January 26, 2022

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Edited Transcript of CPI.L earnings conference call or presentation 5-Mar-20 8:30am GMT

London Mar 26, 2020 (Thomson StreetEvents) — Edited Transcript of Capita PLC earnings conference call or presentation Thursday, March 5, 2020 at 8:30:00am GMT

Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research

Good morning. Could I ask people to take their seats, please? Well, good morning, everyone. I’d like to offer a warm welcome to people here in the room at Capita’s head office in London and also to everyone watching via the webcast. Thank you for your interest in Capita and in our 2019 full year results.

Some housekeeping. In the highly unlikely event that we have a fire alarm going off, I ask that you follow those who work with Capita to the staircases down at the far end of the lifts, the elevators, please.

Okay. Before I start, naturally, I have to draw your attention to the legal text on this slide. Next slide, please, Stuart.

So we have made good progress in 2019 even if we’ve not had it all our own way. I’m in no doubt that Capita is in a much stronger position today than it was, though we have much more work to do. And we have certainly laid the foundations for growth in 2020, something I’ll come back to in a minute. And we’ve done that by improving dramatically our employee engagement. We’ve repaired customer service levels and client confidence in us. We now are effectively pivoting to markets with higher growth potential. We’re channeling investment to software products and in-demand transformational capabilities, and we’ve launched our consulting business. I will cover all of these in more detail in my broader section later on in the presentation.

We had to work hard through some tough markets, but 2019 headlines are as expected, with profit in line with guidance we gave a year ago. 2 years ago, we set out targets for 2020, including a goal of GBP 200 million in free cash flow and double-digit margins. Naturally, I and the leadership team are disappointed, we are updating guidance on this today.

The whole leadership team are resolved to deliver the transformation plan, while doing the right thing for the long-term health of the business. This is reflected in our new guidance for 2020. We now expect to grow revenue for the first time in 5 years and to deliver at least GBP 160 million in free cash flow. My confidence in the long-term of this business remains the same, and I am convinced that our plan remains one that is right: to create a more focused, more sustainable, more predictable business, generating, growing free cash flow.

Now this next slide is familiar to many of you and serves as a quick reminder of the overall transformation plan, which is underpinned by 3 imperatives: to simplify, to strengthen, to succeed.

We’re focusing our business on those markets with attractive margins and strong, long-term secular growth trends where we have distinctive capabilities as a consulting, digital-enabled services and software business. And we have made good progress against all 3 of these imperatives, which is presented on the next slide.

This presents an update on the key transformational work streams, and it is a slide, of course, we’ve shared with you before. The lighter dots represent where we are now and the darker dots are the progress we expect to make in 2020.

As we enter the third year of our multiyear transformation, we can look back on significant progress across a range of issues that needed fixing, and I’ll give a lot more details on these later on.

There’s more to do, but we have made the necessary progress, such that my top priority and the leadership’s top priority this year is to deliver organic growth, and that will be the delivery of growth in this business, of course, for the first time in 5 years.

Now let me hand over to Patrick to go through 2019 in detail. Patrick?

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Simon Patrick Butcher, Capita plc – CFO & Executive Director [2]

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Thank you, Jon. Good morning to you all. I’m delighted to be with you after just over 1 year in post. 2019 was the second year in Capita’s multiyear transformation, and a lot has been achieved. There are many signs of progress on our journey towards becoming a simpler, stronger, more successful company generating free cash flow in a sustainable and predictable manner. However, as these results show, progress has been harder and more expensive than we had hoped, partly because we have chosen to invest for the long term and partly because some of the challenges could not have been fully scoped in early 2018.

There is a lot to cover, so I’ll start with an overall summary. Revenue and profits are in line with expectations, with cost reductions offsetting investments, lost revenue and lower margins on some contract renewals. Some of the benefits of the transformation work, such as profit improvements on the 3 challenging contracts, are reflected in the results. While our core growth businesses have largely shown growth in the second half, that growth has been, however, slower than we had hoped. As in 2018, the results have benefited from some one-off items, as is to be expected in a complex group in transition.

The cost and cash management controls and programs implemented over the last 2 years give us a better base and will continue to provide positive returns in 2020. Interest is reduced following the deleveraging in 2018. The balance sheet was significantly strengthened in 2018, but the headline net debt leverage ratio is at the top end of our range, as a result of lower conversion of EBITDA to cash and more investment being required to fix contracts and lay the foundations for growth.

The group has a liquidity it needs to continue the transformation journey. We expect this liquidity to further improve following the introduction of new funds to replace the current debt that matures over the next 18 months. And as part of our drive for simplification, we decided recently to seek to dispose of a number of core — noncore businesses, the proceeds from which will be recycled to strengthen the group. However, as we said at the half year, securing returns on our investments in the form of positive revenue growth and free cash flow generation are the priorities for 2020.

So turning to revenue. As expected, revenue reduced year-on-year by around 4%. This slide details the key drivers of this movement, many of which have been communicated previously. Firstly, the one-off gains of GBP 48 million in 2018 on the termination of the Prudential and Marsh contracts; and then GBP 105 million of flow-through from contracts lost in 2018, such as Prudential, Marsh and the Defence Infrastructure Organisation; and then a further GBP 109 million of contract losses in 2019, including, as we have discussed, in local government and then spread across other divisions.

Delays in local authorities taking back work meant that the impact of these losses were lower than expected in 2019, but the majority of these have now come to an end. This should, of course, be set against strong retention rates on contract renewals, such as over 80% in customer management. Scope and volume change revenue has decreased due to high competition and market pressures in technology Solutions, and lower volumes in our Life and Pension contracts and Real Estate and Infrastructure business.

Our transactional business has declined a little bit, particularly in Specialist Services. Contract wins of GBP 107 million is made up of GBP 67 million from the annualized impact of wins in the prior year, such as Transport for London, Zurich and the Financial Services Compensation Scheme, and GBP 40 million of new contract wins in 2019, various call center and back-office contracts and product sales and software. This, however, was not as much as expected, particularly in the second half of the year, which explains the emphasis we put on the importance of revenue growth in 2020.

Finally, as happened in 2018, there were a number of one-offs arising from termination payments and deferred income releases associated with contract terminations and changes.

We’ve talked previously about 2 businesses, the closed book Life and Pensions contracts and multiyear, multiservice, local authority contracts as being structurally challenged or in runoff.

This is a more granular version of a slide that we have shown before. The light blue relates to the 2 business areas mentioned as structurally challenged, and the dark blue is the rest of Capita. The data is presented on an adjusted half year basis. And this clearly highlights 2 important points. Firstly, as previously reported, the vast majority, some 85% of the revenue decline over the period, is concentrated in just those 2 areas. And secondly, the remainder of the group, taken as a whole, has seen revenues stabilize, and in the second half, a modest return to growth in most divisions.

In 2020, we expect further declines in the structurally challenged business to be more than offset by revenue growth in the rest of Capita, which should result in modest growth for the group as a whole over the year.

The next slide shows the data for the dark blue box analyzed by division. So this is not our total revenue, just that it isn’t structurally challenged. And this slide shows that, after excluding the structurally challenged runoff businesses, all divisions, except Government Services for reasons explained on the slide, grew in the second half. You will also notice that we’ve renamed IT and Networks as Technology Solutions.

Turning to a familiar topic, which is our cost-out programme. This has been one of the most financially successful aspects of our transformation so far. Capita had been run prior to 2018 as a collection of autonomous business units with limited collaboration or central direction. A disciplined, highly-structured program with weekly challenged meetings across the business has delivered cumulative savings of GBP 200 million, including an expected flow-through of GBP 40 million into 2020.

Some examples of that are the consolidation of 26 service desks and software into 1; we’ve closed another 32 properties and reduced our overall property footprint, saving GBP 7.7 million in 2019; integration of business units in Technology Solutions, saving GBP 8 million; and smarter travel using technology, saving GBP 1.8 million. In addition to these year-on-year savings, there have been in-year and one-off benefits. And as we leverage investments, for example, of over GBP 10 million that we have made in robotic process automation and our existing offshore capabilities, there is more to come.

However, as the following slide shows, there is more to the results than just revenue growth and cost-out initiatives. This slide breaks out the revenue and cost impacts on profit. The margin from contract wins and the benefits from improved performance on 3 challenging contracts, which have been highlighted separately, are offset by the combined impacts of contract losses and scope and volume reductions described earlier.

From a cost perspective, the cost savings have been offset by cost inflation, mainly inflationary pay increases focused on lower-paid colleagues, and investments in strengthening functions such as growth. A range of other group-wide actions, such as a lower bonus accrual, resulted in the final profit before tax number which is in line with the range that I communicated at the start of the year. While I appreciate that this slide is busy, it does highlight the number of moving parts in a business that is not yet as simple as we would like.

Looked at from a divisional perspective, margins across the divisions grew from 11% to 12.2%, driven by cost-out initiatives and supported in some divisions such as Government Services and Specialist Services by the one-off benefits referred to earlier. This was offset by an increase in group costs, resulting in a small overall decline in margins. The increase in group costs reflects investments in technology, growth and our new consulting business, which are targeted at the delivery of future revenue growth.

Investments have also been made in other functions to strengthen governance and controls. We now, for example, have much improved controls over the risks accepted in new contracts, which will result in a more stable and predictable business, which Jon will talk about later. These investments provide the resource and control we need to support the business as it grows. In 2020, we will, as part of the cost-reduction work, look for further overhead efficiencies in some of the larger functions included in group costs.

As you know, we adjust profit to take account of items that we believe are not reflective of current trading. In 2018, the net effect of these items was less than GBP 10 million. However, in 2019, it has been higher, which is why we exclude these items from adjusted results. There was a reduction in the amortization impairment of acquired intangibles because: firstly, the previously inquired intangibles run down each year; and secondly, we haven’t made material acquisitions in recent years; and finally, in 2018, there was a one-off write-down of some GBP 62 million.

Restructuring increased as the transformation programme expanded in the year. The impact of business exits was reflected the in-year trading losses of those businesses of GBP 70 million and write-offs of GBP 52 million associated with 2 businesses being exited at year-end. And of course, IFRS 16 was adopted in the year, but its impact is excluded to aid comparison with 2018.

As expected, capital expenditure increased in 2019, in line with the transformation objectives as the investment in property and IT infrastructure continued. 2019 also saw a ramp-up in expenditure on technology and growth. Looking forward, the level of capital expenditure will fall materially as the mix of work changes. For example, as clients move out of on-premise and data center solutions to cloud-based architecture, CapEx reduces and OpEx spend with cloud providers increases.

Turning to cash flow. The first component of total cash flow is adjusted free cash flow, which is one of the key metrics established at the time of the rights issue in 2018. On this slide, we have analyzed working capital to separate out the effect of contract-driven movements such as deferred income, accrued income and contract fulfillment assets. This, plus EBITDA, gives cash from trading operations, which I think is a more helpful way to think about these movements rather than describing them as working capital outflows and provides a more stable and consistent view of the operating cash flows being generated by the business. This change has allowed us to focus in on the management of real working capital. We remain committed to paying all suppliers in line with the prompt payment code. However, through improving and standardizing processes and controls, we are looking to improve our performance in our management of debtors and creditors in 2020.

As described earlier, CapEx has increased. The tax line shows the impact of the tax refund received in 2018 following the implementation of IFRS 15, and finally, in 2018, the impact of the GBP 110 million to clear the receivables financing. However, that’s not the whole cash flow story. As in 2018, there are a range of other cash flows that impact net debt. We continued to pay down our pension deficits in line with the plan agreed in 2018. This, combined with the cash flow associated with the restructuring spend earlier, contributed to an increase in net debt of around GBP 330 million. Other cash flows include the payment of dividends to joint venture partners.

At the time of the rights issue, we expected to invest GBP 720 million over 3 years. Over the last 2 years, through a mix of operating costs, restructuring and capital expenditure, we’ve invested some GBP 650 million spread across the 3 categories identified. The table at the bottom of the slide shows that an increase in proportion of the investment is in operating costs and restructuring. The restructuring spend will continue into 2020, although at a lower level. And as I’ve said earlier, CapEx will also reduce in 2020 as the business mix changes. Overall, this will result in investment nearer GBP 800 million, excluding the impact of 2020 OpEx investment. We will also make the final payment in the agreed 3-year deficit reduction plan on our pension scheme.

A few words on headline net debt. Last year, the business had GBP 640 million worth of cash. GBP 200 million of this was used to pay down debt that matured in 2019. The business cash outflow of GBP 330 million was a bit higher than expected, reflecting movements already described, resulting in headline net debt being at the top of the guidance range. But as we have said, while we remain focused on cost and cash management, it is taking longer than we had thought and requiring more investment.

The chart on the bottom left shows that our net debt is lower over the last 2 years and much more stable as we managed period ends differently. For 2020, we expect headline net debt to be in line with current consensus — sorry, for 2020, we expect headline net debt to increase modestly, and going forward, to then decline as we reach the end of the restructuring changes and complete the final payment in the 3-year pension deficit reduction plan.

A few words on outlook. In the light of the investment that has been made in building platforms for growth, we expect that revenue growth in our core businesses will translate into modest organic revenue growth for the group as a whole in 2020. Contractual working capital outflows will reduce by more than GBP 120 million as a result of known contract movements. And our planned focus on the management of debtors and creditors will generate further benefits. Capital expenditure, as discussed earlier, will reduce significantly in 2020. And so adjusted free cash flow is expected to be at least GBP 160 million. As a result of planned restructuring in the last of 3 agreed payments towards our pension deficit, net debt will rise modestly. All of these items are before taking account of the impact of potential disposals and the impact of IFRS 16.

I’ll now hand you back to Jon.

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Jonathan Lewis, Capita plc – CEO & Director [3]

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Thank you, Patrick. As I said in my opening remarks, we have made significant progress over the last 2 years, and we are clearly in much better shape than we were in early 2018, and we have now set the foundations for growth. In this section of my presentation, I will provide more details of this progress, starting with an update on our initial focus on fixing what we inherited.

We have done a lot of the heavy lifting on this and thereby have substantially derisked our overall transformation plan. This creates the stable platform we need as a precursor to delivering long-term sustainable revenue growth and growth in free cash flow. As it is my top priority this year, the second part of my deck will then go on to talk in more detail about how we plan to achieve this. Next slide.

As a services company, we are only as good as the ability of our colleagues on any day to delight our clients’ customers. And I would like to take this opportunity to thank all of our colleagues for their hard work in 2019, which was another demanding year.

We aspire to become a truly progressive, purpose-led, responsible business. And our blueprint sets out 4 principles shown on this graphic, in support of our purpose, which you will remember is we create better outcomes. This defines our desire to serve society and to drive value for all of our stakeholders.

Our purpose-led responsible business blueprint has progressive elements beyond those you would find in a typical ESG strategy, and this has unquestionably helped us attract talent and change perceptions of Capita in the last 2 years. One important government stakeholder told us, and I quote “Capita’s commitment to be at the forefront of social responsibility is recognized and welcomed by government.”

We need to invest in our people if we are to delight our clients. And we, therefore, took the decision to guarantee the real living wage for our U.K. staff effective the 1st of April this year. This improves the salaries of circa 6,000 people, 6,000 of our colleagues here at Capita. Together with improved parental pay and life insurance packages, we estimate the cost in 2020 will be circa GBP 10 million, more than we planned when we put our transformation plan together in 2018. However, the long-term benefit will be seen in further improvements in employee engagement, something I’ll come back to, lower levels of voluntary departures, and therefore, lower recruitment costs and reduced cost of poor quality.

Two data points support this progress. I’m delighted that we have seen a 14-point improvement in this year’s net — employee Net Promoter Score, and 72% of our colleagues are now proud to work for Capita, which is a huge improvement in the just over 50% who would make that statement 2 years ago.

The benefits of having an engaged and motivated team of colleagues can be seen also in the market increase in voluntary attrition over that same period and an improved customer Net Promoter Score, something I will also come back to.

For the first time in many years, in Q3, our third-party defined reputational measure amongst external stakeholders became positive. I want to emphasize that this is not about corporate ego, but is an important proxy for the improved operational performance that underpins Capita’s transformation progress to date. And we are now much better perceived by broader, particularly influential, stakeholders. In summary, this is a key foundational element to our much improved license to operate, a theme that will run through the rest of my presentation. Next slide.

In 2018, many of you will remember, we established a contract review committee to make sure that there is a consistent form of governance over any contract and scope of work we sign up to. Major improvements have been made to ensure that we derisk the scopes of work we committed to going forward. We have now embedded a more disciplined approach to what we choose to bid and the risks and financial returns we seek from those bids.

For example, a much more detailed contract execution plans are defined prior to bid to flush out potential problems, rather than simply focusing on PBT. Cash returns over the lifetime of the contract also play a significant part. This means we decided not to bid on a number of contract opportunities in 2018. This included a highways agency contract, where the opportunity cost was too high; and an enforcement services contract, where the scope, terms and pricing opportunity did not match the risk profile we are willing to accept. Strategy also plays a key role here, of course.

The Executive Committee also — now also regularly reviews early-stage operational performance on contracts to ensure that implementation is going to plan. There is also a tie-in here to investment we have made in our skilled program managers and in the evolved proprietary program management tool we have been using the last 18 months.

And we have now also put in place a continuous process for feeding lessons learned back into the bidding process. We can already see the benefits of this far more disciplined approach. Contracts signed since 2018 have experienced far fewer operational issues than the legacy portfolio we inherited. And I’m pleased to say that the average net margin on contracts signed since 2018 exceeds 10%. The CRC then is another core building block of our transformation that makes Capita a higher-quality, lower-risk business now and in the future.

Now failing to deliver on our commitments to too many clients, including some very high-profile contracts — on some very high-profile contracts, has been a drain on our resources for many years. Many of you are very familiar with these. And we have spoken regularly of fixing 3 key contracts. We remain on track to breakeven on each of these this year. And we are, perhaps, more importantly, now embedding many of the lessons we’ve learned across our entire contract portfolio.

I’ve worked in other industries where cost of poor quality, COPQ, metrics are well-established, ultimately forming part of the routine performance management and pay for managers. We’ve created a new policy and methodology tool to begin to do the same at Capita, and you will expect me to update you — you can expect me to update you on this regularly.

In 2019, I’m pleased to report that we saw a marked improvement in contract delivery performance. We are now hitting 92% of our key performance indicators on our entire portfolio of contracts. And while not directly comparable, we have also seen a 70% decline in the penalty payments to clients, as you can see from the graph on the right. We are doing a far better job today than we were 2 years ago of delivering against our client commitments. This has come at an additional short-term cost, as we rebuild our clients’ trust in our ability to deliver a fundamental and necessary precursor to us growing the business.

Now the benefits of an ever more client-centric approach and investment of fixing poorly performing contracts can be seen in our improving client Net Promoter Score, which is in positive territory for all of our divisions for the first time. This was a major contributing factor to the reduction in revenue attrition in 2019. I’m particularly proud of the swing of 35 points in 1 year in our Government Services division, no small achievement. And the improvement speaks to strong key stakeholder management, investments we have made to improve our service delivery and alignment of our values and sense of purpose with what government, in particular, now expects of its strategic suppliers. This is an essential element of our ability to win future government work, and it is another indicator — sorry, another indicator of client satisfaction is our contract renewal rates, also showing a healthy improvement in year, excluding People Solutions where we have more work to do, the renewal rate in 2019 was 91%.

Now our recruitment contract with the British Army, a contract to digitize and improve the process of recruitment, has also made very significant progress. This contract is, in fact, a great example of the impact the investment we have talked about can have.

In 2017, 5 years into this contract, the contract was failing, and the relationship between ourselves and the Army and the MOD was broken. In fact, recruitment in the Army was a national issue. In 2018, we successfully reset the partnership with the Army at very senior levels, and both parties agreed to invest in the execution of the scope of work.

In 2019, we have delivered dramatically better performance for the client and are currently within a few recruits of the regular soldier recruitment target of 9,404, or 9-4-0-4, for the 12 months ending March 2020. I am very confident that we’ll get there in the next 3 weeks, which will be the first time we have hit the target since the contract began.

We have also improved other aspects of this contract as part of our broader digital transformation on that engagement. For instance, our candidate conversion rate is now 1 in 8, materially better than other complex public sector programs, such as the police.

Now in 2019, we continue to review our business portfolio in line with our ambition to simplify Capita and focus on becoming a consulting digitally-enabled services and software technology business. To date, the portfolio simplification is focused on our Specialist Services division. This was put together, you’ll remember, in 2018 and included several stand-alone businesses that did not naturally fit with our overall growth platforms and that would be, therefore, managed for value.

We have concluded that a number of these assets, including our government JVs FERA and AXELOS, would benefit from closer alignment with our core growth platforms. The regulated businesses, Life and Pensions and mortgage services and the Irish-based customer services business are moving to Customer Management, where they will benefit from shared best practice.

Some of the other businesses in Specialist Services are likely to benefit from the focus of new owners, and we are progressing disposal options as we speak. Clearly not appropriate to give any more details at this stage, as you will understand, but we will keep you updated as and when we can. As Patrick has mentioned, the benefits of this simplification will be used to strengthen the core business.

Now the second part of my presentation focuses on our plan to deliver revenue growth. Since 2018, we’ve learned a great deal about Capita. Looking back, we now realize we underestimated the amount of effort it would take to fix all the issues we inherited. However, this is today offset by our increasing confidence in our ability to grow revenue. At the half year results in August, we talked about the role emerging growth opportunities would play in our overall transformation.

It is well known that Capita hasn’t grown organically for many years, and yet the markets we serve are benefiting from long-term secular growth trajectories. And there are 2 questions I ask myself and my team. One would be, why haven’t we been growing? The second would be, and why do we believe we can grow in 2020?

Taking these in turn, why haven’t we been growing? First, we have been far too reliant historically on simply responding to tenders and then essentially winning on price alone rather than using our deep expertise to truly understand clients’ needs and collaborate on solution design and sharing in more of the value created. Second, we were particularly good at winning one-off contracts, but that reduced our ability to reuse components successfully and didn’t always mean we cherished our client relationships as we should have. Thirdly, instead of investing in innovation of products, we prioritized diversification through acquisition. And finally, we had to deal with the extra pressure from the slowdown in contracting as a result of austerity and political uncertainty here in the U.K.

And why are we — why am I now confident in our ability to grow this year? Well, firstly, the market opportunity is large, growing and the client need clear, although this is assuming no major market dislocations associated with coronavirus.

Conventional analysis on Capita usually focuses on the relatively low growth government outsourcing or private sector BPO markets, where we have, of course, significant presence and ongoing opportunities, but that does not capture all of the more dynamic consulting, digitally-enabled services or software markets, which we are also exposed to.

I’m sure you are familiar with how advances in AI, robotics, IoT, 5G, cloud and cyber are throwing up opportunities and some threats to businesses and governments. Either way, they are looking to us as well as others for help. Our clients have told us they want us to be far more proactive than we have been historically, not reactive to tenders. They want us to offer them more transformational services and to innovate and lead them through the next phase of their business change.

In PwC’s Global CEO survey last year, 81% of CEOs agreed that technological progress, read digital transformation, will fundamentally change their organizations. This comes together in a U.K. digital transformation market estimated to be worth GBP 36 billion annually and growing at 12% per annum, with the U.K. being right at the forefront of this dynamic trend.

Using, very importantly, a practitioner mindset developed from being responsible for executing today many of the business processes that need digitally transforming, we have already begun to build a track record applying these solutions to our clients, but there is more we can do.

The graphic on the right of this slide captures how our business model has evolved to address this. Consulting is the front end, working with clients to design solutions, which are implemented in the change or transform phase, which then moves into the operational process or deliver phase.

The plan to deliver growth, as we flagged at the half-year, has four distinct parts to it. First, we

have refreshed the Capita brand, by which I don’t just mean the new imagery. We have engaged with our clients and conducting then an advertising campaign to help people understand what Capita now stands for, a modern, purpose-led, innovative differentiated business.

Next, and for the first time at Capita, we have defined all of the products and services we sell, and our first cut of the data showed we had more than 180. From this long list, we were able to identify clusters of capabilities and products that best aligned to our clients’ needs, which are scalable and repeatable, and these now inform our investment decisions.

Third, we have addressed our lack of sales proactivity by promoting a consultative sales process launched, Capita Consulting, I’ll come back to that, and restructured sales incentives.

Finally, we have recognized parts of our account management approach. We’ve adopted a single instance of CRM Salesforce across Capita, and we are rolling out dedicated expert client partners, who are responsible for understanding their clients’ needs and bringing all the relevant parts of Capita to them. Let me now go into each of these in a bit more detail.

At the beginning of 2019, we commissioned a comprehensive third-party study into what our clients thought of us and wanted from us. This gave us clear insight that our clients thought that Capita was a strong and resilient brand in the B2B and B2G spaces, in stark contrast to how we’re often portrayed in the media in the more familiar B2C space.

As the chart on this slide shows, and perhaps this comes as a surprise to some of you, the Capita brand’s — the Capita brand holds its own in the international tech-enabled professional services peer group, and we are significantly ahead of traditional outsourcers. Our clients trust us to know their sector and their business needs inside out, often better than they do themselves, and to be able to deliver complex transformation projects. And in the market today, we are displacing more established incumbents, as you can see from some of this year’s wins against the so-called top 3 on this slide.

More than half of our investments in the past 2 years have been in our software products, where we have leveraged the benefits of the 1,200 people, who now work at our digital development center in Pune in India. They’re focused on optimizing product management, driving standardization and reducing development life cycles.

We used to have a slow waterfall or monolithic development process that was subscale, fragmented and can take anything up to 18 months to deliver new product. We now have an agile 13-week target development cycle that has dramatically increased our ability to deliver innovative client solutions more quickly.

In 2019, and we delivered cloud-enabled versions of SIMS, Retain and our One platforms, as well as SaaS, Software-as-a-Service, enabling core enterprise products to enter new markets, particularly mid-tier markets, such as our flow product solution for the utility challenger brands.

We’re expanding our core platforms to increase our client offerings. For example, our SIMS education ecosystem now offers new applications such as SIMS Pay and SIMS Finance as well as new analytics dashboards such as curriculum-led financial planning. We are also exploring new adjacent opportunities, such as Literacy 360, into the reading assessment space. Returns from these investments made over the last couple of years underpin our target to grow software revenues by mid- to high single digits in 2020.

Now as mentioned a few moments ago, during 2019, we went through a major exercise to define our market offerings, and we now have a much better sense of which of our products and services our clients need the most. We have identified 6 foundational or transformational capabilities, which capture a significant proportion of the opportunity in our addressable market. And we are not newcomers to this party. We already do a lot of work in these areas, but we were rarely joined up, so historically, investment was inefficient and uncoordinated, and we lacked scale, and we were unable to capitalize on growing market demand as we might.

As a first step, we have now appointed leads to each of the 6 capabilities. They are responsible for coordinating Capita’s capabilities in the space and implementing superior go-to-market or commercialization approaches to develop and win new work. You can expect regular updates from me on how we are progressing across all 6, and I will kick off with more details in a moment on automation and IoT, the Internet of Things. But before I do that, a very brief introduction to the other 4.

Customer experience is about designing processes and adopting a range of digital technologies to deliver a seamless service for the end user, our clients’ customer. It is a measure of how intuitive and relevant the customer journey is as well as how reliable and cost effectively it can be delivered for our client. We are combining existing resources with additional hires and investments in technology, such as Dragonfly, with our intimate knowledge of clients’ operations and needs to enhance our customer experience offerings. The Dragonfly team are here today, along with Munnypot, 2 of our investments in technology start-ups through Capita scaling partners. Please do go and talk to them and see a demo of their, I have to say, rather cool products after the formal presentation has finished.

Data and insight at its core is about using information to make better decisions. The possibilities here are growing every day, of course. An interesting example of this is our work with law enforcement agencies using a range of sources, including social media, to speed up their ability to identify potential or real emergencies. Using the cloud brings quicker, cheaper, scalable and more agile services to clients. We’re working with a major media company here in London to advise them on their cloud migration strategy. And more than 20% of the pipeline of opportunities in our Technology Solutions division today speaks to cloud enablement.

Cybersecurity is particularly relevant in our long-standing client base across government, utilities and financial services, for whom we have a strong track record of delivering networks and technology infrastructure. Cyber is a natural extension of this capability.

Let me now turn to automation and IoT. Well-designed and correctly implemented automation drives efficiencies, greater reliability, accuracy and speed. And Capita’s experience working on automation projects goes back many years. For example, we have been running several hundred bots for O2 since very early on, on that contract term.

We’ve now coordinated our previously separate teams and ramped up this capacity over the last 2 years, initially to apply automation internally to existing and new contracts. As the U.K.’s largest outsourcer, we are ideally — we are an ideal test bed for such technology, something we have absolutely leveraged. Today, Capita is one of the largest — has one of the largest dedicated robotic process automation teams in the U.K. And now the priority is to take this experience and know-how we have gained to market.

I think it’s too early to know how far automation will go. The ONS, for example, has predicted that 1.5 million roles in this country could be automated in the future. But whether this is right or not, we are now superbly positioned to take advantage of this.

A good case study in our application of RPA is to the peak period GPN — GP pension submissions in our NHS PCSE contract, which has delivered major improvements to all stakeholders. We’ve halved the time it takes for submissions to be processed. We’ve significantly improved accuracy, and perhaps more importantly, we have freed up advisers to spend more time helping doctors with more complex challenges.

Now in IoT, Capita is already a leader in designing and managing a number of very large and structurally complex contracts. This, again, is a natural evolution of our work in networks and infrastructure, contracts such as the Scottish Wide Area Network and the work we’ve done for Transport for London around congestion charging and the ultra-low emission zone solution.

We help our clients to gather and unlock large amounts of data in a secure and reliable way to make customer experience better and create efficiency in their operations. Capita subsidiary, the Data Communications Company, or DCC, were set up to support government policy to design and roll out smart meters in the U.K. energy system. The scale of the DCC network is already impressive. It sent more than 500 million encrypted messages in 2019 alone. So far, it has connected 4 million second-generation meters and is migrating more than 14 million first-generation meters on to the network.

In time, the network will connect 30 million homes and businesses across the U.K., some 99% of all premises. It will then, at that point, be the largest IoT solution in the country designed, implemented and run by Capita.

As a secure network, its data and connectivity applications have significant potential as an IoT platform for the long term, bringing with it potential for many further opportunities. And in ever more connected world, our IoT expertise will increasingly be valued.

Now one of the most significant events of 2019 for me was the launch of Capita Consulting. It’s a new brand reflecting a more practitioner approach, but we’re not starting from scratch. Capita has owned a number of small consultancies for some time, but they were subscale and not designed or particularly effective at driving pull-through revenue for the rest of the business. They also tended to focus on internal to Capita versus external client opportunities.

In the second half of 2019, we brought these businesses together. This included our data science teams at Barrachd and our customer experience — customer digital experience teams at Orange Bus. And we have now brought further 30 client partners and industry experts together with that, sourcing from both our existing talent pool and new hires from the big 4 and digital service providers. I have been particularly encouraged by the caliber of talent we have been able to attract to our consulting business. We have now over 40 partner-level individuals running that business.

A strong consulting front end in which we proactively work with clients early on in the sales process to co-create solutions will reduce over time our reliance on the timing and tenders of — timing of client tenders.

It also leverages one of our core assets, our position as the U.K.’s largest outsourcer. Put simply, we know more about our clients’ business processes and their technology needs than almost anyone else. Who better then trust to safely design and deliver a change to a current business process than the entity who does that work for you today? This practitioner-led model is a major differentiator in the market when clients compare us to our digital transformation peers. We understand them in ways others don’t.

In 2020, from a base of GBP 12 million in revenue, we expect to grow this business to closer to GBP 50 million. More importantly, we are targeting the rest of Capita to benefit in the region of around GBP 250 million of total pull-through contracts. That’s TCV. We will not see all of the benefit of that revenue in 2020.

Now we can’t talk about all of the clients for whom we’ve already engaged with through our consulting business, but I’m very pleased with the traction we are gaining in the market today, as indicated by the logos on this slide. We launched this in December. I’m very pleased with the velocity at which opportunities are developing.

Now experience with TFL neatly summarizes everything we have talked about today and what happens when we deliver on one scope of work, and in so doing, create a platform for additional Capita offerings. Indeed, our business with TFL is a microcosm of what we wish to achieve across many of Capita’s clients and evidences the rationale for our strategy.

We have transformed our position with TFL from performing badly a few years ago on 1 contract in 1 division to delighting the clients across 4 divisions today. Daily for TFL, customer management provides front office, multichannel services to over 5,000 of their customers. Capita Software’s Pay360 platform collects over 16,000 payments. Capita’s Technology Solutions manages the infrastructure to capture 1.4 million vehicle movements, and 13,000 physical documents are managed by Capita Specialist Services. And the result for our client is that TFL has delivered a 35% reduction in nitrous, NO2 emissions in the first 6 months, the equivalent of around 200 tonnes. And as of March 14, Capita technology services will have completed the infrastructure or the implementation of mobile telephony, the mobile telephony infrastructure for the Jubilee Line. Over the past 2 years, our TFL revenues have almost quadrupled with a healthy pipeline of new opportunities to go after. Again, it is a microcosm of what we wish to achieve across many of our larger clients and evidences the rationale for our strategy.

As a reminder, we have improved employee engagement, repaired customer service levels and confidence in us, pivoted towards growth markets, channeled investment to software products and in-demand transformational capabilities and launched Capita Consulting. Put simply, we have already done a lot of the heavy lifting, which has substantially derisked the transformation since 2018.

Now the priority is to deliver growth. The price remains the same, to deliver sustainable and growing cash flows for the long term. Thank you for your attention. And Patrick and I will be very happy to take questions.

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Questions and Answers

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Robert John Plant, Panmure Gordon (UK) Limited, Research Division – Analyst [1]

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It’s Rob Plant from Panmure Gordon. You’ve clearly set out that in consulting and digital and IT, you’re not keeping up with the market. I just wonder if you ever worried, would — are your businesses good enough? I just — I’m concerned that Capita is too small, you’re too diverse, your balance sheet is fairly stretched to compete against big international IT and tech firms, and you’re just going to keep losing market share.

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Jonathan Lewis, Capita plc – CEO & Director [2]

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Look, as I indicated on the material we’ve shared, we compete with many of those same entities today, and we are able to win against them. I think what differentiates us is our deep domain expertise. I was at pains to point out our practitioner understanding and experience in that section. We are the U.K.’s largest outsourcer. We are managing back-office processes for more entities, more FTSE companies and sections of government than anyone else. And one thing I learned many years ago in the application of technology is that it is an understanding of those business processes and your ability to leverage your understanding of those business processes to effectively and successfully implement technology platforms, that is, if you like, the secret sauce. I did that for 10 years in software in the States when I worked in oil and gas. That practitioner understanding is what differentiates us and why we believe we can be an effective competitor in this space. And those are growing opportunities for us today. Paul?

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Paul Daniel Alexander Sullivan, Barclays Bank PLC, Research Division – Director & Analyst [3]

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Great. It’s Paul Sullivan from Barclays. Just a few on cost, the positive P&L contributions this year. What was the expectation when you set targets at the beginning of 2019? And what do you envisage the movements in 2020?

And then just following on from that, the GBP 41 million of one-off cost positives, that seems very high. A little bit of sort of color there. Can you provide some sort of color on the group central costs for 2020?

And then when you think about sort of the bigger picture, your 10% margin target for 2020 that you set originally, that does feel like it was plucked out of thin air. Could you give us any comment because it seemed have been dropped.

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Jonathan Lewis, Capita plc – CEO & Director [4]

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I’ll let Patrick talk about the initial financial questions, and I’ll come back to the margin comment.

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Simon Patrick Butcher, Capita plc – CFO & Executive Director [5]

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Okay. So the key slide on costs is the — sorry, is the GBP 105 million that is in the year-to-year bridge from ’18 to ’19, where you can see on the page that we are — it’s Page 11. And we’re expecting GBP 40 million of that to flow through into 2020. We’ve got cost programs that will deliver, yes, further savings into 2020. As I described earlier, the — as we look into 2020, we’ve got some revenue headwinds on a local government work, which left towards the very end of 2019, so that’s a headwind in. And I’ve talked about lower margins on contract renewals. While we’re still hitting, as Jon said, through our governance process, double-digit margins, cash margins over the life for those contracts. Yes, there’s — Capita has a mix of high-margin and low-margin activities. In the second half, we had a number of quite high-margin contracts that we renewed. So we’ll continue to focus into 2020.

On the group costs and support services, we — it’s difficult to overstate what wasn’t here a couple of years ago. And so we had to make a lot of investment in what you would regard as, in a large business like this, a basic control, so the commercial controls we’ve talked about, implementing the new sales system that Jon talked about. We’re implementing a new HR system. We’ve made investments in financial systems and controls, yes, strengthened the legal department, strengthened HR. So that’s driving that, plus, obviously, investment in the consulting division and all of the client account managers and the growth activity that Jon has talked about. And so that sort of level of investment is going to continue into 2020.

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Jonathan Lewis, Capita plc – CEO & Director [6]

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So Paul, you know me well enough to know that I would not have plucked a number out of the sky. A great deal of diligence went into modeling the commitments we made for 2020. At that point in time, we didn’t appreciate the amount of investment, the sheer amount of investment we would have to make in the business. We didn’t appreciate the degree to which we would see the level of revenue attrition we have, and we also didn’t appreciate the switch between CapEx and OpEx. We are spending less on CapEx because of the nature of the business today. We are spending more on OpEx, all of which, of course, impacts [PBT], and that is why we have come off that number. We are 2 years into a multiyear transformation. As an investor in the business, and I am a substantial investor in the business, I want to see that we are growing the top line and that we are growing cash generation. That, we believe — those, we believe, are the 2 fundamental measures that really determine success in executing the transformation. And that is why we’re focusing on those 2 metrics. Suhasini had a question here.

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Suhasini Varanasi, Goldman Sachs Group Inc., Research Division – Equity Analyst [7]

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Suhasini from Goldman Sachs. A couple from me, please. You mentioned that you had originally planned for GBP 720 million of investment, restructuring and transformation costs, and that’s moving to GBP 800 million, excluding additional OpEx investments in 2020. Can you give a little bit of a breakdown on this additional GBP 80 million spend and maybe quantify the OpEx spend for 2020, please?

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Simon Patrick Butcher, Capita plc – CFO & Executive Director [8]

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So the OpEx spend is going to be at about the same. If you look on Slide 18, you can see that in FY ’19, we’re calling out GBP 76.9 million of operating costs as investment. That will broadly continue into 2020.

In terms of the restructuring spend in 2020, it is more of the same. There’s no fundamental change. We’ve got more to do to continue and restructuring the central functions that — about half of it will go on cost to achieve the savings that we’re looking to get in 2020. We’re still — while we’ve made really good progress on a number of our contracts, we’ve got a number of businesses where we’re still reorganizing and restructuring them, and that requires additional resource as they go through that transition. A good example of that would be our pensions administration business, where it’s absolutely core to Capita in the long term. It’s business processing. But what we’ve typically done is, as we’ve taken on — and this is in our People Solutions division, as we’ve taken on contracts, we’ve sort of designed the process for each contract. So we’ve got literally hundreds of contracts, all of them working individually. And so there’s a big investment which we call project fortify, which is to, yes, restructure, redesign the processes, standardize where we can. It’s a great opportunity to implement robotic process automation. So there’s a — yes, that’s just an example.

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Suhasini Varanasi, Goldman Sachs Group Inc., Research Division – Equity Analyst [9]

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One is on your revenue growth for 2020. I think, for software, you mentioned that you expect to grow mid- to high single digits. Can you give some color on some of the other divisions, please?

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Jonathan Lewis, Capita plc – CEO & Director [10]

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Yes. I think the first thing I would say about growth is that we have spent the last 2 years putting in place improved offerings, understanding the markets we wish to focus upon. We spent the second half of last year investing in what we call our client value propositions, and those are specific to each of the divisions. We have dramatically improved the competency of our salespeople. The quality of sales insight and market insight we have is far superior through what we’re doing with Salesforce than we’ve had historically. We’ve upped the competency and capability of our sales individuals. And of course, we have Capita Consulting, which, as we talked about in the presentation, we believe will create pull-through opportunities. Each of the growth platforms, therefore, we anticipate delivering modest revenue growth in 2020.

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Thomas Richard Sykes, Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research [11]

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Tom Sykes from Deutsche Bank. I wondered if you could just help us bridge to the GBP 160 million of — or at least GBP 160 million of free cash flow, obviously, particularly the kind of combined deferred income, AI, et cetera, working capital and CapEx. Because if you’re having quite a significant swing in working capital, how can you convince us that the rest of the group is actually generating much cash in order to get to that GBP 160 million?

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Simon Patrick Butcher, Capita plc – CFO & Executive Director [12]

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Okay. So the best slide to look at, as I answer this question, is Slide 16, which is the adjusted free cash flow. As I mentioned in my remarks, the movements in deferred income — so for example, if you get to the end of the contract or you terminate or restructure a contract early, you then release the deferred income on the balance sheet. That shows up as revenue and profit and then shows up in the working capital statement as an outflow. And that, to me, isn’t the best way to look at it. So what I’ve done is put together the contractual working capital movements, that deferred income, contract performance assets and accrued income. And then if you take that with EBITDA, you get this metric that I’m calling cash from trading operations. And I think that’s a better measure of the extent to which the operating business is generating cash flow. And so we expect, as we move into 2020, that, that — that our conversion of EBITDA to cash is going to go from roughly 42% as of this year to about 72% next year because we can see upfront what’s going to happen to deferred — to those balances because they’re on long-term contracts. So that contractual working capital of minus GBP 228 million is going to be significantly lower. We’re calling out about GBP 120 million lower, and that then gives you more cash from operations.

Then if you go down to CapEx, we described the change of our business model. We’ve done quite a lot of investments in IT, infrastructure, property, so CapEx will come down to below GBP 100 million for next year. And then as I mentioned, now that we’ve got a much clearer view on — or sort of real working capital, the traditional debtors and creditors that you’re all familiar with, we’ve set up a specific program to focus on that. And that will result in the sort of real working capital being inflow, and then the combination of those numbers gets you to the GBP 160 million.

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Thomas Richard Sykes, Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research [13]

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Sorry. What’s approximately the level of working capital inflow you would expect if you hit consensus?

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Simon Patrick Butcher, Capita plc – CFO & Executive Director [14]

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It’s going to be GBP 30 million to GBP 40 million.

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Thomas Richard Sykes, Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research [15]

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GBP 30 million to GBP 40 million. Okay. And then if you don’t dispose of any companies, what’s the rough leverage that you would expect to get to, if you’re at GBP 160 million? Because…

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Simon Patrick Butcher, Capita plc – CFO & Executive Director [16]

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So if you do the math, we’re guiding that net debt is going to go up, and we’re guiding that cash from trading operations is going to go up, but a chunk of that is working capital. So EBITDA is going to come down. So net debt is going to rise. We’re comfortable that, over the medium term, the right metric is — in pre-IFRS language because, of course, it will change, is between 1 and 2x but it will be above 2 for 2020.

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Jonathan Lewis, Capita plc – CEO & Director [17]

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And in terms of this year’s EBITDA, what’s the level of noncash-backed profit that you’re looking at…

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Simon Patrick Butcher, Capita plc – CFO & Executive Director [18]

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That’s just the — I’ll answer it the other way. It’s that 42% to 72%.

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Thomas Richard Sykes, Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research [19]

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Right. Okay. And then finally for me, just when you look at some of the larger businesses in the group, so software, in particular, SIMS, AXELOS, how are you — and the high-margin business, so the social housing software as well, what’s the budget for them? So SIMS and social housing, are you expecting those to actually grow?

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Jonathan Lewis, Capita plc – CEO & Director [20]

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So Tom, we’re not going to reveal budget by product family, but…

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Thomas Richard Sykes, Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research [21]

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But you haven’t really — it’s unfair. You haven’t really discussed the profit movements by division there in the appendix, rather than in your presentation. So we’re just trying to get some granularity on what’s happening in parts…

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Jonathan Lewis, Capita plc – CEO & Director [22]

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Yes, what we — what we did say, of course, is that the lion’s share of our CapEx investment has gone into the software business over the course of the last 2 years.

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Thomas Richard Sykes, Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research [23]

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Right. So the ROIC on that businesses has come down. Then isn’t that the main…

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Jonathan Lewis, Capita plc – CEO & Director [24]

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Well, that is another business where we have had to — we had to take 29 separate software businesses that weren’t integrating, which weren’t innovating at the pace they needed to innovate. We’ve invested in product management. We’ve invested in the development center in Pune to improve the output from that division. And we’re starting to see that now in terms of order book. And if you look what happened to the order book in software in 2019 increased. In fact, our book-to-bill ratio was 106%. We didn’t see that reflected in the revenue because a lot of that is migrating to SaaS, and we’re seeing that revenue realized over a longer period of time. But if you were to ask, are we starting to see the impact and benefits of the 3 years, some of this predates this leadership team, 3 years of work that’s being done to integrate, rationalize, streamline and focus on those core markets where we believe we have long-term growth opportunities. Yes, we’re starting to see benefits of that.

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Thomas Richard Sykes, Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research [25]

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And sorry, a final follow-up on that is just on the shift to cloud and the changes that, that does do to your revenue recognition and the profitability. Is that going to have a significant effect at all on the operating profit, as you would see them? I mean, how much of SIMS, for instance, is cloud based? Or is it still largely installed, so it’s kind of incremental sales?

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Simon Patrick Butcher, Capita plc – CFO & Executive Director [26]

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Okay. So if you take the conversation to the group level, there are — there is a change in mix, which is less CapEx, more OpEx, but over the — yes, once you’ve kind of gone through the change, you get back to where we want to be. In software, specifically, if you — why did the margins come down in 2019? There was some increased costs we incurred as we went into — we sought to go into the U.S. market. We’ve reduced that — we’ve — market entry. There’s a bit of change there. And then there was some specific change revenue that you normally get every year as government rebases benefits, and then we make the changes, and then we charge like the authorities for the changes in that very high-margin work that wasn’t there. And then as we’ve talked about, we’re transitioning to this digital delivery center. And so that means you’re building up capability in India, and there’s a little bit of double running cost, and that will start to come out. So we would see software margins normalizing at around where they were last year.

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Jonathan Lewis, Capita plc – CEO & Director [27]

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Thanks, Tom. We’ll do one more question. I think there’s a gentleman. Yes.

In that case, thanks very much, everyone, for your interest in Capita. Good morning.

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