises our Health business and our Citizen Services operations, the latter including welfare, business support and BPO services for the public sector, our various support operations to European Agencies, and other direct services such as our environmental and leisure services for local authorities.  Serco's operations in the three other geographic regions are reported as separate divisions, being Americas (consisting principally of our operations in the USA, together with those in Canada), 'AsPac' (the Asia Pacific region, consisting our operations in Australia, together with those in New Zealand and Hong Kong) and the Middle East.  The Global Services division consists of Serco's private sector BPO operations, which for statutory reporting purposes are classified as discontinued operations following Serco's previously announced strategic exit from this market.  Serco's underlying measures include the Revenue and Trading Profit of these discontinued operations for the sake of consistency with previous guidance.

Aligned to statutory reporting and consistent with the reporting of the Year ended 31 December 2014, Serco's share of revenue from its joint ventures is not included in divisional revenue, while Serco's share of joint ventures' profit after interest and tax costs is included in divisional Trading Profit.  As previously disclosed and for consistency with guidance, Serco's Underlying Trading Profit measure excludes Contract and Balance Sheet Review adjustments (principally OCP releases or charges), the beneficial treatment of depreciation and amortisation of assets held for sale, and any other one-time items such as the profit on early termination of a UK local authority contract that occurred in 2015.

*        Statutory reporting only includes the post-tax result of discontinued operations as a single line in the Consolidated Income Statement.

**      The total benefit from not depreciating and amortising assets held for sale is £11.8m including £0.1m of amortisation of intangibles arising on acquisition within Global Services.

***  Other one-time items in the year reflect the profit on early termination of a UK local authority contract.

*        Statutory reporting only includes the post-tax result of discontinued operations as a single line in the Consolidated Income Statement.
 

UK Central Government

The UK Central Government division includes our frontline services in Defence, Justice & Immigration and Transport (including contracts for the Department for Transport as well as those for devolved authorities).

Revenue for the year was £742.1m (2014: £961.4m), a decline of 23%.  At constant currency and excluding the impact of disposals (the Collectica debt collection business disposed in June 2014), the organic decline was 22%.  The principal drivers of the significant revenue reduction were the end of the contracts for the Docklands Light Railway (DLR), National Physical Laboratory (NPL) and the Colnbrook immigration removal centre; together, these three contracts accounted for around 90% of the organic revenue decline.  Other reductions included lower project or volume-related revenue, for example managing the Thameside prison expansion in 2014.  There was limited growth elsewhere to offset these contract ends or reductions, with the largest being the start of the Caledonian Sleeper contract which Serco began operating on 31 March 2015.

Underlying Trading Profit was £53.1m (2014: £58.0m), representing an implied margin of 7.2% (2014: 6.0%).  Trading Profit includes the profit contribution from joint ventures (the vast majority of which for the Group are in this division), and if the £697m share of revenue was also included the overall divisional margin is 3.7% (2014: 3.5%); the joint venture profit contribution of £33.8m was £4.2m ahead of the prior year.  Within Underlying Trading Profit there was £57m of Onerous Contract Provision (OCP) utilisation, which was broadly in line with our original expectations.  This includes those for COMPASS, PECS and FPMS, which as previously disclosed were amongst the largest provisions taken as part of the Contract and Balance Sheet Review.  While there was around an aggregate £28m of loss from these three contracts in 2014 which was neutralised by OCP utilisation in 2015, this benefit was more than offset by the significant reduction in profit contribution from contract attrition and lower project-related profitability, as well as the disposal of the Collectica business.

The Contract and Balance Sheet Review charge taken in 2014 in Central Government was £300.8m.  The net impact of adjustments to key assumptions and other related changes was a £7.1m net release in 2015.  The key movements were OCP releases due to operational improvements on the FPMS and HMP Ashfield contracts, which contributed to more than offset additional charges that were required to be taken such as on the PECS contract where reassessment indicates higher costs to deliver our contractual commitments; reassessment of the OCP required for COMPASS did not result in a charge or release.  After the Contract and Balance Sheet Review adjustments of £7.1m, Reported Trading Profit for the year increased to £60.2m.

UK Central Government represented around £100m of the Group's aggregate total value of signed contracts during the year; there were a limited number of bids due for decision in 2015, with the majority of the value signed reflecting rebids or extensions such as our RAF Northolt and helicopter fleet support operations.

Looking ahead, the impact of known contract losses or other revenue reductions is currently anticipated to have a gross impact of around £100m or approximately 15% in 2016.  The key drivers of this attrition are the transfer back of services that Serco had previously been providing to the Defence Science and Technology Laboratory (Dstl) and the end of the current Defence Business Services arrangement, together with a number of smaller contracts ending or reducing in scope.  The end of the Northern Rail franchise in early 2016 will also result in a substantially lower joint venture profit contribution than the £8.2m received in 2015.

Additionally, of existing work where an extension or rebid will be required at some point during the next three years due to a scheduled contract end date before the end of 2018, there are 12 contracts with annual revenue of over £5m within the UK Central Government division; in aggregate, these represent approximately 40% of the current level of annual revenue for the division.

In terms of areas for future growth, there are two major bids currently under consideration, being the Defence Fire & Risk Management Organisation and the operation of the Clyde and Hebrides Ferries Services.  Following the significant disruption to our customer relationships with UK Central Government in 2013 and the subsequent Corporate Renewal process that was put in place over the course of 2014, we now believe that our relationships with our UK customers are on a firmer footing.  We believe that a number of major opportunities will emerge over the next two years as the UK Government continues its efforts to save cost and improve services.  In particular, as one of the leading suppliers of custodial services in the UK, we are obviously heartened by the declared intention of the UK Government to focus on reform and improvement of the prison system, and are hopeful that this policy may in time produce opportunities for us.

UK and Europe Local and Regional Government

The UK and Europe Local and Regional Government division includes our frontline services in the devolved public service delivery markets of Health, primarily hospital facilities management services, and Citizen Services, which includes welfare and business support operations, BPO services for the public sector, various support operations for European Agencies, and other direct services such our environmental and leisure services for local authorities.

Revenue for the year was £905.8m (2014: £959.8m), a decline of 6%.  At constant currency and excluding the impact of disposals (the Braintree Community Hospital clinical healthcare services business disposed in March 2014), the organic decline was 4%.  There was modest revenue growth from the start of new contracts such as Lincolnshire County Council BPO services and Havering environmental services, together with additional volume-related revenues in health procurement services and a small number of other Citizen Services contracts.  These areas of growth were offset by the end of contracts such as Westminster City Council BPO support, Suffolk Community Healthcare and private sector facilities management for an aviation industry customer, together with a number of other reductions in volume-related revenue predominantly in other Citizen Services operations.

Underlying Trading Profit was £4.7m (2014: £3.4m), representing a margin of 0.5% (2014: 0.4%).  Within Underlying Trading Profit there was £11m of non-exceptional OCP utilisation, which was modestly better than our original expectations.  The main movements in Underlying Trading Profit were the removal of loss on the National Citizen Service contract, together with some initial progress on reducing overhead costs, which were broadly offset by the reduction in profit contribution from the effect of contracts ending or reducing in scope and the in-year loss on the Lincolnshire County Council contract.

The Contract and Balance Sheet Review charge taken in LRG in 2014 was £93.8m.  The net impact of adjustments to key assumptions and other related changes was a £28.2m net charge in 2015.  The principal driver of this was the establishment of a new OCP, together with related impairments and charges, for our business process and contact centre services contract with Lincolnshire County Council; there has been significant operational challenge in the first year, predominantly related to our responsibility to implement a new ERP system, which is now expected to result in losses for the remaining contractual period.  Separately, there was a one-time profit of £9.0m relating to the Thurrock BPO services contract where settlement on early termination had been mutually agreed with the customer; the one-time profit represents a payment to Serco in lieu of anticipated profit in future years, net of direct costs, impairments and other charges.  After these Contract and Balance Sheet Review adjustments and the one-time profit on early termination, the Reported Trading Loss for the year was £14.5m.

LRG represented approximately £400m of the Group's aggregate total value of signed contracts during the year; the largest items were the successful rebids of Serco's support services to Wishaw General Hospital and Norfolk & Norwich University Hospital, various IT support services for European agencies, the new win for facilities management services to the new district general hospital for NHS Dumfries and Galloway, an extension until the end of 2017 for the Child Maintenance Group (CMG) case management contract and a one-year extension to our operation of the Work Programme.

Looking ahead, the impact of known contract losses or other revenue reductions is currently anticipated to have a gross impact of around £200m or approximately 25% in 2016.  The key drivers of this significant rate of attrition are the end of the Suffolk Community Healthcare and National Citizen Services contracts which were heavily loss-making and were not rebid, the early termination of the Thurrock BPO services contract, the ending of certain infrastructure services support to private sector customers, lower revenues on healthcare procurement operations, the reducing scale of CMG operations and a number of other smaller contracts ending or reducing in scope.

Additionally, of existing work where an extension or rebid will be required at some point during the next three years due to a scheduled contract end date before the end of 2018, there are 10 contracts with annual revenue of over £5m within the LRG division; in aggregate, these represent approximately 20% of the current level of annual revenue for the division.

In terms of areas for future growth, we are focused on building our pipeline of opportunities in the UK in Citizen Services (which includes Environmental and Leisure) and Health.  Sharply reduced Local Authority spending is having some unpredictable results: some Local Authorities are taking services back in-house, others are outsourcing them.  Similar pressures apply in the Healthcare sector, where we have a strong position in non-clinical services.  There are currently a number of environmental and hospital facilities management opportunities in the pipeline.  We are working hard across all sectors of this market to develop compelling propositions, and are confident that they will appeal to customers.  In our European business we continue to bid for major IT and operational support projects for government agencies, and are also looking for opportunities to offer other parts of our portfolio, such as immigration services.

Americas

Our Americas division provides professional, technology and management services focused on Defence, Transport, and Citizen Services (principally process outsourcing for government agencies).  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 the year was £693.0m (2014: £708.1m), a decline of 2%.  In US dollars, the main currency for operations of the division, revenue for the year was equivalent to US$1,061m.  The strengthening particularly of the US dollar provided growth of £40m or 6%, with the decline at constant currency being 8%.  This decline was driven by contract attrition from the end of various areas of operations on behalf of the US Federal Retirement Thrift Investment Board (FRTIB), certain US intelligence agency support services and visa processing work.  There was partial offset from expansion in existing services such as the US Affordable Care Act (ACA) eligibility support services contract and naval installation task order work under the Sea Enterprise IDIQ framework.

Underlying Trading Profit was £44.3m (2014: £43.2m), representing a margin of 6.4% (2014: 6.1%).  Within Underlying Trading Profit there was £10m of OCP utilisation, which was more than our original expectations.  The main movements in Underlying Trading Profit were the benefits of cost reduction initiatives and the £2m favourable currency movement, which were largely offset by the reduction in profit contribution from contract attrition.

The Contract and Balance Sheet Review charge taken in the Americas division in 2014 was £26.7m.  The net impact of adjustments to key assumptions and other related changes was a £17.3m net charge in 2015.  The principal drivers of this were the required provision, together with related impairments and charges, for the Virginia Department of Transport (VDOT) operations following operational challenges on the sub-contract related to implementing a new IT system, and an increase in the existing provision for the Ontario Driver Examination Services contract.  After these Contract and Balance Sheet Review adjustments, Trading Profit for the year reduced to £27.0m.

Americas represented approximately £750m of the Group's aggregate total value of signed contracts and order book progress during the year.  The largest were: the successful re-compete of air traffic control services for the Federal Aviation Administration and rebid of classification services for the US Patent and Trademark Office; securing a third year of the expanded services providing eligibility support to the US Affordable Care Act (ACA); and winning a new contract to support the US Naval Facilities Engineering Command (NAVFAC).  Amongst a large number of other smaller contract awards were a one-year extension to the 5 Wing Canadian Forces Base in Goose Bay contract, and rebids of cost analysis support to the US military and personnel identification support to the US Navy.

Looking ahead, the impact of known contract losses or other revenue reductions is currently anticipated to have a gross impact of around £100m or approximately 15% in 2016.  The key drivers of this significant rate of attrition are the early end of the VDOT contract, and the loss of the rebid for record processing at the National Benefits Center.  Additionally, of existing work where an extension or rebid will be required at some point during the next three years due to a scheduled contract end date before the end of 2018, there are five contracts with annual revenue of over £5m within the Americas division; in aggregate, these represent approximately 40% of the current level of annual revenue for the division.

In terms of areas for future growth, our pipeline for the Americas division has remained more buoyant than the UK divisions.  Major new bid opportunities due for decision over the next two years include passport processing for the Department of State and Department of Homeland Security and several opportunities to provide various support functions to the US Navy.  Looking beyond, the market for defence services remains attractive in size and growth potential and other potential bids in transport operational support and Citizen Services are expected to progress through our longer term prospects list.  Options to develop Serco's involvement in non-clinical health support and parts of the Justice & Immigration market will also be evaluated over the longer term.
 

AsPac

Operations in the Asia Pacific division include Justice, Immigration, Defence, Health, Transport and Citizen Services.  With Serco's operations in Australia being by far the largest element of the division, the country represents 16% of total Revenue for the Group.

Revenue for the year was £544.7m (2014: £706.0m), a decline of 23% in reported currency and 15% at constant currency.  In Australian dollars, the main currency for operations of the division, revenue for the year was equivalent to A$1,106m.  Local currency weakness, particularly the Australian dollar, contributed a decline of £57m or 8%.  Excluding the impact of disposals (the Great Southern Rail business disposed in May 2015), the organic decline was 9%.  This decline was driven almost entirely by a further reduction in the volume of work in Australian immigration services, which more than offset growth from the Fiona Stanley Hospital in Perth and the Auckland South Corrections Facility which both became fully operational in 2015, as well as some growth from other areas of scope expansion to existing services such as Acacia prison.

Underlying Trading Profit was £11.9m (2014: £35.5m), representing a margin of 2.2% (2014: 5.0%).  Within Underlying Trading Profit, there was £20m of OCP utilisation, relating principally to the Armidale Class Patrol Boat (ACPB) contract and which was lower than our original expectations; in 2014, the losses on ACPB were not included within Underlying Trading Profit as they were included as part of the Contract and Balance Sheet Review charge.  The main drivers of the reduction in Underlying Trading Profit reflect the impact of the significant scale reduction in Australian immigration services, the in-year loss incurred at Mount Eden Correctional Facility, together with a £2m adverse currency impact.

The Contract and Balance Sheet Review charge taken in 2014 was £237.1m.  The net impact of adjustments to key assumptions and other related changes was a £46.9m net release in 2015.  The agreement reached with the Australian Government to amend the terms of the ACPB contract, which was the Group's single-largest OCP, resulted in a release of £63m, principally due to the contract now ending in June 2017 rather than running through to 2022.  There was partial offset to this release from OCP charges being required on Serco's operations in Hong Kong and in relation to the operational challenges faced on the Mount Eden Correctional Facility contract.  After these Contract and Balance Sheet Review adjustments, Reported Trading Profit for the year increased to £58.8m.

AsPac represented approximately £300m of the Group's aggregate total value of signed contracts and order book progress during the year; the single largest element of this reflects the order book increase to account for a rolling one-year estimate of volumes for Australian immigration services; additionally, a three-year extension for our traffic camera services contract in Victoria was awarded, while most of the other progress represented contracts for various Citizen Services processing support work.

Looking ahead, the impact of known contract losses or other revenue reductions is currently anticipated to have a gross impact of up to £50m or 10% in 2016; this includes the annualisation effect of the GSR disposal and a number of other small losses or reductions, though the result for 2016 will still be susceptible to the prevailing volume of work in Australian immigration services as this single contract represents more than a quarter of the total revenue for the division.  Additionally, of existing work where an extension or rebid will be required at some point during the next three years due to a scheduled contract end date before the end of 2018, there are seven contracts with annual revenue of over £5m within the AsPac division; in aggregate, these represent approximately 15% of the current level of annual revenue for the division.

During the year, Serco was unsuccessful in the major new bid opportunities for Wellington's metro rail service and Australian offshore immigration detention services.  It should be noted that in early February 2016, the Australian Government decided to re-tender the offshore immigration services contract, and as Reserve Bidder in the original tender, has invited Serco and the originally selected Preferred Bidder to re-tender for this opportunity, though as yet we have not included the opportunity in our pipeline as at the time of reporting we have not decided whether to participate in this tender.  A third opportunity in the pipeline, the Icebreaker vessel to be used by the Australian Antarctic Division (AAD), saw Serco selected as Preferred Tenderer, but, as this contract is yet to be signed, it has not been included in the value of signed contracts and remains in the Group's major bids pipeline.  In the short-term, there are few bids due for decision, however over the course of 2016 we expect more to enter the pipeline particularly in the areas of Justice and Immigration services.  Looking beyond, other potential opportunities are expected to be developed in Transport, Citizen Services and non-clinical health services.
 

Middle East

Operations in the Middle East division include Transport, Defence, Health and other Direct Services such as facilities management.

Revenue for the year was £291.4m (2014: £260.4m), an increase of 12%.  Stronger local currency provided growth of 6% and a small health support services acquisition added 2%; organic growth at constant currency was therefore 4%.  This revenue growth was driven by the start of the new contract for the Saudi Railway Company as well as growth from the annualisation of contracts won during 2014 or increases in scope of existing operations, which was partially offset by a small number of operations reducing in scope and the end of air traffic control operations in Erbil.

Underlying Trading Profit was £18.9m (2014: £19.1m), representing a margin of 6.5% (2014: 7.3%).  Within Underlying Trading Profit, OCP utilisation was immaterial.  While Underlying Trading Profit was held level with the prior year, there was margin pressure as a result of attrition and scope reductions being concentrated in areas that were higher margin.

The Contract and Balance Sheet Review charge taken in 2014 was £19.3m.  The net impact of adjustments to key assumptions and other related changes was an £8.5m net release in 2015.  This related to allowances for doubtful debts that had been charged in 2014 but subsequently collected in 2015.  After these Contract and Balance Sheet Review adjustments, Reported Trading Profit for the year increased to £27.4m.

The Middle East represented approximately £200m of the Group's aggregate total value of signed contracts during the year; the largest of these was the new win to support the Saudi Railway Company in the operation of the North-South Railway.  Other wins included successfully securing existing work for logistics and base support services provided to the Australian Defence Force (ADF) in the region, facilities management at Abu Dhabi Global Market Square (formerly Sowwah Square), for Baghdad Air Navigation Services (ANS) and to operate and maintain the Palm Jumeirah Monorail System in Dubai.

Looking ahead, known contract losses or other revenue reductions are currently not anticipated to have a material impact in 2016.  There is though some pressure resulting from the planned transition of certain ANS roles to customers in the region.  Additionally, of existing work where an extension or rebid will be required at some point during the next three years due to a scheduled contract end before the end of 2018, there are seven contracts with annual revenue of over £5m within the Middle East division; in aggregate, these represent approximately 30% of the current level of annual revenue for the division.

In terms of areas for future growth, there remains a vibrant public service outsourcing market in the region and Serco has strong references to continue expanding; whilst the recent reductions in the oil price may lead to some projects being delayed, we, as operators, tend to get involved only when the infrastructure build is at or near completion.  Major pipeline opportunities due for award in 2016 or 2017 now include three major light rail and tram operations in the region, as well as further developments in defence training services and in non-clinical health and other facilities management support.

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, and these include the costs of the Corporate Renewal Programme.

Corporate costs in 2015, before Contract and Balance Sheet Review adjustments, were £51.2m (2014: £52.8m).  While there was some one-time Corporate Renewal implementation work that occurred in 2014, and the benefit of actions taken during 2015 to reduce costs at the centre, these were partially offset by some increased costs in 2015 associated with implementing the Strategy Review and investment in improved management information, systems and processes.

The Balance Sheet Review charge taken in 2014 was £37.3m.  The net impact of adjustments to key assumptions and other related changes was a £3.3m net release in 2015, reducing Corporate Costs within Reported Trading Profit to £47.9m.

Global Services (discontinued operations)

The Global Services division consists of Serco's private sector BPO business, predominantly for customers in the UK, India and North America, following the transfer of public sector BPO operations to our other divisions.  The operations consist of middle and back office skills and capabilities across customer contact, transaction and financial processing, and related consulting and technology services.

As part of Serco's previously announced strategy to exit non-core markets and to focus on the provision of public services, Serco is seeking to exit its private sector BPO operations.  On 31 December 2015, the transaction to dispose of the majority of the offshore private sector BPO operations was completed.  Two smaller but separate transactions relating to some operations in the Middle East are expected to complete in 2016.  The remaining private sector operations, which are predominantly UK onshore operations, will be exited either by further disposals, transfers, early termination or running-off the contracts over their remaining contractual period.

For statutory reporting purposes, the Global Services division is classified as discontinued operations, therefore only the post-tax result of these operations is included as a single line in the reporting of the Group's Income Statement.  However, for consistency with previous guidance, Serco's underlying measures include the Revenue and Trading Profit of these discontinued operations.

Revenue was £337.6m (2014: £359.3m), a decline of 6%.  Stronger local currency provided growth of 2%, with the decline at constant currency being 8%.  The start of the new contract won in 2014 for multi-channel contact services for a major UK retailer provided revenue growth, as did expansion in domestic Indian BPO operations; however, this was more than offset by contract attrition, largely as a result of our managed exit of a number of smaller loss-making contracts in the UK.

Underlying Trading Profit was £14.3m (2014: £6.8m), representing a margin of 4.2% (2014: 1.9%).  Within Underlying Trading Profit, there was £15m of onerous contract provision utilisation.  Drivers of the improvement in Underlying Trading Profit include the benefit of provision utilisation and other actions taken to reduce the impact of loss-making operations.

The Contract and Balance Sheet Review charge taken in 2014 was £30.3m.  The net impact of adjustments to key assumptions and other related changes was a £0.6m net release in 2015.  As the division included assets designated as held for sale, there is a benefit of not charging depreciation and amortisation of £11.7m.  After these Contract and Balance Sheet Review adjustments and held for sale benefits, Reported Trading Profit for the year increased to £26.6m.

Given the disposal of the majority of the offshore operations completed on 31 December 2015, and because there was also good progress during 2015 in managing the exit from the loss-making contracts in the remaining UK onshore operations, the Revenue of £337.6m in 2015 reduces very substantially; Serco's budget for 2016 includes approximately £20m of residual revenue contribution, which will vary depending on the timing of exiting remaining contracts.  The residual operations are expected to contribute an Underlying Trading Loss of around £10m in 2016, reflecting contract losses up to the point of exit together with the effect of 'stranded' shared service centre costs and other overheads previously absorbed by the Global Services division.  Serco is targeting to make progress reducing these stranded costs through additional cost savings over the course of 2016 and beyond.

Finance Review

Overview of Financial Performance

*Restatement of earnings per share reflects adjustment to the weighted average number of shares associated with the Rights Issue

Revenue

Revenue declined by 11.6% in the year to £3,177.0m (2014: £3,595.7m), an 11.2% reduction in constant currency.

Revenue including that arising from operations classified as discontinued declined by 11.1% in the year to £3,514.6m (2014: £3,955.0m), an 11.1% reduction in constant currency.  

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

Trading Profit 

Trading Profit is defined as operating profit as shown on the face of the Consolidated Income Statement before i) amortisation and impairment costs of intangibles arising on acquisitions and ii) exceptional items, adjusted to include the Trading Profit arising on discontinued operations.

Trading Profit increased in the year to £137.6m (2014: Trading Loss £632.1m). The improvement from 2014 is primarily attributable to the 2014 impact of the Contract and Balance Sheet Review that resulted in significant asset impairments, onerous contract provisions (OCPs) and other charges of £745.3m being recorded in that year.

Trading Profit for the Group includes that arising on discontinued operations of £26.6m.

Underlying Trading Profit

Underlying Trading Profit is defined as Trading Profit adjusted to exclude charges and releases made to OCPs, charges and releases made in respect of other items identified during the 2014 Contract and Balance Sheet Review, the beneficial treatment of depreciation and amortisation on assets held for sale and any other one-time items.

Underlying Trading Profit was £96.0m, a decline of 15.2% from 2014. At constant currency Underlying Trading Profit was £95.9m. Commentary on the trading performance of the Group is provided in the Chief Executive's Review and the Divisional Reviews sections above. 

Excluded from Underlying Trading Profit were net charges to OCPs of £3.0m following the annual reassessment undertaken as part of the budgeting process, which would have been a net release of £5.4m at constant currency. Also excluded from Underlying Trading Profit were net releases of £23.9m relating to other provisions and accruals for items identified during the 2014 Contract and Balance Sheet Review.

Underlying Trading Profit excludes the benefit arising from the non-depreciation of assets classified as held for sale. In 2015 depreciation and amortisation of £10.0m and £1.7m respectively was not charged to operating profit on assets classified as held for sale relating to those businesses classified as discontinued operations.

Other one-time items relate to the early termination of a UK Local Authority contract where settlement has been mutually agreed with the customer. The one-time profit represents a payment to Serco in lieu of anticipated profits in future years, net of direct costs, impairments and other charges.

In 2014, Underlying Trading Profit of £113.2m excludes non-exceptional charges made in respect of OCPs, asset impairments and other provisions arising from the 2014 Contract and Balance Sheet Review of £745.3m. 
 

Discontinued operations

Completion of the sale of the majority of the offshore private sector BPO business, which accounted for the bulk of the Global Services division, occurred on 31 December 2015.  The disposal of operations based in the Middle East to the same purchaser is expected to complete in two tranches during 2016 following receipt of the necessary approvals; the balance sheet items associated with these operations remain within assets and liabilities held for sale at 31 December 2015.

During the course of 2015 the other predominantly UK onshore private sector BPO operations have either been sold or exited early, or will be in the near future. As a result, in 2015 the Global Services division is deemed to be a discontinued operation in accordance with IFRS. Those onshore BPO businesses which have not yet been exited are treated as assets held for sale and segregated from the other assets and liabilities on the balance sheet.  

The results of discontinued operations were as follows:

Joint ventures - share of results

The most significant joint ventures are the Atomic Weapons Establishment (AWE) and Northern Rail.  Serco manages AWE in a consortium with Lockheed Martin and Jacobs Engineering Group in a 25-year contract that runs to 2025. In 2015 Serco's share of revenue was £326.1m (2014: £329.8m) and profit after tax was £18.6m (2014: £16.9m). Northern Rail is a 50% joint venture with Abellio to operate a rail franchise that runs until 31 March 2016. In 2015 Serco's share of revenue was £292.7m (2014: £288.7m) and profit after tax was £8.2m (2014: £6.5m). While the revenues and individual line items are not consolidated in the Group Income Statement, summary financial performance measures of the aggregate of all joint ventures are set out below for information purposes.

Exceptional items

Exceptional items are non-recurring 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. 

Exceptional items have arisen on both the continuing and discontinuing operations of the Group. Exceptional items arising on discontinued operations are disclosed on the face of the Consolidated Income Statement within the profit or loss attributable to discontinued operations. Those arising on continuing operations are disclosed on the face of the Consolidated Income Statement within exceptional operating items.

Exceptional loss on disposal of businesses arising on continuing operations

The total exceptional loss on disposal of businesses in 2015, excluding profits or losses arising on the disposal of business classified as discontinued operations, was £2.6m (2014: £2.3m). In May 2015 the Group completed the sale of its Great Southern Rail (GSR) business in Australia for a cash consideration of £2.9m, resulting in a loss on disposal of £2.8m. The transaction was part of the disposal programme of businesses identified as not being core to Serco's future strategy, as announced initially in November 2014. In addition, in January 2015, the Group disposed of its National Physical Laboratory (NPL) business for a consideration of £12.1m, with no gain or loss on disposal.  AgPlus was a subsidiary of NPL which was retained and sold separately with a gain of £0.5m being recognised. In June 2015, the Group also disposed of its Serco India Private Limited business, representing the Group's frontline public services operations in the Indian transport sector, for a consideration of £1.0m, resulting in a loss on disposal of £0.8m. All of these businesses were classified as held for sale as at 31 December 2014. In 2015 there was also an exceptional gain of £0.5m recognised relating to transactions completed in prior periods.

Other exceptional operating items arising on continuing operations

Goodwill is tested for impairment annually or more frequently if there are indications that there is a risk that it could be impaired. The recoverable amount of each Cash Generating Unit (CGU) is based on value in use calculations derived from forecast cash flows based on past experience, adjusted to reflect market trends, economic conditions, the Group's strategy and key risks. These forecasts include an estimated level of new business wins and contract attrition and an assumption that the final year forecast continues into perpetuity at a CGU-specific terminal growth rate. The terminal growth rates are provided by external sources and 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.

In 2015, we conducted impairment testing of our CGUs that has identified a non-cash exceptional impairment to continuing operations of £87.5m (2014: £181.2m), primarily due to a higher level of contract attrition than previously forecast and the associated impact on future cash flows. The impairments arose in the following CGUs.

In 2015, a charge of £19.7m (2014: £24.0m) arose in relation to the restructuring programme resulting from the Strategy Review. This included redundancy payments, provisions, external advisory fees and other incremental costs.

The disposal of the Environmental and Leisure businesses was aborted in the year and as a result the one-off costs of £1.7m associated with the aborted sale have been treated as exceptional.

In 2015, there were exceptional costs totalling £1.2m associated with the UK Government reviews, this reflected external costs incurred and included external adviser costs related to these reviews. In 2014 costs totalling £9.2m were incurred associated with both the UK Government reviews and the programme of corporate renewal.

In 2015, the exit of the UK Frontline Clinical Health contracts was completed with the Cornwall Out of Hours contract being exited in May and the Suffolk Community Healthcare contract ended in September. On completion of the contract exits, existing OCPs of £2.8m that are no longer required were released and recorded as a credit in exceptional items.      

In November 2014 the Group agreed to settle a dispute with the Trustees of the Docklands Light Railway (DLR) Pension Scheme over the extent of its liability to fund the deficit on the scheme. The settlement resulted in a total exceptional charge inclusive of costs of £35.6m, consisting of the full and final settlement amount of £33.0m and costs of £2.6m.  The settlement is to be paid over four equal annual instalments from January 2015 to January 2018 covering all past and any future DLR associated pension liabilities. 

In 2014 an exceptional provision of £20.1m was recognised for legal claims made against Serco for commercial disputes. This provision was based on legal advice received by the Company. There have been no further charges in 2015 in relation to these disputes.

In 2014 an impairment review was performed on the Australian rail business, Great Southern Rail (GSR), resulting in a charge totalling £37.2m. This consisted of an impairment of £23.1m to reduce the carrying value of its net assets to the estimated recoverable amount and a charge of £14.1m in relation to the break costs of leases relating to the business. The GSR business was exited in May 2015, with the loss on disposal of £2.8m, included within loss on disposal of businesses.

Exceptional profit or loss on disposal of discontinued operations

Completion of the sale of the majority of the offshore private sector BPO business occurred on 31 December 2015. During the year the Group also disposed of businesses in relation to the predominantly UK onshore private sector BPO business. The net assets at the date of disposal of discontinued operations were:

The loss on disposal is calculated as follows:

The offshore disposal reflects the majority of the offshore BPO operations, which excludes the consideration and net assets related to the smaller but separate disposal transactions of operations in the Middle East that are subject to separate completion in 2016. As at 31 December 2015 the net assets relating to the Middle East were £15.0m and expected consideration in respect of the disposal was £15.0m.

The UK onshore business is being sold or transferred as components to various different purchasers.  One element was sold in the year and the elements remaining at the year-end are expected to be sold or transferred during 2016.

Other exceptional operating items arising on discontinued operations

In 2015 a charge of £2.2m (2014: £8.7m) has arisen in discontinued operations in relation to the restructuring programme resulting from the Strategy Review.

During 2015, an impairment test of the Global Services business was conducted as a result of the offers received in the year together with movements of the assets held for sale since the end of 2014. The impairment testing identified a non cash exceptional impairment of goodwill relating to discontinued operations of £65.9m (2014: £284.8m) as a result of a reduction in the carrying value of net assets due to a decrease in the estimated recoverable amount of the CGU; this was recorded at the half year. Assets other than goodwill have also been impaired by a total of £14.9m (2014: £39.2m). The impairment of goodwill relates primarily to the offshore Global Services business, the majority of which was disposed of on 31 December 2015, and the other asset impairments to the UK onshore business.

Exceptional finance costs

In December 2014, agreement was reached for the Group to defer its December 2014 covenant test until 31 May 2015. As a result, costs were incurred in 2015 to preserve the existing finance facilities.  In addition, payments were made to the US Private Placement (USPP) Noteholders as a result of early settlement following the Group refinancing.  Total charges of £32.8m have been treated as exceptional items as they are outside of the normal financing arrangements of the Group and are significant in size.

Other finance costs and investment income on continuing and discontinuing operations

Investment income of £8.2m (2014: £6.2m) principally relates to interest earned on deposits during the period of £3.2m and interest accruing on net retirement benefit assets of £4.9m.

Other finance costs of £40.2m (2014: £42.9m) principally relate to interest incurred on the USPP loans and the Revolving Credit Facility (£24.7m), facility fees and other charges (£7.2m) and the movement in discount on provisions (£5.6m).

In total, pre-exceptional net finance costs were £32.0m (2014: £36.7m).

Taxation on continuing and discontinuing operations

Our tax strategy is to manage all taxes to ensure that we pay the appropriate amount in the countries in which we operate, while both respecting applicable tax legislation and utilising appropriate legislative reliefs.  Our strategy is aligned with the Group's business strategy and endorsed by the Board.  Responsibility for tax strategy and risk management sits with the Chief Financial Officer.  Day to day delivery of the strategy is executed by a global team of tax professionals who are aligned with our businesses and who work closely with local tax authorities and local advisers.

Tax charge

In 2015, we recognised a tax charge of £36.7m on a pre-tax and pre-exceptional profit of £100.7m representing an effective tax rate of 36.4%.  The tax charge on an underlying basis, reflecting Underlying Trading Profit of £96.0m less pre-exceptional net finance costs of £32.0m, was £30.5m, representing an effective tax rate of 47.7%.

A £3.1m tax credit was also recognised on exceptional losses of £220.3m.  The principal reasons for the absence of a tax credit on these exceptional costs is that no UK deferred tax asset is being recognised in respect of UK costs and no tax deduction is available for the impairment of goodwill in any territory.  The credit of £3.1m represents tax relief on restructuring costs in overseas territories and the benefit of a tax credit from losses sold to joint venture partners.

The principal reasons why the effective tax rates are higher than the UK standard corporation tax rate of 20.25% are due to higher rates of tax on profits arising on our international operations, together with the absence of any deferred tax credit for losses incurred in the UK (which includes the result of UK divisions, the majority of corporate costs and certain interest costs).  The increase in the effective tax rate has been partially offset by a tax credit on the recognition of additional deferred tax assets that were not previously recognised on provisions in Australia.

Our tax charge in future years will continue to be materially impacted by our accounting for UK deferred taxes.  To the extent that future UK tax losses are not recognised, our effective tax rate will be higher than prevailing standard corporation tax rates as we will not be able to recognise the associated tax benefits arising.  To the extent that our existing UK tax losses are subsequently recognised or utilised, our effective rate will be impacted by the associated tax benefit and will reduce accordingly. 

Contingent tax assets

At 31 December 2015, the Group has gross estimated unrecognised deferred tax assets of £1.05bn (£195m net), which are potentially available to offset against future taxable profits.  These principally relate to tax losses of £890m.  Of these tax losses, £761m arise in the UK business (net £137m) - £584m arising in Serco Limited, the Group's principal UK trading entity; the remaining £177m of tax losses arise in other UK group companies.  Of the net £137m of UK tax assets in respect of losses, only £10.5m is recognised on the balance sheet on the basis of forecast utilisation against future taxable profits, with the remaining £126.5m being a contingent asset not recognised.

Taxes paid

Net corporate income tax of £9.4m was paid during the year, relating primarily to our operations in Americas (£2.2m), India (£6.7m), Middle East (£1.3m), Europe (£3.6m) and offset by tax refunds arising in AsPac (£4.4m) in respect of prior years.  The Group's UK operations have been loss making overall and accordingly no tax payments have been due.  During the year the Group has transferred tax losses to its profitable joint ventures in return for cash payments from the joint ventures of £6.7m, resulting in an overall tax paid figure in our cash flow of £2.7m. 

Dividend

As indicated in March, the Board is not recommending the payment of a dividend in respect of the 2015 financial year. The Board is committed to resuming dividend payments when it is prudent to do so.  The Directors' decision as to when to declare a dividend and the amount to be paid will take into account the Group's underlying earnings, cash flows and financial leverage, together with the requirement to maintain an appropriate level of dividend cover and the market outlook at the time.

Share count and earnings per share

The equity placing conducted in May 2014 and Rights Issue in April 2015 increased the weighted average number of shares for earnings per share ('EPS') purposes to 986.5m (2014: 655.1m). The annualising effect of the Rights Issue will further increase the weighted average number of shares to approximately 1,099m for 2016.

EPS before exceptional items from both continuing and discontinuing operations was 6.55p per share; including the impact of exceptional items there was a loss of 15.47p per share.

Underlying EPS was 3.44p per share. This measure reflects the Underlying Trading Profit £96.0m and deducts pre-exceptional net finance costs (including those for discontinued operations) and related tax effects.

Cash flow and reconciliation to net debt

The table below shows the operating loss and Free Cash Flow reconciled to movements in net debt.  Free Cash Flow is the cash flow from subsidiaries and dividends received from joint ventures and is stated before exceptional items which are considered non-recurring in nature. Free Cash Flow for 2015 was an outflow of £16.2m compared to an inflow of £62.2m in 2014.  

Operating cash flow (before movements in working capital, exceptional items and tax) was £82.5m, a reduction of £3.9m from the prior year; included within this are movements in provisions that in the year predominantly reflect the cash outflows in relation to onerous contracts whilst in the prior year the movement reflects the establishing of provisions for onerous contracts identified following the 2014 Contract and Balance Sheet Review. The year-on-year decrease in other non-cash movements is principally due to the 2014 impairment of working capital items that arose following the Contract and Balance Sheet Review.

2015 free cash flow reflects a £22.6m outflow in working capital from the continued normalisation of balances at the end of the statutory period compared to the average for the period, tax returning to a paid position compared with a small net refund received in 2014 and higher net purchases of tangible and intangibles assets of £36.0m.

The impact of the Contract and Balance Sheet Review was mostly non-cash in nature in 2014, relating principally to provision movements and other impairments.

Average net debt for the year ended 31 December 2015, calculated on a daily basis, was £454.8m a reduction of (£323.8m) from the 2014 average net debt of £778.6m. The reduction in net debt was predominantly due to the Rights Issue and proceeds from the disposal of the offshore private sector BPO business. 

The table below provides an analysis of trading cash flow and provides the pre-interest and pre-tax cash flows equivalent to Underlying Trading Profit. This is derived from the cash flow from operating activities excluding tax items and is shown after net capital expenditure and after dividends received from joint ventures.  

The percentage conversion of Underlying Trading Profit into trading cash flow is also provided in this table and this is 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. This measure is impacted by provisions related to onerous contracts, and we would expect it to be impacted in future periods by the expected utilisation of OCPs.  

The Underlying Trading Profit conversion into trading cash flow was 20.7%. This was due primarily to the cash outflows on provisions movement, including assets held for sale £116.0m, the outflow of working capital of £22.6m in the year from the continued normalisation of balances at the end of the statutory period compared to the average for the period, and from the net purchase of tangible and intangible assets £72.5m. These reductions to cash were largely offset by the impact of depreciation, amortisation and impairments during the year, including the Underlying Trading Profit benefit relating to assets held for sale, £83.2m, the cash inflows arising from one-time items and the collection of bad debts provided for under the Contract and Balance Sheet review £18.4m and other non-cash items £31.3m.

Analysis of net debt

Net debt, including assets held for sale, reduced to £77.5m (2014: £682.8m), predominately due to the proceeds received from the Rights Issue and from the disposal of the offshore private sector BPO business.

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 - 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 review. 

Liquidity and funding

As at 31 December 2015, the Group had committed funding of £855m, comprising a £480m revolving credit facility with a syndicate of banks and £375m of private placement notes. In addition the Group had a receivables financing facility of £30m.  The principal financial covenants attaching to these facilities are that the ratio of net debt to EBITDA should not exceed 3.5x and the ratio of EBITDA to interest expense should be greater than 3.0x. 

In April 2015 the Group raised gross proceeds of £555m from the Rights Issue, of which £450m was used to reduce gross indebtedness (see Rights Issue, debt refinancing and covenants below).

Following the disposal of the majority of the offshore private sector BPO operations, the Group was required to offer the net disposal proceeds to the debt holders in prepayment. Two thirds of the proceeds were offered to private placement note holders at par and one third to repay any outstanding drawdowns on the revolving credit facility (nil outstanding at 31 December 2015). As a result of this process, £113m of private placement notes were repaid on 16 February 2016, leaving £262m of private placement notes in issue at that date.

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 policies require us to maintain a minimum proportion of fixed rate debt as a proportion of overall net debt and for this proportion to increase as the ratio of EBITDA to interest expense falls.  As at 31 December 2015, more than 100% of the Group's net debt was at fixed rates. Interest on the revolving credit facility is at floating rate, however it was undrawn. 

Foreign exchange risk

The Group is subject to currency exposure on the translation to GBP 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 GBP and USD. 

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. 

Rights Issue, debt refinancing and covenants

The Group announced in November 2014 plans for new equity to be raised through a Rights Issue and for the proceeds to be used primarily to reduce the Group's indebtedness. This was launched on 12 March 2015 and received shareholder approval on 30 March 2015. The equity Rights Issue successfully completed in April 2015 raising approximately £555m of gross proceeds (£530m net after expenses), with trading in new shares commencing on 17 April 2015 and 549,265,547 new shares being issued.

On 30 April 2015, the Group concluded a refinancing with its lending banks and private placement noteholders. This included the reduction of gross indebtedness by £450m.  The Group's committed revolving credit facility was reduced in size from £730m to £480m and the maturity date extended by two years to April 2019. Financial covenants across the Group's funding arrangements are unchanged, reflecting the strengthening of the Group's balance sheet by the Rights Issue. Fees and expenses relating to the repayment of the Group's borrowings and amendments to the existing finance agreements were £33m, and these included a premium of £25m on the early settlement of private placement notes.  These expenses have been treated as exceptional finance costs.

In accordance with the amended terms of Serco Group plc's borrowing facilities, compliance certificates for the year to 31 December 2014 and 12 months to 30 June 2015 were submitted to its lenders in May and September 2015 respectively, and these showed the Group complied with the financial covenants.

For covenant purposes the definition of Consolidated Total Net Borrowings (CTNB) represents Group recourse net debt at the balance sheet date adjusted to exclude encumbered cash, loan receivable amounts, and also adjusted to reflect the impact of currency hedges associated with recourse loans.   The covenant definition of EBITDA is the twelve month operating profit of the business before exceptional items, deducting profits from joint ventures and after adding back depreciation, intangible amortisation, share-based payment charges and dividends received from joint ventures. The covenant test for 31 December 2014 was deferred until 31 May 2015. The covenant definition of EBITDA for 31 December 2014 and the 12 months to 30 June 2015 was amended to exclude the impact of charges arising from the Contract and Balance Sheet Review whilst CTNB was calculated after the proceeds less underwriting charges from the equity Rights Issue. The covenant test for the years ended 31 December 2014 and 2015 are shown below.

Balance sheet summary

The balance sheet at 31 December 2015 is summarised below showing the impact of the assets and liabilities held for sale for each line item. At the year end the balance sheet had net assets of £282.1m, a movement of £348.3m from the 2014 closing net liabilities position of £66.2m. The movement is mainly due to the funds raised through the Rights Issue and a reduction in provisions due predominantly to utilisation, partially offset by the impairment to goodwill. The balance sheet is summarised below:

Provisions

The total of current and non-current provisions, excluding provisions related to businesses held for sale, has decreased by £96.2m since 31 December 2014, the majority of which relates to a reduction in contract provisions as a result of the utilisation and release of provisions against losses on onerous contracts, offset by new or additional onerous contract provision charges made in the year.  Movements in contract provisions, including those related to businesses held for sale since the 31 December 2014 balance sheet date, are as follows:

Onerous Contract Provisions (OCPs) arising from the Contract and Balance Sheet Review in 2014 accounted for £447.1m of the 31 December 2014 contract provisions balance shown above. A full assessment of the forecasts that form the basis of the OCPs is conducted annually as part of the budgeting process.

In 2015, additional charges have been made in respect of future forecast losses on onerous contracts of £91.8m. This increase related to revisions to existing contracts of £53.1m and new provisions raised on contracts of £38.7m. New contract provisions include charges of £34.0m in respect of the Lincolnshire contract, details of which are provided below. In 2015, releases to the income statement from OCPs were £91.6m, including a release of £62.7m resulting from the renegotiation completed in November 2015 of our contract to operate and maintain a fleet of patrol boats for the Royal Australian Navy. This contract was the single largest OCP charged in 2014.

Utilisation of OCPs in 2015 was £124.9m; of this £10.8m was utilised against OCPs recorded as exceptional items. The OCPs arising as exceptional items relate solely to contracts within the UK Frontline Clinical Health sector following the decision in 2013 to exit this sector; this exit was completed in September 2015 when the Suffolk Community Healthcare contract ended.

Below is an update for the largest OCP contracts following the reassessment conducted as part of the annual budget process: 

Armidale Class Patrol Boats (ACPB)

The ACPB contract relates to the operations and maintenance of a fleet of patrol boats for the Royal Australian Navy.  This contract was entered into in December 2003 with an initial design and build phase, after which the fleet became operational in 2007. Serco's key obligation is to have the fleet available for operations for a fixed number of days a year.

In November 2015, agreement was reached with the Australian Government customer to amend the terms of the ACPB contract. The main changes agreed within the amendment are for an improved service regime under an enhanced maintenance and remediation scope of works and schedule, for Serco to provide maintenance and remediation work on an agreed cost recovery basis subject to strict expenditure caps and audit processes, and that the contract will end in June 2017 rather than running through to 2022. Furthermore, under the terms of the Settlement and Amendment Deed, both parties agreed to a mutual release of claims they may have had against each other prior to the point of contract amendment. As a result of the agreement the OCP forecast has been reassessed resulting in a release of £62.7m.

Commercial and Operational Managers Procuring Asylum Support Services (COMPASS)

The COMPASS contract with the UK Home Office is for the provision of accommodation, transportation and subsistence payments for asylum seekers whilst their claims are being processed. Claim processing can take from a few months to several years. This contract commenced in 2012 and provides services in two of the six administrative regions of the contract in the UK; the North West, comprising fourteen Local Authority areas; and Scotland and Northern Ireland. The contract runs to December 2017, with a further extension of up to two years at the option of the customer.

In 2015, the numbers of service users continued to be volatile, however for the year as a whole utilisation of the onerous contract provision was in line with the forecast expectation. The forecasts for the contract have been reassessed with the result being that the remaining balance of the provisions as at 31 December 2015 of £89.1m, is considered sufficient to cover the anticipated losses over the remaining contract term. The final outcome over the contract life will be heavily dependent on the future number of asylum seekers, the volatility of numbers and our ability to find suitable accommodation.

Future Provision of Marine Services (FPMS)

The FPMS contract that commenced in 2007, which has a 15-year duration, provides marine support services to the UK Ministry of Defence (MOD) dockyard ports of Portsmouth, Plymouth and Faslane as well as support to military exercises and training to the Raasay Ranges. 

In 2015 the contract has performed better than expected due largely to lower costs in respect of backfill vessel bookings and dockings, and the revenues from additional taskings from the customer. The forecasts for the contract have been reassessed with the result being a net release of £2.1m due to both the favourable performance in the year and savings expected in future years from a voluntary redundancy programme run in 2015; partially offset by lower RPI inflation on the contract than previously forecast and costs relating to the purchase of a new vessel.

Prisoner Escort and Custody Services (PECS)

The contract provides prisoner transportation between courts and prisons and for the management of prisoner welfare when at court for the Ministry of Justice (MOJ). It was awarded in 2011 and runs for seven years.

In 2015, utilisation of the OCP was slightly higher than originally expected. The contract is operated with a very challenging KPI regime and in order to meet these KPIs we require a larger workforce than previous envisaged, along with the associated recruitment, training and contract management costs; the forecast for the contact has been reassessed with the result being an increase to the OCP of £11.3m. In the case of this contract, we have judged that it is unlikely that the customer will wish to extend this contract beyond its minimum term in 2018 on the current basis.  If this judgement proves to be incorrect, further OCP charges may be required.

HMP Ashfield

The HMP Ashfield PFI contract commenced in 1999 and runs through to 2024. In 2013 the operational role of Ashfield changed from a Young Offender Institution to an adult male sex offenders' prison, resulting in a changed cost base. Since the change of operational role of the prison the MoJ has imposed a level of pricing that we dispute, and which would result in substantial losses over the remaining life of the contract. Discussions with the MoJ around re-pricing proposals are expected to conclude in 2016.

In 2015 performance has been slightly better than expected due to the benefit of in year cost savings. The forecast for the contract has been reassessed with the result being a release of £8.7m due to the expected future ongoing benefits of the cost reductions and efficiencies delivered in 2015.

Lincolnshire County Council

The Lincolnshire contract commenced in April 2014 with a transition phase expected to complete in March 2015 before full operational services were due to commence in April 2015. The contract is for an initial five year term, commencing April 2015, with a further two extension periods of two years each exercisable at the customer's option.

The contract scope is to provide the following outsourced services: information management and technology services and support; back office services including finance, HR and payroll services; and customer services acting as the internal and external point of contact for Lincolnshire County Council and all Council services.

In 2015 the contract had difficulties implementing a new Enterprise Resource Planning (ERP) system and resolving these issues has been more complex and protracted than originally anticipated. While we are making good progress, the full implementation of the new system is not expected until later this year. The delay has impacted our ability to make the wider service transformation changes needed to make the contract more efficient and also led to operational service difficulties, triggering service credits. The issues have also resulted in the requirement to increase and maintain additional management and support resources on the contract to remediate the problems faced.

As a result of these factors a charge totalling £34.0m was taken in 2015, comprising a provision for future losses over the remaining term of the contract. In 2015 £5.3m of the provision was utilised against the impairment of assets. The in-year losses incurred on the contract, of £5.2m, were recorded within Underlying Trading Profit.

The OCPs referred to above account for 76% of the total OCP balance as at 31 December 2015.

Other OCP movements in the year occurred across multiple sectors and geographies in which Serco operates and at 31 December 2015 there were no other OCPs that have expected cumulative future losses in excess of £15m.

The other movements include additional charges made in the Americas in respect of revised expectations and contract exits, additional charges relating to our Hong Kong operations, a further provision on a UK Transport contract and new charges made in respect of a Justice and Immigration contract in AsPac.

Other Contract and Balance Sheet Review items

In addition to the net charge of £3.0m impacting non-exceptional OCPs, there were other adjustments arising in the period on items identified during the Contract and Balance Sheet Review. These adjustments relate to a number of items including:

·         The releases of other provisions and accruals of £26.5m where liabilities have either been settled for less than the amount provided or accrued or have lapsed due to the passage of time.

·         The release of allowances for bad debts of £8.5m following the receipt of payments in respect of old outstanding balances.

·         Additional charges made in the year of £11.1m to increase provisions or settle further liabilities arising on items identified during the Contract and Balance Sheet Review.

The overall net improvement to Trading Profit from OCPs and other Contract and Balance Sheet Review adjustments was therefore £20.9m in the year.

Pensions

At 31 December 2015, the net retirement benefit asset included in the balance sheet arising from our defined benefit pension scheme obligations was £94.8m (2014: £101.1m). The pension scheme asset base is £1.3bn (2014: £1.5bn).

The Group provides a number of occupational defined benefit and defined contribution schemes for its employees.  The Group's principal defined benefit pension scheme is the Serco Pension and Life Assurance Scheme (SPLAS) and this had a surplus of £127.1m (2014: £143.9m) calculated under IAS19 rules and is shown in the non-contract specific section of the above table. 

The decrease in the surplus was driven principally by a decrease in the value of Liability Driven Investment (LDI) assets in the year. Certain LDI assets were transferred to a separate gilt portfolio in late December to back the longevity swap and those gilts (£50m) still contribute to the Scheme's overall interest rate and inflation protection but do not fall under the classification of LDI. Assets have also been disinvested to meet cashflow requirements (particularly member benefits) over the year.

Of the total net retirement benefit asset of £115.6m (2014: £130.5m), of that related to non-contract specific schemes there was a surplus of £127.1m (2014: £143.9m) in SPLAS, a deficit of £11.1m (2014: £13.1m) in the Serco Section of the Railways Pension Scheme and a deficit of £0.4m (2014: £0.3m) in a small German pension scheme.

The last formal actuarial valuation of SPLAS was undertaken as at 5 April 2012 and showed a deficit of £24m. The estimated actuarial deficit at 31 December 2015 was approximately £28m (2014: deficit £5m). The principal difference between the actuarial valuation and the IAS19 valuation relates to the use of a lower discount rate applied to measure the scheme liabilities for the actuarial basis.  The main investments of this scheme are LDI assets that seek to reduce volatility by matching the liabilities of the scheme for changes in interest and inflation rates through a combination of gilts and corporate bonds with inflation and interest swap overlays.  

In the period, Serco Caledonian Sleepers Ltd began to trade and the Serco Caledonian Sleeper Shared Cost Section of the Railways Scheme became part of the Group. As at 31 December 2015 there was a nil deficit on the Serco Caledonian Sleeper Shared Cost Section of the Railways Scheme contract after the franchise adjustment. 

Pre-tax ROIC

Pre-tax ROIC is calculated as Trading Profit divided by the Invested Capital balance.  Invested Capital represents the assets and liabilities considered to be deployed in delivering the trading performance of the business.  Of the total assets on the balance sheet, Invested Capital assets are: goodwill and other intangible assets; property, plant and equipment; interests in joint ventures; trade and other receivables; inventories; and assets classified as held for sale.  All other assets are excluded from Invested Capital, being: retirement benefit assets; tax assets; derivative financial instruments; and cash and cash equivalents.  Of the total liabilities on the balance sheet, Invested Capital liabilities are trade and other payables and liabilities classified as held for sale.  All other liabilities are excluded from Invested Capital being: retirement benefit obligations; tax liabilities; provisions; obligations under finance leases; derivative financial instruments; and loans. 

In 2015 Invested Capital is calculated using the two-point average of the opening and closing balance sheets for the year. For 2014 a single point was utilised due to the significant reduction in net assets during the year.

For 2015 the return from Underlying Trading Profit was 11.1%. The composition of Invested Capital and calculation of ROIC is summarised in the table below. 

Invested Capital and Pre-tax ROIC %

Profit Forecast

On 11 March 2015, we issued profit forecast guidance based on a number of forecasting assumptions that were published in the Group's Rights Issue Prospectus. Our Trading Profit results for the year, prepared on a comparable basis to the profit forecast assumptions, are consistent with our reported Underlying Trading Profit of £96m. Hence, our results for the year are broadly in line with the published Trading Profit forecast of around £90m.

Notes:

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

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