Codan Limited (CDA) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to the Codan investor webinar for the half year results ending 31, December 2022 for half year FY '23. Joining me from the company today is Managing Director and Chief Executive Officer, Al Ianniello; as well as Chief Financial Officer and Company Secretary, Michael Barton. Following a brief summary of the results released to the ASX this morning, investors and research analysts will have the opportunity to ask questions. [Operator Instructions] Thank you and over to you, Al.

Thank you. Good morning. I'd like to welcome everyone to the FY '23 half year results presentation for Codan. I'm Al Ianniello, the CEO. Alongside me, I have Michael Barton, CFO, Company Secretary. I'll be presenting the business portion of the presentation, while Michael will present the financial summary. Post the presentation, we'll field any questions that may arise. The group delivered revenues of $212 million, which is towards the upper end of the AGM guided range. Net profit after tax was $30.8 million, which was slightly above our expectations in a challenging macro and geopolitical environment. The results reflect ongoing disruptions in Minelab African market, offset by strong organic growth in communications. Pleasingly, communications exceeded revenue guidance, growing the top line at 16% against prior corresponding period, while the forward order book is also growing at 16% versus the 30th of June 2022. As you would appreciate, the strength of the order book is typically a lead indicator in predictability of future revenues. This should be an encouraging sign as the group continues to work hard to provide sustainable and profitable growth for shareholders. This slide shows Codan's recent history since FY '19. Notably, 3 distinct periods, pre-COVID, the COVID era that defined FY '21 and FY '22 and from FY '23 onwards what we've termed as a stronger Codan. Pre-COVID, the business was heavily dependent on Minelab, notably our African business, with 70% of revenues coming from the sale of metal detectors. The second period we've defined is the COVID era, where the business experienced unprecedented cover impacts. This was characterized by 3 key factors. Firstly, government stimulus and COVID-related demand, driving significant growth in the Rest of World metal detection sales. Secondly, unprecedented demand for metal detectors in Africa, as people temporarily moved away from traditional forms of employment during the crisis. And lastly, we experienced supply chain challenges pushing up inventory. Critically, during this period, Codan paid $174 million in cash to purchase both Zetron and DTC, 2 fantastic acquisitions for the Codan Group, particularly in terms of the company's future stability and success. And that brings us to the final period where the group is focused on continuing to make this business a stronger Codan. We significantly reduced the reliance in Africa with the African sales making up less than 10% of our first half sales. In doing so, the company is now much better balanced between metal detection and communication segments. We are focused on increasing predictability of revenues. The DTC and Zetron acquisitions have significantly increased our addressable markets, and we now operate in several key growth markets. We continue to invest in engineering and increase our products and solutions offering to increase market share, and we are focused on cash generation and individual business unit contribution. And with these actions, we are confident that we'll continue to build a stronger and more resilient Codan, which will deliver long-term shareholder value. As many of you are aware, Africa has been Codan's single largest market in prior years. While Africa continues to remain a very important market for us, it can be unstable and therefore, a highly unpredictable market. In order to reduce risk and address our strategic goal of generating more predictable revenues and profitability, it is extremely important for us to reduce our relative dependence on Africa. While we remain committed to maximizing African sales, our goal is also to expand sales into other geographies, bringing with it a greater level of stability and predictability. During the half, Africa's revenue reduced to 8% of group sales and therefore, is not currently a significant contributor this financial year. I will now hand over to Michael to take you through the financial section of the presentation.

Just as a general statement on the financials back in October at our AGM we not quite detailed guidance around revenue and profitability for each business unit and overall. And we confirmed 2 weeks ago that we had achieved all of those targets or exceeded them. As I go through the financials this morning, I'll just hit on the most important points. So on the profit and loss performance, as Al has already highlighted the reduction in group revenue and profits against the prior period, really due to the ongoing disruptions in Minelab's African market. We delivered a net profit after tax of $30.8 million, which was above the top of the guidance range that we provided at the AGM. Our effective tax rate was 22%, which was lower than prior periods as a result of a greater proportion of our profits coming from our communications business and primarily out of our U.K. operations with the U.K. having a 19% tax rate. We have noted in the presentation that, that U.K. tax rate will increase to 25% later in 2023. We delivered an NPAT margin of 15%, which was in line with our guidance. And the 5-year chart on this slide shows that FY '23 is performing in line with the pre-COVID era of Codan. And these charts show that historically, Codan has had stronger second half performance. And that seasonality was driven by Minelab's African business. So given the change in that market, that seasonality factor is no longer relevant going forward for Codan. So we turn to the balance sheet. So in the half, we had an increase in working capital, primarily as a result of an investment in inventory, which increased $11.8 million, and this was due to 2 factors. One being the investment in new products, specifically the Manticore and the Equinox 700 and 900 metal detection products, which Al will touch on later in the presentation. And in addition to that, incoming inventory commitments for orders that will place some 12 to 18 months ago during the height of the supply chain shortages that many companies faced. The company has scaled back production of our overstocked gold detectors, and therefore, we expect this inventory to decline over the remainder of FY '23 and FY '24, releasing some of this working capital balance. As announced at the AGM, we expected to end the half with a net debt of circa $70 million. Pleasingly, we achieved a greater reduction than anticipated, and we reported a $61 million debt number. And this was a result of an ongoing focus on working capital management with both debtors and creditors being well controlled. We expect cash flow positive in the second half of this year. Capital management options continue to be evaluated by our Board, and the company is very focused on maintaining the balance sheet in a strong position and there's an ongoing focus on improving operating cash flow. Cash will be used to enhance and optimize the existing businesses and their product development pipelines and to retire debt when appropriate. Cash will also be used to invest in growth opportunities. As we announced this morning with the GeoConex acquisition when that's deemed to be the best use of capital by the board. As mentioned at the AGM in October 2022, an on-market share buyback remains under consideration. And the company has no intention to change its dividend policy. Have a slide that just shows the change in our net debt position over the half. Which shows operating cash flows of circa $31 million after allowing for the investment in inventory with key investment in CapEx engineering, as mentioned and inventory, net debt did increase to $61 million, at December. As we work through this excess inventory over the next 12 to 18 months, we'd expect positive cash generation and a reduction in net debt. During the half, we continued critical investment of $23 million into engineering, which further strengthened the pipeline of products and solutions that we have. It represents about 10% of our revenues that have been reinvested back into product development and innovation. Investing in product development remains a key strategic initiative for Codan. Our technology road map support short, medium and long-term growth opportunities. And Codan has a really robust product development process, which has proven to be a key strength of Codan. Our willingness to invest and innovate is being successfully replicated now in our major acquisitions of DTC and Zetron so that we can continue to deliver great products to the markets that we serve. Importantly, our engineering investment is well distributed right across our key businesses and all of their growth markets. And I'm going to hand back to Al to take us through the business units in the outlook section of the presentation.

Each of our 3 business units, Minelab, Tactical Communications and Zetron have in-depth 1,000-day strategic plans. This slide summarizes some of the key near-term objectives. Minelab continues to focus on promoting the recently launched new products, increasing sales through e-commerce and expanding geographically. This is in conjunction with rebuilding and maximizing sales in the African market. Tactical Communications continues to enhance their offering as a full solutions provider and penetrate key adjacent markets. We continue to invest in go-to-market sales capability within this business with dedicated resources across all key growth markets. Our strategy to invest in product development will allow us to serve large addressable markets and have the opportunity to participate in large multiyear programs. And as such, create sustainable revenues into the future. Lastly, Zetron is focused on expanding and growing their system solution and support contracts. As per the announcement this morning, the team will be focused on successfully integrating GeoConex with Zetron. While we are still relatively early on in our sustainability journey, we have a dedicated sustainability council, and we are currently applying globally accepted principles and frameworks. The Sustainability Council has several initiatives across each ESG pillar. For example, we are committed to reducing our carbon footprint, and this year, we have engaged consultants to help facilitate this process. We look forward to reporting our progress when we publish our fourth sustainability report in Q3 of this calendar year. Minelab's revenue of $74 million for H1 FY '23 was just below the range provided at the AGM, which was $75 million to $80 million. Mine Lab segment profit margin of 31% was consistent with the AGM guidance. In Africa, Minelab's personnel are actively promoting and educating artisanal miners on Minelab detectors. The company believes the market represents a medium-term rebuild opportunity within Africa. Elsewhere, our Rest of World revenue was $61 million, representing a decrease of $8 million on the prior corresponding period after adjusting for the ceased Russian market sales. Most of the reduction relates to the timing of project wins in Countermine. Pleasingly, despite the 3 distinct periods within Codan's recent history, the sale of metal detectors into recreational markets have remained remarkably resilient. These sales are performing at a consistent rate with prior periods, which were fueled by government stimulus and covered for later demand. Consistent with our growth strategy, Minelab has introduced 3 detectors that are specific to the Rest of World recreational sales being the Manticore, Equinox 700 and Equinox 900. The first shipments of these products took place in December and feedback from the customers so far has been very positive. To elaborate on these products, Manticore is the first high-end coin and treasure detector we have launched in 10 years. This product operates with improved debt and discrimination. With fast recovery speeds, the Manticore also locates and discriminates closely spaced targets, while 2 dimensional discrimination provides improved identification of targets. Since the product has been made available for sale, the feedback has been very positive and is exceeding our internal expectation at this point in the release cycle. Moving on to Equinox 700 and 900. This is the next generation of our existing Equinox products, which also has improved debt and discrimination. Another key feature is its collapsible carbon chance, providing the customer a lighter-weight product that packs considerably smaller than previous models. Again, these products are the direct result and output of prior engineering investment to drive innovation, a core feature of the Minelab business. Turning now to Codan Communications. In a really pleasing result, this segment delivered a strong first half with revenues increasing by 16% to $136.6 million, with both Tactical and Zetron contributing to this growth. First half revenues not only exceeded guidance that was provided at the AGM, but also exceeded internal expectations. To reiterate, the key reason for the AGM guidance revenue range was the lack of certainty regarding the shipment of product for the large communications project announced in October 2021. Despite only partially shipping against this specific project during the half, we still managed to exceed this range. H1 FY '23 Communications segment profit margin was 25% versus 21% prior corresponding period. Again, a pleasing result as the company continues to target long-term communication segment profit margins of 30%. As previously mentioned, communications is supporting the company's objective to continue to grow revenues with greater predictability. A tangible achievement during this half was not only growing communications revenues by 16%, but also growing the forward order book by 16% to $173 million from the 30th of June 2022. As a lead indicator of future revenue, this provides us with confidence heading into the second half. Tactical Communications experienced a very strong first half, driven by growth in revenue orders and opportunities across all key growth markets being unmanned systems, military, law enforcement and broadcast. Tactical Communication has also succeeded in its strategy to diversify revenue across these adjacent markets. A specific example of this is the size, weight and power of our tactical comms software-defined radio, a differentiating feature of our technology suite with direct application within unmanned systems markets. In this market, specifically, we have seen an increased demand due to the ongoing Ukraine conflict. Again, a consistent feature across our entire group. This business will continue to invest in its product and technology road map across all key growth markets. As a result, we eagerly anticipate new radios currently under development, which will provide future growth opportunities. Zetron. Also achieved a very strong first half, as this business continues to realize the advantages and synergies of the integrated Zetron business. We have seen increased demand for our complete command control solutions. And as we increase installations, we also increased the number of support contracts, typically a more reoccurring source of revenue. Pleasingly, the first half support contracts made up approximately 30% of revenues, again, providing enhanced predictability of future revenues. Zetron is focused on increasing the proportion of support contract revenues in the future, Targeting over 50% over the medium term. As announced this morning, Zetron acquired 100% of GeoConex's shares. GeoConex technology portfolio consists of computer-aided dispatch and mapping solution. These systems are utilized by dispatches, call takers and phone operators in emergency call centers to prioritize and record incident calls, identify the status and locational responders in the field and effectively dispatch responder personnel. Importantly, Zetron has had a longstanding relationship with GeoConex spanning across 13 years. This acquisition is consistent with Codan's strategy to diversify and grow the Zetron business with acquisitions that enhance the solutions we can offer to the public safety sector. This acquisition is critical to Zetron's technology road map and will position the business to maximize the opportunity for the next-generation 911 U.S. government funding to upgrade the suite of emergency response communications. This slide illustrates key products and markets and the boxes highlighted in green is where GeoConex technology forms part of the Zetron solutions offering. So why did Codan acquire GeoConex? CAD is the largest and fastest-growing segment of the public safety control rate market. The Tier 3 and Tier 4 public safety market is fragmented. Zetron's competitive advantage is that it is a full solution provider. And therefore, it was important that we controlled the IP. Further to this, CAD is a critical component in our next generations of products and any in-house development would have taken significant time. The GeoConex technology is absolutely core to our technology road map, and we are very pleased to own this IP. Now in terms of the remainder of FY '23, when we consider the second half of FY '23, there are a few key factors to note. Rest of World metal detection second half revenues are expected to exceed first half, primarily driven by the new product releases. The African gold detector market is likely to remain soft. The company expects full year communication sales to grow between 10% to 15% versus prior corresponding period. And we will closely monitor global geopolitical and macroeconomic conditions. In light of these considerations, the board is not in a position to provide full year guidance, but we will continue to keep shareholders updated as the year progresses. In closing, I'd like to recap a couple of key points highlighted within today's presentation, particularly as we strive to become a stronger Codan and generate sustainable value for shareholders. We have a more diverse earnings base across our business. We have significantly reduced our reliance on Africa as we continue to lay the foundations to achieve more predictable revenue streams. We have grown segment profit margins across our Communications segment. We continue to invest heavily into product development, which will have us more placed for the future. We seek to further strengthen the balance sheet with a focus on working capital and flexibility. Codan's focus is to deliver sustainable revenue and profitability growth. We are confident that these strategic initiatives currently in place will position Codan to not only grow market share, but also expand our products and solution to serve new and adjacent markets. Thank you very much for taking the time today. Sam, I'll hand back over to you.

[Operator Instructions] The first question we have is from Elijah Mayr at CLSA.

Just the first one from me. Maybe just looking at comms, are you able to break out how much of that contributed in the first half '23, and how much is expected to contribute in the second half? I think my memory is, to be $25 million still to come through in FY '23?

Yes. So it's really no significant difference half 1, half 2 Elijah.

So it should be split sort of $12.5 million each?

Yes, ballpark.

And then maybe just secondly on comms. You sort of break out, I guess, the assumptions that go into the 10% growth or the 15% growth for the full year. Obviously, you got sort of 16% in the first half of '23. So can you sort of just maybe give us some color on what would drive that guidance range?

I think we've been consistent when we talk about comps and its future outlook that over a full year, we would like to see 10% to 15% growth rate. And due to some of the project timing in and out, we thought we would provide that guidance for that range of 10% to 15% to exit the year on.

[Operator Instructions] Next question, submitted question from Jason Palmer at Taylor Collison. You've called out Rest of World Minelab sales expectations to be larger in the second half versus first half due to new product related that we're expecting this to come from discounting or promotional activity impacting margins.

Thanks for the question, Jason. No, we will not be discounting products. The growth in the Rest of World is predominantly driven by the demand that's being generated by Manticore Equinox 700 and 900. So that's our expectation.

Next question from [indiscernible] Minelab Africa. The USD gold price and USD movements have become tailwinds for artisanal miners. Can you talk to African builders and how the sales were spread over the first half and any second half feedback on pull-through demand at the dealer level?

Yes. Thanks for the question, Jason. Really, in terms of how our sales performed over H1 largely consistent. There's no pattern that has back-ended those sales or anything like that. So the sales were relatively consistent Q1 and Q2. And as we've called out in the presentation, we think that market remains soft in H2. And really, the start of our trade in that market for the second half, consistent with what we saw in the first.

Our next question comes from Cameron Bell, Canaccord.

Yes, I was going to ask about Africa going from sort of 69% down to 13, but you've kind of answered that just then. So I'll have 2 other questions, if I may. So the first one, just on the comms margins getting to 30%. When do you think that can happen? And are we expecting much of an improvement in the second half?

I think when we talk about the 30% over the last 12 months, that 30% is all driven by operating leverage. So if we continue the growth rates we're at, I would suggest within 12 to 18 months, we would be closer to a 30% contribution margin.

Sure. And then you guided to that 10% to 15% growth, do you think it's reasonable for us to use that as a base case longer-term growth rate for the division? Like I mentioned when we answered the question for Elijah, we have strong expectation that it's double-digit growth. And that's why we bought the 2 acquisitions. So I think there is a good assumption that will be double digits moving forward.

Next question submitted from James Lennon, Petra Capital. Do you have a time frame or revenue figure, the 30% margin will be delivered from communications?

Yes, I think we just answered that question. Just to extend some, or just to put some color around that, we've created a lot of discipline around order book management and pipeline management moving forward. So that's really our foundational work we're doing to ensure we're achieving these double-digit growth rate. So that just puts a bit of color that we've created significant discipline to push this forward. But I think we've answered that question previously.

Next question from James at Petra. Is there a debt figure that needs to be obtained before capital management initiatives will be inactive?

I think that some of the capital management initiatives are really driven by events like acquisitions such as GeoConex being able to execute on acquisitions such as that. So at the moment, we're looking to have a positive second half in terms of cash generation and continue to look for acquisitions and the timing of those will sort of drive any other decisions the board might make around capital management. But there's not a set number as such.

And I think we've got another question on the line of Jason Palmer. Jason, please go ahead with your question. Okay, we'll come back to Jason's question. Just on the GeoConex acquisition announcement this morning, can you elaborate on the long working history of GeoConex and why now is the right time to execute this acquisition?

Yes. So I think the history, there is a long partnership between Zetron and GeoConex. We've only acquired the Zetron business some 18 months ago. So these transactions take some time to come to fruition. And yes, we're very happy that we've concluded it now some 18 months after we acquired Zetron.

And then just the final question today, unless anyone else has any other questions is on the new products, how significant a milestone are the release of these new products? And what other products do you have in the pipeline that you can talk about?

Okay. I think when you talk about significance and new products, I think these new products again, has re-established why Minelab is the leader in metal detection. Now they continue to create a significant technology gap to the competitor base. So that's extremely positive. But also bringing in the new products after a significant amount of time on that 10-year period really has excited the market again in that specific field of recreation of detectors, hence, creating an uptick in revenue. We have further detectors coming out in H2. And with Minelab pedigree, we have significant products in the road maps going into FY '24 and FY '25. but definitely, the products have been extremely well received in market.

We've just got a few more questions coming in. So we might pass it to Mitch Sonogan at Macquarie.

Just a couple of quick ones for me. Just on metal detection, you're also been expanding the distribution or retail sales just tend to give a little bit of color on how you're seeing that or how you're progressing from a regional perspective. And just following on from that, have you seen any headwinds starting to come through from any potential consumer softness in any regions and looks like with that there was a lot expected 6 months ago. Just trying to see what you guys are seeing or viewing on the ground.

Yes. So in terms of the ongoing distribution of Minelab, consistent with what we've talked about previously, Mitch. The business is doing very well in Central Latin America. We've opened our footprint in India. So we continue with that geographic expansion. There's nothing that's changed significantly since we have spoken last calendar year. So it's been more of the same. The second part of your question was around have we seen the impact on our business of the changing economic conditions. So far, our business has been quite resilient. These sales in the first half comparable with the prior corresponding period in that part of our market, which has been pleasing. I think we've got the unique position where we've got some really exciting new products that are coming out and going to market, and that's going to help us weather some of the uncertainty around the general global economic conditions. We did mention in the announcement that we continue to closely watch the impact of the economic slowdown and how that may impact our business. So we're watching that closely. But at this point, we think the new products will offset that.

Yes. Great. Very clear. Just a quick one on the comms orderbook growing 15% to $173 million. I want to just provide some insights in terms of the expected time of delivery. I guess I'm just wondering how much that second half growth that you're guiding on the 10% to 15% is coming from the orderbook as opposed to, I guess, shorter term across the customer base as well?

Yes, Mitch. The orderbook does represent multiple years of orders. So certainly, with a business like Zetron that has sort of 30% of its revenues through support contracts, that means we've got multiple years in that order book number. So it doesn't all translate into revenue in H2. It'd be fair to say both of our communications businesses still have book and ship numbers that they need to achieve in the second half, consistent with where we'd normally be positioned at this time of the year. So not really anything different from where we were 6 or 12 months ago.

We've just got a couple more written submitted question. Can you please speak around what you have seen in the past around coin and metal detector releases and the types of value-added demand you get from these? Including size of the Manticore or Nox orderbooks, if possible?

Yes. We have acquired an order book for product releases. Minelab is not normally a business where an order book is relevant. So I think the only commentary that we've given is so far, all of the feedback and the commentary we're getting from our customers has been very positive. Time will tell about how successful we are over H2 with that product. But right for now, it's still relatively early in that cycle.

Next question. Can you talk through the Countermine division, how you expect this to perform in H2 and FY '24?

I think Countermine has an extensive list of opportunities in front of it. But one of the key points with Countermine, it's dealing with governments or departments of defense and it's all timely. So with Countermine we'll continue to be roughly the same size it's always been. You don't sell a significant amount of units, but the value of the units are considerable. The geopolitical environment that's across the globe at the moment is definitely helping that part of our business. But with everything, when you actually get an inquiry for a Countermine, then you need to do demonstrations, the technical view. So I think Countermine, as it's been in the past, will be a consistent contributor moving forward.

Okay. Great. I think that wraps it up for the question-and-answer session today. So maybe I'll just pass it back to you, Alf and Michael, for any closing comments.

Thanks. I would just like to reiterate that Codan is confident in its disciplined approach to achieving its strategic initiatives in the near and long term with this is a stronger Codan, but more importantly, a great global technology business. We're quite positive about the future. It's been a busy morning here, considering we had getting the GeoConex acquisition over the line. So clearly demonstrates through the presentation and through our actions that we're continuing down our strategic plan. And things are coming together. So I'd just like to thank everyone for their time today and their interest in Codan.

Okay. Thank you very much for joining today's Codan H1 FY '23 Investor Webinar. Enjoy the rest of your day. Thank you, and goodbye.