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Edited Transcript of COA.L earnings conference call or presentation 1-Aug-19 8:00am GMT

Half Year 2019 Coats Group PLC Earnings Call

Aug 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Coats Group PLC earnings conference call or presentation Thursday, August 1, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Rajiv Sharma

Coats Group plc - Group Chief Executive & Executive Director

* Rob Mann

Coats Group plc - Head of IR

* Simon Boddie

Coats Group plc - CFO & Executive Director

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Conference Call Participants

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* Charles Hall

Peel Hunt LLP, Research Division - Head of Research

* James Edward Zaremba

Barclays Bank PLC, Research Division - Research Analyst

* Joseph William Spooner

HSBC, Research Division - UK MidCap Equity Analyst

* Mark Lewis Fielding

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to the Coats Group plc 2019 Half Year Results. My name is Brita, and I'll be coordinating today's call. (Operator Instructions) And I will now hand over to your host, Rob Mann. So Rob, please go ahead.

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Rob Mann, Coats Group plc - Head of IR [2]

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Great. Thank you. Good morning, ladies and gentlemen, and welcome to the call. I'm Rob Mann, Head of Investor Relations for Coats. Presenting the half year results today are Rajiv Sharma, our Group's CEO; Simon Boddie, our CFO.

Following the presentation, we will open up the call to questions. The presentation is also available on our website, and this webcast will be available in archive shortly after the call.

And with that, I'll hand over to Rajiv.

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Rajiv Sharma, Coats Group plc - Group Chief Executive & Executive Director [3]

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Thank you, Rob. Good morning, ladies and gentlemen. Welcome to the 2019 half year results presentation. In terms of the running order for today's call, I will take you through the highlights of the first half of the year, give a business update and progress on our strategic initiatives. Simon will follow with the presentation on our financial performance. I will wrap up with the outlook before opening up for questions.

Coats has delivered a robust set of results in H1 2019. Before I talk about the business performance, let me touch upon progress made in a few areas that are critical to our long-term strategy. Sustainability is embedded in the DNA of Coats and is the key reason for our success over 260 years. It is also integral to our business strategy.

In March, we released our sustainability report that outlines the strategy and future targets. In the past 4 years, we did 5 bolt-on acquisitions. I'm pleased to report that 4 of them have continued with strong double-digit sales growth in H1, while the fifth one that was completed a few months back is being integrated within Coats.

In 2018, we announced a 2-year transformation program called Connecting for Growth. It was designed to reduce complexity and cost in the organization while improving speed, agility and compliance. This program has been well executed and actions are mostly complete. Savings from this program are being reinvested in digital, innovation and talent to further future-proof the business.

In February, we completed the sale of North America Crafts. This business was nonstrategic and noncore. Coats is now a pure-play global industrial company.

Following the opening of our first innovation hub in the U.S. in October 2018, we have now opened our second and third innovation hubs in Turkey and China, respectively. This completes the network of 3 globally dispersed, fully functioning innovation hubs.

In summary, the first half of 2019 has seen significant progress in delivering our longer-term strategy.

Slide 5 outlines the financial highlights for the period, but let me start with the overall context first. On the demand side, external environment was challenging. Retail sales of garments, shoes and bags remains muted across major markets. Industrial output grew at a lower rate in most sectors and global automotive production was down. Despite this, there were winners in the market, and our focus has been to win with the winners.

On the supply side, we experienced delays with supply of certain raw materials, but this has normalized towards the end of H1. In the past 12 months, we have exited 7 tail markets that were nonstrategic and financially unattractive. So that as a context delivering 2% sales growth was pleasing. Operating profit was up 8% with 80 basis points improvement in margin. Most of this is attributable to price and self-help programs. Free cash flow up 24%, and leverage reduced to 0.9x was particularly pleasing. This allows Coats to continue investing in the business and also pursue acquisitions in line with our strategy.

The Board has approved a 10% increase in the interim dividend. This reflects our confidence in the strategy and future direction of Coats.

Now let me turn to business performance in the first half and other strategic developments. Following the sale of North America Crafts earlier in the year, Slide 7 sets out our new reporting segments. We have started reporting segmental profits for Apparel and Footwear and Performance Materials. But before I go on, it might be useful to take a step back and give an overview of the 2 global sales. Apparel and Footwear accounts for approximately 75% of group sales.

We are the world's largest industrial thread company with over 20% share of a $4 billion market. Our strategy delivers profitable share gains, and we have grown at 2x the market in this decade. Our depreciation comes from having global scale, the largest product portfolio, superior product quality, customer service, digital tools and ESG. We are adding speed, agility, innovation and marketing to the list of differentiators. The balance 25% of the group sales comes from the faster group Performance Materials segment, which has strong positions in the U.S. and Europe. The segment focuses on 5 discrete categories that range from Telecom and Energy, Transportation, Personal Protection, Household and Recreation and several other niche applications.

Across Performance Materials, we have a blended average market share of 9% in a $3.5 billion addressable market that is growing. Our strategy is to take share and grow more than the market. 3 key growth levers are: innovation, just-in-time supply, quality assurance, ability to customize small product runs, Asia with existing products and acquisitions.

With this overview, let me turn to the next slide and update you on the H1 performance of each segment.

Slide 8 sets out our Apparel and Footwear performance in the period. It is important to note that during H1, we exited 7 tail markets and organized several niche products. We have also discontinued serving nonstrategic and unprofitable customers in select geographies. This resulted in sales growth of 1% instead of 2%. Thread is the largest product in Apparel and Footwear and grew in line with expectations at 3%. Higher margin premium threads grew between 5% and 7%. We were able to offset raw material inflation through price. Activewear, athleisure and outerwear categories grew, while casual wear and mid-market apparel remained soft.

The U.S.-China trade dispute has resulted in many U.S. brands exploring ways to de-risk sourcing from China. As this plays out, Coats will benefit due to its strong presence in all major sourcing markets. Zips sales were flat due to European footwear fashion trends and a generally slow retail sales environment. Despite flat sales, we increased profits.

In June, Twine launched its digital thread coloring printer. This allows the customer to have thread of any length, any color, any time at touch of a button. This printer uses no water and very little electricity. Coats has invested in Twine and is an exclusive strategic partner for the Apparel and Footwear industry. I will speak a bit more about sustainability in a few minutes.

Last year, we launched the world's first 100% recycled premium sewing thread. Demand for this product is very strong. We also launched a new recycled sewing thread made of organic cotton with organic dyes and chemicals. We will continue to add more environmentally friendly products to our portfolio.

I mentioned earlier our new 5 end-use categories in Performance Materials and Slide 9 outlines these in more detail. The end markets in Telecom, Energy, Personal Protection and Transportation are expected to grow over the medium term, driven by increasing regulation in Personal Protection, 5G rollout in Telecom and light weighting in automotive. We intend to grow faster than market through innovation, globalization and acquisition. Household, recreation and other industrial end markets are expected to grow between 0% to 2% over the medium term. Our strategy is to take share through innovation, globalizing existing products in emerging markets and superior service.

The right-hand side of the slide gives you the approximate sales split for each of these 5 categories during H1 2019.

Let me now talk to you on Slide 10 about the overall sales performance of the segments in H1. Performance Materials delivered 4% growth in H1 with key strategic focus areas of Telecom and Energy growing 27% and Personal Protection growing 8%. Our 2 acquisitions, Gotex in Europe and Patrick Yarn in the U.S. had strong sales and profit growth. Overall, Europe was the standout region for Performance Materials with 7% sales growth. Despite world car production being down, we have managed to keep our transportation sales in H1 broadly flat, which is a good result. We are pushing hard to grow shares in the Household and Recreation segments and other industrial applications. However, the overall consumer durable space in the U.S. remains solid.

To drive our profitable sales growth in Performance Materials, we have invested in 3 innovation hubs and more promotional camps.

Slide 11 shows the 3 main areas of reinvestment from Connecting for Growth. Connecting for Growth is a 2-year program that will end by December 2019. Over 2 years, we would have spent $30 million to take out roughly $35 million of cost and reinvest $10 million of these in 3 main areas, which are innovation, digital and talent. With the cost takeout phase nearly complete, our attention is now shifting to extracting benefits from the reinvestment.

Over the past 10 months, we have opened 3 state-of-the-art innovation hubs, one each in the U.S., Turkey and China. These hubs will help us improve speed and scale of innovation. Customers are already placing orders for products created in these hubs. In H1, we created 150 new products across these 3 hubs that delivered $8 million of sales.

In the areas of Digital, our move to cloud is largely complete, giving us a secure, flexible and cost-effective computing environment. Our pilot to exploit machine data in 2 factories indicates opportunities for better labor utilization, less waste, just-in-time inventory and more efficient machine management. We will scale this over the next 2 years across our factories. I'm also proud that over 100 managers within Coats have got expanded roles or new roles. This has been very energizing for the manager and staff as they see opportunities to develop and progress within Coats. We have also hired people with specialist skills to accelerate our journey in innovation, digital, automation and analytics.

Slide 12 outlines our progress in the important area of ESG. In the recent past, we have seen our industry getting more focused on ESG. Customers and local authorities have better enforcing standards and laws. At Coats, we welcome higher ESG standards and enforcement as this further differentiates us from the competition.

In March, we released our sustainability report, which outlines our ESG strategy and future targets. We have achieved a lot in the past 5 years, yet we have set tough for deliverable targets for 2022 in 5 areas. These are: water, electricity, effluent & emissions, social and waste.

In June, we held our first sustainability-focused investor event at the London Stock Exchange. We have received good feedback, especially in demonstrating the strong link between ESG and value creation for multiple stakeholders.

With that, let me hand over to Simon who will take you through the financial performance in the first half.

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Simon Boddie, Coats Group plc - CFO & Executive Director [4]

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Thank you, Rajiv. I'd now like to take you through the key details of the half year results for 2019, which is set out on Slide 14 in our U.S. dollar reporting currency. We specifically highlighted the performance of our financial KPIs. Organic sales growth for the period was 2% with continued revenue growth in both our Apparel and Footwear and Performance Materials businesses for the reasons that Rajiv set out earlier.

At a reported level, revenues were down 3%, reflecting the same foreign exchange translation headwinds that we saw at our recent trading update in May. At current exchange rates, we expect a broadly neutral translation impact in the second half of the year. It is pleasing to see good growth in our adjusted operating profit, which grew by 8%, and I'll come on to explain the drivers behind that performance on the next slide. At an adjusted earnings per share level, there was a 4% decline in the period. The primary reason why this was lower than the adjusted operating profit performance is down to nonoperational items, namely foreign exchange impacts, some legacy interest charges and the impact of the new leasing accounting standard this year. Adjusting for those one-off nonoperational items, earnings per share growth was 4%. Cash generation continued to be robust with adjusted free cash flow in the first 6 months up 24% on the same period last year. I'll explain the key drivers in more detail later.

Our return on capital employed has increased by 200 basis points on last year to 40%, despite capital expenditure being in excess of depreciation and was driven by our good operating profit performance.

Lastly, we've announced an interim dividend of $0.55 per share, which is a 10% growth on last year. As Rajiv mentioned earlier, this reflects our Board's collective confidence in the strategy and the future direction of the business.

On Slide 15, you can see the details of the operating performance of the business. Overall, sales growth was 2%, which was driven by 3% growth in the key Asia region, where our large Apparel and Footwear markets continue to perform well. In the Americas, we saw encouraging growth in some of our key Latin American Performance Materials markets, including Mexico and Brazil, although this was offset by continued softness in the U.S. consumer durables market and the Apparel and Footwear markets in Brazil and Argentina, which remain challenging. Overall, this drove a 6% decline in that region.

In the EMEA region, we saw 7% growth, following a strong performance in Performance Materials, where, in particular, the Telecoms and Energy business saw good growth, and this includes our Gotex business, which was acquired in 2016. The Apparel and Footwear market in EMEA saw consistent low single-digit growth. The 8% organic operating profit growth was driven by pricing, productivity and procurement gains, continued tight cost control as well as the incremental year-on-year savings from the continued Connecting for Growth program of $10 million. These benefits were partially offset by the continued structural inflation which we faced in many of our markets, in particular, the impact of rising oil prices and energy costs. We passed on our raw material cost headwinds through price. However, this cost pass through as well as adverse manufacturing variances in the Americas has driven a reduction in our reported gross margin.

Despite this impact on gross margin, and largely due to the cost savings we've delivered, we saw an 80 basis point increase in operating margins to a healthy 14.5%.

On Slide 16, we set out the performance of the business across the new operating segments that Rajiv introduced earlier, Apparel and Footwear and Performance Materials. It's pleasing to see that we delivered sales and profit growth across both businesses. As Rajiv set out, we see significant scale benefits in our market-leading Apparel and Footwear business, this has continued to deliver strong margin progression in the period of 110 basis points to 14.7% and profit growth of 9%.

In Performance Materials, there's less scale than the Apparel and Footwear business. However, the margins in this business benefit from the specialization of the product solutions we developed for customers. It is key to note that because of the size of the Performance Materials business as well as the higher average order value, we can expect to see financial results sometimes impacted by specific items. Two particular items impacted the progression of Performance Materials margins this period being a specific customer-related bad debt and inventory write-off as well as some initial operating costs from the new innovation hubs that were opened in the period. Despite these specific impacts, Performance Materials profit growth was 4%. The margins were flat in the period at 13.7%. Excluding these specific items, Performance Materials would have seen healthy progression in margins in the period.

On Slide 17, we can see the bottom half of the profit and loss account at reported currency rates. I've already explained the drivers of the increase in adjusted operating profit, so I'll focus on the items below this. Exceptional and acquisition-related items have decreased significantly year-on-year and are minimal in the period. This reflects the strategic progress we've made following the significant Connecting for Growth reorganization charge in the first half of 2018 as the bulk of the reorganization actions took place.

Reported operating profit and earnings per share are essentially in line with our adjusted measures as a result. Finance costs are somewhat higher than last year, and this is essentially due to the nonoperational items that I alluded to earlier. These include a mark-to-market foreign exchange loss booked at the period end as we proactively took steps to hedge off sterling U.K. pension cash flows. We also saw an increase in interest as a result of the new leasing standard. Lastly, we saw some legacy interest costs, for example, in our China entity that impacted adjusted earnings.

On tax, we saw the underlying rate continue to trend down from 31% in 2018 to 30% in this period. We saw a further small discontinued item following the completion of disposal of the North American Crafts business in February, which included predisposal operating losses of that business. As a result of the above, at an adjusted EPS level, we saw a 4% decline year-on-year. But if we were to exclude the nonoperational items I referred to in relation to foreign exchange, leases and legacy interest charges, our earnings per share growth was 4%.

On Slide 18, you can see the free cash flow for the period increased by 24% to $21 million. This was driven by increasing operating profits, controlled net working capital and despite maintaining capital expenditure a level that is above depreciation. We expect capital expenditure to be in the $45 million to $55 million range for 2019 full year, which is in line with previous guidance. I should flag that this is the first time we are reporting the first half cash flows rather than the last 12-month basis, which we've done previously. As is normal in our business, we see working capital outflows in the first half as reporting inflows in the second half. On the previously reported last 12-month basis, we delivered a strong result with $100 million of adjusted free cash flow.

On the right-hand side, you can see that our balance sheet remains in a strong position, with leverage of 0.9x and lower than at the end of 2018. This leverage calculation excludes the impacts of the new leasing standard, which remains our leverage basis for covenant purposes. Adjusting for capitalized assets and associated liabilities as a result of the new leasing standard, we see an increase in net debt of $58 million from the previous basis $210 million to a closing net debt position at 30th of June of $269 million and leverage on this basis at 1.1x.

So lastly for me, as you can see on Slide 19, it's worth reflecting that despite the macroeconomic uncertainties, we and others are faced with, our financial delivery remains robust. We've delivered ongoing organic growth across both businesses, alongside group operating margin expansion and increased cash generation. We have a strong balance sheet, which will enable us to fund -- to have the funds to reinvest selectively in the most appropriate value-adding opportunities, both organically and inorganically. Our strategic reorganization activity is largely now behind us, and we can see the quality of our earnings generation flowing directly to our bottom line. This shows the fundamental quality of our business.

And with that, I'll hand you back to Rajiv to wrap up and summarize our outlook for the remainder of the year.

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Rajiv Sharma, Coats Group plc - Group Chief Executive & Executive Director [5]

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Thank you very much, Simon. Slide 21 is our outlook statement for H2 2019. In the second half of the year, we will continue to drive performance through our focus on customer service and building on our innovation and digital capabilities, supported by self-help initiatives.

Our full year earnings per share will be impacted by the highlighted foreign exchange movements, IFRS 16 changes and certain legacy interest charges. However, while we remain mindful of current macroeconomic uncertainties, we anticipate delivering 2019 full year adjusted operating profit in line with our expectations.

So to wrap up and summarize, we are delivering on our strategy. We continue to deliver robust growth in Apparel and Footwear while leveraging our global scale, strong customer relationships, technical support, digital, innovation and ESG credentials.

Performance Materials remains an exciting growth driver for Coats. Sales growth is and will be primarily driven by innovation, globalization and acquisitions. We believe in delivering in any kind of external environment and hence, self-help programs are critical to our success as we have seen these actions underpin our performance in H1. We continue to look for acquisitions in Apparel and Footwear and Performance Materials. All these factors result in continued strong financial delivery during cash generation.

As Simon said, we have the balance sheet available to deploy resources to further deliver value in line with our strategy.

And with that, I hand over to Rob.

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Rob Mann, Coats Group plc - Head of IR [6]

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Great. Thank you, Rajiv. We will now open up the call to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question from the phone line today comes from Charles Hall from Peel Hunt.

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Charles Hall, Peel Hunt LLP, Research Division - Head of Research [2]

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Can I just ask a couple of questions. Firstly, on material input costs. Can you just quantify what those were in the first half and what your price experience was? And following on from that, what your outlook for the second half is on the input costs given the trends in related prices?

And secondly, could you just give a bit more color on the acquisition pipeline as to sort of size of businesses that you're looking at and the sort of quantum of valuation that you'd be looking to pay?

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Rajiv Sharma, Coats Group plc - Group Chief Executive & Executive Director [3]

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All right. Let me start with the first question. In the first half of the year, we experienced about $14 million of inflation in -- linked to raw material prices. There was a difference between Q1 and Q2. So we started to see raw material prices come down in Q2, but it's been at a slower rate. We were able to realize about $16 million of price. So price more than offsetting the inflation from raw material costs. Looking into H2, we see that raw material costs will continue to come down moderately and that should be good for us going forward. We also had another issue in H1, which was availability of certain raw materials which had a slight impact in our Performance Material area. And we will start to see those supply issues recede this month and next month. So we hope to have a more normal H2 from a supply security standpoint.

And your second question around acquisitions. As always, the pipeline that we are looking at is healthy and robust. We continue to look for acquisitions. The last one we did, Patrick Yarn had sales of about 40 -- $42 million at the point of acquiring them. We are clearly looking for slightly bigger acquisitions. If we do find the right one which is strategically important and financially attractive, we would then go for acquisitions which are bigger than what we have done in the past.

And again, performance areas continue to be Performance Materials, Software Solutions and Apparel and Footwear and we're certainly open to other categories within the core Apparel and Footwear -- I mean our segment that will allow us to build a bigger moat around the core business.

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Charles Hall, Peel Hunt LLP, Research Division - Head of Research [4]

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Great. And just following up on that point of availability of raw materials for Performance Materials, what was the cause of that? Was that a particular area of the supply chain that was under pressure and not delivering products? And what was the impact on you? Is that a price or was that an inability to supply?

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Rajiv Sharma, Coats Group plc - Group Chief Executive & Executive Director [5]

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So it was a combination of 2 things. One is that in China there were a couple of chemical plants that went off-line and they provide the feedstock for nylon and some other raw materials. So that created an impact. We've also seen the demand for aramids, which is the raw material that goes into Personal Protection being very, very, very high. So essentially, demand was outstripping supply in this area. And some of the suppliers were rationing supply. So we were able to get the supplies, but have we got more, we could have sold more. Those are the 2 factors impacting the supply availability.

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Charles Hall, Peel Hunt LLP, Research Division - Head of Research [6]

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And should that lead us to think that the revenue performance in Performance Materials should be stronger in the second half than it was in the first half?

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Rajiv Sharma, Coats Group plc - Group Chief Executive & Executive Director [7]

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I think if you look at the overall sales growth of 2%, this should have been more than 2%, more like 3 -- slightly 3-plus-percent, had it not been for 3 factors. One, the external demand side was a bit soft, especially in Apparel and Footwear; two, we had some moderate supply issues in certain categories that held us back; and three, actions taken from Connecting for Growth where we exited certain tail markets and harmonized certain niche unattractive products. So when you actually combine these 3 factors together, it has had roughly a 1 point impact on our sales growth.

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Operator [8]

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(Operator Instructions) We now have the next question from Joe Spooner from HSBC.

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Joseph William Spooner, HSBC, Research Division - UK MidCap Equity Analyst [9]

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Sorry, I apologize. I was on mute there. I'm just trying to keep track of the Connecting for Growth savings, and I think last year you delivered $15 million, there's another $10 million landing in the first half. So does that mean there isn't any more now left to deliver in any period going forward they will now in the numbers, so to speak?

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Simon Boddie, Coats Group plc - CFO & Executive Director [10]

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So yes, if you think about it, so I think we delivered in last year, we -- if you look at half-on-half about $4 million in the first half of last year $15 million and so there was an incremental kind of level in terms of this period, and we've given guidance as that's $25 million in terms of the full year. So when you look at half 2 on half 2, the benefits will be the -- basically the same at a net level. Growth might be a bit higher, but we've got more in reinvestment going in, in terms of the second half.

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Joseph William Spooner, HSBC, Research Division - UK MidCap Equity Analyst [11]

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So there's certainly net benefit in the second half, the net benefits have now been delivered into the numbers?

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Simon Boddie, Coats Group plc - CFO & Executive Director [12]

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Yes. So it should be that the net benefit -- sort of half-on-half for the second half should be the same; higher growth, but with more reinvestment in terms of the key initiatives around innovation. And Rajiv talked about the innovation centers that we got at digital and in terms of talent.

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Joseph William Spooner, HSBC, Research Division - UK MidCap Equity Analyst [13]

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So I'm confusing myself. So if I look at last year, there were $15 million of benefits delivered for the full year. You've talked about another $10 million being delivered so far this year. So that gets you to $25 million. So the full $25 million to this point have been delivered. There is no more net benefits to land in the remainder of the year?

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Simon Boddie, Coats Group plc - CFO & Executive Director [14]

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That is correct. The point I'm making is that the growth is going to be higher, but we're going to have more reinvestment. So you're right absolutely on the net, but if you look above that, there is a bit more growth and then -- but there is more reinvestment.

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Joseph William Spooner, HSBC, Research Division - UK MidCap Equity Analyst [15]

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Perfect. And in terms of the exceptionals around that, then presumably because there's some more growth coming through there that we should expect some more exceptionals to land over the remainder of the year?

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Simon Boddie, Coats Group plc - CFO & Executive Director [16]

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Yes. So we guided there around $30 million. So we would expect the balance of that to be in the second half. Yes.

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Joseph William Spooner, HSBC, Research Division - UK MidCap Equity Analyst [17]

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Okay. And on the hubs, I think you spoke about 150 products out of these hubs already. Can you just talk a little bit about what these products are? Are they kind of bespoke projects for specific clients? So are they products that could perhaps have a bigger life after their creation?

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Rajiv Sharma, Coats Group plc - Group Chief Executive & Executive Director [18]

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Yes. So roughly 55% of those 150 products were in the area of Personal Protection and 20-odd-percent was in the area of sustainability. These products were launched at various times during H1. The $8 million, which I mentioned to you, is the overall sales coming from these 150 products over the 6-month period. It's hard for me to say, right now, as to the scale, in fact, I think time will tell, but I am reasonably confident that certain Personal Protection yarns that we have developed will actually scale up over the next 3 years to be in the $50 million to $70 million range. I expect some of our recycled products, especially in Apparel Premium threads will start to grow. And that could have a material impact over these 3 to 5 years.

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Operator [19]

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(Operator Instructions) And we have a follow-up question from Mark Fielding from RBC.

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Mark Lewis Fielding, RBC Capital Markets, LLC, Research Division - Analyst [20]

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One question -- can I ask actually -- more than one question, maybe 2 or 3. Firstly, in terms of the tail market exits and the headwind of that -- small headwind that have on sales, and I think you've also -- combination of exiting specific businesses, but also exiting certain low-margin areas. How much more of that should we expect to see in second half of this year? Does it continue into next year as well? And just how do we think about that?

And then, separately, in terms of Performance Materials, obviously, you flagged that it can be impacted by specific factors. How much do we think about things like innovation hub costs being a factor set in the second half? Or is there anything else we need to be aware of in that area?

And finally, just blinking in term -- Performance Materials point in terms, is the growth variation that we're seeing, obviously, it's quite widespread of growth rates across the new categories that you've given us, is that having a significant impact on margins at all? Is there a sort of margin spread across those areas, particularly with obviously the strength of growth in the areas maybe where you're having to invest more?

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Rajiv Sharma, Coats Group plc - Group Chief Executive & Executive Director [21]

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Okay. So let me take the first one, and then I'll request Simon to respond to your second and third questions here. Regarding tail markets and unprofitable customers, the majority of the actions have been completed in H1. So there will be very, very minimum impact in H2.

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Simon Boddie, Coats Group plc - CFO & Executive Director [22]

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I think the second question was around hubs -- the innovation hubs and the costs on those? Yes, is that right? Mark?

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Mark Lewis Fielding, RBC Capital Markets, LLC, Research Division - Analyst [23]

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Yes. And just whether you think, like, you obviously flagged that it was sort of holding back margins of Performance Materials and how we think about that evolving from here?

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Simon Boddie, Coats Group plc - CFO & Executive Director [24]

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Yes. So what we've had is on the hubs, we had basically one -- we opened the U.S. one last year, then we've opened the Turkey and the China one in the period. So we will have ongoing, for the second half, the cost of the sort of the full year in terms of the cost that's certainly the Turkey and the China one. So that is an impact. That's one of the reinvestments that we've made from some of the benefits we've got on with Connecting for Growth. So that will -- in terms of innovation, it will be for the full year where those are fully in the cost.

And I think the final piece was around sort of growth on Performance Materials. And as we highlighted, there are some very different sort of growth rates in terms of those particular categories. And you saw some of the strong growth that we had in a number of those categories around Personal Protection and the Telecoms, Energy area. So we are seeing some variability in terms of those. And that's really what gives the overall kind of blended margin that we see in terms of Performance Materials, which is by and large at the same level as Apparel and Footwear. You've got the specialization in Performance Materials, whereas you've got the sort of scale in Apparel and Footwear.

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Mark Lewis Fielding, RBC Capital Markets, LLC, Research Division - Analyst [25]

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I suppose where I think of this, do we think if the growth rates continue with the spread they are now, you're saying that, that would continue to be a broadly stable margin impact from that or is there any margin skew over time if you continue to see, particularly the more, so I would call it, sort of traditional businesses and weaker markets and declines, where I assume margin's still relatively robust, but maybe a little bit under pressure now?

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Simon Boddie, Coats Group plc - CFO & Executive Director [26]

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Yes. So you have got some variability in that, but you've also got innovation coming along in terms of the margins on those. And as we build scale in those particular subcategories, you get benefits in terms of those. So there's quite a number of different factors going on, just beyond segment, subsegment mix, which is, I think the thing that you're asking about.

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Operator [27]

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And we have another question from the phone lines, and that's from James Zaremba from Barclays.

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James Edward Zaremba, Barclays Bank PLC, Research Division - Research Analyst [28]

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I've got a few questions, please. One, just a kind of a high level in terms of -- about -- meaning to ask the guidance, the kind of drivers of future earnings growth. If I look at this period, I guess, you've had perhaps $7 million or $8 million of EBIT growth, and we've had $10 million benefit from Connecting for Growth, which always doesn't repeat. So I was just wondering can you kind of talk about, do we expect less structural cost inflation in future periods? Or is there something which is going to drive the growth, which isn't the self-help?

And then just on the currency, if you could help a little bit in terms of that 5% headwind, maybe kind of breaking it down between the different key currencies, are you going to show them to reconcile that?

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Rajiv Sharma, Coats Group plc - Group Chief Executive & Executive Director [29]

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Okay. So let me, maybe, take this high level and then I'll request Simon to come in and give the specifics. Looking forward, as we're not giving any numbers here, I think the reasons to believe going forward are innovation that should help us drive margin improvement over the medium to long term. We expect Performance Materials to achieve scale, so as scale happens that tends to usually improve margins. We are also now shifting our attention as far as digital is concerned internally within our supply chain. So things like factor the future that will help us achieve more agility, lower cost and certainly a lot more yield. That should help improve the margins going forward. So we are working on multiple fronts, but these are all medium- to long-term improvement programs. Simon, do you want to add anything to that?

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Simon Boddie, Coats Group plc - CFO & Executive Director [30]

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No, I think that's a good -- certainly, looking at many areas in terms of going forward, I think innovation obviously included on that top line. In terms of your point on the foreign exchange, it's principally in terms of 3 currencies, which we've pulled out, which is kind of the Indian rupee, the Turkish lira and the Brazilian real. So those are the main factors which have driven the headwinds that we've seen in the first half on foreign exchange. We've also said that if you look at the current rates -- exchange rates that there are there, we are expecting a broadly neutral position in the second half.

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Operator [31]

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(Operator Instructions) You have a follow-up question from Charles Hall from Peel Hunt.

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Charles Hall, Peel Hunt LLP, Research Division - Head of Research [32]

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Could you just give a bit more detail on Patrick Yarn. They had a relatively slow top line performance in last year post-acquisition as you've got groups of that business. Can you just give us a feel for the performance this year? You talked about it as being strong, but just give us some details on how sales are trending and also margin performance?

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Rajiv Sharma, Coats Group plc - Group Chief Executive & Executive Director [33]

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Yes. So last year we -- at the time of acquiring Patrick Yarn, they had just started an ERP implementation, and that clearly created some problems for us in the first 3 to 4 months post the acquisition. We have managed to improve their operational efficiency. We have changed a little bit of the mix where we have increased the price. So on the top line, they have grown double digits and that is also the case as far as EBIT is concerned. So their overall EBIT margin is in line with the investment case that we have made for the acquisition of Patrick Yarn.

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Operator [34]

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(Operator Instructions) We have no questions from the phone line, so I'll hand back over to you, Rob.

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Rob Mann, Coats Group plc - Head of IR [35]

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Great. Thank you very much. Well, if that's the case, I would like to thank everyone for dialing into the call today. I wish everyone a good day. Thank you.

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Rajiv Sharma, Coats Group plc - Group Chief Executive & Executive Director [36]

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Thank you very much.

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Simon Boddie, Coats Group plc - CFO & Executive Director [37]

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Thank you.