REG-Capita PLC: Annual Financial Report

CapitaAnnouncement

23/04/2018 14:50

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



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