Serco Group PLC

LSE:SRP

Earnings Call Transcript 2022-Q4

[Mark Irwin, Group CEO & Director]

Good morning, everyone. My name is Mark Irwin. I'm Chief Exec for Serco Group. And joining me this morning for our results presentation is Nigel Crossley, our Group CFO. May I start by thanking everyone who has joined us in the room today for the session as well as those joining us online. We appreciate your time, interest and support for Serco. As is required, I ask that you note the disclaimer on the screen. There's also a copy of it in the results booklet, which you have with you in the room today.

The format for today's session is similar to what you would have seen in previous years. After my introductory comments, Nigel will take us through the numbers, and I will come back and speak briefly about the business before moving to Q&A.

Now we were actually in this very same building talking to you about our 2021 full year results on the 24th of February last year, the same day that Russia invaded Ukraine. After 2 years of COVID, in the hopes of a return to some version of pre-pandemic normal were subsequently lost to a prolonged conflict, rattled energy markets, inflation at levels not seen in decades and labor shortages among a long list of challenges faced by citizens, governments and businesses.

And so it is against that difficult backdrop that we believe our full year results for 2022 is demonstrative of the operational and financial resilience of our business. Our revenue, which exceeded £4.5 billion was up 11%, excluding the impact of COVID-related work going away and currency movements.

Our underlying trading profit at £237 million was slightly better than what we indicated at the pre-close in December, but significantly better than the initial guidance of £195 million at the start of the year. Our cash generation continues to be strong. We converted 97% of UTP during the year and underlying return on invested capital remains high.

Now Nigel will talk through the detail of our capital allocation model. But generally, when you look at the achievement, we are pleased that we are delivering well against all of our stated priorities.

Our international portfolio is delivering with more than 75% of our underlying trading profit being generated outside of the U.K. And the agility of our B2G platform allowed us to respond to increased demand for case management services in the U.S. and immigration services in the U.K., Australia and Europe as key areas of growth. But we're pleased that in every division, we saw good performance in 2022.

We did have some negative impact in energy prices in the U.K. in the first quarter of last year. But over the course of the year, inflation, tight labor markets and supply chain challenges were generally all well managed. And we had another good year of order intake and our pipeline at year-end remains healthy at £8.4 billion. And our guidance for the coming year is maintained, as are our medium-term growth targets. And you will be aware from the announcement this morning that our Board has supported a further £90 million share buyback for 2023.

I wanted to spend just a minute on this slide, which I hope will clearly show that the hard work that has been done in the business since 2014 has not only resulted in a turnaround, but provides a platform for sustainable, profitable growth and shareholder value creation. If we use 2019, the last year in which our results had no impact of COVID-related work as a baseline, we see that through to the end of 2022, our revenues have grown by 40%, our underlying trading profit has nearly doubled, ROIC is better by more than 500 basis points, and our pipeline has remained robust despite strong conversion rates and continues to offer good visibility to further growth opportunities to meet our medium-term growth goals.

And as we work toward those medium-term growth goals, we will take a systematic approach to strengthening our international business to government platform by focusing our execution on 3 value drivers: growing customer impact and market share, growing the value of colleagues work and growing margins and efficiency.

And I'll come back to these a little later in the presentation, but I'll now hand over to Nigel to take a closer look at our financial outcomes for FY '22.

[Nigel Crossley, Group CFO & Director]

Thank you, Mark, and good morning to everybody. Before I run through the numbers, I just want to take a minute to assure everybody that the delay in last week's announcement had nothing to do with the quality or the accuracy of the group's results. This was purely due to a standard audit procedure which had not been fully completed by KPMG.

And this came up unexpectedly and we were first made aware of it less than 48 hours before we're due to announce our results. This was frustrating and inconvenient for us, and I'm sure for you, for which we apologize. But just to emphasize that the results you're seeing today are audited and they're exactly the same numbers and same results that we would have presented last Thursday. So there's been no change.

So moving on. Sorry. Moving on. I'm going to start with a summary of the group's financial results, which, as Mark said, have turned out considerably better than we expected at the beginning of the year. Revenue grew just over 2% to £4.5 billion in the year. There's been a 3% growth from acquisitions, including ORS and Sapienza, which we closed this year in Europe, as well as the full year effect of the 2021 acquisition of WBB in North America Defense.

Organic growth was a negative 4%, but this only tells half the story. Within organic growth, there's been a negative 11% impact from the ending of COVID-related work in the U.K., partially offset by strong performance in the rest of the business, which has grown organically at about 7%, including a small benefit from inflation. Underlying trading profit was £237 million, an increase of 4% on 2021, with margins stable at 5.2%. And similar to revenue, profit performance from the base business has been strong and up more than 30%, excluding currency and COVID-related work.

Of note is that all our international regions delivered both increased profits and margins in the year, and combined, they now account for around 3/4 of the group's profit before corporate costs. And I'm also pleased with the way the business stood up to inflation in 2022. There's been no significant net profit impact in either direction, and inflation protection mechanisms within our contracts have served the portfolio well. There have been some pockets where the timing of cost pressures have run ahead of revenue uplifts such as in the U.K., HGV drivers and energy costs. But overall, it has been a successful year for managing the financial impacts of inflation.

There was a strong underlying EPS performance, which is up 11% to £0.139 per share. This reflects a good trading profit performance, slightly lower finance and tax costs as well as the benefit of the share buyback program that we completed in the year and reduced the share count. And this also supported another significant increase in the dividend per share, which has increased 19% to 0.0286 per share.

And then finally on this slide, we continue to report a good return from our invested capital with underlying ROIC 20% -- over 20% in the year. And while this is a little lower than 2021, it is mainly because of the full year impact of the WBB acquisition in the invested capital base.

So moving now and looking at the different regions. We're going to start with the Americas, which now contributes 49% of the group's underlying trading profit before corporate costs. And the Americas' revenue was up 13%, which did benefit from a strong U.S. dollar as well as 3% from last year's acquisition of WBB. Organic growth was down just 1%. The defense sector grew by 2% on a constant currency basis. With the increased revenue from WBB broadly offset by the reduced volume of task orders in the low-margin CANES ship modernization program.

Underlying trading profit was £137 million, and we grew margin to 10.8%. And this improvement was largely due to some strong contract profit performance and a portfolio mix, particularly in the defense sector.

But the North America highlight for 2022 was their order intake of £2 billion, which was a book-to-bill of 160%. The majority of these wins were in the defense sector. And we're particularly pleased with METS, which we acquired in 2019, who secured $1.2 billion of wins and a book-to-bill of over 400%, with both rebids, including the Navy C21 contract, and new bids like NOMARS and SHAPM. These wins will set the business up for a strong 2023.

And also the Americas' pipeline has been replenished after the strong order intake in 2022. It currently stands at £2.5 billion, up from £2.2 billion. Once again, the pipeline is a strong weighting to defense, but there are some interesting opportunities in Canada and sit in the services sector. And we should just say that 2023 has got off to a good start with a successful rebid of CMS, which we announced last week.

So moving on to the U.K. And the U.K. business delivered a strong result in 2022. While revenue was 1% lower in the period, this did include a £22 million -- sorry, a 22% impact from £480 million of reductions in COVID-related work. And this has largely been offset by strong organic growth coming from DWP Restart, defense and higher volumes in immigration. Similarly, profit was down just £24 million after absorbing £65 million impact in 2022 from the end of AWE and COVID work.

Just as immigration had a very strong year and in particular, immigration services, where the number of asylum seekers has continued to increase significantly during the period. And we've also expanded our immigration business into Europe with the acquisition of ORS in September.

Citizen Services benefited from the ramp-up of DWP Restart contract. And as expected, these have been more than offset by the end of the COVID work. Other highs and lows in this year include leisure, which is performing well on its post-COVID recovery path, and Environmental Services, which did experience increased operational pressures in the year impacted by tight labor markets, particularly from HCV drivers.

Defense has traded well with a successful start-up of DIO contracts under the VIVO joint venture. And our share of profit here largely replenished the lost profit from the end of AWE joint venture. Elsewhere, the conclusion of the future provision of Marine Services, our FPMS contract, was successfully transitioned to a new interim 2-year contract. And transport continued to recover post the pandemic with volumes and profits higher in the year. MerseyRail, which was one of those areas significantly impacted by COVID, improved profitability as passenger volumes continue to rise.

Order intake of £1.9 billion included the HMP Fosse Way new prison and also securing the Maritime Services contract. We were clearly disappointed on some of the losses, including Skynet and HMP Lowdham Grange, but our £3.7 billion pipeline of new business remains healthy, particularly in Justice & Immigration and Defense.

And moving on to AsPac, who traded well across the year. Organic revenue growth was flat as higher volumes in Immigration Services were offset by reduced volumes within our Citizen Services portfolio. This was particularly affected by tight labor markets and higher vacancies as well as a reduction in the scope of work at Fiona Stanley Hospital, where some services were taken back in-house in 2021. The underlying trading profit for the period has increased 31 basis points to 6%, which has principally been due to higher volumes and mix of services in the immigration contract.

Order intake in the period was relatively subdued following the unsuccessful bids of 2 large new business contracts, Frankston Hospital and vehicle licensing in Victoria. The business is now focused on rebuilding their pipeline, which includes defense-based support, one of the largest business opportunities in the group. But the priority for the division in 2023 is the re-tender of the immigration services contract, which is due to end in December this year.

And finally, in the Middle East. The Middle East results continue to reflect the impact of Dubai Metro contract that we exited in September 2021. This had a £90 million impact on revenue, but minimal impact on profit due to its lower than average margins. The transport business has seen an improvement in their airport based contracts during the year as travel has started to return and is now approaching pre-COVID levels. Despite the lower revenues, profit increased 17% and the profit margin improved almost 2.5 percentage points. The successful exit of Dubai Metro has been accretive to margin supported by good performance elsewhere in the sector.

And in the year, we successfully rebid our Dubai navigation services contract as well as a new win to provide facilities management services to Riyadh International Airport. We've also seen wins on smaller but higher-margin contracts for asset management consulting services in Saudi Arabia, where there continues to be a strong pipeline.

So moving on to free cash flow. Free cash flow at £159 million delivered trading cash conversion of just under 100%. And since the significant cash drain of OCPs in 2018, the cash conversion has averaged over 100% for the last 4 years. Adjusted net debt was slightly better than we expected at £204 million, which was flat in the year excluding the impact of foreign exchange movements, and this reflected strong free cash flow being offset by £90 million of share buyback, £30 million of dividends and £26 million of acquisitions.

And we've not used any financing facility or efforts out of the ordinary to reduce our net debt at the period end. And our average daily net debt in the full year was just £27 million higher than the closing net debt. And leverage at 0.8x EBITDA remains below our 1 to 2x medium-term target and underlines the strength of our balance sheet.

So now turning on to capital allocation. And 2022 has been another year where we invested capital in all of our 4 priority areas, including funding organic growth, increasing dividends, completing acquisitions and returning surplus cash to shareholders. Generating organic growth continues to be our first priority for capital. But as we've said in the past, our operating model is capital light. But in 2022 -- but we have invested in our people. Recognizing the cost of living crisis and tight labor markets globally, we've increased pay faster than we expected to. We've distributed £9 million in we care payments to our frontline workers, and we funded other support programs for our people.

In addition, we have recommenced our residential slots with university leadership and contract manager courses. And this has contributed towards ending 2022 with fewer vacant roles than we had at the start of the year. We've also increased -- also during the year, we've increased our investment in business development and particularly in North America.

Our second priority is dividends, and we've announced today a final dividend for 2022 of £0.0192 per share. This is a 15% increase on total dividend cash payout for 2022, but combined with the share buyback, results in a 19% increase on a pence per share basis. And we remain on track to reduce dividend cover towards 3x in the medium term.

And our third priority is to fund acquisitions, and we completed 2 acquisitions in Europe during the year. We started to build our scale and presence in a strategic priority region. Sapienza closed in July, which supports our European space business. And more significantly, ORS closed in September to extend our immigration capability into Mainland Europe.

And our final priority is to return surplus cash to shareholders. In 2022, a £90 million share back was completed. And today, we have announced our intention to undertake an additional £90 million share buyback in 2023 based on our strong balance sheet position.

And finally, on guidance, which is laid out clearly on the screen for 2023 and is essentially unchanged from the December pre-close announcement. The only one update is net debt, which reflects the stronger closing position in 2022 and the impact of the 2023 planned share buyback. Revenue is expected to be at least £4.6 million, which is a 2% to 3% increase in the year. This will be driven by the Americas following the strong order intake, combined with modest growth from other regions after absorbing the impact of contracts ending in the U.K.

Underlying trading profit guidance of around £235 million is similar to the 2022 outturn. And our free cash flow is expected to be approximately £120 million. Net debt should end the year around £200 million after factoring in the 2023 share buyback. Both net finance costs and the effective tax rate are expected to increase slightly in 2023. The net finance costs will include higher prevailing interest rates and borrowings, and we expect lease interest costs to increase as more properties are leased in response to the volume growth in our U.K. immigration contract.

The effective tax rate will increase as higher corporation tax in the U.K. take effect. And in later years, we have introduced -- we will have the introduction of corporation tax in UAE and global minimum tax.

So that finishes the financial review, and I'm going to hand back to Mark now.

[Mark Irwin, Group CEO & Director]

Nigel, Thank you. In the remaining part of this morning's presentation, I'd like to reflect on some of the highlights and lowlights from the prior year and then touch briefly on what we will focus on going forward. The right place for me to start is to say that we are immensely proud of the achievements of our more than 50,000 colleagues around the world, whose dedication and tireless efforts have led to another successful year for the group. As you saw in the detail presented by Nigel, our performance was much better than we expected at the start of the year, showing our platform enables the business to respond to both risk and opportunity to consistently deliver positive results.

And while we had good results across the group, I think worthy of highlighting again, following on what Nigel shared previously, that we had a particularly strong finish in our North American business with 160% book-to-bill driven out of strong win and rebid rates in our METS business unit. You will recall that we made this strategic acquisition in 2019 to add a platform for growth in maritime engineering, design, technology and sustainment.

We also see across the group more and more examples of leveraging capability cross-divisionally and across sectors where that collaboration is resulting in better solutions for our customers. Through one of those collaborations, we entered the employment services market in Canada in the second half of 2022, winning a 5-year £110 million contract as a result of work done between our Citizen Services teams in Canada and the U.K. In the U.K., we've been doing this work for the U.K. Department of Work and Pensions for a long period of time, and so we were able to share that knowledge and experience and help our Canadian colleagues enter that new sector.

Also, as you heard from Nigel, our results for '22 continues a track record of strong performance, which has enabled us, again, to deliver on all of the pillars of our capital allocation strategy with consistency. And we've spoken previously about contractual protections and our portfolio mix affording protections and mitigation against inflation risk. And we were able to manage well again through last year despite the significant surge in inflation seen globally. And we did so while being mindful of the hardship brought to colleagues by cost of living pressures in the broader economy.

We increased wages more than we budgeted for during the year, and we also distributed an additional £9 million in we care payments to colleagues outside of management ranks in September. This follows a £6 million payment announced at the end of 2021, which was paid in February 2022, and a broader portfolio of support through our employee assistance program, our financial well-being hub, hardship grants, which are provided to employees through the Serco People Fund and our Serco My Benefits Program, which offers employee savings at more than 1,000 retailers.

And finally, when we look at our highlights, our order book remains robust at £14.8 billion, and that excludes the £1.5 billion of order book in VIVO, our joint venture with EQUANS. And our qualified pipeline of new business, which stands at £8.4 billion, has been replenished during the year, and we believe remains at a healthy level.

And some lowlights on the other side of the ledger. As Nigel said, in relation to the VicRoads deal and a PFI hospital opportunity in Australia, we took some big swings at adjacent new growth opportunities, where we were unsuccessful in our first runs. So while the outcomes were disappointing, we take lots of learnings from those bids to similar opportunities in the future. And we were also unsuccessful at a few but large rebids in the U.K. towards the end of 2022, which took our rebid rates below what we have seen in recent years.

In relation to our workforce, we have reduced the number of vacancies across the group, but it remains really hard work. While we are able to attract new colleagues into the business, retention continues to be a significant challenge for us. Another disappointment was the announcement by the Scottish government to end the Caledonian Sleeper franchise despite recognition from the public and the government itself that we have totally transformed that service.

And I'd like to acknowledge that the positive impacts of immigration volumes is evident in our financial results, but our AASC contract in the U.K. made those outcomes possible because of the fantastic response of our teams on the ground. We're very conscious of the fact that they continue to face a challenging and dynamic operating environment, as do our colleagues in the Civil Service in addressing the complex issues related to asylum accommodation.

And I note the last but critically important point on the slide. As restrictions largely came to an end related to COVID during the year, we saw service users and our staff return to circumstances they had not faced in more than 2 years, for some of our staff not faced at all since they joined us during the pandemic. And what we saw during the year was custodial regimes normalizing, traveler numbers swelling and backlogs for driver testing and other public-facing services seeing rapid demand during the year. And that resulted in more of our colleagues being injured.

The safety and well-being of my team is personal to me and a responsibility that I care deeply about. So doing everything that I can to make think safe, work safe, home safe a reality for every colleague in our business every day is my first priority, and we are committed to do better in 2023.

I've been a member of the Serco Executive Committee since 2014 and part of the team that developed our strategy. Looking forward, I remain confident that the strategy provides the best pathway to value creation for our customers, our colleagues and our shareholders and our performance framework to grow revenue faster than market, profit faster than revenue, and to convert that profit to cash serves as a good measure for that.

Our focus, therefore, in coming years is the execution of our strategy to achieve our goals of 4% to 6% growth at increased margins over the medium term, while impacting a better future for people, place and planet. Our strategic framework, therefore, remains unchanged but with a clear focus on executing against 3 value drivers, our 3Cs, customers, colleagues and capabilities, which I will elaborate on in just a moment.

When we look more broadly at the market, our view remains that the market for private sector delivery of government services is both large and growing. Partnering with the private sector to deliver impact allows governments flexibility in the design of solutions, in the efficiency of service delivery and in the measurement of impact for citizen, community and country.

In 2021, we conducted a market review, which included using 2 independent research firms. The conclusion of that work indicated that the total outsourcing spend by governments on services in the markets that we operate in was estimated to be £715 billion and that the market was expected to grow over the medium term at a rate of 2% to 3%.

While noting that the market remains fragmented and despite Serco being a leading international provider of services to government, we think our market share is still quite small, somewhere between 1% and 3%. So based on that data, we should have significant opportunities to grow our share of existing market. And we think that the manifestation of the 4 forces, which we've discussed previously, may see potential acceleration from structural labor market challenges and the development and conversion of technology, all of that providing fertile ground for us to achieve our growth objectives.

Our B2G platform was introduced at our Capital Markets Day in December 2021. And in the context of the current challenges that we see governments facing, we believe that it continues to offer differentiated Serco capability, capacity and agility that enhances rather than replaces public sector effort. So going forward, we aim to participate more broadly across our customers' value chain from advisory to operations, from designing services to enabling better outcomes in flexible partnerships focused on delivering impact. And the 3Cs I mentioned earlier is all about delivering our medium-term growth targets: growth in revenues, growth in colleague enablement and growth in margins.

Let me take a look at each of these in turn. In terms of our focus on customers, we've worked hard in recent years to earn credibility and our customer relationships are now strong. We will work even harder in the period ahead to elevate those relationships, and we'll be forensic in our understanding and targeting of the existing market while remaining agile and responsive to new and emerging opportunities.

In our chosen markets, we believe we have the broadest touch points with government amongst their strategic suppliers. We will build those partnerships stronger by giving our customers long-term cross-department, non-institutionalized and pragmatic perspectives so that they can address their challenges drawn from Serco's experience and capability around the world. We will grow revenues by increasing share of customer and share of market and support our mission to impact a better future by evolving from outsourcer to impact partner to the world's leading governments.

In terms of colleagues, our commitment to the safety and well-being of our colleagues remains foremost in our efforts to protect and deepen the relationship between Serco and the people whose dedication and commitment stands behind our success. To support retention, we will continue to develop our employee value proposition to build on the purpose-driven foundations we already have and to grow the value of work we ask people to do. We will have renewed emphasis on work process reengineering with a technology-first approach to support productivity.

We'll extend the high levels of engagement we have to high levels of enablement through workforce augmentation, which will allow colleagues to focus their efforts on areas of highest social and economic value. And so our targeted progression in coming years is, therefore, growing the value of work, deepening the relationship between the company and our colleagues and then turning our colleagues into advocates for Serco.

And the third C is capabilities. We're going to put significantly more effort on technology enablement and continuous learning across the group. In past years, we've invested in building a robust IT infrastructure and cyber capability. We will continue to protect those core elements of our technology platform while accelerating our capability to fully exploit the functionality of platforms we've already invested in, and we will pivot our ambition to harness new and emerging technologies to help everyone in our business work safer, be more productive and grow value.

We will explore scaling artificial intelligence, AI, but in a very practical sense to extract value by applying it to decision-making in operations and then to evolve our structure and culture around the optimization that it may offer. In other words, we will look for answers to put robotics and automation in, in order to take unproductive costs out. In the coming years, we will access those enabling technologies from a broader capability ecosystem by proactively partnering with both startup and established tech companies.

And so to wrap up. Our FY '22 results further builds on Serco's track record of delivering better outcomes for citizens, for customers, for colleagues and for our shareholders. We hope that it gives confidence that our strategy of being a focused supplier of services to government operating through our Serco management framework and using our B2G platform to win and deliver business continues to create value. As Nigel said, our guidance for 2023 remains unchanged in terms of revenue and profit, noting the £90 million share buyback.

We exited the prior year with good momentum in our win rate, and 2023 is off to a good start with the success of rebidding the CMS contract in North America. And so in the period ahead, we will place systematic and rigorous execution focus on growing market share through deeper relationships with our customers and a more ambitious and rigorous targeting of the post-pandemic government services market by growing value in the work our colleagues do to increase enablement, retention and the advocacy of colleagues and growing our margins by leaning into technology to deliver productivity through process automation and workforce augmentation.

And all of this is consistent with our broader goals of growing revenue faster than the market, growing profit faster than revenues and shareholder returns growing faster than profits over the medium term. And importantly, we will do this by embedding our ESG commitments to protect people and planet to deliver meaningful social value and ensuring robust governance in everything we do in our mission to impact a better future.

Thank you. And we will now go to Q&A.

[Michael Donnelly, Investec Bank]

It's Michael Donny from Investec. Just a quick one, I think, for you, Nigel. U.S. margin is up 30 bps. And I think you're saying it's due to defense. Now assuming that defense is still half the U.S. Navy and the U.S. Navy is mainly cost plus. Should we infer that the plus bit of cost plus has got a bit bigger? Or are you doing more sort of time materials or fixed price contracts within that portfolio?

[Nigel Crossley, Group CFO & Director]

So I think that 10.8% margin, and we've said this before, is probably overachieving versus the portfolio that we have. We know that the CMS contract has helped that margin over the last few years. And when it goes through rebid, we know that was going to be competitive. We priced it competitive. So at the start of the CMS contract, you'll see a bit of a drag on margin from North America. I think when you look at the big contracts we've just talked about like SHAPM, like, C21. They are cost-plus contracts. And their cost of contract with a decent margin, but not as high as what we could potentially go on some fixed price margins. So, we're not seeing that cost plus margin going back, if that was your question. And I think -- we'll always have a mix of both fixed price and cost plus the most recent wins have been cost plus.

David Thomas Brockton Numis Securities Limited, Research Division – Research Analyst

It's David Brockton from Numis. May ask 2, please? The first related to the U.K. and the second to the U.S. In terms of the U.K., can you just give an update on where you currently stand in respect of the U.K. asylum contract? I appreciate your budgeting for a higher level of finance leases, presumably as you take on more properties at the expense of hotels. Are you budgeting for volumes and service users to normalize and reduce through the current year? Or are you expecting to remain as elevated as they are? That's the first question.

The second question, just in respect to the U.S. I know you appreciate the business has been through a period of sort of reduced task orders. But clearly, met and the business now is performing a lot better. Should we now view the backlog is cleared? Or could we see a period of, I guess, super normal performance across the remainder of 2023?

[Mark Irwin, Group CEO & Director]

Yes. So if I start on the asylum question, the government has indicated that they would like to exit hotels by the end of 2023, and we are working closely with the home office in that transition. We think that over the course of the year, volumes will remain high, but we may see a shift in the mix of the type of accommodation that we provide during 2023. We today provide dispersed accommodation is a core part of that contract. We expected the DA volumes in that regard will increase as we go through the year and the hotel volumes will reduce, but that the overall numbers will stay high.

[Michael Donnelly, Investec Bank]

Can I just follow up on that? Would there be any profit change as a result of that given that the volume levels are still high, but the mix, I guess, is changing from hotels to post the combination?

[Nigel Crossley, Group CFO & Director]

Look, I think we'll probably see more of an impact on the top line. I think the cost per night is more in a hotel, obviously, than in a dispersed accommodation. But there may be some other models as well that they end up using. So I think the impact will be greater on the top line than it will be on the bottom line. But there will be some bottom line impact as well.

Sorry, on the other question -- the other question was the U.S. METS. Because I realize -- do you want to take that?

[Mark Irwin, Group CEO & Director]

I guess just to start, we have clearly seen some clearing of that backlog. But we think that in terms of the broader geopolitical landscape that they will continue to be investment in defense, both in terms of new capability, but also in terms of modernization and leveraging the asset base that is in place.

I think the other encouraging sign that we see in our North American defense business is diversification in that portfolio. So when we look at the shape and contract that Nigel mentioned before, that includes program management for the next-generation submarine fleet in the U.S., and we see potentially the opportunity where AUKUS, the relationship that extends now across geographies are actually based in our 3 largest geographies.

And so we see that potential diversification of that capability and our ability to grow beyond that particular contract in a strategic platform. And the other is NOMARS, which we've mentioned previously, but we see that also as a strategic important platform for growth beyond the task order type work. The push towards autonomy is something that is core to all different strategies and the design and now our responsibility to build the first prototype of a large unmanned surface ship for the U.S. government, we think also is another pivot for us to continue to move more broadly, but also higher up the value chain in defense.

[Paul Sullivan, Barclays]

It's Paul Sullivan from Barclays. So Mark, how should we think about the 3 Cs translating into operational performance? And do you think M&A and higher CapEx will play a part in the delivery of what you're trying to achieve there? And then secondly, are there any common themes behind sort of contract losses or unsuccessful bids? And what does that say about the sort of competitive environment and how that's changed?

[Mark Irwin, Group CEO & Director]

Okay. So I'll start and if I missed anything Nigel can fill in the gap.

[Nigel Crossley, Group CFO & Director]

Yes.

[Mark Irwin, Group CEO & Director]

Well, in terms of the 3 Cs, it's about improving the business we have, and we'll do that systematically, as I said, over the coming period. Productivity is important for us, one from a cost position, but also as we continue in this battle for talent. We need to make sure we've got people really working on the things that only they can do. So we see that helping us with retention and helping us with productivity across the business. Technology enablement, I think that is a real value driver. But we will go carefully down that path. We're not going to pursue technology for the sake of technology. We have to find practical use, and there's got to be a solid business case behind that. But we do see these being real levers for us over the next 2, 3 years for us to continue to build value into the business. Your second.

[Nigel Crossley, Group CFO & Director]

Let me just finish up on the 3 Cs from an M&A or a CapEx number. Let me take the CapEx one first is, over the last few years, we've been investing heavily in our base systems and our base processes. So we are quite happy with where we've got those 2 today. And I think what Mark's talking about here is well, let's take that base and say, how can this improve our performance better. And that really is looking at increasing productivity on the stuff we do in-house. But we'll only invest in that if there is a clear business case to invest in that, and we're going to get a real cash return.

And similarly, we might invest in some stuff that helps us get better solutions and customers have better productivity in those contracts. Same case, we'll be looking for a business case to support that.

As far as M&A is concerned, we've had 3 pretty clear criteria about what we're looking for, for M&A. And I think that is, can we buy something that -- and all that criteria is around really is it going to help me enhance my future organic growth. So that's really around am I buying capability will help support my business or help me grow my business? Is it giving me access to new markets or new customers? Or is it just buying the scale and capability that we can then add on to our existing business. So that's always been our M&A criteria. This 3 Cs just actually plays more clearly into that and say these are the things that will be interesting investing in.

[Mark Irwin, Group CEO & Director]

Yes. In general, we -- as we've said, we look at M&A as higher risk more than organic growth. And so it will always supplement our primary focus on organic growth, but we continue to see what opportunities there are out there in the market. The question you asked about our U.K. rebid and those outcomes, as I said, they were late in the year. We are in the process of really going through all of those losses in detail as we do with our wins to understand if there is anything thematic that's come out of that, if there are any shifts in the market, if there's anything different in terms of buying behavior with our customers. And we will be digging into all of that in the coming weeks.

[Nigel Crossley, Group CFO & Director]

Paul, can you pass the microphone to Oscar. Oscar?

[Oscar Val Mas, JPMorgan Chase]

It's Oscar Val Mas from JPMorgan. I have 2 questions. The first one on wage inflation. Could you comment on how much that has contributed for the full year and how you see that developing into 2023 by region, U.S. versus others? And then the second one is on, I guess, recent acquisitions. It looks like the NSBU is performing well, and you're starting to really develop synergies with other regions. Can you talk about WBB and how that has performed? And then I guess, you mentioned M&A, but do you see opportunities near term in Europe to develop that platform, you started with ORS?

[Nigel Crossley, Group CFO & Director]

Yes, when I talked to you about inflation. And when we look at inflation, really, what we're looking at here, do we have the mechanisms within our contract that's protecting our bottom line, and that's what we're interested in. If we look across the U.K., we've probably had just a little bit less than a 6% average increase. Virtually, all our waste settlements for 2022 have gone through. And actually, we've had very little disruption in our contracts from any kind of strike action. So that's where we've been.

Then when I look at what's really happened in our profit, that kind of largest covered this in my script is that we feel good that the contracts -- the mechanisms we've got in our contracts have protected our bottom line. So it has worked for us. And there's no reason why we would expect that not to work in 2023 because those are the same mechanisms that we have.

[Mark Irwin, Group CEO & Director]

And in terms of the existing acquisitions as we see so 2 years in, that's really coming alive now and are seeing that through pipeline conversion and identification of future opportunity we're probably 6 to 12 months behind in terms of WBB getting to that same point. We do those opportunity for that to accelerate because the capability that exists in WBB is being leveraged now to cross-sell more broadly across defense, so capability in cyber capability in organizational design and optimization, we're bringing that capability to bear across the rest of the defense and broader North American portfolio. And so we are positive about how WBB will perform and against its investment case and against our growth targets in the coming period.

From a Europe perspective, we closed the ORS acquisition in September, as you know. So we're in the early part of fully integrating that. We see demand really strong in the geographies that we currently serve in Switzerland, in Germany. We do a little bit in Southern Europe. But the acquisition of ORS, as Nigel said, was about giving us a platform in a market where we see high demand that we can now grow from. The last point that I would make on ours with all of the other acquisitions, Nigel spoke about that strict criteria that we have when we consider a potential acquisition, there is also the discipline of what happens after the acquisition.

So post acquisition, integration, making sure that we can extract the value that we expect from this. And that's the phase that we are going through right now with ORS. So bringing it into the circa network, making sure from an information and security perspective, we've got everything in place and then really supporting the business to grow in a market where we think there is significant potential.

[Arthur Truslove, Citigroup]

Arthur from Citi. So first question was just on the U.S. defense. Obviously, it looks like you had a pickup in order rate in the second half. So first question on that is, how has that progressed into the first half of '23? Are you expecting book-to-bill to accelerate further? And also when does the revenue actually start to kick in? Second, also on U.S. defense, how are you getting on the non-naval side? I know there was a sort of very much optimistic case about how that might accelerate and just wonder how that was going?

And then, finally. Obviously, while the lowlights that you mentioned was the Skynet contract. I just wondered sort of how competitive you view your space offering to be at this moment in time? And if there was anything that sort of gone wrong with that contract, if that makes sense?

[Nigel Crossley, Group CFO & Director]

Do you want me to take the first one, the "when does revenue kick?" And then you take the next one

[Mark Irwin, Group CEO & Director]

Yes.

[Nigel Crossley, Group CFO & Director]

So U.S. defense, you're right, Arthur. our wins were late in the year. But we expect those -- most of those contracts we went towards the end of last year to start kicking in, in quarter 1. So we should see a good impact on the 2023 revenue number.

[Mark Irwin, Group CEO & Director]

In terms of other services, the sequence in terms of our shares, as you said, is significantly in U.S. Navy currently followed by Air Force and then Army, WBB was part of our strategy to respond to building that out across the services. They were successful just in the last few weeks on an Army contract. And so we will look to continue to build on that platform. What we want is diversification and to be able to balance the portfolio. But based on the position we already have with Navy, we want to make sure that we protect that as we go through developing the other services.

And in terms of Skynet, the MOD announced just recently the outcome of that, we are waiting to have the formal debri for the customer. And the athena consortium, of which we were the lead partner, we will go through that analysis and understand exactly what the customer's decision was based on. So we are still in the Skynet bridging contract now, SSCC until March next year. And we'll be working obviously on 2 fronts: one, to make sure that the handover of such a critical capability is done professionally and secondly, to be clear about what happened in the bid and how we position ourselves for future working space.

On space more broadly, though, it is a core sector for us that we will continue to pursue growth in. We've got a strong position in civil space, as you know, in Europe. We've got strong interest. Almost every country has a space ambition. We've got strong interest to leverage that into other markets, including back here into the U.K. in the civil space area. And then defense space are being a key part of our work, Skynet, the core of that. But we do other work, as you know, in that sector as well. And so we will continue to develop that.

[Arthur Truslove, Citigroup]

Sorry, one bet, I think I might have missed. Just in terms of order momentum in the U.S. defense business, obviously, so it looked like it accelerated in the second half. Are you expecting it to accelerate again in the first half of '23 or not? We think over the year, we've got good visibility to pipeline and opportunities. So we'll continue to work through that. I mean our pipeline is still strong at the end of the year, Auto, but we did have an exceptional end of the year. Don't extrapolate that piece out. Do you want to go to Chris? Chris Burberry Ben. Just a couple of questions. One of the profit drivers tissue obviously the efficiencies and see improvements on existing contracts. Just if you could perhaps highlight the greatest opportunities lie. And secondly, if there's any more detail you could give us on the Middle East debtor discussions, the progress you're making there, where you've got to since, say, December time? Or that would be helpful.

[Mark Irwin, Group CEO & Director]

Yes. So the two areas in terms of just contract profitability improvement has been to scale so where we can scale and leverage our existing infrastructure. And that's volume-driven. So we see that benefit clearly. It sounds obvious, but it's very evident in our results when you see us in more volumetric businesses being able to pull more volume through those contracts. And the second key lever is robotic process automation. The benefit that we've had in the CMS program in the U.S. has been our ability to successfully automate significant parts of that processing. And so today, we have higher volumes of applicants going through that contract with about 1/3 of the staff that we had when the contract was first started in 2013.

[Nigel Crossley, Group CFO & Director]

And then on the Middle East debtor, we've raised that in the pre-close statement that we have not made a cost for that what we have. We've got a very strong legal case, and we are now having increasingly positive conversation with a customer, and it feels like we're getting very close to getting paid, but we have not yet been paid. Move to Stephen.

[Stephen Rawlinson, Applied Value Limited]

Stephen Rawlinson. Two questions, if I may. Firstly, with regard to the asylum seekers contracts in the U.K., which you say in the report here is your largest single project. As it moves during the course of the year out of hotels and into dispersed accommodation, one of the issues has been in and around the agreement on utility costs, which have escalated to a level that probably couldn't have been even thought about at the time you first took the contract on. To what extent might that move into dispersed to combination require renegotiation around utility costs and where you're up to with that if I've got my assumption correct about the base case, not being actually not favorable.

And the second issue is just when the whole process transformation of Serco started some 7 years ago, disposals and noncore were part of the -- what happened in Telenet and so on. Set me right where you are with some areas. You spoke about space being core. But what are some of the areas where competition is quite brutal. We just lend itself to some of the techniques and things you've talked about, such as health. Is there a board debate about exiting some areas perhaps and thoughts about some that won't come up to a group target for margins because at the moment, we're talking as if which going forward is a great growth story, but there might be some disposals or some areas of lesser interest going forward, where as you know, when we started down this route, you wouldn't have expected to have gone into FM and defense in the way you have, for example, or space perhaps too. So could you say -- give us a closed - or a broad debate about that, please?

[Nigel Crossley, Group CFO & Director]

Let me take the first one here, yes. So Stephen, on the asylum seeker contract, we do not talk about individual negotiations with customers or changes to contracts in public. So there's nothing to add with -- or add to that one. So that's all I will say on the asylum seekers. And Mark, do you want to about...

[Mark Irwin, Group CEO & Director]

Yes, in terms of potential, yes, disposals, we actively manage our portfolio, right? So we actively manage our portfolio for performance on the contracts we have and in the sectors we operate. And we continue to look at the sectors where we will assess whether we can be effective long term. And that's the process that we look at the Executive Committee and certainly is a topic of discussion at our board.

[Nigel Crossley, Group CFO & Director]

And then we keep going to the left.

[Alex O’Hanlon]

Alex O’Hanlon from Liberum. Just one question from me, if I may. At Asia Pacific, you mentioned on the underlying trading profit that benefited from favorable volumes and mix on immigration work in 2022? What's driving that? And is that expected to continue into 2023?

[Nigel Crossley, Group CFO & Director]

Yes. Look, as we've seen on this contract over 8, 9 years that we've been running, we've seen some scope group, we've seen particularly high volumes going into what's called -- which over a temporary combination, and that has reduced as we've gone through quarter 4. So we're expecting those high volumes that we saw through -- maybe through the whole of the COVID period and a good chunk of last year. It's dropped off and it's more of a kind of more sustainable ongoing level that we're seeing now. So that's all built into our guidance for 2023.

[Mark Irwin, Group CEO & Director]

If there aren't any questions --

[Nigel Crossley, Group CFO & Director]

Sorry, there's one other question right behind you.

[Nicole Manion, UBS]

It's Nicole Manion from UBS. I just wanted to ask on the colleague retention point really. If you could give us a little bit more detail, but obviously, there's been significant efforts throughout the year to support the front line, but it's still obviously a challenging environment. Do you think that will improve this year? Is the stuff sort of in your hands that you can do to drive that? Or is it just really tough as a consequence of the backdrop?

[Mark Irwin, Group CEO & Director]

Yes. Look, we think it will continue to be difficult as we go into '23. We have, as I said, seen improvements in terms of the reduction in our vacancy rates, but we think the competition for talent will continue. What's in our control? We work on a number of areas. The value proposition, as I said, we continue to evolve that value proposition being more targeted in terms of the potential workforce that we would like to attract. And we're doing that we've invested in our recruitment team to make sure we've got the right capability and the capacity that we need to deal with the turnover rates we have. And we're looking to technology for some of those assets, helping us with profiling and making sure that we have the highest opportunity to select in the first place colleagues that will join Serco, perhaps for a job, but that we hope will stay for a career.

[Nigel Crossley, Group CFO & Director]

Are there any other questions in the room? So -- are there any questions on the call?

[Mark Irwin, Group CEO & Director]

Yes.

[Operator]

[Operator Instructions] And your question comes from the line of Kean Marden from Jefferies.

[Kean Marden, Jefferies]

I have two quick ones, please. So just firstly, on your technology partnering strategy. Is that likely to involve direct investments, joint ventures, acquisitions? Or is this more of a traditional client and supplier relationship that you have in mind? And then secondly, on U.S. defense, so a few questions on that. But maybe the best way of framing this is what's the revenue, the annualized revenue run rate in your U.S. Defense unit in excess of £900 million.

[Mark Irwin, Group CEO & Director]

Okay. So if I can take the technology question first. Our primary factor for this is to partner, right? We so far have been very successful in engaging both small and large tech companies who want to partner with us because of our ability to scale because of our ability to take technology and put it into quite difficult operating environments. And so we will continue to work through that partnership model as our primary way to access technology.

I mentioned in my introductory comments that we also have invested in platforms today that we don't believe we have fully exploited the functionality of and so those partnerships with the likes of Microsoft and SAP and so on, we will look to extract value from those. And then finally, part of our capital allocation strategy is that we will invest in the business where we can derive value from productivity, from cost, from performance improvement. And so we will look at those on a case-by-case basis. But we will cascade through those choices and invest where we need to on the basis that those business cases are sound. But we don't expect to be clear, we don't expect this to be a massive capital outlay. We think we've got enough access through those channels to be able to deploy technology that is already available in the market to the extent that configuration and so on is required. We've got good in-house capability there.

[Nigel Crossley, Group CFO & Director]

And Ken, just to answer the U.S. defense question. Our U.S. defense revenue in 2022 was up at £800 million. And from the wins that we've had in 2022, we would expect that number to increase and see good growth on that number in 2023.

Are there any other questions from the line?

[Unidentified Company Representative]

If not, we do have some questions from the webcast. So Eoghan Reid from J O Hambro. Two questions. First on what are your learnings from the lost bids in Australia? And the second one is, can you speak of a specific case where AI has or could have a positive impact to decision-making.

[Mark Irwin, Group CEO & Director]

How generous of my CFO. So I think these are 2 quite different bids. We have done PFI models before. We've got a track record of doing that in the U.K. Historically, PFIs, as you know, have not really been a favored way for government to access assets for the last 5 or 6 years. And so I think there was us really just coming out of the blocks in understanding how as part of a consortium, it's not only your part that drives the success or failure, but the collective competitiveness of that consortium. So I think our biggest lesson out of that was to make sure that we choose our partners carefully and strategically to make sure that the proposition to win is strong from the get-go.

In terms of AI in our business, we are starting to do some of this work now in the U.S. and it's largely around the ability to sort and manipulate data. That's the key area for us today. Some of that work is quite labor intensive for us to do. But when we look at the volumes of data we manage, AI is starting right now to play a role in helping us through that productivity.

[Unidentified Company Representative]

The next question comes from Andy Brooke at RBC, who asks, how should we think about 2024. There are likely profit reductions from CMS, Australian immigration and Skynet. Is there enough in the pipeline that you're confident of winning to offset?

[Nigel Crossley, Group CFO & Director]

You want me to say that. We are not giving any specific guidance on 2023 -- on 2024, we've given very specific guidance on 2023. We've given medium-term guidance that we expect to grow the business at 4% to 6%. But we've always said, well, that's on average, we will grow at 4% to 6%. Clearly, in the last few years, we've been growing at double digits. And I think some of those headwinds we've talked about from which Andrew just mentioned, will slow us down a little bit as we go into 2024.

But I'm hoping -- we're not going to give a specific number, but -- and -- so are we confident we've got enough to offset that? I think the answer we would say we are confident that the underlying base business can grow to ongoing at 4% to 6%. We will just take us -- in 2024, there will be a little more of a step down because of the big rebates that we've got coming through that even though we've won CMS, the impact from CMS is real in '24 as well. So that's as much of an once we're going to give on 2024 at this point.

[Unidentified Company Representative]

And the last...

[Mark Irwin, Group CEO & Director]

Hang on. No, just...

[Unidentified Company Representative]

Sorry. Yes, go ahead.

[Mark Irwin, Group CEO & Director]

I didn't want my previous answer to be vague. It wasn't deliberate. It's just being careful about the areas of work where we can speak about. But if I can give a general example just so that it's not all abstract. If we look at chip design, right now, we iterate, right? We work through sometimes hundreds of different designs to come to an optimal design. AI is starting to cut through all of that to give us optimization much more quickly and without tens and tens of ship designers, naval architects and engineers working through those processes. So an example, as I said, of where we might see debt being expanded in our business in a more tangible way. Hopefully, that helps.

[Unidentified Company Representative]

And the last one is from Joe Brent, Liberum, who asks in the absence of any further acquisitions, would you expect the buyback to be ongoing?

[Nigel Crossley, Group CFO & Director]

So what we set out here as guidelines is that we expect our leverage to be between 1 and 2x. And what we've also said is if our leverage is below 1x. We said we call that surplus cash, and we've made a commitment that we will return surplus cash to shareholders. So if you take our current -- if you do the math and say that our guidance for net debt at the end of this year, 2023, £200 million, that will be less than 1x. But we've got plenty of capacity in 2023 to do acquisitions. So we'll come back and revisit that when we get through 2023, see where our leverage is and see what acquisitions we've done. And we'll look on the horizon of what potential things may be coming up very quickly. But -- that's the answer.

[Mark Irwin, Group CEO & Director]

Well, if I can thank everybody for their time and interest again. We look forward to keeping you updated as we go through the business here. But I really appreciate your time this morning. Thank you.