Chemring Group PLC (CHG) Earnings Call Transcript & Summary

Good morning, and welcome to the presentation of Chemring's results for the half year to April 30, 2020. As a result of the coronavirus pandemic, we have adapted to new ways of working. And in Chemring, our core value of safety extends across our colleagues, their families, the communities in which we operate and our wider stakeholders, including you, our investment community. For that reason, we have prerecorded this presentation instead of our usual face-to-face briefing. I'm joined today by Andrew Lewis, our Group Finance Director. I will provide an overview of the group's progress. Andrew will then take you through the financial results. And I will then comment on the areas of focus for the remainder of FY '20. Safety is and always will be our core value. And the work we have done to embed a proactive safety culture has played a key role in how we have responded to the coronavirus pandemic. We have adopted an agile approach balancing risk mitigation and business continuity, which at all times has been based on government guidelines in each of our home markets. Our sites have remained open, and we have made every effort to sustain operations in support of our customers and their essential defense and national security missions. The response of our colleagues has been outstanding. They have risen to and exceeded the challenge, adopting working environments and practices to minimize the spread of the virus. In parallel to coronavirus activities, we have maintained delivery of our HSE strategy, including investments in modernization and automation of our manufacturing facilities. Turning now to our performance in the first half of FY '20. Over the past two years, our focus has been on building a stronger, higher-quality business, and the resilience that has been demonstrated in recent months confirms solid progress has been made. Against the challenging and changing environment, we can report H1 performance has been ahead of our expectations, with revenue up 37% to GBP 191 million and underlying operating profit, up 112% to GBP 25.6 million. Encouragingly, these results have been driven by strong performance across both sectors. In our Sensors & Information sector, we continue to make progress in our U.S. Programs of Record. In the HMDS program, further delivery orders were placed. And in May, we received a contract modification, increasing the current IDIQ by $200 million. Also in May, the customer awarded a contract for low-rate initial production in the EMBD biological detection program. At Roke, we have seen double-digit growth in revenues and orders, including the first U.S. DoD order for electronic warfare systems. This was a strategic objective for the sector and was delivered through significant collaboration between Roke and our U.S. Sensors business. Elsewhere, demand for Roke's products and services has remained buoyant. We have also seen improved performance in our Countermeasures & Energetics sector. As expected, our global Countermeasures business benefited from an increase in revenue as our Australian and U.K. facilities were operational, following F-35 qualification activities in Lara and Salisbury's phased restart. Sector momentum has been enhanced with a receipt of significant U.S. DoD orders and U.K. MOD long-term framework agreements. Our U.S. business received orders totaling $77 million to supply various countermeasures. And our Australian business received a definitized contract for $107 million to supply F-35 countermeasures. As a reminder, the undefinitized contract had been awarded in May 2019 at a value of only $60 million. In the U.K., our Countermeasures & Energetics businesses signed a long-term framework agreements with the U.K. MOD covering the next 5 years with an option for a further 2 years. With operating cash conversion at 160% and the strategic exit from the commoditized Energetics businesses, we are seeing the results of the work we are doing to strengthen and improve the quality of the group. With 95% of the expected H2 revenue either already delivered or in the current order book, the Board's expectation for the full year are unchanged. That concludes my overview, and I'll now hand over to Andrew to take you through the financial results.

Thanks, Mick, and good morning, everyone. As it's at the forefront of everybody's mind, I'll start with a brief overview of how COVID-19 impacted the first half year financial performance and position. As the risk of COVID-19 emerged in mid-March, the group focused on 3 key financial areas: ensuring our available liquidity was maximized; optimizing commercial terms to positively impact cash flow; and carefully managing discretionary spend and CapEx. In respect of liquidity, in March, the group drew a further GBP 50 million of its GBP 145 million cap RCF; and in April, secured an additional short-term facility of GBP 100 million, of which GBP 50 million was drawn. This increased immediately available liquidity to enable the group to flexibly respond to any reasonably foreseeable change in circumstances. Commercially, early engagement with our customers ensured cash was received on time and in some cases, early. This has resulted in approximately GBP 15 million of receivables being pulled into the first half which were expected early in the second half. We identified the risk of customer testing and acceptance of goods as having the potential to adversely impact the timing of revenue recognition. This did not materialize at the half year. In fact, in some cases, we were able to accelerate delivery dates to customers, including some part shipments, which contributed to the strong revenue performance in the first half. I hope that provides a little backdrop and context before we move into the detail. The financial results for the first half of 2020 were slightly ahead of our initial expectations, driven by strong performance in both divisions and some positive timing differences. The key messages from this period's results. Revenue was up 37%. Operating profit grew significantly to GBP 25.6 million, up 112%. Our operating margin improved 470 basis points from 8.7% to 13.4%, which starts to demonstrate the margin progress we targeted in our medium-term objectives last year. The 36% reduction in the interest charge was driven by the repayment of expensive private placement loan notes early in November and the continued focus on reducing intraperiod net debt volatility through the better management of day-to-day working capital. Operating cash conversion was strong at 160% of EBITDA, leaving net debt down GBP 15 million at GBP 60.6 million. Diluted earnings per share was up 156% to 6.9p. The Board has declared an interim dividend for 2020 of 1.3p, up 8%. Operationally, order intake remains strong driven by countermeasures orders for our Australian and U.S. plants, further HMDS orders on the U.S. Program of Record and another strong period at Roke. This left the closing order book of GBP 504 million, of which GBP 179 million is expected to be delivered in the second half, which covers 95% of expected H2 revenue. The next slide shows a more detailed income statement. I've covered most of the highlights already, so I will just pull out the fall in the underlying tax rate for the period to 17.8%, which is based on our expectation of the 2020 full year rate. This was driven by the finalization of prior year tax computations, where returns were optimized as local legislation was finalized. Looking forward into 2021, we expect the effective rate to return to the low 20s. The revenue and profit bridges show the key drivers of the group's results this period. At a revenue level, Sensors & Information was positively impacted by the HMDS program being in full rate production for the whole period and strong market conditions for Roke. Countermeasures & Energetics saw significant progression from the Australian and U.K. Countermeasures sites being up and running after being closed in the same period last year. At an operating profit level, we see the revenue growth dropping through as expected. Foreign exchange had very little impact this period. Moving to the segmental results and starting with Sensors & Information. The results show revenue up 25% and operating profit up 33% to GBP 13.3 million, reflecting the impact of a full period of the HMDS program and the strong period at Roke, which delivered double-digit growth in orders, revenue and operating profit. Roke's information security and data science markets continued to grow, and it secured its first order for the electronic warfare product RESOLVE into the U.S. DoD. We continue to invest in resource and skills, which positions Roke well for continued future growth. In the U.S., after the period ends, the customer extended the ceiling on the HMDS IDIQ contract by $200 million, having placed orders of $32 million in the period, which had maxed out the previous contracts. In May, we were pleased that the customer approved and awarded the contract modification for low-rate initial production on the EMBD program. The AVCAD and JBTDS programs progressed as planned, with the next customer procurement decision not expected on these until late this year or early 2021. Moving on to Countermeasures & Energetics. The results has benefited from both the Salisbury and Australian sites being operational this half year after being largely closed in the equivalent period last year. This has moved the margin forward significantly from 8.3% to 14.2%, which represents excellent progress towards our medium-term goal of achieving mid- to high-teens margins in this segment. The countermeasures market outlook continues to look positive particularly in the significant U.S. market. The investment in capacity expansion and automation at our Tennessee facility to support expected F-35 extruded flare requirements remains on track to produce its first incremental revenues in FY '22. Our Australian site delivered its first F-35-related products in the period, and the customer has increased the duration and value of their initial contract. Our niche Energetics businesses in Scotland, Norway and Chicago had a strong period. I won't dwell on this slide as FX has not had a material impact this period. Looking forward, the current rate is $1.23 and the rate clearly has the potential to continue to be volatile in the second half of 2020. And as a guide, the sensitivity to a $0.10 movement in the U.S. dollar rate in the first half would have impacted underlying operating profit by approximately GBP 1.5 million. The cash flow shows the group's net debt at the end of the period at GBP 60.6 million. This includes the GBP 6.5 million impact of adopting IFRS 16 for the first time. So the like-for-like reduction in net debt is GBP 22 million, which has been driven by strong operating cash conversion. The operating cash conversion ratio was 160% of EBITDA. The improved operating cash generation has come about from the focus on reducing intraperiod net debt volatility through the implementation of sustainable improvements in business practices, which have resulted in improved working capital disciplines, as you can see on the graph. In the last 6 weeks of the period, this was supplemented by accelerated payments from a number of customers in light of the COVID-19 challenge. This is viewed as a timing difference that will reverse in the second half. The significant non-trading item in the period was CapEx, which continues in the guided annual range of GBP 40 million to GBP 50 million for 3 years as the investment in the Tennessee site continued. On to the balance sheet. Our net debt-to-EBITDA ratio decreased from 1.24x at year-end to 0.8x at half year. Early in the period, we repaid the final tranche of the U.S. private placement loan notes. This will further reduce our interest bill in the future as these were 5.7% notes. Other items of note in the balance sheet. Property, plant and equipment has increased as the investment in the Tennessee site has continued. We expect CapEx to run at GBP 40 million to GBP 50 million over the next 2 years as the investment in the Tennessee site is completed. Working capital from the continuing businesses decreased by GBP 10 million as receivables were collected ahead of expectations. Finally, the pension scheme shows a GBP 4.8 million surplus on an IAS 19 basis. The decrease of GBP 5 million since year-end represents 5% of assets, and the robustness of the investment strategy, which includes an LDI, has been demonstrated as the wider equity and bond markets have fallen more significantly in the aftermath of COVID-19 market disruption. No cash payments are expected in 2020 or 2021. With net debt of GBP 61 million at half year and a net debt-to-EBITDA ratio of 0.8x, which compares to our banking covenant of 3x, our balance sheet is robust, which positions the group well to continue to invest and build a stronger, more resilient business. Finally, looking at the order book. At a group level, the closing order book was GBP 504 million, with GBP 179 million expected to be delivered in the second half of 2020, giving 95% cover of the expected H2 revenue. In both segments, we continue to work on improving the quality of the order book, leveraging deep, strong, long-term customer relationships. Turning to each segment, starting with Sensors & Information. Order intake was up 10%, and book-to-bill was 130%. The order book in this division tends to be shorter cycle. And of the GBP 97 million order book, GBP 57 million is expected to be delivered in H2 in addition to orders won and delivered in the period, giving 89% cover of expected revenue, which provides improved visibility. In Countermeasures & Energetics, order intake was GBP 163 million; and book-to-bill, 132%. The closing order book of GBP 407 million, GBP 122 million of which is for delivery in H2, giving 98% cover of expected H2 revenue, which has improved visibility of future revenue compared to prior years. With that, I'll hand you back to Mick. Thank you.

Thank you, Andrew. I'll now take a few minutes to update you on the progress we have made against the 3 broad objectives we set for FY '20. As a reminder, they were: one, defend and grow our Countermeasures business; two, grow our Roke business; and three, protect and grow our U.S. Sensors business. As mentioned earlier, our global Countermeasures business has benefited from an increase in revenue with our Australian and U.K. facilities operational and with all sites now focused on improving efficiency and competitiveness through modernization, automation and lean manufacturing. The actions we have taken to consolidate our Countermeasures businesses into a single global structure are progressing well. Strong working relationships and collaboration are now common, as is the sharing of operational best practice, supply chains, market intelligence and new product development. Significant order intake reinforces the mission criticality of our product and underpins our decision to invest in our manufacturing facilities. Roke provides mission-critical support to the U.K. government through its clients in defense, National Security and National Law Enforcement. We will continue to prioritize business development activities with our U.K. government customers. And in parallel, we will seek to develop further opportunities in both the industrial sector and internationally. We will continue to invest in the Roke business, and we will be recruiting a further 50 graduates this year. Our U.S. Sensors business continues to make good progress in all the Programs of Record. In the sole-sourced EMBD biological detection program, the customer awarded a contract modification, moving the program from development into low-rate initial production. As a reminder, this program is expected to be valued at $100 million over 5 to 10 years once in full-rate production. In our other sole-sourced biological detection program, JBTDS, we continued to deliver against our engineering and manufacturing development contract, and we expect a customer LRIP procurement decision in FY '22. The AVCAD chemical detection program continues to progress through its EMD phase, and we expect a customer LRIP procurement decision in FY '21. As always, I will remind you this is a competitive program, and we continue to focus our efforts on building a winning solution. In explosive hazard detection, the significant progress made on the sole-sourced HMDS program provides us with good visibility over the medium term. So in conclusion, we have made some significant progress during the first half with our values of safety, excellence and innovation being the foundation on which we build every day. I'll now turn to the subject of ESG. Just after period end, we concluded the exit from the group's commoditized Energetics businesses. And in doing so, we retired reputational risk and improved the quality of the group and its future earnings. Chemring is now a business with an evolving purpose of innovating to protect. And with that, we are focused on protecting our customers' people, assets and information. ESG is an area of increasing focus, and we are committed to the ethical, responsible and safe operation of our business. We continue to seek ways in which we can further improve our environmental performance. All of our sites are certified to the ISO 14001 environmental management system. And in addition, the reduction of energy consumption is an area of focus. In Chemring, we value all of our colleagues, and we are working to build a culture and environment founded on inclusion, respect and diversity. We want all of our colleagues to be able to bring their whole self to work and then return home safely at the end of every day. We continue to strengthen our corporate governance and reinforce our commitment to conducting business in an ethical and responsible manner. And we have established a Group Ethics and Compliance Committee, which is chaired by our Chairman, carl-Peter Forster. A core part of any culture is the tone from the top. And separately, we have announced today the appointment of Fiona MacAulay as a non-executive director, further strengthening the diversity and experience of our Board. In conclusion, a lot has been achieved in the first half of the year. We set ourselves demanding goals, and the teams have risen to those challenges in exceptional circumstances. I'd like to take this opportunity to thank all of my colleagues across Chemring for their commitment and hard work. The work that has been done to build a stronger, higher-quality and sustainable business based on our values of safety, excellence and innovation is delivering positive results for all of our stakeholders. The resilience the business has shown as we have adapted to the coronavirus pandemic, the solid demand and increased visibility that we continue to see for our products and services and the innovation and dedication of our people enables me to look to the future with confidence. With 95% of H2 expected revenue covered by the order book and with a less pronounced bias to the second half than in previous years, the Board's expectation for the full year remain unchanged. We will continue to drive performance across the company to deliver our evolving purpose of innovating to protect. So that concludes the presentation. If you do have any questions, do get in touch with us either directly or through our advisers. We look forward to hopefully seeing you face-to-face at the full year results in December. But in the meantime, stay safe, stay well, and thank you for joining us.