The Group's financial instruments comprise cash deposits, bank loans and overdrafts, finance lease obligations, derivatives used for hedging purposes and trade receivables and payables.
Treasury Policy
The Group reports in Sterling and pays dividends out of Sterling profits. The role of the Group's treasury activities is to manage and monitor the Group's external and internal funding requirements and change to financing risks in support of the Group's corporate activities.
The Board of Directors has approved a policy which governs all treasury activities.
The Group uses a variety of financial instruments, including derivatives, to finance its operations and to manage market risks from these operations. Derivatives, principally comprising forward foreign currency contracts, foreign currency options and interest rate swaps, are used to hedge against changes in foreign currencies and interest rates. Hedges of net investments in foreign operations are also used in the management of foreign currency risk.
The Group does not hold or issue derivative financial instruments for speculative purposes and the Group's treasury policy specifically prohibits such activity. All transactions in financial instruments are undertaken to manage the risks arising from underlying business activities, not for speculation.
During the year the Group has implemented physical cash pooling. This has resulted in increased cash being held in Dechra Pharmaceuticals PLC as the Master Account Holder.
Capital Management
The capital structure of the Group consists of net borrowings and shareholders' equity. At 30 June 2019, net borrowing was £227.8 million (2018: net borrowing was £211.4 million), whilst shareholders' equity was £509.1 million (2018: £505.0 million).
The Group maintains a strong capital base so as to maintain investors', creditors' and market confidence and to sustain future development of the business.
The Group manages its capital structure to maintain a prudent balance between debt and equity that allows sufficient headroom to finance the Group's product development programme and appropriate acquisitions. There were no changes in the Group's approach to capital management during the year.
The Group operates globally, primarily through subsidiary companies established in the markets in which the Group trades. The Group's operating subsidiaries are generally cash generative and none are subject to externally imposed capital requirements.
There are financial covenants associated with the Group's borrowings, which are interest cover, and net debt to underlying EBITDA. The Group complied with these covenants in 2019 and 2018.
Operating cash flow is used to fund investment in the development of new products as well as to make the routine outflows of capital expenditure, tax, dividends and repayment of maturing debt.
The Group's policy is to maintain borrowing facilities centrally which are then used to finance the Group's operating subsidiaries, either by way of equity investments or loans.
Financial Risk Management
The Group has exposure to the following risks from its use of financial instruments:
- liquidity risk
- market risk
- credit risk
This note presents information about the Group's exposure to each of the above risks, and the Group's objectives, policies and processes for measuring and managing risk.
Liquidity Risk
Liquidity risk is the risk that the Group will not have sufficient funds to meet liabilities as they fall due. Cash flows and covenants of the Group are monitored half-yearly. These are reviewed to ensure sufficient financial headroom exists for at least a 12 month period.
The Group manages its funding requirements through the following lines of credit:
- £235.0 million multi-currency revolving credit facility, with an accordion of £125.0 million;
- £350.0 million Term Loan facility; and
- £5.8 million bank loans;
The Group's revised borrowing facilities at 30 June 2019 are detailed in note 21.
Market Risk
Market risk is the risk that changes in market prices, such as foreign exchange rates or interest rates, will affect the Group's income or the value of its holding of financial instruments.
Interest Rate Risk Management
The majority of the Group's borrowings bear interest at floating rates linked to base rate or LIBOR and are consequently exposed to cash flow interest rate risk.
Foreign Exchange Risk Management
Foreign currency transaction exposure arising on normal trade flows is not hedged. The Group matches receipts and payments in the relevant foreign currencies as far as possible. To this end, bank accounts are maintained for all the major currencies in which the Group trades. Translational exposure in converting the income statements of foreign subsidiaries into the Group's presentational currency of Sterling is not hedged.
The Group hedges selectively expected currency cash flows outside normal trading activities. The Group has designated a US Dollar loan of $97.0 million as a net investment hedge of US Dollar net assets.
Credit Risk
Credit risk is the risk of financial loss to the Group if a customer or counterparty to a financial instrument fails to meet its contractual obligations.
The Group considers its maximum credit risk to be £96.0 million (2018: £79.0 million), which is the total carrying value of the Group's financial assets excluding cash and cash equivalents.
Cash is only deposited with highly rated banks in line with our treasury policy.
The Group offers trade credit to customers in the normal course of business. Trade and bank references are obtained prior to extending credit.
Our principal customers are pharmaceutical wholesalers and distributors. The failure of a large wholesaler could have a material adverse impact on the Group's financial results.
The largest customer of the Group sits within the NA Pharmaceuticals segment and accounted for approximately 22.0% of gross trade receivables at 30 June 2019 (2018: 21.2%). This customer accounted for 20.4% (2018: 19.8%) of total Group revenues. One other customer accounted for more than 10% of total Group revenues (2018: one).
Trade receivables are written off when there is no reasonable expectation of recovery. Indicators that there is no reasonable expectation of recovery include, amongst others, the failure of a debtor to engage in a repayment plan with the Group.
Fair Value of Financial Assets and Liabilities
The following table presents the carrying amounts and the fair values of the Group's financial assets and liabilities at 30 June 2019 and 30 June 2018. The following assumptions were used to estimate the fair values:
- Cash and cash equivalents – approximated to the carrying amount.
- Derivatives (Interest rate swaps) – based upon the amount that the Group would receive or pay to terminate the instrument at the balance sheet date, being the market price of the instrument.
- Receivables and payables – approximated to the carrying amount.
- Bank loans and overdrafts – based upon discounted cash flows using discount rates based upon facility rates renegotiated at the year end.
Analysis of Financial Instruments
The financial instruments of the Group measured at amortised cost are analysed as follows:
| 2019 | 2018 |
|---|
Carrying
value
£m | Fair
value
£m | Carrying
value
£m | Fair
value
£m |
|---|
| Financial assets | | | | |
| Cash and cash equivalents | 80.3 | 80.3 | 79.7 | 79.7 |
| 80.3 | 80.3 | 79.7 | 79.7 |
| Financial assets measured at amortised cost | | | | |
| – trade receivables | 91.1 | 91.1 | 76.0 | 76.0 |
| – other receivables | 4.9 | 4.9 | 3.0 | 3.0 |
| 96.0 | 96.0 | 79.0 | 79.0 |
| Total financial assets | 176.3 | 176.3 | 158.7 | 158.7 |
| Financial liabilities | | | | |
| Bank loans and overdrafts | (310.8) | (310.8) | (294.5) | (294.5) |
| Trade payables | (31.9) | (31.9) | (33.0) | (33.0) |
| Other payables | (1.9) | (1.9) | (12.3) | (12.3) |
| Accruals | (56.6) | (56.6) | (26.0) | (26.0) |
| Deferred and contingent consideration | (36.0) | (36.0) | (36.8) | (36.8) |
| Total financial liabilities | (437.2) | (437.2) | (402.6) | (402.6) |
| Net financial liabilities | (260.9) | (260.9) | (243.9) | (243.9) |
Fair Value Hierarchy
The table below analyses the Group's financial instruments carried at fair value, by valuation method. Where possible, quoted prices in active markets are used (Level 1). Where such prices are not available, the asset or liability is classified as Level 2, provided all significant inputs to the valuation model used are based on observable market data. If one or more of the significant inputs to the valuation model is not based on observable market data, the instrument is classified as Level 3. There were no transfers between Level 1 and Level 2 during the year.
| 30 June 2019 | Level 1
£m | Level 2
£m | Level 3
£m | Total
£m |
|---|
| Financial instruments held at fair value through the profit and loss | – | – | – | – |
| Derivative financial liabilities | – | – | – | – |
| Deferred and contingent consideration | – | – | (36.0) | (36.0) |
| Total | – | – | (36.0) | (36.0) |
| 30 June 2018 | Level 1
£m | Level 2
£m | Level 3
£m | Total
£m |
|---|
| Available for sale financial instruments | – | – | – | – |
| Derivative financial liabilities | – | – | – | – |
| Deferred and contingent consideration | – | – | (36.8) | (36.8) |
| Total | – | – | (36.8) | (36.8) |
Deferred and contingent consideration is recorded at fair value based on risk-adjusted future cash flows discounted using appropriate interest rates, which are reviewed annually. The inputs relating to future cash flows will include cash flows relating to the relevant contractual arrangements. There would be no material effect on the amounts stated from any reasonably probable change in such inputs at 30 June 2019. Refer to note 4 for amounts recognised in the Consolidated Income Statement in the year.
Credit Risk
The Group applies the IFRS 9 simplified approach to measuring expected credit losses which uses a lifetime expected loss allowance for all trade receivables.
To measure the expected credit losses, trade receivables have been grouped based on shared credit risk characteristics, and the days past due. The expected loss rates are based on the payment profiles of sales over a period of 36 months before 30 June 2019 and the corresponding historical losses experienced within this period. The historical loss rates are adjusted to reflect current and forward- looking information on macroeconomic factors affecting the ability of the customers to settle the receivables.
The loss allowance provision as at 30 June 2019 is determined as follows:
| 30 June 2019 | Not due
£m | Past due (up to one month)
£m | Past due (one to three months)
£m | Past due (over three months)
£m | Total
£m |
|---|
| Expected loss rate | 0.03% | 0.03% | 0.03% | 75.0% | |
| Gross carrying amount - trade receivables | 85.8 | 4.2 | 1.3 | 0.9 | 92.2 |
| Loss allowance | – | – | – | 0.2 | 0.2 |
| Specific loss allowance | 0.2 | – | – | 0.7 | 0.9 |
| Total loss allowance | 0.2 | – | – | 0.9 | 1.1 |
The loss allowance provisions for trade receivables as at 30 June 2018 is not materially different to the balance reported and therefore no restatement is necessary through the opening retained earnings for 1 July 2018.
The movement in the loss allowances for trade debtors at 30 June 2019 reconcile to the opening loss allowances as follows:
| 2019
£m | 2018
£m |
|---|
| At start of period | 0.6 | 3.2 |
| Impairment provision recognised/(released) | 0.6 | (0.1) |
| Impairment provision utilised | (0.1) | (2.5) |
| At end of period | 1.1 | 0.6 |
Liquidity Risk – Contracted Cash Flows of Financial Liabilities
The following table shows the cash flow commitments of the Group in respect of financial liabilities at 30 June 2019 and 30 June 2018. Where interest is at floating rates, the future interest payments have been estimated using current interest rates:
| At 30 June 2019 | Deferred and
contingent
consideration
£m | Bank loans
and
overdrafts
£m | Trade and
other
payables
£m | Total
£m |
|---|
| Carrying value | (36.0) | (308.1) | (33.8) | (377.9) |
| Arrangement fees netted off | – | (2.7) | – | (2.7) |
| Future interest | (26.4) | (1.9) | – | (28.3) |
| Total committed cash flow | (62.4) | (312.7) | (33.8) | (408.9) |
| Payable: | | | | |
| Within 6 months | (2.9) | (2.6) | (33.8) | (39.3) |
| Between 6 months and 1 year | (2.7) | (0.6) | – | (3.3) |
| Between 1 and 2 years | (10.7) | (180.7) | – | (191.4) |
| Between 2 and 3 years | (9.3) | – | – | (9.3) |
| Between 3 and 4 years | (3.2) | – | – | (3.2) |
| Between 4 and 5 years | (3.8) | – | – | (3.8) |
| Over 5 years | (29.8) | (128.8) | – | (158.6) |
| (62.4) | (312.7) | (33.8) | (408.9) |
| At 30 June 2018 | Deferred and
contingent
consideration
£m | Bank loans
and
overdrafts
£m | Trade and
other
payables
£m | Total
£m |
|---|
| Carrying value | (36.8) | (291.1) | (45.3) | (373.2) |
| Arrangement fees netted off | – | (3.4) | — | (3.4) |
| Future interest | (25.2) | (1.4) | — | (26.6) |
| Total committed cash flow | (62.0) | (295.9) | (45.3) | (403.2) |
| Payable: | | | | |
| Within 6 months | (5.0) | (1.9) | (45.3) | (52.2) |
| Between 6 months and 1 year | (4.2) | (0.6) | – | (4.8) |
| Between 1 and 2 years | (4.7) | (1.3) | – | (6.0) |
| Between 2 and 3 years | (9.4) | (134.3) | – | (143.7) |
| Between 3 and 4 years | (3.0) | – | – | (3.0) |
| Between 4 and 5 years | (3.9) | (157.8) | – | (161.7) |
| Over 5 years | (31.8) | – | – | (31.8) |
| (62.0) | (295.9) | (45.3) | (403.2) |
Foreign Currency Exposure
The Sterling equivalents of financial assets and liabilities denominated in foreign currencies at 30 June 2019 and 30 June 2018 were:
| At 30 June 2019 | Australian
Dollar
£m | Danish
Krone
£m | Euro
£m | US
Dollar
£m | Other
£m |
|---|
| Financial assets | | | | | |
| Trade receivables | – | – | 7.8 | 0.5 | 1.6 |
| Other receivables | – | – | 0.1 | – | – |
| Cash balances | 0.6 | – | 31.7 | 15.2 | 15.7 |
| 0.6 | – | 39.6 | 15.7 | 17.3 |
| Financial liabilities | | | | | |
| Bank loans and overdrafts | – | (2.2) | (2.7) | (92.2) | – |
| Trade payables | – | – | (2.7) | (0.4) | – |
| Other payables | – | – | (0.7) | (0.3) | – |
| Deferred consideration | (21.9) | – | (6.7) | (6.6) | – |
| (21.9) | (2.2) | (12.8) | (99.5) | – |
| Net balance sheet exposure | (21.3) | (2.2) | 26.8 | (83.8) | 17.3 |
| At 30 June 2018 | Australian Dollar £m | Danish
Krone
£m | Euro
£m | US
Dollar
£m | Other
£m |
|---|
| Financial assets | | | | | |
| Trade receivables | – | 1.6 | 3.9 | 1.1 | 0.1 |
| Other receivables | – | – | – | 0.4 | 0.2 |
| Cash balances | 0.8 | 1.3 | 1.5 | 10.3 | 4.0 |
| 0.8 | 2.9 | 5.4 | 11.8 | 4.3 |
| Financial liabilities | | | | | |
| Bank loans and overdrafts | – | – | (7.6) | (107.9) | – |
| Trade payables | – | – | (5.8) | (0.2) | (0.3) |
| Deferred consideration | (24.1) | – | (2.0) | (9.6) | – |
| (24.1) | – | (15.4) | (117.7) | (0.3) |
| Net balance sheet exposure | (23.3) | 2.9 | (10.0) | (105.9) | 4.0 |
Sensitivity Analysis
Interest Rate Risk
A 2.0% increase in annual interest rates compared to those ruling at 30 June 2019 would reduce Group profit before taxation and equity by £6.0 million (2018: £4.4 million).
Foreign Currency Risk
The Group has significant cash flows and net financial assets and liabilities in Danish Krone, US Dollar and Euro. The Group does not hedge either economic exposure or the translation exposure arising from the profits of non-Sterling businesses. The Group is hedging certain foreign currency translations through the designation of a US Dollar loan as a net investment hedge of US Dollar net assets.
During 2019, we have been exposed to transactional and translational currency risk. In addition to the transactional gain of £0.7 million being recognised in the Consolidated Income Statement, £3.8 million foreign exchange gain translational impact was recognised in the Consolidated Statement of Comprehensive Income in the year.
As part of our acquisition strategy, we seek to balance the foreign exchange debt and related interest payable risk associated with non-Sterling acquisitions with the underlying related income and assets in foreign currencies.
The following table shows the impact on the Group's profit after taxation of a 10% appreciation of Sterling against each of these currencies compared to the rates prevailing at the year end date. In this analysis, only financial assets and liabilities held on the balance sheet at the year end are assessed and are only considered sensitive to foreign exchange rates where they are not in the functional currency of the entity that holds them. There is no impact on other equity reserves.
| Profit after
taxation
£m |
|---|
| Danish Krone | (0.2) |
| US Dollar | – |
| Euro | 3.7 |
The sensitivities above represent the Directors' view of reasonably possible changes in each risk variable, not worst case scenarios or stress tests. The outputs from the sensitivity analysis are estimates of the impact of the effect of changes in market risks assuming that the specified changes occur at the year end and are applied to the risk exposures at that date. Accordingly, they show the impact on profitability and the balance sheet from such movements.
Actual results in the future may differ materially from these estimates due to commercial actions taken to mitigate any potential losses from such rate movements, to the interaction of more than one sensitivity occurring and to further developments in global financial markets. As such, this table should not be considered as a projection of likely future gains and losses.