Dechra has delivered another strong set of financial results, from both existing business and acquisitions. We continue to invest both organically and through acquisitions to deliver enhanced shareholder value.

Richard Cotton
Chief Financial Officer

Overview of Reported Financial Results

To assist with understanding our reported financial performance, the consolidated results below are split between existing business and acquisition; acquisition includes those businesses acquired in the current and prior year, reported on a 'like for like' basis. Additionally, the table below shows the growth at both reported actual exchange rates (AER), and constant exchange rates (CER) to identify the impact of foreign exchange movements. The acquisition loss includes underlying operating profit of £9.0 million and non-underlying items of £26.6 million. These non-underlying items are comprised of amortisation of acquired intangibles of £18.7 million, non-cash uplift on acquired inventory of £5.1 million and acquisition costs of £2.8 million.

Including non-underlying items, the Group's consolidated profit before tax increased by 4.9% at CER (1.0% at AER). Dechra existing business grew by 66.4% at CER (65.4% at AER), with reported profit before tax of £47.3 million.

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Overview of Underlying Financial Results

When presenting our financial results, we use a number of adjusted measures which are considered by the Board and management in reporting, planning and decision making. Underlying results reflect the Group's trading performance excluding non-underlying items. A reconciliation of underlying results to reported results in the year to 30 June 2018 is provided in the table below. In the commentary which follows, all references will be to CER unless otherwise stated.

In the year, Dechra delivered consolidated revenue of £407.1 million, representing an increase of 13.9% on the prior year. This included £389.0 million from its existing business, an increase of 9.0%, and a £18.1 million contribution from acquisition business.

Consolidated underlying operating profit of £99.2 million, represents a 24.0% increase on the prior year. This included £90.2 million from Dechra's existing business, an increase of 13.3%, and a £9.0 million contribution from acquisition business.

Underlying EBIT margin increased by 200bps to 24.4%, with the accretion coming from both the existing and acquisition business in EU Pharmaceuticals.

Underlying diluted EPS grew by 20.9% to 76.45p reflecting the profit growth from the existing and acquired businesses, offset by higher finance charges from the increase in debt and equity issuance to fund the acquisitions, adjusted by the change in mix of the applicable tax rates.

Reported Segmental Performance

Reported segmental performance is presented in note 2. The effect of acquisitions made in the year was material: the reported segmental performance is analysed between existing and acquisition businesses, and at AER and CER in the table below. The acquisition elements capture the additional base business coming into the Group, the growth Dechra generated in them during the year, and the synergies that have already been realised by the Group since acquisition. This analysis becomes less definitive the further in time from the completion of the acquisition, as the acquisition business is progressively integrated with the existing business.

76.45p

Underlying Diluted Earnings per Share

Underlying Segmental Performance

European Pharmaceuticals

Revenue in European (EU) Pharmaceuticals grew by 11.4%. The existing business grew by 3.7% including like for like Apex revenue: excluding third party contract manufacturing, which is being reduced in line with our strategy and replaced with own product manufacturing, revenues increased by 4.4%. This growth was driven by the strong contribution from market penetration and new product launches in the Companion Animal Products (CAP), Equine, Food producing Animal Products (FAP) and Nutrition. The acquisitions of Apex (like for like year on year, acquired in October 2016) and RxVet Limited (Dechra Veterinary Products International business), acquired in December 2017, and AST Farma B.V. and Le Vet Beheer B.V. (acquired in February 2018) contributed a combined £18.1 million to revenue and are reported within EU Pharmaceuticals.

Operating Profit from existing business grew 9.7%, with operating margin expanding to 28.1% and consolidated operating margin increasing to 29.8% as a result of operating leverage and the accretive operating margin of AST Farma and Le Vet, partially offset by increased investment in our Dechra Veterinary Products International business to drive growth in new international markets.

£258.7m

EU Pharmaceuticals Revenue

£77.0m

EU Pharmaceuticals Operating Profit

North American Pharmaceuticals

Revenue from North American (NA) Pharmaceuticals grew by 18.2% to £148.4 million. All of the growth was in the existing business, with no acquisitions in NA Pharmaceuticals within the current or prior year. The growth came from market penetration and product launches in CAP and Equine, slightly offset by a reduction in FAP as older non-strategic (ex-Brovel) FAP products were withdrawn from the market in Mexico, and replaced with Dechra CAP portfolio products which have been successfully registered.

Operating Profit from the business grew by 18.3% with the EBIT margin constant at 32.5%, as further investments were made in the commercial team to drive future growth.

Pharmaceuticals Research and Development

Pharmaceuticals Research and Development (R&D) expenses increased by 22.0% from £15.0 million to £18.3 million, with existing business research and development increasing by 18.7%. R&D activities of the acquisitions of Apex, RxVet, AST Farma and Le Vet added £0.5 million. Overall R&D expenses as a percentage of sales increased from 4.2% to 4.5%, excluding the acquired R&D expenses, the increase was from 4.2% to 4.6%. This was in line with the previously communicated strategic intent to expand the Group's product pipeline to drive enhanced future growth.

£148.4m

NA Pharmaceuticals Revenue

£48.3m

NA Pharmaceuticals Operating Profit

£18.3m

Development spend

Revenue by Product Category

CAP revenue continues to be the largest proportion of Dechra's business at 65.5%, up from 62.3% in the prior year. CAP grew 21.1% in the year from market penetration, product launches and the addition of the acquisition revenues. Equine revenue grew strongly by 28.3% in the year, with growth in both EU Pharmaceuticals and NA Pharmaceuticals. Equine now represents 8.5% of the business (2017: 7.6%). FAP revenue contracted slightly over the prior year by 0.4%, whilst delivering growth in EU Pharmaceuticals: this was due to the intentional withdrawal of older (ex-Brovel) non-strategic FAP products from the market (as described under NA Pharmaceuticals above). FAP now represents 12.0% of the business (2017: 13.2%). Nutrition revenue grew 4.4% on the prior year: this pleasing growth follows the launch of the refreshed cat range with new improved packaging.

Other revenue contracted by 17.9% to £27.9 million, now representing only 6.8% of the business as we continue our planned exit from third party contract manufacturing in line with our manufacturing strategy, to improve the production efficiency of Dechra's own products.

Revenue by Product Category (at AER)

CAP 65.5%

Equine 8.5%

FAP 12.0%

Nutrition 7.2%

Other 6.8%

Underlying Gross Profit

Underlying Gross Margin for the existing business increased by 120 bps to 55.4%. The consolidated Underlying Gross Margin grew by 160 bps to 55.9%, reflecting the accretive Gross Margin in the acquisition businesses, in particular AST Farma and Le Vet.

Underlying Selling, General and Administrative Expenses (SG&A)

SG&A costs at AER grew from £99.6 million in the prior year to £110.0 million in the current year, a growth of 10.6%. This represents growth from both acquisitions and the existing business, and infrastructure cost added to manage the acquisitions. It represents an increased investment within overall SG&A to drive further growth. Within this, Corporate and unallocated costs rose slightly to £7.8 million; this represents a slowing down in the historical rate of investment in central infrastructure in Corporate costs.

More significantly, SG&A as a percentage of revenue declined in the year from 27.7% in 2017 to 27.0% in 2018, as the revenue growth in the business generated operating leverage from the cost base.

Non-underlying Items

Non-underlying items incurred in the year are fully described in note 5. In summary, they relate to the following:

• Amortisation and related costs of acquired intangibles of £54.1 million – this includes the amortisation of the acquired intangibles, and has grown significantly in the year from £40.4 million following the acquisitions in the current year;
• Remeasurement of contingent consideration gain of £0.1 million – this relates to the excess release to the income statement of the contingent consideration on remeasurement of milestone and sales performance liabilities;
• Non-cash inventory adjustment of £5.1 million – the non-cash inventory adjustment which increases the value of acquisition inventory sold relates to the acquisitions of RxVet, AST Farma and Le Vet. It is the result of the fair value exercise carried out in accordance with IFRS 3 'Business combinations' on acquisition;
• Expenses relating to acquisition activities of £3.1 million – this includes the transaction costs associated with the acquisitions of RxVet, AST Farma and Le Vet;
• Rationalisation of manufacturing footprint reorganisation of £2.9 million – this includes the costs associated with this strategic programme;
• Finance income of £0.5 million – this represents the unwinding of the present value discounts relating to deferred consideration due and associated foreign exchange. This is offset by the acceleration of arrangement fees in relation to the existing financing facility on refinance in July 2018;
• Taxation credit of £26.4 million – this represents the tax impact of the above, as well as the revaluation of deferred tax balance sheet items following changes in corporate tax rates, notably following the Tax Cuts and Jobs Act in the USA.

Taxation

The reported effective tax rate (ETR) for the year is a credit of 24.9% (2017: 8.6%), primarily reflecting the one off impact of the reduction in USA tax rates on deferred tax balances; this includes both the underlying and non-underlying business. On an underlying basis the ETR is 20.5% (2017: 21.9%): the main differences to the UK corporation tax rate applicable of 19.0% (2017: 19.75%) relate to patent box allowances, and differences in overseas tax rates particularly by the extent of growth in NA Pharmaceuticals, though this effect has moderated to an extent due to corporate tax rate reductions in USA from the Tax Cuts and Jobs Act.

The underlying ETR is expected to remain broadly similar in the current year, due to the anticipated mix of profits from different countries.

We continue to monitor relevant tax legislation internationally as it may affect our future ETR. Further details can be found in Understanding Our Risk.

Earnings per Share and Dividend

Underlying diluted EPS for the year was 76.45 pence, a 20.9% growth on the prior year. The EBIT growth of 24.0% was slightly offset by higher interest costs from increased debt to part fund the acquisition of AST Farma and Le Vet. The weighted average number of shares for the year was 97.5 million (2017: 93.5 million).

The reported diluted EPS for the year was 37.04 pence (2017: 27.93 pence).

The Board is proposing a final dividend of 18.17 pence per share (2017: 15.33 pence), added to the interim dividend of 7.33 pence, the total dividend per share for the year ended 30 June 2018 is 25.50 pence. This represents 18.9% growth over the prior year. Dividend cover based on underlying diluted EPS is 3.0 times (2017: 3.0 times). The Board continues to operate a progressive dividend policy recognising investment opportunities as they arise.

Currency Exposure

Currency rate movements have been less significant in the year than in 2017. The average rate for £/€ has declined by 3.4%, and the £/$ rate has increased by 5.7% during the financial year. The effect in the Consolidated Income Statement and Statement of Financial Position is analysed in the above paragraphs of this review between performance at AER and CER. CER analysis compares the performance of the business on a like for like comparable basis.

Currency Sensitivity

Euro €: a 1% variation in the £/€ exchange rate affects underlying diluted EPS by approximately +/- 0.7%.

US Dollar $: a 1% variation in the £/$ exchange rate affects underlying diluted EPS by approximately +/- 0.5%.

Current exchange rates are £/€ 1.1028 and £/$ 1.2914 as at 29 August 2018. If these rates had applied throughout the year, the underlying diluted EPS would have been approximately 3.7% higher.

Statement of Financial Position

The Statement of Financial Position is summarised in the table below.

• Non-current assets increased from £453.2 million to £765.6 million mainly due to the acquisition of AST Farma and Le Vet (£307.3 million).
• Working capital has increased from £62.5 million to £92.5 million following the acquisition of AST Farma and Le Vet. This was also impacted by a planned increase in inventory to support the shutdown of production lines at the Bladel facility during their manufacturing site upgrade, and to increase service levels in North America.
• Net debt has increased in the year by £91.4 million from £120.0 million to £211.4 million; net of cash generation by the business, this includes £133.4 million of additional debt drawn to part fund the acquisition of AST Farma and Le Vet. Exchange rate variations favourably affected the Net Debt position by £5.7 million.
• Corporate and deferred tax has increased from £51.0 million to £98.9 million mostly as a result of the acquisition of intangible fixed assets associated with AST Farma and Le Vet.

£505.0m

Net assets

Cash Flow, Financing and Liquidity

The Group enjoyed strong cash generation during the year, with the EBITDA margin strengthening from 24.5% to 26.2%. However, as mentioned above, working capital has increased by £23.4 million, mainly due to planned increases in inventory at Bladel and in North America and increased working capital to support the Oracle implementation which occurred in the last quarter of the financial year. This resulted in net cash generated from operations before non-underlying items of £85.6 million, representing cash conversion of 81.9%. It is expected that the increased working capital levels will unwind to a certain extent during the forthcoming year as these strategic projects conclude.

Net Debt Bridge

Notable cash items are listed below in the Net Debt reconciliation table:

• Capital expenditure on tangible and intangible assets was broadly similar at £12.6 million (2017: £10.7 million), representing 1.7 times depreciation and amortisation, which includes sums for the ongoing Manufacturing remodelling project.
• Acquisition of subsidiaries, associates and minority interests of £229.1 million includes the acquisition of RxVet, AST Farma and Le Vet. Further details in note 32 to the accounts.
• Net equity issued of £103.3 million, includes the proceeds of the equity placement and issue of new shares as consideration for the acquisition of AST Farma and Le Vet, and the settlement of vested employee share schemes.

• The Net Debt/underlying EBITDA leverage ratio per the borrowing facilities' leverage covenant, which includes the proforma adjustment to full year EBITDA for the acquisitions, was 1.75 times (2017: 1.4 times). This is broadly in line with the guidance provided at the time of the acquisition of AST Farma and Le Vet of 1.7 times, the bulk of the difference being attributable to adverse currency exchange rate movements since completion in February 2018.

Borrowing Facilities

Revolving Credit Facility

On 25 July 2017, the Group signed a new credit agreement, refinancing its previous £205.0 million Revolving Credit Facility (RCF). The committed facilities are a new five year multi-currency RCF with two one year extension options for £235.0 million, through seven banks: Bank of Ireland, BNP Paribas, Fifth Third, HSBC, Lloyds, Raiffeisen and Santander. The RCF has an Accordion facility of a further £125.0 million.

There are two covenants governing the RCF:

• Leverage: Net Debt to underlying EBITDA not greater than 3:1 (30 June 2018: 1.75) compared to the previous covenant of 2.5:1; and
• Interest Cover: underlying EBITDA to Net Finance Charges not less than 4:1, unchanged from the previous facility (30 June 2018: 15.4).

There is a non-utilisation fee of 35.0% of the applicable margin. The margin over LIBOR (or equivalent) ranges from 1.3% for leverage below 1.0 times, up to 2.2% for leverage above 2.5 times.

The first of the two one year extension options was exercised on 25 June 2018. The termination date for the RCF is now 25 July 2023.

Term Loan Facility

On 24 January 2018, the Group signed a new Term Loan facility of £350.0 million to provide funding for acquisitions. The committed facility has a termination date of 31 December 2020. It has an initial availability period of 30 June 2018 which was subsequently extended to 31 December 2018 on 25 June 2018. A sum of €150.0 million was drawn on 12 February 2018 to fund part of the consideration paid for the AST Farma and Le Vet acquisition.

The facility has the same covenants as the RCF above. However the Leverage covenant on both facilities was increased from 3:1 to 3.25:1 for the measurement period ending on 30 June 2018, after which it moves back to 3:1 on both facilities.

Return on Capital Employed (ROCE)

ROCE fell to 15.4% in the year (2017: 17.7%). This is largely due to the inclusion in the metric of 100% of the assets acquired from AST Farma and Le Vet in mid February in the Capital Employed element, but only 4.5 months' profit in the Return element. We expect this to rise in the coming year as the Group consolidates a full year of profit from the acquisition.

Acquisitions

The Group has made several acquisitions in recent years. Performance of the acquisitions made during the 2018 and 2017 financial years is separately summarised compared to the existing business in the sections above.

In December 2017, the Group acquired the entire issued share capital of RxVet Limited, a small CAP business in New Zealand. RxVet has been Dechra's distributor in New Zealand since 2010, with revenue in the year to March 2017 of NZ$1.4 million; sales of Dechra products account for about half of this. The business has been successfully integrated into the Group, has been renamed Dechra Veterinary Products NZ Limited, and is performing in line with management expectations. The acquisition was financed from the Group's existing working capital resources.

In February 2018, we completed the acquisition of AST Farma B.V. and Le Vet Beheer B.V. for a total consideration of £307.3 million (€340.0 million) on a debt-free and cash-free basis. The combined revenue in the year ended 31 December 2016, excluding business with Dechra prior to the acquisition, was €36.9 million. The total consideration was satisfied as to approximately 75% in cash and 25% in new Dechra shares, which are subject to a two year lock-in. The acquisition was financed from the £102.3 million proceeds of an equity placing, issuance of new consideration ordinary shares, and debt drawn from a new Term Loan facility (see Borrowing Facilities above). Integration has proceeded in line with plan, and the ongoing synergy realisation programme is on schedule.

Accounting Standards

The accounting policies adopted are outlined in note 1 to the accounts. There are no accounting policy changes which have impacted the 2018 financial year.

note 1 to the Accounts identifies the evaluation of the impact of IFRS 9 (financial instruments) and IFRS 15 (revenue recognition) which the Group will adopt in 2019, and the effect on the 2018 accounts when they are realigned with the new standard, which is not material. The status of the Group's impact assessment of IFRS 16 (leases) which will be adopted in 2020 is also outlined in note 1.

Summary

The existing business has performed well in the year, with above market growth rates and operating leverage. This has produced additional resources to invest more intensively in R&D, the newly formed International business and the North American commercial team, to provide future organic growth, whilst still growing the operating margin.

We are very excited by our investments in the acquisitions of RxVet, AST Farma and Le Vet and the future growth and breadth which they will deliver, as well as the ongoing investments in the Manufacturing remodelling programme which are proceeding to plan.

The Group's balance sheet is strong, enabling us to continue to consider further relevant acquisition opportunities as they arise.