Edited Transcript of ESNT.L earnings conference call or presentation 28-Feb-20 8:30am GMT

The 3 acquisitions that we’ve done, MicroPlastics, Hertila and most recently Innovative Components, are all on track. And if you take MicroPlastics, the longest standing acquisition of this period, it’s actually exceeding our financial expectations.

Filters, I have been talking to you about these game-changers. I said that by December 2019, we would decide whether to fish or cut bait on each of those. Fortunately we have caught fish of varying sizes, but we do have progress, substantive progress on all 3, and we can talk more about that in a minute. And the margins were held stable. Iain will justify this big statement that this is the best overall performance in Packaging since 2015, and I’m delighted to say that Nekicesa is — the acquisition we did in Spain in September is doing well.

Our stability agenda. Getting the basics right. Again, I’ll dimensionalize that, but that has continued its progress on all metrics in all businesses. At the beginning of last year, we started this business process redesign project. This is — yes, it was about going from 46 or 47 ERP systems to 1. But it was also about taking the opportunity, say this isn’t an IT project, this is actually about designing processes that are joined up, that are efficient and will enable us to pursue this growth agenda. Linked to that, we will be looking at our G&A expenses. We’ll be looking at how we work smart rather than hard. And I’ll be talking more about that at the interims.

Underlying the financials, in line with expectations and underlying profit growth. The thing to remember is that when you look at ’18 versus ’19, we have net sold GBP 8.5 million, GBP 9 million or so of profit. That’s the net of the disposals in year. As we will come and hopefully show to you, we expect further progress in 2020 strategically, financially and operationally.

If you look at the numbers, and obviously Lily will cover this in infinitely more detail, 1.5% on a underlying basis in revenue. And I’ll put that in some kind of historic context. At a headline 5.4% operating profit down, on a underlying basis 2% up. Reported operating profit of GBP 80 million versus GBP 47 million, we had a lot of one-off adjustments in 2018. You can see therefore that the reported basic EPS GBP 0.147 versus GBP 0.93.

Net debt is 2x the full — sorry, after IFRS 16 1.9x before. And we are maintaining the dividend at GBP 0.207 for the full year.

It has been a busy year. Just to walk you through some of the events. In January we sold the first of what was the specialist components businesses Pipe Protection Technologies. We acquired the balance which is 49% of our filters joint venture in Dubai. In June we sold our extrusion business in Holland. We acquired Innovative Components in Chicago and Costa Rica. And we sold Specialty Tapes. June was a particularly busy month for Kathrina there.

And then we followed that up by a relatively small divestment of our Card Solutions business. First acquisition in a long time in Packaging, Nekicesa, Iain will talk about that. And what we did was also transfer Tear Tapes into filters and Reid industrial supply distribution business into components, the former reflecting the fact that there’s a strong overlap in customers. Tear Tapes largest customer-base is the tobacco MNCs. And we’re already seeing the benefits of actually being able to offer and talk about a broader portfolio. And Reid has gone into components.

And then excitingly, we announced the JV in Xiamen at the end of November. I said that I’ll try and contextualize this. You can see at the group level underlying revenue at minus 9% became minus 2%, became plus 1.4% and plus 1.5%. And from the low point of 8.2% operating margin, we continued to increase there. On an underlying — going on to Packaging, in the lower half, you can see that from minus 9% we have gone up to 5.5%. And the financial metrics that we put around the recovery journey on Packaging are 200 to 250 basis point margin, and 5% to 6% sales. So Iain and the team have delivered that and you can see that we had a 200 bps improvement ’18 on ’17, and then we had a 270 bps improvement. So as we will talk later, we remain on track for our stated target of getting to industry standard margins of 8% to 10% in 2021.

I’ll just spend a little bit of time, if I may, talking about what’s been going on in Components and Filters before I hand over to Iain. Excluding Reid, so (inaudible) that was transferred in positive revenue on a like-for-like basis and operating margin broadly maintained. The whole essence of this business is supplying small quantities of small components exactly when the customer needs it, and what we call hassle-free service provision. As you see about halfway down, our service levels on time in full have improved by almost 2 full percentage points to 94.3%.

That has been given the complexity of supply chain. And given we have no improved systems, that is very, very major progress. What’s really encouraging as well is this NPS, that’s Net Promoter Score, which is a measure of customer satisfaction, record score of 41. Broadly, I think received wisdom is that if you’re anywhere above 30, you tend to be in market share gain territory. Just calling out one particular product category which we got into through the acquisition of a company called Mesan in Turkey. Access Hardware, and you can see a little picture of it at the bottom right there, particularly strong, and interestingly enough, the Innovative Components product range is very complementary and I’ll talk about that in a second.

This is a business with tens of thousands of products and tens and thousands of customers. And whilst they do not purchase online, our customers, if they want to find the right [space bar], the right nylon screw or whatever, will, in the vast majority of instances, go online. So actually having a good state-of-the-art website was a particularly critical challenge. We invested some GBP 5 million or so in the — in 2019, and have deployed into 10 countries, which is about now we’re up to about 3/4 of our revenue. And it is like night and day.

So that we have had very, very positive feedback from. And what that does is it enables us, which is probably the single thing if we get anything right, which is cross-selling of categories, because we have a whole range of categories. And customers actually need most of the products. So our ability to sell cable management and caps and plugs to the same customer is the simplest, easiest way to make progress. It is so much easier to sell more to an existing customer than to procure new customers.

We talked about the importance of hassle-free service of actually having the right product in the right place at the right time. And our logistics infrastructure is vitally important to that. There are lots and lots of manufacturers that use distributors. There are lots of distributors that source from other manufacturers. What we have and what makes our business model unique is we have world-class capabilities both in manufacturing and warehouse. And clearly you can do that through know-how and through, if you like, the insights of your people, but actually having the infrastructure in place, and you can see that our Houston, Texas warehouse, and it’s soon to be joined by new one in about 5 months’ time in Germany. This will simply just enhance our capabilities and in a Brexit context, it will reduce our reliance on our Kidlington, Oxford warehouse.

We talked about the improvement in service. We talked about the fact that all acquisitions are doing well. It is important that we keep doing those kind of Innovative Components-type deals. Typically, and I’ve talked to a lot of you about this, we will buy 7x or 8x multiple. We’ll try and get that to 5x or 6x multiple after synergies. And if you look at the value that is ascribed on some of the parts basis by the analyst community, many of whom are here today, it tends to be valued about 12x or 13x.

We refer to it internally as doing a Bunzl. Effectively what we do is we build up a pipeline of invariably private companies, small mid cap, and foster those relations and at some time or other, there will be an opportunity to do something structural with them. And the other point, we’re 1 year into a 5-year program. We are starting with the finance of procurement. And then from an operational point of view, our components business. And in that context, the milestones that we set for ourselves in the first year are on track.

I talked about Innovative Components. It’s in Schaumburg in Chicago. What does it make? It makes knobs, pins and handles. We’re not a particularly exciting company, I’m sorry. But that kind of thing really does turn us on. What does it do? It complements particularly the Access Hardware stuff that I told you about. What it does for Innovative Components, they had 10,000 customers for their products. Now they have 110,000. We had 90,000 product lines to offer. Now we have 100,000 order of magnitude. What it also does is it adds manufacturing capability in Costa Rica. There is a phenomenally talented pool of very, very well-trained young people in Costa Rica and that’s a real asset for us in the future.

Filters. Filters, underlyingly a marginal decline in sales, underlyingly much better than the overall tobacco market. The key drivers of that twofold, one of which is China. The joint venture that we announced was important both offensively, but also defensively. China perceives the tobacco industry as very, very important strategically. It provides 8% of all of the Chinese government’s income and as we’ve seen in other strategically important industry, so it’s looking to internalize it.

The fact is that we were selected, blessed by the Chinese state monopoly and working and in partnership with 4 of the largest provincial manufacturers. So that’s a really exciting opportunity and the counterbalance to this internalization trend. The other point, and Lily will talk about it, is that there were some challenging market conditions. Frankly we chose in light of some compliance issues to actively walk away from business because we would rather lose revenues than compromise the standards and ethics that we set for ourselves.

Excluding that Middle East, this business actually showed a positive growth. And the really encouraging thing is with the game-changers, we believe that for the medium to long term, mid-single-digit growth is the kind of path for the course that we can expect in that business. We couldn’t have said that for the last decade-and-a-half.

We talked about the fact that on October the 1st we integrated Tear Tapes into the division. The expertise has helped improve the operational performance. It is 50% or so reliant on the tobacco industry, but if you look at things like resale tabs, if you look at the kind of [ripper] tape they use on Amazon, there is a clear and an emerging and a very distinct trend to broadening that product portfolio without losing focus on the core of that business.

We talked about the fact that the China JV had been signed. We had our first major outsourcing over 6 years’ worth order of magnitude GBP 10 million per annum. And I’m delighted to say that with this week we have also had another large outsourcing award with another major MNC. And there are other discussions going on as well. And in the next generation product for those of you who perhaps are not familiar, that’s really 2 kinds of product, one of which is Heat Not Burn or [THP], depending on which phraseology you prefer, and vaping. The exciting thing particularly about Heat Not Burn is it’s basically a filter with a little bit of reconstituted tobacco.

There are — I cannot think of a manufacturer in the space that we are either not providing product to or doing pilot developments with. Clearly we can only grow as fast as that market. It isn’t a significant part at the moment, but it does also give us strategic optionality and on a strategic hedging. And then the basics, we talked about stability, strategy and growth, the operational KPIs, and I’ll put some numbers around it later, do underpin the fact that we can claim to be genuinely world-class. And just as a, if you like, a strategic footnote, we, along with one of the MNCs, are the largest manufacturer now of special filters in the world.

In early January before you all back away from me, and it’s in Xiamen weather precisely zero category — zero cases recorded, I had the pleasure of formally opening the joint venture with the full — led by Fujian tobacco. You can see in the bottom chart there that although China has about 20% of the world’s population, and has 45% of the cigarettes 5.3 trillion. And the Chinese managed to get through 2.3 billion of those, I believe something like that, 2.4 billion, quite a lot of cigarettes.

We will own a 49% shareholding, but we have management control and we will be able to consolidate. The really exciting thing is that we have and it’s the penultimate bullet point in the brackets there, the penetration of special cigarettes is about 4%. It’s 4x that in the rest of the world. Why is that important? It’s important because the whole strategy of China is to increase the revenue it gets by upgrading the product mix by going from standard cigarettes to ones that have nice shapes or have capsules or slims or super slims or whatever. So if you think about the potential there, we derive less than 10% of our sales from market that if it goes to normal levels of penetration should grow fourfold. So that truly is a game-changer. The plan there is to start with product development and sales. And then we should have manufacturing operational within 12 months. Until then we will continue to serve as an export market out of Thailand and Indonesia.

So that’s a little bit about components and filters. Before we hand over to Lily to do the numbers, I’ll ask Iain to come up, please, and tell us about what’s been going on in the last few years.

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Iain Percival, Essentra plc – MD of Packaging [2]

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Thanks very much, Paul. Thank you.

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [3]

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Great.

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Iain Percival, Essentra plc – MD of Packaging [4]

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So after 3 years, to be able to stand here and say that 2019 was Packaging’s best of the year, as Paul said, it’s a pretty bold statement. So I hope I’m going to do justice and explain just why, not just me, but we believe in our team that we are delivering the best performance and importantly, we’ve got the momentum to continue to drive this business forward.

So just the headlines. When we look at the business in 2019, across the broad range of business metrics, not just financials, commercial, operational, people, all of those metrics are moving in the right direction. And I’ll take some time shortly just to take you through the examples of that.

In terms of the headlines though, Paul already mentioned 2019. We delivered on our commitment of top line growth of between 5% and 6%, 5.6%. Remember, we’re in the pharmaceutical and beauty secondary packaging markets. These markets typically in packaging are growing at between 2% and 3%. So growth of 5% to 6% is significantly ahead of the market. And converting that top line growth profitably into margin improvement, again for the second year running, delivering more than the 200 basis points margin improvement.

Now great result financially. I think we have to say still a lot of work to do. But the momentum that we are building and we have been building actually for 3 years is what’s giving us confidence that we’re on track to deliver that commitment of getting back to industry average margins by the end of 2021, the 8% to 10%. And if I reflect what are the things, the drivers that we are focused on in packaging, that is really helping us achieve this turnaround, in simple terms, it’s 3 things.

It’s about rebuilding and has been about rebuilding our relationships with our customers, many major pharmaceutical players, many major beauty players. Rebuilding those relationships, capturing the growth as a result. It’s about focusing on operating excellence, making sure we’re doing the basics of quality and service and responsiveness, but doing them exceptionally well. And driving, say, cost savings and efficiencies through our 24 manufacturing plants. And last but by no means the least, it’s about making sure we reengage with our people who had become quite disenfranchised — as I came into the business in 2017, quite disenfranchised by the difficult and complex integration from Clondalkin since 2015.

So those are the 3 drivers, focus on customer operational excellence, and people. Let me take a few minutes just to add some color as to why I believe we’re moving in the right direction on all 3. Let’s start with the customer. As I mentioned, many of our customers, major global pharmaceutical and beauty organizations, what do they want? They want strong, capable, reliable suppliers that are able to service their demands and be responsive to their demands wherever in the world they’re operating.

What we’ve been doing actually even since 2017, as soon as I came in, I spent a lot of time listening to some of our customers. I can tell you, the meetings we had back in 2017, Paul was in with me in many of them, they were far from comfortable. But they were telling us a very clear message. Look, we do want Essentra. We do want you to be a good supplier to us. But right now you’re not, you need to fix your basics. If you can do that, you can grow.

So we — of course, we’ve been fixing the basics underneath the stability agenda, getting our quality and service right. I’ll talk about that in a minute. But we also wanted to put in place key account management. What does that mean? It’s about putting cross-functional teams in front of our customers to really understand the cross-supply chain, finance, procurement, technical operations, what are the needs of the customer? What is it that they want from their suppliers? And how can we as a central packaging respond to those needs by identifying a few key projects that we will then work on collaboratively with our customers?

And many of those projects relate to the second key theme, which has been around investing in our design hub capability. It’s our innovation, our process and product development center, where we’re taking those customer needs and converting them. For example, developing tamper-evident labels to help our customers on Falsified Medicines Directive, or for example, helping our customers on how they generate and produce artwork. And finally, it can be things like going to customer sites and helping our customers make packaging, our packaging run more efficiently on their packing lines. Those are examples, real examples of listening to customer need, translating them through our capability, which we’ve been investing in into real tangible results.

So this focus on listening to the customer, understanding the customer, translating that into real tangible, value-added delivery of projects is a key theme that we believe is part of our success, why are we able to grow faster than the market. And certainly that success is something we believe as momentum. Now that it’s in place, we continue to drive those key themes forward.

Turning to operational excellence. Again, from a customer perspective, what is it that they want? They want great quality. Well, we’ve been measuring quality weekly at every site, ever since the beginning of 2017, having a weekly review of quality performance, understanding where it’s not meeting expectations. What are the actions that we need to resolve. This is a big focus. You remember we are talking about 24 manufacturing sites, all of which are being focused on, on a weekly basis for quality service. So by doing that process, rigorously following up on quality, identifying root cause of quality issues, implementing corrective actions, we have been able to improve our quality by almost 50% in the last 3 years, and you’ll see a slide later.

In terms of agility and service, our reputation actually is a responsive supplier. To give you a statistic, last year in 2019, we supported our customers with more than 500 new product launches. Now what does that mean? It means, very often we get the artwork delivered to our sites on the Friday. The approval tends to come from the regulators on a Friday afternoon. And by Monday we’re trying to deliver product to our customers so that they can pack, fill and get it into their supply chains. And ultimately, whether it’s to a consumer or a patient, get that product into the market to help consumer and patient.

So product launches and responsiveness and agility is a real key theme and a key value driver for our customers. And we’re very good at it and we’ve got a good reputation. And on the day-to-day side of delivery, our on-time in full performance improved again last year, 96.6% across 24 manufacturing sites. Actually, many of our sites are delivering 98% week in week out. That is world-class service performance. So great service, great agility, focus on quality, key parts of helping drive the operational excellence.

And the last point, how do we make sure we drive efficiency from our assets? In this case, the chart is showing you the improvement, dramatic improvement that we made in our Americas operations during 2019. But really this is a program that we put in place back in 2017. You can see we invest in training our people, more than 600 of our employees. That’s around 20% of our employees have been trained in lean techniques, how to help get more out of our existing assets. And some fantastic results. Just — I’ll just pick one example. In Greensboro, which is a literature site in the U.S. team put together after this training. So shop floor employees supported by continuous improvement experts over the course of the year improved the change over time of the main press by 10 minutes. 10 minutes doesn’t sound a lot, but 10 minutes when you’re changing over, 6, 8, 10 times a day, that’s an hour, an hour-and-a-half to be able to produce more product out of the same asset, the same cost-base.

That’s an example of driving efficiency, and we’re doing that at 24 manufacturing sites. So again, it’s not something that’s new specific for 2019. Focus on quality, focus on service and responsiveness and driving efficiency, but you can see the momentum that is building and we’re gaining — really gaining momentum.

And finally, last but by no means least, on the people side. Yes, when I came in, in 2017, it was evident that we needed to reenergize the leadership team. You can see the statistic. More than 50% of the senior leadership team in Packaging are new. That complements the talent that already existed in our packaging team. But for example, the commercial directors in both Europe and the Americas, highly experienced packaging and pharmaceutical packaging individuals, they know the customers, they know the markets, they know our products. Very quick to boost the capability and the relationship with our customers. So really bringing together and building a really high-performing capable senior leadership team.

Then talking to engagement, Paul talks in these a lot about engagement, we really value making Essentra sites better places to work. We’re really proud in Packaging every year, we’ve been improving our engagement score. Now that’s just a number. What sits behind the number is listening to our employees through the survey, identifying 3 or 4 actions at every site that we take together with those employees to make those sites, those offices better places to work. And then delivering on those actions, the “You said, we did.” And by doing that, we are improving and it’s tangible when I go to town halls, (inaudible) town halls is tangible, the amount of engagement that we get from our employees. They’re positive. They’re motivated. They want to learn. They want to drive this business forward.

And finally on health and safety. We all in Essentra believe that 1 accident is one too many. We all need to go home safe. What’s really encouraging, the thousands of observations that our employees are making of their environment to help stop an accident before it happens. The hundreds of Kaizen events, improvement events to make their workplaces safer. And as a result of that, again in 2019, we improved our safety performance. So still more to do, but keeping people safe, making sure that we’re engaged, and making sure that we invest and have the right capable skills, key part of how we’re driving this improvement in the business.

Highlight for me last year and for all of us in the packaging team was the acquisition of Nekicesa. Fantastic business. Great, great business to bring into the packaging family. Based in Spain, it gives us the market-leading position in the Spanish market, an important European pharmaceutical market. It brings with it value-added capability, serialization, digital capability. This is stuff that our customers demand, not just in Spain, but we can use that capability elsewhere in the network. And a fantastic and highly talented management and workforce team to complement our existing talent.

So really, I mean, hitting the sweet spot on so many angles. And you can see the picture. The only slight down point for a Man United fan was having to go to Real Madrid and spend the first day that welcoming the Nekicesa team to our family and really sharing between each other what we’re trying to achieve. But a fantastic day, and you can see the picture there. Again a great example of starting an integration off in the right way and learning some of the lessons perhaps from the past.

So lots — I hope I’ve given a flavor and some examples of what underpins the turnaround and the success that we’re driving in Packaging. It’s about the focus on our customers putting them at the heart of our business. It’s about continuing to drive the operational excellence. And it’s about really engaging with our people. If we continue to do those 3 things right, hey, we’re still ways away from our target. But we’re confident we’ve got the momentum. We’re doing the right things, and we’re going to get back to that 8% to 10% margin. Thank you.

I’ll hand over to Lily.

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Lily Liu, Essentra plc – CFO & Executive Director [5]

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Thank you for the (inaudible).

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Iain Percival, Essentra plc – MD of Packaging [6]

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Thank you.

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Lily Liu, Essentra plc – CFO & Executive Director [7]

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Morning, ladies and gentlemen. Glad to be here. Before we get down to numbers for 2019, let me take a moment to reflect a busy year for Essentra. As Paul has already mentioned, we had high volume of very successful corporate and business development activities. As a result, our group structure was substantially simplified. And look, as a result of activities, we also — last year you would recall we disposed just over GBP 100 million of annualized revenue, about GBP 15 million of annualized trading profit, which make it somehow difficult when you do year-on-year comparison. But among that — along that backdrop, I would say I’m really pleased with the robust profit delivery and I’m really pleased with the strong balance sheet position.

If you look through it, we delivered both underlying top line growth and underlying bottom line growth. And our margin was 9%, 20 bps improvement. A strong cash conversion at 82%. And we have invested in net working capital supporting Iain’s growth, supporting Brexit mediation and also supporting the outsourcing deal in filters that we announced last year. Strong cash at 82%.

Now moving down to balance sheet. Net debt 2x after IFRS 16. And we recently putting a refinancing for the $80 million. And if you look at it, Paul has already mentioned dividend maintained at GBP 0.207. We also have steady improvement on ROIC. Now among all the positives, it was really disappointing to see the sanction market compliance failures in our Filters business. The impact of — on the group is immaterial and I will provide more details in my section a bit later.

Turning on to income statement. At the summary level underlying revenue growth by 1.5% and 20 bps margin expansion. Adjusted EPS at GBP 0.203, a reduction of just under 10% on constant ForEx. The reduction was largely driven by the disposal activities I mentioned. Now both Paul and Iain have already mentioned the performance by division. So I just pick up a few salient point from my perspective.

Clearly a strong performance in Packaging, 5.6% underlying growth, thanks to those measures Iain has just outlined in terms of commercial, operational and people. And despite the macroeconomic uncertainty, and also subdued PMI performance, Component delivered a really resilient top line performance and thanks much to the pricing management. And Filters’ revenue was a moderate decline, Paul has already mentioned. I just want to highlight we implemented a very strict control and compliance framework. The delay to certain orders, and the withdrawal from certain customer relationships had a negative impact on the top line growth. But to talk to Paul’s point, we delivered overall a 1.5% growth. Also, I just want to mention both acquisitions performed well in the year.

Now turning on to operating profit by division. Underlying operating profit grew by 2% with a 9% margin. This was delivered with the 200 bps margin expansion in Packaging as expected. And 21.3% resilient margin in Components, helped by pricing management offsetting market volume decline. And also we have seen some margin dilution from the integration of the Reid business and also the Innovative Components acquisitions. A flat OP margin for Filters, thanks for the further operations excellence improvement and offsetting some of the Tear Tapes margin dilution. I want to point it out to you, the central services cost was just under GBP 29 million. This was GBP 1 million better than my guidance that I spoke about last August.

You would recall that we have highlighted there is about GBP 2.5 million central cost unallocated as a result of Specialist Components business being dissolved. The true like-for-like increase on the central cost from 2018 to 2019 was largely driven by higher IT depreciation costs following the investment in cyber and also IT infrastructure. We have put in some new and upgraded skill set in the center to support the business. As Paul mentioned, we will start rolling out our BPR program in the second half of this year. We are commencing a review on our G&A cost. Now I am expecting our central services cost in 2020 to be broadly in line with 2019.

So moving on to the bottom half of the income statement, financing charge GBP 14.5 million, about GBP 3.6 million higher than 2018. Now the big reason there was there’s GBP 2 million on IFRS 16 change. And the remainder is because of higher GBP-denominated debt. Now I’m expecting this number to be broadly flat, or with moderate decline in 2020. Effective tax rate 19.9% firmly in the region of what we guided. For 2020, we expect it to be 19% to 20%. We’re watching the government budget closely.

A minority interest in 2019 reflected a full year of our India JV and the quarter of our Dubai JV. Now coming to 2020, it will reflect 2 JVs. Not Dubai JV, but the China JV, as Paul mentioned. So we expect to consolidate our China JV we will — it will impact the minority interest line.

Now I have talk about adjusted P&L. Let me spend a moment on our exceptional cost. In 2020, we reported — sorry, in 2019, we reported exceptional gain of GBP 15 million, just over GBP 15 million. And largely that’s driven by the very successful divestments we’ve implemented during the year, GBP 15.9 million. Now as I mentioned in the interim, the cash tax associated with this was high because the tax base was lower than the accounting base. The benefit was realized in previous years. We also spent couple of million pounds on other restructuring costs and some integration cost. And if you add everything else on the page, it’s a credit of GBP 1.6 million.

GBP 9 million of credit for certain property provisions release was offset by certain costs recognized by the group. In relation to — I mentioned investigation in the sanction compliance failure in the Filters division. Now our commitment to ensure a comprehensive review of the past business conduct and full cooperation with the U.S. government is reflected on the number on the page that we spent GBP 3.6 million doing the investigation and providing remedial actions. Now as a result of the investigation, we have made a voluntary disclosure to the Office of Foreign Assets Control. And our discussions with the U.S. government continue.

Guided by our external professional advisors, we have recognized an estimated GBP 2.3 million financial penalties in our book. We have reviewed our balance sheet carefully. And we impaired GBP 1.6 million specific items from the balance sheet. Now the time and money we spend is significant in terms of enhancing the processes and conducting the review. The business response has been robust, has been a — a very comprehensive compliance transformation program and it is designed to ensure future business safety. A step change has started and I’m confident that our compliance culture will continue to strengthen.

Now I covered P&L both adjusted and exceptional. Now moving on to cash flow. As I said in the beginning, 82% cash conversion. A few factors I want to draw your attention to. The operating cash flow adjusted of GBP 72 million, beyond the aforementioned disposal effect, we also invested working capital supporting Iain’s top line growth. We also invested finished goods supporting our Brexit mitigation. And we also had spent about GBP 7 million extra CapEx supporting the first outsourcing deal in Filters, which actually make our CapEx slightly overall guidance of GBP 55 million this year, and after paying interest and tax, our free cash flow was 47 — GBP 41 million.

Now linking to my statement of strong balance sheet position at the beginning, our net debt ratio was 2x after IFRS 16 and net debt reduced by about GBP 8.5 million during the year. Our free cash flow in 2019 we recognize temporarily did not cover the full amount of dividend payment within a year. Let me repeat the reasons. There was a disposal. There was 4 disposals happen in the year, I just remind you. Annualized basis, that’s GBP 15 million trading profit and net working capital support, top line growth of Packaging, supporting finished goods in Components to do Brexit mitigation. So — and also the GBP 7 million extra investment in Filters outsourcing deal.

Now with us, continue to drive for growth agenda, and Iain continued to deliver the 5% top line growth and 250 bps margin expansion. We are expecting to rebuild the dividend cover from the P&L perspective, and also we’re expecting to get close to — if not, 1x cash cover by the end of this year.

So wrap everything together. ROIC, it’s really pleasing to see in the last 3 years, ROIC has steadily improving on adjusted basis. I am confident that we have the right setup to further improve this measure on a steady basis. Why am I saying that? And that is underpinned by our very rigorous capital allocation policy. And lately, we established an investment committee process to actually approve all major CapEx spend across the group.

Let me just summarize my section here. Overall, I would say it has been a very active year for Essentra and during which all businesses have taken some big steps forward. The group has maintained a strong financial position. And we look forward to delivering further progress this year.

Now with that, I’ll hand you back to Paul to discuss further on growth agenda.

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [8]

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Thank you, Lily. And thank you Iain. If, as a Manchester United supporter, your sole problem is going to Real Madrid, I think you’ve missed something, you don’t look at the table.

Growth has to be — you have to earn the right to grow and you have to get the basics. Otherwise all you do is you increase the size of the cataclysm when everything unwinds. So we talk about stability, strategy, and growth. I’m probably going to retire honorably these slides henceforth because as is demonstrated, I think now we’ll close in many. So dimensionalizing world-class through death by PowerPoint is probably not a productive strategy going ahead. But humor me very briefly. So we’ve had over the last 2 years a 50% reduction in both the number and intensity of lost time incidents. As Iain says, that’s still 32 too many, but it is so much better.

Services is critical, and you can see there every division has progressed 96.6% in Packaging, 94.302% and 98.5% in Filters. We won’t take our eye off it. But actually OTIF as a measure now is not the key one, it’s then the lead times. So we now look to shrink the lead times whilst holding the OTIF stable.

Quality, this is the incident rate. So it’s good that it’s going down. We can see Components has halved. Filters is reduced by a factor of 3. And Packaging has halved in 3 years. One of the self-inflicted goals that I talked about in February 2017 was an under investment in IT. There are 2 aspects to that. There’s the kind of plumbing, there’s the basics, does our IT prevent our factories working or not? And then there’s, if you like, the value-added applications.

In the former category, can we just do it, you can see there this measure is the major incident. So major incident is an IT issue that closes down a factory or a main function for an hour or more. And you can see in 2 years, that’s come down by 75%. So there is an impact on morale. But also there’s a cost benefit of that.

Employee engagement. I’m delighted to say we are now probably 65th percentile. We’ve still got a long way to go. But we were probably about 6.5th percentile in 2016. So huge, huge progress there. Oshin who is in the audience came in as group HRD, and has brought a wealth of experience and skill, and has really started building an outstanding function. How we are managing things now, and you can see that on the bottom right is the 7-stage employee lifecycle from attracting all the way through to people moving on.

Mary Reilly has been appointed as board employee champion and has been fantastically zealous in getting out, taking the pulse of our people, and really also just giving that independent feel to the board as to what our people are really thinking. And sustainability, I’ll talk about that in a minute, it would be fair to say that we are part of the way through developing that strategy and those measures. And I’m hopeful that at the time of the interims, or maybe slightly later than that, we’ll be able to be very much more precise.

There is a new sustainability committee that coordinates at the top of the pyramid, all of our activities in ESG. It is not only the right thing to do, but it is the right thing to do. We’re very much linking our initiatives in 4 areas on the bottom right chart there to those various UN sustainable development goals about responsible resources and energy and climate, that’s the environmental aspect, people and community and then a responsible supply chain.

We basically process lots and lots of materials to — from a vast range of global suppliers. And we supply them to hundreds of thousands of global customers and increasingly focusing on the responsibility of that such as, for instance, the development of environmentally responsible cigarette filters through to potential recycling schemes for things like one-off caps and plugs in the auto industry. Just 2 examples of work that we are doing in this area. And then the other key enabler — and please just focus on the left-hand side — what are the benefits of this business program, business process redesign program as you recall I said it’s a 5-year program starting with Components and then finance and purchasing from a functional point of view.

It is — we are succeeding at the moment, in spite of our systems, rather than with the assistance of our systems. For a company of our size to have 46 flavors of ERP is Bonkers with a capital B. So that is a critical — probably the critical self-inflicted goal that we have still to address. What it will do as well and hopefully I’ve been able to kind of cover that a bit and Iain’s talked about the benefits as well, this enabled a strategy. So if we acquire, when we acquire businesses in Components or Packaging being able to slot them in. If we want to make material improvement now on net working capital, it’s about joining up and leaning and having the ability through a single ERP system to treat our global network for instance, Packaging as a virtual factory.

So I think how do we get to the next stage of asset utilization and drive up that ROIC other than profit improvement, it’s all about leaning and redesigning our business model. If we look longer, further ahead, take each of them in turn, Components, these were the strategic milestones that we set ourselves. I’ve talked about the digital platform rollout, and a self-assessment there of the various milestones and where we think that we are. What is important for 2020? I talked about this vital must-win of cross-selling continuing to gain market share. If you recall, the formula that I said for this business is industrial production output plus 4%. And that’s 2% to 3% from price, 1% to 2% from market share gain. And as you can see the improved pricing discipline, which is led by a mayor who’s now moved and joined the dark side at the center with us here actually delivered well in that case.

What is also important is to continue to both increase the functionality and the coverage of the new website. So for me, I’m a real sucker for that “people who bought this also buy this” Amazon-type functionality. That’s, if you like, the smartest way to facilitate and encourage cross-selling. That will be in the next wave when we go to version 2.0.

If you take Filters, again pretty much hitting all the key strategic milestones. What are the challenges there? Really build on this China joint venture. The opportunity to grow our business in China by a factor of 5 to 10 I think is very material. Just look at the size of the market, look at the inside track we have through endorsement by [CNTC] and these partnerships and that 4% penetration compared to the mid-teens penetration in the rest of the world of special products. Outsourcing opportunities, clearly we’ve landed a (inaudible) and the team have landed a second one this week and then to continue to develop these next generation products.

Iain and the team, he’s talked a lot about those, what are the key things, operational agility. We are so, so different from a standard say consumer good packaging company. Their bag size might be in the millions, ours in the tens of thousands. It’s all about high service levels, high responsiveness and that customer dialogs solved problems. I’ll give you one example. The most regular query we have at the moment in our design hub is how do you design plastic out and how do you design cardboard in. It’s very much about focusing on the recyclability. Hitherto it’s been how do you make it cheaper using less, but I think Iain’s is fair to say that’s the major request we’re getting at the moment and that’s fantastic. So it’s both doing the right thing and also benefiting us. And we are pretty much unique in our ability to do that. Maybe there’s one other company in the world that could. And then it’s about really using that key account management structure and design hub to continue this 5%, 6%, 7% growth.

So if I look ahead, notwithstanding the macro context I think that our foundations are increasingly strong. You look — we do have an even stronger hand of God’s than we had when I took over in 2017. We’ve given examples now of customer franchise people and Filters would not give us outsourcing deals with tens of millions if they didn’t trust us implicitly.

I’ve hopefully shown you that we are class-leading in every business now and operationally you’ve seen examples of employee engagement and an enhanced pipeline. This is very much the basis across the group now, a kind of 5-legged stool if you can have a 5-legged stool on which we will be building. Yes, of course there is macro uncertainty at the moment which has been exacerbated by Covid-19, but please recall the fact that effectively cigarettes and medicine is broadly non-cyclical. So yes, we do see that volatility although we proved our ability to hold in a tough market in Components. So we expect strategic financial and operational progress. We cannot do anything particularly about Covid-19 or industrial production, but what we can do is pull that wealth of levers that are in our control.

So again I won’t repeat all of that, but 3 messages. We are a very, very different more focused set of global divisions. Those divisions have done all the basics, have the strategies, have the people, have the customer franchise to continue to grow and underlyingly a robust performance which match or maybe margin exceeded expectations.

With that I will take questions. The only 2 taboo subjects are Manchester United and Covid-19. Anything else I will happily — James, good morning.

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Questions and Answers

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James Beard, Numis Securities Limited, Research Division – Analyst [1]

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James Beard from Numis. I’ve got 3, all on Filters as it happens. Firstly, can you give a little bit more background on the compliance issue that Lily talked about, and how it was identified and whether there is a risk of further similar compliance issues being uncovered over the course of time? Secondly, on the outsourcing contract that you’ve (inaudible) today, that you sign this month, how big is that and are there any CapEx investment requirements for that contract? And then thirdly, just want to — I appreciate this is one of the taboo subjects that you just mentioned, but on the China JV, what if any impact would you see on the sort of — because I think you said you would anticipate producing first shipments towards the end of 2020, but clearly with the Covid-19 situation what is the likelihood that that gets delayed and by how long?

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [2]

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Let me do those in reverse then. If the situation, we are continuing to do all of the development work for the China joint venture. If you said what do I think assuming things in the next 2 to 3 months stabilize, I reckon you’re looking at becoming operational in the first quarter or so of 2021, so that’s about 3 month delay. That’d be my best guess, but who knows what’s going to happen with Covid-19? The second outsourcing deal is for at least 3 years in order of magnitude is GBP 30 million, so it’s broadly the same per annum. It’s a minimum of 3 years and there is no CapEx required. And then the nature — I’m not sure that’s (inaudible), I’ve got John in the room. I’ll have a go and you just go like that if I’m saying anything too much. Yes.

It relates to, as you say, the filters and in particular as we’ve said it’s focused on the Middle East. Having said that, James, what we have done is scrub and review every single possible area of similar risk either that division or in other divisions in kind of theoretical at-risk territories and we’re very comfortable that there is nothing else of that nature. We have put a thorough program and I reckon that it is — we are as, if you like, sensitized and with the rigorous compliance processes and review process and approval process as it’s almost humanly possible to be.

So could I say nothing would ever happen ever again? No, but would I say that it is a cleaner than clean business? Yes. The nature really is in 2 categories. There were 2 individuals who without reasons of personal gain as we believe it, if you like, acted in a inappropriate manner and secondly there was in a limited number of instances a breakdown in the review processes that allowed, if you like, a breach of the ethics which we — the ethical standards and legal standards that we expect. Is that fair, [John]?

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James Beard, Numis Securities Limited, Research Division – Analyst [3]

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That’s fair. (inaudible) There’s still a discussion (inaudible).

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [4]

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Okay. Charles?

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Charles Hall, Peel Hunt LLP, Research Division – Head of Research [5]

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Charles Hall from Peel Hunt. Just a few questions on Components. You talked about MPSs exceeding expectations. Can you give a bit of color as to where that’s coming in terms of like sales or margins or operation improvement? Secondly, on…

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [6]

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MicroPlastics? Yes.

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Charles Hall, Peel Hunt LLP, Research Division – Head of Research [7]

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Yes. Secondly, on pricing, is that 2% to 3% price improvement we already bedded in and you’ve already put the numbers into the processes to ensure that comes through this year, and then you commented about Ningbo being back up and running next week. What does that actually mean? Is that at full production capacity with all your people back and what’s the state of what is at that plant?

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [8]

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It will be at 95% capacity. There are 9 individuals who are still stuck in Wuhan or whatever. We do track on a regular basis the wellbeing and status of all of our individuals. I’m delighted to say everybody is safe and accounted for and nobody has developed anything. So yes, we will be at 95%. So de facto full tilt on Monday. The — on MicroPlastics, it effectively is at the level now in terms of margin having been half that level of the division. And what was the third question Charles had?

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Lily Liu, Essentra plc – CFO & Executive Director [9]

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Pricing.

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [10]

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Pricing. The reference I made was to 2019. But we are confident that 2020 will follow that pattern as well.

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Charles Hall, Peel Hunt LLP, Research Division – Head of Research [11]

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And just lastly on the rollout of the online platforms, you said you got up to 70% of your revenue. How quickly do you think it’ll get up to 100?

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [12]

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We won’t focus on getting it up to 100. We’ll increase it in 2 or 3 other key territories, and then we will focus on doing version 2 because there’s actually more leverage in sticking at 85% and increasing the efficacy of the 85% rather than taking it to some of our deeper sea, but smaller markets, is that fair to say? Thank you. Hey, Tom.

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

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Tom Sykes from Deutsche Bank. One question just following on from the answer you gave on the lack of CapEx and the outsourcing deal that you announced. Could you maybe sort of help us bridge to a better cash conversion? So when you look at the growth opportunities that you have, how capital-intensive do you think those are? You’re obviously running at quite a high level of CapEx now, so just how we should think about that kind of bridge to the better cash conversion, please?

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [14]

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Yes. I think clearly, we’ve had — we had a Brexit stop build and the outsourcing that’s probably GBP 10 million or so of nonrecurring cash, Tom. We will have the profit growth now remember we did so quite a lot, but now you’ll begin to see annualized acquisitions and underlying profit growth I’m very confident with the one obvious caveat. CapEx — look, if we think the cash conversion is primacy, then we can continue to drive those strategies with a marginally reduced CapEx and for BPR will have a kind of peak expenditure in the next year or so. And then as we deploy, it becomes further — it becomes less capital-intensive. I think also we’ll do — try and do things like work on our cash tax bill, et cetera. So there’s multiple levers. If the world obviously goes really, really bearish, then we will act appropriately. We have levers, we can be more draconian, but what we don’t want to do, haven’t got the strategies and the building blocks in place, is really to compromise that plus in terms of working capital, we have been supporting Iain in terms of doing that particularly as he expands his product ranges and his customer base.

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

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Okay. And just one assumes you’re not focused on margin in every single facility. There’s obviously skews, you’ve got 24 facilities. So maybe could you give us a little bit of color about where — how skewed is the incremental improvement again to maybe other particular facilities, particular end markets, particular customers that you’re addressing, which you’re going to make a disproportionate impacts to that incremental change in the Packaging business?

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [16]

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The key driver of the recoveries is the chart that Iain showed, which was the OE, so that’s how much we fill our factories. We are — we do have variations in OE, but we still have for the runway that over the next 2 years we have scope to improve across all of them. There are some sites that are — probably do a kind of review of — or continuing the review we’ve have been doing in kind of customer margin because if you recall I’ve said before that there were some customers at a gross margin level we were kind of making nothing at all or even marginally negative because we priced contracts historically with no cognizance of where the — what the true cost of manufacturer was, Tom. So I think it’s across the board, if Iain gets at 65 up to 68 or something like that, that would be when I go into meetings, I say roughly 2/3 of the margin improvement comes from operational gearing, something like that.

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Thomas Richard Sykes, Deutsche Bank AG, Research Division – Head of Business Svcs Co. Research & Industry & Leisure & Transport Research [17]

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And obviously you’re comfortable therefore, but the assets which over the lower level of utilization are servicing end markets, which are growing enough and have enough market share gain for you to be able to get that incremental revenue in that?

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [18]

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Absolutely. Absolutely. I mean, the key statistic is we deal with 19 of the top 20 pharma medical products companies in the world. We have a 4% market share. We could continue that growth and not get another customer. Doesn’t mean we’re not going to get new, smaller customers. The share of wallet, it’s very similar story to Components with cross-selling actually. We — I would trade share of wallet for any new customer any day. Yes. Anybody else? James, you always come back for seconds. Charles?

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Charles Hall, Peel Hunt LLP, Research Division – Head of Research [19]

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Obviously you had a very busy year last year. Now got a bit of time on your hands. Have you got some pipeline of acquisitions to keep you busy this year? And secondly, on Packaging, you’ve talked about India in the past as being an area of interest. (inaudible) on that?

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Paul A. Forman, Essentra plc – Chief Executive & Executive Director [20]

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Yes. The answer is, yes, we do have discussions going on and the team with the divisional heads and with Kathrina kind of using the — it doesn’t really feel like your quiet time, Charles, (inaudible), but using that quiet time to build. So Scott will be — Scott Fawcett will be spending a week or 2 going around Italy and Germany for instance in April. Okay. Well, not Northern Italy as we said. So yes, we are making progress. If I take what’s important in each division, Filters it’s about I think 4 things, it’s those 3 game-changers plus I really do want us to see make progress in environmentally responsible filters.

Packaging, yes, we might contemplate something, but Iain and the team have a lot to do making Nekicesa work, so I wouldn’t see anything until later in the year. And yes, we are having discussions in India. For Components, it’s China. For Packaging it’s India. And I’m hopeful that we could do not least because our customers want to. The customer overlap with 1 or 2 of the companies that we have is very significant, very significant. And Components, yes, but I’d rather they — if they’re going to burn calories they burn them on really landing the business process, redesign, rolling out the website and focusing on cross-selling and therefore market share gain. So yes, we are talking in 3 different continents to potential new members of the family, shall we say.

But we’ve — contrary to your perceptions, we’ve still got quite a lot to do on the day job. If you see me on the beach, or whatever at 11:00 a.m., you can call. Anybody else? Okay, well, thank you very much indeed. Should we — we normally go into cyberspace and say could the clever people at the back check if there’s anything in cyberspace? I’m looking, nobody’s waving. So okay. For those of you on terra firma, there’ll be tea and coffee and we’ll be here answering any questions. Thank you.