Avon Technologies Plc (AVON) Earnings Call Transcript & Summary

[Audio Gap] broadcast conference call. At this time, I would like to turn the conference over to Paul McDonald, CEO. Please go ahead, sir.

Good morning, ladies and gentlemen, and welcome to our 2021 half year results. For our presentation this morning, I will start with the key highlights. Nick will present the 2021 half year financials and outlook, following which, I will provide an overview of our medium-term outlook and future opportunities before closing with the key takeaways and questions to finish. Before we start, I'd just like to point your attention to the picture, where you'll see our combined offering featuring the C50 respirator and Team Wendy helmet, which has been a fantastic addition to the group and demonstrates how the business continues to evolve. Following the transformative year in 2020, we've made a strong start to 2021, delivering growth in both orders and revenues whilst making further progress against our strategic objectives. We've seen significant growth in respiratory protection from both Military and First Responder customers. Team Wendy has performed well following the acquisition in November. And we completed the integration of the ballistic protection business acquired from 3M. We're making good progress to resolve the delays in product approval for our body armor programs and remain on track to commence shipments in the first half of 2022 financial year. Given the $157 million order book and strong pipeline of opportunities, we're confident of delivering full year expectations and remain excited by the medium-term prospects. Having transformed the group into a focused provider of personal protection systems, we plan to change our name to Avon Protection plc, which better reflects the shape and direction of the group. The new name will be followed by the performance of old strap line, which reflects the expectation of the customers, the products and the group. And I'll share some further insights on this later in the presentation. With that, I'd like to hand over to Nick for the financial review.

Thanks, Paul, and good morning, everybody. So now turning to our half year financials and outlook for the rest of the year. Let's start with a quick look at our progress against our investor proposition KPIs, which we have consistently used to measure our performance over recent years. Revenue excluding the benefit of the Team Wendy acquisition is up 17.6%, well ahead of our 3%-plus guidance, driven by a strong underlying momentum in our respiratory portfolio, offsetting a softer ballistic performance due to the previously reported contract delays. Adjusted EBITDA margin of 19.7% is down 120 basis points on last year, reflecting the expected weighting of revenues to the second half and an even spread of overheads across the year. We expect this to reverse in the second half as the revenues come through. Cash conversion of 58.5% was impacted by increased inventory holdings ahead of second half shipments and to manage longer material lead times due to COVID supply chain disruptions. We expect cash conversion for the full year to be in line with our 90%-plus guidance as the inventory build unwinds and revenues turned into cash. Reflecting our confidence in full year delivery, we have once again increased our interim dividend by 30%, in line with our dividend policy. As you can see on the slide, we have delivered a positive start to the year, benefiting from strong momentum in our respiratory portfolio and the first-time contribution from Team Wendy. We saw strong order intake across the whole business, with orders up 46.5% or 30.5% excluding Team Wendy. Our military orders grew by 31.3% as a result of initial orders of $38 million under the new NATO respirator contract, follow-on orders for the M69 and M53A1 mask systems and the $19 million IHPS helmet order following extension of the existing low-rate initial production contract. We also saw strong continuing demand from First Responders for both respiratory and ballistic products, with orders up 28.3%. The strong order momentum and the first-time contribution from Team Wendy supported revenue growth of 41%, and that's 17.6% excluding Team Wendy. I'll cover our revenue performance in more detail on the next slide. Moving further down this slide, you'll see that adjusted operating profit is up 25% and adjusted EPS up 28%. Excluding -- operating profit excluding Team Wendy of $11.4 million was lower than last year due to the weighting of Avon Protection revenues to the second half and the even spread of overheads across the year. Following the completion of the Team Wendy acquisition, net debt excluding finance leases was $12.9 million, representing leverage of less than 0.2x consensus EBITDA for the full year. I'll come back to the cash flow bridge and movements in net debt on a later slide. So I now want to talk a bit more about our revenue growth. As I've previously mentioned, revenue increased by 41%, reflecting strong growth from the respiratory portfolio and the acquisition of Team Wendy. Military revenue was $74.3 million, grew by 17% over last year, with a $13.8 million or 29.5% growth in respiratory revenues more than offsetting the $3 million reduction in ballistic revenues resulting from contract delays. First Responder revenues were up 19.1% at $27.4 million, with respiratory revenues up 12.2% and ballistic revenues growing by 237% to $2.7 million compared to $0.8 million last year. Now moving on to talk about our cash flows and strong balance sheet position. As you can see on the right-hand side of the slide, our year-end -- our end of March net debt excluding leases was $12.9 million. This was after payments totaling $135 million in connection with the Team Wendy acquisition and $7.6 million of costs and tax related to the milkrite | InterPuls divestment. Operating cash flow was impacted by increased working capital of $10 million as we built inventory ahead of second half shipments and to manage longer material lead times, as I mentioned earlier. CapEx of $15.8 million includes $9 million of capitalized product development costs and $4.7 million of IT infrastructure investment related to the integration of the ballistic business. Other significant cash outflows in the half include the 2020 final dividend of $7.7 million and purchase of own shares of $4.3 million to had share awards granted in the period. The sole net debt position before lease liabilities, together with our $200 million medium-term bank facility, provides both short-term liquidity as well as significant funding to make further value-enhancing acquisitions. And I want to talk to you in a bit more detail about our $157 million order book and the visibility that provides for the second half and beyond. On the chart, you can see the split of the order book between the different parts of the business. I've also shown in red the proportion of the order book scheduled for delivery in the second half, with the gray bars -- gray part of the bars representing orders for FY '22 and later years. Across the group, approximately 50% of the order book is scheduled for second half delivery. However, this does vary between the different parts of the business, as you can see. Within the Military line of business, the mixture of the medium-term contracts results in larger orders for delivery typically over periods of up to 18 months, in addition to short-term orders to meet immediate needs and requirements. First Responder and Team Wendy are much more run and repeat businesses with short turnaround times on orders. On average, we expect to receive around $2 million of orders a week from these 2 businesses. I imagine that if we were all together in the same room for this presentation, I'd be seeing most of you doing the sums on your pads to work out what this means. So with consensus requiring around $160 million of second half revenue, you've probably already worked out that around 50% or $80 million comes from the opening order book and the 25% or so from run and repeat business in First Responder and Team Wendy, which leaves roughly 25% to come from military orders to be won and delivered in the second half. This is a typical win and deliver profile for our business at this time of the year. We have good signs of a number of DoD and rest of the world military respiratory opportunities to achieve this win and delivery requirement. So as you can see, the order book run and repeat business and our opportunities pipeline gives excellent visibility for the second half. And we've also continued to build revenue visibility into 2022. Now given all the moving parts over recent months, I'd like to walk you through our 2021 building blocks. For the full year, as you can see on the slide, we expect revenues to benefit from continued strong growth from the Military Respiratory business driven by strong demand under the new NATO contract, offsetting the decline in Military ballistic revenues resulting from the previously reported contract delays, with continued momentum in First Responder and the first 11 months of contribution from Team Wendy. Whilst our switch to dollar reporting has greatly reduced the FX volatility in our numbers, we remain exposed to currency movements from our U.K. cost base. Every dollar cent movement in the average exchange rate for the year reduces our profit by around $160,000. With the dollar exchange ramp now over 1.41 compared to our average rate for last year of 1.275, this has become an increasingly significant headwind as the year has progressed. As a result of the FX headwind and the lower ballistic revenues, we now expect our EBITDA margin will reduce by up to 100 basis points from the 22.9% reported last year. On an operating profit level, this will be offset by lower depreciation and amortization, which we now expect to be around $14 million due to the production delays for the new body armor contracts and the next-generation IHPS. To be absolutely clear, whilst updating our guidance for EBITDA and depreciation and amortization, we're not changing our operating profit or EPS guidance. Our tax and cash conversion guidance also remains unchanged. So before I hand back to Paul, I'd just like to finish with a summary of our outlook for the rest of the year. We are confident in achieving full year expectations given our current momentum and the revenue visibility from our $157 million opening order book, a strong pipeline of military opportunities and continued strong demand from First Responder and Team Wendy. Thank you very much. I will now hand you back to Paul.

Thanks, Nick. The last few years have been a remarkable period, and the group continues to evolve at significant pace. We've made a number of positive changes in the strategic direction of the group, and there remains numerous growth opportunities ahead. So I'd like to spend some time to discuss the things people should consider when thinking about the future. When looking at the picture, you appreciate how far we've evolved and how the shape of the business has changed over the last decade. This was not by chance and has been a deliberate strategy to expand the core product range, upscale our technologies and acquire into wider product adjacencies. When considering what comes next, please remember the world is evolving around us, and we see a long-term positive global outlook that will benefit Avon for the future. Global security threats are on the rise with increasing geopolitical tension from China, Russia and asymmetric threats that are driving the hybrid agenda. There is a growing incidence of chemical weapons around the world. COVID-19 has changed the outlook of biological risks possibly forever. And we are seeing growing civil unrest and political tensions with an increase in violent crime. Collectively, this is increasing the product technology requirements for higher protection levels, modular and integrated systems with reduced size and weight to protect the user and keep them safe. This will drive increased spending on next-generation respiratory and ballistic products, creating growth in the years ahead. We've also made significant progress integrating our ballistic protection acquisition, establishing a fully aligned management structure through our executive leadership team. The customer relationships are being managed through our combined Military and First Responder lines of business. And we've also established a global operations structure responsible for the full product groups. The business has been transitioned to the Avon IT platforms and infrastructure, which was achieved during lockdown. And the U.S. DoD ballistic contracts have been novated from 3M to Avon Protection Ceradyne, which allowed us to exit the transition service agreements with 3M. We have implemented the Avon R&D processes and have made significant progress in aligning the Avon businesses, so they can work effectively and learn from each other to deliver best practice. Having completed Team Wendy in November, we're operating this business on a stand-alone basis due to COVID and limitations of travel. But we've already migrated Team Wendy onto the Avon governance and performance management processes, are working together on major sales tenders, have started collaboration on the IHPS pads and commercial helmet designs and have delivered procurement benefits from utilizing Avon's buying power and supplier relationships. I'm delighted with the progress we've made during this period and the platform this provides for the business to grow in the future. Over the last 4 years, we followed a consistent growth strategy. Our strategy is based on creating value through 3 key elements: growing the core by maximizing revenue from our current portfolio and improving our operational efficiency; selective product development to maintain and expand our leading product positions through organic product development activity; and targeting value-enhancing acquisitions to further accelerate growth and add value to the group. The strategy is consistent, and we're building a consistent track record of delivering against it. This has transformed the group in recent years. So over the following slides, I'd like to explain how continued execution of this strategy will drive further growth over the medium term. This strategy has been highly effective over the last 4 years and will be no different in the years ahead. At its heart, growing the core is about maximizing the sales of our existing product portfolio to both new and existing customers whilst driving operational efficiency. The current framework contracts underpin our medium-term outlook and gives us confidence that we can deliver growth in the years ahead. Our leading position in military respiratory market was consolidated by securing the NATO contract. And we continue to actively pursue a number of identified opportunities with the DoD and Rest of World Military customers. The combined Ceradyne and Team Wendy helmet portfolio provides enhanced competitiveness in international markets and is an area we expect to grow. We're seeing strong continued demand from First Responders for both respiratory protection systems and ballistic helmets, which creates margin upside from operational leverage and manufacturing efficiencies as we continue to grow. This brings us to our continued investments in product development, which has continued to maintain a full pipeline of multiyear R&D programs. For those that are new to Avon, we're a customer-centric business. In our minds, this means looking at our customers, understanding their needs and identifying the technologies that do not yet exist, to further enhance their capability and effectiveness and growing our business around our customers. We maintain our competitive advantage by continuing to develop the next generation of technology in partnership with our customers to meet their future operational needs. Over the last 10 years, we've consistently invested in product development and will continue to do so. Only 2 years ago, we were spending approximately $10 million per year, whereas today, we're committed to somewhere between $20 million to $30 million. So it shows you we've continued to increase our investment in this area and how this will drive the business for the future. It's been a busy year in product development, but I'd like to add a little further color with some key investments. The body armor approval process for both DLA and VTP are on track for deliveries to commence in FY '22, which will unlock significant value. We've conducted a thorough review of the first article testing failure that was confirmed in December and have finalized revised product designs to address the issue. We're currently manufacturing test samples of the new design and remain on track for these samples to be submitted for testing during our fourth quarter. We have developed the new helmet shell and liner pad design for the next-generation IHPS and have removed significant weight from the original design to put less burden on the user. We have completed trials of the MCM100 with the U.S. Navy and continue to see Rest of World interest in this product. Avon Protection and Team Wendy have started collaborating on a new commercial helmet with an emphasis for the First Responder market, whilst we also launched the new CH15 next-generation hood and are developing longer-term focus on systems integration for our user community. This now brings us to value-enhancing acquisitions. Our strong balance sheet, free annual cash flows and $200 million debt facility provides significant capacity to execute on acquisition opportunities to further accelerate growth. We are continuing to target acquisitions which are complementary and broaden our product portfolio. We have established a clear set of strategic, commercial and financial criteria, and any acquisitions must contribute to revenue margin and cash conversion objectives. We are actively tracking multiple opportunities across a range of technologies and geographies and expect to deploy the capital we have available over the next 3 to 5 years. We have demonstrated our disciplined approach to acquisitions and believe there are additional opportunities that we will capitalize on when the criteria is met. This brings us to the medium-term outlook for Avon and what you should be expecting over the next 3 to 5 years from the group. At the end of 2020, we delivered revenue of $214 million. When you consider the organic growth of the U.S. DoD soldier protection systems, the NATO respiratory platform and our growing First Responder and Team Wendy businesses and the impact of deploying the acquisition firepower that we have at our disposal, then it should be possible for Avon to deliver revenue in excess of $500 million over the next 3 to 5 years, which presents a significant growth opportunity for the future. We believe our future performance is sustainable, is highly visible and has a wider range of medium and longer-term opportunities across both Military and First Responder. Our products have high barriers to entry with significant advantages over our competition. We are committed to product development in partnership with our customers to develop the next generation of our products and have maintained a full pipeline of R&D. We believe maintaining competitive advantage is critical to our strategy along with further complementary M&A. And collectively, this will lead to further value creation for the future. All of this supports our confidence for 2021 and the group's medium-term outlook beyond. When considering this, I hope like us, you're all equally excited that the next 3 to 5 years will be very positive for the group, and we look forward to the years ahead. Ladies and gentlemen, that's it from me. I'd like to thank you for listening, and we'll move to the Q&A section. We'll take questions from the conference call first. And then for those who've submitted questions via the webcast, we'll read them out and answer them. We'll now take questions from the conference call. And if I could please ask you to state your name and company followed by the question. Thank you. Sorry, operator. Over to you.

[Operator Instructions] We will now take our first question from Henry Carver from Peel Hunt.

Just a quick one from me around the margins and sort of margin implications for products where you're combining Team Wendy and Ceradyne Tech. Does that have a positive long-term implication? Or is it not something really that we should be thinking about too carefully?

It does have a positive impact over the medium term. And at the moment, we're sourcing some of these components from other suppliers and by making the maximum use of Team Wendy, we obviously then get a bigger share of the margin in the value chain. And so we very much are looking now to align our portfolio with the Team Wendy technology around liner pads, retention systems, other textile componentry as well. So that will help us to achieve our medium-term 25% EBITDA target that we've been talking about for some time.

[Operator Instructions] We will now take our next question from Rory Smith from Investec.

Could I just seek some clarification, please, on your comments around the body armor contract time lines. In the statement, you're quite explicit that the legacy DLA contract that remains on track, but no mention of VTP. Is that now on a different time line? Or is that going according to sort of previous guidance as well?

Yes. No, good question, Rory. The VTP is actually running a couple of weeks behind, so we're effectively making -- we've been running a simultaneous development project. We're now running all of the SAT samples where the customer has to come in and witness the actual products being made. So we're dealing with the DLA first. That's going to be happening at the start of this quarter. The VTP will follow straight behind. So I think a bit like the old fashioned London bus, you'll probably get very close to each other.

[Operator Instructions] As there are no further audio questions, I'd like to turn the call back now for any questions from the webcast.

Thank you. We've had one question in so far from Andy Douglas from Jefferies. He said, good morning. Two questions, please. One, can you give us an update on MCM100 progress and when we may hear anything on potential contracts? And two, please, can you give us an update on your competitive landscape across all parts of the business? Thank you, Andy. So firstly, the MCM100, these are full sort of crash tests that they've done, so it's quite a comprehensive testing. I'd say there's been multimillion dollars' worth of testing that's gone into this. We ended up sort of -- the Navy bought 7 units. We ended up sort of remapping the software, which we talked to you about. All of that works, we haven't been able to physically visit and see the customer. We've been speaking to them each week on Zoom. So we don't believe that there's any technical issues in there. We're now waiting for their next sort of updates, which we believe will be looking at buying units towards the back end of this year. So I think we're waiting for the RFP and the guidance. But that testing only finished at the beginning of this month, so we're at the very early stages of that, Andy. But I think probably the back end of the year, we'll know where we are with an RFP and timing of those units. So I'd say that will probably be an update in the full year in November. In terms of sort of give us an update on the competitive landscape across all parts of the business, Military on the respiratory side is going very strongly. Obviously, the DoD, we've got the position we've got. With NATO, we started with the 4 lead customers, which was Finland, Norway, Holland and Belgium. We are speaking to another couple of countries. We've currently got another 3 that we've started engaging with and talking about joining this platform. So what we've seen the NATO contract give us is really a license where the products have been approved, the products have been tested. If somebody wants them, effectively, you transfer the money, and you immediately come onto that framework agreement with NATO. So that's starting to look very positive. I think we are seeing probably a growing influence of military replenishment stage. I think last year, a couple of people will have been using these products, and they've used the stocks that they have. So you're starting to see probably a bit more stronger replenishment, which is why those numbers are up. We're also aware one of our largest competitors are exiting the market in respirators. So I think that's going to be another positive sort of statement for us. On the military helmets, obviously, our focus is IHPS and dealing with body armor there. That's my first priority into next year, and then it's about how we start going into Rest of World. So I'm really just dealing it in that sequence and order. But I think what you will see is the Rest of the World is increasing their protection levels up to where the U.S. DoD is, so that gives us a sort of product advantage. And then First Responders, obviously, we've got a growing business. It's growing year-on-year. I think the respiratory side has had a very good year. It's been helped by COVID. But as Nick said, you're starting to now see us match both the respirator and the helmet coming through and actually selling both of those products simultaneously is something that we're gaining traction with. There's a great growth rate of a low number. But I think over the next sort of 10 years, we should start to see the ability to get that helmet portfolio at the same sort of level and weighting as the respiratory one. So it shows you that structurally, there's probably quite a lot of growth in that First Responder market as we go forward. Hopefully, that's given you a -- it was a fairly long update. It's a wide question. So Anthony Plom has also sent a question and he says, morning. Two questions, please. One, what level of capitalized development costs should we expect in H2? And on an ongoing basis, will it be these levels? And then two, can you give any additional color on the 25% of orders that need to be won and delivered? For example, are there any bigger one-off orders that we could expect?

Yes. So in terms of the capitalized development costs, we've guided to sort of total CapEx spend for the full year of around $30 million. Around 50% of that will be capitalized development costs. We have had quite a lot of activity in the first half around the reengineering of the body armor, preparing for the IHPS next-generation program, which is that's been slightly heavily weighted in this first half, heavily weighted towards the first half. And so for the full year, we're sort of guiding to around 15% or so on the capitalized product development. And really sort of that is, I think, the level, as we grow as a business now, the number of opportunities that we have available to us to sort of enhance the portfolio, you can expect to see that kind of level for the footprint that we now have as we move forward. In terms of the win and deliver, we've got a range of opportunities in that pipeline. We have further orders in the pipeline with the DoD for M50, M53A1, that we're discussing, scheduling and timetables with them. And there's also on the NATO contract, as Paul mentioned, there are other customers looking to -- other countries looking to come on to that program. And some of the existing customers are also looking to place further orders as they move through the program. And then we then have a number of smaller opportunities across the globe, Middle East as well, where there's a few things in the pipeline as well. So there's a good spread and which is typical for this time of year, which gives us the confidence of being able to sort of turn that around in a normal fashion.

We've got another one from Andy Chambers from Edison. This is for you, Nick, I've already decided. Can you run through the inventory development for the second half? And also, do you expect the increase in D&A? What do you expect the increase in D&A to be next year assuming you start amortizing against the new armor product sales?

So in terms of the inventory for the second half, we've seen supply lead times stabilize throughout the last couple of months, not getting any worse. And we're actively working with our supply base to get back to more normal time lines, and we're expecting that now to -- in the second half for us to start to move back towards normal cycle times with our supply base. We've also -- we did build inventory in the second quarter ahead of shipments under the NATO contract in the second half, and so we're part way through building a number of mask systems to fulfill those orders. And so we expect that to unwind in the second half. So at the moment, that's the expectation that this is a sort of temporary situation that unwind. In terms of D&A, yes, this is moving out to the right in terms of the start-up of the depreciation on the body armor and next-generation IHPS and some of the equipment that we need to ramp up the body armor production. So we're not really changing our out-year guidance on depreciation and amortization at this time because it will catch back next year.

The next question we've got is from Henry Carver from Peel Hunt. And Henry says, to what extent of COVID travel restrictions suppress your ability to make sales? So what I would say is I think what we've seen during this period is the industry leaders that probably benefited because they already had those preexisting relationships. It's probably made it harder for sort of start-ups to enter business and win sales during this period. With the growth rates that we've had, you can see the orders coming in has not been a problem. I think like every company, it's been around supply chain lead times. Things have got a bit longer. We have added a bit more inventory to overcome that. We committed to material orders. We saw this coming fairly early. So it's the normal sort of COVID disruption that every other company will have talked about for the last 12 months, 14 months. But in terms of sales, I think MCM is the only one, because it's such a complex product, it would have been better if we've been able to be with the customer in person. However, we have been speaking to them every week. We have gone through that program. So it shows you it is possible, it's just not ideal, Henry. And then finally, the last question we have is from Richard Paige at Numis. And he says, what was the influence of additional work on the ballistic contracts in the additional R&D investment in that period, please? Do you want me to take that?

Yes.

So a great question, Richard. What we basically did, body armor has 3 elements to it. One is the ceramic. The second is the sort of what we call the backing material, the energy absorption material. And the third is an encapsulation of that whole process. For the DLA exactly, we've ended up changing the backing material, so we put effectively a new material with greater energy absorption to be able to stop the bullet coming through the material and slow the bullet down. So that's where all of our sort of development focus was on. And then the VTP program, we're actually using that same sort of material, but it's thinner. And then we've upgraded the ceramic plate as well. So it was then basically looking at a combination of the backing material and the different ceramics. In total, we developed about 12 different combinations, so it has been a fairly sort of comprehensive development and testing phase that we've had in there. I think the team has done a remarkable job of turning that level of work around to where we are. We fully tested those products, and we've now got confidence that we've got the sort of contingency beyond just what the product has to do. We know it can go beyond the limits that we've got, and that's why we're confident that we'll pass through on this space. So hopefully, that's answered your questions in there. At this time, there's no further questions. So back for closing remarks from me. I'd like to thank you all for listening. I think it's been an interesting 6 months for the group. Obviously, we did the acquisition of Team Wendy in November. They've been a fantastic addition to the group. We had the disappointing news in December. We had to deal with it. I think we've put that behind us now, but we've got to get the final piece of paper to show that approval, and we look forward to receiving that in the second half. I think we've battled COVID like everyone else, but it shows you that hasn't held the firm back. And I think there's a lot of underlying momentum within Avon. The other announcement we made this morning is regarding Nick's decision to retire. Nick will be seeing out the financial year with us. He'll definitely be doing the November results with me, so it's a fairly long goodbye. He is contracted through to sort of March, but we will start the process. And when a suitable, capable replacement has been found, then we'll sort of update the market. So it's very sorry news, but Nick's retirement will allow him to spend time with his family, and we understand that. So that's it from me. Thank you all for listening, and I look forward to seeing you all soon.