Victoria PLC – Interim Results

Victoria PLC (LSE: VCP) the international designers, manufacturers and distributors of innovative floorcoverings, is pleased to announce its interim results for the 26 weeks ended 29 September 2018.

Financial and Operational Highlights

	H1 FY19	H1 FY18	Growth
Revenue	£273.4m	£189.5m	+44%
Underlying EBITDA1	£45.4m	£24.6m	+85%
Underlying EBITDA margin Underlying operating profit1	16.6% £34.0m	13.0% £18.2m	+360 bps +87%
Operating profit	£13.6m	£12.9m	+5%
Underlying profit before tax1	£28.2m	£15.5m	+82%
Earnings per share:
– Basic adjusted1	17.91p	13.10p	+37%
– Basic	0.58p	6.55p	-91%
Cash generated by operations	£34.8m	£17.4m	+100%
Net debt	£342.7m	£98.6m
Net debt / EBITDA2	3.09x	1.77x

Financial highlights

·     Revenue grew by 44% versus the same period in the prior year, from £189.5m to £273.4m

·     Like-for-like revenue growth3 (LFL) of more than 5% in UK & Europe soft flooring, where there have been no acquisitions in the period, and more than 3% across the Group

[1] Underlying performance is stated before the impact of exceptional items and amortisation of acquired intangibles within operating profit.  Underlying profit before tax and adjusted EPS are also stated before non-underlying items within finance costs (comprising mark-to-market adjustments, BGF redemption premium charge, earn-out liability fair value adjustments, release of prepaid finance costs and exchange rate differences on foreign currency loans).

Revenue	H1 FY19	H1 FY18
UK & Europe, soft flooring	£138.6m	£130.7m
UK & Europe, ceramic tiles	£81.7m	–
Australia (AUD)	A$95.3m	A$98.8m
Australia (GBP)	£53.1m	£58.8m
Group	£273.4m	£189.5m

·     Underlying EBITDA margin rose to a record 16.6%, from 13.0% for the same period last year (and 15.2% at the year-end)

·     82% increase in underlying profit before tax, from £15.5m to £28.2m

·     An increase in one-off exceptional costs in the period, resulting from the acquisition of Ceramica Saloni and other corporate M&A activity, as well as ongoing operational synergy projects as previously disclosed

·     Total capital expenditure in the period of £20.9m, comprising:

–     £8.8m of replacement capex, plus

–     £12.1m of expansionary capex, with key areas of being: a new backing & finishing line at our carpet factory in South Wales (c. £4m), further investment in the new UK distribution centres as a continuation of the logistics project that commenced last year and is expected to complete early next year (c. £1.5m), and expansion of atomising and press capacity in Keraben (c.£5m)

·     Continued strong cash generation, with cash generated by operations of £34.8m, being over 100% of underlying operating profit, and double that of the comparative period last year

·     Following the period end, the Group considered a Bond issue to refinance its existing bank facilities but the rates available at that time were not in Shareholders' best interests. The Group may consider revisiting this in the future if appropriate

·     Net debt as at 29 September 2018 of £342.7m, representing 3.09x EBITDA², following the acquisition of Ceramica Saloni in August, with significant headroom against covenants remaining

The Board expects the full year result to be in line with market expectations.

Operational highlights

·     Continued progress achieved against strategic priorities, including:

–     achieving LFL growth and gains in market share in soft flooring, driven by new value-orientated products and brands, and

–     adding further scale in branded, mid-high end ceramic tiles with the acquisition of Ceramica Saloni in August

·     Identified operational synergies between Keraben Grupo and Ceramica Saloni ahead of original expectations

·     In Italy, the planned investment in production facilities at Ceramiche Serra completed in May 2018 and now delivering a significant improvement in performance

Geoff Wilding, Executive Chairman of Victoria PLC commented:

“Victoria continued to make strong operational progress during the period. We again delivered against our strategy designed to grow market share, improve cash generation, and increase earnings per share, via both acquisition and organically, and we continue to focus on synergies and integration to ensure operational excellence within the Group.

“Our progress was made against a backdrop of a challenging market and our strategy of achieving product and market diversification over the last few years has enabled us to adapt well to various market conditions and tailor our offering accordingly. This remains a key strength of the Group relative to its competitors. In the UK, for example, we have been able to materially grow market share by introducing new value-orientated products and brands (alongside existing, predominantly mid-upper priced, products), safe in the knowledge that, although our margin growth is a little slower this year – albeit expected to be some 200 basis points higher than FY2018 – growth will be continued next year driving returns for our shareholders.

“With the Group's focus on generating cash, driving earnings, and continued operational integration, I look forward to the second half of the year with confidence and to updating our shareholders on our progress in due course.”

Chairman's Statement

H1 trading review

The Board is pleased to report that trading in the first half year to September 2018 continued to be good – especially given the market backdrop – with like-for-like (“LFL”) organic revenue growth³ of more than 3% across the Group, and Victoria winning market share as planned. Overall, the Group has delivered revenue of £273.4 million, versus £189.5 million in the comparative period last year, and underlying EBITDA margin of 16.6% compared to 13.0% last year.

UK & Europe

Soft flooring

The UK flooring market has seen a mid-high single-digit decline in volume over the past 12 months. However, Victoria has achieved more than 5% LFL organic revenue growth³ in the six months to September by taking advantage of these conditions to materially grow market share. This growth is expected to continue for the balance of the year, albeit at the temporary expense of some potential margin gains, as previously announced. (It is important to understand the Group's margin is, however, still growing and will be some 200 basis points higher than in FY 2018, in line with guidance provided in October). To clarify, this slower margin gain is not the result of price cutting; Victoria has no intention of diluting our high-quality brands. Instead, the Group has introduced new value-orientated products and brands to increase our share of wallet at existing retailers and to attract new retailers to our products.

This strategy has been, and continues to be, successful and therefore the Board is firmly of the view that it is the right approach to consolidate the Group's position as the largest, most successful flooring manufacturer and distributor in the UK. Furthermore, the Group is implementing several internal, proactive measures during the second half of the year and next year. These will resume the margin growth whilst maintaining the market share gains, such that the medium-term outcome will be a larger, more profitable and more stable business.

Ceramic tiles

Following the acquisition of Ceramica Saloni in August, the Group's operational management in Spain are firmly focused on delivering the identified synergies in raw materials procurement, utilisation of Keraben's atomisation capacity, and production efficiencies. These actions are now well advanced and are expected to be fully delivered by the end of the current financial year. I am pleased to advise that the outcome of these synergies is likely to be better than the Board had initially expected, which will make a material contribution to achieving continued growth in FY 2019.

Our Italian ceramic tile business, Ceramiche Serra, is having a very strong year. For the last 25 years Serra has operated a unique production model employing a number of patented technologies to manufacture a cost-effective product tailored for specific end markets (100% of the company's production output is exported from Italy). When Victoria acquired this company in December 2017, Serra had begun the process of replacing one of its existing production lines – all of which produced red body tiles – with a new line designed to manufacture higher margin porcelain tiles. This was a very substantial project and quite disruptive to the business for a number of months, but the installation was completed as planned by the end of May and the new products are selling well, which is driving significant improvement of the performance of Serra.

The Group is also looking at potential initiatives to broaden our export markets in ceramic tiles, including to increase sales of our products into the UK, which is currently a very small market for our businesses.

Australia

Australia represents around 13% of operational profits. Following a period of very strong growth, the Australian market has been a little softer this year following the tightening of mortgage lending and some decline in consumer confidence. Victoria's Australian operations recorded LFL revenue of -4% in H1. However, the Australian economy is still growing and the Group is fortunate in having very strong management at Victoria Australia, Quest, and Dunlop Flooring, who have developed plans to ensure improved performance next year. The Board has a high degree of confidence in them to deliver these improvements.

Strategy

Victoria has executed a simple strategy to create wealth for shareholders over the last six years: use carefully selected acquisitions to build scale, market position, and diversification; focus on synergies and integration to drive higher margins and increase cash flow; deploy the cash flow to pay down debt arising from the acquisitions; and then repeat.

Our pace of growth has been steady and measured and includes 13 businesses acquired over the last six years. All are performing as anticipated, reflecting the highly selective nature of our acquisition process. A successful acquisition typically takes nine to twelve months to complete given the intense nature of our due diligence and for every acquisition that is announced, there are many that are not pursued for a wide variety of reasons. Value isn't created by doing deals, it's by doing good deals.

Accompanying the acquisition activity, we have carefully built the most effective operational management team in the sector, which has ensured an intense management focus on further developing the high-quality businesses that have been acquired.

At this stage of Victoria's development and following the sizeable acquisition of Ceramica Saloni in August of this year, our efforts are now firmly on delivering the potential synergies (progress is very encouraging and all workstreams are expected to be completed by the end of the current financial year) and generating cash across the Group to pay down debt as per the strategy described above.

Capital expenditure

The Board and management of Victoria are committed to building a long-term successful business. Although we would clearly be willing to trim capex budgets during difficult economic conditions, the policy is to ensure that our businesses remain well invested and to broadly match capex to depreciation over an economic cycle. This approach should reassure shareholders that the Group will remain operationally competitive and sustainable into the future.

In addition, the Group selectively invests in organic expansion projects where the Board determines there is a meaningful benefit in terms of growth in capacity or ongoing cost reduction. For example, this month Victoria commissioned a new backing and finishing line at its carpet manufacturing plant in South Wales. This is a significant investment and as a result, Victoria now has the fastest, most productive manufacturing facility, with operational savings that will deliver a significant improvement in margins next year and a payback period of only about 2.5 years.

Exceptional and other non-underlying costs

As discussed above, Victoria's strategy is to make carefully qualified acquisitions and then to integrate them in order to deliver synergies to drive higher margins and improved cash generation. Of necessity, this acquisition and integration activity produces large, one-off costs as well as some accounting adjustments that are not representative of the underlying business. While we continue to execute our strategy such costs will continue to be generated, but this will stop the moment that we stop pursuing acquisitions or undertaking synergy projects.

The notes to the accounts provide further details, but these costs fall into the following key categories:

1.         Acquisition activity. Pursuing acquisitions comes with prospecting costs, acquisition advisory costs, legal fees, due diligence fees (often covering financial, tax compliance, legal and environmental amongst other areas), as well as costs associated with intercompany and capital structure advice. Furthermore, as we are extremely selective with the acquisitions that we undertake, unfortunately, but inevitably, costs are incurred on deals that we choose not to complete.

2.           Reorganisation costs. Delivering operational integration and cost synergies requires restructuring activity, producing large, one-off costs in terms of redundancies, plant and machinery relocation, reconfiguration and planning, site disruption, etc. These are unavoidable if the incremental benefits from the acquisitions are to be achieved, but are also genuinely non-recurring (a factory can only be closed once, for example). These costs have increased in the last 12-18 months because, whilst earlier in the development of the Group the synergies being delivered were 'softer' (procurement savings, application of best practice, etc), once the Group reached a certain scale in a number of product areas, we were able to look at more substantial synergy projects involving consolidation of physical operations. However, accepting the one-off costs today, the positive impact on margins going forward are material – building a stronger, more profitable Group for the future.

3.          Intangible amortisation. The goodwill and other intangible assets on Victoria's balance sheet are a product of the Group's strategy to only buy the very best businesses it can find. Therefore, because acquisition prices reflect profitability and cash flow, the price paid will often exceed the net asset value of the target, resulting in intangible assets, some of which are then amortised over a fixed period in line with accounting standards. This amortisation cost is entirely non-cash, and of course these assets do not need to be 'physically' replaced once they are fully amortised.

4.      Adjustments to earn-outs and deferred consideration. Wherever possible, the Board includes deferred consideration within the structure of the Group's acquisitions, often contingent on the ongoing performance of the target over a number of years (an “earn-out”). Such structures pass risk from the Group back to the vendor, as well as serving to incentivise management. The fair value of these liabilities is fully recognised in the Group's balance sheet, with any variations over time charged to the income statement. Whilst the final payment of earn-outs is of course made in cash, these adjustment items are themselves non-cash and not related to the underlying operating business.

5.          Write-down of pre-paid financing costs. As the Group has made acquisitions over the last few years, its debt has been refinanced on a few occasions to update its capital structure as the Board deems appropriate for the enlarged business. Accounting standards require that up-front financing fees are held on the balance sheet and amortised over the term of the loan. So, if a loan is replaced early with a new facility on making an acquisition, the entire outstanding fee that has not yet been amortised is written-down in one go. This is, of course, not a normal occurrence and also a non-cash event.

In summary, acquisitions and operational integration will result in exceptional costs from time to time. However, by setting these out in detail in the financial statements we hope to help shareholders better understand these items and be encouraged by what is actually happening at an operational level in the Group.

Borrowings and cash generation

Following the acquisition of Ceramica Saloni in August, the Group had net debt of £342.7 million at 29 September 2018, which represents 3.09x adjusted EBITDA². The Group has significant headroom in its covenants at this level, but the Board sees this level as an internal ceiling and is therefore emphasising paying down debt at this time.

Victoria has consistently demonstrated over the last five years that, while there is seasonality in its net debt (our working capital levels generally peak in September due to building stock levels to meet increases in demand during the pre-Christmas rush), overall cash generation is aligned to annual earnings. Flooring manufacturers structured like Victoria can generate large amounts of cash, with the Group generating pre-tax operating cash flow of between 95% and 100% of underlying EBITDA over the last three years. Management across the entire Victoria Group is very focused on cash generation with favourable supplier arrangements, manufacturing matched to demand, customer payment terms, and longevity of key items of plant all contributing to a very high percentage of reported earnings turning to net cash, which we have been able to use to make acquisitions, invest in capex, and reduce debt.

Operational cash generation across the Group is, and will continue to be, strong.

Brexit

I am somewhat reluctant to add to the almost limitless verbiage on Brexit. Nonetheless, given Victoria's next full report to shareholders will be following Brexit, I thought I should share some comments on the matter and its likely minimal impact on Victoria. 

Firstly, there is very little trade of product manufactured in the UK by Victoria into Europe or vice-versa. Therefore, any tariffs or other trade barriers between Europe and the UK are not expected to have a negative effect on the Group's general trading. Indeed, given some 60% of the soft flooring sold in the UK is imported (and almost entirely from Europe), any trading barriers which have the practical effect of reducing imports represent a material opportunity for the Group to further grow its UK market share. 

Secondly, whilst any marked depreciation in the value of Sterling will have an impact on certain raw material costs for our UK factories, clearly this will also affect the raw material costs of our UK competitors and, importantly, this will have a much more severe impact on our European competitors who supply around 60% of the UK market, making them less competitive with UK manufacturers.  In addition, the Board is comfortable that Victoria is able to pass on the impact of increased raw material prices – exactly as we did following the 20% drop in Sterling after the Brexit referendum in July 2016 (shareholders will recall our margins improved that year by 1.1%, despite the drop in Sterling). 

Furthermore, most of the raw materials that we import into the UK come from countries outside of the EU and therefore, to the extent there are tariff or non-tariff trading barriers between the UK and the EU, the direct impact on Victoria will be minimal. However, to be prudent and protect our UK factories' supply chains from any delays in the delivery of raw materials, we plan to carry a greater quantity of certain raw materials than usual for a period of time.

Finally, as I explained in the 2018 Annual Report, general economic downturn in the UK (or elsewhere) is something we are always mindful of, Brexit or no-Brexit. To that end I would remind shareholders of the following:

1.   Low operational gearing. 54% of Victoria's cost base is made up of raw materials, which, of course, are wholly variable with revenue. A further 31% of costs (labour, marketing, logistics) are semi-variable. The result is that in the event of a decline in sales, the overwhelming majority of costs fall as well, reducing the impact of lower sales on profits.

2.   Historical resilience during the 2007-09 recession. Every year between FY 2006 and FY 2011 Victoria recorded organic growth (6% CAGR) in sales (no acquisitions were done during this period) due to its mid-upper market product positioning and strong sales focus. The Group today is a much larger, more resilient and more diversified business, but the same characteristics remain.

3.   Victoria has a highly effective operational management team. The importance of this strength is difficult to overstate. Their decades of experience mean that they have lived through several economic cycles and they know how to respond to changing conditions to protect the business.

4.   Effective use of outsourcing. The Group has long practised outsourcing a small percentage (up to 5%) of its product manufacturing requirements to provide operational flexibility and a production buffer in the event of a downturn, and therefore more time for management to respond to changing conditions.

5.   Diverse economic exposure. Although the Group has manufacturing facilities in four countries (Spain, the UK, Australia, and Italy), it exports a significant amount of product all over the world. As a result, 40% of earnings come from other countries, reducing the Group's exposure to any one economy.

Outlook

In conclusion I, the Board and management are confident in the outlook for the Group, and believe that Victoria is on track to meet its objectives for the current financial year.

Material market share gains in the UK will secure long-term earnings growth. The Group's Australian businesses are expected to return to growth next year as a result of actions being taken today. In Europe, we are achieving greater than expected operational synergies in our Spanish businesses, which will add to earnings in FY 2020, together with strong performance from our Italian business which is producing record profits.

Victoria's operational management teams are firmly focused on the delivery of our organic strategy while we will continue to seek and review high-quality companies to ensure there are suitable acquisition opportunities when the time is right to execute them.

Finally, I am acutely aware that Victoria's share price is not where I believe it should be given our current trading and prospects. As one of the largest shareholders, you can be assured that I, and the other directors and management, are focused on building the confidence of investors and delivering the financial results expected of Victoria.

It is important to remember, together we own a very robust, well-managed, and growing business with over 3,000 employees who manufacture and sell some of the finest flooring in the world. The events of the last couple of months have not distracted management from delivering and for that reason I am highly confident of Victoria's continued long-term success.

Geoffrey Wilding

Executive Chairman

26 November 2018