IAS 1 para 25, going concern uncertainty, note, viability statement, emphasis in audit report

Capita plc – Annual report – 31 December 2017

Industry: support services

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (extract)

(b) Basis of preparation

The consolidated financial statements have been prepared under IFRS where certain financial instruments and the pension assets have been measured at fair value. The carrying value of recognised assets and liabilities that are hedged are adjusted to record changes in the fair values attributable to the risks that are being hedged. The consolidated financial statements are presented in pounds sterling and all values are rounded to the nearest tenth of a million (£m) except when otherwise indicated.

In determining the appropriate basis of preparation of the financial statements for the year ending 31 December 2017, the Directors are required to consider whether the Group can continue in operational existence for the foreseeable future. The Board has concluded that it is appropriate to adopt the going concern basis, having undertaken a rigorous assessment of the financial forecasts and with consideration of the anticipated net proceeds from the announced Rights Issue which the Board is confident will be approved.

The Group’s committed revolving credit facility, bank term loan facilities and private placement notes are subject to compliance with covenant requirements including maximum ratios of adjusted net debt to adjusted EBITDA. The Group’s covenanted maximum ratio is 3.0 times or to 3.5 times depending on the debt instrument in question. They are tested semi-annually.

The Group has net debt of £1,117.0m at 31 December 2017 (2016: £1,778.8m) and adjusted net debt of £1,219.4m at 31 December 2017 (2016: £1,809.3m). The components of net debt and adjusted net debt are shown in the table below. Net debt is reported in note 31 – additional cash flow information. Adjusted net debt is used to calculate the gearing ratio adjusted net debt to adjusted EBITDA (refer to Alternative Performance Measures on pages 202–204).

The Group’s calculation of adjusted net debt to adjusted EBITDA at 31 December 2017 is 2.27 times and is compliant with the relevant ratios.

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On 31 January 2018, the Group announced a multi-year transformation plan, encompassing strategy, cost competitiveness, sales, IT and its capital structure, to improve the performance of Capita over the medium-to-long term. This transformation plan includes an assessment of the appropriate financial leverage for the Group over the medium term, to ensure that Capita has a sustainable capital base to support its customers and operations, increase investment in the business and deliver future strategy. The Board’s view is that the appropriate leverage for Capita over the medium term should be between 1.0 and 2.0 times adjusted net debt to adjusted EBITDA (prior to the adoption of IFRS 16). Accordingly, the Board has decided to raise additional equity of £701m by way of a Rights Issue, which is fully underwritten by Citigroup Global Markets Limited and Goldman Sachs International.

The transformation plan is being finalised, and the key actions and forecast impacts incorporated into detailed business plans. These are in support of the new strategy that has been reviewed and approved by the Board. Details of the new strategy are outlined in the Chief Executive Officer’s review on pages 6–12.

For the purpose of the going concern assessment the Directors have considered a ‘base-case’ set of projections that cover the first two years of the new strategic plan, to 31 December 2019. This base-case includes cost reduction identified to date but not the anticipated proceeds from the Rights Issue and planned strategic disposals, and therefore importantly does not include the investment these will enable the Group to make, and the benefits these will deliver over the longer term.

The Group’s committed facilities and private placement notes are subject to compliance with covenant requirements including maximum ratios of adjusted net debt to adjusted EBITDA. This covenant threshold is tested semi-annually, and is set at 3.0 times to 3.5 times depending on the debt instrument in question. The Directors have applied judgement in terms of how the ratio is calculated by applying the same treatment that has been applied in preparing and presenting the financial statements. Accordingly, items that are presented as non-underlying are excluded from the covenant definition of adjusted EBITDA (with the exception of acquisition costs), as are restructuring costs that are now presented within the underlying results as set out in note 3 to the consolidated financial statements. This basis of calculation is consistent with the approach adopted in prior years.

In assessing the going concern assumptions, the Board has undertaken a rigorous assessment of the forecast outturns and assessed identified downside risks and mitigating actions, by reference to the relevant covenant tests. The downside risks include a number of severe but plausible scenarios, incorporating underperformance against the business plan, unexpected cash outflows and customer attrition and unwillingness to award the Group new contracts and extensions to existing arrangements. The Board has considered mitigating actions available to the Group in response to these sensitivities.

Whilst the ‘base case’ scenario shows the business can operate in compliance with its adjusted net debt to adjusted EBITDA covenants and applying the reasonable downside scenarios indicate that, absent the anticipated net proceeds from the announced Rights Issue, and assuming no other mitigating actions are taken by the Group, the available headroom is not sufficient to operate within the 3.0 times adjusted net debt to adjusted EBITDA covenant test. The Board has therefore considered the Rights Issue net proceeds in its assessment of going concern and the Group’s ability to realise their assets and discharge their liabilities in the normal course of business.

Rights Issue

The Company has today launched a Rights Issue to raise £701m.

The Rights Issue will be subject to shareholders’ approval and the general meeting to approve the equity raise is scheduled for 9 May 2018.

The Rights Issue is fully underwritten for £701m, by Citigroup Global Markets Limited and Goldman Sachs International.

Material uncertainties

In assessing the going concern assumptions, the Board has reviewed the base case plans, identified downsides and anticipated receipt of proceeds from the Rights Issue. Following this assessment, the Board has a reasonable expectation that the Company and the Group will be able to operate as a going concern for the foreseeable future.

In undertaking the assessment, the Board has considered the fact that a shareholder vote is required in order to raise additional capital through the Rights Issue, and that the underwriting agreement is subject to certain specific conditions which, although customary in nature, are outside the control of the Company. These events and conditions indicate a material uncertainty on the completion of the Rights Issue which may cast significant doubt about the Group’s and parent company’s ability to continue as a going concern.

The Board is confident that the Rights Issue will be approved and the proceeds received and based on this expectation believes that, even in a reasonable downside scenario, the Group and parent company will continue to have adequate financial resources to realise their assets and discharge their liabilities as they fall due. Accordingly, the Directors have formed the judgement that it is appropriate to prepare the financial statements on the going concern basis. Therefore, the financial statements do not include any adjustments which would be required if the going concern basis of preparation is inappropriate.

The Auditors’ report on pages 170–184 refer to this material uncertainty, and their opinion is not qualified or modified in this regard. 

INDEPENDENT AUDITOR’S REPORT TO THE MEMBERS OF CAPITA PLC (extract)

  1. Material uncertainty related to going concern

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VIABILITY STATEMENT

The Board has undertaken a rigorous assessment of the going concern assumption using the base-case financial forecasts and considering a wide range of downside scenarios.

The transformation plan is being finalised, and the key actions and forecast impacts incorporated into detailed business plans in support of the new strategy that has been reviewed and approved by the Board. These business plans cover a five‑year outlook and encompass the full benefits that the Board is confident the transformation plan will deliver.

The base-case projections prepared for the going concern and viability assessment are derived from the business plans, but are necessarily more cautious as they do not include the impacts that are outside the control of the Company. Accordingly, they exclude future planned strategic disposals where external third parties will be involved and also exclude the disposal proceeds that will be available for re-investment. In addition, the base-case projections incorporate a cautious assessment of business prospects for 2019 and 2020 with only an initial view over cost efficiencies identified to date.

For the going concern assessment the Board have considered the base-case projections for the period to 31 December 2019. Provision C.2.2 of the 2014 revised Code requires the Directors to also consider the viability of the Group over a longer-term period and for this viability statement the Board has assessed the prospects for the Group using the base-case forecasts over an extended period to 31 December 2020. The Board considers this three-year period to be appropriate as there is sufficient clarity to consider the business prospects and the base case over this period provides a foundation to stress test against severe but plausible downside scenarios.

The Board acknowledges that the base case includes only an initial view of the cost efficiencies identified to date and by covering only the first three years is necessarily cautious with regard to the full benefits that will be delivered over the longer term and does not include the positive impacts the plan will have on the longer-term strategic positioning of the Group across the markets that it serves.

In assessing the going concern assumption, the Board has undertaken a rigorous assessment of the forecast outturns and assessed identified downside risks on a probability weighted basis and mitigating actions. The downside risks include a number of severe but plausible scenarios, also on a probability weighted basis, incorporating underperformance against the business plan, execution risk associated with the transformation plan, unexpected cash outflows and customer attrition and unwillingness to award the Group new contracts and extensions to existing arrangements. These financial downsides (SCENARIO 1) capture political, economic and reputation risks.

In considering the viability of the Group, the Board has extended the above financial downside scenarios to include stress testing and sensitivity analysis of the impact of various severe but plausible potential scenarios involving the threats posed by other principal risks. These have included (but not limited to) scenarios in respect of:

SCENARIO 2: an information security breach – an accidental significant loss of data or release of a significant amount of sensitive personal client data. The Board has considered among other items the potential impact to cash and profits arising from potential penalties and fines, compensation payments and negative impacts from such reputational damage in terms of an inability to win new business or retain existing contracts;

SCENARIO 3: legal and regulatory risks – failure of financial crime controls around AML assessment, due diligence and sanction assessment leading to a significant AML incident and investigation. The Board has considered among other items potential fines, and any actions taken that may prohibit or suspend the Group from operating within certain regimes;

SCENARIO 4: the efficacy of IT and infrastructure systems and controls – a significant IT incident causes failure to key systems for hosted services to major clients. The Board has considered among other items any contractual penalties that may arise, capital costs required to address any immediate infrastructure improvements, potential contract terminations and the negative impact on new contract wins; and

SCENARIO 5: a wider economic impact on Group financial stability – uncertainty of earnings as a result of a change in the UK Government to a party with a strong mandate for radical policy change. The Board has considered among other items new barriers to entry, changes to corporate taxation, and the termination of public sector contracts.

The Board has conducted stress tests against each individual scenario in order to test the resilience of the Group taking into account the efficacy of possible mitigating actions. In addition to testing individual scenarios, the Board also considered the impact of a combination of the scenarios over the assessment period. This was in order to stress test an aggregation of severe but plausible risks occurring that would represent the greatest potential financial impact but in the short terms and longer-term viability period.

The Directors considered mitigating factors that could be employed when reviewing these scenarios and the effectiveness of the actions at their disposal, which were applied to the models. An example of the actions identified included adjusting the Group’s investment in discretionary and maintenance capital projects, having due regard to the need to ensure the integrity of the Group’s IT systems is not compromised nor the security of the data held therein; the reversal of the unwinding of the seasonal working capital assumed in 2018; and further reduction in discretionary operating expenditure.

Notwithstanding the actions available, the Directors concluded that the downside scenarios indicate that absent the anticipated net proceeds from the announced rights issue the available headroom is not sufficient to operate within the Company’s key adjusted net debt to adjusted EBITDA covenant test. The Board has therefore considered the Rights Issue net proceeds in its assessment of viability.

As set out on page 98 the Rights Issue is subject to a shareholder vote, and the arrangement to the underwriting is subject to certain specific conditions, which are customary in nature but are outside the control of the Company. These events and conditions indicate a material uncertainty on the completion of the Rights Issue which may cast significant doubt about the Group’s and parent company’s ability to continue as a viable concern.

The Board is confident that the Rights Issue will be approved and subject to the inclusion of the anticipated net proceeds the Directors therefore have a reasonable expectation that the Group and parent company will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment.

On behalf of the Board:

Jon Lewis

Chief Executive Officer

Nick Greatorex

Chief Financial Officer

23 April 2018

CORPORATE GOVERNANCE STATEMENT (extract)

GOING CONCERN

The Group’s business activities, together with the factors likely to affect its future development, performance and position are set out in the strategic report on pages 03 to 48. The financial position of the Group, its cash flows, liquidity position and borrowing facilities are described on pages 91 to 95. In addition, note 28 to the financial statements on pages 141–149 includes the Group’s objectives, policies and processes for managing its capital, its financial risk management objectives, details of its financial instruments and hedging activities, and its exposures to credit risk and liquidity risk.

In determining the appropriate basis of preparation of the financial statements for the year 31 December 2017, the Directors are required to consider whether the Group can continue in operational existence for the foreseeable future. The Board has concluded that it is appropriate to adopt the going concern basis, having undertaken a rigorous assessment of the financial forecasts and with consideration of the anticipated net proceeds from the announced Rights Issue which the Board is confident will be approved.

On 31 January 2018, the Group announced a multi-year transformation plan, encompassing strategy, cost competitiveness, sales, IT and its capital structure, to improve the performance of Capita over the medium-to-long term. This transformation plan includes an assessment of the appropriate financial leverage for the Group over the medium term, to ensure that Capita has a sustainable capital base to support its customers and operations, increase investment in the business and deliver future strategy. The Board’s view is that the appropriate leverage for Capita over the medium term should be between 1.0 and 2.0 times adjusted net debt to adjusted EBITDA (prior to the adoption of IFRS 16). Accordingly, the Board has decided to raise additional equity of £701m by way of a Rights Issue, which is fully underwritten by Citigroup Global Markets Limited and Goldman Sachs International.

The transformation plan is being finalised, and the key actions and forecast impacts incorporated into detailed business plans. These are in support of the new strategy that has been reviewed and approved by the Board. Details of the new strategy are outlined in the Chief Executive Officer’s review on pages 6 to 12.

For the purpose of the going concern assessment the Directors have considered a ‘base-case’ set of projections that cover the first two years of the new strategic plan, to 31 December 2019. This base-case includes cost reduction identified to date but not the anticipated proceeds from the Rights Issue and planned strategic disposals, and therefore importantly does not include the investment these will enable the Group to make, and the benefits these will deliver over the longer term.

The Group’s committed facilities and private placement notes are subject to compliance with covenant requirements including maximum ratios of adjusted net debt to adjusted EBITDA. This covenant threshold is tested semi-annually, and is set at 3.0 times to 3.5 times depending on the debt instrument in question. The Directors have applied judgement in terms of how the ratio is calculated by applying the same treatment that has been applied in preparing and presenting the financial statements.

Accordingly, items that are presented as non-underlying are excluded from the covenant definition of adjusted EBITDA (with the exception of acquisition costs), as are restructuring costs that are now presented within the underlying results as set out in note 3 to the consolidated financial statements. This basis of calculation is consistent with the approach adopted in prior years.

In assessing the going concern assumption, the Board has undertaken a rigorous assessment of the forecast outturns and assessed identified downside risks and mitigating actions, by reference to the relevant covenant tests. The downside risks include a number of severe but plausible scenarios, incorporating underperformance against the business plan, unexpected cash outflows and customer attrition and unwillingness to award the Group new contracts and extensions to existing arrangements. The Board has considered mitigating actions available to the Group in response to these sensitivities.

Whilst the ‘base case’ scenario shows the business can operate in compliance with its adjusted net debt to adjusted EBITDA covenants applying the reasonable downside scenarios indicate that, absent the anticipated net proceeds from the announced Rights Issue, and assuming no other mitigating actions are taken by the Group, the available headroom is not sufficient to operate within the 3.0 times adjusted net debt to adjusted EBITDA covenant test. The Board has therefore considered the Rights Issue net proceeds in its assessment of going concern and the Group’s ability to realise their assets and discharge their liabilities in the normal course of business.

Rights Issue

The Company has today launched a Rights Issue to raise £701m.

The Rights Issue will be subject to shareholders’ approval and the general meeting to approve the equity raise is scheduled for 9 May 2018.

The Rights Issue is fully underwritten for £701m, by Citigroup Global Markets Limited and Goldman Sachs International.

Material uncertainties

In assessing the going concern assumptions, the Board has reviewed the base case plans, identified downsides and anticipated receipt of proceeds from the Rights Issue. Following this assessment, the Board has a reasonable expectation that the Company and the Group will be able to operate as a going concern for the foreseeable future.

In undertaking the assessment, the Board has considered the fact that a shareholder vote is required in order to raise additional capital through the Rights Issue, and that the underwriting agreement is subject to certain specific conditions which, although customary in nature, are outside the control of the Company. These events and conditions indicate a material uncertainty on the completion of the Rights Issue which may cast significant doubt about the Group’s and parent company’s ability to continue as a going concern.

The Board is confident that the Rights Issue will be approved and the proceeds received and based on this expectation believes that, even in a reasonable downside scenario, the Group and parent company will continue to have adequate financial resources to realise their assets and discharge their liabilities as they fall due. Accordingly, the Directors have formed the judgement that it is appropriate to prepare the financial statements on the going concern basis. Therefore, the financial statements do not include any adjustments which would be required if the going concern basis of preparation is inappropriate.

The auditors’ report on pages 170–184 refer to this material uncertainty, and their opinion is not qualified or modified in this regard.

 

 

 

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