Annual Financial Report

RNS Number : 2641H

Serco Group PLC

12 March 2015

 



Serco Group plc - 2014 Annual Report and Accounts

12 March 2015

The 2014 Annual Report and Accounts have today been published on the Company's website.

In accordance with Listing Rule 9.6.1 a copy of the 2014 Annual Report and Accounts has been uploaded to the National Storage Mechanism and will be available for viewing shortly. The documents are also available on the Company's website at www.serco.com.

Compliance with Disclosure and Transparency Rule 6.3.5 ("DTR 6.3.5") - Extracts from the 2014 Annual Report and Accounts

The information below, which is extracted from the 2014 Annual Report and Accounts, is included solely for the purpose of complying with DTR 6.3.5.  It should be read in conjunction with the Company's Full Year results announcement being published today.  Together these constitute the material required by DTR 6.3.5 to be communicated to the media in unedited full text through a Regulatory Information Service. This material is not a substitute for reading the full 2014 Annual Report and Accounts. All page numbers and cross-references in the extracted information below refer to page numbers in the 2014 Annual Report and Accounts.

Principal Risks and Uncertainties (pages 15 to 20)

Principal risks and uncertainties

In our business, we face many risks and uncertainties which we mitigate and manage through our Board approved Risk Management Processes. The Group Risk Register identifies the principal risks facing the business as a whole, including those that are managed directly at the Group level through our Executive Committee and reported to the Board.

During 2014, we commenced a three-year programme to refresh our overall risk management approach to better support the development and ongoing performance of the global business. In 2014 we enhanced our policies, processes and systems and gave more clarity on roles and responsibilities, governance and reporting. In 2015 we will continue training our business leaders and employees, improve risk management capacity and capability in our global business, and improve visibility of risk profiles focusing on management information and decision-making. In 2016, we will evaluate our progress and ensure that our risk management programme is fully embedded at all levels of the business to the contract level and within all Group functions.

In 2014, we also undertook a review of the risks and uncertainties affecting our business which resulted in changes to the key risks on the Group Risk Register. Summarised below are the key risks and uncertainties that face us: our operations, people, revenue, profit and cash flow.

Contract Non-compliance and Contract Performance

Our success depends on our ability to write contracts which balance risk and reward and meet the contractual requirements into which we have entered with our customers, which could be through direct delivery of services, through the use of sub-contractors, or through Joint Venture consortium partners. We are subject to risks associated with bidding for and entering into contracts (most of which are multi-year and/or fixed price contracts), including correctly assessing and agreeing pricing terms that provide for a level of return on the contract appropriate to the risks involved, accurately anticipating the costs of strict performance conditions, employee requirements and other obligations, correctly evaluating contractual and operational risks, and the risks of potential early termination or change of scope of contracts by customers. Failure to bid and negotiate performance criteria and contract provisions that can be operationally delivered at the price estimated can result in losses. Unclear, ambiguous, misread, misinterpreted contract obligations and expectations of contract performance can result in perceived or actual contract non-compliance and/or poor performance. The same is true if we, or our sub-contractors or consortium partners do not have the right expertise, tools and resources adequately to manage and monitor compliance with contract obligations and expectations. These potential failures could result in the cancellation of a contract, claims for loss, or compensation arrangements under the contract being triggered, as well as reputational damage leading to a decrease in business being undertaken with one or several customers, and an adverse effect on our financial condition, or operating or financial results and on our ability to win new business.

We are party to a number of contracts that are multi-year, fixed price, carry strict performance conditions and/or contain volumetric or other risks relating to original bid assumptions that have proven incorrect and we expect to result in losses, as a result of which we have determined the contracts to be onerous. In the second half of 2014 there were several contracts where operational issues and/or discussions with our customers resulted in us substantially revising upwards our estimates of the costs to complete our obligations under such contracts or lowering our revenue expectations. A risk based independent review of our principal contracts to identify loss-making contracts against a specific scope revealed that we have a number of contracts that have, or are expected to result in, or could result in material loss, which we have determined to be onerous. The costs to complete these contracts outweigh the financial benefit, and they are, therefore loss-making resulting in lower than expected returns and economic damage for which provisions have been made in the accounts, and there is a risk that the losses damage our reputation. The scope of contract reviews was based on a structured interview process with the relevant business and divisional teams addressing contractual features, operational and financial performance and outlook, each contract being categorised as high, medium or low risk based on the level of risk, uncertainty and judgement existing in each contract.

High risk contracts underwent a full scope review including a full financial review of the contract, a review of the accounting model including challenging and stress testing the assumptions as well as a contract balance sheet review. Those contracts deemed to be medium risk were subject to a review of specific contract risks as well as a focus on the financial impact of the key contractual clauses and a review of the contract balance sheet. Where a contract was deemed low risk, no further work was undertaken. It has not been practical to complete a full legal, operational and financial review of every contract, given the scale, complexity and volume of the contracts and the cost and time that this would have taken. No assurance can be given that the onerous provisions that we have recorded will be sufficient to cover the losses ultimately incurred under the contracts for which onerous provisions have been made or that further provisions for such contracts will not be required in the future or that the costs of fulfilling other contracts to which any member of the Serco Group is a party will not exceed the actual or expected economic benefit under such contracts resulting in the need for further onerous provisions for such contracts. Inevitably, the review of contracts was carried out at a specific point in time and with the information available at that time, which may not prove to have been entirely accurate or complete. Further, the review could not cover all possible circumstances on all contracts under which losses could in the future possibly be incurred. Contracts that have not been reviewed may in future become loss-making; and losses on contracts that have been reviewed may turn out to be worse if, for example, the review was based on information which is subsequently superseded or revised in light of any further review work undertaken or circumstances under the contract change. Similarly, we may have over-estimated the provisions taken with respect to one or more of our contracts. The onerous provisions that have been made are management's best judgement at the time of the review. The onerous provisions are subject to change if additional information comes to light in the future. If additional provisions and/or increased costs need to be recognised in the future, this may result in lower returns and economic, reputational and other impacts associated with onerous contracts, which could materially adversely affect our business, financial condition, results of operations and prospects. If any of our material contracts became loss-making, and an onerous provision covering multiple years of future losses under such contract becomes necessary, such an onerous provision might have a significant impact on a single year's operating profits, as can be seen from the results for 2014.

We have undertaken a reappraisal of Group policies for bidding, contract management and a review of compliance has been undertaken as well as improving the review and governance of bids. The resulting refreshed policies clarify our expectations of contract management and provide for enhanced contract management training. Contract performance monitoring tools are being developed to assist in providing clarity on contract performance targets, contractual obligations and commitments. Stronger management accounting systems are in the process of being put in place to report monthly the status of contracts up to Group management more accurately.

Failure to Win Material Bids/Rebids

We depend and will continue to depend heavily on large contracts with a relatively limited number of major government customers and other public sector bodies and agencies for a substantial proportion of our revenue, some of which expired in 2014 or are subject to contract expiration, rebidding, contract extension or renegotiation in 2015. If such customers decrease the amount of business they undertake with us for any reason, or if the relationship with such customers were impaired, or we sustain damage to our reputation, or we are subject to negative publicity, we could lose business across our customer base and face significant economic damage. Such damage could also include losing renewals and extensions of existing contracts. The realisation of the pipeline of opportunities for new bids and rebidding for existing contracts can involve a lengthy and costly bidding process. Bid and rebid success rates determine how much of the pipeline of opportunities is realised and turned into profitable business and how much existing business is retained. Contracts with national and local governments and public sector bodies and agencies or major commercial customers may contain unfavourable or onerous provisions. Furthermore, as a supplier to public sector bodies and agencies and government regulated customers, we are subject to procurement rules and regulations and procurement delays that may increase our bidding, performance and compliance costs and could have an adverse impact on our business, financial condition, results of operations or prospects.

To win our share of new opportunities as well as our key rebids we must clearly understand our customers and their requirements. We must be aware of our competitors and their strengths and weaknesses.

Additionally, our customers must understand our strategy and our strengths. These elements, combined with the building of strong credible teams, are essential to us developing the compelling propositions needed to win.

Failure to realise the pipeline of opportunities, particularly having invested time and money in the bidding process, could impact our ability to deliver on the strategy developed in our 2014 Strategy Review.

The 2014 Strategy Review has directed the business focus to where we are strongest, which is a supplier of services to governments and public sector service providers. Better targeting of our pipeline of opportunities will allow us to make more effective and efficient use of our bid resources as we strengthen our bid pipeline.

We have put in place improved bid management policies, strengthened the criteria, processes and level of scrutiny for Divisional and Group level management review of all bids and rebids, especially those that are critical to our success. We have ensured stronger risk management earlier in the bid process to help identify potential onerous performance criteria and contract provisions as well as, transition and operational concerns.

We invest in appointing high calibre people for our key bids; train our bidding teams to improve competency and performance; and monitor our results through effective management reporting.

Major Information Security Breach

We collect and retain confidential information in computer systems regarding our business dealings and our customers, service end-users and suppliers. The secure processing, maintenance and transmission of this information is critical to our operations. We must comply with restrictions on the handling of sensitive information (including personal and customer information). This is a heightened risk, particularly with respect to government contracts, due to the sensitive and confidential nature of government data.

We and our appointed third party service providers are vulnerable to a major information security breach resulting in the loss or compromise of sensitive information or wilful damage resulting in the loss of service. We provide high profile services, which adds to our attractiveness as a potential target. The threats facing sensitive information managed by the Group increased in 2014 with malicious and high profile attacks against major brands across the globe by well-known Hacktivist groups. Alongside this threat is the more insidious and low profile attack instigated by certain foreign governments and their proxies to obtain information for defence or economic advantage.

A major information security breach could have a significant negative impact our reputation. This impact could result in the loss of new or existing business by disqualification from future work, contract termination, and heavy financial penalties causing a negative impact on our strategic objectives. Such breaches are costly to rectify and could dilute shareholder returns and result in criminal or civil action; contract and business external accreditations being withdrawn; and significant media attention scrutiny, all of which could materially adversely affect the business, financial condition, results of operations and prospects.

Continued investment in our internal Cyber Security programme, known as 'Think Privacy', has allowed us to mitigate our vulnerability to the accidental loss of sensitive corporate or customer data. To provide a proactive cyber defence and risk reduction capability for the Group, our Cyber Defence Programme incorporates a Global Security Operations Centre, the investment for which was approved in 2014, Cyber Essentials training and delivery of supporting security infrastructure.

SFO Investigation

As we have disclosed before we are under investigation by the SeriousFraud Office. In November 2013, the UK's Serious Fraud Office announced that it had opened an investigation, which remains ongoing, into our Group's Electronic Monitoring Contract. We are cooperating fully with the Serious Fraud Office's investigation which is still in the early stages and it is not possible to predict the outcome, however, in the event that the Serious Fraud Office decides to prosecute, the range of possible adverse outcomes is any one or a combination of the following: (i) that the Serious Fraud Office prosecutes the individuals involved; (ii) that the Serious Fraud Office prosecutes the Serco Group entities involved; or (iii) that the Serious Fraud Office and the relevant Serco Group entities enter into a deferred prosecution agreement. If the Serious Fraud Office decides to prosecute the individuals involved then it is possible that contracting authorities will take the view that we should be subject to discretionary debarment from future contracts with UK Government entities. If the Serious Fraud Office decides to prosecute the entities involved, potential outcomes are that (a) the Serco Group entities involved defend the action successfully, or (b) the Serco Group entities involved are convicted, resulting in financial penalties and mandatory debarment from pre-qualifying for future contracts with UK Government entities. Under the "self-cleansing" provisions of the Public Contract Regulations 2015, any such Serco entity could provide evidence to the relevant contracting authority to demonstrate its reliability as public contractor with the UK Government despite the conviction. If such contracting authority considers such evidence to be sufficient, we would not be excluded from a contract bid or rebid.

If any Serco Group entity enters into a deferred prosecution agreement with the Serious Fraud Office, potential outcomes could include significant financial penalties and discretionary debarment from pre-qualifying for future contracts with UK Government entities. Such debarment would be at the discretion of a contracting authority to which the relevant Serco Group entity submits a pre-qualification questionnaire for any given bid or rebid.

Any discretionary debarment could be removed if we were able, under the "self-cleansing" provisions of the Public Contract Regulations 2015, to provide sufficient evidence to a contracting authority to demonstrate its reliability as a public contractor with the UK Government.

It is possible that further actions beyond those being implemented under the Corporate Renewal Programme may need to be taken by us to remove any mandatory or discretionary debarment, or that such debarment will not be removed for a significant period of time.

If the Group faces any criminal convictions, debarment consequences or enters into a deferred prosecution agreement, any such outcome could result in significant fines and have a material adverse impact on the Groups ability to contract with the UK Government and its reputation which would, in turn, materially adversely affect its business, financial condition, results of operations and prospects.

In addition, a criminal conviction of a Serco entity or of one or more of the Group's current or former employees would allow the Ministry of Justice to re-open the £64.3m settlement agreed in respect of certain issues arising under the Electronic Monitoring Contract. In such circumstances, the UK Government may seek additional payments from Serco.

Upon any such conviction or possibly following entry into a deferred prosecution agreement, the Group would be subject to enhanced scrutiny with respect to its other contracts with the UK Government, including potential designation as a "High Risk" supplier by the Cabinet Office, which could result in the UK Government reducing the additional work given to the Group under its existing UK Government contracts and requiring the Group to undertake certain further organisational actions to remove such designation. Following such conviction, the UK Government could potentially also terminate certain contracts it has with us.

We will continue to cooperate with the Serious Fraud Office's investigation.

Political and Economic Risk

The sustainability of our existing and future business with governments is dependent not just on normal stable government but also on a favourable policy climate to private sector provision of public services. In addition, as a supplier to governments, our business model depends on the development and maintenance of trusted relationships with politicians and officials in government. Outsourcing of governmental activities and public services is inherently controversial in many markets and geographies. Our government customers are also affected by financial, regulatory, political constraints or policy changes.

A substantial part of our business is, therefore, susceptible to adverse changes in the global economy, fiscal and monetary policy, political stability, political leadership, budget priorities, the perception and attitude of governments and the wider public to outsourcing, and policy and economic conditions. Any of these could result in decisions not to, or no longer to, outsource services, delays in placing work, cancellation, abandonment or significant reduction in scope, pressure on pricing or margins, withdrawal of projects, early termination of contracts, lower contract spend than anticipated or the adoption of less favourable contracting models. Such factors could have a significant negative impact on the number, size, scope, type, timing and duration of contracts and orders, in particular those relating to the provision of public services, maintaining and improving public infrastructure, immigration, health, the criminal justice system, defence, and the attitude to outsourcing of services and activities to the private sector, particularly in the UK, Europe, Australia, the Middle East and the US.

We operate in politically and socially sensitive sectors and our activities are therefore subject to high degree of political and social scrutiny. Failure to satisfy the requirements or targets set by government clients, or to meet the expectations of the public, could have an adverse effect on our reputation, business and operations. In addition, adverse publicity in these sectors either generally or experienced by other service providers could have an adverse impact on the public perception of us.

Political and economic risks also impact the amount of new business available for us to bid in our chosen markets. Challenging economic conditions and shrinking government expenditure, rising public debt, and high rates of unemployment could result in a lack of new investment by certain governments, increased competition and new competitors, and an increasingly price-driven environment. Other factors that can contribute to fewer bid prospects are changes in procurement requirements or eligibility to bid criteria, failure to comply with qualification to bid criteria, delays to procurement and award or increased promotion of new entrants to the market as a consequence of public sector procurement competitive policies.

The 2014 Strategy Review aims to ensure our portfolio and geographic diversity to spreadthe risk as changes to political policies follow different cycles in different regions. We are primarily focused on developed markets with strong and established legal systems providing protection from changes in contract terms. Dedicated teams in each region monitor the political landscape and government activities and report on government policy changes and the political environment in which we operate. Our presence across four regions allows us to move from lower growth economies to higher growth economies and focus on areas where political polices are more aligned with our core services. The business strategy is managed through Divisional boards that closely monitor and reflect changes in government policy and budgets in their delivery of the strategy.

Rights Issue

If the proposed Rights Issue does not proceed and we unable to obtain further waivers of our financial covenants under our financing agreements, and we are unable to avoid a breach of our financial covenants or cross-defaults through the successful implementation of one or more funding alternatives including proposed disposals, shareholders are at risk of losing all or a substantial amount of their investment in the Group and the Group is at risk of not being able to continue as a going concern.

We have agreed with the lenders and the noteholders to make certain amendments to the terms of our existing finance agreements, which will become effective once we receive the net proceeds of the Rights Issue and use the net proceeds of the Rights Issue to pay down a portion of the amounts outstanding under existing financings agreements. In the event that the Rights Issue does not proceed, however, we will be unable to pay down amounts outstanding under these financing arrangements. Furthermore, if the Rights Issue does not proceed, the amendments will not become effective as they are conditional upon us receiving the net proceeds of the Rights Issue and the payment by us of £225m under the US Note Purchase Agreements to the noteholders and confirmation by us that we will pay down £225m (or, if less, the amount then drawn) under the Facility Agreement to the lenders from such proceeds. In these circumstances, although we still expect to be able to meet the financial covenant tests under our existing finance agreements on 31 May 2015 unless further waivers or amendments are granted, we expect that we would breach our financial covenant tests and cross default thereafter.

Following any such breach the lenders or noteholders would be entitled to demand the accelerated repayment in full of any amounts outstanding, including any interest due and the payment of a "make-whole amount" payable to noteholders, and we do not expect that we would have the funds available to repay such amounts at that time unless we are able to implement funding alternatives such as proposed disposals. In such circumstances, in the absence of being able to successfully agree or implement any such alternatives, we would be unable to continue as a going concern.

As a result, if the Rights Issue does not proceed and the amended finance agreements do not become effective, we would first seek to negotiate further waivers of our financial covenants in order to avoid any such breach of financial covenants and cross-default. We may be unable to obtain such waivers either at all or without significant cost to us and the lenders and noteholders would potentially demand to have significant involvement in our business and operations which could adversely affect implementation of our new strategy or result in us changing our strategy. Any such waivers would likely subject us to additional fees or impose more onerous obligations on us. Without the proceeds of the Rights Issue, any covenant waivers under, or any other amendments of, the existing finance agreements would only be a short-term solution that would not fundamentally address our balance sheet and capitalisation issues.

Failure to Act with Integrity

Integrity generates trust which is central to maintaining our reputation as a business. A number of factors can influence this including: how we manage our brand; compliance with legal requirements on ethical issues; and how we and those who work for us behave. Failure to manage these effectively presents a risk that might negatively impact our reputation, and from there impact our ability to grow our business. This could significantly impact the economic value of our business, increase the risk of regulatory intervention and our ability to attract and retain talent.

2014 has seen this risk remaining at an elevated level. There continue to be high levels of media scrutiny of our operations with incidents generating adverse publicity which could impact on the perception of the Group held by customers, subcontractors and suppliers. The critical area of risk for us is where operational weakness or failure intersects with a highly charged political environment.

Also given the nature of our work and the countries we work within, we are at risk of being accused of ethical breaches including relating to bribery and corruption, human rights issues or unethical behaviour by either our people or third parties not directly under our control - subcontractors, consortium partners, consultants and/or agents. These accusations would challenge the integrity of our business and could have an adverse impact on our reputation and brand.

To mitigate this risk we have developed clear policies on ethical issues including anti-bribery and corruption, protection of human rights, respect for competition law, avoidance of money laundering, conflicts of interest and employment of ex-government officials. Alongside this we have refreshed our code of conduct (www.serco.com/codeofconduct) and appointed a senior Ethics Officer at the Group level and ethics leads in each Division. We have strengthened procedures on due diligence of third parties and ongoing monitoring of those relationships. We have spent time training our leaders and managers to better understand business ethics and how their behaviour impacts the ethical culture of the business and rolled out training on our Code of Conduct and key compliance areas to all staff. Through our policies, processes and ongoing training we aim to make it clear that Serco does not engage in and will not tolerate unethical behaviour and how our people can avoid such risk.

Significant tactical programmes centred on effective reactive responses to operational issues and a proactive process of brand rebuilding is underway to preserve our reputation. We have controls and processes in place to react to emerging issues based on policy, clear guidelines, and internal networks.

People

People are at the core of our business at all levels of our organisation. Underpinning our success is the ability to attract and retain the right people in leadership roles - particularly in Executive Management, Contract Management and Bid Management. The Group is dependent on its ability to attract, train and retain its senior managers and highly skilled employees. Employee engagement is fundamental to our success; engaged employees deliver better service to our customers, are more productive, and want to stay with us. Failure to attract, motivate and engage employees can create a decline in morale and an increase in labour turnover, which may adversely affect our ability to win new and retain existing customers owing to a lack of appropriate skills and a reduction in customer satisfaction. In turn this could impact integrity, brand and reputation, and could have a material adverse impact on our financial condition and results of operations.

A renewed framework for talent management is under development to identify the development needs of individuals and to identify successor candidates for senior roles. We continue to implement new strategies to improve employee engagement including employment engagement awareness for managers and employees, full cascade of our employee survey (Viewpoint) results and actions, and regular checks and communication with managers relating to actions arising from Viewpoint.

Delivery of the Group's Strategy

The Group's strategy focuses us on our core competencies, built up over the last thirty years, as an expert provider of services to governments and other bodies who serve the public or protect their nation's interests. Our focus on being a Public Services Provider operating in a number of countries requires us embark on a programme of change, which will result in our becoming smaller and more focused in order to resume profitable growth.

Failure to deliver our strategy may arise from failure to execute the strategy; having the wrong strategy; or the impact of outside factors. The Group's failure to deliver the new strategy, or the successful delivery of the new strategy not achieving its intended results, could have a material adverse effect on our business, results of operations, financial condition and prospects. Factors contributing to this risk including a failure to implement cultural change successfully; insufficient development of or maintenance of our core competencies; a lack of speed of change; unrealistic or unclear expectations or a failure of employee buy-in, commitment or accountability; an inability to achieve the intended cost savings targets; a failure to develop a sufficient pipeline of new work or contracts; a failure to effectively win a fair share of new contract bids; a failure to effect the intended disposals or to make disposals on unfavourable terms; and the possibility that exiting the private sector may provide us with insufficient opportunities.

Our decentralised organisational structure contains an element of operational risk, as the Group delegates considerable operational autonomy and responsibility to our Divisions, and within the Divisions to line managers. The Group is at risk of regional or local managers not complying with the policies; of accounting irregularities, accounting misstatements or breaches or local legislation; there is also the risk that the Group will not be successful in monitoring contract performance, ensuring compliance to policy, updating controls or ensuring efficient and reliable IT systems. Any of these could individually or collectively have a material adverse effect on our business, results of operations or financial condition.

We have revised our investment approval processes to approve only those investments that support our new strategy, and in particular to ensure that major bids are properly assessed, managed and supported. Rigorous Divisional and Business Unit performance reviews now enable us to monitor progress against our new strategy goals. Our ongoing review of capability and skills development in key areas such as business development, transition and operations will ensure we develop and maintain our core competencies, and the active transfer of knowledge and best practice in our pillars will grow expertise still further. The delivery of the Corporate Renewal Programme with the accompanying revision of the Group's management systems to enhance controls and compliance, self-assessment tools for contract managers and employee training on our policies, and enhanced communication of our strategy begins our cultural change journey and the achievement of employee buy-in.

Failure of Financial and Commercial Controls

Strong financial and commercial controls are critical to the Group's ultimate success and underpin customer, supplier and shareholder trust and confidence in our organisation.

During 2014 we have the Group has issued a number of profit warnings and recognised substantial impairments in the carrying value of goodwill and other intangible assets, together with other adverse financial adjustments to the 2014 results all of which threatens this confidence.

A major finance transformation programme has commenced looking at the finance function end to end, from the contract to Division, from the shared service centre to head office, and in so doing will map the processes to understand and mitigate the key risks. Given the nature of this initiative, there will be a heightened risk of financial control issues as we change the processes and improve efficiency to reduce the overall cost of the function and at the same time improve its effectiveness.

A key deliverable of the finance transformation programme is to enhance our existing financial controls environment. The programme's Steering Board will oversee and approve all proposed changes prior to implementation and progress will be subject to close monitoring.

Related Party Transactions (note 39 to the consolidated financial statements on page 201

Related Party Transactions

Transactions between the Company and its wholly owned subsidiaries, which are related parties, have been eliminated on consolidation and are not disclosed in this note. Transactions between the Group and its joint venture undertakings are disclosed below.

Trading transactions

During the year, Group companies entered into the following material transactions with joint ventures:

	2014 £m	2013 £m
Royalties and management fees receivable	1.7	2.1
Dividends receivable	34.8	51.5
	36.5	53.6

The following receivable balances were held relating to joint ventures:

	2014 £m	2013 £m
Current:
Loans and other receivables	0.1	0.4
	2014	2013
	£m	£m
Non-current:
Loans and other receivables	9.0	9.5

Joint venture receivable and loan amounts outstanding have arisen from transactions undertaken during the general course of trading, are unsecured, and will be settled in cash. Interest arising on loans is based on LIBOR, or its equivalent, with an appropriate margin. No guarantee has been given or received. No provisions are required for doubtful debts in respect of the amounts owed by the joint ventures.

Remuneration of key management personnel

The Directors of Serco Group plc had no material transactions with the Group during the year other than service contracts and Directors' liability insurance.

The remuneration of the key management personnel of the Group is set out below in aggregate for each of the categories specified in IAS 24 Related Party Disclosures:

		2014 £m	2013 £m
Short-term employee benefits		8.4	10.9
Post-employment benefits		0.1	0.1
Share-based payment expense/(credit)		0.9	(0.7)
		9.4	10.3

The key management personnel comprise the Executive Directors, Non-Executive Directors and members of the Executive Committee (2014: 19 individuals, 2013: 16 individuals).

Independent auditor's report to the members of Serco Group plc (pages 134 and 138)

Independent Auditor's Report to the members of Serco Group PLC

Opinion on financial statements of Serco Group plc

In our opinion: ·         the financial statements give a true and fair view of the state of the group's and of the parent company's affairs as at 31 December 2014 and of the group's loss for the year then ended; ·         the group financial statements have been properly prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union; ·         the parent company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and ·         the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the group financial statements, Article 4 of the IAS Regulation. The financial statements comprise of the Group Income Statement, the Group Statement of Comprehensive Income, the Group and Parent Company Balance Sheets, the Group and Parent Company Cash Flow Statements, the Group and Parent Company Statements of Changes in Equity and the related notes 1 to 57. The financial reporting framework that has been applied in their preparation is applicable law and IFRSs as adopted by the European Union and, as regards the parent company financial statements, as applied in accordance with the provisions of the Companies Act 2006.

Emphasis of matter - Going concern

As required by the Listing Rules we have reviewed the directors' statement contained within Strategic Report in respect of the group's ability to continue as a going concern. As described in the note 2 to the financial statements the group is in the process of re-financing its debt facilities and seeking approval to raise approximately £555m by way of a fully underwritten rights issue. The completion of the rights issue is dependent on approval from the shareholders of the Company, which at the time of issuing these financial statements has not yet been obtained. If the proposed rights issue is not approved, the group is forecast to breach the covenants in its loan facilities which, in the absence of a waiver, would result in all of the group's debt facilities becoming repayable on demand. In this event, the Group does not anticipate that it would have the funds available to repay such amounts at that time, and would need to take alternative steps in order to be able to continue as a going concern. Whilst we have concluded that the directors' use of the going concern basis of accounting in the preparation of the financial statements is appropriate, these conditions indicate the existence of a material uncertainty which may give rise to significant doubt over the group's ability to continue as a going concern. We describe below how the scope of our audit has responded to this risk. Our opinion is not modified in respect of this matter.

Our assessment of risks of material misstatement

The assessed risks of material misstatement described below are those that had the greatest effect on our audit strategy, the allocation of resources in the audit and directing the efforts of the engagement team and are the same risks identified as in the prior period other than for the inclusion of going concern and covenant compliance.

Risk	How the scope of our audit responded to the risk
Going concern & covenant compliance The group is in the process of re-financing its debt facilities and seeking approval to raise approximately £555m by way of a fully underwritten rights issue which as explained in the emphasis of matter paragraph above is dependent on approval from the shareholders of the Company. In the event that the group does not obtain approval for the rights issue, the group is forecast to breach its covenants by June 2015 which would then make the group's debt payable on demand unless the group is successful in obtaining a waiver for such breach.	·       We considered the impact of group's ongoing discussions with the group's existing lenders noting the covenant deferment received for the measurements of financial covenants as at 31 December 2014; ·       We assessed the group's financial forecasts and assessed linkage of the forecasts to the business model and medium-term risks; ·       We assessed the historical accuracy of forecasts prepared by management and the review and challenge by management on the current forecasts; ·       The group applied commercial and operational sensitivities to its forecasts, We challenged the level of sensitivities applied for reasonableness; and ·       We have also considered the adequacy of the extent of disclosure around the uncertainty affecting the going concern assumption. We include in 'Emphasis of matter - Going Concern' the conclusion of our review of the directors' statement in respect of the group's ability to continue as a going concern.
Revenue and profit recognition Revenue and profit recognition on contracts requires judgement over complex areas including assessment of stage of completion; consideration of onerous contract terms; recognition of pre-contract costs; and billing and cash flow arrangements. During the year, the group identified a number of contracts had become onerous. For these contracts, the group has recognised onerous contract provisions at 31 December 2014 of £476.1m to cover the excess of unavoidable costs of meeting the obligations under the contracts over the economic benefits expected to be received over the remaining term of such contracts. Such provisions arise predominantly where contractual volume and / or price risk rest with the group and forecast revenues are largely fixed. The group is required to make operational and financial assumptions over periods that can extend up to 10 years into the future in order to estimate the onerous contract provisions. The prediction of future events contains inherent risk and a high degree of management judgement. The group is also required to assess whether the onerous contract provision is a change in estimate arising from an event in the current year or in relation to a prior year error. Refer to notes 2 and 3 for the group's accounting policy and critical accounting judgements over revenue and profit recognition and refer to note 30 for detailed disclosures of onerous contract provisions recognised by the group as at 31 December 2014.	·       We carried out tests relating operating effectiveness of controls over revenue recognition, including the timing of, and the right to recognise, revenue. ·       We performed tests relating to controls over internally generated data that the group relies on to recognise revenue over a sample of its contracts. ·       We also reviewed forecast costs to complete and profit recognition policies on those contracts where the requirement is to recognise revenue on a percentage of completion basis. ·       We developed an expectation of revenue from contracts where the contracts stipulate fixed revenue on a regular basis or by using external volume data and applying the rates per unit as per the contract to test the revenue recognised by the group. ·       Where the revenue is not based on a fixed amount or fixed rates per unit, we have performed test of details by testing the underlying work order / change orders for the contracts and the actual expenses incurred to provide those services. ·       We challenged specific contract forecasts and historical operational costs to assess whether contracts are deemed to be onerous and reviewed provisions for anticipated losses. This has included a review and challenge of evidence produced by third party experts in determining certain future contract costs. ·       We have tested the historical accuracy of forecasting costs to complete. ·       For contracts where onerous contract provisions have been recognised, we have assessed whether the provisions were a change of estimate arising from new circumstances in the year or whether they represented the correction of a prior period error.
Impairment of goodwill and intangible assets The group has previously recognised goodwill of £1,270.8m allocated to its various cash generating units (CGUs). In the current year, the group has recognised an impairment of £466.0m of goodwill, including £339.7m in respect of businesses held for sale. Refer to note 20 for further detail on impairments and notes 2 and 3 for the group's accounting policy and critical judgements over impairment of goodwill. The test of impairment of goodwill requires management to estimate the recoverable amounts for the CGUs to which such goodwill is allocated. Estimation of the recoverable amount requires that the group make assumptions in respect of forecast operating cash flows and discount rates. The group has previously recognised £185.7m of intangible assets and recognised £41.7m of impairment and amortisation in the year. Refer to note 21 for further detail. The risk for intangible assets is that there are insufficient future operational cash inflows to allow the recovery of these assets which would then result in impairment.	·       We have considered the results of management's strategy review and its implications on the carrying value of goodwill for related CGUs. ·       Where businesses are held for sale, we have tested management's estimate of fair value less estimated costs to sell in arriving at the impairment of goodwill. ·       We challenged management's assumptions within the cash flow forecasts used in the value in use calculations for CGU by reconciling the forecasts to budgets approved by the Board and by performing tests on historical forecasting accuracy. This has included a review and challenge of discount rates provided by third party experts. ·       We have challenged the discount rate applied to the separate CGUs by utilising valuation experts, the prevailing group cost of capital at the year end and our understanding of the future prospects of the group. ·       We have challenged management's assumptions on the recoverability of intangible assets from future cash flows together with management's assumptions in the allocation of intangible corporate assets to related CGUs. ·       We have tested the consistency of forecasts used by management for the assessment of potential impairment of goodwill and intangible assets to the forecasts used for onerous contract provisions, recoverability of deferred tax assets and going concern.
Presentation of exceptional items The group has recorded £661.5m as expenditures in respect of transactions that fall outside of the normal course of trading. Refer to note 3 for the group's critical accounting judgement on identification and note 11 for disclosure of such transactions. In particular, the group undertook a strategy review in the year and have decided to dispose of certain non-core businesses as disclosed in note 41 to the financial statements which has resulted in impairment of the related goodwill and intangible assets of £339.7m. Exceptional items are not defined by IFRSs as adopted by the European Union. The group is required to exercise judgement in respect of what constitutes a one-off transaction that would distort the underlying performance of the business and comparability of the results with previous years. The group has taken into account the Financial Reporting Council's ("FRC") guidance issued in December 2013 in respect of disclosures of such transactions.	·       We reviewed the nature of exceptional items, challenged management's judgements in this area and agreed the quantification of the items to supporting documentation. ·       We assessed the other significant gains / losses incurred in the year to ensure that any other items that are exceptional in nature are appropriately disclosed. ·       On the impairment of goodwill and intangible assets, we reviewed and challenged management's forecasts and underlying assumptions in determining the level of exceptional costs recorded. ·       We obtained and challenged the Directors assessment in respect of inclusion of the costs related to the strategy review in one-off transactions and verified the costs to appropriate audit evidence. ·       In respect of the sales of businesses in the year, we also tested the component parts of the profit on disposal calculation to source documentation including the proceeds received, the net assets disposed of and the costs associated with the disposal, including goodwill allocation to the disposed entities.
Pension commitments The group has a net pension related asset in relation to its SPLAS scheme of £143.9m and a net pension related liability of £17.4m for other schemes as at 31 December 2014. Refer to note 34 to the financial statements for further details. The net asset value is based on actuarial assumptions used in the measurement of the group's pension commitments which involves judgement in relation to mortality, price inflation, discount rates, and rate of pension and salary increases. Judgement is also exercised in determining whether a pension surplus should be recognised as an asset, and the extent of the group's pension liability in respect of franchise and other contractual agreements. The group's accounting policy and critical judgement disclosures in relation to recognition of pension assets and liabilities are set out in note 2 and 3.	·     We evaluated the appropriateness of the principal actuarial assumptions used in the calculation of the group's pension commitments, using our own actuarial experts, by making enquiries of the group's external actuary as to the key assumptions made and comparing these to our knowledge of market practice. ·     As part of our work we obtained advice received by the group and used our internal actuarial specialists to challenge the advice in relation to the group's unconditional right of refund and the recoverability of pension surplus amounts. ·     We challenged contract specific pension commitments recorded including those arising from franchise arrangements.

The description of risks above should be read in conjunction with the significant issues considered by the Audit Committee discussed on page 92.

Our audit procedures relating to these matters were designed in the context of our audit of the financial statements as a whole, and not to express an opinion on individual accounts or disclosures. Our opinion on the financial statements is not modified with respect to any of the risks described above, and we do not express an opinion on these individual matters.

Our application of materiality

We define materiality as the magnitude of misstatement in the financial statements that makes it probable that the economic decisions of a reasonably knowledgeable person would be changed or influenced. We use materiality both in planning the scope of our audit work and in evaluating the results of our work. We determined materiality for the group to be £20m, which is set at 3% of adjusted pre-tax loss. Pre-tax loss has been adjusted by adding back net exceptional costs of £661.5m. We have used our judgement to continue to use an income statement based measure and have selected pre-tax loss as the basis for setting materiality to reflect the impact of the current year performance of the group. The loss before tax is adjusted for the net exceptional costs as these costs are of one-off nature and do not represent the underlying performance of the business. The significant losses in the current year have resulted in the Group being in a net liability position as at 31 December 2014. Our selected materiality is less than 1% of the total assets of the Group. In the previous year, materiality for the group was set at £12.5m which was set at 6.5% of the adjusted pre-tax profit for the year ended 31 December 2013 and was less than 1% of the total assets of the Group. The pre-tax profit was adjusted by adding back net exceptional costs of £90.5m. We agreed with the Audit Committee that we would report to the Committee all audit differences in excess of £0.4m (2013: £0.2m), as well as differences below that threshold that, in our view, warranted reporting on qualitative grounds. We also report to the Audit Committee on disclosure matters that we identified when assessing the overall presentation of the financial statements.

An overview of the scope of our audit

Our group audit was scoped by obtaining an understanding of the group and its environment, including group-wide controls, and assessing the risks of material misstatement at the group level. Our identification of significant components is in line with the group's identification of its segments. During the year, the group split the erstwhile UK & Europe (UK&E) segment into Central Government (CG) & Local & Regional Government (LRG) segments and the Australia, Middle East Asia & Asia (AMEAA) segment into Asia Pacific (ASPAC) and Middle East (ME) segments. Therefore, in the current year, we have identified seven significant components compared to the four in the previous year which are all subject to a full scope audit. The seven components and the scope of work performed on each are described below: Component Component auditor used Component materiality (£ m) CG No 4.6 LRG No 3.9 SGS Yes 3.9 ASPAC Yes 3.9 ME No 3.5 Americas Yes 3.9 Corporates No 3.5 The scope of work over the components set out above provided us with 100% coverage over the group's revenue and net assets. The group audit team visited the component audit teams in Australia, America and India respectively during the current year audit. In addition to the component auditors mentioned above, we have directed the performance of audit procedures at the group's shared services centre in India and at the group's ME operations with full oversight by the group audit team. At the parent entity level, the group audit team has tested the consolidation process and carried out analytical procedures to confirm our conclusion that there were no significant risks of material misstatement of the aggregated financial information of the remaining components not subject to audit or audit of specified account balances. In addition to the components described above, the group audit team issued referral instructions to the auditors for the group's joint ventures and reviewed their audit work to seek assurance over the joint venture results included in the financial statements.

Opinion on other matters prescribed by the Companies Act 2006

In our opinion: ·        the part of the Directors' Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and ·        the information given in the Strategic Report and the Directors' Report for the financial year for which the financial statements are prepared is consistent with the financial statements.

Matters on which we are required to report by exception
Adequacy of explanations received and accounting records	Under the Companies Act 2006 we are required to report to you if, in our opinion: ·         we have not received all the information and explanations we require for our audit; or ·         adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or ·         the parent company financial statements are not in agreement with the accounting records and returns. We have nothing to report in respect of these matters.
Directors' remuneration	Under the Companies Act 2006 we are also required to report if in our opinion certain disclosures of directors' remuneration have not been made or the part of the Directors' Remuneration Report to be audited is not in agreement with the accounting records and returns. We have nothing to report arising from these matters.
Corporate Governance Statement	Under the Listing Rules we are also required to review the part of the Corporate Governance Statement relating to the company's compliance with ten provisions of the UK Corporate Governance Code. We have nothing to report arising from our review.
Our duty to read other information in the Annual Report	Under International Standards on Auditing (UK and Ireland), we are required to report to you if, in our opinion, information in the annual report is: ·        materially inconsistent with the information in the audited financial statements; or ·        apparently materially incorrect based on, or materially inconsistent with, our knowledge of the group acquired in the course of performing our audit; or ·        otherwise misleading. In particular, we are required to consider whether we have identified any inconsistencies between our knowledge acquired during the audit and the directors' statement that they consider the annual report is fair, balanced and understandable and whether the annual report appropriately discloses those matters that we communicated to the audit committee which we consider should have been disclosed. We confirm that we have not identified any such inconsistencies or misleading statements.

Respective responsibilities of directors and auditor

As explained more fully in the Directors' Responsibilities Statement, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board's Ethical Standards for Auditors. We also comply with International Standard on Quality Control 1 (UK and Ireland). Our audit methodology and tools aim to ensure that our quality control procedures are effective, understood and applied. Our quality controls and systems include our dedicated professional standards review team and independent partner reviews. This report is made solely to the company's members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the company's members those matters we are required to state to them in an auditor's report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company's members as a body, for our audit work, for this report, or for the opinions we have formed.

Scope of the audit of the financial statements

An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the group's and the parent company's circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors; and the overall presentation of the financial statements. In addition, we read all the financial and non-financial information in the annual report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.

Richard Knights (Senior Statutory Auditor)

for and on behalf of Deloitte LLP

Chartered Accountants and Statutory Auditor

London, United Kingdom

12 March 2015

Responsibility statement of the Directors in respect of the Annual Report and Accounts (page 131)

Directors' responsibilities statement 

The Directors are responsible for preparing the Annual Report and the financial statements in accordance with applicable law and regulations.

Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors are required to prepare the group financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union and Article 4 of the IAS Regulation and have elected to prepare the parent company financial statements in accordance with Financial Reporting Standard 101 Reduced Disclosure Framework. Under company law the Directors must not approve the accounts unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period.

In preparing the parent company financial statements, the Directors are required to:

·     Select suitable accounting policies and then apply them consistently

·     Make judgments and accounting estimates that are reasonable and prudent

·     State whether Financial Reporting Standard 101 Reduced Disclosure Framework has been followed, subject to any material departures disclosed and explained in the financial statements

·     Prepare the financial statements on the going concern basis unless it is inappropriate to presume that the company will continue in business.

In preparing the Group financial statements, International Accounting Standard 1 requires that Directors:

·     Properly select and apply accounting policies

·     Present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information

·     Provide additional disclosures when compliance with the specific requirements in IFRSs are insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity's financial position and financial performance

·  Make an assessment of the company's ability to continue as a going concern.

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

Responsibility statement

We confirm that to the best of our knowledge:

1.   The financial statements, prepared in accordance with International Financial Reporting Standards as adopted by the EU, give a true and fair view of the assets, liabilities, financial position and profit or loss of the company and the undertakings included in the consolidation taken as a whole

2.   The strategic report includes a fair review of the development and performance of the business and the position of the company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face

3.   The annual report and financial statements, taken as a whole, are fair, balanced and understandable and provide the information necessary for shareholders to assess the company's performance, business model and strategy.

By order of the Board

Group Chief Executive Officer                           Group Chief Financial Officer

Rupert Soames                                                  Angus Cockburn

12 March 2015                                                    12 March 2015

Directors' responsibilities

Alastair Lyons CBE     Non-Executive Chairman

Rupert Soames OBE Group Chief Executive Officer

Edward J Casey, Jr    Group Chief Operating Officer

Angus Cockburn         Group Chief Financial Officer

Mike Clasper CBE      Senior Independent Director and Non-Executive Director

Ralph D Crosby, Jr     Non-Executive Director

Tamara Ingram                       Non-Executive Director

Rachel Lomax             Non-Executive Director

Angie Risley                Non-Executive Director

Malcolm Wyman         Non-Executive Director

We confirm that to the best of our knowledge:

1. The financial statements, prepared in accordance with the relevant financial reporting framework, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; and

2. The management report, which is incorporated into the Directors' Report, includes a fair review of the development and performance of the business and the position of the company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.

 

END

 

 

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