Chemring Group PLC (CHG) Earnings Call Transcript & Summary

Good morning, and welcome to the presentation of Chemring's results for the full year to the 31st of October 2020. As we remain working under the restrictions resulting from the coronavirus pandemic, we have again decided that the safest and most effective way of communicating with our investment community is virtually instead of our usual face-to-face meetings. I am, as usual, joined today by Andrew Lewis, our Group Finance Director. I will provide a brief overview of the group highlights for the year. Andrew will then take you through the financial results. I will then comment on the progress made this year and areas of focus for FY '21. Starting with a brief overview of our performance during FY '20. Our focus in recent years has been to put in place the foundations on which to build a stronger, higher-quality business, and the resilience that has been demonstrated throughout the financial year confirms that solid progress has been made. Against what was a challenging and changing environment, it's very pleasing to report that full year performance was ahead of our expectations with revenue up 20% to GBP 402.5 million, and underlying operating profit of 24% to GBP 54.7 million. Encouragingly, these results reflect strong financial performance whilst maintaining focus on both the needs of our customers and the safety and well-being of our people and the wider environment. We have delivered improvements in our safety performance, and we have reduced environmental impact, where we have seen a reduction in our greenhouse gas emission, energy usage and water usage intensity. We have seen solid demand across our home markets and the group's strong order book, up 6% to GBP 476 million, provides good medium-term visibility. The U.S. remains our largest market, and we are well positioned to benefit from this. With 78% of FY '21 expected revenue covered by the order book, the group is somewhat insulated from any near-term disruption caused by U.S. presidential transition. Following the U.K. government's announcement in November 2020 that an extra GBP 16.5 billion will be spent on defense over the next 4 years, the U.K. will remain a leading European defense market. And Chemring is well placed to benefit from this increase, selling directly to the Ministry of Defence, security agencies and prime contractors. In our Australian home market, we see good opportunities as a result of the current large-scale equipment and capability upgrades and the Australian government's intention to grow the defense budget annually to 2030. Elsewhere, we have continued to see solid demand for our products and services from European, Middle East and Asia Pacific customers. 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. By implementing proportional and flexible measures based on government guidelines in each of our home markets, we have balanced risk mitigation and business continuity. Our sites have remained open throughout the year, and we have made every effort to sustain operations in support of our customers and their essential defense and security missions. Across Chemring, we have adapted our working environments and practices to minimize the spread of the virus, and we have made every effort to safeguard and support the well-being of our colleagues. We have provided a 24/7 employee assistance program and flexibility and working arrangements to enable our colleagues to balance the demands at home and their work life. In parallel to coronavirus activities, we have maintained our focus and commitment to building a proactive safety culture, which focuses on the interaction of people, plant and processes. We will continue to invest in modernization and automation of our facilities, which is key to improving the safety and quality of our business and our ability to deliver sustainable growth into the future. That concludes my overview, and I will now hand over to Andrew, who will take you through the financial results.

Thanks, Mick, and good morning, everyone. I'm delighted to be presenting a strong set of financial results for 2020, which have been delivered in spite of the significant external challenges we've seen this year. The results have been driven by strong performance in both sectors, with Countermeasures & Energetics showing particularly good progress. The key messages from this year's results: Revenue was up 20%. Operating profit grew significantly to GBP 54.7 million, up 24%. Our operating margin increased 50 basis points from 13.1% to 13.6%, which starts to demonstrate the margin progress we targeted in our medium-term objectives last year. The 35% reduction in interest charge was driven by the repayment of expensive private placement loan notes early in November 2019 and the continued focus on reducing intra-period net debt volatility through the better management of day-to-day working capital. Operating cash conversion was strong at 110% of EBITDA, leaving net debt down GBP 27 million at GBP 48 million, which was after the adoption of IFRS 16. So down GBP 34 million on a like-for-like basis. Diluted earnings per share was up 34% to 14.8p. The Board has declared a final dividend for 2020 of 2.6p, up 8% and making a total of 3.9p for the year. Operationally, order intake remained 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 year at Roke. This left a closing order book of GBP 476 million, of which GBP 326 million is expected to be delivered in 2021, which gives 78% of expected 2021 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 year to 17.6%. 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 year. At a revenue level, Sensors & Information was positively impacted by the HMDS program being in full rate production for the whole year, and the continued strong market conditions for Roke, which more than offset a decline in chem/bio revenue as the programs moved from customer-funded EMD into the customer testing. Countermeasures & Energetics saw significant progression from the Australian and U.K. countermeasure sites being up and running after being closed for much of 2019. At an operating profit level, we see revenue growth dropping through as expected. Foreign exchange was a minor headwind this year. Moving to the segmental results, and starting with Sensors & Information. The results show revenue up 4% to GBP 137 million and operating profit up 4% to GBP 27.4 million, reflecting the impact of the full year of the HMDS program and another strong year at Roke, which delivered another year of double-digit growth and strong margins. Roke's information security and data science markets continue 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.A., the customer extended the ceiling on the HMDS IDIQ contract by $200 million, having maxed out the previous contract. In May, we were pleased that the customer awarded a contract modification for low-rate initial production for the EMBD program, with a full rate production transition expected in the second half of 2021. The AVCAD and JBTDS programs progressed as planned, with the next customer procurement decision not expected on these until late 2021. Revenue on these programs was lower in 2020 as they move from the funded EMD phase into customer testing. Moving on to Countermeasures & Energetics. The result has benefited from both the Salisbury and Australian sites being operational this year after being largely closed in the equivalent period last year. This has moved the margin forward significantly from 13.5% to 15%, 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 2022. Our Australian site delivered its first F-35-related products in the year, and the customer increased the duration and value of their initial contract. Our niche energetics businesses in Scotland and Norway had another strong year, and our specialist devices business in Chicago strengthened its position in the space market. Its products played critical roles on both the SpaceX NASA Crew Dragon mission to the International Space Station and NASA's latest mission to Mars, where we have a number of mission-critical devices on NASA's Atlas 5 launch vehicle and the Perseverance rover. I'll briefly touch on FX as it hasn't had a material impact this year as the U.S. dollar average rate moved from $1.26 to $1.28, creating a minor headwind. Looking forward, the current rate is approximately $1.30, and the rate clearly has the potential to continue to be volatile in 2021. And as a guide, the sensitivity to a $0.10 movement in the U.S. dollar rate in 2020 and would have impacted underlying operating profit by approximately GBP 2 million. The cash flow shows the group's net debt at the end of the year at GBP 48.2 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 34 million, which has been driven by strong operating cash conversion. The operating cash conversion ratio was 110% of EBITDA. The improved operating cash generation has come about from the focus on reducing intra-period 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. Indeed, across the last 2 years, operating cash conversion has been 108% of EBITDA, demonstrating that the improvement in business practices is permanent and sustainable. The significant nontrading item in the year was CapEx, which continues in the guided annual range of GBP 40 million to GBP 50 million, as the investment in the Tennessee site continued. This is expected to continue in 2021 before starting to trend back towards depreciation by 2023. On to the balance sheet. Our net debt-to-EBITDA ratio decreased from 1.24x to 0.65x. Earlier in the year, we repaid the final tranche of the U.S. private placement loan notes. This reduced our interest bill as these were 5.7% notes. Other items of note in the balance sheet. Spend on property, plant and equipment has remained at an elevated level as the investment in the Tennessee site continued. We expect CapEx to run at GBP 40 million to GBP 50 million over the next 2 years as the investment in Tennessee is completed. Working capital decreased by GBP 5 million in spite of a 20% increase in revenue. This drove a reduction in the working capital as a percentage of revenue from 27% to 21% as more disciplined commercial management has been embedded throughout the group. Finally, the pension scheme. Despite the fall in equity and bond markets in the aftermath of COVID-19, our pension scheme assets have only fallen by 2%, which demonstrates the dispensive strength of the investment strategy. No cash payments were required in 2020 or are expected in 2021. With net debt at GBP 48 million at the end of the year and a net debt-to-EBITDA ratio of 0.65, which compares to our banking covenant of 3, 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 476 million, with GBP 326 million expected to be delivered in 2021, giving 78% coverage of expected 2021 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 11% and book-to-bill was 108%. The order book in this segment tends to be shorter-cycle, and of the GBP 87 million order book, GBP 76 million is expected to be delivered in 2021 in addition to orders won and delivered in the period, giving 53% cover of expected revenue, which provides improved visibility. In Countermeasures & Energetics, order intake was GBP 288 million and book-to-bill was 108%. The closing order book of GBP 389 million, GBP 250 million of which is for delivery in 2021, giving 92% cover of expected 2021 revenue, which, again, is 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. The first was to defend and grow our global Countermeasures business. It was a year of solid recovery in performance, which benefited from an increase in revenue from our Australian and U.K. facilities being fully operational and with all sites focused on improving efficiency and competitiveness through modernization, automation and lean manufacturing. Order intake was strong with notable highlights being: Chemring Australia's contract for $107 million in support of the F-35 Joint Strike Fighter program; the U.S. countermeasures businesses being awarded contracts totaling $136 million to support the U.S. DoD; and in the final month of the year, our U.K. business being awarded contracts totaling GBP 31 million in support of the U.K. MOD. This order intake reinforces the mission-criticality of our products and underpins our decision to invest in our manufacturing facilities, the most significant of which is our Tennessee capacity expansion program. During the year, GBP 22 million were spent on the facility, bringing the total spend to date of GBP 37 million. The expected total cost of the program remains approximately GBP 50 million with the first incremental revenues from this facility expected in FY '22. The actions we have taken to consolidate our countermeasures businesses into a single global structure continues to progress. Strong working relationships and collaboration are now common, as is the sharing of operational best practice, supply chains, market intelligence and new product development, all of which position us well for the future. Our second objective was to grow our Roke business. Roke provides mission-critical support to the U.K. government through its clients in defense, national security and national law enforcement. Demand for Roke's capabilities remained buoyant, and this has led to another solid year of double-digit growth in revenue and strong margins, which were maintained despite increasing investment in people, technology and infrastructure. While we continue to prioritize business development activities with our U.K. government customers, in parallel, we have developed further opportunities in both the industrial sector and internationally with 2 notable successes during the year. Securing an important first order for Roke's RESOLVE electronic warfare system into the U.S. DoD was a key strategic objective for the year and was achieved through significant collaboration between Roke and our U.S. Sensors business. This provides an excellent platform from which to develop further opportunities to penetrate the electronic warfare market in the U.S. The second was the progress made by Roke in establishing partnering agreements with a number of leading companies and organizations to access further market opportunities. An example of this is the partnership with Samsung in the development and sale of a Dismounted Situational Awareness tool. More broadly, a number of opportunities were secured in European and Asia Pacific regions, with further progress in these areas being a focus for the future. The third objective was to protect and grow our U.S. Sensors business, and throughout the year, we have made good progress against all of our U.S. programs of record. The sole source explosive hazard detection HMDS program continued to progress with deliveries made to schedule throughout the year. This excellent performance led to further orders of $62 million being received and the ceiling of the IDIQ framework contract being increased by a further $200 million. This gives good visibility on this program out to FY '24. The 2 sole source biological agent threat detection programs made good progress throughout the year, with the U.S. DoD awarding a contract change, which advanced the naval variant, EMBD, from development to low-rate initial production. this positions us very well to win the sole source full rate production award, which is expected next year. On the U.S. Army variant of the biological agent detector system, JBTDS; and the chemical agent detector program, AVCAD, we have continued to deliver our engineering and manufacturing development commitments. And we continue to focus our efforts on building winning solutions for the next phases of these programs. The next customer decision points will be at the conclusion of the EMD phase, which are expected to be next year for AVCAD and FY '22 for JBTDS. Elsewhere, the team have made good progress on the development of technology road maps and improving their execution and business development capabilities. Turning now to FY '21 and beyond, and starting with the overall group strategy before looking at each sector in turn. In recent years, significant focus has been placed on building a safe, predictable and resilient business that is able to deliver greater profitability through continuous improvement in safety, operational execution and financial performance. In FY '21, we will continue this process. Safety is, and always will be, at the core philosophy of our group, and our goal remains 0 harm. We will continue to reduce the risk of harm by investing in our people, plants and processes so that everyone goes home safely at the end of every day. Across Chemring, we will continue building a more cohesive group of companies where collaboration and continuous improvement is supported by research and development, new product development and adaptation of existing capabilities to meet our customers' changing needs. We will also continue the process of modernization, automation and driving operational excellence across the group, and where necessary, adapt and strengthen our current capabilities in support of our core customers whilst also seeking opportunities in adjacent markets. In terms of the markets in which we operate, we will continue to focus our efforts on our core home markets in the U.S., the U.K., Europe and Australia, but we will look for opportunities in selected international markets where we can support defense, national security and industrial customers. Turning now to the 2 sectors, and starting with Sensors & Information, where our focus remains on expanding the group's technologies, products and services in the areas of tactical electronic warfare, national security and detection systems. Roke is a key driver of future growth, and as such, we will continue to invest in the business. We will continue to prioritize business development activities with our U.K. government customers as we seek to grow across all areas of the Roke business in the U.K. In parallel, we will continue to develop opportunities to expand Roke's capabilities and offerings into industrial and international markets, particularly in the U.S., in order to provide Roke with a greater international presence. Building on the encouraging progress made this year, Roke will pursue further partnering agreements with other companies and organizations in order to develop and access additional market opportunities. While our focus is on investing in people, technology, research and development and product development to grow Roke organically, we will also pursue potential bolt-on acquisitions, but only if they meet a strict set of criteria, enhance shareholder value and fit with our wider growth plans. Early-stage engagement and a number of transactions took place in FY '20, but we decided not to proceed as our criteria were not met. Our U.S. Sensors business will continue to focus on supporting the current Programs of Record, building winning solutions in these crucial chemical and biological detection programs. We will continue to invest in our technology road maps and in next-generation research and development and product development. A key part of this will be adapting and modifying existing technology to enable its use on a wider number of platforms, for example, the miniaturization of our detection technologies for use on autonomous platforms and vehicles. Also, given the impact that coronavirus has had around the world, we will also explore opportunities to utilize our technologies and expertise within the wider biosecurity markets. In Countermeasures & Energetics, our emphasis will be on maintaining and growing our market-leading positions. We will continue our program of investment in modernization and automation to improve competitiveness through enhanced operational effectiveness and increased capacity. We will also continue the process of aligning our operations, ensuring that where possible, we operate as a single organization that is aligned to our customers' needs and market opportunities. An important part of this will be to further progress our business development and product road maps, ensuring that we are anticipating our customers' needs so that our products remain market leading. I'll now turn to the subject of ESG, which is an area of increasing focus and one where we are committed to being a socially and environmentally responsible business. Good progress has been made during 2020 as we managed our sustainability agenda, and in particular, our exposure to ESG-related risks. During the year, we completed the exit from the group's commoditized energetics businesses, and in doing so, we retired significant operational and reputational risk. Chemring is now a business with an evolving purpose, which is to innovate to protect. And with that, we are focused on protecting our customers' people, platforms, missions and information. We are actively looking at ways in which we can reduce our environmental impact. And this year, we established an Environmental Committee, which is currently finalizing our environmental strategy. However, notable progress has been made during the year with greenhouse gas emission intensity reduced by 11.5%, energy usage intensity reduced by 14% and water usage intensity reduced by 17%. In Chemring, we value all of our colleagues, and we are working to build a culture and a working environment founded on inclusion, respect and diversity. We want all of our colleagues to be able to bring their whole self to work and return home safely at the end of every day. Particular areas of focus have been on professional development, communication and well-being. We have also focused on ensuring that everyone at every level has a voice and the ability to contribute to the way in which things are done. Our real-time employment engagement tool is now live in every part of the business, and over 80% of employees are providing regular feedback. 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. We are committed to building a sustainable company, of which all of our stakeholders can be proud, both now and in the future. In conclusion, we have made excellent progress over the past 2 years and have built strong foundations based on our shared values of safety, excellence and innovation. The resilience of the group in response to the coronavirus pandemic is a result of the dedication and commitment of all of our people and clearly demonstrates we are building a higher-quality business. We set ourselves demanding goals, and the teams have risen to those challenges in exceptional circumstances. And I would like to take this opportunity to thank all of my colleagues across Chemring for their commitment and hard work. In FY '21, we will continue to build on this progress. Trading since the start of the current financial year has been in line with expectations. And with 78% of FY '21 expected revenue covered by the order book, the Board's expectations for FY '21 performance remain unchanged. Chemring is well placed with a robust strategy, market-leading positions across different geographies and sectors and with technologies, products and services that are critical to our customers. Our long-term prospects remain strong. So that concludes the presentation. If you do have any questions, please do get in touch with us either directly or through our advisers. We look forward to hopefully seeing you face-to-face at the half year results in June. But in the meantime, stay safe, stay well, and thank you for joining us.