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Edited Transcript of FGP.L earnings conference call or presentation 14-Nov-19 9:00am GMT

Half Year 2020 FirstGroup PLC Earnings Call

London Nov 30, 2019 (Thomson StreetEvents) -- Edited Transcript of FirstGroup PLC earnings conference call or presentation Thursday, November 14, 2019 at 9:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Matthew Gregory

Firstgroup plc - CEO & Executive Director

* Ryan Mangold

Firstgroup plc - CFO & Director

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Conference Call Participants

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* Alexander Paterson

Peel Hunt LLP, Research Division - Analyst

* Damian Brewer

RBC Capital Markets, Research Division - Analyst

* Gerald Nicholas Khoo

Liberum Capital Limited, Research Division - Transport Analyst

* Joseph Philip Thomas

HSBC, Research Division - Analyst

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Presentation

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [1]

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Great. Well, good morning, everybody. Thank you very much for joining us today. Very pleased to see you all here. This morning, we're going to take you through our half year results, and I'll also give you an update on how we're progressing with our strategy.

But before we start, I'd like to introduce Ryan Mangold, our new CFO, who's up with me at the table today; and also, David Martin, who many of you know, our new Chairman, who become Chairman a couple of months ago. And he's here in the audience.

So to the headlines. Our clear divisional strategies continue to deliver in line with our expectations, with all divisions generating like-for-like revenue growth. Student had a strong bid season bolstered by continued above-inflation pricing and more bolt-on acquisitions. And Transit is winning additional business in the more exciting areas of the mobility market and is progressing with innovation trials. First Bus delivered revenue growth and is poised to deliver further cost savings in H2, and Rail generated GBP 49 million of profit driven by Great Western Railway and the IFRS 16 changes. And the division is bolstered by the new West Coast partnership win that was won back in August.

We have experienced challenges, particularly in respect of further hardening of the North American insurance market and legal environment as well as the need to take a noncash write-down on Greyhound's book value. But in the context of fewer school days in students and worst weather during the summer, impacting First Bus this year, I can see that the business is continuing to move forward. Cash generation and leverage levels, pre-IFRS 16 are also in line with our expectations.

At our full year results in May, I announced a new strategy for the business, which focuses on portfolio rationalization. And we've made good progress with the strategy, and I'll update you with -- on that at the end of the deck. But before we get into all of that, Ryan will take us through the financial results.

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Ryan Mangold, Firstgroup plc - CFO & Director [2]

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Thank you, Matthew, and good morning, ladies and gentlemen. Having joined the group just over 5 months ago, I'm pleased to be on board with the execution of the strategic plan announced in May, including the sale of Greyhound and the separation of U.K. Bus. A lot of good progress has been made in the period against these strategic initiatives, where solutions have been identified to reduce potential barriers, and progress has been made in the execution that Matthew will update later in the presentation. In the appendix, the presentation includes further analysis at a divisional level. And given the large number of key items in the half year to discuss, let's move on to the financial review.

Turning to the financial summary. As a reminder, the first half year is seasonally low period of trading in the group given the school holidays and university holidays impacting our students and Bus business, respectively. The implementation of changes to the accounting standards of IFRS 16 applied from the 1st of April 2019, has had a material impact on the presentation of the results, and this will be discussed in the following slides.

Furthermore, updates to the key judgments in the period relating to the Greyhound carrying value and the North American insurance reserve have resulted in additional impairment and increase in insurance reserves being recognized in the period.

IFRS 16 adoption has resulted in an additional adjusted net charge to the profit before tax level of GBP 7.3 million in the period, resulting in a 31.7% lower adjusted profit before tax of GBP 28.7 million. Excluding the impact of IFRS 16, cash and gross debt before ring-fenced cash at the half year is in line with our expectations.

On Slide 5, the implementation of IFRS 16 and the resulting recognition of right-of-use assets has had a material impact to the financial statements, particularly driven by Rail. There is no restatement to the prior year, and implementation of the standard has the following impact: a material increase to EBITDA with the removal of operating leases; operating profit marginally higher, given the higher depreciation charge, but an element of the lease costs now recognized in financing charges; balance sheet gross up in capitalized assets, resulting in a material increase in operating assets and net debt as reported. There's no impact to the underlying cash flows as Matthew noted. I have a presentation, the lease repayments are now reflected in the financing section of the cash flow statement.

At a divisional level, Rail has had the largest impact to EBITDA, given there were GBP 842 million of right-of-use assets being capitalized at the start of the financial year with the removal of the previously recorded operating leases now replaced by capitalized right-of-use assets that are depreciated. Student has recognized GBP 103 million; First Bus, GBP 75 million; and Greyhound, GBP 78 million right-of-use assets that have been capitalized on the 1st of April, with the impact to underlying EBITDA and operating profit being reflected in order that your models can be updated for future earnings reports. As noted before, divisional analysis is provided in the appendix.

On a consistent GAAP basis, the GBP 181.3 million increase in EBITDA is largely offset by higher depreciation resulting in a net GBP 9 million positive impact to adjusted operating profit, but the largest impact given in Rail, given the scale of the capitalized assets. As a reminder, with Rail taking on the West Coast partnership on the 8th of December, there'll be a further material right-of-use assets being capitalized in the second half of around GBP 700 million, and we'll update with the full year results announcement.

Furthermore, at GWR, the right-of-use assets for that franchise is only capitalized on the assumption that it runs out on the 31st of March 2020. These positive impacts to operating profits are offset by higher finance charges of GBP 16.3 million in the period. And given the scale and complexity of IFRS 16 on our financial results, there are more details in the appendix, as I noted before. And we will look to run a teach-in for our -- for the analyst ahead of the year-end to ensure that your forecast models that are being run are aligned with our accounting treatment. And it must be said that Faisal is particularly looking forward to running this teaching.

Turning to the underlying business performance. Total group revenue improved 4.1% or GBP 138 million on a constant currency basis. Strong improvement has been delivered in Student due to both price increases and volume growth as the business continues to grow both organically and through acquisitions. These positive effects, however, are partly offset by lower operating days and higher weather impact in the period. Transit has also shown strong growth from both price increases and increased scale of total business, with net new business growth in the period.

Greyhound revenues have been impacted by the closure of Western Canada in the second half of the previous financial year, with overall like-for-like revenue growth of 0.7% year-on-year. Greyhound performance will be covered further later in the presentation.

First Bus like-for-like passenger revenue growth was 1.6%, with strong performance in the South businesses overall. The negative impact year-on-year reported revenue is primarily driven by the exit of Manchester as announced in 2019 financial year.

The Rail business revenue growth has benefited from both underlying passenger revenue increases with all [tucks] showing progress but also from higher subsidies at GWR, reflecting the introduction of the new trains.

At an adjusted operating profit level in the half year, the group has benefited by GBP 3.3 million gain on translation as a result of the weaker sterling, and that's expected to continue for the rest of the fiscal year; and a GBP 9 million increase in adjusted operating profit as a result of transition to IFRS 16 I mentioned before, resulting in a baseline comparator of GBP 104.7 million. On a consistent basis, adjusted operating profit was down GBP 7 million year-on-year driven by lower operating days and weather in Student and with higher pricing partially offset by higher operating and insurance costs.

Transit results have been impacted by 2 legacy legal settlements in the period, impacting margins by about 50 basis points, higher insurance and driver costs partially offset by the net gain on pricing and new business that I mentioned.

Greyhound has had a good first quarter, benefiting from very strong immigration volumes on the long haul, particularly in the Southwest. However, more recently, these immigration volumes have reduced to below 2016 levels as well as increased competition in the Northeast. The net impact of the lower fuel pricing recently has also resulted in more people using the car rather than the coach, also impacting profitability. Overall, however, the business has shown improved performance in the period versus last year despite lower gains on property sales.

First Bus has benefited in the period from improved fare pricing, improved cost efficiencies and removal of the loss-making mention of the business. However, these benefits have been offset by increased operational costs and volume decline due mainly to the stronger summer of 2018. The business is focused on recent cost efficiencies that should show a reduction in costs in the second half, whilst at the same time, materially improve overall Bus profitability and margins.

In Rail, the strong performance in GWR continues, benefiting too from the settlement of a number of claim items in the period. Both TPE and SWR remain under onerous contracts and hence, do not impact the results materially in the period. There's a slight anomaly with SWR and TPE on the transition to IFRS 16 but underlying no change to the business performance and onerous contract assumptions that we previously made.

Turning to the income statement. The 5.7% improvement in adjusted operating profit has been offset by higher finance charges as a result from the transition to IFRS 16, resulted in profit before tax of GBP 28.7 million, down GBP 13.3 million year-on-year. The effective tax rate in the period doesn't really reflect the underlying performance given some significant divisional changes in the period. And hence, it's not a read-across for the full year, where we expect the tax rate to be effectively consistent with the prior year of around 22.5%.

Noncontrolling interest in the half year was 0, given that SWR is a non-onerous contract and hence, reporting 0 profit. For the full year, with the West Coast partnership that starts on the 8th of December, the minority interest will be recognized relating to Trenitalia's 30% interest in the franchise profit.

Adjusted EPS ends the period at 2p, down 31% year-on-year.

Turning to the non-GAAP adjusting items in the period. Amortization charges have reduced year-on-year given the full utilization of the previously recognized customer contract intangibles and in the second half, following the Greyhound impairment, this is expected to reduce further. The Greyhound impairment and the increase in the North American insurance reserve, I'll cover in the subsequent slide.

The restructuring and reorganization costs relate mostly to a specific initiative to further improve efficiencies and reduce costs across our organization. This is a significant initiative that was kicked off earlier in the year, and that is expected to deliver strongly in the second half of the year and beyond.

In the first half, GBP 6 million worth of savings have been delivered year-to-date. And the ramp-up is progressing, particularly in Bus, but this is a significant underpinning of our outlook for the year.

With regards to Greyhound impairment, in recent months, record low immigration volumes and high competition, particularly in the Northeast, have had a material impact on performance of Greyhound. Whilst these trends are not expected to reverse in the short term, we have evaluated the carrying value of Greyhound on a cash-generating unit basis, and this has resulted in the group recognizing an impairment of GBP 124 million in the half year to reduce the investment in the cash-generating units to GBP 179 million. As a reminder, Greyhound has a legacy pension arrangement in the U.S.A., which was closed to new members in 1983 and future accrual in 2002 and an open Canadian pension schemes totaling GBP 129 million on an accounting basis as well as their share of the self-insurance reserve of GBP 96 million. The sales process is well advanced, and we'll update you in due course.

In terms of our North American insurance reserve, the auto liability insurance environment has continued to harden in the period, including court judgments that are more punitive and that are finding increasingly in favor of the plaintiffs in certain states. As a consequence of this deterioration in insurance environment, our actuaries have increased the estimates for the historical claim items. And we have further increased our prudence in our estimate to above the midpoint in actuarial assumptions to $588 million, with a range of roughly $490 million to $610 million. Included in this increase in reserve is $11.6 million relating to reduction of the discount rate from 1% to 1.6% from the 2.7% in the full year '19 position. $10.1 million of this discount rate movement has been reflected in the adjusted operating profit results at a divisional level as well as a further $5.7 million taken as an increase in the underlying insurance costs in the period.

The full year impact of the higher insurance cost provision and the underlying results is estimated as an increase of about $12 million year-on-year. Some of this increase in insurance cost is expected to be mitigated by our improved approach to processes with regard to our subrogation claims that we've implemented in the first half.

The group has a strong safety record that continues to improve as well as a key focus on risk management. The processes around insurance and insurance management have been strengthened as we set out in May, and the exposure and how we manage these risks have been implemented with the drive to reverse this trend.

Looking at the cash flow of the group, IFRS 16 does have an impact on the cash flow statement presentation and where operating lease payments have been historically been recorded as part of the operating cash flows. As a reminder, our lack -- our operating results, our cash flows for the half year, whilst in line with expectation, are also impacted by the seasonal pattern of business, particularly in Student that started in September.

In this adjusted cash flow slide, we are separating out the Road business from the Rail to aid in the understanding of the key cash flows impacting the group. As can be seen, we have made significant investments in the road business with around GBP 142 million of CapEx in the period, with the disposal proceeds of GBP 21 million, mainly relating to the sale of the Manchester business, resulting in a net road operating cash flow of GBP 68 million. Rail operating cash outflow was GBP 21 million in the period, including working capital outflows, where the majority of these are been funded through the franchise mechanisms. Like with the full year, more detailed analysis on the Rail cash flows has been shown in the Appendix.

Our cash payments to pension schemes above the P&L charge were GBP 33 million and with GBP 68 million paid in cash interest. Exceptional item cash payments were GBP 20 million in the first half, resulting in a free cash outflow of GBP 75 million, GBP 3 million was spent on the completion of an acquisition made in Student in the period. The second acquisition for around GBP 13 million closed in October, which then resulted overall for a net cash outflow of GBP 78 million at the half year.

Turning to pensions. The April 2019 triennial valuation for the bus pension scheme is progressing with a trustee, with initial indications showing an improvement in funding levels on a technical deficit basis versus the 2016 valuation. As a reminder, the Bus business, the local government pension schemes are well funded and are expected to be in surplus in both funding and accounting basis, and we are currently in discussions for the deficit repair payments to reduce going forward.

As noted before, the Greyhound pension scheme at GBP 129 million makes up the majority of the North American pension schemes deficit under IAS 19.

Following on from the work done to date to manage our Bus pension exposure. As part of the bus separation work that we have undertaken along with our advisers, we have established a framework that we are in the process of reviewing with the trustees if there was a material change to the group's portfolio as a consequence of executing the strategy. This framework includes determining the funding levels of self-sufficiency and a flat path to get there. Liability management exercises through pension of buy-ins with a pension that makes up about 45% of total liability; improvements to the liability management by providing members with more options and flexibility, like enhanced transfer value exercises, flexible retirement options and pension increase exchanges; and derisking the investment strategy as the funding levels improve. Subject to market conditions at the time, we believe that the framework resolving the pension exposure to facilitate the separation of the business and execution of our strategy is currently around GBP 360 million to GBP 400 million.

Turning to the financial position of the group. The group's balance sheet is in a strong position with a significant increase in reported net debt in the period, principally driven by IFRS 16 where GBP 1.1 billion have been capitalized. And as noted before, it's principally in Rail, were GBP 842 million where the right-of-use assets and related debt have been brought onto the balance sheet for the start of the period. Excluding the impact of IFRS 16 and ring-fenced cash and rail, the group's net debt has increased marginally from GBP 1.5 billion in the prior period to GBP 1.56 billion currently, with a net debt-to-EBITDA ratio of 1.6x, which is consistent with the prior year and in line with our expectations.

We currently have 3.8 years of committed facilities with a headroom of GBP 497 million at the half year, with the next material debt maturity is the GBP 350 million, 8.75% bond that is repayable in April 2021.

Furthermore, we continue to be rated investment-grade by both S&P and Fitch, both reflecting stable outlook.

So to close, our group asset for the year before the impact of the adoption of IFRS 16 is in line with our expectations we set out in May, with the expected adjusted operating profit further enhanced the consequence of the continued weaker sterling from translation of the North American operations and being awarded the West Coast partnership that commenced operation on the 8th of December. The full year impact of IFRS 16 is anticipated to be an increase in EBITDA of GBP 420 million to GBP 440 million, an increase in adjusted operating profit by around GBP 20 million to GBP 30 million and an increase in finance costs of around GBP 30 million to GBP 40 million, resulting in a relatively low impact to profit before tax and earnings per share in the year.

We anticipate continued growth in the delivery of the cost and efficiency and savings initiatives I discussed earlier with significant improvement expected in Bus relative to the first half, an improvement in Student and Transit offsetting some of the cost pressures that those businesses face. Overall, we expect finance costs before IFRS 16 to be flat year-on-year with a slight increase in notional interest given the increase in provisions and pension balances. And we expect the effective tax rate to be in line with the prior year of around 22.5%. From a group cash flow perspective, we expect full year net debt before the impact of IFRS 16 and excluding ring-fenced cash to be marginally below where it started.

I'll now hand back to Matthew for the business review and comments on our strategic progress.

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [3]

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Great. Thanks, Ryan. So let me take you through the commercial and operating update for each business. As Ryan said earlier, the financial performance of FirstGroup is heavily skewed towards the second half and so the first half can be affected by some relatively small numbers.

So starting with our largest business, First Student. You can see that we've had a strong bid season, slightly better than our expectations at 88%. Net fleet has risen again to 43,000 buses, and we believe that we have grown our market share by virtue of winning more bids from our competitors than they won from us. This reflects positively on the quality of our business development team as well as the high levels of customer satisfaction generated by First Student, which is 8.75 out of 10 again this year. This high level of customer satisfaction can, in turn, lead to our customers extending their contracts rather than putting them out to bid.

Whilst driver shortages continue at high levels in a number of locations, reflecting the current strength of the U.S. economy, we're seeing price increases continuing to more than offset the cost of inflation. The school start-up has been well managed with a lot of effort required to set up new operations, which is in the context of our high retention rate last year. And I'm also pleased to see that we made 2 acquisitions in this space over the last 5 months, adding 300 buses to the fleet.

The coming bid season is already upon us. And we have a higher than normal number of contracts and buses up for renewal this year, closer to 40% of the entire contract base. However, our high customer satisfaction scores should hold us in good stead for this.

I won't have much to the operating profit discussion that Ryan has given you, other than to be clear that we are looking to ensure that the increased cost of insurance is included in our cost assumptions for our commercial arrangements. And I'd also comment that whilst we have seen a worsening of the outcome of claims through deterioration of the legal environment, our safety record continues to be industry leading.

As we discussed for the full year results, growth in Student is now feasible and also profitable. As mentioned before, we see growth coming from pricing, organic growth -- organic routes and bolt-on M&A.

Looking to the future, you know that we're the industry leader by far and that we've restored our margins to levels that fit that. And I see growth opportunities as follows: organic growth continuing at around the low single-digit level; and next year, retention rates are estimated to be at least mid-80% level, and pricing will continue at levels designed to more than offset inflation as we maintain our discipline on generating the right returns.

We continue to develop and grow our technological offerings to the school boards. We're having success in pitching maintenance service contracts to in-source operations. And we've also been growing the installation of our customer-focused offerings such as our proprietary FirstView app, which allows parents to track the buses as well as growing our position in the routing and scheduling services area.

Finally, we're pleased to have continued on the M&A path, putting $21 million to work on acquisitions. During the period, we bought a 70-bus operation from East End Bus Lines based on Long Island in New York. And after the half closes, we completed the acquisition of Hopewell Transportation, a 214-bus operation, which is focused on the faster-growing special educational needs sector. The M&A pipeline is growing, reflecting the fact that this marketplace is highly fragmented and localized.

Finally, I'm very pleased that Paul Osland has taken over as President of First Student, moving up from the COO role. Paul has already contributed extensively to the improvement of the division, having joined in 2016, and he brings a wealth of public schools experience with him.

So let's turn to Transit. Transit had a good year of contract retention of 93%, and I'm encouraged by some of the growth that we've seen from contract wins, and I'll talk more about this on the next page. Driver shortages, though, continue to affect the business. And this, alongside higher insurance costs, has impacted the profitability of the business. As Ryan commented, we've seen a couple of legal claims affecting the first half this year. However, our cost reduction program will start to offset this in the second half of the year, particularly in the area of procurement and maintenance, and we expect second half margins to improve on last year.

Coming back to the commercial position. As you can see on the slide, we continue to win contracts in the traditional markets, such as a fixed route contract in Arlington, Virginia; a paratransit contract in Spokane, Washington state and Alhambra, California; and we've also been successful in the call center area in the northeast of the U.S. More interestingly, we've won contract for shuttle buses to serve the new TNC hub at Los Angeles airport. We've continued our pilot of autonomous vehicles, particularly in the Houston Metro area, and we've been very pleased to announce our partnership with Lyft. And this is where we're providing wheelchair-accessible vehicles for a number of large U.S. cities.

In addition, the development of our mobility as a service solution continues apace. And I was at an industry customer event in the U.S.A. last month, and I was very pleased to experience firsthand a live demo of the mobility-as-a-service app that our partner and our team have created to showcase some of our capabilities. Developments in this sector are very interesting, and I look forward to giving you an update on more opportunities when we next speak.

Moving on to Greyhound. As we discussed at the year-end, the marketplace remains challenging with continued low-cost airline competition and lower gas pump prices. We did see a strong first quarter in the southern border states and the long-haul market, but this fell away in Q2 as a result of immigration controls in Mexico and other Central American countries.

Competition continues at high levels in the northeast of the country, and this reduction in demand is likely to continue for at least the next quarter. And as a result, we're reducing our mileage accordingly. However, on a more positive note, as we discussed at the year-end, we recommenced investment in our bus fleet through new and refurbished buses. And this is having a positive effect on on-time performance of the business as well as our NPS and customer satisfaction scores.

Moving on to First Bus. The business has continued to generate like-for-like revenue growth of 1.6% through improved customer offering and active network management. This has been offset, however, by the disappointing summer weather experienced versus last year, and this is an impact we've noted across the industry.

Having been the first regional bus operator to implement a contactless payment solution across its entire fleet, we continue to see real progress in making our customers' life simpler and more convenient by offering more modern payment mechanisms. Contactless and mobile app transactions now represent 45% of commercial ticket revenue, and cash now represents less than 43% of all transactions, down from nearly 80% 2 years ago. This is the first time that our digital revenue has exceeded our cash revenue, and we continue to have the highest-rated mobile app of the traditional competitors in the U.K. And in fact, the First Bus app is the 11th highest used and rated travel app on the App Store.

We've also launched fare capping trials in Aberdeen and Doncaster to provide further simplicity and speed to the customer experience. These capping trials has the added benefit of assuring customers that they're paying the lowest fare possible. We continue to work hard at the cost base, and we're expecting to see the benefit of recent network rationalization, scheduling efficiency and maintenance programs in the second half, improving margins.

Our work with the local authority partners continues, prioritizing those areas where the bus travel is valued. Local partnerships supporting the Clean Air agenda are vital, and we progressed these well during the year, particularly in Glasgow, Leeds, Cornwall and Bristol. We're also seeing the benefit for working on a partnership basis when it comes to tackling congestion. For example, our data analytical work with Leeds city council highlighted specific corridors that were causing traffic hotspots. And by working together, these are now being addressed.

And I'm also encouraged with the significant funding being made available by the government with GBP 500 million having been announced in Scotland and GBP 220 million in England for bus prioritization programs, and we are seeking to participate in a number of these. One of the first outputs is the government-funded pilot in Cornwall to subsidize fares and create an enhanced network from May 2020 and this is one of our key markets.

So clearly, any additional funding on promoting public transportation is welcome, recognizing our part to play in the climate change and emissions agenda. And I'm very pleased to note that our decision to move forward early with clean Euro VI buses has enabled FirstGroup to lead the market in the provision of clean technology buses with more than any other regional bus company in the country. So there's a lot of positive activity of Bus that we're playing a really active part in.

So finally, let's move on to Rail. The Rail division has performed well this period with like-for-like passenger revenue growth up 5% and volumes also up. This performance has been led by Great Western, which has grown by nearly 6%, TransPennine at 5% and South West Railway at 4%. And financially, this has dropped through to a profit of GBP 49 million, driven by the strong performance on Great Western and the IFRS changes. Operating performance also continues to be strong on Great Western at more than 90% driven by the introduction of new trains onto the network. However, we're not happy with the performance from South West Railway and TPE that have resulted from infrastructure instability and the knock-on effect of the performance of other [talks], respectively.

The coming period sees significant improvements in service and fleets across a number of franchises. Great Western Railway will see the largest timetable change in a generation as we deliver the benefits of the electrification program through faster journey times and new services. 44 new trains will be introduced on the TransPennine line. And 2 are already in service, with the rest being phase-in regularly until May 2020. And this reflects our ambition to deliver an intercity franchise for the north, and we're encouraged by the broader infrastructure improvements that could be delivered by the TransPennine route upgrade. You will also see new fleets at Hull Trains by the end of the calendar year.

We're continuing our discussions and negotiations with respect to South West Rail franchise, reflecting the infrastructure and industrial relation challenges that we face there. And we're also continuing our discussions on the potential direct award extension on Great Western Railway.

And finally, we're all looking forward to starting the new West Coast partnership on the 8th of December. This is a partnership that will strengthen our Rail division, and we're excited to welcome the West Coast team to FirstGroup.

Having talked about the performance of each of our divisions, let's return to the strategy. As a reminder, in May, I said we had 5 market-leading public transportation businesses within our portfolio. I said that we have very few tangible synergies between each of our divisions, particularly between the U.K. and the U.S. And I also said we have a number of friction costs within the existing structure, which need to be resolved to deliver value. And as a result, I laid out the strategy as follows: firstly, we focus on the future to deliver sustainable value and growth in the North American mobility market with First Student and Transit becoming our core businesses; secondly, I said we'd sell Greyhound; thirdly, we'd seek structural alternatives to separate First Bus from the group; and finally, we continue to operate First Rail according to its terms, scrutinizing the risk and reward profile for any future commitments.

So where are we with this? The Greyhound process is well advanced, running as you'd expect it to, and we look forward to updating the market when we have completed a sale. We've been working very hard to explore all the options with regard to the separation of First Bus. And Ryan's explained how our position on pensions has progressed as a result of being clear about our strategy, and this gives us a backstop on the pension liabilities connected to First Bus and helps evaluate our options.

It's evident that the most likely way forward with this separation is a sale of the business, either as a whole or in 3 or 4 large geographically aligned segments. And we've also worked through a number of the separation issues that we involved in rationalizing the portfolio. We're working very hard to deliver cost savings in the second half, and we expect the business to continue its margin improvement. And we intend to deliver this margin improvement prior to any launch of a formal sale process in 2020 so as to ensure that we capture the full potential and value in this business. And I would like to take the opportunity to reiterate that while we did complete our Manchester sale after having announced our new strategy, these were products to the specific market position in Manchester, and they're not indicative of how we see any broader separation working.

Our Rail business has been strengthened by the West Coast partnership win, and we continue to manage that portfolio for value. And finally, I've talked already as to how we're generating growth in the North American contract businesses, both in Student and Transit. These are attractive and very valuable assets, and we're excited about their growth prospects. So as you can see, there's been a great deal of activity since announcing the strategy, and we are focused on delivering value apace for all stakeholders.

So let me conclude. Adjusted trading has been in line with expectations, and our outlook is also in line. The divisions are generating growth, and cost reduction plans are in place to improve profitability further. We're moving forward with our portfolio rationalization plans, and we're intent on realizing value for all of our shareholders and will, therefore, actively manage our entire portfolio by all appropriate means.

And with that, let me open up to any questions that you may have.

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Questions and Answers

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [1]

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If you won't put your hands up, I think I'll bring the mic to you.

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Joseph Philip Thomas, HSBC, Research Division - Analyst [2]

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It's Joe Thomas here from HSBC. Can you just elaborate a little bit on the pensions framework? And you're saying, I think, GBP 360 million to GBP 400 million is what you've got your eye on there. And the extent to which that is agreed with the trustee, the level of confidence that we can have about that sort of -- that sort of level of requirement. On the cost savings program that you identified, are these fresh cost savings that you're expecting to come through? And I'm just wondering, the phasing of those gross cost savings and the quantum. And then finally, on the M&A program in the U.S., can you give a sense of what the -- sort of returns you're expecting there and the sort of multiples that you're picking these businesses up on?

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [3]

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Sure. But let me cover the cost saving, the M&A program ones, and then Ryan can talk about the pension one. So on the cost savings program, I mean, this is a business that's taken hundreds of millions of costs out over the past 4 or 5 years. And it is a business that needs to continue taking costs out to offset the inflationary pressures that we face here. We've got a very high labor base within this business.

So the program is designed to really get even further into the organization and tackle some of the more complicated and challenging cost savings. And what we're looking at is things like putting tablets on buses in Student. So we're actually automating the way that routes are designed, the way that routes are followed, taking those percentages out of the time it takes to take the children to school, therefore, are the costs. We're looking at things like bus, and we've got a huge amount of work going on in data analytics around the networks and looking at the timetables, whether it's their time, the turnaround time, those kind of things. Really getting into sort of more detailed work.

Now we talked about this back in May. Clearly, we had a lot to talk about back in May, and therefore, it didn't -- probably didn't get quite as much airtime as it might otherwise have done. But what we're really trying to say to people is that this is a cost-saving program that will deliver over time in excess of GBP 100 million. But this is the kind of cost savings that we need to ordinarily generate to offset inflation. So really, it's not something that we're looking people to bake into margin targets other than a sort of a constant grind to improve the margins. So it is very specific to each division. Bus is the area that we definitely want to see some margin improvements coming through, and that's where we're spending a lot of time on that.

On the M&A program, yes, I mean, look, the returns, we look at that. The multiples end up being, for more traditional players in the Student market, people who are just, dare I say, just running yellow buses and are just localized providers, we'd be looking to pay in the sort of 5, 6x EBITDA range. We've been looking to make return on invested capital sort of -- in the sort of 10% to 15% range. It really kind of depends on the quality of the fleet that they're running and the contract that they've got. I mean you can't pay -- you can't pay huge amounts of money for this stuff because the contracts aren't evergreen anymore. You might pay a little bit more than that.

What we're looking at is not just the standard yellow school bus business, but we're also looking at some of the adjacent markets, so some of the special educational needs sector. There are some quite interesting other businesses out there that are slightly less capital-intensive that provide real sort of -- some of the McKinney-Vento type transportation sort of when kids are whether homeless or they're out of state. So we're looking more broadly than just the standard home school. But the reality is that the home school marketplace, there are thousands of competitors, and there is a very good roll-up agenda for us to work through that.

So with that, I'll let Ryan talk about the progress in pensions.

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Ryan Mangold, Firstgroup plc - CFO & Director [4]

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Yes. On the pensions, as you know, we put out our 2019 triennial valuation that we're currently progressing. And as I noted in the presentation is that the funding level has improved since we last looked in 2016. So that's just 1 point. As part of the separation work, we've been able to kind of challenge ourselves a bit harder in terms of what we think that the design could be to be able to facilitate the separation, and as Matthew noted, either by sale of a single or by selling parts. And through that analysis and working with our advisers, we come up with a framework that effectively tries to get the scheme to a level of self-sufficiency. Or as the pensions regulator likes to describe it, that's sort of a low dependency, which is really on a sort of guilt plus 25 basis points for the third member. I mean, that's sort of the enigma for most trustees to try and achieve that.

And in getting there, the confinement structure includes, for example, a pension or buying, limiting the nonterm ability -- volatility that we've got in the future. And at the same time, so we can accelerate the payments and other liability management initiatives, which would leave the scheme in a sort of a self-sufficiency position at a faster pace. And clearly, all of that is predicated on there being actual sales. It's not like we're looking to contribute GBP 360 million to GBP 400 million to discharge the liability today because we're going through a normal process of valuation as part of the triennial exercise with a recovery period that you would normally see for triennial exercises. So this is the framework that only comes into place in the context of there being a significant portfolio rationalization. That being said, some of these initiatives we're going to undertake anyways like, for example, more flexible retirement options and some of the trivial commutations that you're ultimately kind of manage down the liability as we kind of get there.

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Joseph Philip Thomas, HSBC, Research Division - Analyst [5]

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And the level of trustee buying on the framework you've identified?

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Ryan Mangold, Firstgroup plc - CFO & Director [6]

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So we've been -- we have engaged with the trustee. But the first [half] has kind of raised the triennial evaluation, the first thing is to agree that. We've got the numbers back from the trustee from actuarial perspective. We're having a bit of a dialogue with them. The funding levels have improved. The second point then is that how do we get to the sort of self-sufficiency levels? And what does that mean for the trustee and what's the path to get there? What kind of derisking might we well do as we kind of get to that sort of self-sufficiency level? At the end of the day, from our business perspective, the Board and the business have got a fiduciary duty to -- for the members that have help build this business to where we are today. And we're kind of adamant about fulfilling that fiduciary duty.

So back to the point of having a scheme where you've got a buy-in of the pensioners and you've got deferred members that effectively funded up to a sort of deal plus 25 basis points level is an ideal position for the trustee to be in, which means that [30%] are going to own the business but after that point the pension really -- it's not a real issue from a cash flow point of view or a management perspective.

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [7]

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Any further questions?

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Damian Brewer, RBC Capital Markets, Research Division - Analyst [8]

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Damian Brewer from RBC Capital. That's the crispest, cleanest presentation for a long time. Much appreciated. Two questions. First of all, can you elaborate a little bit more about the processes that you're going through to make sure bids, not just school bus, but rail and others, are on an appropriately risk-adjusted basis? And internally, how are you setting the risk metrics, i.e., so we don't get into further write-downs in future on any further bids? If you can elaborate on that? And then secondly, the business, not just U.K., but the Student does remain relatively asset-intensive. And there's clearly a risk around the residual values on assets you're buying now in 15 years' time, particularly on the traction technology. How are you thinking about mitigating and manage that risk, and if possible, deferring it elsewhere?

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [9]

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Okay. Let me cover those. So in terms of the process around risks, I mean, look, they're very different, the process around risk on a rail contract. We saw a huge process involving tens, if not hundreds of people rather than the student contracts, which are much smaller and sort of much more finite. So we have -- in terms of the student contracts, we have -- we set IRR targets. We're looking at, at least 9.5% IRR, which we talked about in the past. We put our cost base into that to make sure that it's fully covered. And we have teams sort of working through all of that. And you've seen us go through a period of 3 or 4 years where we've actually turned business away, we couldn't meet that requirement. We're now in a position where we are getting those price rises through. And with a number of these contracts we're getting significant increases, double-digit increases, the prices renew them. So a lot of work. I mean for the Student business, there is a control mechanism to make sure there's a very good balance between understanding the local requirements and the local competition versus making sure we keep people to a central requirement.

I think on Rail, I mean, I think to some extent, look, we've already done the work on TransPennine and South Western in terms of that -- those bids have been done. I mean we're working through those. So I mean, for West Coast, we talked about that very clearly. Risk mechanisms for West Coast are very different. You saw that. It is a partnership. It is one that migrates over time to a management contract. It's one that has very different risk protection mechanisms in the forecast revenue mechanism. And in fact, as we talked at the time, endorsed by Keith Williams in terms of -- it's a partnership that meets more of his requirements. And we'll hear about that when he announces it in the report. But clearly, the fact that he's endorsed it is really quite helpful and demonstrates that we've looked at the risk. And I think -- then on top of that, you're also looking at the margin as well. And you saw that when we talk about the margin of the West Coast, it's a lot higher margin than we talked about for other ones.

So I think -- we've spent a lot of time looking at this. There is risk in all business, as we all know, and we've adapted our processes accordingly, particularly for the West Coast. It is one that we've spent a lot of time on and we think we've got the right balance there. I think our Great Western one, direct award was slightly different because it's a little bit more open. So I think there's less of an issue there because you see now that's been performing.

So then on the business, yes, a good point. I mean, I think it's -- there's a different approach in the U.K. and the U.S. And I think the U.K. is further forward in terms of the demand it's making on emissions. And I think if I look, by the end of the year, with the buses that we've got on order, we'll have 35% of our fleet, nearly 36% of our fleet will be sort of clean technology. And that includes new electric buses coming in, includes some of the methane, the gas buses in places like Bristol as well as we're doing -- we've done very well in getting government funding for retrofitting some of the sort of the older buses up to the Euro VI standards. So yes, we're thinking that very, very closely.

We're also -- we've also been getting involved in sort of more -- I can't really talk about it this way anymore, but old-fashioned operating leases that give us more optionality around what we do with buses at the end of their life. In the U.S., clearly, we've got different situations. I mean Greyhound, we were looking to sell that business, so not ready to talk about that. Transit, the vast majority of the buses are provided by the authorities. But where we do provide buses ourselves that seems to sort of more sort of, of the university campus and shuttle by business, where we would be looking at electric buses over time. And obviously, the kind of autonomous vehicle work we're doing because we have much more of an understanding of electric vehicles.

But even in Student where we have seen less of a push for improving the emissions, which is kind of counterintuitive, really, and something that we're thinking about in terms of how we talk about the business. We're even -- we've got some trials going on. We've got trials going in Montréal. Yes, it's Montréal, and also trials coming into Rochester to -- for some electric vehicles in there as well. So we're moving forward with that. I mean, obviously, California, we have different rules in California, and we've got gas-type buses there as well. So yes, we're giving that a lot of thought. I think the U.K. is much further advanced and we need to -- we've got a lot of pressure to continue to upgrade the fleet. We're bringing leasing into the mix as well. And in the States, we're looking to get ahead of the curve, actually because we think if we can provide an electric bus -- it seems ideal for electric bus for short journey times. It's the vehicles that go out of a lot and back into a lot. And then they can recharge in the afternoon and then -- we've got to work through infrastructure. I mean, all of this is very, very complicated, how you deal with infrastructure and charging all that. But it's something that we think the student market will be very good for electric buses. But we've just got to convince people that they want to pay the extra [cost] because, in my past life, you can provide the environmentally friendly options but ultimately people don't always choose to take them. But I think at Student, we have some real options to get ahead of the curve there.

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Ryan Mangold, Firstgroup plc - CFO & Director [10]

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Yes. I mean that's the context of the bus, that's actually pretty cheap to start with. So the new technology is, as Matthew points out, is substantially more expensive, how winning on the school boards to be able to pay for this new technology if they really want this, then (inaudible) pricing list.

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Damian Brewer, RBC Capital Markets, Research Division - Analyst [11]

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And I'll just follow-up on 1 thing specifically. You talked about this in the slide, but how you can ensure that not just in the sort of the big picture that what you're assuming on insurance is right, but that -- I want to say an individual state level or provincial level, you're getting the right margin for the relative risk in that area. I think some parts of the U.S. are kind of a bit more litigious than others -- they are making sure that the big picture average is a reflection of maybe...

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Ryan Mangold, Firstgroup plc - CFO & Director [12]

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Yes, they're sort of joined at several liability on some of these claims. I mean we clearly are a big corporate [new assay], and we can become a soft target, even if we're you're not necessarily the cause at all of the accident. And as a consequence of that, we are definitely taking a lot more care in pricing in those new states to sort of be able to mitigate against these risks, making absolutely sure that the margins are full enough to ensure that if something that does happen then we could kind of cover it.

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [13]

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And there is a balance. I mean, we're looking at that in terms of particular states who have these liability issues. We also have to reflect the competitive environment in those states as well. So we have to balance off, putting it in specific dates and potentially making ourselves uncompetitive with a part of it. There is a spread across the whole community.

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Ryan Mangold, Firstgroup plc - CFO & Director [14]

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And just to bear in mind, I mean, this is a provision that's discounted at 1.6% now. And that change in discount rate so we've gone against underlying earnings and kind of take a view of what the medium-term trajectory of North American discount rates are going to be. I'd be amazed if we hear in 5 years' time we're talking about 1.6%. Same period that should reverse and then there's a part of that which should restack up, if that makes sense.

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Alexander Paterson, Peel Hunt LLP, Research Division - Analyst [15]

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It's Alex Paterson from Peel Hunt. 3 quick questions for me, please. Firstly, just on the insurance. You've made an additional protection of $34 million. Could you just give a bit more color around that? Why it was $34 million and not a different number? And is that purely additional protection? Or is that because of any events or claims that have come after the period of the actual review?

Secondly, clearly, you've got a lot going on, both in North America and in your U.K. businesses. But there's also a lot happening in the bus around franchises in Europe and elsewhere in the world. Are any of those of interest to you? And then thirdly, just on First Bus. Obviously, you're going through a separation process. How can you ensure that, that doesn't impact your operational performance, that motivation levels stay high and nothing drops off there?

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [16]

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Sure. Well, let me cover off those second 2 and then Ryan will talk about the insurance. So on First Bus, you're right, it's a challenge. Yes, we put incentives in place to encourage the management to continue to deliver the operational performance. They are -- I mean, the business understands that there is no kind of point in getting distracted by the issues that we have at the group. And it's really about delivering services on the ground. And the vast majority of our 15,000, 16,000 employees in that business are focused on delivering services to the customers on the ground, and they can see some of the improvements we had like the contract payments, like the mobile apps. They can see the work that we're doing on scheduling. They can see the work we're doing on the street furniture and the congestion, all those kind of things. So -- but you're right, it is a challenge, and we put some of the incentive program in place, as you'd expect.

And we just do a lot of communication. And part of today is sort of being clear around that we need to deliver the margin improvements before we sort of consider any sell purchase launch. And what is great about our bus business is that absolutely, all the people in that business, they love that industry. They love the fact they're providing these vital services for the public. And I think provided we continue to communicate with people and the bus team and sales communicate well, then we'll bring people along.

But I think -- it's interesting. I mean the bus environment -- and this isn't just a sales pitch. But there's a lot of good stuff happening around bus at the moment. There's a lot of -- if the money comes through, if the authorities have worked their way to really understanding the emissions agenda, they can really understand the congestion issues. There's a lot of people who've really started to understand how important public transportation is. So yes, that one.

In terms of the broader market, look, I come from an international business background. And I -- in a perfect world, I would love to be in a position where we could expand and take our skills internationally. And in fact, we've been doing some of that. We've done some of that in the past. We're obviously doing that in sort of the Americas. We're sort of -- we do a lot of work. We do work in Panama. We're sort of obviously running into Mexico, those kinds of things. Clearly, our focus is on delivering value today on this strategy. But I'm absolutely not ruling out the opportunity to move into some of those areas once we've worked through these particular issues. I think it's important that we look to growth in the future.

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Ryan Mangold, Firstgroup plc - CFO & Director [17]

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And then on the insurance, for the full year of '19, they were above midpoint from a valuation perspective. We have 2 actuaries upon -- on the provision, and they booked the GBP 125 million to increase it to -- above the midpoint. I've just kind of looked at this and thought rather than see change in policy, I'd just rather be more prudent on the change of explanation and not end up with this sort of ridiculous volatility that we've got. Get the businesses to do pricing right, push it into the operations, make the margins deliver. And that's the view that I've taken. That's far more prudent than we've been in the past.

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [18]

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And just to answer your other question, it's not because we've sat there thinking it's coming off at the year-end or anything like that. I mean I think one of the key things that we've done here, and you see on Page 12, is that we set out what the actuaries -- the 2 sets of actuaries plus our sort of friends from Deloitte as well looking at this, we're setting out the range. These are 5-, 6-year liabilities. They're all subject to the vagaries in the U.S. legal system. So there isn't a number. So we've set out a range and run -- taken a more prudent view on it.

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Ryan Mangold, Firstgroup plc - CFO & Director [19]

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It is an estimate. Yes. There's a huge database of auto insurance in the U.S. that they all look at and put an estimate against that. Obviously, that could allow us be more prudent than otherwise.

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [20]

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Any other questions?

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Gerald Nicholas Khoo, Liberum Capital Limited, Research Division - Transport Analyst [21]

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Gerald Khoo from Liberum. Three for me, starting with -- going back to the insurance I'm afraid. How do you think you're performing relative to the market? How much of this is a FirstGroup-specific issue with regard to its claims track record? How much of it is a market-wide issue?

Secondly, in terms of First Bus, what's your thoughts in terms of what's happening in terms of the political environment, especially with regard to new regulation? And Manchester, what's happening -- what's the latest there? And finally, in Rail, can you give us some visibility on how much of the -- of those contract provisions have been utilized to date -- actually, the other way around. How much of the onerous contract provisions are actually left on the South Western and TransPennine, please?

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [22]

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Sure. Well, let -- I'll -- maybe a joint answer on the insurance one, and then I'll talk about the regulation, and Ryan will talk about the provisions. So I mean, I think, before we talk about the specifics of how we handle it, and maybe I'll cover it all out. Look, we are a major player in the North American market. So we are bigger than a lot of people that you may be looking at. I mean the marketplace is absolutely seeing huge settlement in motor, I think, 4 out of 10 largest legal claims of any sort of motor claims in the U.S. So we believe that this is very much a motor condition. And we're operating in so many states. We're sort of -- we're up against sort of a wide variety of judicial systems.

I think the key thing I would also comment on is that our safety record, particularly in things like student where we absolutely know because these things are filed and available publicly, that we have the best safety record in student. So it's not a question of FirstGroup having poor safety record or -- in terms of the drivers, the maintenance, the provisions, the collisions or injury, things like that, it's not a question of that. It's really down to the insurance market. Now Ryan will talk about this briefly. A lot of things we're doing to really try and improve that we laid out back in May, and he's working through to improve the process of reducing it as much as possible.

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Ryan Mangold, Firstgroup plc - CFO & Director [23]

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Yes. I mean there's a number of -- just by way of example -- for example, a vehicle comes into the shop now, the maintenance guidelines won't let us repair that until it's actually registered with our insurance providers so that they can actually get a claims ticket, so we can kind of pursue some subrogation. And so we have a -- we expect to have a far bigger claim benefits due to subrogation, for example, to kind of mitigate it against the cost. I mean that's a small example of some of the things that we've identified that is now implemented.

We've restructured what the insurance team looks like, we're restructuring the contractual arrangements that we've got with our third-party providers. We're putting in a bit more sort of like data scientists to look at cause and effect of these things, and what's the fastest way to be able to address this, in a settlement far better than for it to sort bouncing along for a while and ending up in the court. So there's a number of things that we are actually doing sort of looking to actually improve this negative trend. Unfortunately, we've just seen sort of 8 quarters a negative trend, which has resulted in a bigger charge going to the P&L. I mean my drive is to reverse the negative trend, which means we're going to have a smaller charge going through to the P&L. But as Matthew noted, there's a tightening and hardening of the auto insurance market in the U.S. and we've got to kind of do whatever we can to mitigate against it, right away from our processes at the moment when next it happens, to final settlement here.

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [24]

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So moving on to Manchester. I mean clearly, we're not exposed to that anymore as such. We are potentially in Oldenburg, but in Manchester, we're not operating. I mean look, I mean, I think, the comments around the reregulation is the same. I mean, the Manchester there is working through its process, and those consultations to be happening right now. I think the mathematics they're all sort of stacked up. We know how much of a subsidy is required in London to deliver the bus service in London and how much everybody is paying is sort of GBP 70, GBP 80 a person for that bus service, and they're paying something like GBP 17 per person in the region.

So I think the mathematics is going to be a struggle. They have to demonstrate that it is financially viable. I mean, we're obviously less concerned about Manchester, we're not seeing anybody else sort of making significant moves there. But what we are doing is we are partnering. And again, I'll come back to -- we're sort of rehashing stuff from 2, 3 years ago. But it's that original legislation talk more about partnerships than a bit about franchising. Yes, we're seeing such benefit from the work we're doing in Leeds, the work we're doing in the West Yorkshire, the work we're doing in Glasgow, Bristol. Call all these places, there's a huge amount of work going on to work with the authorities. And we think that is the way forward. And then finally, just on the relative to actually...

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Ryan Mangold, Firstgroup plc - CFO & Director [25]

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Yes. Gerald, on the basis that we recognize the full-on risk contract provision for SWR, it's clearly a franchise that's more challenging for us in the shortest term, where we are utilizing that provision at a relative pace. And it's all -- probably exhausted some [opportunity] costs of the next fiscal year. For TPE, the performance actually has been better at 6 months than what we actually set up for the budget, marginally better. It's not to say that we aren't going to be using the provision during the course of this year, but the performance is actually better than what we originally assumed.

And we remain firm that we think that the onerous contract will be recognized. Whilst it's not the full contingent capital exposure that we've got, we still believe that, that's still appropriate to maintain it at the current level. I mean subsequent to the full year, we've actually repaid some of the additional funding commitments. So we've kind of continued the capital. Actually, it's gone down. By the time we get to the end of the year, we expect this to go down another GBP 5 million. So in terms of the capital at risk, it's actually reduced year-on-year by the time we get to the full year. But SWR is the one that's the most challenging and has been fully provided for when we booked it earlier for the full year '19.

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Gerald Nicholas Khoo, Liberum Capital Limited, Research Division - Transport Analyst [26]

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When can you think is the buyouts?

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Ryan Mangold, Firstgroup plc - CFO & Director [27]

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In the next fiscal year, yes. I mean we can't -- we're still in negotiation.

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [28]

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I think you're getting a very accounting argument here, which is quite right. It's an interesting balance. So we see on TPE, we came and said, the PCS is far too high. It's a ridiculous number, which means, obviously, it will take longer to burn through on top as well. The PCS was lower and our exposure was lower. I mean in terms of the actual sort of the cash we put in, I think we put around sort of GBP 45 billion in this year. But the reality is that we are having very detailed conversations and discussions and negotiations with the DfT to resolve these issues, the key facts on sales as well. These issues are not down to FirstGroup. We have had issues. Clearly, yes, there are issues on our side as always as franchises.

But the reality of this is that we are -- the infrastructure is aging. It's going into bottlenecks, that's sort of really tight, congested bottlenecks. And we've got these investor relation issues. But whilst we are getting some remuneration for that, that is just not conducive to a functioning and growing railway. And the DfT understand that. So we are still having detailed conversations with them. We expect to be able to deal with that. Ryan's quite right, there is always a risk that this may not be resolved. And we're not going to spend any more than the PCS. But our focus right now is on negotiating with the DfT to find a resolution to this quickly because the biggest challenge itself is rail, it's getting the performance better. The -- and Rachael and Ryan are both customers of this franchise, and it's just not good enough, and between us, the network rail and all of the stakeholders, we have to get it working better.

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Unidentified Analyst, [29]

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[Daniel Robi]. Please, can I just follow-up on that topic, on rail. First of all, Great Western, March '20, is 4 months away also. We've got Christmas and the election and everything else. What happens next? I mean if there's no agreement, does anyone know?

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [30]

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Well, with the sort of -- the way it works is we still used -- whilst it's a direct award, you still have to have very formal bidding because it's clear that everybody wants to see the benefit coming from this huge investment in electrification. So we have to put forward a very clear case. And the government has to make sure that it's value for money. At the end -- the contract will finish at the end of 2020, and we have to get it done before that. They know they're going to -- they've got to get it done. And yes, well, there are -- the DfT does not sort of shut up shop during the election. I mean clearly, like, there are sort of rules about what they can actually contract. But all that detailed work has to go on, is still carrying on. So we believe that will be dealt with by the time we get to the end of the contract.

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Unidentified Analyst, [31]

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And if I can just highlight in the second point, which is, I think you said just a few minutes ago, the limits on SWR in terms of cash, new equity would be what your contingent position was. So the phasing issue here, Great Western needs to be tied up before any risk and if the DfT doesn't renegotiate, you could potentially walk away from the SWR contract. Because if it runs out of equity, and you're not prepared to put any in, it sort of goes the way of the separate East Coast contracts and others. And that looks unavoidable.

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Matthew Gregory, Firstgroup plc - CEO & Executive Director [32]

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Well, I don't think it's unavoidable, but I think if we -- they are 2 very different conversations. We have to manage through this SWR process because, again, we don't believe that the issues on that franchise really are truly down to the bid that we put in. We have been unable to deliver the improvements we wanted because of the infrastructure issues and the IR issues. And Great Western sort of dealt with it as a separate stream and will be dealt with and has been dealt with as a separate issue. I mean the challenges on SWR have been known for at least 12 to 18 months. And at the same time, the government put out the tender for the extension of direct awards. So we're talking to the people, we're talking to the whole of people in the department. And we -- they all know what's sort of going on. So I don't think it's a question of, well, we need to get one sorted before the other. We need to get both sorted quickly.

Great. Well, look, if there's -- unless there's any other questions, I think we'll call it all there. And thank you very much for coming today. We appreciate it.