Smart Metering Systems Regulatory News (SMS)

17 March 2020

Smart Metering Systems plc

Final results for the year ended 31 December 2019

Smart Metering Systems plc (AIM: SMS, "the Group"), which installs and manages smart meters and carbon reduction assets ("CaRe") to facilitate effective energy management, has published its final results for the 12 months to 31 December 2019.

The Group has also signed a partnership agreement with the Columbia Threadneedle Sustainable Infrastructure Fund ("ESIF") to develop SMS's pipeline of CaRe asset opportunities - see separate announcement.

On 12 March 2020, SMS announced that it has conditionally sold a minority of its meter assets to funds managed by Equitix Investment Management for a total gross cash consideration of £291 million. The disposal will enable the implementation of an enhanced long-term, sustainable dividend payment policy and results in a significant reshaping of SMS's capital structure.

2019 financial performance

1 ILARR is the revenue generated from meter rental and data contracts at a point in time. Includes revenue from third-party managed meters.

2 Pre-exceptional EBITDA is statutory EBITDA excluding exceptional items.

3 Underlying profit before taxation is profit before taxation excluding exceptional items and amortisation of intangibles.

4 Underlying basic EPS is underlying profit after taxation divided by the weighted average number of ordinary shares for the purpose of basic EPS.

A reconciliation between reported and underlying performance is detailed in the Financial Review section below.

Highlights

· Financial

• Total ILARR increased 20% to £90.1m (2018: £75.3m)

• Pre-exceptional EBITDA up 14% to £58.9m (2018: £51.6m)

· Disposal - announced 12 March 2020

• £291m gross proceeds from asset disposal

• Cash consideration will result in positive net cash position for Group overall

• Post the disposal, retained Group ILARR is £73.2m as at 29 February 2020

• Partnership with ESIF

• Funds SMS's pipeline of Carbon Reduction (CaRe) assets

• CaRe assets developed within SMS's well-established energy management division

• ESIF to fund and own the CaRe assets - SMS receives incremental long-term asset management fees

• Business positioning and opportunities

• Smart meters

• Growth in metering assets - total market c.36.5m meters to be exchanged

• Existing SMS c.2m smart meter order book expected to add c.£40m ILARR

• Existing SMS customers have additional c.4m to be exchanged

• Dividend

• Long-term sustainable growing dividends with upside potential from existing and new meter assets

• Proposed FY20 dividends increased to 25p - grow at least in line with RPI p.a. to 2024

• Sustainability is at the heart of SMS' operations

• Smart meters are integral part of a flexible, decentralised and decarbonised energy system

• Well placed to originate CaRe assets in current and emerging electricity generation, storage, heat, lighting and transportation industry market segments

Alan Foy, Chief Executive Officer, commented: 

"A 20% increase in our key financial metric - ILARR - and a 14% increase in EBITDA in extremely challenging markets, is a testimony to our market position and operational capabilities.

"Last week's transaction will not only realise considerable cash returns and demonstrates the substantial value of our smart meter portfolio but also will enable us to enhance greatly shareholder value with a significant and sustainable increase in dividends.

"The UK is the first major economy to adopt net zero emissions by 2050, mainly by electrification strategies. This will need the establishment of a decentralised and decarbonised energy system as well as substantial capital to meet that target.

"A combination of our strengthened balance sheet to support our smart meter rollout programme, todays' partnership announcement with ESIF and our energy management division's track record, positions us extremely well to accelerate and rapid expand our CaRe assets in the current and emerging electricity generation, storage, lighting, heating and transportation markets." 

There will be an analyst conference call at 9.00am today - please contact sms@instinctif.com or telephone 020 7457 2077 for details. The full year results presentation will be published on the Group's website shortly.

For further information:

Notes to editors

SMS plc (www.sms-plc.com) installs and manages smart meters and carbon reduction assets ("CaRe") to facilitate effective energy management. Established in 1995, SMS provides a full end-to-end service for metering financing, installation, management and maintenance, with a highly skilled workforce and deep engineering expertise.

SMS had 3.73 million meter and data assets under management as of 31 December 2019. SMS's smart meter expertise also enables the Company to provide consultancy services that allow organisations and corporates to enhance long term efficiency and effectiveness in the management of energy.

SMS's energy management and asset installation services also include infrastructure design, installation, consultancy and project management services for new gas, electricity, water and telecoms connections for licensed energy and telecoms suppliers, end consumers and the UK's licensed electricity Distribution Network Owners (DNOs).

SMS employs in excess of 1,200 people across the UK who support the installation and ongoing management of metering assets.

SMS plc is headquartered in Glasgow with 12 locations across the UK.

SMS's shares are listed on AIM.

Chairman's statement

Introduction

I am pleased to report that we ended the year in line with our expectations, and delivered continued growth in our ILARR, despite various industry-wide challenges. The continued volatility in the UK smart meter rollout has seen industry installation run rates lag behind previously anticipated volumes, and technical issues, beyond our control, have meant delays to certain customers getting "SMETS2 ready". As a result, we have had to navigate the knock-on effect of this on our operational activity and financial results.

Despite these challenges, and the resulting impact on our short-term profitability, it is important that we keep sight of the long-term opportunities our business can address. The smart meter rollout remains core to a lower carbon future for the UK. Further, the strategic acquisition of Solo Energy has strengthened our energy services platform to accelerate the delivery of extended energy services to our customers.

We previously announced that we were exploring options to monetise the value of a minority of the Group's meter assets. On 12 March 2020, the Group conditionally agreed to dispose of a minority of the Group's meter assets for the gross consideration of £291m. This represents £18.4m ILARR and SMS will continue to manage the disposed assets for an RPI-linked management fee of c.£0.8m.

This transaction generates considerable cash returns and demonstrates the substantial value of our smart meter portfolio. The value that this transaction delivers enables the acceleration of shareholder returns, with the proposal of a significant change to our dividend policy, detailed further below.

We remain focused on securing long-term sustainable revenue streams, supported by an efficient capital structure, and are committed to seeking additional opportunities that enable the fulfilment of our mission: to deliver the future of smart energy.

Our results

Investment in our portfolio of revenue-generating assets has remained strong, reflected in the 20% increase in our ILARR to £90.1m and an overall increase in our assets under management to 3.7 million from 3.1 million at the end of 2018.

Our business delivered a resilient performance this year, despite the challenges we faced with delays in the smart meter rollout.

Whilst our statutory profitability after tax was lower than last year, our pre-exceptional EBITDA of £58.9m continued to grow, reflecting the strength of our index linked, recurring revenue base together with the significant efforts of the management team to manage our cost base in order to mitigate the impact of the rollout delays on our near-term profitability.

Navigating the smart meter rollout and creating opportunities for the future

The UK smart meter rollout continues to represent a core opportunity for us over the next few years. With 16.5 million smart and advanced meters operating as at 31 December 2019, there are still c.36.5 million meters to be exchanged.

Our contracted c.2 million pipeline opportunity from existing contracts with independent energy suppliers should add a further c.£40m of ILARR. With the range of technical issues during 2019 now predominantly resolved, as further detailed in the Operational review below, our focus for 2020 is to work closely with our customers and help them deliver their smart meter installation plans efficiently and effectively.

The energy market provides a wealth of opportunities for future growth, especially as the UK continues its decarbonisation journey with a legally binding net-zero carbon emission target by 2050. A new market for the management and operation of carbon reduction ("CaRe") assets, including EV charging points and battery storage, continues to evolve and developments in this space are accelerating. We are already well positioned to respond with the strategic acquisition of Solo Energy and its FlexiGrid platform, which operates the integration of energy storage systems, renewable generation and vehicle charging into the UK's energy systems and builds out our energy management business.

Delivering our strategy

During 2019 we were focused on continued growth of our ILARR, including preparations for the establishment of an asset base in CaRe assets, and overall operational efficiency through careful management of our installation capacity and engineering productivity.

The smart meter rollout will remain the core focus in the immediate future and with an increasing installed base of smart meters we continue to progress the origination of new CaRe assets. With the likely extended rollout period for smart meters, we will ensure our resources and cost base are aligned with a strong focus on operational efficiency.

Our strategic priority of capital efficiency has been the subject of a comprehensive review by the Board, to ensure we are optimising our capital structure in the face of changing markets and opportunities. The recently announced disposal of a minority of our I&C portfolio assists in the delivery of this. We have also entered into a partnership with the Columbia Threadneedle Sustainable Infrastructure Fund ("ESIF") to finance our pipeline of CaRe assets. Further details are provided in the Chief Executive Officer's statement.

Dividend

Over the last few years, we have aimed to provide a progressive, through-cycle dividend that shares the rewards of our profitability and growth with shareholders and provides a sustainable return. In this context, the Board is proposing a final cash dividend of 4.58p per ordinary share for the year ended 31 December 2019 (2018: 3.98p). In addition to the interim dividend of 2.30p (2018: 2.00p), this will give a total ordinary dividend of 6.88p (2018: 5.98p), an increase of 15% on last year.

Following the minority asset disposal, the business will be in a net positive cash position on completion. This will allow us to generate significant additional value for shareholders from our existing asset base.

I am, therefore, pleased to announce an intended, new and enhanced dividend policy of 25p per share per annum. Effective from 2020, this will be payable in quarterly instalments and will increase with RPI through to 2024. Representing over three times the dividend of 6.88p in 2019, this marks the start of returning materially increased value through distribution to shareholders over the medium term.

Continued investment in sustainability: the environment, our people, and health and safety

With a core Group focus on investment in assets that help reduce carbon, operating sustainably is a key focus area for us and we aim to be transparent with our investors on the impact we are having on both the environment and society around us, and our people.

In 2019, we developed a holistic view of our sustainability, quantifying our positive impacts delivered through our services, and negative impacts from our business estate and fleet. I am very proud to confirm that, in 2019, the positive services we were able to provide significantly outweighed the footprint we left behind, supported by our products and services and efforts to reduce our own footprint through fleet upgrades, property refurbishments and procurement of renewable electricity.

The success of our business is undoubtedly reliant on the continued support of our employees. We put our people first, placing considerable value on their engagement. During 2019, we refined our values and behaviours through a collaborative project, with extensive involvement from employees at all levels. We now have a clear set of values that align with our strategic objectives and future focus. I would like to thank all our employees for their hard work and commitment during the year.

The health and safety of our employees and customers continues to be a key priority. I am pleased to report that our performance over the year remained stable, despite a significant increase in our engineering workforce, with no notable detrimental changes to our accident frequency rates.

Coronavirus

As the situation continues to evolve, our primary concern is for the welfare of our people. We are following the development of the coronavirus outbreak closely and have implemented several immediate measures to both protect our employees and to prepare for possible consequences of the virus. Whilst the outbreak has not yet had any direct impact on our operations, it is unclear how it will develop. It is currently difficult to assess the potential impact this could have on our 2020 business activities and results, but we will continue to follow developments closely and are prepared to take further action as appropriate.

Current trading and outlook

We have demonstrated during the year our resilience in managing the short-term challenges arising from the volatility of the smart meter rollout, whilst addressing future market opportunities through strategic investment and development of our carbon reduction proposition. With the technical issues experienced during 2019 substantially behind us, and support from BEIS in the form of a proposed extended rollout timescale to the end of 2024, we are well placed to progressively deliver the rollout in an efficient manner with our customers.

Capital efficiency remains a key strategic priority for us, ensuring we can effectively respond to market developments, and take advantage of additional opportunities, whilst also increasing shareholder value.

The years ahead hold more exciting developments for our business, with the ongoing smart meter rollout and growth in our CaRe asset base. The Board remains confident in SMS's strength and potential in the face of a transforming energy landscape.

The current year has started in line with the Board's expectations and we continue to actively engage with both existing and potential customers in securing our future order book.

Chief Executive Officer's statement

Net-zero carbon at the heart of our activities

The scale and urgency of global action required for climate change to be addressed has undergone a step-change during 2019. This has resulted in a governmental, business and consumer response that is likely to bring significant market disruption with the UK becoming the first major economy to legislate for net-zero carbon emissions. The impact of this will be especially evident in the energy industry, with long-term structural changes to how and where energy is generated, stored and used.

The UK's net-zero target will continue to drive public policy decisions in our industry, one of which is the need for smart meters. Smart meters are an integral part of a flexible, decentralised and decarbonised energy system - central to reducing CO2 emissions and reliance on unsustainable energy sources.

Sustainability is therefore at the heart of our business. Central to the government's decision to convert the UK to smart meters is the clear impact that control over energy consumption has on reducing carbon emissions. This macro trend provides substantial opportunities for our business, and with 25 years' experience in the energy industry and a well-established IT, data and engineering platform, SMS is well positioned to take advantage of them and contribute positively towards a sustainable future through the development of CaRe assets that complement and are enabled by smart meters.

Strategy

The industry trends provide a clear direction and substantial opportunity for the continued long-term success of our business, delivering and maintaining both meter and CaRe assets, which provide high-quality and secure recurring revenue streams.

To deliver this, our focus remains on the following three pillars of our strategy, on which we have made strong progress in 2019:

• securing long-term index-linked sustainable revenue streams;

• efficient operational delivery and customer excellence; and

• efficient capital structure to assist in generating shareholder value.

Index-linked revenue streams

The core focus of the Group is securing long-term index-linked, sustainable, recurring revenue streams.

We have clear visibility of our recurring revenue pipeline, with substantial opportunities to grow this further given both the continued growth in the independent energy retail sector to over 30% market share and the c.36.5million meters still to be exchanged in the industry as a whole.

Operational efficiency and excellence

In 2019 we continued to invest in engineering capacity, meter stock and IT infrastructure to support the transition to SMETS2 and ensure continual improvement in the efficiency, customer service, quality and health and safety standards with which we deliver our services.

Our IT systems are increasingly integrated with our customers', enabling growing numbers of end consumers to book meter installation appointments through their energy suppliers' "apps" and websites, or at any point in which they speak directly to their energy supplier. We continue to implement innovations which minimise and automate the touchpoints we have with end consumers during our established customer journey processes, improving the customer experience and reducing the volume of activity within our contact centre as a result.

These integrations with our customers are also important to co-ordinate customer engagement and conversion with the energy suppliers, who are taking ever greater ownership of that process in the context of regulatory targets for smart meter deployment.

The proposed extended delivery period through to the end of 2024 for the smart meter rollout will mean a smoother rollout profile ahead of us, and we have already taken steps in H2 2019 to improve productivity by increasing the amount of transactional, revenue-generating "callout" activity we provide to energy suppliers.

We will maintain a strong focus on engineering efficiency and cost discipline in 2020, aligning our resource base to the longer rollout profile, whilst ensuring we have the flexibility to ramp up installation rates to meet the significant opportunities ahead.

Capital structure optimisation and shareholder value

Whilst we have sufficient funding to meet our immediate contracted opportunity pipeline, with net debt of c.£220m at 31 December 2019 from a facility, at that time, of £420m, we continually review our financing to ensure we are optimising our capital structure.

We have successfully agreed the conditional disposal of a minority of our I&C portfolio, consisting of £18.4m of I&C ILARR for £291m gross proceeds to funds managed by Equitix Investment Management Limited. SMS will continue to manage the disposed assets with an average age of c.4.7 years for £0.8m of RPI-linked management fees.

In addition, we have retained a portion of I&C assets and will continue to participate in the I&C market through our utilities connections business. At completion, the disposal generates a net positive cash position for the Group, enables acceleration in dividend policy, enhances ability to maximise future meter ILARR opportunities, demonstrates value of meter assets and provides additional funding flexibility. We are well placed to accelerate both growth and dividends whilst maintaining prudent leverage through the investment cycle.

• Growth funding

We have several funding options which provide significant flexibility to maximise opportunities in the smart metering space: long-term cash generation from our mature meter portfolio (post dividend payments), a revised £300m RCF on attractive terms, incremental cash generated from deployment of new assets and further capital optimisation opportunities.

We have originated a strong pipeline of opportunities in CaRe assets and have partnered with ESIF to provide funds for the development of these assets. SMS's revenues and cash flows from these assets and services are expected to increase over time.

• Sustainable and long-term dividend policy

As part of our recent announcement of a minority asset disposal, we also proposed a revised, sustainable and long-term dividend policy. This starts at 25p per share for 2020, payable quarterly and with a partial scrip alternative, and then growing at least in line with RPI per annum during the meter growth phase to 2024. The dividends are covered by cash generated from our retained existing meter and data assets, providing strong forward visibility.

The Board believes there is further dividend upside potential to the dividend policy summarised above.

2019 performance

The business experienced challenges in 2019 during the market's transition from SMETS1 to SMETS2, with industry installation run rates remaining largely flat throughout the year as a consequence. "Radio frequency" interference issues in the northern region of the rollout proved a significant impediment to mobilisation of SMETS2 meter installations, whilst the end date for SMETS1 meter installations meant there were no viable alternatives.

With these technical issues relating to radio frequency interference now substantially resolved, SMETS2 meters are being installed in increasing volumes. The solution continues to mature as a result, with c.4m SMETS2 meters connected to the network across the industry as of 27 February 2020, although these have largely been fitted by the Big Six UK energy suppliers. The government has consulted to extend the smart meter rollout to December 2024, reflecting a more realistic and pragmatic approach. We believe this provides greater certainty to plan and deliver the rollout in an efficient manner with our customers and expect the rollout profile to be more evenly spread through to 2024 as a result. With compulsory annual installation targets and the introduction of a stricter regulatory regime for energy suppliers, we will continue to work closely with all our customers to mobilise and deliver their rollout requirements.

Some independent energy suppliers are still finalising integrations with the Data Communications Company (DCC) and end-to-end testing, with their readiness to commence mass SMETS2 meter rollouts at varying stages of development.

The industry issues in 2019 led to engineer productivity related challenges, particularly in H1, which had a short-term impact on profitability. Nonetheless, careful management of our operational activities and a strong focus on engineering efficiency enabled us to significantly reduce the impact on profitability. This is a testament to the strength and resilience of our business model that, despite these challenges, the execution of our strategy delivered a robust financial performance highlighted by a growth of 20% in our primary financial KPI - ILARR.

We ended 2019 with £90.1m of ILARR. This growth was primarily driven by the smart meter exchange programme, with recurring revenue from domestic smart meters increasing by 40% in 2019 from £27.1m to £38.1m. We have also continued growth in all our other segments with I&C meters £21.2m (2018: £19.0m) at 31 December 2019, of which £18.4m have been subsequently sold, data assets £12.3m (2018: £12.2m) and traditional domestic meters £18.6m (2018: £17.1m). As we continue to roll out smart meters, recurring revenue from our traditional meters will steadily reduce.

Continued growth and new opportunities

Domestic smart meters and data

We have a contracted order pipeline of c.2 million meters from our independent energy supplier customers which will initially add c.£40m to our ILARR. SMS is also well placed, operationally and financially, to take advantage of additional opportunities which we see beyond this pipeline. We continue to focus on leveraging our valued turnkey services to originate long-term, index-linked return on our capital investment in meter assets.

The rollout of smart meters has created additional data opportunities for SMS. We are focused on growing our data services by launching elective half-hourly settlement and SMETS2 firmware management services for our energy supplier customers. We believe this is a substantial market opportunity in its own right, and the revenues originating from these activities are also index linked and recurring in nature.

CaRe assets

We also see significant growth opportunities in CaRe assets from within our energy management division. Established over the last 25 years, we have developed a strong IT, Data and Energy platform which coupled with our end-to-end turnkey solution and industry-wide partnerships provides us with significant opportunities and competitive advantage.

SMS is well placed to support the UK government's net zero ambition by 2050. We can do this by continuing to leverage our well- established energy services business as the UK transitions to a more sustainable and low-carbon economy. Our partnership with ESIF provides capital support for SMS's identified pipeline and future opportunities of CaRe assets. Such initial CaRe assets include energy efficiency systems (such as LED lighting, data and controls), energy storage, distributed generation, and EV charging infrastructure.

This year marks our 25th anniversary, which is testament to our secure business foundation and long-term business model. We are committed to creating a resilient energy infrastructure for the future, focused on delivering long-term value for all our stakeholders.

Operational review

Asset management division

*Excludes depreciation on revenue-generating assets, recognised within cost of sales. Refer to the Financial review for definitions and details on the Group’s alternative performance measures.

Our focus

The asset management division is focused on growing our secure, long-term, index-linked and sustainable revenue streams. Our primary strategic objectives are to:

• grow our ILARR, focused on recurring rental from the UK smart metering market opportunity;

• manage and track all assets through their life, controlling capital deployment and return on investment; and

• continually ensure a capital-efficient structure, to maximise the opportunity available to us from the smart meter rollout.

Through our industry accredited services, we continue to work with energy suppliers to support them in managing the challenges and opportunities smart metering brings. For example, by growing our data and accredited industry settlement (half-hourly data) services and providing firmware management test labs and services for SMETS2 meters. These are opportunities for us to continue to grow our ILARR, and to play a critical role in the realisation of the smart energy grid, and a greener, low-carbon energy network.

Performance summary

• ILARR increased by £14.8m, a 20% increase, to £90.1m.

• Our mature I&C and smart meter asset portfolios contributed £59.2m to the ILARR, with our smart meter portfolio growing 44% to over 1.2 million meters.

• Further opportunity beyond this pipeline with contracted and potential customers.

• Focus on capital efficient structures, ensuring sufficient financial capacity to maximise opportunities in the smart meter rollout whilst delivering secure and growing dividends for the long term.

Our smart meter portfolio grew 44% to 1.2 million meters, adding 369,000 smart meters in the year (300,000 from our own installation activity), and we expect installation run rates to be more evenly spread following the BEIS extension of the smart meter rollout to 2024.

Data recurring revenue is in line with last year at £12.3m (2018: £12.2m). This reflects the maturity of the I&C market where we predominantly provide these services and our decision to step back from some domestic data services, which require low-margin transactional meter-read activity. We believe there is still an opportunity for data services, both in the I&C and Domestic markets, particularly in supporting energy suppliers with the settlement of half-hourly data from smart meters (which does not require manual meter readings).

Market conditions

Whilst there have been pressures on the deployment of smart meters, the broader market continues to transform at a rapid pace, with continued growth in the "independent" energy supplier market, which now supplies over 30% of all customers. This was before the recent acquisition of the SSE domestic retail business by Ovo Energy, which had c. 12% market share. The independent market segment with which SMS is most heavily engaged, benefits from our turnkey approach including both installation and active asset management. There are significant opportunities for us to grow our market share beyond our contracted order book.

We have continued to see some smaller energy suppliers struggle financially. In some cases, Ofgem's Supplier of Last Resort (SoLR) has been implemented and, as a result, there has been further consolidation in the market. This brings a small amount of risk to SMS in respect of short-term credit risk to rental payments from energy suppliers. However, the SoLR process has proven that, where a more creditworthy supplier is appointed to take over a supplier portfolio, then we have a standard industry process that transfers our meter points to the new supplier and protects our rental revenue streams going forward. Over the life of these long-term assets and on a portfolio basis, this provides a secure backdrop to the significant capital we deploy.

Our well-established turnkey integrated service remains unique in the market and is a strong foundation for our continued growth. We see competition in the market from other asset financing businesses, and some energy suppliers using the smart meter rollout extension to segregate some parts of the delivery process - most notably taking greater ownership over the customer journey.

Asset installation division

*Net portfolio additions include removals. 2019 net portfolio additions of 313,000 exclude 69,000 smart meters acquired from a customer during the year.

Our focus

The installation division is focused on operational excellence and efficiency. Our primary strategic objectives are to:

• safely deliver the installation of meter assets which provide long-term recurring revenue to our business;

• align our engineering capacity and installation profile over the proposed, extended BEIS rollout period, using technology to drive efficiency improvements and an improved customer experience and appointment booking process; and

• reduce the carbon footprint of our delivery - in particular, from our vans by implementing more dynamic scheduling and introducing electric vans where practical.

The installation division is working with our customers to trial the installation of next-generation asset classes, in particular smart home and domestic EV charging point devices which can be installed at the same time as smart meter installations.

Performance summary

• Completed operational, technology and supply chain transition from SMETS1 to SMETS2 in 2019 and supported investment in capacity platform.

• Technology enhancements that provide online supplier booking portals, to increase portfolio conversion and reduce operational expenditure.

• Successful navigation through third-party challenges e.g. Radio Frequency interference issues in northern region resolved and SMETS2 meters being deployed on a national basis.

• Maintenance of a reliable engineering resource base, supported by in-house training academy.

• Continual productivity improvements in H2, supported by increase in chargeable transactional activity.

• BEIS consultation, proposing an extension to 31 December 2024 means SMS expects a smoother installation profile, with engineering business being sized accordingly and sufficient flexibility through supply chain to manage peak demands.

• Working closely with domestic and small I&C energy suppliers to meet rollout obligations.

2019 was a challenging year for the smart meter installation market, with the government having mandated an end date for SMETS1, effectively enforcing a transition to SMETS2. This was then followed by a technical Radio Frequency interference issue with the SMETS2 meter installations - which connect immediately to the central DCC - leading to the inhibition of installations, most notably in the north of England and Scotland.

In addition, each energy supplier's readiness for SMETS2 has varied, in particular regarding their end-to-end connectivity to the DCC to enable smart meters to be installed and commissioned. The largest "Big Six" suppliers have typically been the most advanced, with some independent energy suppliers, particularly the small and medium-sized ones, still some way behind.

Overall, therefore, the industry has seen a slow-down in smart meter installations in the year.

Therefore, whilst SMS has had the engineering capacity to fulfil initially forecasted customer demand during 2019, actual installation numbers and hence productivity have proven to be challenging. This resulted in smart meter installations remaining relatively flat over the year.

Working closely with our customers and supply chain, these radio frequency technical issues have been resolved. In addition, we, have continued to collaborate with all our customers to ensure their systems and DCC connectivity are fully operational for the mass rollout. We have also taken steps throughout 2019 to address the productivity challenges, particularly increasing the volume of chargeable transactional activity in the second half of the year.

Whilst some technical challenges remain, predominantly around the use of SMETS2 meters in prepayment situations, firmware versions and availability of meter variants, DCC and SMETS2 are increasing in maturity and reliability. We are increasingly optimistic regarding the continued deployment of these solutions through the smart meter rollout - with c.36.5 million smart meters still to be exchanged across the industry by 2024.

Market conditions

The BEIS consultation on the smart meter rollout proposed extending the rollout to 31 December 2024 with a target of 85% of all meters being exchanged by this point. It has also indicated an intended stronger underlying regulatory regime.

Energy suppliers were initially obliged to take all reasonable steps to offer and deliver smart meters to all customers by the end of 2020, whereas now they have to meet annual compulsory targets in order to adhere to the revised programme end date.

This proposed extension reaffirms the importance of the smart meter rollout to the future of the UK energy system. We now expect to see a smoother installation profile through the course of the rollout and are sizing our engineering business accordingly to deliver our contracted meter installation pipeline. This includes allowing sufficient flexibility in our model to meet customer peak demand and additional opportunities from existing and potential new customers.

Through our accredited training academy, we are engaged in industry-wide initiatives to continually improve health and safety (H&S) performance, with smart meter installations providing an ideal opportunity to identify any existing quality issues in the meter or the incoming electrical/gas supply.

Energy management division

Our focus

The well-established energy management division is focused on deploying assets and solutions which help our customers reduce their energy consumption and carbon footprints, thereby helping them in their journey to net zero. Our primary strategic objectives are to:

• build and deliver a capital project pipeline to deploy services and assets to reduce our customers' carbon footprints;

• generate long-term, secure recurring returns from energy efficiency, distributed generation, storage and EV charging projects; and

• partner with multiple distribution channels to maximise this project pipeline opportunity.

A strong pipeline of CaRe opportunities has been identified based on ongoing trials and projects, which are at various stages of discussions. Through our new funding partnership with ESIF, we are able to deploy capital into these CaRe projects without diverting the cash flows from our meter assets business, resulting in cash positive returns to the Group.

SMS's revenues and cash flows from CaRe assets and services are expected to increase over time, with no funding obligation and no significant cost needed to accelerate growth. This provides an additional lever for further rebasing of future dividends.

Performance summary

• Revenue and gross profit increased in line with expectations from delivery of energy efficiency strategies and energy management services.

• Strategic positioning to deliver capital projects which improve energy efficiency and reduce carbon emissions, through investment in new generation, storage, electric vehicle assets and energy services projects.

• Investment in Solo Energy, with "FlexiGrid" technology platform which integrates distributed generation, battery storage and EV chargers across domestic and commercial buildings to create a virtual power plant (VPP).

• This VPP enables SMS to control and manage the long-term revenue streams from these new asset classes.

• Industrial expertise, customer relationships and extensive, highly skilled engineering base demonstrated through long-term blue-chip customer relationships.

Our energy management division has performed well in 2019, continuing to specialise in working with I&C customers, particularly those with large, complex, multi-site portfolios. We advise on and implement effective strategies that reduce both energy costs and consumption, by providing a full range of energy consultancy services, including bill investigation, bureau, energy reduction and environmental management.

Our approach is built on data, using our data analytics platforms and often working closely with our accredited industry data services, to identify opportunities to reduce our customers' carbon footprints.

We have continued in 2019 to deliver several capital projects, funded by customers, which reduce energy intensity, such as an LED lighting project and smart controls project for a major UK hotel chain. We have a strong pipeline of activity and other similar projects which have a positive outlook for the continued growth of these services in coming years, intended to be funded through our infrastructure fund partnership.

We have established a full turnkey end-to-end delivery, supported by strong industry relationships. The increased urgency to address net-zero greenhouse gas emissions provides substantial opportunity for our business.

Market conditions

There are several factors driving the emergence of smart technologies and a new way of delivering and using energy including:

• the ongoing digitisation of our energy system;

• the introduction of the net-zero carbon target for 2050;

• the resulting renewed public policy focus on the climate change agenda; and

• the rapidly shifting business, consumer and investor sentiment.

Energy efficiency remains the first and most important step in this hierarchy. However, this data-driven transformation is expected to have a profound impact on how and where we generate, store and use energy - making it more dynamic, connected and sustainable. In particular, the necessity for increasing levels of renewable generation and peak electric vehicle charging demand (especially at the local level) requires new assets, capital investment and software data controls platforms to respond to energy and price signals.

Whilst smart meters are at the heart of this transformation, by enabling two-way flow of energy and smart and dynamic time-of-use tariffs, SMS has the proven knowledge and platform to work with end customers and energy suppliers to deliver these new asset classes.

Our investment in Solo Energy also provides us with a cloud-based energy flexibility IT platform - FlexiGrid - to control and aggregate data and revenue from generation and battery storage assets. This fully integrated platform enhances our ability to provide a comprehensive end-to-end service proposition to our established industrial, domestic and energy services customer base.

By integrating energy storage, renewable generation and vehicle charging into the UK energy system, FlexiGrid can help shape consumer demand to follow renewable energy supply and operate as a VPP. This fully integrated platform enhances our ability to provide a comprehensive end-to-end service proposition to our established industrial, domestic and energy services customer base and will address the market disruption affecting the UK and global energy system. Crucially, it provides the technology platform to support the deployment of these new infrastructure CaRe asset classes.

We continue to fully integrate the Solo Energy platform with our wider energy services and leverage our well-established energy services foundations to remain at the centre of the energy system as we transition to a more sustainable and low-carbon economy.

Financial review

Given the challenges we have faced during 2019, primarily driven by the continued industry-wide issues and delays surrounding the smart meter rollout, I am very pleased to be able to present a set of financial results that are in line with market expectations.

Whilst our statutory profit from operations indicates modest growth, the continued significant investment in our portfolio of revenue-generating assets is driving a 20% increase in our key performance measure, ILARR, to £90.1m. Our underlying performance, as measured by pre-exceptional EBITDA, has increased by 14% against a backdrop of the volatility of the smart meter rollout and lower installation volumes, highlighting the strength of our underlying business model in investing in assets that generate recurring revenue.

We fundamentally manage the business on a long-term basis, in line with our strategic priorities, and focus on delivering secure returns for our shareholders. We exit the year comfortable with our results and performance.

Well placed for the next phase of our growth and development, the conditional disposal of a minority of our meter asset portfolio on 12 March 2020 realises significant value for the Group and there is a fundamental positive impact on our future strategy, as discussed further within this report.

Reconciliation of reported to underlying results

SMS uses alternative performance measures, defined at the end of the Financial Review, to present a clear view of what the Group considers to be the results of its underlying, sustainable business operations. By excluding certain items, this enables consistent year-on-year comparisons and aids with a better understanding of our business performance.

A reconciliation of these performance measures is disclosed below:

Revenue

Total ILARR increased by 20% to £90.1m as at 31 December 2019 compared to 31 December 2018, in line with our expectations. Consistent with the prior year, most of the growth was seen in the electricity meter division, with an increase in ILARR to £28.1m at 31 December 2019 (31 December 2018: £20.3m). The installation of dual fuel meters as part of the smart meter rollout favours higher growth in our younger electricity portfolio, when compared with our historical gas-weighted portfolio.

The overall growth in ILARR reflects the flow through impact of new contract wins from 2018 and the first quarter of 2019, and growth in the meter estate, together with the combined effect of increases in RPI and rental rates for deemed non-contracted customers. We continue to actively engage with both existing and potential customers in securing our future order book.

Group revenue rose 16%, driven primarily by continued growth in the asset management and energy management divisions, offset by a decline in asset installation revenues. Whilst installation run rates were slower than anticipated through the year, for us and the wider market, our domestic smart meter portfolio has still increased, generating additional revenue.

Together with a favourable increase in the RPI in April 2019, and a pricing increase on deemed non-contracted customers, revenue has increased by 27% in the asset management division to £82.9m (2018: £65.5m).

Energy management revenue has increased 39% to £9.0m (2018: £6.5m), which continues to be attributable to the capital projects in progress for a large hotel chain. Over 190 sites were completed in 2019 as part of the ongoing energy-efficient lighting project; and, towards the end of the year, we embarked on a second significant project for the same hotel chain, delivering smart heating controls.

Asset installation revenue was £22.4m (2018: £26.6m) reducing largely due to legacy installation-only work for third parties coming to an end in the first half of the year, in line with the Group's decision to reallocate internal engineering resource to fit the SMS portfolio of smart meters. The decline in installation revenue has been partially offset by higher volumes of emergency and transactional work on SMS's portfolio of traditional meters, which have required direct replacement whilst energy suppliers become SMETS2 ready.

Gross margins

Overall, the depreciation-adjusted gross margin at a Group level remained broadly consistent at 64% (2018: 63%). SMS includes depreciation on revenue-generating assets within cost of sales and removing this from the margin analysis provides a better comparison of underlying trading performance year on year.

Whilst the Group has experienced a higher than expected proportion of installation costs that are unable to be capitalised, revenues from transactional work have also been higher than expected, providing an offset that has kept the overall depreciation-adjusted gross margin steady.

The depreciation-adjusted gross margin for asset management has also remained steady at 93% (2018: 92%), reflecting the growth in the underlying asset base. The gross margin, including depreciation, has decreased by 6% from 61% to 55%, primarily as a result of a change to a depreciation related accounting estimate, made with effect from 1 January 2019, in relation to SMS's traditional meter assets. As a result, there is an additional £7.3m recognised within depreciation in cost of sales on a statutory basis - see note 1(a) to the financial statements for further details.

The asset installation business reported a negative gross profit margin of 25% (2018: positive 23%). This primarily reflects the Group-wide strategy to focus its internal resources on the smart meter rollout, with legacy external installation contracts coming to an end at the beginning of the year, reducing external revenues and removing the contribution to profitability seen in prior years.

Through the first half of 2019 there was continued investment made in retaining the Group's installation capacity to ensure the business was appropriately positioned to benefit from the run rates initially anticipated from progression to the main SMETS2 phase of the smart meter rollout. Gross profit margin for the asset installation business saw a significant reduction as a result to negative 48% in H1. As initial installation targets in the market started to look increasingly challenging, attention was turned to controlling our operating cost base in order to increase efficiency in the labour force. As a result, the gross profit margin improved to negative 6% in H2. Cost control will be a key focus through 2020 and beyond. It remains key that our overall capacity is right sized in order to meet customer demand efficiently. The full year reported gross margin for the asset installation business, whilst negative, thus reflects management's cost control in the latter part of the year.

The energy management gross margin has increased to 24% (2018: 21%), supported by the commencement of a smart heating controls project at slightly higher margins.

EBITDA

Pre-exceptional EBITDA increased to £58.9m (2018: £51.6m) with statutory EBITDA increasing to £50.4m (2018: £35.5m). This demonstrates that, whilst costs have been incurred to create capacity to support future growth, our increase in revenue has been high enough to offset this.

The Group's tactical retention of its internal engineering workforce, the successful setting up of a dedicated contact centre to help drive the business through the smart meter rollout and ongoing development of key IT platforms that underpin the end-to-end service offering, have increased cost of sales and general overheads in 2019 as a result.

Other costs in the year which impacted our underlying profitability include a £0.8m bad debt write off in relation to smaller independent energy suppliers that have ceased trading and been transferred to much larger energy suppliers under the SoLR mechanism. The last two years have seen a large number of independent energy suppliers enter administration, as a result of a failure to settle their financial obligations with Ofgem. This trend is not anticipated to continue to the same extent into 2020 and beyond. We have also incurred £3.8m of bad debt expense arising from individually impaired trade receivable balances with specific customers.

Despite these additional costs, pre-exceptional EBITDA continued to grow as a result of the strength of our index linked, recurring revenue base.

Statutory EBITDA has increased, due to a flow through of the above points together with lower overall operating exceptional costs of £8.5m, as compared with £16.1m in the prior year. These are detailed further below.

Exceptional items

The operating charge to the income statement in respect of exceptional items of £8.5m continues to be largely driven by net losses on our meter portfolio of £6.0m, arising from the removal of traditional meters and a proportion of SMETS1 compliant smart meters.

Technical communication issues for some SMETS1 meters on supplier churn have continued through 2019, with the enrolment and adoption process into the DCC delayed into 2020. As a result, the Group has continued to see a very small proportion of SMETS1 meters removed from the wall. As these removals are attributable to the temporary industry transition period, management has taken the judgement to recognise losses arising on the disposal of these meters as exceptional.

In the prior year, we incurred an exceptional charge of £5.6m in relation to the impairment of the traditional meter portfolio, reflecting a higher volume of removals than anticipated and a reduction in future rental income from the reducing portfolio of meters remaining on the wall. There was no similar impairment charge in 2019.

Of the remaining exceptional cost, £2.0m relates to legal and professional costs incurred in the reported sale process of a minority of the Group's meter assets, detailed further below.

Operational and pre-tax profits

Depreciation costs on general property, plant and equipment, excluding meter assets, have increased by £2.2m to £3.6m (2018: £1.4m). This is largely driven by the decision to purchase the Group's fleet of vans, previously leased on an operating basis. £0.9m of additional depreciation has also been recognised as a result of the implementation of IFRS 16; see note 29 to the financial statements for details.

The BEIS consultation, that proposed a new monitoring framework for the smart meter rollout through to 31 December 2024, was still outstanding at the balance sheet date and, therefore, no change to the useful economic life of the traditional meter portfolio has been made in 2019. Upon ratification of the consultation in 2020, management intends to revise the useful economic life through to 31 December 2024 to align with the market. This will be applied prospectively and will see the annual depreciation charge on the traditional meter portfolio decrease.

The net interest charge is £8.3m (2018: £5.7m), reflecting higher average net debt as a result of the continued investment in assets.

Underlying profit before taxation has decreased by 38% to £15.6m. The Group's overall depreciation charge, largely driven by the meter portfolio, and our largest non-cash cost item, has grown from £21.8m to £35.1m. Together with a flow through of the above points, this has resulted in a drop at the pre-tax level. Management is optimistic that pre-tax profits will start to show an upwards trajectory as the smart meter rollout picks up pace and, in the meantime, uses ILARR, revenue and pre-exceptional EBITDA as the key performance measures of the business.

Taxation

The effective tax rate on statutory profits was 26.81% (2018:16.6%). The increase in the effective rate is driven primarily by an increase in permanent differences from disallowable items, including legal and professional costs incurred in the sale process of a minority of the Group's meter assets.

The Group's capital expenditure as it pertains to meter assets qualifies for capital allowances, providing the Group with tax relief on such expenditure. These allowances are claimed in the tax year in which the asset is acquired and set against taxable profit for that year, thus reducing the total tax payable. As a result, the Group was not tax paying in either the current or prior year.

The Group's deferred tax balance of £13.8m is primarily made up of £11.7m in respect of accelerated capital allowances.

Earnings per share (EPS)

Underlying basic EPS, which excludes exceptional costs, amortisation of intangibles and their associated tax effect is 11.30p (2018: 18.46p), reflecting the underlying profitability of the Group. Statutory earnings per share decreased to 3.56p (2018: 3.97p) as a result of lower statutory profits for the reasons detailed above.

Diluted EPS does not vary significantly from basic EPS; a small decrease is seen as a result of the dilutive impact of shares issuable in the future to settle the Group's share scheme obligations.

Dividend

With regard to the 2019 final dividend, the Board has continued to pursue a progressive dividend policy, aiming to increase the dividend proposed by c.15% on its prior period comparative.

The Directors recommend a final dividend of 4.58p per share (2018: 3.98p), bringing the total dividend payable in respect of the year to 6.88p per share (2018: 5.98p), an increase of 15%.

The total final dividend is expected to total c. £5.2m and, if approved, will be paid on 4 June 2020 to shareholders on the register at 24 April 2020, with an ex-dividend date of 23 April 2020.

Cash flow

The Group generated an operating cash inflow of £42.4m (2018: £40.0m), supported by underlying revenues and good cash collection.

There has been a significant increase in inventory, with the strategic purchasing of SMETS2 meters to ensure SMS can meet forecast installations in the first part of 2020.

Capital expenditure on property, plant and equipment was £101.7m (2018: £132.6m), excluding right-of-use asset additions of £4.9m. Of this, £95.2m has been used to purchase revenue-generating assets. This capital expenditure is lower than the prior year as a result of lower than anticipated installation run rates throughout 2019 as well as a lower unit cost for SMETS2 meters compared to SMETS1.

A further £6.9m investment has been made in intangible assets. This includes development of software to support the installation business, together with investment in a Group-wide Enterprise Resource Planning system that will consolidate, integrate and update various support systems.

A £1.0m cash outflow was made for the acquisition of Solo Energy Limited, a block chain energy flexibility IT platform.

There has been a £97.9m net cash inflow from drawdowns on the loan facility in the year. £9.2m of finance costs have also been paid (2018: £4.8m), including £3.1m of arrangement fees in relation to the new facility.

Financial resources

With further growth anticipated as the UK domestic smart meter rollout continues, SMS has access to sufficient funding to accelerate installation in line with market demand.

On 21 December 2018 a new banking facility was signed, providing the business access to £420m on a fully revolving basis over the next five years. The first drawdown under this new facility was on 3 January 2019, and at that date the Group's obligations under the previous facility were settled.

At 31 December 2019, utilisation of the new facility totalled £269.3m, net of £2.5m arrangements fees which will be amortised over the term of the facility. No principal repayments are required until 2022, providing us with greater flexibility during the current industry transition period.

Net debt was £219.2m at 31 December 2019, £77.2m higher than at 31 December 2018, primarily as a result of increased funds drawn down from the Group's banking facility for the purchase of revenue-generating assets. The Group's available cash and unutilised element of the revolving credit facility stood at £200.8m (2018: £278.0m). The Group had cash in bank of £50.1m at 31 December 2019 (31 December 2018: £30.0m).

Disposal of a minority of the Group's I&C portfolio (the "Disposal")

In respect of the 2019 financial statements, this transaction represents a non-adjusting post-balance sheet event, disclosed further in note 28 to the financial statements. It was deemed that the transaction at 31 December 2019 was not highly probable and, therefore, it did not meet the Held for Sale criteria under IFRS 5 at this date. The effect of the Disposal will be accounted for in our financial statements for the year ended 31 December 2020.

The Disposal, generating gross proceeds of £291m, fully resets the Group's leverage, resulting in a positive net cash position versus net debt to pre-exceptional EBITDA of 3.7x at 31 December 2019. Forming the core of our strategy going forward, the size of proceeds received for the disposed portfolio of c.187,000 I&C meter assets reinforces the inherent value present within our meter assets, with their index-linked long-term cash flows and limited maintenance requirements.

Following the deduction of transaction and other expenses, and subject to completion, the Group expects to receive net cash consideration of £282 million which, together a revised debt facility, significantly enhances our ability to maximise domestic smart meter opportunities and secure additional ILARR. The Disposal is expected to result in a gain on disposal of £193m, which will be classified as an exceptional item in the Group's financial statements.

It is intended that the proceeds from the Disposal will be used, in part, to settle our existing loan facility and an amended £300m revolving credit facility will be established on the same terms. This provides significant headroom to manage the business going forward on a low leveraged basis and the Group will have several funding options, providing flexibility to maximise growth in a capital efficient way.

The Disposal also enables us to announce an intended new enhanced dividend strategy of 25p per share, increasing at least with RPI through to 2024. This revised dividend policy seeks to provide SMS shareholders with a long-term and secure dividend pay-out, underpinned by the Group's highly sustainable, annuity-style cash flows.

A key feature of the Disposal is that we will continue to manage the portfolio of disposed assets for the new owners, generating annual RPI-linked recurring management fees of £0.8m for these services. We will still apply our knowledge and expertise in relation to managing the portfolio as we do for other third-party meter owners.

Definitions of alternative performance measures

1. Exceptional items are those material items of income and expense which, because of the nature or expected infrequency of the events giving rise to them, merit separate presentation on the consolidated income statement.

Consolidated income statement

For the year ended 31 December 2019

1 Refer to note 3 for details of exceptional items.

The profit from operations arises from the Group's continuing operations.

Earnings per share attributable to owners of the parent during the year:

Consolidated statement of comprehensive income

For the year ended 31 December 2019

1 May be reclassified to profit or loss

Consolidated statement of financial position

As at 31 December 2019

Consolidated statement of changes in equity

For the year ended 31 December 2019

See notes 23 and 24 for details of the own share reserve and other reserve.

Consolidated statement of cash flows

For the year ended 31 December 2019

1 Non-cash exceptional items include a £6,837,000 loss on disposal on our meter portfolio, £68,000 cost relating to deferred remuneration arising on the acquisition of a subsidiary in 2016 settled in shares in April 2019, £751,000 stock write-back for returned SMETS1 meters, £93,000 acceleration of loan arrangement fees in relation to the refinancing of the loan facility and £79,000 for non-recurring impairment charges.

In 2018, non-cash exceptional items included a £7,040,000 loss on disposal on our meter portfolio, £5,612,000 impairment on our meter portfolio, £1,653,000 traditional meters stock write down, £720,000 relating to deferred remuneration arising from the acquisition of a subsidiary in 2016 to be settled in shares, £43,000 for impairment of an investment and £358,000 acceleration of loan arrangement fees in relation to the refinancing of the loan facility.

Accounting policies

This note provides a list of the significant accounting policies adopted in the preparation of these consolidated financial statements. These policies have been consistently applied to all the years presented, unless otherwise stated. The consolidated financial statements of the Group for the year ended 31 December 2019 were approved and authorised for issue in accordance with a resolution of the Directors on 17 March 2020. Smart Metering Systems plc is a public limited company limited by shares and incorporated in Scotland, with its registered office at 2nd Floor, 48 St. Vincent Street, Glasgow G2 5TS. The Company's ordinary shares are traded on AIM.

Basis of preparation

The consolidated financial statements have been prepared in accordance with EU-endorsed International Financial Reporting Standards (IFRSs), IFRIC interpretations and the Companies Act 2006 applicable to companies reporting under IFRSs.

The financial statements have been prepared on a historical cost basis, modified by the revaluation of certain financial assets and financial liabilities that have been measured at fair value.

The consolidated financial statements are presented in British Pounds Sterling (£), which is Smart Metering System plc's functional and presentation currency, and all values are rounded to the nearest thousand (£'000) except where otherwise indicated.

The financial information set out above does not constitute the Company's statutory accounts for the years ended 31 December 2019 or 2018 but is derived from those accounts. Statutory accounts for the year ended 31 December 2018 have been delivered to the Registrar of companies and those for 2019 will be delivered in due course. The auditor has reported on both sets of accounts; its reports were unqualified, did not contain an emphasis of matter reference and did not contain statements under section 498 (2) or (3) of the Companies Act 2006.

Going concern

Management prepares budgets and forecasts on a five-year forward-looking basis. These forecasts cover operational cash flows and investment capital expenditure and are prepared based on management's estimation of installation run rates through the UK smart meter rollout.

On 21 December 2018 a new banking facility was signed, providing the business access to £420m over the next five years. The first drawdown under this new facility was on 3 January 2019, at which point the Group's obligations under the previous £280m facility of £172m were settled. These transactions were settled concurrently on a net cash basis.

Net debt amounted to £219.2m at 31 December 2019 and, at that date, undrawn facilities were £150m. The Group balance sheet shows consolidated net assets of £223.6m (2018: £226.1m) of which £398.7m (2018: £350.4m) relates to meter assets.

Based on the above, the Directors consider it appropriate to continue to prepare the financial statements on a going concern basis.

Basis of consolidation

The consolidated accounts of the Group include the assets, liabilities and results of the Company and subsidiary undertakings in which Smart Metering Systems plc (SMS) has a controlling interest. Control is achieved when the Group is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Specifically, the Group controls an investee if, and only if, the Group has all of the following: power over the investee (i.e. existing rights that give it the current ability to direct the relevant activities of the investee); exposure, or rights, to variable returns from its involvement with the investee; and the ability to use its power over the investee to affect its returns.

The acquisition method of accounting is used to account for business combinations by the Group (refer to note 19).

When necessary, adjustments are made to the financial statements of subsidiaries to bring their accounting policies into line with the Group's accounting policies.

All intra-group assets and liabilities, equity, income, expenses and cash flows relating to transactions between members of the Group are eliminated in full on consolidation.

Foreign currency translation

Group companies

The results and financial position of foreign operations (none of which has the currency of a hyperinflationary economy) that have a functional currency different from the presentation currency are translated into the presentation currency as follows:

• assets and liabilities for each balance sheet presented are translated at the closing historical rate at the date of that balance sheet;

• non-monetary assets at the date of acquisition are translated at the historical rate and are not subsequently revalued;

• income and expenses for each statement of profit or loss and statement of comprehensive income are translated at average exchange rates (unless this is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions); and

• all resulting exchange differences are recognised in other comprehensive income and accumulated in a separate reserve within equity.

Goodwill and fair value adjustments arising on the acquisition of a foreign operation are treated as assets and liabilities of the foreign operation and translated at the closing rate.

Transactions and balances

Foreign currency transactions are translated into the functional currency using the exchange rates at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions, and from the translation of monetary assets and liabilities denominated in foreign currencies at year-end exchange rates, are generally recognised in profit or loss. They are deferred in equity if they relate to qualifying cash flow hedges and qualifying net investment hedges or are attributable to part of the net investment in a foreign operation.

Foreign exchange gains and losses that relate to borrowings are presented in the statement of profit or loss, within finance costs. All other foreign exchange gains and losses are presented in the statement of profit or loss on a net basis within administrative expenses.

Use of estimates and judgements

The Directors are required to make judgements, estimates and assumptions about the carrying amount of assets and liabilities that are not readily apparent from other sources. These estimates and associated assumptions are based on historical experience and other factors that are considered to be relevant. Actual results may differ from these estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods.

Critical accounting judgements

The following are the critical judgements that the Directors have made in the process of applying the Group's accounting policies and that have the most significant effect on the amounts recognised in the financial statements:

• capitalisation of internal installation costs:

· a significant level of in-house installation of customers' meter assets is carried out by the Group, certain costs of which are capitalised (£39.7m in 2019) and depreciated as part of property, plant and equipment depreciation. Judgement is required by management to ascertain the appropriate categories and proportion of overheads and other expenses that are directly attributable to installation of meter assets. Typically, capitalised costs will include staff costs, and a systematic allocation of any production overheads, deemed to be directly attributable to the process of installing a meter owned by the Group. Other general and administrative overheads, such as sales, marketing and training costs, are expensed directly to profit and loss; and

• presentation of losses on disposal of certain meter assets as exceptional items:

· as a result of the inherent volatility associated with the smart meter rollout, and removal of traditional meter assets as part of this, management has taken the decision to show losses arising on disposal of these meters, being the net book value less the associated termination income received representing proceeds on disposal, as exceptional administrative expenses. By disclosing these amounts separately, the traditional meter asset portfolio can be better tracked to assist the users of the financial statements. A loss on disposal of traditional meter assets has been recognised as an exceptional cost in the year ended 31 December 2019. The change in accounting policy to reduce the residual value of the traditional meter asset portfolio to nil (see note 10 for further details) was designed to reflect the consumption of economic benefit from installed assets, being the income earned from the provision of the meter. On disposal, the receipt of termination income, recognised as a component of the net gain or loss on the disposal of these meter assets, will vary depending on the energy supplier and is therefore not within our control. As the receipt of proceeds from disposal is inherently volatile, a loss on disposal can still arise in certain circumstances.

· technical communication issues for some first-generation smart meter assets (SMETS1 meters) on supplier churn have continued through 2019, with the enrolment and adoption process into the DCC delayed into 2020. As a result, the Group has continued to see a very small proportion of SMETS1 meters removed from the wall. As these removals are attributable to the temporary industry transition period, management has taken the judgement to recognise losses arising on the disposal of these meters as exceptional.

Key sources of estimation uncertainty

The key assumptions concerning the future and other key sources of estimation uncertainty at the reporting date that may have a significant risk of causing material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below:

• recoverability of carrying value of meter assets portfolio:

· as the smart meter rollout progresses, our portfolio of traditional meter assets is diminishing. It is therefore crucial that the recoverability of the carrying value of our meter assets, recognised in property, plant and equipment, be assessed. The two main drivers for assessing this recoverability are:

1) the timing of the removals of these meters given this decision lies with the end consumer and removals are largely undertaken by third parties. We thus have little control over the timing and quantity of these removals; and

2) the estimated future cash flows from termination income, which are derived using historical data and analysis around the risk of churn between contracted and non-contracted customers. This assessment includes consideration of the extent to which termination income and future rental income are received as traditional meters continue to be removed from the wall.

In 2019, this assessment has identified that the carrying value of the traditional meter assets portfolio is recoverable and, therefore, no impairment charge has been recognised. The carrying value of the traditional meter assets portfolio at 1 January 2019 included an impairment charge of £5.6m, which was recognised in 2018 as an exceptional cost of sales in line with our accounting policy (refer to details in note 10).

Revenue recognition

Refer to details in note 2.

Exceptional items and separately disclosed items

The Group presents as exceptional items on the face of the consolidated statement of comprehensive income those items of income and expense which, because of the material nature or expected infrequency of the events giving rise to them, merit separate presentation to allow shareholders to understand better the elements of financial performance in that year, so as to facilitate comparison with prior periods and to assess better trends in financial performance.

Termination fee income is reported as part of "Other operating income" on the consolidated statement of comprehensive income given the materiality and nature. Any termination fee income arising on the loss of meter assets is reported within administrative expenses as a component of net gain or loss on disposal. Termination fee income does not arise from the principal activities of the Group. Any such gain or loss on disposal relating to traditional meter assets and SMETS1 meter assets is disclosed as an exceptional item.

Financial assets

The Group's financial assets include cash and cash equivalents and trade and other receivables. Investments consist of an immaterial debt investment held at amortised cost.

Classification

The Group classifies its financial assets in the following measurement categories:

• those to be measured subsequently at fair value, either through other comprehensive income (FVOCI) or through profit or loss (FVPL); and

• those to be measured at amortised cost.

The classification depends on the Group's business model for managing the financial assets and the contractual terms of the cash flows.

For investments in equity instruments that are not held for trading, this will depend on whether the Group has made an irrevocable election at the time of initial recognition to account for the equity investment at FVOCI. The Group reclassifies debt investments when and only when its business model for managing those assets changes.

Recognition and derecognition

Financial assets are initially recognised on trade date. Financial assets are derecognised when the rights to receive cash flows from the financial assets have expired or have been transferred and the Group has transferred substantially all the risks and rewards of ownership.

Measurement

At initial recognition, the Group measures a financial asset at its fair value plus, in the case of a financial asset not at FVPL, transaction costs that are directly attributable to the acquisition of the financial asset. Transaction costs of financial assets carried at FVPL are expensed in profit or loss.

Trade and other receivables

Trade and other receivables are recognised initially at fair value and subsequently measured at amortised cost. They are generally due for settlement within 30 days and are therefore all classified as current. Due to their short-term nature, carrying value is considered to approximate fair value.

Cash and cash equivalents

Refer to accounting policy.

Impairment

The Group assesses, on a forward-looking basis, the expected credit losses associated with its debt instruments carried at amortised cost and FVOCI. The impairment methodology applied depends on whether there has been a significant increase in credit risk. For trade receivables and accrued income, which include contract assets and billed and unbilled receivables arising from contracts with customers, the Group applies the simplified approach permitted by IFRS 9, which requires expected lifetime losses to be recognised from initial recognition of the receivables.

Trade receivables and accrued income are written off, and derecognised, where there is no reasonable expectation of recovery. Indicators that there is no reasonable expectation of recovery include, amongst others, the customer ceasing trading and entering administration with no expected recovery from the Supplier of Last Resort process, or a failure by the customer to make contractual payments for a period of greater than or equal to 365 days past due. Indicators are assessed on an individual customer basis.

Impairment losses, including the loss allowance, on trade receivables and contract assets are presented within administrative expenses. Impairment losses on accrued termination income are presented within other operating income. Subsequent recoveries of amounts previously written off are credited against the same line item.

Further information about the impairment of trade receivables and accrued income, and the Group's exposure to credit risks, can be found in note 18.

Financial liabilities

The Group's financial liabilities include trade and other payables, bank loans and overdrafts.

Classification

Financial liabilities are classified as financial liabilities at fair value through profit or loss or loans and borrowings, as appropriate. The Group determines the classification of its financial liabilities at initial recognition.

Recognition

All financial liabilities are recognised initially at fair value and, in the case of bank loans, net of directly attributable transaction costs.

Measurement

Trade and other payables and bank overdrafts

Trade and other payables, and overdrafts, are subsequently measured at amortised cost using the effective interest rate method.

Trade and other payables are presented as current liabilities unless payment is not due within twelve months after the reporting period. Due to their short-term nature, carrying value is considered to approximate fair value.

Bank loans

Bank loans are subsequently measured at amortised cost. Interest expense on bank loans is recognised in the consolidated income statement using the effective interest rate method.

Transaction costs on revolving credit facilities are recognised as transaction costs of the loan to the extent that it is probable that some or all the facility will be drawn down. In this case, the fee is deferred within other assets until the drawdown occurs. Upon drawdown of the first loan, these costs are reclassified from other assets to bank loans and subsequently amortised over the term of the facility.

Borrowings are removed from the balance sheet when the obligation specified in the contract is discharged or cancelled or has expired. The difference between the carrying amount of a financial liability that has been extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred, or liabilities assumed, is recognised in profit or loss as other income or finance costs.

If a facility is modified, then it is assessed whether the modification is significant enough to constitute an extinguishment either qualitatively or quantitatively, where the change in present value of cash flows, including any transaction costs paid, exceeds 10%. If a modification is considered an extinguishment of the initial loan, the new modified loan is recorded at fair value and a gain/loss recognised immediately in the consolidated income statement for the difference between the carrying amount of the old loan and the new loan. Where a modification is not significant enough to be an extinguishment, the cash flows under the modified loan are rediscounted at the original effective interest rate and an immediate gain or loss is recognised accordingly in the consolidated income statement on the date of modification.

Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least twelve months after the reporting period.

Offsetting of financial instruments

Financial assets and financial liabilities are offset, and the net amount reported in the consolidated statement of financial position, if, and only if, there is a currently enforceable legal right to offset the recognised amounts and there is an intention to settle on a net basis, or to realise the assets and settle the liabilities simultaneously.

Research and development

Expenditure on pure and applied research activities is recognised in the consolidated statement of comprehensive income as an expense as incurred.

Expenditure on product and system development activities is capitalised if the product or process is technically and commercially feasible and the Group intends and has the technical ability and sufficient resources to complete development; if future economic benefits are probable; and if the Group can measure reliably the expenditure attributable to the intangible asset during its development. The expenditure capitalised includes the cost of materials, direct labour and an appropriate proportion of overheads.

Capitalised development expenditure is stated at cost less accumulated amortisation and accumulated impairment losses.

Amortisation is calculated when the asset is available for use, so as to write off its cost, less its estimated residual value, over the useful economic life of that asset as follows:

Capitalised development expenditure on ADMTM units is disclosed within property, plant and equipment as part of meter assets and amortised over the same useful economic life as that applied to the tangible ADMTM unit.

Capitalised IT development expenditure is disclosed within intangible assets as part of IT development and software. Development and software were previously disclosed separately but have been combined into a single asset class for the year ended 31 December 2019 as all costs capitalised within these categories relate to information technology and, with effect from 1 January 2019, are amortised over the same useful economic life of five years.

Intangible assets

Intangible assets acquired separately from third parties consist of software costs, including licence fees. These are recognised as assets, measured at cost and classified as part of IT development and software.

Internally generated intangible assets relate to IT development and are recognised as part of IT development and software. Refer to further details in the research and development accounting policy above.

Intangible assets acquired as part of a business combination are recognised outside goodwill if the asset is separable or arises from contractual or other legal rights. They are recognised at their fair value at the date of acquisition and are subsequently amortised on a straight line based on the timing of projected cash flows of the contracts over their estimated useful lives.

Following initial recognition, intangible assets are measured at cost at the date of acquisition less any amortisation and any impairment losses. Amortisation costs are included within the administrative expenses disclosed in the consolidated statement of comprehensive income.

Intangible assets are amortised over their useful lives as follows:

Useful lives are examined on an annual basis and adjustments, where applicable, are made on a prospective basis.

Goodwill

Goodwill represents the excess of the consideration transferred over the fair value of the identifiable assets and liabilities of the acquiree at the date of acquisition. Goodwill on acquisitions of subsidiaries is included in intangible assets. Goodwill is not amortised but is tested annually for impairment and is carried at cost less accumulated impairment losses. See note 12 for detailed assumptions and methodology. Impairment losses are not subsequently reversed.

Goodwill is allocated to cash-generating units (CGUs) for the purpose of impairment testing. The allocation is made to those cash-generating units or groups of cash-generating units that are expected to benefit from the business combination in which the goodwill arose. The units or groups of units are identified at the lowest level at which goodwill is monitored for internal management purposes, being the operating segments.

Contingent consideration is recorded initially at fair value and classified as equity or a financial liability. Contingent consideration classified as equity is not remeasured, but contingent consideration classified as a financial liability is subsequently remeasured at fair value through profit or loss.

Adjustments to provisional fair values of identifiable assets and liabilities (and to estimates of contingent consideration) arising from additional information, obtained within the measurement period (no more than one year from the acquisition date), about facts and circumstances existing at the acquisition date are adjusted against goodwill. Other adjustments to provisional fair values or changes in contingent consideration are recognised through profit or loss.

Impairment

At each reporting date, the Group reviews the carrying amounts of its property, plant and equipment and intangibles, including goodwill, to determine whether there is any indication that those assets have suffered an impairment loss. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss (if any). Where the asset does not generate cash flows that are independent from other assets, the Group estimates the recoverable amount of the CGU to which the asset belongs.

The recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a discount rate that reflects current market assessments of the time value of money and the risks specific to the asset for which the estimates of future cash flows have been adjusted.

If the recoverable amount of an asset (or CGU) is estimated to be less than its carrying amount, the carrying amount of the asset (or CGU) is reduced to its recoverable amount. An impairment loss is recognised as an expense immediately.

Where an impairment loss subsequently reverses, the carrying amount of the asset (or CGU) is increased to the revised estimate of its recoverable amount, but so that the increased carrying amount does not exceed the carrying amount that would have been determined had no impairment loss been recognised for the asset (or CGU) in prior years. A reversal of an impairment loss is recognised as income immediately.

Detailed assumptions used in the annual impairment test for goodwill, with regard to discount, growth and inflation rates, are set out in note 12 to the accounts. Detailed assumptions used in the impairment test for meter assets, namely traditional meter assets, are set out in note 10.

Property, plant and equipment

Property, plant and equipment is stated at cost, net of accumulated depreciation and any accumulated impairment losses. Such cost includes the cost of replacing part of the property, plant and equipment. When significant parts of property, plant and equipment are required to be replaced in intervals, the Group recognises such parts as individual assets with specific useful lives and depreciation, respectively. Pursuant to the acquisition of the meter installation businesses on 18 March 2016 certain internal costs to the Group are also capitalised where they are demonstrated as being directly attributable to bringing the meter assets into their usable condition.

All other repair and maintenance costs are recognised in the consolidated statement of comprehensive income as incurred.

For each asset depreciation is calculated using the straight line method to allocate its cost, net of its residual value if applicable, over its estimated useful life as follows:

An item of property, plant and equipment and any significant part initially recognised is derecognised upon disposal or when no future economic benefits are expected from its use or disposal. Any gain or loss arising on derecognition of the asset (calculated as the difference between the net disposal proceeds and the carrying amount of the asset) is included in the consolidated statement of comprehensive income when the asset is derecognised. The asset's residual values, useful lives and methods of depreciation are reviewed at each financial year end and adjusted prospectively, if appropriate.

Property, plant and equipment is initially recorded at cost.

The following changes in estimates with regard to property, plant and equipment were made with effect from 1 January 2019:

• Subsequent to the impairment review carried out at 31 December 2018, the estimate of residual value on the domestic traditional meter asset portfolio has been reduced to 0% to reflect management's updated forecasts and assumptions regarding the recoverability of value on these assets. As a result, the income statement has been charged with an additional £7.3m, recognised within depreciation in cost of sales.

The following changes in estimates with regards to property, plant and equipment were made with effect from 1 January 2018:

• A review concluded that there should be a change to the I&C electric estimate of useful life from 15 years to 20 years on the basis that these meters are no longer subject to a certification period and fall under the same considerations as smart meters. The impact on the financial statements for the year to 31 December 2018 was a decrease to the depreciation charge in the consolidated income statement and statement of comprehensive income of £266,000.

• The I&C gas portfolio saw the estimate of residual value reduce to 0% to reflect revised customer terms in new customer contracts. As a result, the income statement for the year to 31 December 2018 was charged with an additional £340,000 recognised within depreciation in cost of sales.

• With respect to the domestic traditional meter asset portfolio, the useful life of all opening assets was extended to 5 years to reflect the fact that the expected end date for the domestic smart meter rollout is likely to be at the end of 2022. It is accepted that the rate of meter exchange to smart meters will vary year by year as the rollout proceeds but there is currently no reliable basis on which to predict the annual profile. Accordingly, a straight line approach to depreciation of these assets continues to be adopted. The impact on the financial statements for the year to 31 December 2018 was a decrease to the depreciation charge in the consolidated income statement and statement of comprehensive income of £2.9m.

See note 29 for further details on the recognition and measurement of right-of-use assets under IFRS 16.

Inventories

Inventories are stated at the lower of cost and net realisable value. Cost comprises direct materials and purchases of meter assets at cost. Net realisable value represents the estimated selling price for inventories less all estimated costs of completion and costs to be incurred in marketing, selling and distribution.

Cash and cash equivalents

Cash and cash equivalents in the consolidated statement of financial position comprises cash at bank and in hand and short-term deposits with an original maturity of three months or less. For the purpose of the consolidated statement of cash flows, cash and cash equivalents consists of cash and short-term deposits as defined above, net of outstanding bank overdrafts.

Leased assets and obligations as lessee

With effect from 1 January 2019

As of 1 January 2019, SMS adopted IFRS 16 Leases. Refer to details in note 29.

Up to 31 December 2018

Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases. Assets acquired under finance leases are capitalised in the balance sheet at their fair value or, if lower, at the present value of the minimum lease payments, each determined at the inception of the lease. The corresponding liability to the lessor is recorded in the balance sheet as a finance lease obligation. The lease payments are apportioned between finance charges to the income statement and a reduction of the lease obligations.

Rental payments under operating leases are charged to the income statement on a straight line basis over the applicable lease periods.

Group as lessor

With effect from 1 January 2019

As of 1 January 2019, SMS adopted IFRS 16 Leases. Refer to details in note 29.

Up to 31 December 2018

Leases in which the Group does not transfer substantially all the risks and rewards of ownership of assets are classified as operating leases with meter income recognised in line with the meter rental income policy.

Pension costs

The Group operates a defined contribution pension scheme for employees. The assets of the scheme are held separately from those of the Group. The annual contributions payable are charged to the consolidated statement of comprehensive income.

Share-based payments

IFRS 2 Share-based Payment has been applied to all grants of equity instruments. The Group issues equity-settled share-based payments to certain employees under the terms of the Group's various employee share and option schemes. Equity-settled share-based payments are measured at fair value at the date of the grant. The fair value determined at the grant date of equity-settled share-based payments is expensed on a straight line basis over the vesting period, based on an estimate of the shares that will ultimately vest.

Share capital

Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of new ordinary shares or options are shown in equity as a deduction from the proceeds.

Own share reserve

The Group offers a Share Incentive Plan for all employees and has established a trust to facilitate the delivery of SMS shares under this plan. The holdings of this trust include shares that have not vested unconditionally to employees of the Group. These shares are recorded at cost and are classified as own shares. The cost to the Company of acquiring these own shares held in trust is shown as a deduction from shareholders' equity.

Dividends

Dividend distributions to the Company's shareholders are recognised in the accounting period in which the dividends are paid.

Taxation 

Tax currently payable is based on the taxable profit for the year and any adjustment to tax payable in respect of prior years. Taxable profit differs from accounting profit as reported in the consolidated statement of comprehensive income because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible. The Group's liability for current tax is measured using tax rates that have been enacted or substantively enacted by the reporting date.

Deferred tax is the tax expected to be payable or recoverable on temporary differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax bases used in the computation of taxable profit and is accounted for using the balance sheet liability method. Deferred tax is recognised in respect of all temporary differences that have originated but not reversed at the balance sheet date, where transactions or events that result in an obligation to pay more tax in the future or a right to pay less tax in the future have occurred at the balance sheet date.

Deferred tax is measured at the tax rates that are expected to apply in the periods in which the asset or liability is settled based on tax rates (and tax laws) that have been enacted or substantively enacted at the balance sheet date. It is recognised in the income statement except when it relates to items recognised in other comprehensive income or directly in equity, such as share-based payments. In this case, the deferred tax is also recognised in other comprehensive income or directly in equity, respectively.

Deferred tax assets are recognised to the extent that it is probable that future taxable profit will be available against which the temporary difference can be utilised. Their carrying amount is reviewed at each balance sheet date on the same basis.

Deferred tax liabilities are recognised for all temporary differences, except in respect of:

• temporary differences arising from the initial recognition of goodwill or an asset or liability in a transaction that is not a business combination and at the time of the transaction affects neither the accounting profit nor taxable profit or loss; and

• temporary differences associated with investments in subsidiaries where the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future.

Deferred tax assets and liabilities are offset where there is a legally enforceable right to offset current tax assets and liabilities and where the deferred tax balances relate to the same taxation authority. Current tax assets and tax liabilities are offset where the entity has a legally enforceable right to offset and intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

Standards and interpretations

New and amended standards adopted by the Group

The Group has applied the following standards and amendments for the first time for their annual reporting period commencing 1 January 2019:

The Group had to change its accounting policies as a result of adopting IFRS 16. See further details in note 29. The other amendments listed above did not have any impact on the amounts recognised in prior periods and the current period and are not expected to significantly affect future periods. The Group does not currently have any material uncertain tax positions.

The following new accounting standards and interpretations have been published that are not mandatory for 31 December 2019 reporting periods and have not been early adopted by the Group. These standards are not expected to have a material impact on the entity in the current or future reporting periods and on foreseeable future transactions:

Notes to the financial statements

For the year ended 31 December 2019

1 Segmental reporting

For management purposes, the Group is organised into three core divisions, as follows:

• asset management, which comprises regulated management of gas meters, electric meters and ADM™ units within the UK;

• asset installation, which comprises installation of domestic and I&C gas meters and electricity meters throughout the UK; and

• energy management, which comprises the provision of energy consultancy services and, following the acquisition of Solo Energy Limited, the management of Distributed Energy Resources (DER) assets.

The Group's chief operating decision maker (CODM), being the SMS plc Board, receives certain management information at a granular "utility" level. Asset management includes reporting on gas meter rental, electricity meter rental, gas data and electricity data. Asset installation includes reporting on gas transactional work and electricity transactional work. However, whilst the Group has the ability to analyse its underlying information in this way, this information is only used to assess performance for the Group as a whole. These utility levels are thus combined within asset management and asset installation, respectively, on the basis that they have similar long-term economic characteristics - they derive from the same asset, use similar delivery processes, have consistent customers and have similar long-term gross margins.

For the purpose of making decisions about resource allocation and performance assessment, it is the operating results of the three core divisions listed above that are monitored by management and the CODM. It is these divisions, therefore, that are defined as the Group's reportable operating segments.

Segment performance is evaluated based on gross profit.

The following segment information is presented in respect of the Group's reportable segments together with additional balance sheet information:

Inter-segment revenue relates to installation services provided by the asset installation segment to the asset management segment.

Depreciation of £31.5m (2018: £20.4m) associated with meter assets has been reported within cost of sales, in the asset management segment, as the meter assets directly drive revenue.

All revenues and operations are based and generated in the UK.

The Group has one major customer that generated turnover within each segment as listed below:

Segment assets and liabilities

Assets not by segment include cash and cash equivalents, trade and other receivables and investments. In 2018, assets not by segment included cash and cash equivalents, trade and other receivables, other assets and investments.

Liabilities not by segment include trade and other payables and deferred tax liabilities. In 2018, liabilities not by segment included trade and other payables, other liabilities and deferred tax liabilities.

Additions to non-current assets within each segment are listed below:

2 Revenue from contracts with customers

2 (a) Disaggregation of revenue from contracts with customers

The Group reports the following segments: asset management, asset installation and energy management, in accordance with IFRS 8 Operating Segments. We have determined that, to meet the objective of the disaggregation disclosure requirement in paragraph 114 of IFRS 15, which is to disaggregate revenue from contracts with customers into categories that depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors, further disaggregation is required into the major types of services offered. The following table thus discloses segmental revenue by type of service delivered and timing of revenue recognition, including a reconciliation of how this disaggregated revenue ties in with the asset management, asset installation and energy management segments, in accordance with paragraph 115 of IFRS 15.

1 The "Metering" service line within asset management includes operating lease rental income recognised under IAS 17. Approximately 86% of the revenue recognised of £58,507,000 in 2018 relates to operating lease income. See note 29 for further details on the Group's lessor accounting under IFRS 16, effective 1 January 2019.

2 (b) Assets and liabilities related to contracts with customers

The Group has recognised the following assets and liabilities related to contracts with customers:

Trade receivables and unbilled receivables are disclosed in note 14.

(i) Significant changes in contract assets and liabilities

Contract assets and contract liabilities have not changed significantly and movements reflect the general timing of revenue recognition and status of services in progress at the end of the year.

(ii) Revenue recognised in relation to contract liabilities

The following table shows how much of the revenue recognised in the current period relates to carried-forward contract liabilities:

No revenue was recognised in 2019 in relation to performance obligations satisfied in previous periods.

(iii) Transaction price for which performance obligations not satisfied

All our utilities connections and energy management contracts are either for periods of one year or less or are billed periodically based on time and resources incurred, or other unit measures. As permitted under IFRS 15, the transaction price allocated to these performance obligations unsatisfied at the end of the reporting period is not disclosed.

2 (c) Accounting policies and significant judgements

(i) Metering

Meter rental

The Group acts as a gas and electricity meter asset provider, providing and installing meters to energy suppliers on behalf of the end consumer.

With effect from 1 January 2019

As a result of the Group's assessment of contracts on implementation of IFRS 16, and any potential interaction with IFRS 15, the arrangements the Group has in place to act as meter asset provider were reconsidered and it was determined that the contract does not constitute a lease of the meter asset to the energy supplier. See note 29 for further details. With effect from 1 January 2019, therefore, the related income for the service of providing a fitted meter is recognised in accordance with IFRS 15.

The provision of meter assets to energy suppliers (MAP services), together with the initial installation, is considered a distinct and single performance obligation on the basis that, as Meter Asset Provider (MAP), the Group has an obligation to its customers to provide a fitted meter. This is a separately identifiable service to which a stand-alone selling price is typically allocated. Over the course of the contract term, which runs into perpetuity, the Group delivers a series of monthly services for which benefits are simultaneously received and consumed by the customer.

MAP charges are calculated daily based on the number of installed meters and invoiced to customers monthly once validation checks have been completed. As revenue from MAP charges is attributed to services provided daily, revenue is always based on the actual level of service provided and, therefore, any uncertainty at the end of each reporting period is limited to the extent that validation checks are still being completed. Revenue is thus recognised over time based on our right to invoice and includes contract RPI uplifts.

As a result of industry regulations, and subject to specific contract terms with a customer, the Group may be required to make payments to customers for shortfalls in the level of service provided. These charges are directly related to the service being provided to the customer and thus recognised as a reduction to revenue in the month in which the service failure occurred. Where service levels are set based on annual targets, charges are estimated monthly and subsequently finalised at the end of the year. Uncertainty, as it pertains to these payments to customers, is thus typically resolved by the end of the reporting period.

If a MAP contract is cancelled, termination fees may be levied on the energy supplier. There has been no change in the accounting of these termination fees and they continue to be classified within other operating income unless they have arisen on the loss of the meter assets, in which case they are reported within administrative expenses as a component of net gain or loss on disposal.

If the services rendered by the Group exceed the payment received, then accrued income is recognised. This is subsequently reclassified to receivables at the point at which the Group has an unconditional right to payment.

Up to 31 December 2018

The provision of the meter asset is accounted for as an operating lease under IAS 17 on the basis that the energy suppliers have control of the data being collected from the meter over the duration of the contract. Meter rentals receivable from energy suppliers are accounted for as operating lease payments and recognised as rental income under IAS 17. This income is calculated daily, based on the number of meter assets, and invoiced to customers monthly. Rental contracts do not operate on a fixed-term basis and are cancellable at any time by the lessee.

The installation of the meter is considered integral to the use of the underlying asset and therefore is accounted for as part of the lease of the meter. Consideration for installation is recognised as part of the total consideration earned from meter rentals.

If a rental contract is cancelled termination payments may be levied on the energy supplier. In line with the underlying contractual terms, termination fees due are recognised at fair value upon notification of de-appointment and are classified as other operating income unless the fees have arisen on the loss of meter assets, in which case they are reported within administrative expenses as a component of net gain or loss on disposal.

If the services rendered by the Group exceed the payment received, then accrued income is recognised. This is subsequently reclassified to receivables at the point at which the Group has an unconditional right to payment.

Asset management services

The Group provides meter asset management and operations services to energy suppliers. These services are considered a distinct performance obligation from the meter rental on the basis that these are separately identifiable services to which a stand-alone selling price is allocated, and they are not necessary to bring the meter asset into use.

Over the course of the contract term, which can either be fixed or into perpetuity, the Group delivers a series of monthly services for which the benefits are simultaneously received and consumed by a customer. Therefore, these are accounted for as a single performance obligation.

Service charges are calculated daily based on the number of meters appointed and invoiced to customers monthly. As revenue from service charges is attributed to services provided daily, revenue is always based on the actual level of service provided and, therefore, there is no uncertainty at the end of each reporting period. Revenue is thus recognised over time based on our right to invoice and includes contract RPI uplifts.

The Group's meter asset management contracts also include the provision of transactional meter works. These are considered further in accounting policy (iv) below.

If the services rendered by the Group exceed the payment received, then a contract asset is recognised. This is subsequently reclassified to receivables at the point at which the Group has an unconditional right to payment.

(ii) Data services

The Group provides data collection and aggregation services to I&C electricity customers and, through use of the ADMTM unit, to I&C gas customers. Over the course of the contract term, which can either be fixed or into perpetuity, the Group delivers a series of monthly services for which the benefits are simultaneously received and consumed by a customer. Therefore, these are accounted for as a single performance obligation.

Service charges are calculated based on the number of meters/ADMTM units appointed and invoiced to customers monthly. As revenue from service charges is attributed to services provided periodically, revenue is always based on the actual level of service provided and, therefore, there is no uncertainty at the end of each reporting period. Service charges, including contract RPI uplifts, are billed to clients annually in advance and therefore a contract liability is recognised and subsequently released to the income statement over the year on a straight line basis. The Group uses the practical expedient under IFRS 15 from adjusting revenue for any significant financial components of one year or less.

The ADMTM device is a proprietary product for the Group and there are no other market providers of this device. A customer cannot therefore benefit from the data services without installation, and the installation is not separately identifiable as it is integral to the subsequent data services. This is therefore accounted for along with the data services as a single performance obligation and any corresponding charges are recognised over the term of the contract.

(iii) Utility connections services (gas and electricity)

Gas and electricity connections services are provided under fixed-price contracts with I&C customers and can be delivered to a single site or multiple sites. Whilst each service consists of multiple activities, the Group's promise in the contract is to deliver an integrated end-to-end service to which the underlying activities are inputs. Where services are delivered to multiple sites, and these are substantially the same, a series of services is being provided. In all cases, therefore, these contracts give rise to a single performance obligation to which the fixed price is allocated. Subsequent variations to this price, due to changes in the inputs required, are accounted for as contract modifications and recognised on a cumulative catch-up basis.

Services are transferred over time on the basis that these are customised services with no alternative use and the Group has an enforceable right to payment for work completed to date.

Revenue is recognised on the stage of completion with reference to the actual services provided as a proportion of the total service expected to be provided under the contract as the services can enhance a work in progress asset for the customer and have no alternative use. This is determined on a contract by contract basis using a milestone approach with reference to the milestones set out in the contract or otherwise agreed. Where relevant, consideration is also given to material services provided between milestones. Estimates of revenues, costs or extent of progress towards completion are revised if circumstances change and any resulting increases or decreases in estimated revenues or costs are reflected in profit or loss in the period in which the circumstances that give rise to the revision become known by management.

The customer pays the fixed amount based on a payment schedule. In certain circumstances the customer pays in advance and therefore a contract liability is recognised and subsequently released to the income statement based on the measure of progress detailed above. As the contract is cancellable at the customer's discretion, subject to settlement for services provided to the date of cancellation, a contract liability is not recognised until the cash has been received.

If the services rendered by the Group exceed the payment received, then a contract asset is recognised. This is subsequently reclassified to receivables at the point at which the Group has an unconditional right to payment.

The Group utilises the practical expedient available under IFRS 15 for costs to obtain a contract. Commissions paid as part of obtaining a contract are expensed as incurred on the basis that the contract term is typically less than twelve months.

(iv) Transactional meter works

Transactional works, which include emergency, adversarial and other maintenance services, and are typically short term in nature, are accounted for as a separate performance obligation to asset management services (see section (i) above) on the basis that these are separately identifiable and can be performed by another party. A customer, being the energy supplier, is legally obligated to appoint a meter asset manager and can therefore benefit from this service in isolation, without the subsequent transactional works which are initiated on an ad-hoc basis upon demand by the customer.

Transactional meter works also include contracts with customers for installation-only services.

The transaction price allocated to transactional works is based on stand-alone selling prices (per unit, where relevant) and revenue is recognised at a point in time when the transaction has been completed and accepted by the customer. This is the point at which the customer is charged for the service and a receivable is recognised by the Group as we have an unconditional right to payment. The customer will settle the transaction price for these services as part of the regular monthly billing cycle for metering services.

The customer pays the fixed amount based on the transactional services provided and this is charged once the service has been completed and accepted by the customer.

For segmental purposes, this transactional, non-recurring revenue is recognised within asset installation.

(v) Energy management services

Energy management services provided mainly to I&C customers include utility bureau and bill validation services, risk management and procurement services and energy reduction and environmental management services.

Certain services, such as utility bureau and bill validation, are delivered through a series of monthly services over the course of the contract term, for which the benefits are simultaneously received and consumed by a customer. These are accounted for as a single performance obligation. The transaction price allocated includes a fixed monthly service charge together with a variable component for specific activities that may not be carried out every month. As revenue from charges is attributed to services provided monthly, revenue is always based on the actual level of service provided and, therefore, there is no uncertainty at the end of each reporting period. Revenue is thus recognised over time based on our right to invoice.

Contracts for specialist consultancy services may include multiple projects. Where these projects are separately identifiable within the contract and are not interrelated, they are accounted for as separate performance obligations. The transaction price is allocated based on the stand-alone charges for each project.

Other energy reduction and environmental management services are typically longer-term, multi-site contracts and, therefore, the revenue recognition is consistent with that detailed above for utility connections - see details in note 2 (c)(iii) above.

(vi) Assets and liabilities arising from contracts with customers

Costs to fulfil a contract

In certain circumstances, the Group may incur costs to fulfil its obligations under a contract once it is obtained, but before transferring goods or services to the customer. These costs are assessed on a contract by contract basis and, where they are considered to meet the definition of fulfilment costs under IFRS 15, they are recognised as an asset and amortised on a systematic basis consistent with the pattern of transfer of the services to which the asset relates.

Contract assets and liabilities

We receive payments from customers based on a billing schedule, as established in our contracts.

The timing of revenue recognition, billing and cash collections results in:

• billed and unbilled accounts receivable, which are recognised when our right to consideration becomes unconditional, and classified as trade receivables and accrued income respectively;

• unbilled amounts, where we have a conditional right to consideration based on future performance, recognised as contract assets. These amounts will be billed in accordance with the agreed upon contractual terms; and

• payments received in advance of performance under a contract, recognised as contract liabilities. Contract liabilities are recognised as revenue as (or when) we perform under a contract.

For project-based services, work in progress is billed in accordance with the agreed upon contractual terms with the customer. We typically receive interim payments as work progresses, which can give rise to a billed or unbilled accounts receivable, where our right to payment is unconditional, or a contract asset, where revenue has been recognised based on progress completed but our right to payment is still conditional on future performance. For some contracts, we may be entitled to receive advance payments. We recognise a contract liability for these advance payments in excess of revenue recognised.

Cancellation terms can vary but typically include provisions that allow the customer to terminate the contract at their discretion subject to a penalty or settlement of amounts for work completed prior to termination. Contracts allow both parties to cancel without penalty in the case of a material breach of contract.

3 Profit from operations

The Group has identified a number of items which are material due to the significance of their nature and/or amount. These are listed separately here to provide a better understanding of the financial performance of the Group.