Chemring Group PLC (CHG) Earnings Call Transcript & Summary

Good morning, and welcome to the presentation of Chemring's results for the full year till 31st of October 2021. Whilst we remain working under COVID restrictions, with the current concern around the Omicron variant, we have again decided that the safest and the most effective way of engaging with our investment community is virtually rather than our usual face-to-face briefing. I am, as usual, joined today by Andrew Lewis, our Group Finance Director. I'll provide a brief overview of the group's highlights for the year. Andrew will then take you through the financial results. And I will then comment on the progress made this year and the areas we are targeting for further growth in FY '22 and beyond. Starting with a brief overview of our performance during FY '21, a year in which we successfully navigated a number of operational and financial challenges, including foreign exchange headwinds and delays to customer procurement processes. The focus we have placed in recent years on building a higher-quality technology-based business has resulted in another period of strong operational and financial performance. This performance, which was in line with the Board's expectations, demonstrates good progress against our strategic goal of balancing short-term performance with longer-term value creation. The dedication and commitment of our teams ensured that we made good progress in both sectors throughout the year. And despite the foreign exchange headwind, which has resulted in our revenues being slightly down year-on-year, our underlying operating profit increased by 5% to GBP 57.5 million. Earnings per share was up 12% to 16.9p, resulting in the Board recommending a final dividend of 3.2p per share. With the interim dividend of 1.6p per share, this results in a total dividend of 4.8p per share, an increase of 23%. Trading since the start of the current financial year has been in line with expectations, with 84% of 2022 expected revenue covered by the order book. The Board's expectations for 2022 remain unchanged. At Chemring, our purpose is to help make the world a safer place, delivering innovative protective technologies to detect and defeat ever-changing threats. Our commitment to protection goes beyond our customers. It embraces many stakeholders, including our people, our customers, our suppliers and the communities in which we operate. And it recognizes the need for us to contribute towards a sustainable future. Safety remains a core value, and it is pleasing to see further progress that was made throughout the year. Our total recordable injury frequency rate was 0.67, a reduction of 21% on the previous year. We continue to focus our efforts across the areas of controls of major accident hazards, injury reduction and risk management. Our goal of zero harm goes beyond the management of safety and recognizes that we have a duty to ensure we take appropriate actions to minimize the impact of our operations in many different areas from employee well-being to climate change. Safe, values-based and ethical business conduct is at the heart of Chemring's commitment to be in a socially and environmentally responsible business, of which all our stakeholders can be proud both now and in the future. That concludes my overview. I'll now hand over to Andrew to 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 2021. Both segments have performed well with double-digit growth in Sensors & Information, and Countermeasures & Energetics showing good improvement in operational performance. The results have been delivered in spite of a significant foreign exchange translation headwind this year. The key messages from this year's results. Revenue was GBP 393 million, which was up 1% at constant currency. Operating profit grew 5% to GBP 57.5 million. Our operating margin improved 100 basis points from 13.6% to 14.6%, which is a continuation of the trend of margin progression as we move towards our targeted medium-term objective of mid- to high-teen segmental margins. The 47% reduction in the interest charge was driven by the continued focus on the management of day-to-day working capital. Diluted earnings per share was up 11% to 16.5p. Our operating cash conversion for the year was strong at 105% of EBITDA, and this left net debt down 45% to GBP 26.6 million. The Board has declared a final dividend for 2021 of 3.2p, which together with the interim of 1.6p makes a total for the year of 4.8p, up 23%, which continues the progression of growing our dividend and moving towards the medium-term objective of 2.5x dividend cover. Operationally, the strong performance in Sensors & Information was driven by Roke, which saw double-digit growth in order intake, revenue and operating profit and the delivery of further HMDS orders on the U.S. Program of Record. In Countermeasures & Energetics, the improved operational and financial execution at our U.K. countermeasure site drove margin improvement. The closing order book is GBP 501 million, of which GBP 358 million is expected to be delivered in 2022, which covers 84% of expected 2020 revenue. As the impact of foreign exchange has been significant this year, this slide shows the key income statement metrics at constant currency. On a constant currency basis, revenue was up 1%, operating profit up 10% and EPS up 17%. With just over half of our revenue in U.S. dollars, the full year translation effect of the $0.10 movement in the U.S. dollar was a headwind of GBP 15 million on revenue and GBP 2.6 million on an operating profit level. I've covered most of the other highlights already, so I will just pull out the fall in the underlying tax rate for the year to 14.8%. This was driven by the recognition of a deferred tax asset in respect of potential future interest deductions in the U.S. of GBP 4 million, offset by a GBP 2 million charge relating to the revaluation of deferred tax liabilities arising from the increase in U.K. corporation tax rates from 19% to 25% announced in the spring 2021 budget. Looking forward to 2022, we expect the group effective tax rate to remain in the mid-teens. In 2023 and beyond, the change to the U.K. corporation tax rate will impact the annual current tax charge and this is expected to increase the group effective tax rate to approximately 20%. 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 strong market conditions and excellent execution at Roke and growth in the HMDS program of record. Countermeasures & Energetics experienced a softer year, with the niche Energetics business weaker in the commercial aviation market for Metrons and space seeing some timing differences due to customer acceptance testing delays. FX was a significant headwind. At an operating profit level, in Sensors & Information, we see the revenue growth dropping through as expected, with the margin improving as the higher margin in Roke business grows faster than the U.S. Sensors business. In Countermeasures & Energetics, operating profit progressed in spite of the fall in revenue as the project to improve the operational performance of the U.K. Countermeasures site saw a full year of benefit. As already noted, foreign exchange was a reasonably significant headwind in this year. Moving to the segmental results and starting with Sensors & Information. The results show revenue up 7% to GBP 147 million, and operating profit up 15% to GBP 31.6 million, reflecting the strong year at Roke, which delivered another year of double-digit growth and strong margins. Indeed, 2021 was a record year for order intake at Roke, exceeding GBP 100 million for the first time in its history. As shown by the graph on the right-hand side, Roke's information security and data science business, operating primarily in the U.K. national security and defense markets, has an impressive growth track record over the last 5 years. To position Roke well for continued future growth, we're ensuring we invest in resource, skills, product development and infrastructure. This includes opening Roke USA in the year, which will require some further sales and marketing investment in 2022, ahead of the revenue curve. In the U.S. Sensors business, results benefited from the continuation of the HMDS program of record and the customer placed further orders of $69 million under the previously announced $200 million IDIQ contract, which provides good visibility under this program well into 2022. Low rate initial production deliveries for the EMBD program progressed as planned, with a full rate production contract awarded in October. This is a $99 million 6-year framework contract with an initial delivery order of 16 million, which will largely be fulfilled in 2023. The AVCAD and JBTDS programs progressed as planned, with the next customer procurement decision expected on these in late 2022. Moving on to Countermeasures & Energetics. The most significant impact on the result was the improved operational efficiency at the U.K. Countermeasures site, which following a period of investment in modernization and automation, achieved its revenue and profitability objectives this year. This has moved the margin forward significantly from 15% to 16.2%, which represents excellent progress towards our medium-term goal of achieving mid- to high-teens margins in this segment. The graph shows the margin progression over the last 4 years, which demonstrates the benefit of the investment in modernization and automation of our sites. The investment in capacity expansion and automation of our Tennessee facility to support expected U.S. extruded flare requirements remains on track to produce its first revenues in the second half of 2022. This investment is the final key enabler of the segmental profitability improvement program. And we expect to see the revenue benefit in 2023 and improved profitability following in 2024. On the niche Energetics side of the business, our Scottish-based business saw some softening in demand for Metrons in the commercial aerospace market driven by COVID-19. And our business in Chicago saw some timing delays on customer acceptance testing in the space market. Together with the FX headwind, these temporary differences were the main drivers of the fall in revenue in 2021. However, operating profit was maintained through the improvement in margin. The cash flow shows the group's net debt at the end of the year at GBP 26.6 million, a reduction of GBP 21.6 million in the last year, which has been driven by strong operating cash conversion. The operating cash conversion ratio in the year was 105% of EBITDA. Indeed, across the last 2 years, operating cash conversion has been 108% of EBITDA, demonstrating the improvement in business practices is permanent and sustainable. The significant nontrading item in the year was CapEx, which at GBP 30 million, was slightly lower than planned as the impact of COVID delayed some project starts. We expect this to catch up in 2022 with CapEx remaining elevated before seeing CapEx spend starting to trend back towards depreciation in 2023 and 2024. With net debt of GBP 27 million at the end of the year and the net debt-to-EBITDA ratio of 0.35x, and new banking facilities of GBP 150 million in place, the group is in good financial health and positioned well to continue to invest for growth. It's now 3 years since we set out our strategy to deliver a higher-quality business. So I thought it would be worth spending some time recapping on the financial progress we've made in that time. Our focus has been on building a financially sustainable and robust group. We've made good progress towards our margin objective, have seen 3 years of clean numbers with no exceptional items, and have achieved greater than 100% cash conversion in each of the last 3 years. This has allowed us to invest. CapEx has run ahead of depreciation. And despite this high level of investment, we've been able to significantly reduce net debt. We will maintain our focus on doing the basics well as we continue the group's development in the coming years. Finally, looking at the order book. At a group level, the closing order book was GBP 501 million, with GBP 358 million expected to be delivered in 2022, giving 84% cover of expected 2022 revenue. In both segments, we continue to work on improving the quality of the order book, leveraging deep, strong, long-term customer relationships, which has improved our short- and medium-term visibility. Turning to each segment, and starting with Sensors & Information. Order intake was up 18% and book-to-bill was 120%. The order book in this segment tends to be shorter cycle. And of the GBP 114 million order book, GBP 103 million is expected to be delivered in 2022 in addition to orders won and delivered in the year, giving 65% cover of expected revenue, 12% higher than the previous year. In Countermeasures & Energetics, order intake was GBP 255 million and book-to-bill was 103%, reflecting the delivery of the 2-year F35 Countermeasure order received in the comparative year. The closing order book of GBP 387 million, GBP 255 million of which is for delivery in 2022, which gives 95% cover of expected 2022 revenue. And with that, I'll hand you back to Mick. Thank you.

Thank you, Andrew. I'll now take a few moments to look at the broader market and thereafter, how this relates to our two business sectors. The market outlook remains positive with solid demand for Chemring's products and services in our core markets of the U.K., the U.S., Australia and NATO. In the U.K., we've seen considerable activity this year. Following GBP 16.5 billion uplift for defense spending in November of last year, the U.K. government has this year set out its defense and national security priorities through the publication of the integrated review. The U.K.'s future priorities are well aligned to those of the U.S. and include the need for new military and security solutions that are data- and intelligence-driven, with science and technology as a key element of U.K. soft power. Recent comments by the Secretary of State for Defense regarding the future soldier program and by the Chief of the Secret Intelligence Service on the need to team with technology companies to be able to compete with adversaries illustrates that the strong pivot towards the acquisition of high technology capabilities in the areas of cyber, artificial intelligence, electronic warfare and digital integration. Our capabilities in our Sensors & Information sector, particularly Roke, fit very well with these growing requirements. In the U.S., President Biden's $753 billion budget request for FY '22 suggests that the administration is looking to create a modernized force structure with strong emphasis on technology and military readiness. Throughout the budget request, there is a strong focus on advanced capability enablers and research and development. Several of the identified priorities for targeted investment such as artificial intelligence, electronic warfare, hypersonic technology, cyber and biosecurity create opportunities for us to deploy group-wide capabilities. The President's request also includes a $12 billion request for an additional 85 F-35 aircraft, which continues to drive demand in our Countermeasures & Energetics sector. We note the U.S. budget's Continuing Resolution funds government operations at current levels through to mid-February 2022. At that point, the budget must be adopted or another Continuing Resolution passed. In response to what it sees a deteriorating regional environment, the Australian government has plans to significantly increase its total defense spending over the next decade. Associated with this budgetary increase is an objective to foster a robust and resilient indigenous industrial base. The recently announced Orca Security Alliance confirmed that the U.K. and the U.S. intend to share, with Australia, their expertise in security and defense related to science and technology, including the areas of cyber and artificial intelligence. Orca covers three of Chemring's home markets. And the even greater cooperation that this pact will engender has potential for it to create new opportunities for the group's capabilities. And in Europe, near-term defense spending is growing as several countries are looking to approach the recommended NATO commitment. The budget of the major European defense sectors, France, Germany, Italy and the U.K., all have an upward trend. While the planned U.K. budgetary increases and areas of focus have already been outlined, it should also be noted that France and Germany are continuing with their existing expenditure commitments even after implementing significant investment programs to sustain their national industries confronted by the pandemic. While the ultimate economic impact of the pandemic on European defense budgets has yet to fully evolve, the near-term outlook for the European market is potentially positive with a number of niche opportunities for our capabilities. Against that market background, our strategy for FY '22 and beyond is to deliver profitable growth by operating in markets where we have differentiators such as intellectual property, niche technology, high barriers to entry and deep long-term customer relationships. We will continue to focus our efforts on building a safe and resilient business that is able to deliver margin progression through continuous improvement in operational performance and execution. We'll continue to invest in our people, our infrastructure and in the group's product and service and capability offerings, constantly innovating to enable our customers to deliver operational and competitive advantage. In doing so, we will deliver sustainable growth into the future. In our Sensors & Information sector, we see significant growth potential for both Roke and the evolving Roke USA business. Roke will continue to execute a strategy that is delivering strong organic growth. And this organic effort will be supplemented by further bolt-on acquisitions. The target will be to maintain double-digit percentage revenue growth over the coming 3 years, whilst preserving strong margin performance. For Roke's national security activities, we will continue to grow by following our customers' mission and accessing skills and talent across the country through Roke's hubs in Romsey, Gloucester, London, Manchester and Woking and through academic partnerships. The national security priorities and technology challenges highlighted by the Chief of the British Secret Intelligence Service in his recent public address give us confidence of the growing criticality of Roke's capabilities. As outlined earlier, Roke's niche capabilities in defense are well aligned to high priority requirements for both the U.K. and international customers. We are delivering a number of key U.K. programs in the defense landscape that is becoming increasingly digitally transformed and where our electronic warfare, electronic countermeasures and artificial intelligence capabilities can deliver real military advantage. Internationally, Roke has seen strong demand from customers located in the Middle East and North Africa as well as those in the Baltics and NATO-member states. As we're doing this, we will continue to maintain our efforts in building a more comprehensive cross life cycle capability. Growth can also be anticipated in our industry and in our public sector activities. Efforts in our industry business line will be focused on targeting opportunities in health care, high-value manufacturing, information, communications, transport and utilities, whereas those for public sector clients will look to maintain our strengths in data science and information architecture. The acquisition of Cubica Group in June 2021 has been an excellent strategic and cultural fit for our Roke business and has added further market-leading capabilities to Roke's technology portfolio. The integration has progressed to plan and the business is performing well. Cubica will continue to focus on applying advanced technology to solve societal problems and with a particular focus on autonomy and artificial intelligence. Tackling harmful content and activity online remains a key priority in the U.K. and worldwide. Cubica's groundbreaking work in digital and Internet placing domains means that we are well positioned to capitalize on opportunities with a number of high-profile programs. Finally, our Roke USA business, which operates under a special security agreement with the U.S. Department of Defense will continue business development and demonstration efforts to leverage Roke's U.K. capabilities for the benefit of the U.S. customer. Our resolve and perceived electronic warfare systems are currently on trial with a number of U.S. Army divisions, where customer feedback has been excellent. Roke USA will continue to support the customer with a goal to secure further orders from this potentially significant market. In the U.S., our Sensors business continues its strategic focus on building winning solutions to convert current U.S. programs of record into low rate and full rate production. In October, the U.S. DoD approved and awarded a full rate production contract for the Enhanced Maritime Biological Detection System. The value of the sole source framework contract is up to $99 million with an estimated completion date of December 2027. Alongside our sole-sourced HMDS explosive hazard detection contract, which is expected to run for the next decade, we now have converted 2 of the 4 major programs of record we are targeting, providing good medium-term visibility. Our focus continues to be on ensuring that our North Carolina facility is mobilized and resourced to maximize our opportunity to convert the two remaining chemical and biological detection programs of record. The sole source Joint Biological Tactical Detection System program is progressing as planned through engineering and manufacturing development, its EMD phase, and a customer procurement decision is expected in FY '22. The Aerosol and Vapor Chemical Agent Detector program is also progressing through its EMD phase. The next customer procurement decision point is still expected to be at the conclusion of the EMD phase in FY '22. Chemring remains 1 of the 2 contractors currently selected for this competitive program, which is expected to be worth up to $800 million. Beyond the programs of record, we continue to invest in our technology road maps and the next-generation research and development and product development. A key part of this is adapting and modifying existing technologies to enable them to be deployed on a wider number of platforms, including autonomous ground and air systems and in biological point of care diagnostics. In an increasingly contested world, advances in synthetic biology give our national adversaries the capabilities to deliberately engineer organisms to create hazards and cause harm. This is an area of growing concern to our customers and Chemring's [indiscernible] research and development project aims to develop a deployable and cost-effective solution for the identification of biological threats. In Countermeasures & Energetics, our strategy remains to strengthen and protect our niche world-leading positions through continuously improving our technological and operational base, whilst working closely with our customers in the development of new solutions to meet ever emerging needs. In recent years, our focus has been on the modernization across all sites, building a safe and resilient business that is able to deliver margin progression through continuous improvement in operational performance and execution. In a number of our businesses, this investment phase has completed and the sites are now delivering to expectations. The Tennessee capacity expansion project remains on track despite delays in the supply of advanced manufacturing equipment due to suppliers being impacted by COVID-19. The new facility began its commissioning phase in October and will now go through a period of characterization and testing as production ramps up. We still expect to generate revenue from this new facility in the second half of our 2022 financial year. Elsewhere, we are initiating investment CapEx projects that will continue the process of modernization and automation, ensuring that our operations remain safe and that we will continue to improve our competitiveness. Investment in our plant and processes alongside investment in our product portfolio is vital for us to continue to secure long-term contracts and partnering agreements with our blue-chip customers. This improves short- and medium-term visibility and provides a framework for long-term planning and investment decisions. An example of this would be the agreement that our business in Scotland signed with the Martin Baker Aircraft Company. This 15-year agreement will see Chemring supply propellant material and pyro-mechanical devices for use in a wide range of Martin-Baker’s ejection seats and is valued at up to GBP 160 million. At Chemring, we take seriously our responsibility to contribute to a sustainable future, and we are fully committed to being a socially and environmentally responsible business. From an ESG perspective, 2020 was a baseline year for Chemring, where we focused our efforts on gaining a better understanding of our data, identifying gaps within our knowledge, completing the restructuring of the portfolio to focus on protective technologies and putting in place the infrastructure and governance to deliver our sustainability agenda. We continue to build on this progress in 2021 with the overriding goal of elevating our ESG-related activities. A crucial first step in this and a priority goal for the year was to undertake a materiality assessment to identify the areas of greatest importance to our stakeholders and to identify those areas and activities where our actions could have the greatest positive impact. The materiality assessment identified the most significant environmental, social, and governance topics, both risks and opportunities, and ranked them according to the feedback from a selection of stakeholders, including customers, suppliers, employees and investors. Key focus areas included health and safety, diversity and inclusion, reducing climate change and employee well-being. We also conducted a mapping exercise to assess the alignment of the organization to the United Nations sustainable development goals and assess the opportunity to measure and manage our contribution going forward. Both exercises have been fundamental in enabling us to set appropriate near- and longer-term targets against which our progress can be measured. And ESG performance targets will be part of our annual and long-term incentive arrangements going forward. This slide sets out our ESG framework and near-term targets. These include our commitment to reduce our direct and indirect emissions year-on-year to be carbon neutral by 2030 and net zero by 2050. Our broader sustainability goals and near-term targets, including our commitment to greater diversity and representation are disclosed in greater detail in both our stand-alone sustainability report and this year's annual report on accounts, both of which can be viewed on the group's website. To facilitate and ensure a consistent approach to sustainability across all our businesses, a group Sustainability Committee was formed during the year. The committee, which I chair as the Board Director responsible for sustainability across the group, consists of members of the group's Executive Committee with responsibility for health and safety, environmental impact, people, ethics and business conduct and is supported by internal and external subject matter experts. The committee will shape and monitor the implementation of our sustainability agenda and ensure the group continues to make progress. Our modernization and operational excellence programs will continue as we focus on organic growth, and the actions taken over the past 3 years have resulted in a significantly strengthened balance sheet, which provides the flexibility to consider how and where we allocate capital. As a Board, we remain open to accelerating our growth opportunities through selective acquisitions that enhance shareholder value and align with our wider growth plans. These criteria must be evenly matched by our internal capabilities to ensure that we are match fit to receive and successfully integrate any acquisition. This activity is principally focused on our Sensors & Information sector where we see opportunities for long-term growth. In conclusion, 2021 was a year in which we continued the process of transformation that was launched in 2019, as we build a stronger, higher-quality and technology-focused business. We have maintained our relentless focus on living our values of safety, excellence and innovation. In doing so, we are driving our collective purpose of delivering innovative protective technologies to help make the world a safer place. I'd like to thank all of my colleagues across Chemring for their determination, hard work and support. The progress made over the past few years would not have been possible without their collective efforts. Trading since the start of the current financial year has been in line with expectations. And with 84% of 2022 expected revenue covered by the order book, the Board's expectations for 2022 performance remain unchanged. Chemring is well placed with a robust strategy, market-leading positions across different geographies and sectors and with products and services that are critical to our government and blue-chip customers. Chemring's 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 advisors. 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.