Final Results

Issued: 01 March 2005 Release: 01 March 2005 Contact: Please see below SERCO GROUP PLC Preliminary results for the year ended 31 December 2004 2004 2003 Turnover £1,637m £1,556m up 5.2% Profit before tax pre-amortisation £73.9m £67.0m up 10.3% Earnings per share pre-amortisation 12.20p 11.03p up 10.6% Profit before tax £57.4m £52.9m up 8.6% Earnings per share 8.37p 7.75p up 8.1% Dividend per share 2.63p 2.34p up 12.4% Continued strong sales, profit and cash growth * Underlying turnover (excluding disposals and contracts exited) up 14.0% * Underlying profit before tax, amortisation and 2003 exceptionals up 16.4% * Recommended final dividend of 1.82p, giving a total of 2.63p for the year, up 12.4% * Group EBITDA to cash conversion of 94.9% (2003 - 80.7%) * Free cash flow of £55.8m (2003 - £47m) Strong organic growth * 82% of the increase in underlying turnover came from growth in existing contracts and new wins * Continued win rates of over 90% on rebids and over 50% on new bids * Contracts won valued at £4.1bn, including £2bn share of Northern Rail franchise, Electronic Monitoring and FAA Air Traffic Control Towers Acquisitions strengthen our capabilities where we see strong organic growth opportunities * ITNET plc - one of the UK's leading suppliers of IT and business process outsourcing services to local authorities, with expected 2004 sales of £ 209m * Resource Consultants Inc (RCI) - supplier to US federal government of business process management and IT services, with expected 2004 sales US$293m * ITNET acquisition completed in February 2005. RCI expected to complete in March 2005 High visibility of future earnings * Record forward order book of £12.7bn at year end * 91% of 2005 planned turnover secured, 76% for 2006, 64% for 2007 * Bids worth £4.7bn submitted and under evaluation * Strong start to 2005 with new wins of £0.4bn and contracts at preferred bidder valued at £0.9bn * Over £16bn of further potential opportunities identified Note: EBITDA is earnings before interest, tax, depreciation and intangible amortisation. Free cash flow is reconciled in Section 3 of the finance review. Executive Chairman Kevin Beeston said: 'Today's results demonstrate once again how Serco's focus on customer service and relationships is building a strong business around the world. Underlying Group turnover and profit have grown by 14% and 16% - principally through high levels of organic growth. The drive for better value for money public services around the globe puts Serco in an excellent position to continue its strong growth, further enhanced by our recently completed acquisition of ITNET in the UK and the planned acquisition of RCI in the US.' - Ends - INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) Serco has today issued a separate stock exchange announcement providing an update on its transition to IFRS. WEBCAST A webcast of the results presentation will also be available on www.serco.com from 1800hrs (GMT) on the day of announcement. To pre-register for viewing please visit: http://www.axisto.com/webcast/media/serco/010305/index.htm CONTACTS For further information please contact Serco Group plc: T: +44 (0)1256 745900 Dominic Cheetham - Corporate Communications Director Richard Hollins - Head of Investor Relations Chairman's statement 2004 was another very good year for Serco, and 2005 has started in excellent fashion too. Our ability to achieve continued strong growth is rooted in a number of factors that are fundamental to Serco. These include our broad range of markets and services, our good reputation and the commitment and professionalism of our staff. We work in partnership with clients and stakeholders to deliver value for money and real service improvements. As in the past, more than half our sales growth was achieved by expanding the scale and scope of existing contracts. This organic growth remains the primary focus for our business. We can only deliver it through high levels of customer satisfaction and a proactive and thoughtful approach to deepening our customer relationships and services. We continued to strengthen our cash position and maintained our outstanding earnings visibility. By the end of 2004 we had achieved preferred bidder status on £0.9bn of contracts and had secured 91% of our planned revenues for 2005, 76% for 2006 and 64% for 2007. Over the year our forward order book rose from £ 10.3bn to £12.7bn, substantially boosted by our largest-ever contract win - the Northern Rail franchise, valued at some £2bn to Serco. Other wins included a £ 300m seven-year contract to provide court escort and custody services. Successful rebids included our air traffic control contract with the US Federal Aviation Administration (FAA) and multi-activity contracts with the UK's Royal Air Force and Naval Air Command. In fact, our defence business had its best year ever, with a good combination of organic growth and new business wins. And we further strengthened our position in the growing justice and national security markets. To continue building our capabilities in areas where we see strong organic growth opportunities, in December we announced two significant acquisitions that will bring additional skills and capabilities in the UK and US, currently the world's largest public service outsourcing markets. ITNET plc is a leading supplier of IT services, business process management and consulting to UK local authorities and private sector companies. Resource Consultants Inc (RCI) supplies business process management, IT services, supply chain management, systems engineering and consulting to the US federal government, primarily in defence. We expect this acquisition to complete during March 2005. We expect both acquisitions to be earnings enhancing in 2005 and to further increase our ability to develop in current and emerging markets. People Ultimately, Serco's continued success stems from the achievements of dedicated, passionate people. Through the annual Chairman's Recognition Awards we acknowledge those individuals and teams who make exceptional contributions. Their stories emphasise how - day in, day out - the people of Serco are bringing service to life. Leaders of the UK's major companies have recognised our employees' efforts by rating Serco as the UK's most admired support services company, and the sixth most admired company in the UK, in the Management Today 2004 annual survey. This recognition from peers and analysts is a tribute to the effort and commitment of everyone in the company. We congratulate and thank them all. Financial performance Sales and profit Turnover grew 5.2% to £1,636.8m. After adjusting for the effect of disposals and contracts exited, underlying turnover growth was 14.0%. Pre-tax profit rose 10.3% to £73.9m before intangible amortisation and 8.6% to £57.4m after intangible amortisation. The previous year's profit figure benefited from exceptional items with a net profit of £3.6m; excluding these, the underlying profit growth before intangible amortisation was 16.4%. Earnings per share rose 10.6% to 12.20p before intangible amortisation and 8.1% to 8.37p after intangible amortisation. Cash performance Our cash performance continues to strengthen. Free cash generation increased to £55.8m, compared with £47.0m in 2003. Conversion of Group EBITDA (earnings before interest, tax, depreciation and intangible amortisation) into cash was 95%, ahead of the previous year's 81%. This is a significant achievement in a rapidly growing business. Dividend The recommended final dividend of 1.82p per share gives a total for the year of 2.63p - an increase of 12.4% over 2003. It will be paid on 11 May to shareholders on the register on 11 March 2005. Strategy Organic growth Organic growth is Serco's primary strategic aim - and it delivered 82% of our underlying turnover increase in 2004. The majority (61%) came from extending the duration or scope of existing contracts and a further 21% came from new business wins. We aim to leverage the value of every new contract win. By working in partnership with clients and stakeholders to deliver value for money and real service improvements, we create opportunities to broaden and deepen our relationships. In 2004, for example, we were awarded an extended court escort contract valued at £300m over seven years: double the size of the original contract. We also maintained our 90% success rate in rebids, including our contract to manage the UK's National Physical Laboratory, valued at over £500m, our US$118m air traffic control contract in the US and the £55m contract at RAF Northolt and Uxbridge. Our strategy is to remain focused on areas with the right scope for growth through service delivery. In line with this strategy, we disposed of a number of smaller asset management contracts in Australia and New Zealand. In the UK, as agreed with Network Rail, we ended our rail maintenance contract for the East Midlands zone in January 2004. Acquisitions In tandem with our strong organic growth, we make acquisitions to gain capabilities or market access as a foundation for future organic development. In the UK, the business transformation and local government outsourcing markets are set to grow by 50% by 2007 and we have sought to increase our present capabilities. The ITNET acquisition strengthens our offering to local government and brings expertise in business process management, an important element in the broader outsourcing contracts that we are increasingly pursuing. ITNET's consulting expertise, through French Thornton, complements our own growing consultancy business, which is helping to stimulate favourable change in our key markets. We also see opportunities to strengthen our service offering to markets such as health, justice, transport and defence, both in the UK and overseas. The US is the world's largest service contracting market and the announced acquisition of RCI deepens our access to federal government, where demand for outsourced services is accelerating. RCI has strong customer relationships in defence, which accounts for more than 75% of federal spending on services and is an area where we have much to offer. In the North American market, RCI's federal focus complements our existing customer base, which is largely civil agencies, and state and local governments. And RCI's significant business process management and IT service capabilities complement our existing change management and service delivery resources. International strategy Our international strategy remains clear. As markets develop, we leverage our skills from one geographic market into another. In turn, increased diversity across borders and markets helps reduce risk. In 2004 we continued to transfer skills and capabilities around the globe, notably in defence, aerospace, prison services and road traffic management. Consistent values To deliver the service, relationships and growth we aspire to, it is essential to develop and nurture consistent values and principles. Our four governing principles - to foster an entrepreneurial culture, enable our people to excel, deliver our promises, and build trust and respect - are embedded in all our policies and processes. Operational highlights Bringing service to life Around the globe, people are experiencing a quality of service from Serco that makes a genuine difference to their lives. Our rail businesses had a particularly good year in 2004. Merseyrail continued to set new performance standards and the Docklands Light Railway carried record numbers of passengers. In Australia, our iconic train The Ghan also carried record passenger numbers and ran its longest-ever trains on the world's first North-South transcontinental service. In England, with our partner NedRailways, we successfully phased-in the combination of two previously separate operations to launch the new Northern Rail franchise, which is already improving punctuality and modernising ticketing systems. In other UK markets, pupils in Walsall are receiving significantly improved education thanks to the partnership between Serco's Education Walsall and the borough's council. An official inspection described the improvements as `spectacular'. The young people in our care at Ashfield Young Offenders Institution near Bristol are receiving significantly improved education and support to reduce reoffending, thanks to a dramatic 15-month turnaround programme praised by the Chief Inspector of Prisons. An MoD customer survey rated Serco among the best of its `key suppliers'. In the US, our focus on safety and service to pilots was recognised with a second award from the FAA, for which we now operate 54 air traffic control towers. In Asia Pacific, the first of 12 new patrol boats being supplied by our joint venture was launched. We are also currently installing a traffic information and management system which will benefit commuters on the Shenzhen corridor, linking Hong Kong with mainland China. Strong start to 2005 While still focused on growing the scope and scale of our existing services, we continue to win a broad range of new work. In the UK we have signed the £400m Defence Academy Campus Integrator contract, which runs for nearly 24 years, to join the MoD's three existing postgraduate education colleges into an international academic centre of excellence for senior military and civilian personnel. We already manage one of the three colleges on the Defence Academy campus - the Joint Services Command and Staff College. In the United Arab Emirates (UAE) we have entered into an agreement to form a joint venture to provide facilities management services to the UAE University's new campus in Al Ain for a minimum period of 10 years. Market development Our vision to be the leading company in our chosen markets requires us to be a thought leader, proactively helping to shape the way our markets develop. Serco Government Consulting is bringing our expertise to the leading edge of public policy and service development by contributing strategic and operational expertise across a range of UK government departments. In the past year it has worked with the BBC, Department for Constitutional Affairs, Department for Environment, Food and Rural Affairs, Department of Health, Office of the Deputy Prime Minister and a number of local authorities. In addition, the Serco Institute researches trends in competition and contracting and is stimulating debate worldwide on how governments can provide better public services. Corporate responsibility We are responsible for providing services that are essential to everyday life. For those working at the heart of society, corporate responsibility has to be second nature. At Serco it is. It underpins the culture and values that help distinguish us in our markets and is an explicit part of the Serco Management System that shapes the way we run our business. Our Corporate Assurance Group, which oversees our approach to corporate responsibility, reports directly to the Group Board and takes an integrated view of all aspects of our corporate governance, risk management, health and safety, and social responsibility. In 2004 our investment in community initiatives totalled £0.8m in cash and in kind, representing 1.4% of pre-tax profit. Our staff have begun a coordinated effort in 2005 to support the victims of the tsunami that devastated so many lives. In an effort that has united people across the company in fundraising and volunteering, by mid-February employees had already raised £73,000 to match Serco's £100,000 donation to the Disasters Emergency Committee. We look forward to reporting progress in this area during the year. Our second corporate responsibility report will be published in March. It explains more about our values and objectives, and details many of our initiatives. It will be available both in printed form and on our website at www.serco.com/corporate_responsibility. Corporate governance Our commitment to effective governance embraces the whole organisation through the Serco Management System. Group Board members have continued to engage with employees, customers and investors to develop a deep and consistent understanding of our operational and strategic performance and to see at first hand how we are perceived by stakeholders. In 2004, each Group Board meeting was held at a different Serco location to help Board members maintain their understanding of this rapidly expanding business. In addition, our Senior Independent Director attended meetings with institutional investors and all Board members attended the AGM. For the third successive year, all Directors participated in a formal Board appraisal process and the results and actions were discussed by the full Board. Full details of Serco's governance arrangements are described in the corporate governance report within the Annual Review and Accounts. Board developments In March 2004 Iestyn Williams retired as an Executive Director, and in April Rhidian Jones retired as a Non-Executive Director. Both became Directors of the newly-created Serco in 1987 after the buyout of RCA's UK business. We thank them for their significant contribution, commitment and guidance over the years. In addition to their other Board responsibilities, in April, DeAnne Julius took over the role of Senior Independent Director and David Richardson became Chairman of the Audit Committee. In February 2005 Joanne Roberts was appointed as Company Secretary - succeeding Julia Cavanagh, who has become Finance Director of our Government Services division. We thank Julia for her contribution over six years as Company Secretary. Executive team developments In light of our two acquisitions we have reorganised and expanded our executive team, which reports to the Group Board for Serco's direction, organisation, performance and governance. Two members of our executive team have taken on additional responsibilities. Strategic Projects Director Ian Downie has become Chief Executive of the ITNET business. And Chief Development Officer Steve Cuthill has relocated to the US to become Chairman of Serco North America and to take responsibility for integrating the RCI acquisition once it has been completed. In addition, we have strengthened the executive team with Grant Rumbles, formerly Chief Executive of Serco Continental Europe & Middle East, as Group Operations Director; Clive Barton, formerly Chief Operating Officer of Serco Solutions, as Group Marketing Director; and Bridget Blow, formerly ITNET Chief Executive, as Group Technology Director. Outlook Across the world, governments and commercial organisations are increasingly seeking to deliver better services and gain greater value for money. In the past year we have taken important steps towards our vision: to be the leading service company in our chosen markets. Our service delivery record and customer relationships help maintain and grow our business base. The acquisitions of ITNET and RCI strengthen our position in key markets and our major contract wins provide further scope for development. With our management further strengthened we believe that we have a better platform than ever for delivering continued strong growth. Finance Review 1. Financial performance Analysis of the Group's financial performance in 2004 is shown in Figure 1. Figure 1: Profit and loss account Year to 31 December 2004 2003 Increase £m £m Total turnover 1,636.8 1,555.5 5.2% Group turnover 1,381.4 1,324.3 Joint venture turnover 255.4 231.2 Gross profit 190.9 180.8 5.5% Administration expenses (139.7) (138.5) Exceptional items (net) - 3.6 Joint venture profit 24.8 24.0 Net Group interest (2.1) (2.9) Profit before intangible amortisation and 73.9 67.0 10.3% tax Intangible amortisation (16.5) (14.1) Profit before tax 57.4 52.9 8.6% Tax (20.4) (19.1) Profit after tax 37.0 33.8 Minority interest (1.0) (0.5) Profit for the financial year 36.0 33.3 Effective tax rate 35.5% 36.1% Average number of shares 430.1m 429.9m Earnings per share before intangible 12.20p 11.03p 10.6% amortisation Earnings per share after intangible 8.37p 7.75p 8.1% amortisation Dividend per share 2.63p 2.34p 12.4% 1.1 Turnover Total turnover for the year to 31 December 2004 increased by 5.2% to £1,636.8m. After adjusting for the effect of disposals and contracts exited (see 6.1 Disposals), turnover grew by 14.0%. Turnover for 2004 includes an incremental contribution of £35m from Premier Custodial Group (PCG) following the acquisition of the remaining 50% in July 2003. From this date the results of PCG have been included in Group turnover. Gross margin on Group turnover, representing the average contract margin across the portfolio, has increased to 13.8% (2003 - 13.7%). 1.2 Exceptional items There were no exceptional items in 2004. During 2003 there were three exceptional items resulting in a net profit of £3.6m. 1.3 Profit before tax Profit before tax and intangible amortisation increased by 10.3% to £73.9m, representing a net margin on turnover of 4.5% (2003 - 4.3%). Profit before tax, intangible amortisation and the contribution from exceptional items in 2003 grew by 16.4%. Profit before tax and after intangible amortisation increased by 8.6% to £ 57.4m. 1.4 Intangible amortisation Intangible amortisation, arising primarily from goodwill, was £16.5m in 2004 (2003 - £14.1m). The increase results largely from the acquisitions of the remaining 50% of PCG in July 2003 and the Ontario Driver Examination Services (DES) franchise which commenced operation in September 2003. 1.5 Tax The tax charge of £20.4m (2003 - £19.1m) represents an effective rate of 35.5% (2003 - 36.1%). The small decrease in the rate is primarily due to changes in the geographical mix of profits. 1.6 Earnings per share As a result of the above, earnings per share before intangible amortisation increased by 10.6% to 12.20p. Earnings per share after intangible amortisation grew by 8.1% to 8.37p. 2. Dividends The proposed final dividend of 1.82p per share gives a total dividend for 2004 of 2.63p, a 12.4% increase on 2003. 3. Cash flow Free cash flow for 2004 was £55.8m (2003 - £47.0m). Further analysis is shown in Figure 2. Figure 2: Cash flow Year to 31 December 2004 2003 £m £m Operating profit before exceptional item 34.7 28.2 Exceptional item: reorganisation costs - (4.5) Operating profit 34.7 23.7 Non-cash items 36.9 33.8 Group EBITDA 71.6 57.5 Working capital movement (3.6) (11.1) Operating cash flow 68.0 46.4 Dividends from joint ventures 14.2 12.6 Interest and taxation (5.2) (7.8) Exceptional item: GSR sale and leaseback - 5.8 Capital expenditure (19.3) (21.8) Disposal of assets - 8.9 Other items (1.9) 2.9 Free cash flow 55.8 47.0 Exceptional item: Norfolk and Norwich refinancing - 4.1 Acquisitions/disposals (9.0) (96.6) Other financing (7.8) 109.5 Dividends paid (10.4) (9.5) Non-recourse debt financed assets (25.2) 47.0 Net cash flow 3.4 101.5 3.1 Operating cash flow There was an operating cash inflow for the year of £68.0m (2003 - £46.4m), an increase of 47%. This represents a conversion of 196% (2003 - 196%) of operating profit and 95% (2003 - 81%) of Group EBITDA into cash. The improvement in conversion rates is particularly notable given that our strong level of organic growth brings an accompanying demand for working capital, typically equivalent to a month's incremental turnover each year. 3.2 Dividends from joint ventures Dividends received from joint ventures during 2004 of £14.2m (2003 - £12.6m) represent an 85% (2003 - 78%) conversion of profit after tax of joint ventures into cash. 3.3 Interest and taxation The 2004 outflow of £5.2m (2003 - £7.8m) benefited from the Group being able to utilise tax losses of subsidiaries that were previously joint venture companies. 3.4 Capital expenditure Capital expenditure for the year, excluding investment in PFI Special Purpose Companies (SPCs), was £19.3m (2003 - £21.8m). This expenditure represented 1.4% of Group turnover, and is broadly similar to prior years. 3.5 Acquisitions / disposals The 2004 net outflow of £9.0m primarily relates to the acquisition of shares in ITNET plc prior to 31 December 2004 for £13.7m and the disposal of businesses in Australia and New Zealand for £3.2m. Further details are in section 6. 3.6 Non-recourse debt financed assets The £25.2m outflow relates to the net movement on expenditure on PFI assets under construction, non-recourse loans and other PFI balance movements. Further analysis is provided in Figure 3. Figure 3: Non-recourse debt financed assets Year to 31 December 2004 2003 £m £m Change in PFI balances PFI debtor 6.9 3.7 Assets in the course of construction (16.3) (33.0) Non-recourse debt (12.8) 26.6 (22.2) (2.7) Change in other balances Non-recourse debt: Ontario Driver Examination (3.0) 49.7 Services Non-recourse debt financed assets (25.2) 47.0 The movements on the PFI balances are the result of timing differences between loan repayment/draw-down and asset spend/recovery. Over the lifetime of each PFI contract, we expect these movements to offset each other. Included within the change in PFI balances is £8.7m of equity and subordinated debt invested into the Traffic Information Services (TIS) PFI SPC in January 2004. 4. Net debt At 31 December 2004 net recourse debt was £14.8 m (2003 - £22.3m). Further analysis is provided in Figure 4. Figure 4: Net debt As at 31 December 2004 2003 £m £m Closing cash 173.9 170.9 Long term loans (167.4) (165.3) Other loans and finance leases (21.3) (27.9) Recourse net debt (14.8) (22.3) Non-recourse debt (256.4) (357.0) Total net debt (271.2) (379.3) Non-recourse debt (see 7. PFIs) represents long term loans secured on the contracts of PFI and other concessions, and not any other assets of the Group. The loans are excluded from all of our credit agreement and other covenants calculations, therefore having no impact on the Group's ability to borrow. Non-recourse debt, utilised to fund PFI assets and the acquisition of the DES franchise, reduced during the year to £256.4m (2003 - £357.0m), largely due to Laser (see 7. PFIs) and the scheduled part repayment of other debt. In addition to Figure 4, non-recourse debt of £51.4m (2003 - £55.2m) is included in joint venture gross liabilities. 5. Pensions For 2004 we have continued to apply the transitional rules and disclosures for the implementation of FRS 17 Retirement Benefits. This requires the market values of the assets and liabilities for defined benefit schemes to be calculated and disclosed in a note, discussed in more detail in Note 32 to the Annual Review and Accounts. In summary, at 31 December 2004, there was a net deficit on an FRS 17 basis in relation to the defined benefit scheme of £75.6m (2003 - £69.7m), and an asset base of £380.8m (2003 - £350.4m). Long term employer and employee contributions were increased in 2003 and have remained at the same level to address the level of deficit in the scheme. 6. Acquisitions / disposals 6.1 Disposals In line with our intention to focus the business on areas with the greatest potential for growth and profitability, we announced in April 2004 the disposal of a number of small and medium sized contracts in Australia and New Zealand. The annual turnover of these contracts was approximately £38m. The disposals were completed by August 2004. The above disposals, together with 2003's disposal of a number of our Swedish contracts and the exiting of our rail maintenance contract with Network Rail in January 2004, have reduced annualised turnover by £140m. 6.2 Acquisitions Also during December 2004, we invested £13.7m in the shares of ITNET plc, a company in which we acquired a controlling interest during February 2005. (See 10. Post balance sheet events). 7. PFIs At the end of 2004 the Group was involved in 11 PFI projects, with 10 equity investments and 11 operating contracts. These contracts contribute £3.2bn to the Group's order book of £12.7bn. During 2004 PFIs contributed £194m (2003 - £ 133.4m) to turnover and £14.6m (2003 - £11.9m) to gross profit. At the end of 2004 we had invested £24.0m of equity and subordinated debt into our SPCs. Cumulatively, as at 31 December 2004, we had generated £26.9m cash from these investments, representing a net inflow to the Group of £3.0m. During October 2004, we stopped accounting for Laser (the National Physical Laboratory PFI SPC) as a subsidiary due to the discussions surrounding the transfer of control of the PFI asset to the DTI. This has removed the non-recourse debt and corresponding PFI debtor from the balance sheet. 8. Treasury 8.1 Treasury management The Group's treasury function is responsible for managing the Group's exposure to treasury risk, and operates within a defined set of policies and procedures reviewed and approved by the Board. 8.2 Credit facilities and liquidity management The Group's liquidity during 2004 was principally provided by a £140m revolving credit facility, which was undrawn at year-end, and two private debt placements. The £140m facility was replaced in January 2005 by a five-year £450m term loan and revolving credit facility. The £450m facility is to fund the acquisitions of ITNET plc and RCI Holding Corporation and is also available to fund the Group's day-to-day liquidity requirements. The £450m facility is unsecured, with covenants and obligations typical of these types of arrangement, which are consistent with our previous facilities. The Group continues to service two private placements which include sterling and US dollar tranches. The first, for £43.2m, was taken out in 1997 and matures in 2007. The second, for £117m, was taken out in 2003 and amortises from 2011 to 2015. 8.3 Foreign exchange risk The Group does not currently hedge the sterling equivalent of the net assets of its overseas operations as the net asset value of these businesses does not represent a significant proportion of the market value of the Group. Foreign exchange gains and losses therefore do not represent a material risk to the consolidated net asset value of the Group. The foreign exchange exposure on the US dollar tranches of the private placements has been fully hedged into sterling in accordance with the risk profile set out above. The nature of the Group's business in general does not involve a significant amount of cross-border trade. Consequently the Group is not exposed to substantial foreign currency transaction risk as sales and costs are approximately matched within overseas operations. Material transactional exposures of individual business units are hedged by forward foreign exchange contracts. Central funding of individual business units gives rise to monetary assets and liabilities centrally and in the business units. Where the asset or liability is denominated in a currency that is not the operating currency of the business unit involved, and a foreign exchange risk would otherwise result, the foreign currency exposure arising is hedged by forward foreign exchange contracts. 8.4 Interest rate risk The Group's exposure to interest rate fluctuations on its borrowing and deposits is selectively managed, using interest rate swaps. 8.5 Credit risk The Group monitors the credit quality of counterparties and limits credit exposures accordingly. 9. International Financial Reporting Standards (IFRS) Serco Group plc will adopt IFRS for accounting periods beginning on 1 January 2005. The Group's interim financial statements for the six months ending 30 June 2005 will be the first under IFRS. The Group is well positioned to ensure compliance within the required timescale. Reporting systems and procedures have been enhanced to support the new reporting requirements and the Group's IFRS accounting policies are being developed. In addition, IFRS training programmes have been provided to ensure that IFRS knowledge is embedded throughout the organisation. A number of areas of difference between IFRS and UK GAAP, which may impact the Group's reported results and financial position, have been identified. These include goodwill and intangible assets, financial instruments, share based payment, employee benefits including pensions, joint ventures and taxation. Areas that may require additional disclosure include segment reporting, service concessions and joint ventures. The key points arising from the adoption of IFRS are: * The Group's underlying performance, cash flow and ability to pay dividends will be unaffected. * The impact on year-on-year earnings growth after transition is likely to be minimal. * The fair value concept may introduce volatility into the balance sheet, largely due to the inclusion. of financial instruments and actuarial gains and losses on defined benefit pension schemes * On transition, the Group's profit before tax will be principally affected by non-amortisation of goodwill, partially offset by a charge for share based payment. * On transition, net assets will reduce principally through recognition of actuarial losses on defined benefit pension schemes. The Group's analysis of the effect of IFRS is ongoing. In addition, the interpretation of standards is evolving so further changes may arise, notably in accounting for pension schemes and service concessions, including PFIs. 10. Post balance sheet events During December 2004, Serco made a recommended offer to acquire all of the issued and to be issued share capital of ITNET plc, a UK listed company. The acquisition of ITNET was declared unconditional in all respects on 3 February 2005. On 17 February 2005, Serco announced that it had acquired, or contracted to acquire, more than nine tenths in value of ITNET's shares and that Serco intended to compulsorily acquire the outstanding ITNET shares. Also during December 2004, Serco made an offer to purchase RCI Holding Corporation, an American private company. The process of obtaining US government approvals is continuing, and we expect to reach completion during March 2005. Consolidated Profit and Loss Account For the year ended 31 December 2004 2004 2003 2004 Joint 2004 2003 Joint 2003 Group Ventures Total Group Ventures Total Note £'000 £'000 £'000 £'000 £'000 £'000 Turnover: Group 2 1,381,417 255,440 1,636,857 1,324,271 231,255 1,555,526 and share of joint ventures - continuing operations Less: Share of 2 - (255,440) (255,440) - (231,255) (231,255) joint ventures Group turnover 2 1,381,417 - 1,381,417 1,324,271 - 1,324,271 Cost of sales (1,190,531) - (1,190,531) (1,143,418) - (1,143,418) Gross profit 190,886 - 190,886 180,853 - 180,853 Administrative (156,204) - (156,204) (157,144) - (157,144) expenses Amortisation of (16,476) - (16,476) (14,131) - (14,131) intangible assets Other (139,728) - (139,728) (138,516) - (138,516) administrative expenses Exceptional item: - - - (4,497) - (4,497) reorganisation costs Operating 34,682 - 34,682 23,709 - 23,709 profit-continuing operations Exceptional item: - - - 3,977 - 3,977 GSR sale and leaseback Share of - 25,437 25,437 - 22,700 22,700 operating profit in joint ventures Interest 31,171 4,111 35,282 16,760 11,397 28,157 receivable and similar income Group 31,171 - 31,171 12,691 - 12,691 Exceptional item: - - - 4,069 - 4,069 Norfolk and Norwich refinancing Share of joint - 4,111 4,111 - 11,397 11,397 ventures Interest payable (33,259) (4,760) (38,019) (15,609) (10,080) (25,689) and similar charges Group (33,259) - (33,259) (15,609) - (15,609) Share of joint - (4,760) (4,760) - (10,080) (10,080) ventures Profit on 32,594 24,788 57,382 28,837 24,017 52,854 ordinary activities before taxation Taxation on (20,371) (19,103) profit on ordinary activities Profit on 37,011 33,751 ordinary activities after taxation Share of joint (577) (198) venture minority interest Minority interest (413) (255) Profit for the 36,021 33,298 financial year Equity dividends (11,810) (10,050) Retained profit 24,211 23,248 for the financial year Earnings per 3 Ordinary Share (EPS) of 2p each Basic EPS, after 8.37p 7.75p amortisation of intangible assets Basic EPS, before 12.20p 11.03p amortisation of intangible assets Diluted EPS, 8.27p 7.74p after amortisation of intangible assets Diluted EPS, 12.06p 11.02p before amortisation of intangible assets The basis of preparation of this statement is set out in Note 1. Consolidated Balance Sheet As at 31 December 2004 2004 2003 Note £'000 £'000 Fixed Assets Intangible assets 215,157 222,950 Tangible assets 79,537 77,398 Investments in joint ventures 27,196 24,886 Share of gross assets 195,475 151,460 Share of gross liabilities (168,279) (126,574) Other investments 13,712 - 335,602 325,234 Current assets Stocks 36,204 39,543 Debtors: Amounts due within one year 4 293,608 278,931 Debtors: Amounts due after more than one 4 333,615 419,589 year Cash at bank and in hand 173,886 170,888 837,313 908,951 Creditors: Amounts falling due within one year Trade creditors 76,886 81,335 Other creditors including taxation and 114,179 90,892 social security Accruals and deferred income 192,032 177,866 Proposed dividend 8,330 6,958 391,427 357,051 Net current assets 445,886 551,900 Total assets less current liabilities 781,488 877,134 Creditors: Amounts falling due after more 415,088 539,798 than one year Provisions for liabilities and charges 61,981 56,526 Net assets 304,419 280,810 Capital and reserves Called up share capital 8,707 8,697 Share premium account 191,510 190,791 Capital redemption reserve 143 143 ESOP reserve (15,815) (16,949) Profit and loss account 119,874 98,128 Equity shareholders' funds 5 304,419 280,810 This preliminary announcement was approved by the Board of Directors on 1 March 2005 and signed on behalf of the Board: Kevin Beeston Executive Chairman Andrew Jenner Finance Director Consolidated Cash Flow Statement For the year ended 31 December 2004 2004 2003 £'000 £'000 Operating profit 34,682 23,709 Depreciation and amortisation of 35,790 32,532 intangible assets Movement in ESOP investment 1,134 1,258 Net increase in working capital (3,642) (11,111) Net cash inflow from operating activities 67,964 46,388 before PFI asset expenditure Movement in PFI debtor * 6,902 3,680 Expenditure on PFI assets under (16,278) (33,001) construction * Net cash inflow from operating activities 58,588 17,067 after PFI asset expenditure Dividends received from joint ventures 14,239 12,630 Returns on investments and servicing of finance Interest received 31,033 5,652 Interest paid (34,767) (6,054) Exceptional item: Norfolk and Norwich - 4,069 refinancing Net cash (outflow)/inflow from returns on (3,734) 3,667 investments and servicing of finance Taxation Tax paid (1,479) (7,354) Capital expenditure and financial investment Purchase of tangible fixed assets (19,257) (21,835) Sale of tangible fixed assets 51 8,878 Exceptional item: GSR sale and leaseback - 5,761 Net cashflows with joint ventures (1,960) 2,969 Net cash outflow from capital expenditure (21,166) (4,227) and financial investment Acquisitions and disposals Acquisitions † (13,890) (107,463) Net cash acquired with acquisitions - 12,843 Net overdraft/(cash) redeemed upon 16 (3,141) disposal Subscription for shares in joint ventures - (3,354) Proceeds from disposal of subsidiary and 3,159 4,471 business undertakings Proceeds from reduction in investment in 1,763 - joint ventures Net cash outflow from acquisitions and (8,952) (96,644) disposals Equity dividends paid Dividends paid (10,438) (9,529) Net cash outflow from equity dividends (10,438) (9,529) paid Net cash inflow/(outflow) before 27,058 (84,390) financing Financing Issue of ordinary share capital 729 - (Decrease)/increase in other loans (782) 115,793 (Decrease)/increase in non-recourse debt (15,798) 76,285 financing Capital element of finance lease (7,782) (6,188) repayments Net cash (outflow)/inflow from financing (23,633) 185,890 Increase in cash in the year 3,425 101,500 Balance at 1 January 170,888 69,388 Non-cash movements (427) - Balance at 31 December 173,886 170,888 * PFI assets and debtor financed by non-recourse loans. † Includes investment of £13,712,000 in respect of ITNET prior to the acquisition offer becoming unconditional. Consolidated Statement of Total Recognised Gains and Losses For the year ended 31 December 2004 2004 2003 £'000 £'000 Profit for the financial year 36,021 33,298 Currency translation differences on foreign currency net (2,714) 6,654 investments Total recognised gains and losses for the year 33,307 39,952 Notes to the Preliminary Announcement For the year ended 31 December 2004 Basis of preparation - preliminary announcement The basis of preparation of this preliminary announcement is set out in note 1. The financial information in this announcement, which was approved by the board of directors on 1 March 2005, does not constitute the company's statutory accounts for the years ended 31 December 2004 or 2003, but is derived from these accounts. Statutory accounts for 2003 have been delivered to the Registrar of Companies and those for 2004 will be delivered following the company's annual general meeting. The auditors have reported on these accounts; their reports were unqualified and did not contain statements under S237 (2) or (3) Companies Act 1985. 1. Accounting policies This preliminary announcement has been prepared in accordance with applicable UK accounting standards. These have all been applied consistently throughout the year, and the preceding year. 2. Segmental Report Classes of Business Joint Group Ventures Total 2004 £'000 £'000 £'000 Turnover Civil government 540,634 6,498 547,132 Defence 320,598 165,907 486,505 Transport 279,049 83,035 362,084 Science 115,972 - 115,972 Private sector 125,164 - 125,164 Total 1,381,417 255,440 1,636,857 Profit before taxation and other costs Civil government 24,374 656 25,030 Defence 23,389 17,620 41,009 Transport 16,125 7,161 23,286 Science 10,439 - 10,439 Private sector 3,081 - 3,081 Total 77,408 25,437 102,845 Other costs Common costs (26,250) Amortisation of intangible assets (16,476) Net interest - group (2,088) Net interest - joint ventures (649) Profit on ordinary activities before taxation 57,382 Net assets Civil Government 66,228 Defence 67,378 Transport 58,108 Science 60,399 Private sector 31,131 Total 283,244 Unallocated assets 21,175 Total 304,419 2. Segmental Report (continued) Classes of Business Joint Group Ventures Total 2003 £'000 £'000 £'000 Turnover Civil government 444,875 42,897 487,772 Defence 252,469 151,496 403,965 Transport 385,793 36,862 422,655 Science 111,004 - 111,004 Private sector 130,130 - 130,130 Total 1,324,271 231,255 1,555,526 Profit before taxation and other costs/income Civil government 17,025 4,195 21,220 Defence 17,878 15,968 33,846 Transport 18,976 2,537 21,513 Science 11,619 - 11,619 Private sector 8,697 - 8,697 Total 74,195 22,700 96,895 Other (costs)/income Common costs (31,858) Exceptional items - reorganisation costs and GSR (520) sale and leaseback Amortisation of intangible assets (14,131) Net interest - group (2,918) Exceptional item - Norfolk and Norwich 4,069 refinancing Net interest - joint ventures 1,317 Profit on ordinary activities before taxation 52,854 Net assets Civil Government 43,749 Defence 53,127 Transport 59,173 Science 64,508 Private sector 32,436 Total 252,993 Unallocated assets 27,817 Total 280,810 2. Segmental Report (continued) Geographical segments Joint Group Ventures Total 2004 £'000 £'000 £'000 Turnover United Kingdom 1,006,310 196,030 1,202,340 Rest of Europe and Middle East 180,612 6,051 186,663 Asia Pacific 105,556 47,747 153,303 North America 88,939 5,612 94,551 Total 1,381,417 255,440 1,636,857 Profit before taxation and other costs United Kingdom 51,986 21,989 73,975 Rest of Europe and Middle East 13,200 496 13,696 Asia Pacific 3,386 2,630 6,016 North America 8,836 322 9,158 Total 77,408 25,437 102,845 Other costs Common costs (26,250) Amortisation of intangible assets (16,476) Net interest - group (2,088) Net interest - joint ventures (649) Profit on ordinary activities before taxation 57,382 Net assets United Kingdom 172,650 Rest of Europe and Middle East 42,352 Asia Pacific 41,252 North America 26,990 Total 283,244 Unallocated assets 21,175 Total 304,419 Note: Turnover is shown by geographical origin. Turnover analysed by geographical destination is not materially different. 2. Segmental Report (continued) Geographical segments Joint Group Ventures Total 2003 £'000 £'000 £'000 Turnover United Kingdom 950,098 174,723 1,124,821 Rest of Europe and Middle East 185,936 8,355 194,291 Asia Pacific 109,627 43,251 152,878 North America 78,610 4,926 83,536 Total 1,324,271 231,255 1,555,526 Profit before taxation and other costs/income United Kingdom 43,017 19,274 62,291 Rest of Europe and Middle East 14,414 227 14,641 Asia Pacific 6,982 2,831 9,813 North America 9,782 368 10,150 Total 74,195 22,700 96,895 Other (costs)/income Common costs (31,858) Exceptional items - reorganisation costs and GSR (520) sale and leaseback Amortisation of intangible assets (14,131) Net interest - group (2,918) Exceptional item - Norfolk and Norwich refinancing 4,069 Net interest - joint ventures 1,317 Profit on ordinary activities before taxation 52,854 Net assets United Kingdom 142,166 Rest of Europe and Middle East 41,670 Asia Pacific 42,553 North America 26,604 Total 252,993 Unallocated assets 27,817 Total 280,810 Note: Turnover is shown by geographical origin. Turnover analysed by geographical destination is not materially different. 3. Earnings per Ordinary Share Basic and diluted earnings per Ordinary Share have been calculated in accordance with Financial Reporting Standard 14 (FRS 14) - Earnings Per Share. Earnings per share is shown both before and after amortisation of intangible assets to assist in the understanding of the impact of FRS 10 on the Group Accounts. 2004 2003 £'000 £'000 Weighted number of shares in issue 430,127,262 429,878,711 Weighted average number of dilutive share options 5,276,198 412,330 Total number of shares for calculating diluted 435,403,460 430,291,041 earnings per share 2004 2003 Earnings Per share Earnings Per share amount amount £'000 pence £'000 pence Basic earnings 36,021 8.37 33,298 7.75 Amortisation of intangible assets 16,476 3.83 14,131 3.28 Earnings before amortisation of 52,497 12.20 47,429 11.03 intangible assets Diluted earnings 36,021 8.27 33,298 7.74 Diluted earnings before amortisation 52,497 12.06 47,429 11.02 of intangible assets 4. Debtors 2004 2003 £'000 £'000 a) Amounts due within one year: Amounts recoverable on contracts 194,261 198,687 Other debtors 39,399 32,572 Corporation tax recoverable 1,784 1,670 Prepayments and accrued income 46,696 35,924 Amounts owed by joint ventures 6,078 2,600 PFI debtor * 5,390 7,478 293,608 278,931 2004 2003 £'000 £'000 b) Amounts due after more than one year: Amounts recoverable on contracts 27,972 22,043 Other debtors 16,064 21,780 Pensions prepayment 34,580 30,580 Amounts owed by joint ventures 2,934 8,869 PFI debtor * 181,816 260,780 PFI assets in the course of 70,249 75,537 construction* 333,615 419,589 Total debtors 627,223 698,520 * The PFI assets analysed above are funded by non-recourse loans of £ 208,905,000 (2003 - £307,239,000). 5. Reconciliation of movements in equity shareholders' funds 2004 2003 £'000 £'000 Retained profit for the financial year 24,211 23,248 Goodwill previously written off released on sale of 249 - subsidiary Currency translation differences on foreign currency (2,714) 6,654 net investments New capital subscribed 729 - Change in ESOP reserve 1,134 1,258 Net increase in equity shareholders' funds 23,609 31,160 Opening equity shareholders' funds 280,810 249,650 Closing equity shareholders' funds 304,419 280,810 6. Analysis of net debt Cash flow Balance Balance movement Exchange Non-cash 31 1 January Disposals during adjustments changes December 2004 2004 2004 2004 2004 2004 £'000 £'000 £'000 £'000 £'000 £'000 Cash at bank and in 170,888 - 3,425 (359) (68) 173,886 hand Other loans due within (4,473) - 3,310 - - (1,163) one year Other loans due after (165,256) 397 (2,528) 11 - (167,376) more than one year Finance leases (23,461) 1,369 7,782 (244) (5,590) (20,144) Recourse net debt (22,302) 1,766 11,989 (592) (5,658) (14,797) Non-recourse debt (356,979) - 15,798 (740) 85,478 (256,443) Net debt (379,281) 1,766 27,787 (1,332) 79,820 (271,240) Non-cash changes to non-recourse debt represents £85,478,000 in respect of the deconsolidation of Laser.

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