Capita plc (CPI) Earnings Call Transcript & Summary

Okay, good morning, everyone. Welcome to our half year results. Just very quick health and safety announcements. There are no planned fire alarms this morning, so if you do hear one, it is the real thing, so you just need to make your way basically out through the doors in which you came and down the stairs. Thank you. Now to Jon. Thank you.

Thank you, Helen. Good morning, everyone. Thanks for joining us in August, when most people are away on holiday, I think. I'm joined by Tim, our CFO; as well as a number of members of the executive management team, who will be here after the formal presentation. And you are very welcome to engage with them. As usual, our disclaimer, which I ask you to refer to. Okay, Capita today is a leading provider of business process services driven by data, technology and people. Put simply, we help our clients realize improvements in productivity and customer experience. We achieve this by combining our deep understanding of their business operations with an increasingly competitive array of digital solutions. As expected, the first half of 2023 demonstrated the financial benefits of our strategy of doing precisely what I just described in our 2 core markets, Capita public services and Capita Experience. Overall, we delivered accelerated revenue growth in the first 6 months with 6% growth after less than 1% disclosed in the first half of '22 and 4% in the second half of '22. This is the fourth successive period of growth and the fastest growth rate this business has delivered for many years. Our competitive solutions mean we are winning in our chosen markets, and our order book is strong. In addition, our strong sustained reputation for operational delivery is further supporting our growth ambitions of mid-single-digit over the medium term. Our top line growth benefited profit before tax, from GBP 25 million in '22 to GBP 33 million in '23, up 34%. Profit before tax was also enhanced by the deferred income release and a commercial settlement in the Experience division. Partly offsetting these was the 10% salary increase we gave to our lowest-paid colleagues earlier this year, in line with our real living wage commitments. This increase, which -- along with other initiatives I will cover later, has helped reduce employee attrition by more than 3% on a 12-month rolling basis and improved our employee Net Promoter Score by plus 5 points -- plus 14 points, sorry. We have continued to make good progress on our disposal program. We've realized GBP 50 million net proceeds in the year-to-date; and of that GBP 50 million, just GBP 5 million net proceeds in the year, in H1, with the remainder of the proceeds being received in the second half. And we continue to make good progress on the disposal of the remaining assets. We have 2 or 3 to complete over the coming months. Our liquidity remains strong. In June, we extended the revolving credit facility to 2026; and then in July, issued just over GBP 100 million in U.S. private placement notes. This diversifies our funding base and extends our debt maturity profile. On balance, a good performance in H1 demonstrating that the foundations we have created are delivering an acceleration in our financial results. There's more to do to reduce costs, including delivery of the GBP 40 million reduction plan we've announced today; as well as improving, as a result of that and other actions, our free cash flow. Our strong client relationships, long-term contracts, our increasingly competitive solutions, our engaged colleagues and our track record for delivery mean we have a resilient business, one that is well positioned for the future. I'll come back to this later, but let me now hand over to Tim to talk us through the numbers. Tim?

Thanks, Jon. Morning, everyone. Apologies for the slightly slow walk across there. I have a bit of a challenge in my Achilles at the moment. Inappropriate sports for a 60-year-old, squash. As Jon has just said, we've seen revenue growth across all divisions and half-on-half growth of 6% for the group as a whole. As mentioned on this slide and consistent with prior presentations, our results are shown on an adjusted basis unless stated otherwise. As announced in May, we've incurred exceptional costs in resolving the cyber incident; and these have been excluded from adjusted profits. Following feedback from investors, we've revised the definition of our free cash flow measures, and these are now presented after deducting the capital element of lease payments and receipts. The comparatives have been represented on the same basis. Turning to the next slide for our financial highlights. We've seen revenue growth of 6% compared with the first half of 2022. This reflected underlying growth; as well as 2 specific factors in the Experience division, being the beneficial impact of the early termination of our old contract and commencement of our new contract with Virgin Media O2 and a commercial settlement in the closed book Life and Pensions business. We've seen an improvement in operating profit, profit before tax and EBITDA, reflecting the growth in revenue and in particular the VM O2 contract transition and the commercial settlement in Experience. There's been a decrease in cash generated by -- from operations, as expected, driven by the noncash nature of deferred income releases, timing of the cash receipt from the commercial settlement, the previously announced furlough repayment and the cash costs of the cyber incident. The increase in free cash outflow reflects a reduction in cash generated from operations together with the increase in technology-related capital expenditure which we flagged at our full year results. Now turning to the divisional performance and Public Service on the next slide. The division saw revenue growth of 2.4% with good growth in the core business areas. This is underpinned by scope increases on the Royal Navy training contract and increased volumes on the Personal Independence Payments contract, offset by contract hand-backs within Local Public Services and a step down in revenues in Northern Ireland where the first half of 2022 saw a benefit from the teachers' laptop contract. The divisional profit margin moved by 1.2% (sic) [ 1.2 percentage points ], as the beneficial impact of the revenue growth was offset by increased IT spend on certain contracts, including Primary Care Support England, as well as incremental property costs in our intelligent communications business as we moved operating locations. Cash conversion was broadly in line with the prior period. The 4.4% increase in order book reflects wins such as the extension to the British Army recruiting contract, which has been renewed for another 2 years, plus an option for a further 1; the City of London Police contract; and expanded scope on Transport for London. Moving on to Experience on the next slide. The division's strong revenue growth was driven by the accelerated deferred income release on new contract revenue, following the renewal of our contract with Virgin Media O2; and a commercial settlement in the closed book Life and Pensions business. The benefits from VM O2 and the closed book Life and Pensions settlement represents an acceleration of revenue from future periods, and we would therefore expect a lower rate of revenue growth in the second half. Operating profit reflected the VM O2 contract transition and the closed book Life and Pensions settlement, offset by flow-through of prior year contract losses, including Carphone Warehouse, The Co-operative Bank; and continued attrition in the remaining Life and Pensions contracts. The reduction in cash conversion reflects the noncash nature of VM O2 deferred income release and the closed book Life and Pensions agreement where we anticipate cash settlement beyond the current calendar year. The reduction in order book was principally due to the new GBP 366 million VM O2 contract being a framework agreement, which under accounting rules no longer ticks the box for inclusion in order book. On the next slide, we provide the reconciliation between adjusted and reported PBT. The GBP 8.4 million or 34% increase in adjusted PBT was driven by revenue growth and the contract benefits outlined on previous slides. We completed the disposals of our Resourcing and Security Watchdog businesses from the portfolio division in May. And the business exits charge of GBP 34.7 million includes disposal-related losses and impairments, trading of the disposed businesses up to the point of exit and transaction-related costs. We incurred a noncash goodwill impairment charge of GBP 42.2 million in respect of a number of businesses remaining in the portfolio division at the half year in recognition of our current expectation of the outcome of the disposal processes underway. Announced previously, the exceptional costs relating to the cyber incident have been excluded from adjusted profit. These costs comprise specialist professional fees, recovery and remediation costs and investment to reinforce Capita's cybersecurity environment. A charge of GBP 21.8 million has been recognized in the half year. This excludes any potential insurance receipts, as these had not met -- yet met the criteria for recognition at the half year. The expected cost of the cyber incident, net of potential insurance receipts, is now between GBP 20 million and GBP 25 million, an increase from the GBP 15 million to GBP 20 million we estimated in the early stages of the forensic data review process. The next slide sets out the detail behind the increase in free cash outflow in the period. EBITDA increased by 10%, reflecting the improvement in profit offset by the reduction in depreciation, amortization and impairment charges, which is driven by a lower level of capital investments in prior periods and the ongoing rationalization of the property portfolio which decreases the right-of-use assets depreciation charge. The period-on-period reduction in cash generated from operations reflects the noncash nature of the commercial settlement in the Experience division, hand-backs in Local Public Services, the GBP 9 million direct cash flow impact of the cyber incident and the repayment of the 2021 furlough-related income which we've announced previously. Capital expenditure reflects increased digitization and technology investment in both divisions, which we highlighted in our year-end results announcement. The reduction in net capital lease payments has been driven by the ongoing property rationalization process. Free cash flow, excluding business exits, in the 6 months was an outflow of GBP 53.4 million, with the increased outflow reflecting the reduction in cash generated from operations and increased capital investment. Just a quick aside on pension contributions. In addition to the GBP 50 million of regular deficit contributions shown separately on the slide, which were paid in line with the 2021 triennial valuation, we also made disposal-related accelerated contributions of GBP 15.6 million, which were included within other cash flows at the foot of the slide. These have contributed to the improved funding position from year-end, with the scheme now showing an accounting surplus of GBP 50.6 million. Net debt was reduced by GBP 166 million year-on-year principally as a result of the impact of the portfolio disposal program and continued reduction in our leased property estate. Moving to the next slide. We received net cash disposal proceeds for the People pillar of GBP 4.5 million in the half year, with deferred proceeds of GBP 6.7 million expected in the second half. During June 2023, we agreed the sale of our Software, PageOne and Enforcement businesses. And all 3 of these sales completed on 31st of July 2023, realizing net cash disposal proceeds of around GBP 45 million. Including this last trio, in aggregate, the completed disposals outlined on this slide have generated net proceeds of around GBP 438 million in 2022 and 2023 to date, with more to come over the next few months from the FERA and Travel processes, each of which is well advanced. Turning to the next slide, which shows the group's liquidity position. In June 2023, we extended the maturity of the group's revolving credit facility out to 31st December 2026, a 28-month extension of RCF maturity from the original expiry date. And in July, we issued GBP 102 million worth of U.S. private placement loan notes; and are surely expecting to early settle around GBP 30 million of euro PPN debt maturities which previously fell due in 2027. The U.S. private placement enables us to reduce the level of periodic drawings under the RCF, which we typically see arising from the inherent cash flow dynamics of our contracting business. And whilst the average interest rate of 9.45% on the new issuance is significantly higher than the rate on debt issued in previous periods, it reflects current market conditions and is broadly comparable with the rate we would be paying on RCF drawings at this point in time. As a result of the RCF extension and the new PPN issuance, we diversified our funding mix, extended the average period to maturity of our debt and reduced our exposure to market volatility. Both events demonstrate debt investors' confidence in Capita's financial resilience. As you can see, during the last 6 months, we've transformed our funding position; and have no need for any further refinancing for a significant period. Now turning to the next slide for guidance on our outlook from a financial perspective. And just to be clear: The guidance on this slide is the core Capita which excludes the remaining portfolio businesses. In the appendix to this presentation, we provided a bridge between the overall group results for half year 2023 and the pro forma results of the core Capita. As noted earlier, we expect a lower rate of revenue growth in Experience in the second half but accelerated growth in Public Service from contract extensions, new wins and increases in the scope on existing contracts. Overall, we continue to expect to deliver accelerated revenue growth for the full year for the group as a whole. We expect EBITDA to increase against full year 2022 due to both revenue growth and efficiency gains. We see further EBITDA upside in 2024 and beyond from the GBP 40 million of cost savings which we expect to deliver through the group and divisional overhead and operating efficiency initiatives highlighted by Jon. Free cash flow in the second half is expected to be broadly in line with H1, as the year-on-year benefit of improved EBITDA is anticipated to be offset by the balance of cash spend on the cyber incident; and continuation of our capital expenditure run rate, which on a full year basis we still expect to be between GBP 50 million and GBP 60 million for the full year. We expect further reduction in net debt in the second half as we complete the portfolio disposal program and to continue to focus on rationalizing our property estate. Looking to 2024 and beyond, we would expect continuing improvement in free cash flow, reflecting a greater level of cash-backed profits, delivery of cost efficiencies and a lower level of deficit contributions arriving from the much improved funding position of the pension scheme. This underpins the expectations set out in today's announcement of a reduction of dividend payments in the next couple of years, with a modest initial payout. So with that, I hand back to Jon.

I think I need to stop you playing squash ahead of results, Tim. Thank you. You may remember the left-hand side of this slide from March, where we highlighted our focus on top line growth, this being the primary driver of accelerated financial performance going forward. And we've made material progress against each of these enablers of accelerated growth in the first half. We've built a strong track record in contract renewals over the last 3 years, with renewals in the high 90% range and Capita public services achieving 100% renewals in the first half of this year, but we're increasingly focused on new client opportunities. And here we saw more than a quadrupling of our win rate in the period. I'm pleased to announce we won GBP 1.4 billion in TCV in the first 6 months, slightly below the first half over the period compared to last year, but if we compare year-to-date with the signing of the disabled student allowance scheme or DSA and our selection as the preferred bidder for 2 expanded scopes around the functional assessment service for the DWP, we are over 50% ahead of where we were this point last year, delivering one of the strongest TCV performances in many years. We also won GBP 650 million in in-year revenue, up 22% year-on-year and the best in-year revenue growth performance of any 6-month period for many years. Our improving win rates combined with our strong order book bodes well for full year growth and onwards. Now one of the areas I am proud of during my time at Capita is becoming a purpose-led company. It has probably been the single biggest lever of cultural and reputational change through the introduction of initiatives such as the real living wage; having employees on the Board; signing up to the Fair Tax Mark, the Good Business Charter, net 0 by 2035, to name but a few. Being purpose-led is our license to operate and has created a company that clients want to contract with and that colleagues are proud to work for. During the first half, we continued to make further progress on these responsible business initiatives, of which a few are mentioned on this slide and which I will let you read at your leisure. Again there have been a number of significant public sector contract wins in '23, DSA being one in which we were commended for our social value score. And we continue to aspire to be the U.K. government's most progressive, purpose-led strategic supplier, credentials that will serve us well irrespective of the political party in power. Our ESG credentials are also an important factor in our ability to attract talent. We see from our recruitment programs and employee service that people increasingly want to work for companies committed to being responsible businesses that's being manifested through deeds and not just words. Now part of our responsibility to our employees and customers is also around data security, a responsibility we take very seriously. The cyber incident we experienced at the end of March was therefore a very challenging period for us, but I am very proud of how the organization responded to this criminal attack, from our very early detection and containment through to the rapid restoration of services, strong business-as-usual service delivery, the [ securing ] of exfiltrated data and on communication -- ongoing communication with stakeholders. We have and continue to fulfill all obligations to the regulators, and we will update stakeholders for any material changes. As a purpose-led business, we have also been extremely thorough in our responsibility to capture and inform anyone whose data was exfiltrated. This has involved significant resource over many months, but our forensic analysis, as Tim has alluded to, is now close to completion. There is no evidence that anyone's personal data has been compromised, something we continue to monitor on the dark web daily. And the incident has not had a material impact on contract awards, as you can see. And in fact, the overwhelming feedback from both the U.K. government and commercial customers has been one of thanks, appreciation and a deeply positive impression of how we handled the incident. Government departments have collectively awarded us more than GBP 1 billion in TCV since the incident. I should also share that we've been approached by a number of Whitehall departments, executive teams, chairs, CEOs to share learnings on how we managed the crisis. Cyber is a risk a bit like safety. Mitigating the risk is in everyone's interests, and cyber knowledge should not be used for competitive advantage. We will be sharing our cyber incident management playbook with third parties, partners, clients and competitors alike, a commitment that the U.K. government has been -- has commended us for. Cyber was and remains the biggest risk to most businesses and increasingly so, so we've redoubled our efforts to ensure we are secured by accelerating an already established multiyear multimillion-pound cybersecurity investment program. And our cyber preparedness will be verified annually by 1 of the big 4 audit firms and we will publish the results. Let me now turn to colleagues. I'm extremely pleased with the strong 14-point improvement in our employee Net Promoter Score measured after the cyber incident. Our investment in recruiting effectiveness and our broader focus on our employee value proposition are delivering a marked reduction in attrition across all areas of the business, and that trend has continued into July. Excluding the Experience business, where higher attrition is a characteristic of the business model, the government's attrition level -- the group's attrition level, sorry, is in the high teens, down from the low 20s. Attrition in Experience is also similarly down, almost 3 percentage points to the low 30s, where it is negatively skewed by a small handful of contracts. Our recruitment engine continues to meet demand. In fact, we hired over 11,000 people in the first half, of which 1,000 are in India in anticipation of expanding contract volumes from Virgin Media O2. Despite this progress, we're not complacent. Pay growth in the U.K. remains strong, and there continue to be cost-saving opportunities associated with further reductions in attrition. And as a growing company, we will continue to maximize efficiency by using and expanding number of delivery centers overseas wherever and whenever we can. One mitigating factor to attrition continues to be the continued benefit of our virtual-first approach to flexible working across the entire organization. It is a key differentiator in terms of recruiting and retention as many other employers increasingly encourage staff to return to offices. As I've shared previously, we've also seen materially less sickness and absenteeism amongst colleagues embracing virtual working. In the first half, this dropped by 1.7% on major contracts in Capita Experience, driving a helpful improvement in productivity. And as Tim has highlighted, there are material cost and balance sheet benefits from the associated reduction in our property footprint, which is ongoing. I'd now like to say a little bit more about growth. The overall trend on renewals, expanding existing scopes and new clients remains positive. Starting at the bottom of the triangle on this slide: Our renewal rate in 1H '23 at 69% was impacted by the loss of one single contract, teachers' pensions, which we lost on price. This was offset by the 100% retention rate in Capita public. In total, more than 750 contracts were renewed in the first half. The pension administration contract we lost would not have met our contract risk-versus-returns criteria at a materially lower price. A loss is a loss, but it is encouraging that we now have sufficient pipeline to realize a few losses and still deliver healthy revenue growth as we continue to push on pricing. And as I've shared previously, we still need to push harder on pricing, especially in the current high inflationary environment. On the whole, we've done a pretty good job at managing pricing on our larger-value contracts, but we have more work to do on the more transactional work and we have a program in place to achieve this. Our win rate for expanding existing scopes was 61%, after 75% in '22, again a function of pushing harder on price, but our new client win rate at 46% is a strong improvement over the 11% we realized in '22 and again speaks to the competitiveness of our offerings. Overall we won GBP 1.4 billion in TCV in H1. And since the end of June, we've secured an additional GBP 800 million in TCV, including signing the disabled student allowance scheme and being named preferred bidder on 2 lots of the functional assessment service. In addition to these larger, more binary, longer-sales-cycle contract opportunities, we continue to deliver growth through a healthy mix of smaller transactional engagements. In fact, we signed over 8,500 contracts with TCV at or below GBP 1 million. And this helped us to deliver the previously mentioned GBP 650 million in in-year revenue in H1, as I mentioned earlier, up 22% and the best performance in years. So a decent overall growth performance and the result of placing particular emphasis on building new client pipeline in '23 and '24. Of course, it also, as I have said previously, speaks to our competitiveness. This next slide shows some of the key contract wins in the first half together with some of the main opportunities in H2. In Capita public services, strong operational performance has helped us to win expanded scopes with Transport for London and a new scope with the City of London Police. And we've extended a significant contract with the Ministry of Defence for the British Army. In the Experience division, our telecoms clients are amongst the biggest in Europe; and we renewed our contract with Virgin Media O2 as expected. There were also multiple wins within the financial services vertical, including new clients Santander and Commerzbank. Looking to H2. Capita public services, as mentioned, has been selected as preferred bidder on FAS and recently signed the DSA contract. Other renewals we have bid on include the Ministry of Justice electronic monitoring scheme and the Gas Safe Register for health -- for the Health and Safety Executive. Our opportunities in Capita Experience in the second half are in the retail, financial services and telecoms sector, but as focused as we are on growth, it is not at the expense of contract alignment to strategy, deliverability at the price bid or balance between margin and execution risk. Our contract review committee, which Tim and I continue to sit on, remains a core and integral part of our governance model. And as I've said before, we are not going to repeat the mistakes of the past. Let me now provide a short update on the 2 divisions. Capita Public Service is the #1 strategic supplier of both software and IT services and business process services to the U.K. government, with around 10% share of a market that's worth roughly GBP 14 billion annually. The division's reputation for delivery is now firmly cemented. This is evidenced, for example, through our contract with the Standards and Testing Agency in which we manage a testing cycle involving more than 3 million exam scripts; a complex logistics process involving schools, Parcelforce, our scanning center in Darlington and several thousand exam markers, in which a core KPI is to deliver 99.9% of exam scripts marked on time. This is an exceptionally difficult and complex process, in which we delivered 99.93%. Another example would be the department of works and pensions Personal Independence Payment contract, PIP, which we have now run for 10 years and which hit a major milestone last month passing the 2 million assessment mark. When you include the Department for Communities contract in Northern Ireland which started in 2016, we've now helped over 2.4 million people across the U.K. get access to essential funding and support while living with a long-term health condition or disability. There is no doubt that our strong performance on both these contracts helped our successful bid for the FAS contract that begins in the autumn of '24. 94% of delivery KPIs in the first half for the division were green, a delivery performance that continues to sustain strong net client promoter scores and trusted client relationships. This undoubtedly contributed to the 100% renewals rate I referred to earlier on, all of which, by the way, were secured with improved financial and commercial terms. Capita public services closed GBP 760 million in TCV in the period, with a further GBP 240 million signed in July for DSA. And I've already mentioned the preferred bidder on 2 FAS contracts, which will add a further GBP 565 million. The division's book-to-bill ratio as of the 30th of June was 1x, but with the DSA signing, this is -- this rises to 1.3x and, of course, will rise further when we sign the FAS contract in September. Revenue growth in Capita Public Service is dependent upon an understanding of the U.K. government's key priorities, government's increasing reliance on the private sector for policy delivery, a strong track record on the part of the strategic supplier and competitive bids with an increasingly large digital content. All of these factors are embedded and trending positively and we are increasingly well positioned to benefit from them. This is the core reason why our total unweighted pipeline for Capita Public Service is substantial at over GBP 7 billion. Of that GBP 7 billion, we have 29 strategic deals worth over GBP 2.9 billion that are targeted for 2024. The largest opportunities are coming from central government, specifically in the Ministry of Defence, the Department for Education and NHS England. Some near-term examples are listed on this slide. One is within our Health, Welfare & Education vertical, where we are piloting mid-life MOTs for the South West of England as part of the government's health and career guidance scheme. As part of the increasing investment in defense, we're also supporting the U.K. government by modernizing the delivery of Royal Navy training; and of course, improving defenses, fire and rescue capabilities. Capita Experience is a full-service customer management solutions provider. We're led by data. It's enabled by technology, and we're powered by our people. It is the #1 customer services company in the U.K. and Ireland and a top 5 in Europe. Within a large and growing market, Capita Experience won GBP 560 million in TCV in the first half of the year and had a book-to-bill ratio of 0.9x. And I will again emphasize Tim's point that, that did not include the Virgin Media O2 renewal. 93% of the division's delivery KPIs were green, on the back of which secured additional scopes have worked from a number of our strategic clients. This resulted in a particularly strong in-year revenue performance up over 70% on the same period last year. Also on the slide are just a few examples of where we have delivered for our clients. For example, in India, as mentioned, in just a few months, we've recruited over 1,000 additional employees in support of expanded scope with Virgin Media O2. For Marks & Spencer, the introduction of gen AI solutions has resulted in the upfront resolution of 1/3 more queries, thereby reducing the number of interactions required to address customer needs. Capita Experience services clients in 4 geographic markets, the U.K., Ireland, Switzerland, Germany, from those markets; and delivery centers in Poland, India, Bulgaria and South Africa. We have a blue chip client base with high customer loyalty in 4 key industries, financial services, technology, media and telco, energy and utilities and retail. On this slide, using data and projections provided by third-party analysts, you can see that the market segments on which we are focused are the largest customer management markets in the U.K. and Europe. And they are predicted to grow by around 5% per annum between '22 and '26. And there are some common themes across the market solutions we provide to these segments, in particular the use of automation technologies for the more mundane, lower-value services versus the use of gen AI as an agent augmentation solution for higher-value services. We are unashamedly pivoting our focus to the upper levels of the triangle on the right of this slide. The shift to more sophisticated digital solutions is improving our [ competitiveness ], as evidenced by our new win rates -- new client win rate; making us more sticky, as evidenced by our renewals; and ultimately drives improved margins. Our partnerships with the hyperscalers are critical in this regard. And this year, there has been a significant step change in our relationships with Microsoft, ServiceNow and Salesforce. Given our market positions, they view Capita as a key go-to-market partner, and there is investment in and executive sponsorship of these partnerships at the most senior levels within those organizations. By combining their platforms with our deep sector process knowledge and very importantly our proprietary data, we see numerous opportunities to drive productivity improvement and enhanced customer journeys. I will share examples of these on the next slide. Our partners' gen AI-enabled platforms are particularly relevant in this regard. We are not new to AI. It underpins our chatbot technology we use in Capita Experience and the image recognition technology we use in Capita public services, but gen AI has the potential to transform how we assist our colleagues in delighting our clients' customers by supporting agents' engagement with customers in real time; summarizing text, summarizing solutions, call conversations; supporting colleagues with financial -- complex financial claims; and automating aspects of complaints handling. Gen AI also has implications for how we manage our data. We've just hired a Chief Data Governance Officer. And one of their key accountabilities will be the definition of and distinction between data that is proprietary to Capita versus our clients. We will also reflect this in our contractual Ts and Cs. Data, of course, that is proprietary to Capita will be core to extending the large language models provided by our technology partners, providing us with distinct competitive capabilities around the very processes we execute for them. We've taken a number of steps to accelerate this digitalization strategy. First, we are providing colleagues with a gen AI platform with which they can experiment. This is an important action, as I'm not sure any of us fully understand all the value-adding applications. We need to get it into the hands of colleagues so that they can assess its potential in the tasks they currently undertake day to day. Second, we have committed to developing a number of gen AI use cases in partnership with Microsoft; and those proof of concepts will be live by the end of this year. We're also exploring use cases with Salesforce and ServiceNow, and some examples of these are summarized on this slide. One is around medical screening assessments, a task we undertake on several contracts across Capita public services. Today, on one contract alone, the team manually screens and reads over 20,000 individual medical records per annum. We're currently implementing a gen AI solution to automatically provide summary medical reports, and early results are very encouraging, reducing the time it takes our medical professionals to perform this task by more than 50%. Other -- another application is on a contract where we currently manually reply to over 40,000 customers per month who are challenging penalty charge notices. This is another very relevant application where we can use gen AI to automate many of these responses, again realizing a significant reduction in processing time. And finally, on one of our financial services contracts within the Experience division, the team has to transcribe more than 700,000 call recordings a year to enable a search against sector-specific terminologies to categorize claims and process them. Using custom speech-to-text gen AI, we've now compressed this process from many months to but a few weeks. Now we recognize that gen AI presents both threats and opportunities. First, we're embracing it rapidly so that we understand the competitive and business model implications. Gen AI represents, after all, an exciting opportunity to redouble our digitalization efforts whilst improving margins. Second, we are working in partnership with the technology hyperscalers, as mentioned, to ensure access to leading technology with its associated secure data controls and management. And third, we will implement the technology in a responsible and ethical manner. Our vision is that gen AI will augment our colleagues, enabling agents to focus on value-added activities where a human empathetic touch is essential. Now before we move to Q&A. As many of you are aware, this will be my last results presentation as CEO of Capita. And I would like to thank all of you for your interest; support; and questions, well, most of them, anyway, over the last several years. Capita today is a very different company to the one I joined in 2017. It had more than GBP 1.1 billion of net financial debt, was an unintegrated portfolio of businesses trying to do too many things in too many markets and with revenue attrition of more than 10% per annum in some years. More importantly, it had no strategy with which to survive. The business had been over-dividended for many years, was starved of investment, had a number of serious and very high-profile contract delivery issues and a rather poor reputation. It had also won a series of very large contracts that could not be delivered for the price bid. Furthermore, it lacked the risk management systems, controls and governance appropriate to a FTSE company of this scale and importance to the U.K. The mechanisms by which to manage the business, frankly, were not in place. Over the last few years, collectively with colleagues, we have addressed all of these challenges and created a purpose-led business with a very clear strategy, a transformed reputation, engaged colleagues, a robust balance sheet and an accelerating financial performance. The foundations for ongoing success are in place. And I think probably the most -- the best example that evidences our transformation was the way colleagues handled the cyber incident back in March. We would not have been able to do that 5 years ago. It has been damned hard work by all involved. And I want to pay particular tribute to my colleagues past and present for enabling us to get to where we are today; and in particular my partner the last 2 years, Tim. So in conclusion. We have strong market share positions in growing markets, with increasingly competitive offerings and a reputation for delivery. And we continue to have strong operational momentum. We're growing. We're profitable. We have a strong balance sheet, strong liquidity; and are on track to meet our revenue growth and margin expectations for 2023 and the medium term. And with that, thank you for your attention. And we would now be happy to take your questions.

A couple of questions from me, please. So first question, just on the free cash flow. I think you said or you mentioned that you're expecting similar in the second half to the first half. And I think, sort of using the former definition of free cash flow, it's a slight downgrade. I think previously you were expecting slightly positive, now slightly negative. Are you just able to explain kind of what's changed there in terms of that free cash flow expectation? Second question: Just on the sort of pension runoff business or the -- which is obviously costing you money each year, are you able to tell me sort of how that's been progressing sort of in total since the full year?

[ I think those are yours ].

Yes. On the free cash flow one. So we had a free cash flow, outflow, in the first half of GBP 53 million. That compares to GBP 17 million outflow on the same basis last year. And the big things that have caused that, one of them continues into the second half, which is the cash costs of the cyber incident, so reflecting that, that's why your slight positive turns into a slight negative on the old definition, because you've got the cyber costs going into our adjusted free cash flow number. I mean the -- when you look at the trading performance on free cash flow in the first half of the year versus the first half of last year, you strip out the furlough repayment. You strip out cyber. You adjust for the step-up in CapEx of GBP 15 million half-on-half. The trading free cash flow reduction is about GBP 7 million, which is around 1 day's worth of cash flows in this business, so you just kind of need to look at it in context.

There was a second question, I think.

Yes. So just in terms of you've obviously had the sort of pensions business that has been costing you money over time. And I just wondered in general how you were getting on kind of getting out of those arrangements and how that changed since the full year.

So you're referring, of course, to our closed book Life and Pensions business, which we have indicated we would like to exit over time but on appropriate economic terms. It's probably not appropriate for me to say too much more other than we continue to have productive conversations with the 2 key clients in that space. And we hope to be able to make material progress in the resolution of those contracts by the end of this year. And that is something I have committed to the Board to stay very close to over that period.

It's David Brockton from Numis. Can I ask 2? They're sort of related and partly related to the last question. In the Experience division, there have been, I guess, several moving parts through the first half in terms of the DI release and also the closed book Life and Pensions that you just touched on there. If you strip those out, can you just give an assessment of where you think you are in terms of the turnaround of that division and the sort of the medium-term expectations you have for both growth and margins for that division? That's the first question. The second question again relates to the sort of the DI release that you've had in the first half. I guess one could look forward to next year and think that, that creates a sort of difficult headwind for further sort of trajectory of profits next year. Can you just touch on whether you've got visibility on your ability to sort of cover that reduction year-on-year and continue to grow profits next year?

So I'll let Tim address the second one. I'll speak to the first one. One of the things we debate is whether or not we should pull out what we call core Capita Experience from Capita Experience total given the drag that the Life and Pensions business over time, not necessarily in the first half but over time, creates. And if you were to do that, I think you would find that core Capita Experience is actually growing and has actually a pretty strong pipeline for the remainder of the year to sustain that growth as well. We've got more pipeline to build for Capita Experience in the long term, but I am very encouraged by the opportunities we see in Europe and Ireland in particular for that business. And we have new leadership over that division as well, and I'm very pleased with the progress we're making in that regard. Tim?

Yes. So the impact of the VM O2 contract transition coupled with the commercial settlement in close book Life and Pensions. Each of those independently is in the teens of millions, so if you adjust to strip that out of the 9% growth that Capita Experience shows in the first half, you broadly halve its growth rate. So 4%, 4.5% growth rate. And to be clear: Group as a whole, that will reduce our revenue growth rate from 6% to 4%, so we're kind of still with both businesses, both the group as a whole and Capita Experience, in that mid-single-digit territory in terms of underlying growth. Experience in the second half isn't going to grow as fast as 9% in the first half. That, I said that in the prepared remarks. Clearly those are relatively significant in the context of a single half. And therefore, the first half of next year, it might be something that we'll be talking about this time next year about the slower growth rate on a reported basis in Capita Experience, but the underlying growth in both divisions is in that mid-single-digit territory.

[ So if I can just follow up one more ], on the annualized cost savings that you touched on that you seek to target. Can you just touch on sort of the phasing of that and how you expect that to come through?

Yes. What we said on the GBP 40 million of annualized cost savings is that will be a run rate to be delivered by the end of 2024. Clearly we'll try and deliver as much as possible as we can, to impact as much as we can, in 2024, but that all up is a run rate at the end of the year. When we talked about the doubling net income target over the medium term at the results announcements previously, we said there were various different components, revenue growth, improving the revenue mix, increasing use of technology and cost savings. And essentially we've quantified a chunk of the deliverables that will get us there in terms of that doubling of the net margin in the group as a whole. That cost reduction comes out of group, divisional overheads, operating costs. Group and divisional overheads currently run at around 11% of revenues. Taking GBP 40 million out of it would get us down into single-digit percentages of revenues, which is more in line with our peers, but even then there would still be more to go for in terms of efficiency.

I mean just a couple of comments to add to Tim's. David, I think we've been quite transparent, the last 2 or 3 reporting events, in stating that as we complete the disposal of portfolio and as we cement in place the very controls, the governance, the functional excellence that we've been building into the business the last 5 years, then there is less resource required to sustain that. And then of course, we've got a reduction in property footprint that Tim and I both talked about. So you combine those together; and there is line of sight to that quantum of cost saving, perhaps more.

It's James Rose from Barclays. I've got 2, please. The release talks to the difference between BPO work and digital transformation work within Capita. Could you talk about the bids in the pipeline? Does that also reflect a shift towards more digital transformation? And then secondly, when do you expect the group to return to positive free cash flow? And could you just give us a -- remind us of the delta as to how we get there?

A nice demarcation between Tim and I, Tim for the second, me for the first.

I think we'll [indiscernible].

Yes. I don't think -- I can't think of a single engagement we have had in the last 18, 24 months in which there isn't digital content. We would not be winning work today. I mean think about it in our personal lives, all right? Anything and everything we do involves digital capability in some form or another, so all of the major contracts, whether it's defense, fire and rescue; whether it's FAS -- I had a conversation with a permanent secretary in one of government departments this week, where we are actively encouraging them to adopt more gen AI, more digital solutions to drive costs down for the taxpayer. So it would be the exception if we were to bid on anything that didn't have a slight -- a significant digital content. Now what's different today compared to what Capita might have done 5, 10 years ago is that, that digital content doesn't require the huge investment in CapEx that it did back then. We are leveraging low-code, no-code platforms from the hyperscalers I mentioned earlier on, ServiceNow, Salesforce and Microsoft. And we can very quickly configure those, with our deep understanding of our clients' business processes, to the applications that our clients are seeking. And that's really how the application of tech, it's true of gen AI as well, will shape the kinds of solutions we deliver going forward, so our ability to compete will be tightly aligned with our capacity to configure horizontal technologies to the business processes in the industry verticals and the government departments in which we operate. And as the single largest provider and manager of those processes today, surely we have some competitive advantage there.

The route to free cash flow. First of all, I should just emphasize the point I said during the presentation. We're not tin eared. We've listened to the investment community and we've changed our free cash flow definition and that is now after deducting the capital element of lease payments. I think, looking at most of the consensus numbers on that basis, it's probably 2025 before most analysts are predicting this group to be in positive free cash flow territory after those capital lease payments. And then in terms of the things that will change between now and then, one thing that actually happened in the first half of the year, which is a reasonable chunk of deferred income on one of our largest contracts has now been released. So that was noncash-backed profits. And therefore, the quality of our profits are improving, moving forward, as we are clearing out some of the legacy deferred income balances. So a great level of cash-backed profits. A presumption: We will not have a cyber incident on a recurring basis. Clearly that is impacting significantly on cash flows in the current half and the second half of the year. Pension contributions, the much stronger position of the pension scheme means that, on a both accounting basis and the same actuarial funding basis as at the last triennial in 2020, the scheme would be in about a GBP 50 million surplus. We're going through a triennial valuation at the moment, effective date of April 2023. That will be completed towards the end of the current calendar year. We sort of know where the answer is going to be in terms of the funding valuation of that scheme, probably somewhere between GBP 20 million and GBP 30 million. That deficit would be covered by our preexisting contributions coupled with some further accelerated contributions we're going to be making as we complete the portfolio disposal program. Therefore, by the time we get to 2025, I would expect a much reduced level of pension deficit contributions. And then finally, now we're including lease payments in our definition. The ongoing property rationalization program will reduce the cash costs of leases. All of those help you in this journey to a positive free cash flow, which in terms of our own time frame is still over the medium term, but as I said, most analysts are modeling, on that basis, 2025 is when you go through from negative to positive.

Chris Bamberry, Peel Hunt. 3 questions. You mentioned obviously you expect CX to have lower growth in the second half compared to the first half's 9%, but how would you compare to the kind of underlying 4% to 4.5%? Secondly, what was the net impact of cost inflation against indexation in the first half? And finally, are you seeing any evidence in any of your verticals in CX of a slowdown?

Let me deal with the latter question, first. I'd refer you, Chris, to the slide we showed, the second CX slide we showed, which talked about the growth in the top 5 markets for CX in Europe. We're in 4 of those. And on average, those are growing at 5% per annum, so we're not seeing any reduction or projected reduction in growth in those markets. And I think what's interesting is that many more of our clients will not, do not have the experience around the application of gen AI solutions because they don't have the scale in order to do that internally, so I think there might very well be incremental demand for our expertise around how we configure and implement some of these complex digital solutions to meet their specific business processes. On indexation, I think we spoke to that in the sense that I'm very pleased with the progress on indexation we've delivered for our largest contracts. It's at CPI or RPI or some merge of and there are some caps on some, but we've done a pretty good job of getting after those contractually agreed indexation increases. And we've made some progress on others where we actually didn't have a contractual obligation on the part of the client to give us a pay rise -- price rise. Where we've got more work to do is on some of the in-year revenue transactional work, where we've got to look much harder at our rate cards, the discipline by which we are sticking to those rate cards in going after those smaller transactions of -- in the GBP 1 million to less category where I believe we are still leaving money on the table. Tim?

Just picking up on that indexation point. There's a slide in the appendices to the pack. It's Slide 33. And coincidentally, the revenue impact, in the first half, of indexation is GBP 33 million of increased revenues from the pure indexation clauses being exercised in the contracts that Jon was talking about. Just to refresh your memory about how those work: Those typically take effect in March, April in terms of the indexation clause. Price rises based on a probably November, December pricing index. And therefore, you've got 2 or 3 months of effect. And therefore, there will be a greater benefit of that moving into the second half in terms of the benefits of indexation on our revenues versus the prior year. In terms of the growth rates in the 2 businesses in the second half of the year, there's going to be a switch-around, so expect Experience to grow more slowly because it won't have the one-off benefits we've seen from the accelerated revenue in respect of the commercial settlement and VM O2 that we saw in the first half. And Capita public, in terms of its business development success, is we'll see more benefit in the second half. So public will grow more quickly in the second half. Experience will grow more slowly. With precision, the point about Experience is Experience had a good second half growth rate last year. And if you'll remember, it stepped up from a small negative in the first half of last year to around 4% growth in the second half of last year. And therefore, it's going to be challenged to have an underlying growth rate at that 4% or 5% we've seen in the first half excluding the one-offs. Group as a whole, we continue to expect to show accelerated revenue growth for the whole year versus the whole of last year.

One other comment, Chris, on growth. Both divisions are either growing at or exceeding the growth rate we built into our financial plan for the first half of this year. We had anticipated that CPS would do a little bit better than that on the back of the disabled students allowance award. That got delayed about a quarter and that's one of the reasons why we've not seen quite the rate of revenue growth in CPS in the first half we were hoping for. They've delivered against plan, but we were hoping to do a little bit better than planned. There must be a few more. Come on.

I've got one online.

Yes. Go ahead.

Thank you. So it is from -- sorry. [ Mind the screen ]. It's from [ Max Himes ], basically asking confidence around the forecast for the costs related to the cyber incident.

Shall I do that? As Jon has said, we're drawing to an end in terms of the forensic exercise going through all of the exfiltrated data to identify who to communicate with. And therefore, we've got a reasonably good handle on what the costs of the exercise will be just because we're getting towards the end of it. You will have spotted there is a range, GBP 20 million to GBP 25 million. Being quite direct about it, the reason for that range is the insurance recovery, the potential insurance recovery. We've got a view on what the costs will be. There will be a bit of a negotiation and a bit of loss adjustment, shall we say, in terms of how much we are likely to get back through insurance, but the GBP 20 million to GBP 25 million is our best estimate, at this point of time, is where it's going to land after a little bit more spend we see in the second half and reflecting a view of the potential insurance recoveries.

Okay, I've got one more. A bit of a cheeky one, this, but it seems a good one to end on. So from somebody called [ Lin ], saying, "Jon, knowing what you know now, would you still have taken the job at Capita?"

Yes. And here's why: I told a very senior [ Citi ] person this week actually, when we started this journey, there were an awful lot of pundits out there who said that this could not be achieved. We were so indebted. Our reputation was so bad. We've been underinvested in for so many years. You needed to break the business up. And when we talked about all of the limitations and constraints, we actually euphemistically referred to it as the Gordian knot that we had to untie to get to where we are today. And through the hard work of colleagues, some great advisers, some of whom are in the room here, we get to where we are today. And I can quite honestly say that, that has been and will be the most professionally satisfying thing I will ever do in my life. Many people said it was impossible. It's bloody nice to prove them wrong, I can tell you. We got to where we are today. The company has been saved. We have a strong basis and foundation for the future. And I'm very confident that, under Adolfo's leadership, we will see sustained growth, free cash flow and margin improvement. The base, the foundations are there to achieve that. Now my job as a turnaround guy is done. I'm going to go and do something else. It wasn't a cheeky question at all. Are we done?

Yes.

Thanks very much, everyone. Nice to see you.

Thank you...