Capita plc - Annual Financial Report

Released : 10 April 2017 16:45

10 April 2017

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 2016. 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 2 March 2017. That information, together with the information set out below, which is extracted from the Annual Report and Accounts 2016, 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 2016.

Risk management

Capita is not a risk averse business and seeks to leverage growth from its appetite to risk. But given the importance and sensitivity of its work to its clients, key risks are identified and managed through its comprehensive Risk Management Framework. This is designed to bring management action to bear on uncomfortable or critical risk issues and trends, but also where there is sufficient ‘gap’ between our residual risk level and our appetite, to identify and act on opportunities arising, thus making for profitable growth.

A key feature of Capita’s historic growth has been its ever changing size and complexity. Each new sector and jurisdiction brings new considerations and the overall risk environment, within which we operate, continues to develop. 

Our Risk Management Framework facilitates business management to identify and manage their risks with a methodology which seeks to sit alongside routine management practices rather than entirely separate. This approach, undertaken in reference to 22 risk categories, and the appetite thresholds is reconfirmed on an annual basis by the Board. The reporting of the residual risk profiles is fed into governance at every level of the business for assessment and challenge.

To provide a ‘top down’ assessment of risks to the overall Group, we further operate a set of 12 Corporate Risks which are higher level articulations of the key risks which the Board can track. Four of these represent areas which, if crystallising to a significant degree, could have an immediate, material detrimental impact on the corporate health of Capita. Eight are risks which can hamper profitable growth. These Corporate Risks are reviewed and confirmed by the Board annually and hence help populate our Principal risks on page 50.

Our risk appetite

In our Risk Management Framework we define risk appetite as the degree of risk the Group is prepared to accept in the pursuit of its objectives before specific action is deemed necessary to reduce it. In determining this, Capita reconciles two thresholds:

  • A risk tolerance: defined as the bearable level of variation Capita is willing to accept around specific objectives.

  • A risk critical limit/concern: defined as the maximum risk Capita can bear and remain effective in delivering its strategy.

Capita has established the tolerance and critical limit/concern risk appetite to help the business to understand the relative significance of any of the business risks faced and better prioritise risk monitoring and control activities. Specifically, risk appetite helps determine the degree of control that needs to be applied to a particular area of risk. To focus risk reporting, emphasis is clearly given to the reporting of risks that are categorised at uncomfortable or critical limit to ensure appropriate action is being taken.

Principal risk categories

Corporate risks to the objectives of Capita plc

We operate a total of 22 risk categories within the risk management framework which are kept under regular review. In accordance with provision C.2.1 of the 2014 revised Code, the Directors confirm that they have carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency or liquidity.

The Board also operates 12 corporate risks which represent the principal risks to the objectives of Capita plc (our ‘top down’ risks). Our risk governance process maps the output of the 22 categories (‘bottom up’ risks) against these corporate risks and thus ensures these are monitored on an ongoing basis across all levels of the business.

1. Significant failures in internal systems of control

Description

A material failure in Capita’s business processes may result in unanticipated financial loss or reputation damage.

2016 Mitigation and Outlook

Capita operates a framework of internal control designed to minimise the risk of unanticipated operational failure, financial loss or damage to our reputation.

Like any major business, risk incidents and control breakdowns can lead to isolated issues – for example fraud incidents and operational risk incidents. Whilst 2016 has seen a number of these limited incidents, they remained well below a level of materiality which would cause a concern to the Board. We continue to seek that business management are actively engaged in maintaining an appropriate control environment, supported by risk functions led by the Group risk and compliance Director, with independent assurance from Group internal audit. In some businesses there is also use of external certifications and agreed upon procedure reviews to assure the control frameworks.

2. Lack of corporate financial stability

Description

The effective management of its financial exposures and access to finance is central to preserving Capita’s profitability.

The Group is exposed to financial market risks and may be impacted negatively by matters such as loss of economic priced funding and extreme forex volatility.

2016 Mitigation and Outlook

Capita continually invests in the improvement of its systems and processes in order to ensure sound financial management.

The Group manages treasury risk through monitoring day to day liquidity as well as carefully managed funding of our acquisition strategy. Capita has been able to successfully raise new funds at a competitive rate throughout the year.

However, 2016 has seen a deterioration of business performance during the second half of the year. This deterioration has had an effect on financial performance of the Group and a higher debt ratio.

The Board has acknowledged the need to bring the debt ratio back into Capita’s medium-term target ratio of 2x to 2.5x and has launched a number of initiatives to address this through 2017. These include the planned sale of the majority of the Asset Services division and our specialist recruitment businesses. Open and regular communication with its lending institutions takes place.

3. Failures in information security controls        

Description

Capita must protect its customer and corporate data and have in place loss prevention and detection measures.

A significant breach of security could impact the Group’s ability to operate and deliver against its business objectives.

2016 Mitigation and Outlook

Capita takes measures ranging from physical and logical access controls to encryption, or equivalent technologies, raising employee awareness and monitoring of key partners to manage its information security risks.

2016 has seen heightened ‘cyber risk’ and Capita is not alone in facing an increase in recorded attacks. However, those attacks have to date not led to material breaches. Incidents, where they do occur, are reviewed for root cause analysis and we work with our business partners and national agencies to promote further corporate cooperation.

We are investing more resource into the evolving threats and enhanced regulatory framework. Further investment has been made in threat intelligence, security management and reviews of our systems.

4. Legal/regulatory risk

Description

Capita plc is subject to regulation primarily under UK legislation.

The regimes which apply to the Group’s business include, but are not limited to: Financial Services, Communication Services, and Energy Market.

The Group is also subject to generally applicable legislation including, but not limited to: anti-bribery, consumer protection, data protection and taxation.

2016 Mitigation and Outlook

The Group’s ability to operate or compete effectively could be adversely affected by the introduction of new laws, policies or regulations, changes in the interpretation or application of existing laws, policies and regulations or the outcome of regulatory investigations.

The Group manages these risks through active engagement in the regulatory processes that affect the Group’s business.

The Group actively seeks to identify and meet its regulatory obligations and to respond to emerging requirements. For example, in Financial Services: compliance controls and processes are in place in the Group’s financial services businesses. Interaction with the relevant regulatory authorities is coordinated between the businesses compliance team, Group Risk and Legal departments. The Group maintains appropriate oversight and reporting, supported by training, to provide assurance that it is compliant with regulatory requirements.

2016 has seen a number of historic compliance and legal issues reach, or near, resolution. These include a fine from the Central Bank of Ireland and the ongoing enforcement investigation by the FCA into the operation of the ‘Connaught’ Fund in 2008–2009.

We continue to develop our regulatory controls to reflect the varied regulatory regimes but also in response to the increased focus by governments and regulators on ‘Corporate Conduct’. For example, work is underway to position ourselves for the implementation of the EU Data Protection Regulation, the Criminal Finances Bill and the requirements of the Prevention of Modern Slavery Act.

5. Adverse financial/business performance       

Description

Adverse performance against business plans can impact the wider corporate position and undermine investor confidence. It can also impact our ability to invest in future growth.

2016 Mitigation and Outlook

Reporting on financial performance is provided on a monthly basis to executive management and the Board.

2016 has seen a materially lower performance by several Capita businesses, particularly in the second half of the year. There are a number of factors for this including a deterioration in business confidence in a number of our key sectors following the EU referendum and a series of sector specific issues around our specialist recruitment business and some IT businesses. Not all of these were risks that management identified as material in the first half of 2016 and this has meant that mitigating actions by management were not as timely as the Board would have planned.

The consequent lower than predicted profits for 2016 are a result of the combination of these separate issues and this was disclosed to investors through market announcements in September and December.

An immediate learning from the second half of 2016 was that the forecasting processes used within the businesses, ultimately feeding through to the Group view, were in need of refresh and the management discipline in their execution required refocussing. This is likely a result of the rapid growth of the business and consequent greater number of input reports where lower level forecast errors/assumptions could roll up to a greater effect than when the systems and processes were first deployed when Capita was smaller.

Work in 2017 will focus on how these financial performance risks can be given greater transparency, through clearer and more timely disclosure and thus allow for contemporaneous action.

6. Failure to innovate   

Description

It is important that Capita is able to stay at the forefront of the industry by identifying emerging trends, developing strategies to exploit competitive opportunities and question the status quo, striving for continuous improvement in all areas of activity.

Capita continues to monitor and engage with industry, sector and stakeholder groups on developments in key service and product areas.

2016 Mitigation and Outlook

Capita has a central futures team, who primarily look to harness intelligence, insight and new technologies and processes to deliver real value to our clients, and work alongside sector and capability experts embedded in business across the Group.

Capita consistently deploys leading edge technologies and methodologies developed both by external suppliers and partners and by our own businesses. The Group has a clear transformation governance framework to provide a consistent process to manage change within our client organisations. Executive management continue to develop strategies built on considering a wide range of possible directions for the business sectors in which we operate, and the products and services that the Group delivers to its stakeholders.

7. Increased internal business complexity          

Description

Capita has consistently managed the pace of change, diversity and increasing scope of our business activities. However, where we take on major contracts with inherent complexity this increases the operational risk of failure to manage multiple complex contract requirements effectively with potentially adverse consequences.

Contract benefits may not be fully realised, costs of service delivery may increase, or business as usual activities do not perform in line with expectations.

2016 Mitigation and Outlook

The Congestion Charge, NHS PCSE and RPP are examples of complex projects which have proved challenging for Capita but where actions have been taken to react to any shortfalls to client expectations. These projects prove challenging because of their inherent complexity and whilst any operational issues are not welcome, there is often a recognition from the client of the complexity involved. Given Capita’s appetite for these complex projects remains, lessons from key projects are folded back into the bidding, planning and execution phases. A new initiative within our Transformation Team to better assess the levels of complexity and how best to address the ‘unknowns’ as well as the ‘knowns’ is designed to help mitigate risks in this area in 2017.

8. Adverse changes in national, international political landscape

Description

Capita operates and owns assets in a steadily increasing number of geographic regions and, as a result, is exposed to a wide range of political environments. The majority of its operations remain in the UK.

The political risks associated with operating across a broad number of jurisdictions and markets could affect the Group’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.

2016 Mitigation and Outlook

Political risk is managed through diversification of sectors and operations, continuous monitoring of key UK and international policies, and focus on the public sector and trade association relations.

The EU referendum in June presented a shock to many observers and whilst Capita had been shadowing the developments running up to the vote, like many firms it could not have predicted the result or the ensuing political turmoil in the UK.

The main downstream impact of Brexit has been experienced in the lack of major central government outsourcing contracts coming to market whilst Departments focus on the Brexit process and the performance of certain Capita businesses with exposure to sectors who have faced the most uncertainty after the vote.

Capita will actively track the developments of how the UK exits the EU and how its businesses remaining in EU jurisdictions (such as Ireland, Germany and Poland) can leverage opportunity.

We maintain a watching brief on the political landscape in all of the geographies we operate in and the impact any change of government will have on our markets.

9. 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.

This could lead to contract retention risks, financial loss, and in the most significant of circumstances, direct cost of redress.

The widespread use of social media increases this risk.

2016 Mitigation and Outlook

Capita has a well proven reputational management and response process. Close links with the business units and a central team allow for rapid reaction to any issues.         A number of operational issues across certain businesses and contracts in 2016 have required ongoing support. Group PR work with Group Risk and other functions to address issues as they are raised.

10. Operational IT risk  

Description

The services that Capita provides to its stakeholders are reliant on a robust and resilient technical infrastructure.

A failure in the operation of the Group’s key systems or infrastructure, on which the Group relies, could cause a failure of service to our clients, impacting contractual obligations and negatively affecting our brand.

2016 Mitigation and Outlook

Capita makes significant investment in technology infrastructure to ensure that it continues to support the growth of the business and has a robust monitoring process of core systems and services.

Performance issues and management change in our IT Services Division have frustrated the improvement plans the Board had planned. The delineation of focus between first class service delivery to our businesses and also to our external client base has been, at times, stretching and this is now being addressed through management changes and remedial actions

The transfer of experienced Capita management to this area from other businesses within the Group and the commitment of the Board to address the issues which have come to the fore in 2016 will deliver better outcomes and provide the growth platform the businesses require. In the meantime, the Board monitors this area as one of its critical risks.

11. Failure to effectively manage Group’s talent and human resources

Description

People at Capita are critical to the Group’s ability to meet the needs of its stakeholders and achieve its goals as a business.

Failure to attract or retain suitable employees across the business could limit the Group’s ability to deliver its business plan commitments.

2016 Mitigation and Outlook

Capita’s most valuable asset is its people, and investing in the training and development of those people, and supporting future talent development is a Board priority.

Capita champions diversity and develops talent through a number of activities, including Graduate apprenticeship programmes, a mentoring scheme, Capita Academy education and a leadership development programme. The cost reduction actions and restructuring in Q4 2016 and Q1 2017 will inevitably cause some impact on staff morale and care will be taken to minimise the potential impact of this on any service. The Board accepts that such organisational and people changes raise people and other risks and are closely monitoring to ensure early identification of any issues arising during the process.

12. Weaknesses in acquisition and contracting life cycle

Description

Capita acquisitions and client contracting fail to generate anticipated revenue growth, synergies and/or cost savings.

2016 Mitigation and Outlook

Capita performs pre-transaction due diligence and closely monitors actual performance to ensure we are meeting operational and financial targets.

Any divergence from these plans will result in management action to improve performance and minimise the risk of service penalties or financial impact.

Executive management and the Board receive regular reports on the status of acquisitions and bid and contract activities, with formal review supported by commercial management and Group internal audit.

The integration of businesses through 2016 has, in the main, been well handled with the integration of Capita Europe a good example of integrating systems and policies in light of differing regulatory and legal requirements but also maintaining key controls and growth.

However, lessons learned from less successful contracting and integration during 2016 have been fed back into the process to identify improvements for future growth.

Related party transactions

Compensation of key management personnel                                                                  

20162015
£m£m
Short term employment benefits11.111.9
Pension0.30.2
Share based payments0.86.0
Total12.218.1

Gains on share options exercised in the year by Capita plc executive directors were £6.2m (2015: £4.3m) and by key management personnel £4.5m (2015: £3.2m), totalling £10.7m (2015: £7.5m).

During the year, the Group rendered administrative services to Smart DCC Ltd, a wholly owned subsidiary which is not consolidated. The Group received £40.3m (2015: £29.5m) of revenue for these services. As at the year end the amounts receivable in relation to these services were £7.6m (2015: £6.0m). 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 32 – Employee benefits.

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 17 February 2017 was as below:

Shareholder                                                    No. of shares                     % of voting rights

Veritas Asset Management LLP*                                        81,163,342                                           12.17

Woodford Investment Management LLP                            72,080,139                                           10.80

Invesco Asset Management                                               65,536,317                                             9.82

The Capital Group Companies, Inc.                                   60,297,424                                             9.04

Baillie Gifford & Co Limited                                                50,632,716                                             7.59

BlackRock Inc                                                                     38,567,956                                             5.78

*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:

  1. 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;

  2. the Directors’ report, including content by reference, includes a fair review of the development and performance of the business and 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.

On behalf of the Board
Francesca Todd
Group Company Secretary

1 March 2017

Forward-looking statement

The Directors present the annual report for the year ended 31 December 2016 which includes the strategic report, governance and audited accounts for this year. Pages 1 to 105 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