Serco Group's (SECCF) CEO Rupert Soames on Q2 2014 Results - Earnings Call Transcript

Aug.12.14 | About: Serco Group (SECCF)

Serco Group PLC (OTCPK:SECCF) Q2 2014 Earnings Conference Call August 12, 2014 4:30 AM ET

Executives

Rupert Soames – Chief Executive Officer

Andrew Jenner – Chief Financial Officer

Ed Casey – Chief Operating Officer

Analysts

Andy Chu – Deutsche Bank

Julian Cater – Numis Securities

Karl Green – Credit Suisse

Graham Brown – Canaccord Genuity

George Gregory – Exane BP Paribas

Kean Marden – Jefferies

Rob Plant – JPMorgan

Rupert Soames

Good morning, everybody. My name is Rupert Soames. Thank you for joining us here today, including those of you who have joined us via the live webcast. This is the agenda for the day.

I am going to start by going through the highlights of the half year, then Andrew will take you through the financials, Ed will give you an operational overview, and I will then summarize and close then, of course, we'll be happy to answer your questions.

So, let me start with an overview of the half year. The financial results for the first half of 2014 were in line with our revised expectations. Revenues in constant currency was broadly level, though profitability is significantly reduced, not only at adjusted operating profit, but more starkly at pre-tax level where the significant burden of exceptionals take us to a first half loss. It makes little difference to the owners of a business whether profits are impacted by current trading or by exceptionals, a loss, in my view, is a loss and it hurts.

The challenges facing the business are numerous and we will talk about many of them today. I am not sure in the Great British Lexicon what the collective noun for alligators nipping at your backside is but, whatever it is, we’ve got it. We’ve recognized at the end of April, that if earnings were to reduce in line with the revised internal forecast, it would impact our leverage ratios. So, we strengthened the balance sheet through an equity placing. This, together with an improved free cash flow have substantially reduced the Group’s net debt.

We are maintaining our guidance for the 2014 full year although it’s clear that many challenges and uncertainties remain and we will cover those a little later. The Strategy Review is running to plan and we have now largely competed the first phase of fact gathering and we are establishing a clear picture of our current markets. Our corporate renewal program is also running to plan with a few outstanding actions due to be completed by the end of this month.

Such progress has made a big difference in our ability to rebuild the trust and confidence of the UK government and I am pleased to say that the government appear to keen to see us back on straight and narrow. Now as a service company, our success is entirely dependent on the motivation and skill of our people.

The events of last year relating to our prisoner escorting and electronic monitoring contracts resulted in a number of senior managers leaving the UK business and the sheer weight of the adverse publicity and scrutiny has had an understandable impact on morale. Serco has always emphasized its values-based approach to management and to most employees at Serco were proud that they work for a company that they believe always operated to the highest ethical standards.

So discover that this have not always been the case came as a profound shock and it was no constellation that the misbehavior discovered was limited to two out of more than 700 contracts. Now, again it’s take time to heal these moves and restore self-confidence and trust.

And as always, actions will speak louder than words. The extensive work we’ve undertaken as part of the corporate renewal program agreed with governments to address the issues has helped. It has helped to restore faith in our determination to uphold the highest corporate values. It is also more than normally important that we show colleagues and customers that we can attract high quality people to the business.

I am therefore, very pleased to say that we have succeeded in making some really strong appointments. Now as you can imagine, I am naturally delighted that the old couple are back together. Angus Cockburn with whom I worked for 11 years at Aggreko will be joining Serco as our new Chief Financial Officer as at the end of October.

He was instrumental in the success of Aggreko, he is a highly experienced CFO and he and I have complementary skills. We’ve also made good progress strengthening our UK management team with the appointments of Kevin Craven, to run the Central Government division and Liz Benison to run Local and Regional Governments, both of them starting next month.

David Eveleigh will join as General Counsel and Company Secretary in November. I would also like to pay tribute to the dedication of Bob McGuiness and Andrew White, who stepped into the breach to run the UK divisions whilst we were looking for new leadership; and of course, I am grateful to Andrew Jenner who has continued to guide the Finance function under circumstances which were far from easy.

And talking of whom, I’ll now hand over to Andrew to take you through the financials which you can see here in the summary. Andrew will be followed by Ed Casey, to give you an operational update. So, Andrew?

Andrew Jenner

Thank you Rupert and good morning everyone. In this section, I’ll cover the Group’s income statements and cash flow as well as net debt leverage and funding. As usual, I will conclude with our financial outlook and assumptions.

So let me turn firstly to the detail of the income statement. £2.4 billion, growing 1.1% at constant currency. Adjusted operating Profit was £51 million, representing a margin of 2.1%. Equivalent constant currency number was £60 million. Adjusted Net Finance Costs reduced by £2 million, which includes the benefit of lower average net debt and adjusted PBT was £33 million.

So let me now show you the breakdown of divisional performances of revenue and then profits. Now just focus here on the table at the top which breaks down by division, the Group’s adjusted revenue decline of 5%.

Organic growth was 2% which is driven by the America’s progress on new contractors started in the second half of last year and by some good growth in the AMEAA region. And Ed will give more details on growth to each division later.

Disposals in the LRG division is principally the effect of the sale last November of the UK transport maintenance and technology business. This reduced Group revenues by 1%. And then in terms of foreign currency, given the strength of the sterling over the last 12 months, this reduced our reported revenue by 6%.

Turning then to the breakdown of operating profits, the chart at the top breaks down the Group’s decline and adjusted operating profit by division and beneath that the principal profit impacts by type. The biggest movement on contracts was on Australian immigration sales it’s DIPB.

We’ve reduced volumes impacting Group profits by about £15 million. In addition to the effect on the AMEAA division the contractors become more mature to support from the UK Central Government division has reduced. And so have a share of the contracts’ profit.

The impact of other contract situation aggregates to approximately £15 million. This includes in Central Government the lots of electronic monitoring and most of the decline in the America division is also attrition-related. A number of other contractor changes have impacted performance.

These amount to over £25 million in aggregate and include the renegotiations of Northern Rail and AWE within Central Government. The initial transformation periods having ended on Shop Direct and AEGON in Global Services and the exit cost to Australian garrison support within SSDS and AMEAA.

Other cost impacts across the Group total about £30 million. The majority is in Central government and includes the investment in additional resources on PECS and COMPASS, together with a booking onerous contract provision of £6 million in the first half.

Actions arising from Corporate Renewal, for example now having two divisions in the UK have also increased period-on-period costs. Of the remaining reduction the largest part is the £9 million impact from currency spread across AMEAA, Global Services and Americas.

Moving to the bottom half of the income statement I am showing here the items the low adjusted profit before tax to reconcile to the statutory measures. There was a decrease in the amortization of intangibles arising on past acquisitions as the amortization has now ended on some of these.

On this next slide given more detailed breakdown on exceptional items all these items except the pension provisions we have disclosed previously with the phasing and amounts consistent with previous expectations.

The biggest element is the restructuring charge that we announced at the start of the year to reduce headcount and related cost such as property.

The provision for settlement relates to pension deficit funding on the DLR swing. As part of the contract we obliged to make a contribution to the reduction in the overall deficit during the contract period. This has been reflected in our annual profits over the life of the contract in line with franchise accounting.

The Scheme Trustees have however recently completed a valuation and we have a dispute over the extent of liability that Serco has to fund the deficit. At 30 June 2014 the Group has recognized a £7.5m provision in relation to this matter for the estimated settlement, together with associated costs.

In normal circumstances any payments arising from such a review would just be a reserve movement. However, given the resolution of any legal process is likely to occur after the end the franchise period, we have treated the potential payment as a settlement of a dispute within the income statement. We do not expect to experience this problem on any of our other franchise pension schemes.

Moving on to earnings per share. Our adjusted effective tax rate increased to 24.9% principally reflecting the mix of profit by region. The share count has also gone up to reflect the impact of the new shares placed in May. These have contributed to the 68% reduction in adjusted EPS at constant currency. Reported EPS takes into account the further impact of net exceptional charges.

In terms of the interim dividend, this has been maintained at 3.10p. As previously stated, the Strategy Review will assess the future shape of the Group's balance sheet and appropriate levels leverage. The final dividend payment for the year will therefore reflect financial performance for the whole and also the outcomes of the Strategy Review.

Let me now turn to where we stand in terms of leverage and financing. Net debt has substantially reduced through an improvement in free cash flow and the proceeds from the successful closing. This has resulted in our leverage ratio coming in at 2.4times, an improvement of where we anticipated.

So leverage is well below the 3.5 times debt covenant and a £1.3 billion of committed facilities we continue to have significant financial headroom.

Turning now to our cash flow. Free cash flow of £53 million in the period is up from £29 million in the first half of last year. Set out as usual is a conversion of adjusted operating profit into free cash flow. While profitability has reduced, working capital has been the key driver of the improvement in free cash flow.

While profitability has reduced, working capital has been the key driver of the improvement in free cash flow. Working capital benefited from a particularly strong period end performance together with a timing benefit from the unwind of some late payments and milestone payments that we haven’t received at the end of 2013.

Relative to the same period last year, there has been a benefit on tax with a net repayment. This is primarily driven by UK losses resulting in tax refund in respect of earlier years. Dividends and joint ventures are down in line with the reduced profits.

This next slide shows free cash flow of £52 million reconciled to the movement in the cost net debt. The cash element of the exceptional items and other costs related to the UK government reviews was £19 million, even it was paid, it was leveled at £36 million and the other material line here is the receipt of the £156 million net proceeds from the placing completed in May. So overall, Group recourse net debt reduced by £166 million in the period.

And this next analysis on net debt shows that reduction. Also shown here our Non-recourse debt and our proportional share of joint venture net cash. So you can see all the definitions of net debt that you may have in your models.

Looking forward and as I have done previously, let me now run through a few more detailed financial assumptions for 2014.

In summary, the guidance for 2014 in today’s statement on the next couple of slides is no different to that given at the start of May and repeated in the close statement in early July. So while challenges and uncertainties remain, we are not expecting consensus to change today for 2014. In terms of revenue, we anticipate this to be at least £4.8 billion at constant currency.

Take in account of the guidance is a great anticipated level of attrition and volume-related impacts in the second half of the year. In terms of adjusted operating profits, at constant currency, this is anticipated to be not less than £170 million or £155 million at reported currency.

As previously anticipated, the phasing of profit is skewed approximately one-third, two-third to the second half despite greater pressure on revenues. This phasing is due to some normal seasonality to profits, for example with some of our transport operations, there have also been charges taken in the first half such as the onerous contract provision on COMPASS and closure cost to SSDS. On top of that, there will be the delivery of greater cost savings in the second half as Ed will mention further.

Finally, as stated in July, the Strategy Review involves a detailed analysis of our contracts which will be completed in time for the full year results. And to the extent that there are financial consequences been they may impact our stated expectations for the year.

With these adjusted operating profit, we are forecasting adjusted net finance cost of approximately £35 million, the adjusted effective tax rate for the year which is forecast to be 25%. The weighted share count will continue to rise the effect of the may placing with our expect being £522 million shares for the year.

As previously guided to, this leads to adjusted EPS guidance of approximately 19P at constant currency, or 17P to 18P at reported currency.

Exceptional items are expected to be around £40 million to £45 million bringing the first half net charge together with the balance of the original estimate of restructuring and corporate renewal implementation costs to come in the second half.

In terms of free cash flow, we are targeting this to be higher than 2013 through improved working capital. We estimate that recourse net debt at the end of the year would be between £550 million and £600 million and leverage, given the profit guidance, it should be approximately 2.5 to 3 times.

Just a few words now on 2015 to conclude. At normal it’s too early at this stage to give guidance, but an early view of revenue show known revenue growth of around 2% being outweighed by known attrition of approximately 7%. There were bid opportunities that can add to revenues in 2015 but there were also some re-bids to secure.

With revenues therefore expected to be low in 2015 than 2014, it would be hard to achieve anything other than the slight improvement in margins notwithstanding the full year benefit of cost savings that we achieved in 2014.

We will have established appropriate guidance for 2015 in due course when the outcome of progress from an improving contract performance delivering cost-efficiencies securing re-bids as well as winning new work has known as well as the strategy review having been completed.

So to summarize then, first half trading has been poor, but in line with revised expectations. Net debt has been substantially reduced from improved free cash flow and the successful placing. The interim dividend has been held somewhat many challenges and uncertainties remain our guidance for the full year is maintained.

And as this is my last result presentation, for Serco, I just like to say how I privileged I’ve been to work for Serco and with so many great people for the last 18 years and looking forward, I wish the company the board well in terms of the next phase of growth.

So thank you and I now hand over to Ed to expand on the operating performance.

Ed Casey

Thank you, Andrew. Both Rupert and Andrew have spoken about a decline in profitability. I would like to share with you some of the operational factors underlying the financial performance.

First of all, we have seen downward pressure on margins for a number of reasons including, from a reduction in contract volumes such as the ongoing decline in the number of people and our care on our immigration services contract in Australia. From the loss of contracts which ran at above average margins, and from significant extensions and contract repricing, which have occurred at lower margins?

We saw fewer new wins over the period than we would have liked, and we have had to invest significant amounts of money to deliver on our promises and improve operational performance on particularly challenging contracts such as COMPASS and PECS.

Profits were also impacted by cost incurred as a result of the implementation of our corporate renewal program. So this has been a period with some huge operational challenges that have put pressure on our profitability. But it has not all been bad news. We are at heart a business that is committed to providing high quality service to our customers and for having extremely dedicated operational people.

This has been no difference over the last six months and I want to share a few recent examples. Our people will rank first among 50 prime contractors in building a network of organizations to deliver the work program.

Our staff at Merseyrail retained for the third time the top position for overall customer satisfaction in the National Rail Passenger Survey, with one of the highest punctuality ratings in the country.

The quality of our healthcare business in the UK has been with all four of our Suffolk hospitals receiving excellent Care Quality Commission reports, and Derriford Hospital was recognized as the leader in infection control.

In the U.S., the important work our people do with veteran-owned small businesses led to them being awarded the Champions of Veteran Enterprise Award. And our support with Kings College, London and the UK Ministry of Defense to the new military college in Qatar, saw its first successful graduates in the period.

Finally, our BPO business received three top awards highlighting excellence and innovation and was recognized for the best overall digital experience. Even during such a difficult period for the Group, the vast majority of our people continue to perform with passion, dedication, innovation and care.

In the first half of 2014, we signed contracts of £2.4 billion, compared to £1.7 billion over the same period last year. The two largest contributors being the £800 million contract to operate the Caledonian Sleeper rail franchise, and the £520 million extension of Northern Rail.

However, our business development performance was poor during the period, of our pipeline of around 40 major opportunities at the start of 2014, we lost eight of 10 bids, far more than we would normally expect.

This is very disappointing and although there isn’t any one single factor that has driven such performance, the distractions in management and the damage to our reputation have undoubtedly played a role.

As a result, our order book has not grown over the period. I am concerned by the depth and quality of our pipeline. The estimated total value of new larger bid opportunities is £8 billion, down from £12 billion just six months ago with the ten major bids that have been awarded having not been replaced in our pipeline.

We have been more discriminating in the bids we are pursuing, but our pipeline needs rebuilding and this will be a priority for Rupert and for me. We have visibility from the order book of 96% of our revenue for 2014. However, our visibility for the next year is estimated at about 70%. While there are lot of bid decisions and other factors that will influence 2015, we currently see net revenue attrition exceeding known revenue growth by approximately 5%.

The attrition is driven by the ending of contracts such as the Docklands Light Railway, NPL and Australian garrison support services. However, there are still some bid opportunities and organic expansion that can add further revenue in 2015 and there are also further re-bids to secure most notably, the immigration services contract in Australia.

As the first half progressed, we’ve been able to look with greater and greater detail into some of our contracts as part of the strategy review as well we have been carefully reviewing our entire organization identifying improvement opportunities where we can, knowing however that the most fundamental improvements will come from the changes in the operating model that will result from the strategy work that will conclude later in the year.

But we are not waiting to take action. We eliminated the AMEAA division and closed the Hong Kong regional office. The Australia, New Zealand and Asia regions and the Middle East region will each report directly into the Group to reduce cost and increase our visibility of these important growth markets.

We are also taking actions in all of our divisions to reduce overheads appropriately and at the same time, rationalize and focus our business developments spend. Benefits in excess of £20 million for the second half have so far been identified.

We also continue to rationalize our business portfolios and further disposals of non-core assets will likely be pursued. Just as a reminder, we have split our UK and Europe divisions into two, Central Government and local and regional governments. The chart on the right shows the latest segment mix.

Let me now turn to a review of the five operating divisions. During the period, Central Government revenue dropped by 4% to £836 million representing 34% of Group revenue. The decline was mainly driven by a reduction of the division’s share of the revenue from the immigration services contract in Australia.

This is the result of an internal sharing agreement struck at the time the contract was originally won. The division has also seen a negative impact on revenue and especially on profits from the end of the electronic monitoring operations.

On the COMPASS contract, the business faced significant operational challenges with some £8 million of trading losses in the period and an onerous contract provision of £6 million to cover our current estimate of future losses. Operational performance has improved significantly, but our forecast of its financial performance relies on assumptions beyond our control such as the number of people in our care and the speed that the government process is done.

The division was able to secure extensions to the Northern Rail and NPL contracts, although we will not re-bid the next Northern Rail franchise and the NPL contract will be taken back in-house.

The division also added the management of the Service Personnel and Veterans Agency through a successful Defence Business Services contract. The pipeline for the Central Government division can best be characterized as a smaller number of relatively large opportunities as shown on the slide.

During the period, LRG, our local and regional government business revenue dropped by 5% to £425 million representing 18% of Group, mostly driven by last year’s disposal of the UK Transport Maintenance and Technology business.’

In the first half, there were additional costs also to implement Corporate Renewal resulting in a lower margin than the previous first half. In terms of good news, the division won the new franchise for the Caledonian Sleeper the Group's largest contract award in the period, the Milton Keynes contract was recently extended and we won a £50 million contract to manage the Wet 'n' Wild waterpark in North Shields.

The division also received a contract extension to provide IT support European Parliament and won a new contract for IT support to the European Space Agency. The division was unsuccessful in its re-bid of the Docklands Light Railway, although the impact on profitability is low, since the contract was operating at a very low margin and Andrew has mentioned the issue regarding pensions.

Although the near-term pipeline in LRG is weaker than we would like, we do see opportunities further out in environmental and integrated waste management services, non-clinical health support services and ferry services.

In the Americas, revenue dropped by 2% to £368 million, the division now represents 15% of Group revenue. The big contract wins last year supporting the affordable care act and the transport contract in Virginia, offset other attrition but the margin mix had a negative impact.

The division secured one of two re-bids on contracts for a US intelligence agency and won a series of other rewards as shown on the slide. There is some further attrition to come in this business as you can see on the slide and the short-term outlook for the federal government services market remains difficult given the current state of budgets and funding.

In the long-term however, the market remains attractive and the pipeline is reasonably healthy, particularly in the non-defense areas.

Moving on to our AMEAA region. AMEAA revenue dropped 6% to £470 million, though organic growth at constant currency was 10%. The division now represents 19% of Group revenue.

The division’s single largest contract, Immigration Services in Australia, continued to experience volume and margin declines. There were also lower profits in the Defence Marine Services business related to increased maintenance required on the Armidale Class Patrol Boats and one-off transition costs to close the Australian garrison support business.

Work successfully one re-bid or extended included health support services in Abu Dhabi, facilities management services for the Abu Dhabi National Oil Company, air navigation support services in Bahrain, and public facilities management contracts for both the City of Melbourne and Abu Dhabi Municipality.

However, our re-bid for the Australian regional defense garrison support services contract was unsuccessful, as were our consortium bids for the Sydney northwest rail link and for the Raven Hall prison in Victoria.

There remained many opportunities in the region, particularly in immigration and justice, transport operations, defense, and non-clinical healthcare support services, all of which will benefit from leveraging capabilities and referencability across the Group.

Global Services saw an organic decline of 1% to £334 million and the division now represents 14% of Group revenues. The division also faced significant profitability pressures. We have seen a reduction in revenue and profit on contracts such as Shop Direct and AEGON as we are no longer being paid for the transformational activity that typically occurs in the start-up of such contracts.

Other contract attrition and volume reductions have resulted in the underutilization of a number of delivery centers in the UK and India. And high margin project and consulting work was significantly reduced in the first half.

Nonetheless, the division has seen a number of successes including the award of a contract with Lincolnshire County Council for the provision of business process and contact centre services. The extension of our ICT services for Peterborough City Council and the London Borough of Enfield and private sector contracts for customer contact centers across Australia, Qatar and the United States.

The current pipeline for Global Services is not as robust as we would like. Staff departures and organizational challenges have resulted in unfulfilled sales and marketing positions and generally weak new business performance.

However, we see opportunities in the private sector multi-channel, customer management services and in further strategic partnerships with local authorities, for BPO, support covering, finance, HR, ICT and other citizen services.

So, overall, I can repeat Rupert’s message, we have seen a poor first half, but performance was in line with revised expectations. We are at heart a business committed to providing high-quality service to our customers and for having extremely dedicated operational people and there has been no difference over the last six months.

We have signed £2.4 billion of contracts but as previously mentioned, our win rates and pipelines need improvement. Actions are underway to rationalize the structure of the business and reduce cost and the strategic review of providing impetus for even more fundamental change.

So a difficult first year, things are on track and beginning to stabilize and as well, as Rupert mentioned, with the additions of new management, we think they will also help to stabilize the business in the second half of the year.

Thank you. Rupert?

Rupert Soames

Well done, Ed. And I would just like to say thank you, Ed for looking after the Company’s CEO between October and May and then sliding seguing as a DJ, I recognize that. So, effortlessly into the role of Chief Operating Officer since my arrival.

You're widely admired in the business and your experience running a division means that you’re greatly respected and it’s been astonishing how quickly you and I have established a really close working relationship and I know that you are looking forward to Angus’s arrival as much as I.

I’d also like to pay tribute to Andrew Jenner who has served the company for some 18 years, during which time, the company has generated huge amounts of shareholder value. Andrew has been incredibly loyal and was stuck for the business to ensure that the wheels could keep turning whilst a new CFO was found.

And, with me stomping around, but I think everybody can imagine, this has not been an easy process for Andrew and I would like to pay tribute to his consummate professionalism throughout.

Now, I want to give an update on where we are on the Strategy Review. We’ve completed the first phase which mainly comprised collecting data from over 700 contracts analyzing them and segmenting them by market and customer type. And this has given us a baseline from which we’ve been able to start thinking about the key drivers for the business going forward.

From here, we go into a second phase which will be a series of deep dives into the individual markets as well as a study of our organization and the way that we manage our business.

This phase will be completed in the autumn which will be in turn followed by a third phase of more detailed planning. And as I said, when I joined in April, we expect to be in a position to present our new strategy to investors at our full year results next March. I thought though, it might be helpful if I gave some early observations of what I found going round in the business.

And over the past few weeks, I have visited customers and colleagues in New Zealand, India, Australia and Middle East, the US, and of course in the UK, and during that time, I’ve been able to get some insights into what they are thinking.

Now as far as customers are concerned, I’ve seen with my own eyes that we do lots of very, very difficult things, very, very well and the vast majority of our customers think we do a good job and value what we do. They value the efficiency, reliability, effectiveness and the flexibility of our approach.

They value the benchmarking and rigor we bring to their operations. I’ve seen enough to be sure that most of our customers are pleased with what we do for them.

I’ve also been particularly concerned to take the temperature of our UK government customer. And whilst this kind of appear at times of a many-headed hydra with many differing and sometimes contradictory views and priorities.

In general, I’ve been encouraged by what I’ve heard and overall I would say that they are keen to see us rehabilitated and I’ve actually been quite surprised by the extent which customers overseas seen largely I’m disturbed by last year’s traumatic events.

But for any service business, the skill and motivation of colleagues is the be all and, and all. The skill and dedication of the many people I’ve met around the world working for Serco is as advertised. There are a lot of people working very hard to please our customers and keep the show on the road.

I would however say, that they’ve been traumatized, they are confused, worried and thirsty to direction and leadership. They are desperately keen to seen Serco restore to being a company that they can be proud of and go home and talk to their families with pride in their voice.

My sense is, that over the past few months, we manage to settle things down a bit and we’ve certainly stemmed the times of losses of senior management in the UK which we saw earlier on in the year. Now, once I can’t give you any insight into the outcome on the Strategy Review, it would be wrong for me not to lift my skirt a little and give you some early observations.

In terms of strengths, I think that our international reach is a differentiator for us. Most of our competitors are diversified either by geography or by sector. And almost none have both international reach and address multiple sectors. Now, we may have taken the number of sectors that we operate in too far, but the principle of having significant operations in more than one country and in more than one sector is I think important.

Now, within our portfolio, we have strong positions and capability in some large markets which I think we can see as having long-term structural growth and where we have some strong customer relationships.

Finally, Serco’s devolved structure and focus on contract management is a strength as well and has served the company well in the past. But reliance on this structure has created a business that is hard to control and direct.

We need to find the trick of being able to maintain the energy, drive and focus of a devolved and entrepreneurial structure, whilst keeping the business disciplined, transparent, capable of identifying and managing risks and by being able to deliver concerted action in pursuit of strategy.

Now every business has weakness, even Serco has a number to deal with. We have wholly organized central functions which do not serve the business as well as they could and this is being caused by a deeply troubled transition to a shared services model.

Our overheads have grown faster than they should have done and recently faster than revenues, which has led to us being uncompetitive in some markets and insufficiently profitable in our business.

There is a worrying lack of operational and financial management information. And we have too many loss-making contracts across too many sectors. Of the last count Serco was operating in 47 different market segments including my favorite which was the provision of dog-wardening services in Birmingham.

Further, sorry, finally, as I said earlier, in the past, I think there has been too much focus on revenues rather than returns. In terms of threats, I think that in many of our markets, particularly those touching on governments, the competitive environment is becoming significantly tougher as a result of changing customer and competitor behavior.

In terms of opportunities, for those of you have to wait for the Strategy Review. But what we now need to focus on looking ahead, there is clearly a long list of things to do and part of Ed’s and my job is to prioritize these, but let me give you a taste of some of the things we are thinking about.

First, I think that our customers value very much our flexibility, innovation and ability to provide value for money. The first two of these probably set us apart from many of our other competitors and we will want to concentrate on making sure that we’ve retained the ability to make our operations fit our customers, rather than the other way around and to bring new thinking and ideas for our customers’ requirements.

I think that as an international company, it is really important that we understand how to make this a benefit rather than a complication. It is certainly been a big advantage having a very large chunk of our revenues outside of the UK at a time when we’ve been in deep trouble in our home markets.

And our diversification by geography has served us well over the last year and in previous years. But it needs to be more than just a safety net. It needs to be a strength and we will want to focus in the future on markets where we can use scale, technology and innovation developed in one market to make us more competitive in another.

Next, in a market where margins are typically low, it is a central to be formidably efficient and agile in all parts of our operations, both in the contracts and in the overheads.

We need as a priority to make our shared services world-class and we need to improve our cost structures and our speed of reaction. And part of this that we have to get the information we need to make good decisions. It’s a major priority of mine to install in effective management information systems along with rigorous risk management processes.

Next, we need to know the lights we will follow to generate shareholder value. And I do think that some of the people who follow us, of course none in this room are somewhat overly obsessive about revenue and others overly obsessive about margins.

Not those of you who know me from my previous life will be aware that I am a devotee of the ugliest phrase in financial metrics. Wait for it, risk-adjusted cash flow, return on capital.

Established a good rate of return, grow revenues of that rate of returns, decent margins, will convert into cash. In Serco, I see contracts with margins of 10% which I wish we could get out of. I see others with margins of 3% which I would love to double in size. It all depends on the risk and the amount of capital we commit. The fact that the business has a model which is generally capital light is fine by me.

And in fact it’s the only way we can justify operating some of the margins our customers and competitors allow us. Now I am not saying that we should not be prepared to invest capital, but we should only do so when we can generate the margins, to generate the returns and then convert those margins into cash.

But no amount of financial theory about wealth creation will serve us if we don’t increase our win rates. And Ed and I are very focused on improving the effectiveness of ourselves in marketing processes. We simply notch being winning enough business.

And as part of this, I think it’s going to be important that we restore our reputation amongst people with it has been damaged and in this regard, there is absolutely no alternative other than to deliver on our promises and it is for that reason that we are investing also known as losing millions of pounds, improving our operational performance on some of our UK government contracts.

Finally, we need to rebuild confidence, trust and belief in our culture amongst our colleagues and so once again turn Serco into a talent magnet. I hope this gives you some idea of the things we are going to be needed to focus on over the coming years and as I said, in my previous employment, it’s really quite simple. All you have to do is to develop the right strategy and execute it immaculately.

What I would say about Serco, is that it is really quite hard in a company of Serco’s size, complexity, diversity and fragmentation. It’s certainly possible, probable even but it is definitely difficult.

So, to summarize and to repeat the outlook. We are maintaining our2014 full year guidance of adjusted revenue of at least £4.8 billion and adjusted operating profit of not less than £170 million in constant currency. As we stated in early July, the strategy review involves a detailed analysis of our contracts, and this process is expected to be complete in time for our full year results.

To the extent that there are financial consequences of this review, these may have an impact on our stated expectations for the year. We’ve had a poor first half. For the first time in living memory, Serco lost money and we’ve not won as many new contracts as we would have liked.

But there is some good news. We are going to have a much better second half. We have strengthened our balance sheet with a successful equity placing made good progress in corporate renewal and rebuilding trust with the governments. Our strategy review is running to plan.

We have made some strong senior management appointments. We have taken action to rationalize the structure of the business and to save costs. All these savings are important steps forward on what will be a long journey to restore the company’s fortunes, but restore them we will.

Thank you for your attention. We are going to do Q&A now.

Question-and-Answer Session

Rupert Soames

Can I ask that since you are all on candid camera and being webcast, yes sir, even you, could you please, say your name when – and not speak until the microphone reaches you. Mr. Chu?

Andy Chu - Deutsche Bank

Hey good morning, it’s Andy Chu from Deutsche Bank. Three questions please. Could I just ask about the bid pipeline? How many contracts are capped at a £1 billion, if any? Could you just give us a flavor of the average length of the contract? And what you expect in terms of the timing of decision on that £18 billion?

And secondly, as you look to increase that pipeline and win more business, could you just sort of tell us a little bit about the shape of bid costs and could you let us know the bid costs please, for the first half this year and what they were the first half last year? And then, lastly, which I'm sure you won't answer this question, but I'll ask it, in terms of loss-making business, in aggregate, what sort of amount are you talking about, please?

Rupert Soames

Right. Well, my colleagues, Andrew who handled the bid cost and Ed, you handle the bid pipeline, I will handle the loss-making contracts. First, too many although, quite a lot of them losing a little. But there is quite a lot that’s still hovering around the line and we have somewhat innovated in the way that we consider them because we are not making a charge on them for the use of capital employed.

But, it’s I give you an indication that in aggregate contracts in 2013 and the pitch is going to be different for 2014 that contracts for 2013 in aggregate lost about £50 million. So whatever we made, we made having – had some contracts over this side but we are losing. That was a few, but not so lot and a quite a lot but lost a little. Andrew, bid costs?

Andrew Jenner

Bid costs, hard to give an exact number, just clearly we’ve got money which we are on very specific bids, but then there is also a lot of work that goes on at the contract levels. So, an estimate of all of it is around £60 million to £70 million a year. No reason, why that shouldn’t be spread broadly evenly across the first half and second half. You did asked that also, has there been any change first half 2013 to first half 2014, yes, they went up by about £5 million half-on-half. At the course of bid cost…

Rupert Soames

Let Ed cover that one after this presentation. I look for bid cost going forward.

Andy Chu - Deutsche Bank

Yes, in terms of the £8 billion pipeline of opportunities that we referenced, those are going to be contracts that are awarded, bids that are awarded either in 2014, or 2015? There are only two of those of forty opportunities capped at £1 billion. And just, if you want to look at – we look at an annual contract value.

First of all, the average duration is about seven years of that portfolio for the contract and if you look at annual contract value, if I look at it and say, those contracts was bids that are £30 million annual value a year or more, it’s probably half of the 40 opportunities are above or £30 million a year or greater. In terms of the direction of bid cost, bid cost has come down this year, I think the first question people say you are mortgaging the future by reducing bid costs.

We are not – there was no concerted effort to reduce bid cost this year. It was just we are rationalizing the bid cost in line with our opportunity of our portfolio. So, I think that, what we will see is that, probably for the next six months, we will stay at the current run rate in terms of our expenditure and I would say that they’ll probably stabilize and next year we’ll probably be flat to up. But I wouldn’t think this go down again next year.

Rupert Soames

Yes.

Julian Cater - Numis Securities

Good morning. Julian Cater from Numis. I’ve got three questions as well please. First one, to you Rupert, I think your final point was about you wanting Serco to be a talent magnet. You’ve obviously made a number of senior appointments, but I wonder whether you could give us a sense of how much is going to evolved or how many positions in the global leadership grouped to get you to where you want to be?

The second question and third question to Andrew. The JV margins come down considerably year-on-year, both AWE and Northern. And I think, you’ve already said that Northern you are not going to re-bid that franchise.

But I wonder whether you could say on AWE, whether that is indicative of some margins from that contracts going forward or whether that was as we’ve seen in previous franchise periods?

And the third question was just in terms of working capital, your payables were up significantly in the first half period and I think you alluded to tight period end control, I wonder whether you could give us a sense as to how much of that is likely to unwind in the second half, please? Thank you.

Rupert Soames

As far as the global leadership the Group is concerned, to the extent that we have turnover installed it’s nearly or been that in UK based. We have taken out a whole layer of management in AMEAA, in Hong Kong, but that was our action rather than an enemy action.

There has been one competitor in particular who has graded parts of our UK business, but I think that that seems to have stabilized now and come to a halt. So I’m not looking – I mean, the key appointment that we need to make was CFO, and the two UK management, in terms of the Middle East and Australia, we kept the management team there. I think that’s keeping a keen observation on the quality of our senior and middle management is part of my job.

But in terms of key appointments, I am pretty pleased that I’ve seen we are looking for a CIO at the moment, and seeing a level that by any role that we have that we are recruiting for at the moment. JV margins, Andrew?

Andrew Jenner

JV margins, in terms of AWE, the main reason for the drop in that margin is – it’s now the beginning of the next five year pricing period, and in accordance with previous pricing periods, I would expect that margin to trend up as we get towards the back-end of that pricing period.

I think it’s fair to say thought that, generally if you look at that five year pricing period as a whole, the margin is lower than last time around. So don’t expect to see it as high as we’ve seen before, but expect to see it trend up over the five years.

In terms of working capital, yes, we were very pleased with the working capital performance in the first six months and it did benefit from the reversal of about £20 million of the timing differences at the end of last year which I reported upon both the Fiona Stanley milestone payment, but also some late payments at the end of last year. So we did benefit to the tune of that.

In terms of – yes, we look at the balance sheet and what’s happening behind working capital as ever, there are some very, very large numbers swinging around on both sides. So it’s never straight forward to forecast. So, indeed I guess, it’s straight forward to explain.

In terms of payables themselves, they’ve gone up, but that’s not the trade payable component, the trade payables is broadly the same. So, if you go behind it, you can see where it’s gone up, it’s contract calls, between a substantial lift up in contract calls and also some increase in deferred income as well.

Clearly, deferred income represents customers paying early which we had customers doing that in the past as well and I’ve talked about that with the results early one in the year. If I go to the other side of the balance sheet and look at debtors, we’ve actually against billed, non-billed, we had less customers paying us in advance than we had before.

So I guess, but if I stand back from it Julian, and look at on the position at the end of June compared to the end of December from a sort of a – that advanced payment perspective, we are in almost in exactly the same position as we were at six months ago. So, aside from the reversal effect that I talked about it was a strong working capital performance.

And I think, you did ask, going forward, do we expect to see similarly good working capital performance in the rest of the year, yes, we do and that’s a key plan behind saying that we expect free cash flow to be higher than in 2013.

Karl Green - Credit Suisse

Thanks very much. It’s Karl Green from Credit Suisse. Again, three questions. Firstly, just on revenues in terms of rebuilding the pipeline, do you think that you are going to be able to go out and rebuild that pipeline before you publicly committed to certain sectors and certain geographies in terms of customers being willing to consider you as a short list contender?

Secondly, on the cost side, in terms of your analysis so far, are you able to say above central costs what the level of overheads are within the contracts, cost of 700 contracts roughly how much of it is kind or overhead rather contract-specific cost, to give you the sense as to how much you might be able to tackle that.

And then the third question is just on your comment on the competition, can you name names, here is particularly upping the pressure on the competitive front? Thanks.

Rupert Soames

So, Andrew if you take the overhead costs, Ed if you could take the question about pipeline, sure I understood it. But, as far as competition is concerned, what I would observe as an outsider coming into this marketplace for the first time.

And I think my comments are particularly reserved for the UK market. It’s I think that the government has gotten much, much better at contracting over the last five years. It is particularly got a lot better at risk - passing risks on to supplies.

And, I mean, one of the things that – I think this is going to – this is a – at the moment, the government is very good at it and does it very well. And whereas in the past, there used to be this thing about first generation, second generation and third generation and the margin is always going down. And everybody is thinking that that was a bad thing.

Actually, what should happen between first, second, and third generation is that a lot of risk should be retired. And whereas previously, in what you might call, first generation outsourcing, you can make good margins and risk was kind of shared between government and between a contractor.

The government saw good transferring risk now. But actually, quite a lot of first generation contracts, may have decent margins in theory, but the suppliers are taking on so much risk, so much unquantifiable risk that you are going to end up losing humongous amounts of money.

And, to what extent the money that we’ve been losing on, for instance, COMPASS, is a consequence of our own incompetence on mis-pricing or people sitting down and making reasonable assessments of risk which just didn’t work.

But the consequence of that is, is that we got a contract that – this year cost us £14 million of what it’s £8 million plus another £6 million of our current estimate of what that might cost us go running out for the next three or four years. So, I think that a lot of the risk side on government contracting has got a lot worth.

I think on the other hand, there seems to a pretty good supply of new vendors coming from market saying, oh, I want to make a strategic bid to get in to this sector. This is great news for the tax payer. If you couldn’t people, it may, in the long-term, be less good news et cetera, for the market.

But we are going to be very, very focused on risk and return and other than making cock-ups, which, from time-to-time they doubt we will, worth simply not going to go and get into dogfights on large chunks of risks coming our way without consummate returns.

And I think we got to be – to the extent which other people are prepared to do that, particularly new people coming into what is a very open market then we’ll just have to set that one out. Where were we? This is another question. Yes, cost.

Andrew Jenner

Karl, just in terms of your question on costs, I don’t think there is anything I can give there of any particular help and there is the stuff in the segment moving up, but to do that, for the moment, I think, your question will be – so that not just focus on overhead, but to also actually look at the contract cost base as well. Could you look at the overheads in the Group were tens of millions but we’ve got billions worth of costs at the contract level.

So, as part of a strategy review, and as part of the operating model discussion, that will address the whole cost base not just overheads. But I think in terms of information is in the public domain for the moment, subject to strategy review, I just use what’s actually in the segment was.

Ed Casey

In terms of your question around the pipeline, let me answer that more broadly, first of all that we mentioned, we are not wining enough. It’s one issue and the second issue is that our pipeline has shrunk in certainly in the last six months.

If we look at why we haven’t won, clearly there are a lot of different reasons. One is the simple execution I think in terms of the distraction that we have had in the business and the fact that, in our two UK divisions, right, when we split into two, is that interim heads and so I think that’s contributed as well.

When we look at – there are number of other reasons but one of the reasons as well is when we look at our strategy review, right, Rupert mentioned we are in 47 different business segments. How can you possibly build deep capabilities in 47 different business segments and the answer is you can’t.

So, undoubtedly, coming out of the strategy review, it’s not that we are not going to do those 47 things, maybe yes, maybe no, but clearly it’s going to be what, smaller number of things can we focus on and truly build deeper capability and invest in. And yes, that might take us some time to work our way through the strategy review.

But on the other hand, in terms of focusing on pipeline, improving execution, those are things that we can start doing right away. And I think our markets are large enough that there are opportunities out there. There are enough opportunities for us to grow and that’s one of the things that Rupert and I are going to try to do working more closely with the division to try to help develop those pipelines and improve the execution of the business.

Rupert Soames

And I am just going to say that, Ed is hiding his light under a bushel because actually the US went through a period of time where its pipeline disappeared and Ed has got a great track record of really focusing on there and rebuilding the pipeline.

And it takes time, 18 months, two years to rebuild a pipeline. But it is possible and we got a strong recognition out there in the marketplace. I don’t think there are many people in many markets who would not want to have us at least offer. I don’t think getting our name but it’s going to be a problem. Right, yes, in the front please?

Graham Brown - Canaccord Genuity

Graham Brown from Canaccord Genuity.

Rupert Soames

You are going to have to turn up the microphone or use the mike otherwise our viewing public will not be able.

Graham Brown - Canaccord Genuity

Graham Brown from Canaccord Genuity. I’ve got three questions. (Inaudible) okay, Graham Brown, Canaccord Genuity. Three questions.

Rupert Soames

Leverage ratio is first one right? Yes, I’ll do that.

Graham Brown - Canaccord Genuity

Yes. I wondered if you could estimate what proportion of the invested capital base is supporting those loss-making contracts. I think you said, £50 million loss coming from the loss-making contracts. How much of the invested capital base is supporting that? And then, finally, I just wondered, if you have a target of where you would like to see return on invested capital that you got – once you got your strategy announced?

Rupert Soames

Right, I am going to take all of those. So, if we do take the leverage ratio, where we are at the moment, I am going to – Andrew, who has been standing up, so he tells me, many results Rupert, 2.5 we can start to get uncomfortable. So, it was certainly at the upper-end of where we would like to be.

And you may conceivably in the past have had me learned friend from Scotland say that a high degree of financial leverage does not match well with a high degree of operational leverage. So, I think that you can say, but actually, the leverage of Serco back of the years, we’ve seen down to one we can offer 2.5 which has been down to 1 which is now back up to 2.5.

Let us say, make a bold assumption that we would feel that this level is at the top end of where want to be and directionally we’d like to be lower. So, you then, saying about, saying, oh, well, how are you going to do that? Well, the answer is, we don’t know, but there are many ways we can do that.

One there are profits in cash, the second is that we can go and dispose our businesses and the third is that we can go and we suck up the equity and say, would you like have this reduced to us. Our leverage ratios and I have no idea what we are going to do, because until we have got the strategy review complete, is we will – that we will not have a view of the volatility of the operational earnings are likely to have.

And then, so, we got to have this partner with the leverage ratios like this be. In terms of the invested capital base of loss-making contracts I think, I would say actually the loss-making contract account for a disproportionately high amount of the invested capital base.

And I am not accounting them, but, and I wouldn’t tell you exactly what it is, but actually, pound-for-pound, we’ve got more capital in contracts that moves. And certainly when you are go unwind in capital charge that makes significant difference to several of them.

And then, your third question is, what would be my favorite level of return on the invested capital? Let me give – there is about three answers to that. One is, you can never be, too thin, too blonde or have a too high return on capital employed. And neither of the first two apply to me but I have had experience with the other one. So, I think the sensible mature answer is to the exactly is, is that will depend on the risk and volatility we are taking. We will clearly tolerate a lower level of return if we have a risk – low risk low volatility portfolio if we have a high risk, high volatility portfolio, we get in these a higher return on capital to keep our shareholders properly rewarded for the risk that they are running. Correct? Thank you very much indeed

George Gregory - Exane BP Paribas

Hi, it’s George Gregory from Exane BP Paribas. I’ve got three please.

Rupert Soames

So, why have somebody have either four or two, you’ve got three, it seems the passion of the day.

George Gregory - Exane BP Paribas

I’ll go with four to outperform. Number one, in terms of – I'm trying to square the circle of margins going up next year against your comments that you are still reviewing your book of contracts.

And I suppose the question that I’d like to have answered is, could we still see a rebasing of the current year margin profile, because you are perhaps to take a more conservative starts on your three cycle margins or do you feel that in your first review of through cycle profitability, that has been appropriately reset? Or rather are you looking at year-over-year margin improvements irrespective to what…

Rupert Soames

So, can I answer that question as first because I'll forget what it is, so I am seeing it to be complicated. And you are in danger of implying things I didn’t – I wouldn't want you to think. Look, we have not completed our strategy review. I know our contracts review.

So, at the moment we see through the glass incredibly darkly and stuff we may find stuff, where will find the stuff between now and if it’s either going to be for good or bad, and change our views. I suppose where we were coming from on the comment about margin and it’s too early to give guidance for the next year.

But we got to talk about the order book and say people go – and we are trying to be helpful within the bounds of what we can is that clearly the margins in the second half are going to significantly higher than they were in the first, I mean, it’s going to be some benefit of cost waive-initiatives.

What we did not want to happen is people to get overly excited about the second half of volumes when projecting forward into next year, because we got things like revenue attrition and to the extent that there is some year-on-year margin from things like cost waiving this year, we think it’s going to be relatively marginal improvements in margins.

So, keep calm and carry on and understand that what was staying here is giving just very, very and it could change. Right, the second question.

George Gregory - Exane BP Paribas

In global services, the – you mentioned that the margin dropped this year as a result of the - maybe initial capital projects or transformation projects related to the big AEGON and Shop Direct contracts.

If I recall back to 2013 margins dropped because of mobilization costs on those two big contracts, obviously we’ve seen another drop this year. So I am trying to understand why we’ve seen two years of margin drops if last year was impacted by more costs?

Andrew Jenner

All of that is correct, I guess, it’s just one on scale which has affected the numbers and there are some other things happening in the first half of this year in Global services. So, yes, we talked about Shop Direct and AEGON. We’ve also seen some attrition in a number of other contracts including Westminster, including our consulting business as well which has accounted for a decent proportion of that drop as well. So this is just about Shop Direct.

George Gregory - Exane BP Paribas

Okay, and I’ll leave it at three, final one for me. Any thoughts on DIPB extension likely magnitude of that contract on potential extension and thoughts on likely success if possible?

Andrew Jenner

I think that we know that, it’s obviously going to be smaller going forward than it has been in the past. I think the numbers are, at the beginning of the year we had about 6400 people in our care and at the half year, it was roughly half that amount. And Stuart has 0 can give you more specific information, but roughly half. So it’s kind of progressed as we thought it would.

We also know that the government has been on a campaign to limit the number of votes and the number of new immigrants into the country. So, we don’t expect that trend necessarily to turnaround. That’s kind of the first point. So the contract going forward should be smaller than one we’ve seen historically.

In terms of probability of success, we certainly have provided excellent service to the Government of Australia on the contracts. It’s a difficult, it’s a complex contract and it’s one – if you think about the transition cost or the risk of transitioning are high. Politicians don’t want to make changes and then have something go wrong. So, I certainly think that, we will have every opportunity to win that re-compete.

Kean Marden – Jefferies

Good morning gentlemen. Kean Marden from Jefferies. Can I start off first of all with Intelenet, just to check with that? Have you reviewed the carrying value of that asset as part of the interim results? So was that something will be tested at the end of this year?

And obviously, cognizant of the fact that the – for the management team recently expired, whether there is a renegotiation process taking place to incentivize them whether they would basically plug into the sort of performance share plans that have been set out for the executive management team over the last few months?

And then related to that, is your intention, given the focus on cash return on invested capital like it’s be that you start incentivizing operational management metrics?

Andrew Jenner

Didn’t quite catch every word. So, I hope I got the jesting and in terms of – Intelenet’s carrying value, that’s part of SGS goodwill. And what we do at the half year as opposed to full year is look to see if there has been any obvious triggers impairment as opposed to doing the full review that we do at the end of the year.

In terms of SGS, that was one of the two parts of the business that we did some more work on, because and clearly we covered earlier on the operating performance of SGS in the first half. But in terms of their forecast and their cash flows, that’s still supports the carrying value of the SGS goodwill.

It’s – the headroom is not as much as it was and we put some sensitivity in the interim accounts. So that you can see that. But I again, I guess as part of the strategy review, then clearly the outcome of that will be to review every - all the components of it.

Ed Casey

In terms of your question around retention, we – this year, I guess, it was in the mid-year, we had the final payment in terms of the proceeds that went to the existing shareholders and senior management. At that time, we also put in a new two year retention plan, largely directed at those who weren’t beneficiaries from the sales proceeds to try to lock that next level of management in place for the next couple of years.

We also put similar retention in for a broader group of people in other divisions as well. So, it wasn’t solely in our Global Services business. As well, we talked about the fact that we had some departures of some people in the UK BPO business, the fact is that the core of the intelligent management team has been very stable and still in place.

Rupert Soames

In terms of putting incentives in around cash flow returns on invested capital, we are getting – it’s quite difficult in our business, because we’ve got a quite a lot of contracts that has been capital employed. So the contract level is quite difficult. I think that acts a more aggregated level, something like that may be possible. But we will be exploring that.

Unidentified Analyst

Three questions.

Rupert Soames

One question.

Unidentified Analyst

No, it’s three, three. First of all, I mean, on these £50 million loss-making contracts or £50 million lost in these loss-making contracts, what you sense is the opportunity to get a reprice?

Rupert Soames

It’s easy to say and hard to do. And on any of these things, I mean, you look logically at it and say, oh, if we didn’t had contracts that lost this money, we would make much more profit. But very often, the contracts that are losing money are quite closely intertwined with other ones that are making you money.

So, we haven’t yet got a strategy around how we are going to do that. But and certainly you caught this go around and say it is – yes, this one is losing money, do something about it. I think you have to take each one on its merits. There is quite a lot to take on the merits.

But I think the other thing is, if you take it – let’s just say - an average duration of a loss-making contract that has got left to run might be 1.5 to 2 years. And I don’t have an exact number on that, but that’s kind or what you expect. You should over a period of time be able to run them down.

You then got the counter back to a point that is then you got to make sure you are not taking more into the front-end. Again, easier said but than done. But I think at least by identifying this issue and putting it on to the table, I think it gives us something to work around.

And where we can become very focused on because clearly, if we got, £50 million of loss-making contracts, if we can release some capital from that and reduce that quantum, it’s going to have a decent impact on our returns and make it a better business, because we don’t want to be busy fools. Right. The second question?

Unidentified Analyst

Yes, why do you not want to re-bid on Northern Rail?

Rupert Soames

What we were?

Unidentified Analyst

Why do you not want to re-bid on Northern Rail?

Rupert Soames

Because, as you know, there are lots of new – there are lots of franchisees available at the time. We got a strong position in rail with Merseyrail and Caledonian Sleeper and alike. And you got to make choices that we’ve been working with Abellio for a long time than Northern Rail.

They are going to bid on Northern Rail. We just made an assessment, I think that there may be other franchisees that we can bid for that will have a greater chance to set on. And at about £6 million a pop to go and bid you got to be pretty sure that you are going to have a decent chance with that. So, we look at the different opportunities. We step our chances to assess and that’s particular one we think that will better of do it bidding elsewhere.

Unidentified Analyst

Thank you and then my third and final question. You mentioned, I think in at the prelim results that you made £450 million turnover last year in the DIAC contracts. How much is that is to be supposed in the UK division please?

Rupert Soames

Andrew.

Andrew Jenner

First half of last year, 80% - 70% was in AMEAA,30% was in Central Government. First half of this year, 80% was in AMEAA, 20% in Central Government and to make it nice and straightforward from July onwards it’s a 100% AMEAA 0% Central Government.

Unidentified Analyst

So, in the UK numbers, there is a big chunk of revenue?

Andrew Jenner

Why, when we first bid for the contract, it required a lot of support from the UK both through the bid phase and also through the operational phase. It’s not the only contract where do that, but by some distance it’s the largest. So reflecting that, the divisions had a profit sharing agreement from the beginning which as the support, there is a level of support in the UK drops over the first few years of the contract, then so there is a percentage of the drop which is why it’s then be down to zero from July onwards.

Unidentified Analyst

Yes, obviously, it distorted UK growth rates for the last two, hasn't it?

Andrew Jenner...

I don’t know, whether it’s distorted it, this is certainly included within the

Unidentified Analyst

Included, so that needs to be 30% of 450, so, anyway. Thanks.

Rupert Soames

So as you say, this is perhaps the sharing revenue has some had long historical basis and has been done for a long time. I don’t know understand it. So, it’s going to be done no more, I don't think.

Andrew Jenner

There is – scale of that anyway.

Rupert Soames

And then some day we hear, Rupert, yes.

Rob Plant - JPMorgan

In terms of Global Services, it’s Rob Plant from JPMorgan, Global Services is the least profit for the businesses. It’s being reclassified. When you talk about the 47 sectors Rupert, you think this was a sector that was too much for Serco to have got into?

Rupert Soames

I am not – no - I mean, I am not going to get into a reexamination of the past. Within SGS, they handle a lot of different segments. So we got, travel, we’ve got web services, we’ve got banking, insurance, and I think this is they are – they have a wide number of different aspects.

Some of which are hugely successful. I mean, the work that we do in banking is absolutely a strong thing. The trust for our customers put in to that and it’s a very good business we provide the telecoms outsourcing for Vodafone in 18 languages. And it’s a very, very capable business. And some that makes money and some of it don’t. So we will – do you have? You have one question, hurray. No problem, Karl, come on. It it’s another three?

Unidentified Analyst

This is a three plus one. We've done the three, which is the last one, just your comments about the requirements with greater financial and operational management information, do you have any sort of sense what it might put the requisite systems in place to deliver that?

Rupert Soames

I don't think we'll use that as an excuse. I mean, we are fortunate in that the – although Mr. Casey, when he was running North America resisted the implementation of SAP successfully.

And so we have - as an organization we have SAP running through IT. So, I am hopeful that we will be able to get our management accounting systems so reasonably consistent, things reasonably quickly. There are other things that again I have to do. But whatever price it comes at, it’s cheap.

Right, are we done? Can we all go forth and multiply? Thank you all very much indeed and see you in a few months’ time. Thank you.

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