Cohort plc (CHRT.L) Earnings Call Transcript & Summary

Hello. I'm Andy Thomis, Chief Executive of Cohort Plc. I've got with me Simon Walther, who's the Finance Director. We're here to present Cohort's results for the year ended 30th of April 2020. I'm sorry, we're not able to do this face-to-face, but I hope that this virtual presentation will serve as a good substitute in the current difficult circumstances. The format of the presentation will be familiar to those of you who know us. I will start with an overview of the group results. Simon will then flesh that out with more financial detail, covering the performance of each of the 5 subsidiaries: the balance sheet, cash flow, banking and tax matters. I will then return to talk about the group's market position and the outlook for this year and beyond. So let me begin with the highlights. First of all, despite the best efforts of the COVID-19 virus, the group grew its revenue and adjusted operating profit again to record levels. That adjustment, of course, is to exclude amortization of other intangible assets, mark-to-market [Audio Gap] of foreign currency holdings and exceptional items to give what we think is a clearer picture of trading performance. GBP 18.2 million is a 12% improvement on last year, and the adjusted EPS was up 10%. That was on the back of an increase in revenue of nearly GBP 10 million to GBP 131.1 million. Simon will unpack the detail of that in a few moments. Another important highlight is the order book and the revenue cover that gives for this year. Order intake was GBP 124.4 million. Now that was lower than last year's record level of GBP 190 million. But last year included several multiyear contract renewals, with a value in total of around GBP 70 million. Taking that into account, order intake and order book have held up well. The GBP 7 million drop in order book is much less than the runoff of those long-term renewals. The result is that looking at the external consensus revenue forecast, we have much better order cover this year, 62% compared to 55%. And by the way, that has now risen to 75% in early July. Finally, it's been a strong year for cash flow, resulting in lower net debt. With this, a strong order book and good prospects ahead, we're very happy to be increasing the full year dividend by 11%, broadly in line with the growth in adjusted operating profit and EPS. So what are the operational activities that have driven that financial performance? Simon will provide the detailed numbers in a few minutes. But in broad terms, these are the main factors. Starting at the top left. We saw a full year of Chess's contribution, compared to 5 months last year, and that was a major factor in driving the growth of the group. At MASS, we saw another record performance with strong revenue and profit and we saw a big turnaround in performance in EID after a disappointing year last year. Those improved contributions were partly offset by weaker performance at MCL and SEA. Both saw reduced revenue and profit. At MCL, that was a result of changes in customer plans and projects. And at SEA, the prime cause was delays in winning export contracts, and there was also some impact from COVID-19. Overall, though the group result was positive, SEA's performance was disappointing after a better result last year. Without the full year contribution from Chess, that would have taken us into negative growth territory. We've begun a cost reduction program there to improve utilization and bring overheads back into line with expected revenues. I mentioned COVID-19, and I should say a little more about the impact of that in 2020 and beyond. We're guiding that 2021 performance will be broadly in line with 2020. In March, when it became clear that the pandemic was taking hold in the U.K., our first priority was the safety of our employees, customers and partners. Our businesses acted very rapidly, helped by our devolved decision-making structure. And in a matter of hours, we were able to arrange for about 70% of our employees to work from home and put in place special hygiene measures to protect those who could only carry out their tasks on-site. The measures were effective. I'm happy to say that we've not had a single confirmed case of COVID-19 across our workforce of about 950, although it's likely that there were a few mild cases at the peak of the epidemic. We're now gradually and carefully reversing this process and bringing more of our employees back to the workplace as the restrictions are lifted. I expect this process to continue, but it is highly dependent on whether and how the government's advice develops. One concern for analysts and investors, not to mention auditors, is liquidity. We considered this carefully as a Board this year. We are comfortable that we have no liquidity issue, taking full account of the planned final dividend payment. Simon will say more about our banking arrangements, but we have more than adequate facilities and covenant headroom. The impact on our own operations has been modest. Working from home has, in the main, been very effective. And by introducing new shift patterns, we've been able to maintain engineering and production capacity close to normal levels. The main impact has been on customers' ability to place new orders and to accept deliveries. There have been some issues with the supply chain, but nothing material. We estimated the impact as about GBP 3 million of revenue and GBP 1 million of operating profit in 2019/'20. We'll catch up most of those delays in the 2021 financial year. But we have seen the impact continuing into our first quarter, which is one reason why we're being relatively cautious with our guidance. Of course, we can't predict the likelihood of further lockdowns at this stage, so we'll keep a careful eye on how things develop over the year, and update if necessary. I mentioned earlier the acquisition of ELAC. As a reminder, they are a highly capable sonar business based in Kiel, Germany. It's a good deal for buyer and seller as the business has some ambitious expansion plans in areas that are out of kilter with Wärtsilä's strategy but are very well aligned with ours. Adding them to the group will develop our maritime systems offering, which currently spans EID, Chess and MCL. We're gradually becoming quite a serious player in that part of the sector, which is where we expect to see global growth over the next decade. They bring new technologies and customers to the group, and we do the same for them. The transaction requires German government approval as they see ELAC's capability as strategic. COVID has had an impact on their ability to process this, but we are in dialogue, and it is clear there is no objection in principle. It's hard to predict the timing, but if we are able to finalize arrangements with the government in the next month or so, which I think is reasonable, we'll be able to complete no later than the end of September. And that's the end of my overview. I'd like to invite Simon now to talk to you in more detail about our financial performance.

Thank you very much, Andy, and good morning, everybody, and it is a shame that we can't see your smiling faces on this morning. Although for me, it does mean getting up at a slightly more reasonable hour than my usual 4:00 start on these days. I shall, as Andy has touched on, I shall go through each of the divisional reviews and then go more into the financial statements. So I'll get underway, I'll start with Chess. Chess had a very good year for us, a better-than-expected performance with higher sales of naval systems. It was an improvement on a like-for-like basis, that GBP 25.2 million compared with GBP 22.9 million for the full 12 months ended April '19. We obviously only reported 5 months last year. The revenue itself was dominated again by export customers, including the U.S. Department of Defense, for which we sell our counter-drone system. We continue to, as we've said last year, to invest in Chess in terms of its processes and procedures and particularly its people. And in the first quarter of this year, it's added in 2 new directors, one in operations and one in project. And the important thing, and you would have all seen this from our recent announcements, the order book for Chess has been very strong recently, with wins both in Northern Europe and in other parts of the European market. The order book now for Chess is such that the coverage for the coming year revenue stands at over 80% for the business. So we expect Chess for the coming year to produce a very similar performance to this year. Moving on to MASS. Well, what can I say about MASS? Again, our strongest performing business, another record year, both revenue and operating profit were up. A very strong operating cash flow at MASS, which was boosted by the MOD's accelerated payment scheme in response to COVID-19. Some of our invoices are actually paid within 2 to 3 days of presentation. We do not expect that to be repeated in the coming year, and I'll guide on the cash a bit later. Very importantly, and you'd have seen earlier this month, we won the extension to the Strategic Command contract that MASS has now been delivering for over 15 years. And that, along with the order book, gives visibility in the coming year of approaching [ 90% of ] our revenue expectations and very good visibility for MASS beyond 2023. Moving to EID. After a disappointing year last year, in part because of a very large delivery that slipped out of the back end of last year into the early part of this year, EID has produced a much stronger performance and in line with our long-term expectations, especially in terms of the operating margin. The actual revenue was driven partly by the export business that I touched on earlier, but also a stronger performance from the Portuguese MOD, with over half of EID sales in the year just finished to its domestic customer. It's got a strong order book of over GBP 36 million, giving coverage for over 90% of its revenue for the coming year. And we expect that the -- that revenue for this coming year will again be dominated by export but there are some key long-term Portuguese orders to be won in the coming year, which will give it better visibility going forward. Turning to MCL. MCL had a slight blip. As we've always said, it's a rather difficult business to predict. Its visibility is typically 3 to 6 months at any point. And as you can see here, the revenue was down and the operating profit down as well. After a period of growth, this is disappointing. But the main reason for this was that '18/'19 saw some large deliveries on its hearing protection systems and [ into ] U.K. submarine programs. As expected, we didn't -- we knew that these wouldn't be repeated. But some work that we did expect to happen, unfortunately, the customer changed their plans. There were some order delays and delivery delays. And in fact, this is what we saw at MCL. MCL's order book for the year-end of GBP 9 million gives similar cover to what we entered the year just finished. But the important thing for MCL is we are starting to look at some very long-term prospects for it, particularly with the U.K. Royal Navy, that should give us both improved growth, sustained growth and better visibility going forward. Turning to SEA. This was our most disappointing performance for the year. After a very good year in '18/'19, the revenue was down as a result of delays to export orders which we expected to come in. And these have slipped, we expect them to be this year, although, again, predictability of these is never certain. The profit, as a result, was impacted more markedly by lower utilization and overhead and we are already implementing a cost reduction, which we expect to see completed before the end of this month, which we expect to deliver around GBP 1.3 million of annual savings and will cost us around GBP 700,000, which we will recognize as an exceptional item in the first half of this coming year. There have been some positive developments at SEA in terms of its research activities continue to grow, particularly in naval research. Submarine communications, after a number of years of diminishing, is looking to return. The Dreadnought program is getting underway. And you'd have seen it also secured some work for the Australian submarine program. And that was just the initial piece of work, which we expect to last for many years. And it completed a trial with the Portuguese Navy in tandem with EID on a new anti-submarine warfare system that we look to -- we will look to develop further this year in tandem with the Royal Navy on their Type 23 frigate. SEA's order book actually for the year is reasonably good and underpins 50% of the revenue for the coming year. We entered last year with only 30% on cover. So it's a better position, but we still do need some export orders for this coming year. And although we are better positioned on those, timing does remain unpredictable. Moving to the income statement. Obviously, I've spoken about each of the divisions already, so I won't go through all that again. The important points to bring out here is: one, the gross profit, which is stronger, reflecting the higher level of products delivery that we now have as a group; the exceptional item, which comprises 3 items itself: the acquisition of ELAC, which is just over GBP 900,000; the relocation of MASS's Lincoln office [ which ] about just under GBP 600,000; and the change in the earnout on Chess, which is around GBP 750,000. And I'll talk about that in a bit more detail. One important point I'd bring out here, the year we've just finished, our split of revenue between H1 and H2 was 46% H1, 54% H2. For the coming year, we're expecting that to sort of retrench a bit to more historical levels, with a sort of 40-60 H1-H2 split. What we've got here is a bridge. I mean, this really is just an illustration of everything I've just talked about, and I don't plan to say any [ point ] on this really, but it's quite a useful graphical representation of everything. Moving to the earnings per share, for those of you who have an interest in this level of technical detail. The 10% increase in adjusted earnings per share, whilst we [ had but ] a 12% increase in adjusted operating profit, is really because the growth has been driven by our part-owned businesses, Chess and EID, and to a certain extent, a lower tax charge. Whilst the 100%-owned businesses, as you can see, have come back a bit, they're weaker. And also, the interest charge has gone up. That includes the impact of IFRS 16, which I will talk about shortly. In terms of the balance sheet, I already mentioned that the Chess earnout have been adjusted. We now expect to pay GBP 4 million on or before the 31st October 2021, that was GBP 5.5 million last year. The amortization of intangible assets, the analysts amongst you, just to show you what's going ahead. Obviously, when ELAC completes, that number will jump up going forward. And finally, IFRS 16. That added nearly GBP 7 million to our fixed assets and GBP 7.5 million to our debt. We do not treat that debt as part of our bank covenant test debt. That's the way we've agreed it with the bank. So they stick to the original accounting principles. And just for conclusion on that, the impact on the profit statement was just over GBP 200,000 was added to the operating profit, just a bit more on interest, and the net effect was about GBP 50,000 reduction in profit before tax. In terms of the cash flow, well, this was better than we expected. We were expecting a level performance for this year compared with last year, but we actually got, as I've touched on at MASS, some accelerated receipts from the MOD. But more interesting probably is the outlook for the next year, which shows the opening net debt really closing at around the same level. All of this is on the assumption that ELAC has not yet completed. Obviously, when that completes, these numbers will all change. Moving to the final slide. On our banking, you would have seen that we've actually increased our facility recently by GBP 10 million to a total of GBP 40 million, of which we've got GBP 15 million available. Obviously, most of that will be used for the acquisition of ELAC, which in itself, when we complete, is expected to bring significant cash balances with it. Now I will hand back to Andy. Thank you.

Thank you, Simon. The final section of our presentation covers the outlook for FY '21 and beyond. I'm going to start with a broad discussion of the market situation and then look at our order book and prospects in more detail. I'll start with our home markets. Those are the U.K. and Portugal, of course, at the moment, and they'll soon include Germany too. In the U.K. after it was kicked into touch because of COVID, the defense review is underway again. Like the first swallow of summer, one can always tell when this is happening, when interservice rivalry reaches the pages of the Daily Telegraph. I'm not going to make predictions about the outcome at this stage. There are too many irresistible forces and immovable objects around for that. Amongst all the noise, though, there are some points that are clear. Firstly, there is pressure on public spending, but there are also strong political reasons for the U.K. to maintain its internationalist stance underpinned by a strong defense. Brexit, the desire to widen international trading relationships, and increasing tensions with China and Russia are 3 of those. Secondly, judging by what he's actually written, Dominic Cummings is not a defense or security skeptic. He has strong ideas on the impact of new technology on security. But a challenge from that direction, in my personal view, is no bad thing. Finally, Cohort's MOD revenue comes from major training exercises, the submarine program and from ISTAR, that is electronic intelligence gathering. It's not impossible that all of those will be cut in the defense review, but it would be a very radical review indeed if they were. So we do expect change as with any defense review, but not fundamental change of a kind that would alter the basis of our relationship with our U.K. customer. In Portugal, the relationships with the Navy and the Army, our main customers, remain good. Winning orders can be a slow process, but we've done well in Portugal in recent years, and we see some good prospects in the year ahead. Both the U.K. and Portugal have rapidly increased public spending to ease the financial impact of their COVID-19 lockdown measures. We can't rule out public spending constraints when the bill comes in for that, and that may be a headwind for us in the years ahead. As I've mentioned, though, it's not the only factor in decisions about defense spending. Looking further afield to export markets, we don't see any change to the long-term drivers of demand. Tensions with Russia and China and with Islamist paramilitaries of all stripes are continuing. In the last year, we've won orders for systems to combat or deter all 3 of these, and we expect that to continue. I mentioned our growing maritime systems capability. SEA, EID and Chess all have world-class offerings as does ELAC, and these are directly relevant to countries that are feeling challenged by China's expansionist policy in the South China Sea. We see good opportunities to build on our existing relationships with Thailand, Indonesia, the Philippines, Vietnam and Malaysia. Finally worth mentioning is that we see very good opportunities with some established first world customers. Historically, we've had some success in these markets, but it's been hard to beat larger, established regional or U.S. players. But we've worked hard to build customer relationships, and we know our offerings are attractive in terms of price and performance. We're starting to see real signs of success in some larger programs in these countries. Overall, although there are risks as well as opportunities, we believe we're well positioned to meet current and evolving customer requirements. This chart shows the runoff of our order book for the next 3 years and beyond. As you can see, MASS has the largest and longest term order book based on its large long-term service contracts. EID also has significant long-term order cover. SEA has a solid order book for the next 3 years, but Chess and MCL fall off rather more quickly. Now that's not untypical, although Chess's situation has developed significantly since the year-end. This slide shows the picture for financial year 2021 in more detail. If you look at the second and fourth columns, you'll see the order levels for the current year compared with the situation at the beginning of last year. It's clear that the overall picture is better this year, in absolute terms as well as in relation to the external consensus forecast. EID and SEA are both in a much stronger position than last year. MCL is in roughly the same position, MASS is slightly behind and Chess is some way behind. However, as you may have noticed, we've been in a busy period for contract awards. In fact, we've received more than GBP 50 million of new orders since the beginning of the year. Those have been particularly concentrated at MASS and Chess, and so the position at both has improved markedly. We're now up to 75% coverage for financial year 2021, considerably better than the position at this time last year. A quick look at recent orders and prospects. As I mentioned, we received over GBP 50 million worth of orders since the beginning of the year. Chess has had a particularly good start, with a land-based surveillance system for use in Northeast Europe; and a counter-UAS order for an international organization for use in Asia. We've also seen the JCAST training activity extended yet again at MASS, and a mixture of smaller orders, some quite substantial but below our GBP 3 million announcement threshold. Together, these have pushed the group order book, and we will recover up very substantially. Looking forward, we see a lot more short-term opportunity. Of course, there's no guarantee that we'll land these, but we believe there is reason to be optimistic. And alongside these prospects, I ought to mention that our strategy to grow through acquisition remains in place. We continue to be interested in businesses that can join as new group members, or which we can integrate with one of our existing portfolio. We're continuing to invest in innovation to support organic growth as well. The GBP 2.7 million number there is significantly less than the total spend on innovation, since a lot of new product development is funded by customers. But here are some examples in the bullet points: submarine detection systems at SEA; new functionality for Army and maritime systems at EID; development of software and training systems at MASS; and automatic target recognition, driven by artificial intelligence for Chess. MCL is also looking at some major organic growth opportunities, but in this case turning its existing skills to larger scale activities and supporting Royal Navy ships and submarines. That's a good example of where customers have confidence in a business's ability to deliver at a larger scale when it's part of a well-resourced group like Cohort. So to conclude, these are the main points I wanted to leave you with: As we've shown, the group's order book is strong, and there's every reason to be optimistic about further order opportunities this year. Already, we have 3 quarters of the external [ fall ] grant revenue on order. There's still work to do, but we're in a much stronger position than at this time last year. The group's offerings are aimed at meeting customers' needs in markets that are growing and that are driven by real threats and challenges: Russia in Northern Europe, China in Southeast Asia, fallout from proxy conflict around the Middle East. The impact of COVID-19 has been manageable, but it has affected customers, and we can't be certain how long it will persist or whether some of the lockdown challenges will recur. On balance, we're guiding that we expect a steady performance in the year ahead. We will update that guidance if circumstances change. Looking in the longer term, we expect to return to growth in the 2022 financial year and beyond as delayed programs come back to life, and we see a strong contribution from ELAC. Thank you very much all for your attention. I hope you found that interesting. If I can just leave you with our concluding remark, which is that we are guiding towards similar performance for the current year. We will update that guidance -- as I've mentioned, we are living in a period of uncertainty, so we'll update that guidance if necessary and appropriate, and we're looking to return to growth in '21, '22 and beyond. Thank you very much, indeed.