23 April 2018
Capita plc
(the "Company")
Annual Financial Report
In compliance with Disclosure and Transparency Rule 4.1, the
Company announces the publication of its Annual Financial Report
for the year ended 31 December 2017.
Pursuant to Listing Rule 9.6.1, a copy of this document has been
submitted to the National Storage Mechanism and will shortly be
available for inspection at http://www.hemscott.com/nsm.do. The
document is also available on the Company's website:
www.capita.com.
Additional Information
A condensed set of the Company's financial statements and
information on important events that have occurred during the
financial year and their impact on the financial statements, were
included in the preliminary results announcement released on
23 April 2018. That information,
together with the information set out below, which is extracted
from the Annual Report and Accounts 2017, is provided in accordance
with Disclosure and Transparency Rule 6.3.5. This information
should be read in conjunction with the Company's preliminary
results announcement. This announcement is not a substitute for
reading the full Annual Report and Accounts 2017.
Principal Risk Categories
Our Risk Framework is based around 22 risk categories against
which our businesses measure their risk exposure and report on
incidents and issues. The ‘critical’ risk exposures from this level
are reported directly to the Audit and Risk Committee to provide
direct line of sight, even if the risk exposures themselves are not
‘material’ at Group level. To provide more focused detail on the
risks that may impact the strategic objectives of Capita, the Board
has defined 13 corporate risks (into which are mapped each of the
22 wider risks) and these are reported on at every Executive Risk
Committee and then on to the Audit and Risk Committee. These
corporate risks represent the principal risks to the objectives of
Capita plc. Of these, five Principal Risks are recognised as having
the ability to cause significant damage to Capita’s value in the
event they crystallise in a severe, rapid and uncontrolled manner.
These are:
– a significant failure in systems and controls;
– a lack of financial stability;
– a significant failure in information security controls;
– a major disruption to our operational IT; and
– significant legal/regulatory actions.
The remaining eight Principal Risks tend to cause issues over a
longer term and hence may have an impact on profitability. These
are:
– a failure to meet financial expectations;
– a failure to innovate;
– the impact of business complexity;
– the impact of political/client strategy risk;
– the impact of reputational risk;
– ineffective talent management;
– inadequate acquisition, contracting and delivery management;
and
– a failure to deliver the planned transformation plan.
Our Principal Risk Outlook
Capita is not risk averse, but it seeks to better oversee and
manage those Principal Risk exposures which arise in the pursuit of
its objectives. During 2017, we have seen emerging risks around the
challenges in our diverse IT estate and greater regulatory and
legal pressures with the introduction of General Data Protection
Regulation (GDPR) and new Tax Evasion legislation. The finalisation
of the FCA investigation into the historic operation of the
Connaught Fund crystallised a long standing regulatory risk.
In addition, the Audit and Risk Committee has increased its
focus on these key operational risks, seeking better information on
the levels of risk exposure and, importantly, testing the
robustness of management plans to mitigate exposures that are
deemed out of tolerance. This includes more in-depth reviews of the
level of IT resilience across Capita and the arrangements for
managing disruptive events through Business Continuity/Disaster
Recovery planning. Further focus was also taken on the arrangements
to meet key regulatory changes such as the new EU Anti-Money
Laundering Directive and GDPR.
Transformation risk is also identified as one of the principal
risks and uncertainties which the Board will focus on in 2018. It
is critical that the business successfully delivers the benefits of
this plan put in place.
Notwithstanding these steps which we are taking, Capita will
continue to have notable residual risk exposures in key risk areas.
A number are linked to our recovery plans and will be monitored by
the Board closely including:
– Financial stability – until the Rights Issue announced in 2018
is successfully completed, Capita will carry significant financial
risk.
– Strategy – the failure to develop and agree on a clear and
sustainable strategy could weaken the confidence of investors and
threaten the future growth prospects of the Company.
– Transformation plan – the failure to deliver the planned
transformation of the business would threaten future growth and
success.
– Cost competitiveness – without matching our cost base to match
industry peers, our ability to strengthen profitability will be
impacted.
In addition to these recovery risks, there are further risks
which the Board will continue to assess as to whether the
risk/reward profile of the impacted businesses/services is
acceptable and in our shareholders’ interest. Where it feels that
the residual risk is incompatible with our stated strategy and
attractiveness of the returns available, the Board will take action
to reduce or remove its exposure accordingly.
The risk areas of notable residual risk which Capita will carry
are:
– Business complexity – Capita has grown rapidly through
acquisitions and contract wins. Poor integration discipline has
created undue complexity and cost as well as less than optimal
delivery outcomes in some areas.
– Regulatory risk – the provision of services to and in the
regulated Financial Services sector in the UK & Ireland.
– Information security risk – given we are a data-led
organisation, we have stewardship over significant amounts of
personal and commercial data.
– Operational IT risk – where the pace of change in technology
across a diverse estate can lead to complexities, risk and adverse
outcomes in any cases of major failure.
– Reputational risk – outsourcing is increasingly facing a more
hostile reputational profile, particularly in the public
sector.
– Political risk – the changing view of public sector
outsourcing and complexities of balancing the transformation
challenges in this sector with the contractual requirements being
delivered out of government. Also the ongoing uncertainty over the
final shape of the UK’s trading relationship with the EU after
Brexit.
Operational Risk
1. Significant failures in internal
systems of control
Description
A material failure in the control frameworks around our business
processes which results in operational incidents, causing
unanticipated and significant financial loss or service detriment
to our clients or end customers.
2017 Developments and Outlook
Capita operates control frameworks designed to minimise the risk
of unanticipated operational failure, financial loss or damage to
our reputation. Our overall assessment is that the risk has
increased, due to the need to develop further our corporate risk
framework (see above), strengthen the business’ own attestation of
controls and issues in the consistency of Business
Continuity/Disaster Recovery controls identified during the
year.
During 2017, we have also experienced two unconnected frauds
which, whilst not material in quantum to the Company, have
identified control weaknesses in the businesses affected. These are
both continuing to be investigated.
2. Failures in information security
controls
Description
The appropriate protection of Capita’s customer and corporate
data is not only subject to greater legislative scrutiny, it is
central to services we provide and any significant failures in this
could lead to material costs, damage to our reputation and loss of
trust from our clients. A significant breach of security could
impact Capita’s ability to operate and deliver against its business
objectives.
2017 Developments and Outlook
Capita employs detailed and extensive controls to secure its
information assets. These include, but are not limited to, physical
and logical access controls, appropriate encryption of data and
communications and raising and maintaining employee awareness of
the threats. The ‘cyber-threat’ landscape is widening and Capita,
like many businesses has been exposed to incidents during 2017 such
as the APT10 and ‘wannacry’ ransomware attacks. Whilst neither
caused significant impact, this enhanced inherent risk together
with a need to continually develop our control framework means this
remains an increasing corporate risk.
Board oversight in this area operates through the Group Security
Risk Committee which has considered our plans to improve staff
training awareness, enhance our threat awareness capability, invest
in new technology and manage our data retention effectively during
2017.
We are actively preparing for the introduction of GDPR in
May 2018 given this raises our
inherent information security risk. Additional investment is
planned through 2018 to strengthen our information security control
framework in tandem with the GDPR work.
3. Increased business complexity
Description
The opportunity cost of a complex business structure and issues
caused by a lack of strategic focus can weaken our ability to
exploit market potential. This in turn threatens shareholder
returns and value. In addition, any failure to manage multiple
complex contract requirements effectively can mean contract
benefits may not be fully realised, service delivery costs may
increase, or activities do not perform in line with
expectations.
2017 Developments and Outlook
Even with our divisional restructure at the start of 2017,
Capita had exposure to an overly diverse set of markets and
sectors. Jon Lewis has noted this
led to the business being potentially too widely spread, making it
more challenging to maintain a competitive advantage in every
business and to deliver world class services to our clients every
time. The CEO review details the plan to address this and bring
strategic focus to our services and target markets. Until that is
delivered, Capita will continue to have an uncomfortable exposure
to a number of markets where we have not or cannot economically
achieve scale.
In respect to complex contracts, Capita is not averse to seeking
major contracts with inherent complexity. But these come with
inherent risk which must be managed and during 2017 the NHS PCSE
transformation continued to prove challenging for Capita. In this
case, actions have been taken to react to any shortfalls to client
expectations, but the work required has been greater than expected
at the outset. 2017 has seen the introduction of a new initiative
to better assess the levels of complexity and how best to address
the ‘unknowns’ in these complex transformation contracts, but the
issues with the historic portfolio are receiving remedial action as
required.
4. Operational IT risk
Description
Capita is a technology-driven services company in that the
majority of our products and services are enabled by a resilient
technical infrastructure. A disruptive failure in Capita’s key
systems infrastructure could lead to a failure of adequate service
to our clients. In turn that means we may not meet contractual
obligations, cause detriment for end customers and lead to
consequent financial penalties and potential regulatory action.
2017 Developments and Outlook
During 2017, our systems have experienced isolated instances of
short but significant impact on IT operational stability. These
occurred in one of our legacy datacentres. The Board commissioned a
review into this incident, which did disrupt some services to
clients over a limited period. It concluded that historic
investments to maintain service failed to fully address all of the
technical risks this legacy infrastructure contains. This has
required increased focus to address throughout 2017 and led this to
assume a critical risk in our reporting, but which is now subject
to remediation plans which we expect to see the residual risk to
reduce through Q2 2018. The Board approved an immediate programme
of remedial works and has sought to accelerate its consideration of
a new IT strategy for its datacentre estate. Board and Audit and
Risk Committee meetings have prioritised reports and reviews on
this matter through the second half of 2017.
The conclusion of the strategy work will set a blueprint for the
investment Capita will make to deliver a more robust and secure IT
infrastructure and data network during 2018, which will support our
growth and more resiliently maintain service for existing
clients.
5. Failure to effectively manage
talent and human resources
Description
Failure to attract or retain the right people would limit
Capita’s ability to deliver its business plan commitments and
continue to grow.
2017 Developments and Outlook
Capita is a people business. The availability and competency of
the right talent is critical to Capita’s ability to meet the needs
of its stakeholders and achieve its goals as a business. During
2017, Senior Talent attrition has been uncomfortable given the
uncertainty which has arisen during this transitional phase.
Organisation restructuring, cost efficiency and productivity
initiatives and uncertainty over performance bonuses have impacted
this group of employees.
Therefore, supporting future talent development and retention
continues to be a Board priority. The Board recruited a senior and
experienced Talent Director in 2017 to recognise the investment we
see as necessary in this field and they are further bolstering
their resource in this area. This new focus offers us the
opportunity to validate and endorse our existing initiatives such
as our well regarded ‘Lead the Way’ Graduate scheme and introduce
our new ‘Talent Hub’. This aims to do a better job of recognising
and promoting our talent from within, showcasing roles and
opportunities across the business, thus promoting internal mobility
and aiding retention. There has also been greater focus on the
development of clearly defined Capita ‘Leadership Principles’ which
will shape further initiatives during 2018 to strengthen our
existing senior management team and offer guiding points for those
who aspire to progress to that level.
The new Chief Executive Officer has expressed a priority in
providing career opportunities for talented people and plans
significant work during 2018 to achieve this. A Chief People
Officer has been appointed to lead this work joining Capita in
April 2018.
See pages 23-24 of the 2017 Annual Report and Accounts for
further information on our people and talent.
6. Weaknesses in acquisition and
contracting life cycle
Description
Capita acquisitions and client contracting fail to generate
anticipated revenue growth, synergies and/or cost savings.
2017 Developments and Outlook
During the year, we have been able to reflect on the efficacy of
our acquisition and integration processes. There have been a few
isolated examples where incomplete integration has caused
consequent risk around performance and systems and controls in
these businesses. We recognise that the speed of integration and
desire to derive the full financial benefit of any acquisition has,
at times, led to certain steps not being prioritised. Some of these
are unavoidable, such as trying to implement our UK-based mandatory
policies in differing jurisdictions, others are not, such as moving
acquired companies to our core financial platforms in a timely
manner.
As mentioned above (Internal business complexity), complex
transformations that have come with some new contracts have also
proved challenging in 2017.
We have enhanced a number of key processes in this area during
the year. First, we have revisited and refreshed our Bids &
Acquisition policies to better focus our due diligence processes
and will shortly be introducing a new Contract Review Committee.
Second, we have created a new approach which sees transformation
expertise embedded in the bidding teams earlier on in the process,
reporting separately on the robustness of any plans and costs prior
to contract signature. Third, we have introduced a new process to
guide acquisitions through the first year of Capita ownership, to
ensure the accountability and transparency that an effective
integration process requires. However, we believe further work will
need to be undertaken to embed these and consider other actions to
manage this risk.
Compliance Risk
7. Legal/Regulatory
risk
Description
Capita plc is subject to regulation primarily under UK
legislation. The regimes which apply to its business include, but
are not limited to: financial services, communication services, and
energy market. Capita is also subject to generally applicable
legislation including, but not limited to: anti-bribery, consumer
protection, data protection and taxation. Failure to adhere to any
of its legal and regulatory requirements could lead to legal and
regulatory sanctions, redress costs, reputational risk and,
ultimately, loss of licence or barring from contracts..
2017 Developments and Outlook
During 2017, Capita closed out a number of historical legal and
regulatory issues. This included material litigation with The
Co-operative Bank and litigation in our Corporate Services business
in Capita Asset Services. In November, the Financial Conduct
Authority (FCA) announced that it reached final settlement with
Capita Financial Managers, a subsidiary of Capita Asset Services,
in respect of historical issues arising from the operation of the
Connaught Income Series 1 Fund during 2008-2009.
The closure of these material cases and the disposal of the
regulated businesses within Capita Asset Services has reduced the
risk profile in this area. However, we recognise that our continued
ability to operate and compete effectively can be impacted
adversely by new legislation, policies or regulations. We work to
identify and address our regulatory obligations and to respond to
emerging requirements. We see that there continues to be a
continued appetite by jurisdictions within which we operate to
increase requirements on what we call ‘Corporate Conduct’. These
can be loosely defined as developing legal requirements and
sanctions that are worded to bring the corporate into an increased
risk of action for its conduct and at times open it to criminal
proceedings.
For 2017, significant work has been undertaken to position
ourselves for the implementation of the GDPR, the Criminal Finances
Act (introducing a criminal offence of facilitating tax evasion)
and the Prevention of Modern Slavery Act.
Working in highly-regulated sectors does mean a higher level of
risk for Capita. The steps outlined above help manage that risk
but, as noted in the introduction to this section, the Board will
continually review the risks and rewards which each sector and
jurisdiction brings to the overall business.
Financial Risk
8. Failure to meet financial
expectations
Description
Adverse performance against our stated business plans undermines
investor confidence and impacts the wider corporate position. Lower
revenues and profits can also erode our corporate position in the
market and weaken our ability to attract and retain the best
talent.
2017 Developments and Outlook
The lower than predicted performance in 2016 indicated that the
forecasting processes used within the businesses were in need of
refresh and the management discipline in their execution required
refocusing. There has been much work carried out during 2017 to
improve transparency of key financial metrics across the
businesses.
However, the update on the trading outlook in January 2018 revealed that further improvements
to the existing risk management framework and system are required.
The faster than anticipated speed in the crystallisation of
financial risks during late 2017 through to January 2018 highlighted that there has been a
weakness in the accuracy of forecasting and translation of
financial risks in the existing framework. Furthermore, the key
strategic decisions made by the Board, particularly around
investing in our people, sales and our transformation plan for the
long-term benefit of the Group has also contributed to the lower
expected Group’s underlying pre-tax profits than initially
predicted in December 2017.
An immediate learning point was that not all key financial risks
were tracked and measured in a disciplined manner, and more focus
was given on strategic and operational risks. Nonetheless, work had
already been underway to improve the robustness of the risk
management framework and system, which include the upgrade of our
financial systems, processes and controls, introduction of Monthly
Performance Reviews, clearer financial KPIs at business and
divisional levels, a new Contract Review process for new business,
more robust delivery governance on critical and complex projects,
and a shift to a five-year planning range. We will continue to work
on these areas in 2018.
In addition, we will ensure that all risks are equally measured
and we will strengthen the financial management controls around the
financial risk management process. We will also ensure that more
onus is placed on the business unit owners by developing a more
formal Risk Control Self-Assessment process and obtaining further
assurance on their control effectiveness.
9. Lack of corporate financial
stability
Description
The effective management of its financial exposures and access
to finance is central to preserving Capita’s profitability and
investors’ confidence; the absence of it would also impact our
growth plans.
2017 Developments and Outlook
Following the deterioration in Capita’s financial performance
during 2016, we sold the Capita Asset Services businesses, focused
on expenses and cash management so as to return the adjusted net
debt: adjusted EBITDA ratio back into Capita’s then medium-term
target ratio of 2.0 times to 2.5 times.
However, the new CEO, Jon Lewis,
and the Board believe that a fundamental shift to longer-term
strategic planning is required. As part of the new strategy
launched, we have set a target range for leverage of 1.0x to 2.0x
adjusted net debt to adjusted EBITDA ratio. The transformation
plan, which encompasses strategy implementation, cost
competitiveness, capital structure, targeted investment,
organisational alignment and re-igniting sales, has been put in
place to execute the new strategy. In the shorter term, our
leverage will be reduced by the net proceeds of the Rights Issue
and by non-core disposals.
Strategic Risk
10. Failure to innovate
Description
The failure to identify emerging trends, developing consequent
strategies and making the most of market opportunities would impact
the long-term profitability of Capita. Major macroeconomic trends
in key industries as well as technological developments like
robotics and automation need to be fully understood and harnessed
to deliver the growth to which we aspire.
2017 Developments and Outlook
Capita has always had technology at the heart of the solutions
it offers its clients, but the rate of change in areas like
robotics and automation requires greater investment and focus. We
have set up an ‘automation centre of excellence’ and built out a
central technological solutions team. We have recognised that we
gain more through specialisation and therefore seek suitable
external technology partners rather than try and develop in-house.
However, our financial position has not allowed us to respond fast
enough to shifting markets and technological change and to keep us
at the forefront of our markets. There is still much to do to
re-ignite our innovative edge as we are uncomfortable with our
current position. We need to be consistently better at tracking the
success of the initiatives outlined above and ensure where Capita
businesses have demonstrated market leading innovation, we are
better at sharing that best practice across the business and
replicating success.
In addition, we need to be more innovative in our contractual
dealings with clients, both private and public, as expectations of
business services providers change in our core markets.
11. Adverse changes in national,
international political landscape
Description
The political risks associated with operating across a broad
number of jurisdictions and markets can affect Capita’s ability to
manage or retain interests in its business activities and could
have a material adverse effect on the profitability, or, in extreme
cases, viability of one or more of its services.
2017 Developments and Outlook
This is an increasing area of risk which the Board recognises
requires careful analysis and action. The UK political landscape
continues to be volatile, a situation which the 2017 General
Election has clearly not remedied. This political environment will
continue to impact our public-sector pipeline as well as our
dealings with central government clients on existing contracts. We
recognise that some in the political spectrum do not favour private
involvement in the provision of public services. We believe that
the best defence to this argument is the consistent delivery of
cost and quality effective contracts to central and local
government.
Until the final deal emerges on Brexit, we believe this topic
will lead to continued drag on our trading as clients themselves
seek to delay potential longer-term investment and purchasing
decisions. There will also be impacts on the limited number of
Capita businesses using Financial Services passports and the
make-up of the labour market we source our talent from.
The impact of political risk is managed through maintaining a
spread of operating sectors and markets, continuous monitoring of
key UK and international policies, and dialogue with Government
departments and trade associations. Changes in our strategy will
likely cause a review of our activities in this area and lead to an
increase in our participation in such fora.
During 2018, Capita will continue to track the formation of the
political and associated settlement of how the UK exits the EU. We
are also considering how our remaining EU businesses (such as those
in Ireland, Germany and Poland) can leverage the opportunity.
12. Operational issues leading to
reputational risk
Description
Capita’s reputation, and that of our clients, could be damaged
by a significant adverse event leading to a loss of trust and
confidence amongst our stakeholders. The diversity of our markets
and clients can widen that risk and the increased use of social
media alongside traditional media to highlight and promote
grievances and issues is appreciated by Capita.
2017 Developments and Outlook
2017 has seen a number of significant issues such as press
concerns about TV Licensing’s officers’ conduct, the efficacy of
the NHS PCSE contract and ongoing criticism about elements of the
DWP PIP contract delivery. These have been managed proactively
together with the clients who we work in tandem with to address any
legitimate concerns and present factual responses to any
comment.
This has been aided by the close links between business units
and our Press Office, a willingness, where necessary, to undertake
further investigation into legitimate issues and remedy where these
are proven. Management, PR and Group Risk & Compliance work to
identify and address issues as they are raised.
The residual level of reputational risk has increased and it has
moved to a point which is at the limit of our previously agreed
tolerances. To address this in 2018, the Board expects that it will
take more active steps to balance the degree to which there is
acceptable reputational risk consistent with the financial returns
on offer in new contracts.
13. Transformation risk
Description
The transformation plan announced by Jon
Lewis, Chief Executive Officer, on 31
January 2018 will, as described earlier in the report,
reshape the Company to address the known challenges. Given the
importance of this and early stages of the work, we have marked
this as ‘uncomfortable’ until we have greater visibility to its
progress and execution.
2017 Developments and Outlook
The key elements of the transformation plan were identified in
late 2017 with the appointment of a Chief Transformation Officer
but the bulk of the detailed planning and execution will unfold
during 2018.
Related party transactions
Compensation of key management
personnel
|
2017 |
2016 |
|
£m |
£m |
Short term employment
benefits |
11.3 |
11.1 |
Pension |
0.2 |
0.3 |
Share based payments |
0.1 |
0.8 |
Total |
11.6 |
12.2 |
Gains on share options exercised in the year by Capita plc
Executive Directors were £0.7m (2016: £6.2m) and by key management
personnel £0.2m (2016: £4.5m), totalling £0.9m (2016: £10.7m).
During the year, the Group rendered administrative services to
Smart DCC Ltd, a wholly-owned subsidiary which is not consolidated
(refer to note 36 of the 2017 Annual Report and Accounts). The
Group received £55.5m (2016: £40.3m) of revenue for these services.
The services are procured by Smart DCC on an arm’s length basis
under the DCC licence. The services are subject to review by
Ofgem to ensure that all costs are economically and efficiently
incurred by Smart DCC.
Capita Pension and Life Assurance Scheme is a related party of
the Group. Transactions with the Scheme are disclosed in note 34 –
Employee benefits on pages 154 to 159 of the 2017 Annual Report and
Accounts.
The following companies are substantial shareholders in the
Company and therefore a related party of the Company (in each case,
for the purposes of the Listing Rules of the UK Listing
Authority).
The number of shares held on 18 April
2018 was as below:
Shareholder |
No. of shares |
% of voting rights |
Veritas Asset Management LLP* |
89,035,975 |
13.34 |
Woodford Investment Management
LLP |
66,758,754 |
10.00 |
Investec Asset Management Ltd |
63,080,896 |
9.45 |
Invesco Ltd. |
60,574,558 |
9.08 |
BlackRock, Inc. |
44,104,108 |
6.61 |
Marathon Asset Management LLP |
21,694,771 |
3.25 |
Vanguard Group |
20,654,592 |
3.09 |
* This includes the holding of Veritas Funds PLC.
Responsibility Statement of Directors
in respect of the annual financial statements
The Directors confirm that, to the best of their knowledge:
a) The financial statements prepared in accordance with the
applicable set of accounting standards, 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
as a whole.
b) The Directors’ report, including content by reference,
includes a fair review of the development and performance of the
business and the position of the Issuer and the undertakings
included in the consolidation taken as a whole, together with a
description of the principal risks and uncertainties that they
face.
Directors’ statement on the annual
report
The Directors consider the annual report taken as a whole, to be
fair, balanced and understandable and that it provides the
information necessary for the shareholders to assess the Company’s
position and performance, business model and strategy.
Forward-looking statement
The Directors present the annual report for the year ended
31 December 2017 which includes the
strategic report, governance and audited accounts for this year.
Pages 1 to 89 of this annual report comprise a report of the
Directors that has been drawn up and presented in accordance with
English company law and the liabilities of the Directors in
connection with that report shall be subject to the limitations and
restrictions provided by such law. Where we refer in this report to
other reports or material, such as a website address, this has been
done to direct the reader to other sources of Capita plc
information which may be of interest to the reader. Such additional
materials do not form part of the report.
Contact: Francesca Todd,
Group Company Secretary, 020 7202 0641