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

Okay. Well, good morning, everybody. Nice to see it for, that's great. In case anyone doesn't know, I'm Andy Thomis, I'm the Chief Executive of Cohort plc, and I'm here with Simon Walther, who's the Cohorts Finance Director, to take you through the results of our financial year ending April 2024. You might be interested to know that the picture you can see there is the assembly of SEA's [indiscernible] sonar going on at the factory in Barseball. So I'm going to start by giving you the highlights of the results that we're announcing today. Simon is going to give you more detail, including a divisional breakdown. Then I'll come back with some comments about the demand picture and about our future prospects. And I'm happy to say that overall, we've once again seen a very strong performance, record operating profit, record revenue and a record closing order book. So here are the numbers. As I said, revenue and profit both up very strongly above market expectations. And we hit two what I'd describe as major milestones in our development as a business. For the first time, we exceeded revenue of GBP 200 million, and we exceeded profit of GBP 20 million. More specifically, as you can see, revenue grew by 11% to GBP 202.5 million. Adjusted operating profit and adjusted EPS also grew strongly to just over GBP 21 million and 42.9p respectively. And those are all record new numbers. And as I mentioned, it was a strong period for new orders. So the order intake of GBP 392 million significantly exceeded the revenue that we recognized. And so the order book grew nearly to GBP 520 million at the year-end. And at that point, that meant that 90% of the consensus forecast revenue for the current year was already on order at the end of April. And our strong order winning run has continued since then. And we've just had another announcement today, in fact, which means that we've taken in something -- well, north of GBP 90 million worth of orders since the year-end. And the order book has grown commensurately, won over GBP 560 million. Well, it should be an extra GBP 20 million by now, Simon. So I'm guessing GBP 580 million by now. And that gives us more than 95% cover for the year as a whole. Finally, worth mentioning the cash performance was also strong. The end of year cash position was much better than we'd expected with net funds of over GBP 23 million. So against that background, the Board was very pleased to be able to recommend a final dividend of 10.1p and that means that for the full year, we've grown the dividend by 10% once more. Now Simon is going to give you a more detailed breakdown of the performance of the divisions, but this slide shows the main factors behind the improvement in the group's performance. And overall, it was the sensors and effectors division that was the driver of revenue and profit growth. Communications and intelligence actually performed slightly behind where they were last year. So in the Sensors and Effectors, Chess and SEA generated the large improvement in operating profit. And one factor in that was a generally positive demand environment, and that was coupled to the fact that we had good products that we've developed to meet what the market needed. And the most notable example of that in the year was the selection by the Royal Navy of SEA's Ancilia product to protect its surface ships. There was an especially strong turnaround in performance at Chess. They exceeded our expectations for revenue and profit in the year. And that was a demonstration of the success of the operating improvements that have been made by the Managing Director there, supported by Simon and myself, and we continue to target further improvements there. ELAC continued to trade its large Italian submarine contract with a degree of caution. But again, it performed well as a business. The Italian submarine sonar, we passed its critical design review and has now moved on into the production phase. Looking at communications and intelligence. The main swing factor there was MCL, returning to a more normal level of performance after the exceptional year of 2022, '23. MASS returned to growth and hit new records of revenue and profit despite being hampered by supplier delays on one of its major contracts. EID had again a disappointing year, making a small loss for the year as a whole. But the good news for EID is that towards the end of the year and at the beginning of this year, it succeeded in bringing in several really important orders with a total value north of EUR 45 million and that bodes well for them for a better year in 2024, '25. And finally, I should mention a small acquisition made by MCL. It's a company based in knaresborough, Interactive Technical Services, ITS. It specializes in providing the support documents that defense customers need when they buy new equipment. And that's a capability which is often contracted out by equipment suppliers and MCL has been itself a frequent user of ITS' services. And we believe that, that acquisition will enable ITS to expand its offering and MCL to offer a fuller service to its customers. The acquisition was completed in May, and it will make a positive -- modest but positive contribution to our trading this financial year. Now as well as delivering successfully in 2023, '24, we have also improved our strategic position for the long term. The demand drivers have remained strong. I'll say more about this, but the world is not showing any signs of return to stability. If history ever did stop, it's clearly restarted again. And that backdrop has led us to invest in new technologies to enhance our growth prospects. And our R&D spend as a result was up very sharply this year. The larger and longer order book speaks for itself. Our book-to-bill ratio was over 1.9 last year. And that momentum, as I've mentioned, is continued into 2024, '25. And the result of that is that we can maintain our growth prospects for the current year with some upside as well from the ITS acquisition, which, as I say, we expect to be modest in size, but positive and accretive to. And thereafter, the positive strategic picture enables us to target further progress. Now I'll say more about all of these points later in the presentation. But for now, I'll hand over to Simon, who's going to take you through the results in more detail.

Thank you, Andy, and good morning to you all. And it's a fine morning. Firstly, turning to the overall income statement. As Andy has already said, and I reiterate, we've had a record full year trading performance for the group. The higher revenue was driven by Sensors and Effectors and as expected, gross margin has recovered from last year. Again, mostly due to the Sensors and Effectors division. As a result of the increase in our order book, we continue to invest in our people, and a trend we showed at the half year. And we now have a rising head count from last April, where we were just at 1,100 people to now just over 1,300, a 15% increase in headcount this year. In fact, over the last 3 years, we've increased the headcount in the business by 30%. Most of the increase in people has been in direct staff, specifically engineers. The cost of recruitment, training, general people investment has driven much of the overhead increase with balances in things like the business development, especially the DSEI show last September and the general investment in Chess and SEA, where we've seen the largest order book increases. I'd like to, at this point, particularly for the analysts in the room, to guide that the tax rates we'll be looking to apply to our adjusted earnings for the coming year will be just below 20% and for the 2 years after that, just above 20%. The overall operating margin for the year at 10.4% was in line with last year. But looking forward, we are targeting a steady rise over the next 3 to 5 years to a low to mid-teen percentage for the group. Firstly, the Sensors and Effectors division. This saw a 24% increase driven by a 38% improvement in trading profit -- sorry, driving a 38% improvement in trading profit. The revenue increase was mostly at SEA as it started to deliver on what was a strong order book at the start of the year and obviously has improved greatly this year. The improved operating margin, as Andy said, was down to Chess, which, as we stated last year, has closed out its problem legacy projects and delivered an operating margin now of over 10%, which last year was only 2%. At ELAC, we completed the critical design stage on the Italian sonar contract and have now entered production of the first shipset. We continue to trade margin prudently on this project, and we expect to deliver that first shipset in '25, '26. ELAC's figures also last year benefited from the last payment from Wartsila, which was part of the deal. That obviously has not been repeated this year. And if you exclude that item, the underlying operating performance of ELAC was up 25% on a similar increase in revenue. SEA as expected, delivered more revenue, but its mix was weaker. We have a greater subcontractor effort, especially for delivery to an OCs customer. The order cover for this division for the coming year is over 95% with good prospects for further orders on some of our key products, including counter-drone systems at Chess. We expect this division to continue to grow in the coming year. with net margin set to approach 12% as against just under 11% for this year. Moving to Communications Intelligence. This division had a weaker year. what was after last year an exceptionally strong performance. The revenue drop was at MCL, which delivered exceptionally high levels of hearing protection into comps to the MOD last year and has now returned to what we see as more historically normal levels. EID's loss for the full year was lower than last year due to continued delays through significant orders in Portugal. And as you saw, we announced on Monday. Some of these have now been finally secured. We do expect the EID to have a better '24, '25 but it still has some way to go to achieve the historical levels of performance, including operating margins that's achieved over 20% and more importantly, to achieve that on a sustainable basis. MASS delivered a stronger result than last year. The weaker net margin for this division was mostly due to the volume drop at MCL. Order cover for this division is also now around 95% following these recent order wins. Historically, this division order cover is lower than Sensors and Effectors due to the short-term nature of some of the work at mass and especially MCL. So I'm pleased to say that 95% is a very strong position at this time of the year. Again, we expect this division to deliver a stronger performance in '24, '25 and a margin of around 16%, which we think it should sustain in the longer term. Now I'm going to move to some pictures. Now Ben was with me when I think we visited to see this hole that you see there on the right. That is the hold into which the test tank for ELAC's new facility was going to go. And you go -- a pretty good example there of the inclement weather of last winter in Northern Germany, which held up our expenditure on the factory and progress. However, it's now back on track, and this is the site as of Monday morning. And you can see that on the right there is the hole has been filled in, and you'll see the top of the tank, which is approximately, I think, around 9 meters deep and 9 meters wide in length. So I think Anne mentioned it's going to be used by the German dive-in team. The facilities themselves, you can see the foundations now being laid. I mean, overall, we remain on track to complete this facility in the summer of '25 and to start the move from the current site to this site over the sort of autumn into the winter. We now estimate the total cost of this new facility will be around about GBP 19 million and that spending will complete in '25, '26. Finally, moving to the net funds for the group. I mean, what was a very good H1 performance was very much repeated in the second half, and we ended up much stronger than I expected. That's partly due to the delay to the CapEx spend in Germany because of the inclement weather. And that will be caught up with over this year, and you'll see at the bottom, my guidance on CapEx spend for the next 3 years GBP 17 million, GBP 7 million, GBP 5 million. Of the GBP 17 million, around GBP 12 million is on the German site. So -- and it's a little bit runs into '25, '26. We then revert to what I would call is a long-term run rate for the group of GBP 5 million. In terms of other operating cash, Sensors and Effectors particularly SEA had a very strong performance this year with customer advances funding some of their work. We do expect that to unwind a bit this year. And so overall, I am guiding towards closing funds of around GBP 15 million for the end of this year. But summing up, -- it's been an encouraging start to '24, '25, and growth expectations are maintained, and I think we've got strong momentum, at which point, I will hand back to Andy.

Thank you, Simon. So that covers the year just passed. Now I'm going to talk about the outlook. And I'll start with the broad market position. Then I'll talk about some of the investments that we're making in new products and technology to maximize our opportunities. And I'll show you then how our existing order book runs off over the coming years and how it's developed over the past 12 months. So let's start with the demand picture. The two main driving forces for demand for defense equipment haven't changed over the year. The continuing conflict in Ukraine is one and the influence of growing Chinese assertingness from the Indian Ocean right across Australasia is the other. And to add to those, since October last year, there has been the developing violent conflict in Gaza, and the related instability in the region, particularly in the Red Sea. The conflict in Central Europe is primarily land-based. It's driven demand directly as the NATO countries seek to assist Ukraine to resist the Russian invasion. 2023 saw a real increase of over 8% in the European NATO allies and Canada defense spending. And it's also made those countries in NATO and elsewhere, think again about the balance of their defense forces and equipment. Now some aspects of that rethink, like, for example, ammunition stockpiles don't have much of an impact on us. But other lessons learned, the importance of electronic warfare, the need to counter drones of all kinds, the need for accurate and timely battlefield intelligence. All of those have had a positive effect on both our orders and our prospects. In Asia, growing Chinese assertiveness has not yet transformed into open conflicts but it has come perilously close at times in the South China Sea. Taiwan also is clearly at risk and the presence in the region of North Korea doesn't exactly have a stabilizing effect either. Chinese investment in its Navy has led to a growth in new maritime programs right across the region and beyond. The most visible and significant consequence of that was the creation of the August alliance between Australia, the U.K. and the U.S. And we are very optimistic of being able to support the new submarines that are being bought under the August alliance. Taiwan and the Philippines have also launched new submarine programs. And South Korea is investing heavily in defense, notably also in its submarine building program. Japan remains committed to a doubling of its national security spending as a proportion of GDP by 2027. And it's really working at that as defense spending increased by 27% in 2023 and by a further 16% in the year to 2024. And it's also joined the Anglo Italian next-generation Combat Aircraft project, balancing its historically strong ties with the United States, we're growing ties to Europe and particularly to the United Kingdom. The conflict in Gaza doesn't have the same direct impact as the other factors, but it is symptomatic of wider tensions in the region, ultimately, between Iran on the one hand and Saudi Arabia and its allies on the other. The attacks on ships in the Red Sea have accentuated the need for drone and missile defense. And more widely, the conflict is likely to drive further defense spending in what remains one of our more important regional markets. It's hard to say how all of these conflicts and tensions are going to play out in the long term. But it is clear that we're not in a situation that can be resolved with a few compromises and a handshake. The world is now in a period of instability and tension that is likely to persist for the foreseeable future, comparable to the Cold War, perhaps even more complex and predictable. And obviously, this isn't something that fills us nor should it with happiness. We should all be concerned for the welfare of our families and the future generations. What motivates us at cohort is that we can make a positive contribution in this situation because the equipment and services that we supply contribute to the security of our nations and to our allies, in what has become a more dangerous world. So what is the impact of all of this in practical terms for our opportunities? Looking at our domestic markets, the most important of those by a long way is the United Kingdom, something like 54% of our total revenue in '23, '24 went to the U.K. directly and indirectly. And in particular, we've got a close relationship with the Royal Navy with Chess and SEA, both the significant suppliers of equipment and support. And the Ancilia win has deepened that relationship further. But we also provide electronic warfare, software and training for the British Army and for the Royal Air Force, a wide range of communications and electronic warfare equipment from MCL and exercise for the U.K.'s strategic command as well. I don't see the recent change of government as being likely to change the fundamentals of U.K. defense strategy. The new Defense Secretary John Healy is a highly able man. He's an experienced minister. And he's appointed George Robertson, the former Defense Secretary and the former Secretary General of NATO to lead the defense review that he's recently announced. All of the indications are that the Starmer government is essentially a responsible government, and I don't think any responsible government would take risks with defense at a time like the present. Our domestic markets in Germany and Portugal are important, although smaller. In Portugal, we've finally seen some good news with order intake for the Army, and we're in discussions also about an important naval program. Looking to our export markets, we're seeing strong demand from the European NATO countries for air defense systems, particularly for countering the drone threat. And that demand comes both directly to us and via partners like Rheinmetall and [indiscernible]. Now that capability has brought us into some markets in Central and Eastern Europe that we haven't accessed before. We're also providing battlefield reconnaissance systems and electronic software and training into those markets. To the east, we see strong demand from Asia, from the Indian ocean all the way to Australasia for naval systems. Torpedo launches and communication systems are both in demand, and we see good opportunities in this region for Ancilia as well as sonar systems. And as I mentioned, submarine programs are being launched worldwide providing opportunities for us in countries as diverse as Canada, Poland and the Philippines. It's NATO and the Indo Pacific some of the regions we supply most but we're also active in South America, Canada and the Middle East. Overall, the demand picture for cohort is robust. And against that encouraging background, we're increasing our spend on technology development to meet the evolving needs of our customers, a 26% increase in spending this year. Many of the products that we develop are sensitive, but I wanted to share some examples with you. Chess, first has developed artificial intelligence-based technology to track small and elusive airborne targets like drones. Now that can be combined with high-power radio frequency jammers to block the command signals and communication signals for the drone or for a more permanent solution, we can use it with something like the [ befores ] 40-millimeter canon that you can see in the slide there. Chess has also developed that technology to provide battlefield surveillance systems that can go on vehicles. And those systems can be elevated using a MASS above tree level, and then used to detect, to track and to designate targets accurately at long ranges. ELAC's new digital sonars and you can see a picture of one of their panels in the middle there, allow greater sensitivity than ever before by combining many thousands of acoustic sensors into an array. And that means that they can detect submarines at greater ranges than the competition. Digital beam for me with some features that are unique to ELAC allows the sensors to determine an accurate position of a target. I've talked before about SEA's towed array sonar, and it's great, but it's suitable for small lightweight surface vessels. And it's apparent from recent exhibitions and conferences and discussions with customers. But the world's navies are looking to grow the number of uncrewed vessels that they deploy, both over and under the water and Crate is ideally suited to those applications. And then last but not least, I must mention Ancilla, the picture you can see on the right-hand side there, SEA system for protecting naval vessels from anti-ship missiles. Now events in both the Black Sea and the Red Sea have shown just how potent that threat is. We see a significant international market for Ancilla as a result of that. And that product comes from a successful collaboration between SEA and Chess. And that's a happy outcome, I would say, of two businesses that are world experts in respectively, decor launches and stabilized positioners being under the same roof, here in cohort. Investments in those and other projects positions us well to meet customer requirements, which are evolving for the reasons that I explained before. And finally, worth mentioning, and no less importantly, we maintain our strategy of seeking and investing in value-adding acquisitions. We're very selective. We won't acquire a business unless we're very confident that it would add value and growth in the long term. ITS is small, but it matches that profile. Now I've talked in broad terms about markets and capabilities. This slide shows the tangible results of the demand picture that I've talked about. Now you can see the order book runoff for the 30th -- from the year beginning 30th of April, 2024 on the right-hand side there. At nearly GBP 520 million, the year-end order book is the strongest that we've ever announced and that includes over GBP 180 million for delivery in the course of this year and over GBP 100 million already for next year. Now of course, the ancillary win at GBP 135 million that we announced in March, made a big contribution to that order book. But it is worth mentioning that even without that, we would have seen order intake of over GBP 0.25 billion, and it would still have been the best year for order intake and the best closing order book that we've ever had. As I mentioned earlier, since the year-end, that order book has continued to grow, it will now be in excess of GBP 580 million taking into account the order that we announced this morning. And that gives us over 95% revenue cover for the year as a whole. The larger part of our order book sits within the Sensors and Effectors division, SEA makes a very strong contribution to that number, and ELAC and Chess also adds significantly to the total. In communications and intelligence and you can see the split between them with the color coding there tends to operate naturally on a short-term order book, so its contribution is quite modest. MASS' order book is substantial, but only increases significantly in those years when we renew one of its large long-term service contracts. An EID has been, as I've mentioned in discussion for some substantial domestic programs for what it seemed like forever and that was still ongoing at the year-end and is recognized in a relatively modest contribution to the order book there. But the good news is that since May, they've taken in more than EUR 45 million of new orders, and that's significantly replenished their order book. Just for comparison purposes, the chart on the left shows the shape of the order book runoff as it was this time last year. And what you can see is that it has maintained its shape in broad terms. All of the columns have increased in size. The change that really stands out, though, which we've highlighted there is the longer-term revenue which has grown from GBP 65 million last year to GBP 167 million this year, almost a 250% increase. And that's the impact of Ancilia and other long-term contracts, providing a steady flow of revenue for over a decade ahead, in fact, out to 2037. And this is a slightly more detailed slide showing you the order book runoff for the current year, together with a comparison against the same position last year. The increase in the total order book from GBP 329 million to GBP 519 million, more than 57% is obviously a strong indicator of the potential for future revenue growth. And as I said, we're now over 95% covered in terms of revenue for the year. The two shaded columns there show the revenue, which is already on order or was in order at the year-end for the year ahead compared to the same position in 2023. In communications and intelligence, we can see now already that the underpinning is rather stronger than it was last year. And since then, we've seen very good order intake from MCL and EID. So that position has improved beyond that quite significantly. But the really big change is in Sensors and Effectors, where the underpinning for the year has risen from GBP 84 million last year to over GBP 120 million this year, more than a 40% increase and that positions us really well for further growth this year. So that brings me almost to the end of the presentation and to a summary of the main points that I wanted to make. It's been another record year in terms of performance. We're not resting on our laurels, but we're very pleased to be growing the size and strength of the group. Maybe more importantly, we've achieved a record order book, and we see an excellent pipeline of further opportunities ahead. As I mentioned, that order book has further increased considerably at the end of June. We've got a strong balance sheet and an excellent relationship with our banks, and that means that we've got the resources that we need to invest in new technology, greater production capacity and when opportunities arise, carefully targeted acquisitions. The markets that we're operating in are growing, and we expect to see those higher levels of spending maintained in the longer term. That book-to-bill ratio that I mentioned of 1.9 is a reliable, quantitative market for future growth. So we maintain our growth expectations for the year, and we expect to see some improvement beyond that from the ITS acquisition. And beyond that time, we believe that the combination of growing demand and our market position allows us to target further improvements in performance. And I hope what you've heard today explains why it is that we've reached that view. And finally, as a result of our performance and our prospects, the Board has again felt confident to increase the full year dividend by 10%. We've grown the dividend every year since we IPO-ed back in 2006. So in closing, I wanted to take the opportunity to say thank you to our management teams and our employees for their hard work and professionals. Thanks to them. This year has seen us take another step towards our exciting long-term future, as a major independent U.K. defense technology group, offering world-class systems to domestic and export customers alike. Our strategy continues to be to generate growth, both organically and through acquisitions, while paying a dividend that reflects our successful financial performance. We believe that this offers the best long-term returns for investors, while creating high-value employment and enhancing the security of the U.K. and its allies. Thank you very much, indeed, for your attention. If you have any questions, Simon and I will do our best to answer them. Simon would you like to come up?

Can you just provide some more color on ITC and the sort of growth potential and how you're going to get the growth? I think I understand that it relies on people to drive the revenue. So maybe touch on like if you're planning to do any recruitment and what that looks like?

Yes. We are planning to do some recruitment and to expand the capability of ITS. We're happy -- we're lucky that there is a rich seam of recruitable people coming out of the armed forces, many of them based not far from where ITS is. It's been somewhat neglected in recent years, but we see plenty of opportunities to grow its capabilities further, not least because of the excellent customer relationships that are at MCL. So we see that as being a good combination.

Robin Byde from Zeus Capital. You have a great order book and great revenue coverage. Can you talk a bit about your ability to deliver those orders? So I'm thinking supply chain issues, capacity constraints, perhaps across all six businesses, if that's possible.

Right. Okay. Well, try not to make this too extended. The answer is that yes. I mean delivery is what it's all about this year because we already have the order cover. Broadly, we are very confident in our ability to be able to deliver. We certainly got the capacity to do what we need to do this year. As Simon mentioned earlier, we've grown our head count and it's people where we really add value. We don't -- it's not about sort of large machines and heavy capital investment for the most part. We've grown our head count to over 1,300 now, which puts us in a good position. We still need to do some recruitment and we're still doing that, but we're in a good position to be able to deliver. Undoubtedly, there are some technical risks and there are some supply chain risks. We're very experienced at dealing with those, and we have appropriate levels of provision to ensure that things go slightly worse than the best possible situation and that doesn't create a big problem for us. So yes, overall, I'd say we're confident, but that's what it's all about. That's what we've got to do.

And just specifically, just a follow up on key components. Are you seeing any pinch points with key components?

Not at the moment. That peaks just after the COVID pandemic came to an end, really, I think when we saw some really serious issues with particularly electronic components, particularly high-performance electronic perhaps. We're not seeing that anymore. We've taken a view to consider buying a little earlier and holding a little bit more stock just because of the experience of that time, which did have an impact. But at the moment, supply chains are in relatively good shape. Further questions?

Ben?

Can you just remind us where we are with the fourth Italians up and when we might hope ELAC might be working on it?

Yes. Now of course, there is no guarantee in these matters. However, we're under contract with three Italian submarines, the sonar suites, and Fincantieri, the prime contractor who's actually building some it has just got its contract for the fourth one. So it would probably be exaggerating to say as night follows day, but I think it is -- I think we can be pretty confident because we're delivering, and it really is an excellent product. that we will, in due course, be on the contract for #4 as well. I would expect that to happen in the course of this financial year.

Just going back to Chess and some of those export opportunities, who can we think of as the best partner to go to market with? Is it the British suites? Or is it the German in terms of opportunity set?