Victrex plc – Annual report – 30 September 2022
Going concern and viability statement
The Directors have performed a robust going concern assessment including a detailed review of the business’ 24-month rolling forecast and consideration of the principal risks faced by the Group and the Company, as detailed on pages 34 to 40. This assessment has paid particular attention to the impact of the ongoing global economic challenges on the aforementioned forecasts.
The Company maintains a strong balance sheet providing assurance to key stakeholders, including customers, suppliers and employees. The combined cash and other financial assets balance at 30 September 2022 was £68.8m, having reduced from £112.4m at 30 September 2021 following payment of the regular and special dividends of £83.5m in February 2022. Of the £68.8m, £2.8m is held in the Group’s subsidiaries in China for the sole purpose of funding the construction of our new manufacturing facilities. Of the remaining £66.0m, approximately 80% is held in the UK where the Company incurs the majority of its expenditure and 85% is held in instant access accounts. The Group has drawn debt of £15.7m in its Chinese subsidiaries (with a total facility of c.£45m available until December 2026) and has unutilised UK banking facilities of £40m through to October 2024, of which £20m is committed and immediately available and £20m is available subject to lender approval.
The 24-month rolling forecast is derived from the Company’s Integrated Business Planning (‘IBP’) process which runs monthly. Each area of the business provides revised forecasts which consider a number of external data sources, triangulating with customer conversations, trends in market and country indices as well as forward-looking industry forecasts. For example, forecast aircraft build rates from the two major manufacturers for Aerospace, World Semiconductor Trade Statistics Semiconductor market forecasts for Electronics through to 2024 and Needham and IQVIA forecasts for Medical procedures.
The assessment of going concern included conducting scenario analysis on the aforementioned forecast which, given current economic forecasts, focused on the Group’s ability to sustain a period of falling demand, whether caused by a pandemic, geo-political event(s) or other global economic challenges. In assessing the severity of the scenario analysis, the scale of the impact experienced during previous economic downturns has been used, including the differing impacts on Industrial versus Medical segments.
Using the IBP data and reference points from previous downturns management has created two scenarios to model the effect of reductions to revenue at regional/market level and aggregated levels on the Company’s profits and cash generation through to January 2024. The impact of climate change and the Group’s Net Zero 2030 goal for its own operations (Scope 1 & 2 emissions) has been considered as part of this assessment. Any impact on revenue over the shorter going concern period, either positive or negative, is likely to be insignificant, with the greater risk being that of higher carbon taxes. The current elevated price of gas and electricity included in the 24-month forecast, reflecting current supply side uncertainty, and the government focus on limiting the impact of the current economic slowdown means that additional carbon taxes over the going concern period are considered unlikely, and therefore no additional costs have been included in either the base forecast or the scenarios noted below.
Scenario 1 – the global economy contracts with sales volumes reducing by 30% from the level seen over the past 12 months, to approximately 280 tonnes per month, from January 2023 for a period of six months (to mirror the length of the most recent downturn in 2020) before a partial recovery to c.330 tonnes per month for the remainder of the going concern period. Medical revenue remains unchanged from the past 12 months’ run rate, with the economic situation historically having minimal impact on this segment.
Scenario 2 – in line with scenario 1, c.280 tonnes per month from January 2023; but, the economic contraction lasts for a full 12 months, i.e. throughout the going concern period. This would give an annual volume of c.3,300 tonnes, a level not seen since 2013. Prior to COVID-19, the last recession was the financial crisis in 2008 and 2009 which lasted approximately 12 months. In this scenario Medical revenue is reduced by 10% during the second six months to reflect a limited impact from a longer lasting slowdown. The Group considers scenario 2 to be a severe but plausible scenario.
Before any mitigating actions the sensitised cash flows show the Company has significantly reduced cash headroom. Under scenario 2 there is minimal cash generation through the going concern period and there is potential that the committed facility would be required to manage intra-month cash flows. However, the Company has a number of mitigating actions which are readily available in order to generate significant headroom. These include:
- use of committed facility – £20m could be drawn at short notice. Conversations with our banking partner indicate that the £20m accordion could also be readily accessed. The covenants of the facility have been successfully tested under each of the scenarios;
- deferral of capital expenditure – the base case capital investment over the next 12 months is approximately £50m as major projects are completed in China and the UK. This could be reduced significantly by limiting expenditure to essential projects, deferring all other projects later into 2024, with the exception of completing the manufacturing facilities in China which will continue as planned;
- reduction in discretionary overheads – costs would be limited to prioritise and support customer related activity; and
- deferral/cancellation of dividends – the dividend payable in June 2023 could be deferred or cancelled. The Company’s intention is to continue payment of dividends where cash reserves facilitate but it remains a key lever in downside scenario mitigation.
Reverse stress testing was performed to identify the level that sales would need to drop by in order for the Group to run out of cash by the end of the going concern assessment period. Sales volumes would need to consistently drop materially below the low point in scenario 2 which is not considered plausible.
As a result of this detailed assessment and with reference to the Company’s strong balance sheet, existing committed facilities and the cash preserving levers at the Company’s disposal, but also acknowledging the current economic uncertainty as a number of global economies close to/in recession and the war in Ukraine continues, the Board has concluded that the Company has sufficient liquidity to meet its obligations when they fall due for a period of at least 12 months after the date of this report. For this reason, they continue to adopt the going concern basis for preparing the financial statements.
1. Assessment of prospects
The Directors have assessed the Group’s longer-term prospects, primarily with reference to the results of the Board-approved five-year strategic plan. This is driven by the Group’s business model (detailed on pages 12 to 13) and strategy (detailed on pages 14 to 19), which are fundamental to understanding the future direction of the business, while factoring in the Group’s principal risks (detailed on pages 34 to 40) and the potential opportunities and risks of climate change (detailed on pages 52 to 57). The Directors continue to consider the ongoing challenges to the global economy and the uncertainty this creates, particularly in the early years of the strategic plan. The Directors have also considered the Group’s ability to generate cash and maintain a strong financial position throughout the economic cycle, including the level of available cash at 30 September 2022.
The strategic planning process is undertaken annually, and includes analyses of profit performance (including our core business and new product pipeline and ‘mega-programmes’), cash flow, investment programmes (including manufacturing capacity increases and our acquisition pipeline) and returns to shareholders. Completion of the strategic plan is a Group wide process engaging employees throughout the business, including all senior management in their respective areas. The strategy was reviewed and approved by the Board in May 2022 (covering the five years to September 2027). The strategy is built market by market, geography by geography recognising the differing dynamics in each whilst also considering the longer-term impact of the Company achieving Net Zero Carbon for its own operations (Scope 1 & 2 emissions) combined with the wider global ambition to reduce carbon usage over varying time periods. The Company also operates a shorter-term rolling 24-month forecast, predicated on the IBP process, which forms the basis for the 2023 budget and key operational decisions over this shorter time frame. The first two years of the strategy align to the rolling forecast.
The Board considers five years to be an appropriate time horizon for our strategic plan, being the period over which the Group actively focuses on its development pipeline and resulting capital investment programme. As part of our longer-term considerations, to support capacity planning, climate change modelling and assessment of projects which will take longer to reach meaningful revenue, the Group does prepare forecasts for a period of more than five years; however, a period greater than five years is considered too long for the strategic plan given the inherent uncertainties involved.
2. Viability period
The Directors have assessed the viability of the Group over the five-year period to September 2027, being the period covered by the Group’s Board-approved strategic plan.
3. Assessment of viability
To make their assessment of viability, the Directors have tested a number of additional scenarios on the base case position of the five-year strategic plan. These scenarios encompass key trading assumptions combined with the potential impact of crystallisation of one or more of the principal risks over the five-year period. Whilst each of the principal risks has a potential impact, the scenario analysis has been focused on those considered to have the most significant financial impact, primarily to the revenue growth of the Group. The risks have been assessed for their potential impact on the Group’s business model, future trading and funding structure.
The continuing progress in the mega-programmes is forecast to have a material impact on the Group’s revenue over the strategic period. The business case behind each of these programmes remains robust, and in most cases is enhanced by the global ambition to reduce carbon emissions and increased desire for wider societal benefits from the Medical industry. Limited delays to the mega-programmes did arise during the pandemic but progress on milestones has accelerated in the past 12 months, as evidenced by the Knee clinical trial programme and acquisition of Magma by TechnipFMC. Timing of milestone achievement and the resulting impact on revenue growth remains the key variable across the mega-programme portfolio which the Directors have incorporated into scenario 3 described below.
The impact on the strategy of both the Company achieving Net Zero Carbon by 2030 for its own operations (Scope 1 & 2 emissions) and the wider economy achieving Net Zero Carbon over a long period has been more fully assessed during 2022. The physical risks and transitional opportunities and risks have been considered in detail as described in the Sustainability report on pages 1 to 74. The physical risks presented by climate change are not expected to have a material impact on the Company’s ability to manufacture product over the strategy period and therefore no sensitivity has been performed. At the revenue level the transitional opportunities are considered to outweigh the risks over both the short and longer time horizons, supporting continued revenue growth albeit the impact of this is only likely to be material outside of the five-year strategy window. The primary transitional risk relates to carbon pricing and the likely levers used by regulators and governments to drive down use of carbon – taxation and levies. The Group’s manufacturing and supply chain does use significant gas, electricity and water whilst also generating hazardous waste. Work is ongoing to reduce the use of carbon in the manufacturing process, both through using green sources but also redesigning the chemical process to reduce the overall energy requirement and waste generation. Acknowledging the risk to the decarbonisation of the manufacturing process, primarily in respect of timing, an increased cost of operation from taxation and levies has been assumed in scenario 4, with annual manufacturing costs increasing by £20mpa, increasing annually by inflation, from 2024.
The downside scenarios applied to the strategic plan are as follows:
The scenarios tested were carefully considered by the Directors, factoring in the potential impact, the probability of occurrence and the effectiveness of the mitigating actions. In addition, whilst considered implausible, a combined scenario (scenario 6) was also tested, which contained an aggregation of all scenarios considered.
Further, to the risk mitigation plans, the Group’s two distinct segments, both with diverse geographic markets, assist in reducing the risk of regional economic challenges and sector specific issues. This diversity has been evidenced through the pandemic where the impact of and recovery from the economic slowdown differed between business units, with Medical Implantable particularly severely impacted with the cancellation of elective surgery and a prolonged period where hospitals have been focused on non‑elective patients, contrasting to, for example, Electronics within the Industrial segment, which has seen a sharp recovery as consumer spending habits have changed in its favour. Geographically the impact was much lower and shorter in length across Asia where demand quickly returned to pre-pandemic levels, compared to a later, deeper and longer impact in US markets which only returned to pre-pandemic levels in the second half of 2021. These differing geographical patterns have continued in 2022 with the US the fastest growing region, whilst Asia has been impacted by the return of strict COVID-19 management policies and associated lockdowns. The strategy of partnering closely with customers to develop the right applications and our existing and growing list of specified products are also important mitigants.
The mitigation assessment also considered the Group’s ability to manage its cost base and raise new finance and the possibility of delaying capital programmes and/or restricting shareholder returns over the viability period if required.
The results of this stress testing showed that the Group would be able to remain solvent and maintain liquidity over the assessment period. The Group is profitable under all scenarios, including scenario 6. The lowest cash balance was in scenario 6, in which the cash balance remains positive albeit at a level where working capital will have to be carefully controlled or the RCF (available until 2024 with covenant compliance tested under scenario 6) will be required to manage intra-month flows through FY 2024 whilst maintaining the regular dividend. Due to the severity and implausibility of scenario 6 and an outcome that may require limited use of the RCF this is considered akin to a reverse stress test.
4. Viability statement
Based on the results of this detailed analysis, the Directors have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the five-year period to September 2027. This is predicated on the assumption that an unforeseen event outside of the Group’s control (for example, an event of nature or terror) does not inhibit the Group’s ability to manufacture for a sustained period.