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

Hello. I'm Andy Thomis, Chief Executive of Cohort plc. And I have with me Simon Walther, who is the Finance Director. We're here to present Cohort's results for the year ended 30th of April 2021. I'm sorry that for the second year running, we're unable to do this face-to-face, as we'd much prefer to be with you in person. But we'll be very happy to answer any questions you might have in the usual way at the end. 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 6 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. But let me begin with the big picture. 10 years ago, in 2011, we were a group of 3 U.K. businesses with a revenue of GBP 65 million and profit of just over GBP 5 million. Today, we've announced revenue of GBP 143 million and adjusted operating profit of GBP 18.6 million. That's a compound growth rate of over 8% for revenue and 14% for profit. In market terms, we've gone from a [ mino ] to a midsized defense business in the U.K. context, and we punch above our weight. We provide critical operational support to the U.K. strategic deterrent and combat aircraft fleet. We're supplying the single most vital combat system onboard the Italian Navy's new fleet of submarines. We export to dozens of friendly countries worldwide. Our customers rely on us for their national security. For the first time this year, the majority of our defense revenue came from sources other than the U.K. MOD. And in 2011, it accounted for 67%. In that 10-year period, we've had no equity fundraising. We reported net funds of GBP 6.7 million in April of 2011 and net funds of GBP 2.5 million in April 2021. In between, we've distributed something like GBP 25 million in dividends to shareholders. It has not been plain sailing. We've had to deal with some problems along the way, some of our own making and some external, including the pandemic, of course. We can only expect more of the same in the future, but we've got through it so far, and I'm confident that, that can continue. I say all this as context for a set of results that again set new records for us. There aren't any big surprises. The message I want to communicate is that we have an effective strategy, we are delivering and that in some ways, the market has moved to our advantage. There's more detail to follow, but let me start with the numbers. First of all, despite the best efforts of COVID-19, the group once more grew its revenue and adjusted operating profit. That adjustment, of course, is to exclude amortization of other intangible assets, mark-to-market of foreign currency holdings and exceptional items to give what we think is a clearer picture of trading performance. Revenue is up over 9% to GBP 143.3 million. Profit is also up, but less dramatically for reasons we'll explain and EPS somewhat lower. 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 180.3 million, our second highest ever performance, taking our total order book to GBP 242.4 million. Just under GBP 100 million of that is deliverable this year. That means our good order cover was maintained and, in fact, improved compared to last year. At the year-end, it was 64% of the external consensus revenue forecast. That cover has now risen to 70% following some good early order intake. Finally, it's been a strong year for cash flow. We succeeded in beating our targets and eliminating the net debt, ending the year in positive funds. With this, a strong order book and good prospects ahead, we're very happy to be increasing the full year dividend by 10% once more. So what are the operational activities that have driven this 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 right, we saw another very strong year from MASS. It was slightly behind last year's record performance, but as usual, MASS remains the largest contributor to group profitability. At EID, we saw a much better performance than last year. It successfully delivered pretty much everything it was planning to and its margin had an uplift from improved efficiency. MCL also delivered more strongly. Towards the end of the year, we saw a real impact from the U.K.'s defense white paper with a number of programs that have previously been uncertain firming up very well. At both Chess and SEA though, we saw weaker performance this year. At Chess, the issue was tighter margins and cost growth. At SEA, it was revenue lost because of late receipt of orders. ELAC SONAR was part of the group for just 5 months but made a welcome contribution, somewhere ahead of our expectations at the time the transaction completed. As we said at the half year point, that was later than we had expected. But it was their contribution that ensured the group was in growth territory for the year as a whole. Before we get on to the financial details, I wanted to say something about recent changes in the senior management of the group. As we announced today, we're delighted that Beatrice Nicholas is joining us as a new non-executive director. In her executive career, she rose to become one of the most senior women in the U.K. defense industry. She brings wide and relevant experience to the Cohort Board, and I'm looking forward to working with her. We have several new faces amongst the senior executives below Board level this year as well. Our model emphasizes a high level of independence and autonomy for the subsidiary businesses. So the managing director roles are especially crucial to our success. Simon will say some more about some of these appointments. That's all I wanted to say at the outset. I'll hand you over to Simon now to take you through the numbers in more detail.

Thank you, Andy, and good morning, everybody. Starting with Chess. Chess has stronger revenue this year on the back of very high order intake, the growth driven by platform work for a Northern European customer, land application and multinational deployment of counter-UAV systems. Despite the higher revenue, Chess' gross margin and trading performance was down with some delivery issues encountered, which we now believe are bottomed out. We have and will continue to strengthen the management team at Chess to address its rapid growth and subsequent growing pains to ensure it delivers its strong order book and improves its operating cash performance going forward. David Tuddenham took over from Graham Beall as Managing Director of Chess at the end of the financial year. Graham was the founder of Chess and has guided it to its present stage of development. He will be staying on to lead Chess' U.S. business development efforts on a part-time basis. David has run the main parts of the business for some time. He faces some challenges, but we believe he is well-equipped to take the business forward to the next phase of growth. 2021, '22 is well underpinned at 60%, and we expect to return to growth in the coming year. EID had a very strong delivery performance driven by a large export order, some of which slipped from last year. More efficient delivery improved EID's margins and drove a very strong net margin performance. Cash performance was also strong due to timing of receipts. Frederico Lemos took over this year from António Marcos Lopes as Managing Director of EID. António had been at EID for 37 years, and we wish him a long and happy retirement. Frederico came to us from Embraer, where he was Head of Sales for a wide region covering the Middle East, Asia and much of Africa. He has already begun to make changes that we think will position EID well for the future. Deliveries to and orders secured from EID's domestic customer, the Portuguese MOD, were down, and this adversely impacted EID's order wins in 2021 -- sorry, 2020, '21. And EID enters '21, '22 with a lower closing order book. And as we previously signaled in May and repeat here, we expect EID's revenue for the coming year to be about 1/3 lower than the year just reported. ELAC joined the group in December last year and has contributed 5 months to the group's reported results for 2021. Its performance was in line with our expectations. The recent Italian SONAR win pushes ELAC's coverage of its target revenue for '21, '22 to over 90%, and we expect ELAC to grow on a like-for-like basis in the coming year. Bernd Szukay and Ole Schneider have joined our senior leadership group as joint Managing Directors at ELAC. They have effectively been in this role for some time under the distant stewardship of Wärtsilä, but they now have been formally appointed a Geschäftsführer. They also have interesting times ahead as the business rapidly builds up to deliver its most ambitious and capable system yet for the Italian Navy. As expected, MASS delivered a slightly weaker performance than last year, although only marginally. MASS remains the strongest contributor to the group. Net margins were improved due to mix, especially in its digital services division. MASS remains strong in its core markets, extending orders for its service provision into future years. 70% of '21-'22 revenue expectation is now in order and elements of MASS' current order book extends out to 2027. A good bounce back from MCL off the back of good order intake, exceeding our expectations. The improved performance was driven by increased hearing protection activity. MCL has a good opening position for '21-'22 with nearly 60% of its revenue on order and is seeing good momentum from U.K. MOD, which represents 95% of MCL's business. A cost restructuring exercise completed in the early part of quarter 2 of the financial year and achieved our expected savings to align with the expected near-term revenue levels of the business. Despite this, 2021 was much weaker than we expected with export orders or those secured coming too late in the year to impact the performance. SEA also saw reductions in its research and transport activity. The former due to completion of a 3-year program and delayed to renewal work as Dstl awaited settlement of its budget, the latter due to COVID lockdown measures reducing traffic volumes and spend priorities at local authorities being changed. On a more positive note, SEA had a record order intake and its closing order book underpinned 60% of '21-'22 revenue target. And one of its orders now reaches out to 2031. Richard Flitton took over as Managing Director of SEA this year from Steve Hill. He's an experienced MD in the defense and technology sectors joining us from L3 Harris' U.K. business, TRL. He joins at a time when the business has gone through a difficult period. But he brings clarity of vision and long experience of dealing with operational issues. We expect SEA to return to growth in the coming year. The summary income statement shows a slight reduction in gross profit margin mainly due to weaker margins at Chess. Overheads have increased, mostly due to the introduction of ELAC. The underlying group overheads are down due to savings in travel and marketing, offsetting increased headcount. This bridge summarizes what I've already discussed at length, but gives you a clear pictorial presentation. The group's EPS was down 9% despite a 2% increase in adjusted operating profit. This reduction was expected with a higher tax charge rising from 6% last year to 17% this year. This was a result of the higher tax rates applying to the profits derived from Portugal, 23% and Germany, 31% and lower R&D credits in Portugal, the latter due to timing. Going forward, we expect the tax rate in '21-'22 and '22-'23 to be around 18% and rising to 24% in '23-'24. The Chess earn-out is now estimated at GBP 2.8 million. It remains an estimate due to the working capital position of option exercise date remaining a forecast. Note the future intangible amortization, which assumes no further acquisitions. The group now has a single defined benefit pension scheme in Germany. The liability was matched by cash left in the business on acquisition. We estimate future cash flows to fund this scheme at EUR 0.5 million per annum, which is in line with the past few years and our expectations at acquisition. The scheme was closed to new entrants in December 2019. The group's operating cash flow was much stronger than we expected due to favorable timing of receipts, especially at EID, MCL and SEA. We expect this [ time an advantage ] to unwind in the first half of '21-'22. The higher other cash outflow was higher tax payments, particularly in Portugal. As already indicated, with the unwinding of favorable working capital, we expect the group to be close to breakeven funds at the 30th of April 2022. The group retains access to strong funds through investment, organic and/or acquisition. We will enter discussion with our banks in late summer, and we'll look to add a German bank to the syndicate. Thank you very much, and I'll hand back to Andy.

Thanks, Simon. The final section of our presentation covers the outlook for the current financial year and beyond. I'm going to start with a broad discussion of the market situation, then look at our order book and prospects in more detail. I'll start with our home markets, the U.K., Portugal and Germany. The U.K. is much the largest of these for us. And so we were delighted to see the scope and ambition of the Defense Command Paper published in March. The priorities are identified and its ambition were welcome news for us. Unlike some other defense reviews, this one has resulted in visible and rapid action, a significant long-term uplift in defense spending and a carrier strike group dispatched halfway around the world. The paper said that the U.K. would be more assertive in demonstrating the will and capability to confront threats openly. Last month, we saw what this means with HMS Defender in the Black Sea. Especially relevant to us are the commitment to the nuclear deterrent, increased emphasis on ISTAR, modernization of the army, more ships for the Navy and investment in new technologies like autonomy and artificial intelligence. We're already seeing the initial impact of army modernization plans at Marlborough Communications, often a bellwether for the direction of U.K. defense spending. In Portugal, we've recently seen a commitment to acquiring 6 new offshore patrol vessels for the Navy. That is good news for EID. A new army communications project has just been launched, and there is a prospective opportunity to supply a substantial number of the new ICC-401 intercoms as part of an upgrade to Portugal's armored vehicle fleet. Portugal does face spending challenges and winning orders can be a slow process, but relationships with the Army and the Navy are good, and we see some significant prospects in the year ahead. Germany is a new domestic market for us. The Bundeswehr sees ELAC as a strategic supplier of secure underwater communication systems and the substantial uplift in naval spending announced recently will underpin more sales of this important product. It's worth mentioning that both EID and ELAC have a strong export focus. And it's likely that this will continue in the years ahead. Looking 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. China has recently completed a massive new submarine construction facility on the Yangtze River near Wuhan. That seems to be a center for unwelcome exports of all kinds at the moment. China's submarine fleet is already the second largest in the world and it's growing fast. The largest, by the way, is North Korea. They have new, quiet conventional submarines, increasing numbers of nuclear submarines. And this year, they launched the largest submarine in the world capable of carrying 48 ballistic missiles. Chinese naval investment is having an electrifying effect in the region and as substantial knock-on effects further afield in Australia, for instance. SEA, EID, ELAC and Chess all have world-class maritime systems offerings that are directly relevant to customers 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. Our businesses also offer valuable capabilities for dealing with advanced threats from land, sea and air from the likes of Russia. We're providing systems to help deal with those threats to customers in Europe, North America and Australasia. Overall, we believe we're well positioned to meet the current and evolving customer requirements. This chart shows the run-off 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 major service contracts. With an excellent run of recent wins, SEA now also has a very strong long-term order book. Similarly, Chess has transformed its long-term revenue cover over the last year with some very good wins. MCL, as always, has the shortest term order book though it's much better positioned than it was this time last year. Based on the chart, ELAC, our new business seems to have rather a modest order book, but that position has been transformed with the recent EUR 49 million contract to supply the Italian Navy. The only one of our businesses that gives cause for concern is EID where the order book is long term, but very thinly spread. There are some good opportunities ahead though. Frederico and his team are working hard to identify and convert more of these. This slide shows the picture for FY '22 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. Chess, MCL and SEA are all in a stronger position. MASS is more or less in line. Only EID is materially behind. The GBP 50 million of new orders we've received since the beginning of the year have made quite a difference in this picture. ELAC, in particular, is in a much stronger position as a result. We are now up to 70% order coverage for FY' 22, slightly behind the 75% we achieved at the same time last year but a strong position, nevertheless. A quick look at recent orders and prospects. I've mentioned the strong performance at the beginning of the year. Looking forward, we see a lot more short-term opportunity. I would single out the unusually large opportunities we see at MCL. We've been looking for a way to provide more long-term stability for MCL for some time and we now see what could be a clear route to achieving this. Of course, there's no guarantee we'll land all of these opportunities, but we believe there is reason to be optimistic. And alongside these prospects, I should 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. The GBP 3.6 million mentioned here is significantly less than the total spend on innovation since a lot of new product development is funded by customers. With the majority of our businesses now focused on product and systems, we have development road maps in place. And of course, the details of these are commercially sensitive. But here are some examples: submarine detection systems at SEA; new functionality for Army and Maritime systems at EID; development of software and countermeasures technology at MASS; improving our automatic target recognition at Chess; and a new generation of sonar transducers at ELAC. MCL is also looking at some major organic growth opportunities. In this case, turning it's 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' 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 want to leave you with: the strong order book and order cover, the good market positioning and continued growth to look forward to. I began with a review of progress over the last decade. As I said, it wasn't all plain sailing, and we had to adapt and change course as the situation evolved. I don't expect the next 10 years will be any less challenging. But equally, I don't think our development will be any less dramatic. We have a well-tested strategy in place based on organic growth and carefully selected acquisitions. At some point, we will need to think about whether the current decentralized structure is right for an ever-enlarging group, but we have a considerable way to go before we reach that point. We've added new and fresh capability to our Board and senior management teams. Our market environment has developed gradually but significantly to our advantage over the last year and is certainly much more promising now than it was in 2011. And last, I have no crystal ball, but I see exciting long-term opportunities to create a major independent U.K. defense technology group, offering world-class systems to domestic and export customers alike. I will leave you with that thought. But if you have any questions, we'll do our best to answer.

[Operator Instructions] We can now take our first question. It comes from Afonso Osorio of Peel Hunt.

It's Afonso Osorio calling from Peel Hunt. Congratulations on your very nice results and presentation. I have 2 quick questions for you this morning, if I may. The first one is on ELAC and the contract being announced this month. Can you provide a bit of color on the revenue profile for the next few years? I think you mentioned that the contract will go until 2030. I was curious to know how that contract will evolve in the next 3 to 5 years, if possible. And secondly, on the COVID situation here in the U.K. Are you seeing any impact on -- of the so-called pandemic on your business? Those are the 2 questions.

Thank you, Afonso. Simon, I'm going to ask you to [ talk ] about the revenue profile of the order from ELAC.

Okay. Afonso, what we're looking at is that for the coming year, so for '21-'22, the year just started, we estimate revenue of around about GBP 5 million from the project. That will stay relatively steady through to around '24-'25 when we actually start delivering the first major systems to the submarine. And then I think the second submarine is going to be delivered towards the back end of the period you talked about. Obviously, although you have a plan to these things, [ it won't ] always turn out as you expect. And -- but that's the current estimate. So it's a reasonably quiet start. It will ramp up a bit and then it will get quite heavy in the middle and then tail off as it gets towards the end. There is -- importantly, I think you mentioned there's an option...

Yes, 2 more submarines.

Two more submarines, which would, I think, run into the mid-20s, 30s.

Yes. Okay. So I hope that covers that part of your question, Afonso. The second part, the answer is not yet. And we hope we won't. The -- we've been -- I'm pleased to say that we've weathered the COVID storm quite successfully. We have had some incidences of COVID infections amongst our employees. Very sadly, we've had one fatality, and we also had people whose families have been affected very severely by this, which is very sad. But our people have soldiered on remarkably well [indiscernible] circumstances, and I'm very grateful [ to them ] for doing that. What we haven't had is any incidents of transmission as far as we're aware. Actually in the workplace, we've adopted some strict rules in relation to workplace hygiene and transmission measures including reducing the number of people on the floor present at a time and having people working from home as far as we possibly can, which is [indiscernible] a significant extent. Whether we -- [ I've certainly read ] about the pandemic and the implications of that. But I'm happy to say that so far, we've not been materially affected by that and I hope that continues. But maybe more of an impact as we go into the holiday season now. But because many of our people in any case work [ from home ], being [indiscernible] or not affect their ability to continue to [indiscernible] and that I'm very happy to say the current situation seems much less likely than it has [indiscernible]

We can now move along to our next question. It comes from Annabel Hewson of Stifel.

Just 2 questions from me, please. First one is around contract size. You're clearly winning more substantial contracts, which is great for forward visibility. But can you remind me what the sort of threshold value is on contract size to sort of really get sort of your central approval in terms of is there a level that smaller things don't need your sign off? And secondly, just around SEA and submarine systems. [ Walther ] mentioned the Dreadnought in the statement. When can we sort of really sort of start to see submarine systems within SEA sort of start to sort of take the steps back up again that we've seen sort of stepping down since 2017?

Simon?

Yes. Annabel, on the first question, the current limits are...

Varies, varies.

It does vary slightly. There's -- for Andy and myself, the [ sign off ] I think is GBP 5 million. It does vary obviously into euros and some businesses have it slightly higher, where we see a lower risk. And then for the Board approval, it's GBP 7.5 million. So that one obviously needed full Board approval. We are seeing more and more of our current bids having to come up to our level for approval.

And which is good news, I think. The Dreadnought, which is when we expect to see submarine [indiscernible] back up.

Well, yes. Yes, the Dreadnought, I mean, it has started. It's not -- it's been a bit slow. We are waiting for some more work to come on that. I mean -- well, fortunately, our system has proved to be quite a low risk element to the submarine program, which means that the focus has been on the more risky elements and they've held off [ basically committing spend ] for our systems. So at the moment, I think we are starting to see more U.K. submarine activities, in probably the next 18 months to 2 years, we'll start to see that coming up again. Whether it will get to the sort of peaks that we saw in the mid part of the last decade in sort of 2015, '16, where we were running at GBP 25 million a year. I wouldn't say at this stage with more volume, obviously, more skewed to submarines. But that's what we expect. But we have got some export opportunities that we're currently executing in SEA and submarine market as well. Does that help you?

And just a follow up, sorry, on the first question really is some of the contract issues we've had at Chess, was that just taking on something a little bit larger in the context of their business? Or just -- was it more of a technological challenge on that side?

Well, let me [ handle ] that one, Annabel. The answer is I suppose you sum it up in terms of growing pains, really. And what we've seen with Chess is that it's been taking on -- and as time will tell, [ it has been able to take on ] large contracts that it's done before and it's been able to successfully compete and win those. And overall, it's delivered pretty well. But I mean there is some change required as it grows from essentially a privately owned [ founder run business ] into one which is -- which has the necessary processes and [ management always really be able ] [indiscernible] We've done a lot last year [indiscernible] about management considerably. Most recently, with our new Managing Directors taking over [indiscernible] business development. So we believe that the current issues [indiscernible] projects have been [ bottomed out ]. And that's not to say it won't anymore in the future, but it's very much in the process of transformation into a larger business that can successfully deliver [ as well as ] revenue, substantial growth.

We can now move to our next question. It comes from Ben Bourne of Investec.

Given the strength of the balance sheet, please can you update us on the acquisition pipeline, specifically, have vendors' pricing expectations changed in the last 6 months? And if you think perhaps [indiscernible] combination might offer some spinout opportunities?