Avon Technologies Plc (AVON) Earnings Call Transcript & Summary

Well, good morning, everybody. Welcome to those online, and thank you those in the room for braving the snow this morning. It's now 18 months since we launched the STAR strategy and we are making excellent progress. This is demonstrated by a much stronger financial performance, improving operating metrics and a fast-growing order book. Yet I am perhaps most excited by the ability of the organization to change and translate strategy into action. We're building a culture and a capability where improving is becoming the Avon way. And the pace of change is accelerating. With confidence increasing, we're more ambitious. We now have plant-wide improvement projects in 3 of our factories and we see further opportunities to reduce inventory, increase quality and drive productivity. The order book increased by 66%. And we have a stronger contract portfolio to support the medium and the long term. This reflects the strength of our product portfolio and the relationships with our customers. There is still a lot to do this year. But with confidence increasing, we see potential to deliver our medium-term targets a year earlier than originally planned. We will expand on all these points during the rest of the presentation. I'll now hand over to Rich to talk you through the numbers. I'll then come back and give you an update on strategy with some detail added from James Wilcox, President of Team Wendy; and Chandlar Gabara continuous improvement lead in Avon Protection.

Thank you, Josh, and good morning, everyone. So as you can see, the headlines point to a year of encouraging progress. As usual, all the comparators will be on a constant currency basis. The order book at the end of 2024 stands at a record $225 million, 64% higher than the prior year. This leaves us well covered for FY '25 with DOD helmet cover stretching well into FY '26. Revenue growth of more than 12% dropped through to strong adjusted operating profit, up 53% at $31.6 million, and my preferred area of focus, return on invested capital came in at 13.7% after significant progress was made reducing the level of working capital tied up in the business. Cash conversion was exceptionally strong, helped in part by the unwind of the high receivables balance coming into the year and the combination of all of these factors resulted in a materially stronger balance sheet with net debt leverage below 1x. Moving on to the P&L. Order intake in the year was very strong at $364 million, up 40% year-on-year. Within this, we have seen good intake on DOD helmets through the year, the highest ever level of orders received for our underwater rebreathers and success in the recompete of the U.K. General Service respirator mask. This has resulted in a closing order book of $225 million, representing significant growth in both Avon Protection and Team Wendy. Revenue growth of 12.2% reflects nearly 50% growth in Team Wendy driven in part by the full year effect of run rate IHPS deliveries. This more than offset the expected decline in Avon Protection, resulting largely from the well-trailed hiatus in U.S. filter orders. Operating profit of $31.6 million over 50% above prior year levels results in margin of 11.5%, an improvement of 310 basis points year-on-year. I'll walk through an operating profit bridge shortly to pick out the key moving parts. Net finance costs of $6.3 million came in at the lower end of our guidance range given the better-than-expected cash flow and the tax charge of $4.4 million equates to an effective tax rate of 17% and which has benefited from a number of nonrecurring adjustments. We would expect our normalized tax rate to be around 22%. This all adds up to basic adjusted EPS of $0.699 per share, a very strong performance. To put the reduced effective tax rate into context, EPS would have been approximately $0.66 per share at a normalized rate. The standout number on the respiratory side of the business is the order book which has doubled over the last 12 months. We have seen good demand growth for our rebreather product with significant orders received from the German and New Zealand Navies and a number of tenders still live in the market with other potential customers. Further, we saw a modest resurgence in demand from the U.S. DOD, with orders up 23% overall, much of which came from increased mask demand. Commercial Americas orders have remained strong through the year, up 29% on 2023. The modest decline in revenue was expected following the gap in the U.S. DOD filter deliveries, and we're hopeful that deliveries will restart later in FY '25. The operating margin held up well in the face of a 7% top line decline thanks to the focus on rightsizing the business and driving operational improvements, resulting in an outturn of 18.3%. Given the strength of the order book, however, Avon Protection is well positioned for a return to growth in 2025. The strong order intake picture in protection carries forward into Team Wendy with order intake up 45% year-on-year driven by strong demand on the 2 U.S. DOD programs. This takes the order book up by over 50%, giving exceptional visibility through 2025 and into 2026 on these 2 important programs. Revenue growth of 49% was driven by the commencement of ACH 2 deliveries and the benefit of a full year of IHPS shipments, which, as a reminder, started in earnest in the second half 2023. The operating leverage effect of this growth has taken operating profit margin from negative 9.3% in 2023 to positive 3.9% in 2024 which is a great improvement, but still some way off our medium-term ambitions. As a reminder, ACH 2 shipments, although driving top line growth will remain dilutive at the gross margin level and significantly so until we have completed the move from Irvine to Cleveland in the second half of '25. So now we move on to the operating profit walk for the year and starting with the $20.6 million jumping off point for last year after adjusting for FX. The first positive bar of $10.9 million shows the effect of the 49% revenue growth seen in Team Wendy. Then you can see a further $6.4 million benefit from the operational gearing effect of that growth which saw gross margins moving forward at a healthy pace. Then we have a $4.6 million headwind from volume decline in Avon Protection more than offset by a $4.9 million benefit from the rightsizing exercise within protection early in FY '24. This is where we adjusted the cost base to ensure an acceptable level of profitability without needing any of the unpredictable large one-off orders that this business does benefit from time to time. The next bar shows a $4.1 million positive effect of lower scrap rates across the business year-on-year as we build maturity into the IHPS production, partly offset by the learner curve effect of early production of ACH 2. And then finally, the last 2 bars demonstrate a step forward in the quality of earnings within the business. The first negative bar represents the fact that the business achieved its financial and operational targets in full for the first time in a number of years, resulting in a triggering of the discretionary compensation schemes from a very low base in 2023. And then the last bar shows the year-on-year headwind from the tightened approach to capitalization of R&D. While our R&D expenditure grew by more than 10% in 2024, we capitalized $3.9 million less than in 2023. In fact, we capitalized nothing at all. So with capitalization at 0 and discretionary comp at max, neither of these 2 items will be a headwind in '25. Moving on to the cash flow statement. You can see that net debt reduced by $21 million in the year. The big driver of this improvement was the release of working capital despite the revenue growth seen by the business. While we had expected the unwind of the high receivables balance at the end of last year, we had also assumed a level of inventory build to support future sales growth. However, owing to the focus on continuous improvement through the year, we have actually held inventory broadly flat. As a reminder, we have prepaid the FY '23 pension deficit contribution in FY '22 and so the year-on-year impact of the $9.1 million contribution in FY '24 is significant, essentially absorbing the increase in EBITDA for the year. And as usual, guidance on future contributions and other financial matters is provided in the appendix to the slides. All of this translates into a meaningful reduction in net debt of $21 million at the end of the year. The big movement to highlight on the balance sheet include the working capital improvements mentioned earlier, which have resulted in inventory turns increasing by 7% in the year and overall average working capital turns which is a measure I like as it eliminates the impact of any period end heroics, improving by 22%. The other item worth drawing to your attention is the significant decrease in the pension deficit to $17.2 million, down from $40.2 million this time last year. This is due in part to our $9.1 million deficit contributions in the year, with the balance owing to a favorable actuarial gain following a change in accounting estimate to use a detailed member-by-member analysis of the deficit. I've included the capital allocation slide in the deck again this time, reflecting the year-end net debt-to-EBITDA ratio of less than 1x. The chart is essentially unchanged other than to highlight the progressive nature of the dividend and given the healthy balance sheet once through our transformation activities, we will be in a position to look at alternative capital allocation opportunities. So I thought it was worth giving a quick update on transformation costs incurred to date and where we expect them to go from here. In 2024, we invested a total of $13 million in OpEx projects, of which $2.2 million related to the accelerated depreciation and amortization of assets, which won't be needed in the future. There was a further investment of $1.7 million in capital equipment related to the transformation programs and the buckets of cost broken out on this slide remain largely unchanged from the breakdown provided at the launch of the initiative a year ago. Investment to date is $3 million higher than originally forecast, partly due to the accelerated D&A costs and partly due to the increased scope of the footprint optimization program. This increased scope will confer incremental benefits over time, which is in part what has highlighted the potential to achieve our medium-term margin and ROIC goals a year earlier than originally expected. Investments in FY '25 is expected to continue at broadly comparable levels to 2024 based on projects that have already been identified and processed through our project appraisal funnel and we remain open to further opportunities with a good payback. The projects in process will be mostly complete by the end of 2025, and we, therefore, continue to expect a substantial decline in transformation costs in '26. So finally, moving on to our expectations for the full year. We expect further good growth in helmet deliveries as we get the full year effect of the ACH 2 ramp-up with IHPS deliveries continuing at a similar level to FY '24. We also expect to return to modest growth in Avon Protection, underpinned by the robust order book in this business. These factors combined equate to a mid-single-digit revenue growth at the group level. As previously communicated, the financial benefits of the transformation program are not expected to drop through to the bottom line until FY '26 and the dilutive effect of ACH2 ramp-up is expected to largely absorb the operational gearing from top line growth, resulting in operating profit margins remaining broadly flat year-on-year. As highlighted on the previous slide, we expect transformation investment in FY '25 to remain at a similar level to that seen in FY '24. And finally, we expect cash conversion to return to a more normal level of above 80%, with continued improvements in operating efficiency being partially offset by increased cash costs of transformation as we exit the Irvine, California facility. You clearly shouldn't expect deleveraging at the same rate as seen in FY '24, however, as we don't have a working capital overhang coming into FY '25. And with that, I'll now hand back to Jos to update you on operational and strategic progress in our areas of focus.

As a reminder, the STAR strategy is designed to deliver our medium-term goals and to deliver long-term growth. When we launched STAR, the strengthen part was about fixing the foundations, and we've now done that. So we've repurposed to strengthen in STAR to be all about continuous improvement. This reflects its increasing importance to value creation. The aims of CI are shown on this slide. Our objective is to use CI to develop our people, create wealth and drive growth. The other lens of STAR illustrated on this slide are unchanged. This slide summarizes the key elements of our continuous improvement approach, starting in the center. On the shop floor, our objective is to improve safety, quality, delivery, inventory and productivity or SQDIP as it's known internally. If you visit any of our factories, you will see these metrics on every line. And each line is expected to improve these metrics through Kaizen, continually taking steps forward. Moving around the outside of the circle. We've done a lot to set the tone from the top, Rich and I regulate on the shop floor taking part in Kaizens and so are the rest of our senior leadership team. You will hear from one of our CI Leads and one of the Business Unit President in a moment. We've reorganized every factory into value streams to increase accountability and ownership. Every production line now has visible metrics showing progress by the hour. And we now have digital data on our most important lines showing progress in real time. We've developed a new production preparation process to completely transform 3 of our plants. This process creates a plan for the whole plant, which is then implemented through Kaizen. We've carried out over 350 Kaizen last year. That gives you an idea of the pace that this organization is moving out. We've now changed the majority of our manufacturing lines from traditional batch manufacturing to flow, resulting in some radical improvements. As part of CI we have a plan to shrink our manufacturing footprint at all plants. This frees up space to do other things, reduce costs and reduce our impact on the environment. As our approach to CI matures, we see the improvement that's being taken faster and faster, velocity is increasing. This slide shows progress on our key operating metrics since the middle of 2023 when we set the targets. As you can see, we're making excellent progress against productivity, scrap and inventory turns. We've already exceeded our original productivity improvement target of 25%. So we've now increased it to 35%. You will notice that productivity dropped a little recently. This is largely because the rolling 12 months revenue no longer includes the big P12 from 2023. The improvement in inventory turns by 37% has freed up $19 million of cash since the middle of 2023. We now believe that through CI, we can free up enough cash from inventory to largely pay for the entire transformation project operational expenditure. We thought it would be good to add some color to how we are driving the improvements we are seeing. So I'll now hand over to our Head of Continuous Improvement in Avon Protection, Chandlar Gabara. He will then hand over to the President of Team Monday, James Wilcox.

Thank you, Josh, and good morning, everyone. I'm known as Avon Protection CI guy. It is my responsibility to help the team identify continuous improvement activities, but also coach and mentor my team so we can all move forward together through Kaizen. To illustrate how all this works, I'd like to talk to you about GSR manufacturing in our U.K. facility which was one of over 350 Kaizen events that Josh mentioned earlier. The spaghetti chart that you can see here up on the board shows the current state of GSR manufacturing pre-Kaizen event. This is a great visual representation of batch production and non-flow. Similar machines are organized with their friends and make components that just go into inventory and WIP as you can see by all the red lines hitting the warehouse there. We recognize that the need to transform our traditional batch manufacturing processes through Kaizen was a necessity. The chart now on the right-hand side shows the current state after the Kaizen was completed. The line flows from raw material, so it does not stop until it's a complete and finished good. To achieve this, we had to move equipment around and also make sure we remove unnecessary movement and waste throughout the process. This Kaizen was able to improve productivity by 25%, reduced our lead times from 4 weeks to 91 minutes, reduced our inventory by 70% and reduced the footprint required by 43%. And one thing that we all need to keep in mind is that Kaizen happens at a very high velocity, and this occurred in a very short period of time. And in true continuous improvement fashion, we took these gains and spread to other processes throughout the U.K. facility. I am confident the Avon Protection has engaged its people, aligned its purpose through our fierce values and is effectively improving our processes through Kaizen, which is a fine recipe for the sustainment of a continuous improvement culture and program. Now it's just a matter of keeping up with our ambitions. But now I'd like to hand it over to James Wilcox, president of Team Wendy. Thank you, everybody.

Thank you, Chandlar. Good morning, everybody. Although my name might be new to many of you, I've been with Avon technologies for over 20 years, working mainly on the respiratory side of the business. Now leading our Team Wendy business, we are seeing significant traction with our transformation programs to improve Head Protection division's operating performance while providing a stronger foundation for DOD and commercial growth. It is hard to convey the amount of change in our Cleveland factory over the last 6 months. Our vision is to have the world's most efficient helmet factory and perhaps the one only with single piece flow. In order to achieve this and to absorb the working moving from California, we've effectively built an entirely new factory in Cleveland. By using our CI methodology, we are reducing the space we need to manufacture. As this slide shows, we expect more than double revenue per square foot in 2026. We have now relaid out all of our commercial lines and build a completely new line for ACH Gen II and IHPs. These lines move us to a much more improved flow so that helmets never stopped moving, apart from where there are planned cure times. As this slide shows, there's significantly reduced people movement with a doubling of productivity a 43% reduction in inventory and much lower scrap levels as a result of having real-time digital data to faster spot inefficiencies in the line. For the customers, this results in higher quality and a 65% reduction in lead time. I will now hand back to Jos.

Thank you very much, James. Now moving on to transformation. This slide is familiar to you. The degree of shading on each star illustrates how far our initiatives have progressed through our gates. Looking at the vertical columns. We've now finished planning almost all initiatives, the exceptions of functional excellence, where we're still planning the removal of SAP from our Salem plant, which could save over $1 million a year. And in commercial excellence, we've identified an opportunity to accelerate our U.S. commercial sales and we had a planning workshop on that only last week. Most projects are now well into execution. And in some cases, we're already seeing the benefits flow into the P&L. In particular, the work done to improve our Cadillac and Melksham plants has helped respiratory margins and the work done through on pricing has helped gross margins. This slide shows the milestones we've achieved so far, starting with footprint optimization. The Unity program to consolidate helmet manufacturing on the U.S. East Coast, is still on track for completion in 2025. In operational excellence, we are partway through major plant transformations at 3 of our plants. In functional excellence, we completed the restructuring of the finance function. We're now switching our attention to HR. We need to improve our ability to recruit great people to support our growth. We have done a lot this year to train people on program management and a new sales excellence program has recently been started. In commercial optimization, we continue to strengthen our e-commerce platform, and we plan to expand that internationally this year. Moving on to growth. The order book is extremely strong. In fact, it's the strongest it's ever been. This slide shows pictorially the main elements of our order book. The main takeaway is that the order book is broad-based, illustrating the strength of our product portfolio. We have strong demand for masks in Avon Protection, particularly from the U.K., U.S. and Australia, as illustrated in the 3 left in boxes. We also have excellent demand for rebreathers and our supplied air products. In Team Wendy, we have excellent orders for IHPS and ACH as well as for bump helmets and pads. Happily, the DOD has decided to offer our cloud line lightweight, high-performance pads as an extra with every IHPS helmet for at least the next year. This is in addition to the pads that come in the helmet, which we also make. We are very well positioned for the medium and the long term, adding to our portfolio of long-term contracts. These support our objective to grow above our markets over the long term. In Avon Protection, we won contracts with the Swedish police, German Red Readers, the U.K. MOD on GSR and masks into Australia. The Australia win is particularly exciting. We expect to equip the Australian military over the next 2.5 years with our most advanced mask, the FM 54. This is an important win for us and cements our position as the key supplier to the Five Eyes Nations. In Team Wendy, we've been told that our contract to supply helmets to the Australian military will be extended by another 5 years. We're also making good progress on discussions with the DOD to extend our next-gen IHPS program into sustainment beyond 2028 and an extension has been identified for ACH Gen II helmets as well. Just stepping back for a moment. Our markets remain supportive. This is driven by technology refresh in helmets and rebreathers, the importance of inventory and CBRN protection as illustrated by the Ukrainian war. The continuing rise in gun crime and drugs in the U.S. drives demand for both ballistic and respiratory protection and the upcoming Soccer World Cup and Olympics on the West Coast of the U.S. drives demand. We do not typically see much difference in defense spending between the Democrats and the Republicans. But note that European defense spending may increase in response to President Elect Trump encouraging NATO members to spend more on defense. In advance, in Avon Protection, winning the GSR contract was important to defending our commanding position in air-powered respirators. Pricing is challenging to start with but it will increase significantly in the second half of 2026. Demand for masks from the DOD has picked up a bit, though obtaining reliable forecast remains a challenge. The DOD recently donated 30,000 M50 mask to the Ukraine, but we do not yet know when those will be replaced. In rebreathers, we've been busy submitting 3 bids to NATO countries and hope to hear whether we have won over the next couple of months. The U.S. Navy canceled its long-running procurement for rebreathers. This is disappointing but we remain hopeful that both the U.S. Navy and SOCOM will ultimately align with other NATO countries and buy our rebreathers. We have the most advanced rebreathers in the world. As a NATO Navy recently said to me, comparing our rebreathers to the competition is like comparing a Tesla to a model T Ford and we are the Tesla in this description. Looking forward, we plan to launch the MITR Mask this financial year. There's actually one on the table there. And we're ramping up production of rebreathers and boots and gloves. We're starting to get traction in chemically resistant suits with some early sales demonstrating that customers do value a one-stop shop in CBR on protection. In Team Wendy, we achieved run rate on IHPS and delivered 5 lots of ACH. We plan to produce around 50,000 ACH in 2025 and approaching 100,000 in 2026. ACH is dilutive from a margin perspective due to historic pricing, but we are making progress getting the gross margin to a level that is acceptable to us. The Epic Helmet is popular with U.S. police forces. The sales in 2024 were hindered a bit by long lead times. We've now got the lead times down, and that should help sales this year. Looking forward, our plan is to increase market share by offering the shortest lead times and exciting new capabilities with a new rifle rated helmet, a new bump helmet and a broader range of accessories. There is a lot to do this year and execution is going to be critical. In revolutionize, we continue to invest in the long term, generally co-investing alongside our customers. We've won funding for 3 different projects to improve the interface between our masks and the DOD's chemically resistant suits. If successful, that could lead to significant revenue in 2027 and beyond. We continue to work on the next generation of filters and diving masks. And perhaps more significantly, we have 2 further funded DOD programs in the pipeline, which will accelerate air-powered respirators beyond the current M50 range. Both SBUs are working towards greater integration of head and respiratory protection, and we're seeking funding to accelerate that project. In Team Wendy, we're working towards higher-performing ballistic materials and next-generation pad systems to further reduce traumatic brain injury and to avoid heat buildup in the helmet. Turning to the medium-term goals. As you can see from the middle row of this slide, we're making real progress towards our medium term. Now we're well into our value creation plan. We can be more precise on timing. We see potential to reach our medium-term goals of operating profit and ROIC targets a year earlier in 2026. Our style is to be transparent about risks. The ramp-up of shell molding on the East Coast will be challenging. The material science is complex, and we will need to be both creative and disciplined to reduce scrap and rework. Recruiting and retaining good operators is tricky, but we are making progress on this front. We don't currently have an order for filters from the DOD. We remain hopeful that this will come. But for now, DOD filter demand is low. We have recently seen increases to U.S. health care costs and employer national insurance in the U.K. We will try and offset these through CI improvement and pricing. With regard to opportunities, we have a pipeline of helmet and rebreather opportunities internationally, which could help accelerate growth. There is also a possibility that the DOD could increase demand for mask to backfill the ones that it's recently given to the Ukraine. With regard to CI, I still see a lot of opportunity in every plant. If we can achieve the capability and culture we want, we may ultimately find that we've been a bit conservative in our modeling. In conclusion, we believe that we have a recipe that will lead to growth, margin, cash and improved ROIC. Our transformation program remains on schedule and progress made to date can already be seen in our financial and operational metrics. We have supportive markets. We have a record order book. And that gives us excellent visibility for the year ahead. We have a stable recurring revenue base, which will get even larger as we deploy rebreathers, masks into Australia and helmets into the U.S. police forces and SWAT teams. We have a strong competitive moat with long-term contracts and the leading technologies. All of these factors give us increased confidence, and we now see the potential to reach our medium-term operating profit margin and ROIC targets a year earlier. Thanks, everyone, for your time.