Dialight plc (3HQ.F) Earnings Call Transcript & Summary

Good morning. I'm David Blood, Chairperson of Dialight. Thank you for joining Dialight's 2020 Results Presentation. I will cover our response to the COVID-19 pandemic and our commitment to a net zero carbon world; Wai Kuen will report on our 2020 financial performance; and Fariyal will speak to our business and importantly, our key competitive strengths of best-in-class products, a history of product innovation and our people. Let me start by acknowledging the COVID-19 pandemic has taken a terrible toll on families, communities and economies. We extend our deepest sympathy to the families and loved ones of our valued colleagues, who we have sadly lost to the virus during this past year. The safety and well-being of our employees and their families continues to be our highest priority. Dialight responded and will continue to respond to the COVID-19 challenges with resilience and purpose. As the COVID crisis unfolded, Dialight took 3 important steps. First, we prioritized the health and safety of our employees, which enabled us to achieve essential business status faster than most. Secondly, we prioritized serving our customers. We did not furlough our U.S. sales force. We kept safety stock and we maintained order lead time. We believe we increased our market share in 2020. Lastly, we sought financial flexibility by increasing our bank facilities by GBP 10 million and demonstrated strong working capital management by reducing our inventory by GBP 13.5 million, enabling us to reduce our net debt position at December 31 by approximately GBP 5 million. The transition to net zero carbon is both an opportunity and an obligation for Dialight. Our products had helped enable our customers achieve net zero. We are committed to working with them to do so. Moreover, Dialight itself commits to being a net-zero business by 2040. We will engage with the Science Based Targets Initiative to set appropriate interim targets and report them. We also commit to reporting under CDP and the task force and climate-related financial disclosure protocols. Lastly, we know the Dialight story is not well known. We are committed to working with the market to change this, and Fariyal's presentation this morning will be the first step. Ultimately, however, make no mistake. We also know the most important thing we can do is to perform. Wai Kuen?

Thank you, David, and hello to everyone listening in today. I am pleased to be presenting my first set of results for Dialight, and we'll start by taking you through the key financial highlights of 2020. COVID-19 had a significant impact on our revenue, which resulted in an overall 21% decline year-on-year. The decline was mainly in the lighting projects business, which historically made up 60% of our lighting revenue. Such projects were largely stopped as most companies deferred their CapEx projects to conserve cash. The Signals and Component business performed relatively well, with revenue declining by only 6%. Overall, group revenue declined by GBP 32 million, of which GBP 30 million from Lighting whilst GBP 2 million from Signals and Components. Gross margin deteriorated by 50 basis points year-on-year. The benefits that we should have seen from in-sourcing our production were negated by COVID-19 impact on production costs. Our production costs are predominantly fixed following COVID restrictions imposed on the number of production staff allowed per shift. Coupled with a lower production volume, this translated to higher per unit production costs. The unprecedented year has brought about many challenges outside of our control, but we stayed focused on those we could influence, which primarily was our cost base. We achieved 17% reduction in operating costs with a significant reduction in travel, mainly from field-based lighting sales force and headcount savings as a result of salary reductions, furlough and redundancies. These non-underlying costs incurred in 2020 at GBP 2.4 million was significantly lower than last year. The GBP 0.9 million of redundancy costs arose when we reviewed and permanently rightsized our cost base following the reduction in revenue. The GBP 0.7 million of litigation costs were related to fees for the case with our former outsourced manufacturing partner. Finally, we disposed of our non-core Brazilian subsidiary through a management buyout by the joint venture partner, which gave rise to a loss on disposal of GBP 0.9 million. Moving on, this slide outlines the year-on-year movement of the underlying operating results. In 2019, the underlying operating loss was GBP 5 million. The GBP 32 million lower revenue highlighted earlier has led to a reduction of GBP 6.2 million in EBIT. It is worth noting that H1 revenue declined by 26%, while H2 declined by 16%. The COVID disruption costs included pay for vulnerable staff and costs incurred during the planned shutdowns in the first half of the year. We estimated total impact to be GBP 6 million. The benefits from in-sourcing our production were GBP 5.7 million, which largely offset the COVID cost impact. We expect to see the full benefits as volumes recover. The impact of lower revenue was mainly offset by the cost-reduction measures, as explained in the earlier slide, amounting to GBP 5.1 million. All these moving parts translated to an underlying operating loss of GBP 6.4 million for 2020. We now move on to our net debt position, which demonstrates the positive outcome from management's relentless focus on cash conservation and liquidity throughout the year. At the end of the year, despite the reduction in revenue and operating loss, the group had reduced its net debt by GBP 5.1 million to GBP 11.4 million. The single largest driver was the GBP 12.6 million reduction in inventory following various inventory reduction initiatives and our sourcing strategy. Additionally, our receivables reduced by GBP 3 million, driven by the lower revenue, but more importantly, our customers continue to pay on time demonstrating the high quality of our customer base. We have also renegotiated improved credit terms with 60% of our suppliers. Whilst conserving cash, we have continued to invest in the new products and to fulfill portfolio gaps amounting to GBP 3.7 million, alongside a further GBP 0.8 million on maintenance CapEx for our production facilities. During the year, the group increased our banking facility with HSBC with an additional GBP 10 million facility through a combination of GBP 8 million under the COVID-19 Large Business Interruption Scheme and GBP 2 million commercial loan. This brings our total committed facilities with HSBC to be GBP 35 million as of December 2020. In the first half of the year, the existing covenants have been replaced by a new test based on exceeding a 12-month EBITDA target for the period from June 2020 to June 2021. We revert back to the leverage and interest cover test in quarter 3 2021. The group was compliant with its revised banking covenant as at December 31, 2020. Moving on to my final slide. This provides an overview of our current year planning assumptions. Net interest is assumed to be broadly in line with 2020, whilst the tax rate to be circa 25%. For CapEx, we will continue to invest in R&D, expected to be around GBP 5 million alongside a GBP 2 million of maintenance CapEx. The inventory unwind is expected to continue, and we are targeting a year-end position in the GBP 30 million to GBP 32 million range. We are focused on further improving our working capital efficiency as revenue recover and grow. Our trading performance will be H2 weighted as in previous years. With that, I will now hand over to Fariyal, who will go through the business review.

Good morning, everyone. I would like to start by describing our business in more detail. Dialight is a technology company with 50 years of experience in the LED market. We have been and continue to be a pioneer of innovation through continued development of technologies to help our customers achieve their sustainability targets. Our products last up to 5x longer than traditional legacy lighting. We have the largest installed base within the industrial market, with over 2 million fixtures worldwide. Our products focus on the increasing needs of our customers to enhance safety, reduce energy costs and more importantly, the heightened priority of the transition to net zero carbon. We have a major and growing part to play in this transition. We have the best-in-class designs and are regarded as a premium product in the markets we operate within. Our industry-leading 10-year warranty, backed by the reliability and efficiency of our product performance, has been recognized by the National Lightings Bureau's Trusted Warranty Program. This strength of our products is backed by our highly trained sales team with a strong channel to market. The industrial market is still dominated by older, inefficient technologies with less than 10% conversion to LED. We believe the catalyst for mass conversion is improved safety, increased energy savings, eliminating maintenance costs and increased regulations to phase out older technologies. Dialight's core strengths center around our products which have a long history of innovation. They provide the best cost of ownership to industrial customers. Our in-house custom-designed power supply enables us to stand behind our market-leading 10-year warranty. Our customized optics ensure improved light illumination, providing uniformity and quality plus enabling our customers to use fewer lights to illuminate the target area. Our integrated design significantly reduce the burden of installation and virtually eliminate maintenance costs. Our products have the ability to withstand harsh environmental conditions such as extreme temperatures, humidity, high vibration and corrosive environments. The addition of sensors and controls brings an additional element of the value proposition to our customers. Turning to our strategy. Our primary goal is to deliver significant growth. We believe that the combination of our products, strong ESG credentials, people and culture differentiates us from our peers. Our growth strategy is focused on 3 key objectives. First, to protect and grow within our core heavy and harsh industrial markets which offer a significant growth opportunity. We have a leading position within this space, and combined with the strength of our highly qualified sales team, we will continue to expand within this space. Second, we believe that sustainability will be a major driver in the conversion to LED, and this will be accelerated post COVID-19. Therefore, we are building a strategic accounts team focused on expanding our market reach, leveraging corporate ESG goals and our differentiated products. This is key to securing larger-sized orders and multi-rollout lighting upgrades. In order for us to increase our customer reach, we need to expand our sales channels. This means increasing the number of distributors and developing further channels such as EPC, engineering firms and electrical contractors. Third, we continue to lead the market in innovation so we can widen our market-leading position. This will also include filling any portfolio gaps, so we remain strategically relevant to our customers. The next generation of technology is heavily focused on building on the sustainability needs of our customers with the goal to have the first fully recyclable product. Turning to our product strategy. Our continued investment in technology is based on a deep analysis of the attractiveness of the market, balanced against Dialight's ability to win. Customers may be limiting their spending now, but the demand for new and innovative products will increase once the global economies begin to recover. By retaining our focus on innovation, we can extend our long-term advantage, the time line for developing new products and our ability to quickly react to market requirements will increase our innovation lead. During 2020, we developed 2 key products. The bulkhead was originally introduced in 2012 and has been a very successful product for walkway illumination, general plant area lighting, stairways and platforms suitable for onshore and marine applications. The new bulkhead has been completely reengineered in order to extend the product life cycle and take advantage of our technological advancements. This has resulted in the efficiency being more than doubled in the upgrade. The second product we launched was a new 60K high bay. This product was designed for very high ceiling heights which provides substantial challenges for installation. Our upgraded version is 60% smaller, significantly improving the ease of installation. Moving on to lighting. Dialight's sales model is a direct specification sale to end users, transacting through distributors. Direct sale allows for the value proposition to be articulated. Distributor inclusion enables simplified contracting and support for larger supply contracts. We have 2 types of orders. Firstly, maintenance, repairs and operations, which tend to be a small order size but is regular flow business. Secondly, CapEx projects, which consist of full or partial lighting upgrades to our plan. With the onset of COVID-19 at the end of Q1, CapEx projects largely disappeared as many companies conserved cash. This represented 60% of our business in 2019. However, many of our customers are deemed essential businesses and operated throughout this pandemic and this has led to a need for replacement fixtures. Our strong customer relationships have deepened due to challenges presented by COVID-19. These were allied with lead times that did not falter, enabling us to maintain excellent customer service and significantly increase our MRO business, thereby winning back market share. Turning to lighting order performance. Unlike many competitors who implemented large-scale furlough actions and finished goods inventory reductions, we adopted a strategic approach that has enabled us to begin to win back customers and distributors we lost during our operational issues. We have been focused on maintaining an uninterrupted supply to our customers. Despite not being able to visit customers, we have maintained our experienced sales team to ensure we provide good service levels. We have used this time to provide extensive product training internally and externally. We've also had targeted marketing campaigns, focus on key sectors and on promoting the benefits of using our fixtures. This was particularly invaluable given customer site access was restricted. In our most important market, the U.S., the relative resilience of the MRO business resulted in orders being down 24%. The recent economic slowdown as a result of COVID-19 illustrates the importance of maintaining business units that serve a variety of markets. Our Signals and Components segment provides greater financial stability during volatile periods for the Lighting business. The Signals and Components business contains an amalgam of LED products that serve markets where Dialight has been a long-established brand name for up to 50 years through limited strategic investment and product improvements. These businesses have been the bedrock of the group by generating strong cash flows. A significant number of the Signals and Components customers provided written testimony to the Mexican and Malaysian government in order for us to obtain essential business status. In 2020, orders were 7% higher than 2019. The resilience of the business is due to the diversity of the products sold and the range of the end markets served. Moving on to operations. Operationally, we made significant progress with on-time delivery at 80% and lead times at pre-COVID levels. Our Malaysian factory was closed for 6 weeks, and our Mexican factory was closed for 3 weeks during 2020 while we awaited essential business status. We were granted this for all of our facilities. We have 200 employees classified as vulnerable under Mexico guidelines and are not allowed to work. Our priority is to protect this group due to their underlying health issues, and we continue to pay their salaries. Once we reopened our facilities, there were restrictions on the number of staff permitted per shift and the social distancing measures have impacted productivity. However, in terms of output, we are back to pre-COVID levels of production and have sufficient capacity to support our growth ambitions. Our supply chain remains the single biggest factor in ensuring the group has market-leading lead times, a high number of SKUs and reliance on long lead time components creates challenges in the supply chain. We were able to execute on our comprehensive plan to drive down inventory, which ended the year GBP 13.5 million lower than at the start of the year. This was achieved through refining our forecasting and focusing on localizing sourcing. We have made good progress in negotiating new credit terms with our supplier base, coupled with a controlled dual-sourcing strategy, which were key to leveraging price reductions. Our vendor-managed inventory and consignment stock plans will remain central to our strategy going forward. We will continue with more local sourcing as border closures during this crisis have highlighted the need for a more localized approach. We did experience some challenges relating to our critical suppliers and logistical issues caused by COVID-19, and we expect some ongoing impact will continue in 2021. We are a small company with a global impact, and we take our corporate responsibility extremely seriously. Our strategic priorities focus on driving organic growth, improving margins while developing new technologies. This strategy affects how and with whom we do business and we are embedded in the communities where we operate. People are at the heart of our business. It is through our people that we will progress our strategy and ensure that we realize the potential for growth. Communication, both within and across the group is key to engagement. In the early months of the pandemic, when there was extreme uncertainty, I held weekly global calls to ensure real-time engagement. These calls also included Q&A sessions open to all staff. Development is a cornerstone of the drive to continuously improve the quality of our business. Outside of technical competence, our focus is on the development of management and leadership skills. Well-being continued to be a key theme in 2020, such as maintaining mental health as well as developing healthy habits. We recognize we have an important role to play in the local communities where we have facilities. In light of this, we formed the Dialight Foundation in June 2020. It is governed by our employees across the globe. Our carbon footprint is a combination of the CO2 that we use in production and the CO2 benefit to our customers by using our fixtures compared to older inefficient technologies. We have installed over 2 million fixtures, saving over 1 million tonnes of CO2 per annum, which is the equivalent of removing 40,000 cars from the road per year. Our customers' CO2 savings are 10x higher than the CO2 in our production. Our goal is to be carbon-neutral in our internal processes by 2040. As we build on our strong ESG credentials, one of the key projects we're working on is to externally certify the carbon footprint of our products. We started by preparing an environmental product declaration for our Vigilant Bulkhead launched in 2020. This gives our customers a measurable and tangible metric to judge the superior performance of our products. We're also working with our supply chain to identify opportunities to reduce waste at source as well as recycling opportunities. In summary, our focus will be on utilizing our existing sales team to drive growth in our core markets, building a strategic accounts team focused on expanding our market reach, leveraging corporate ESG goals. Our continued focus on innovation will continue ensuring our product development is strategically relevant for our customers. The next generation of technology is heavily focused on building on the sustainability needs of our customers. In the short term, conditions remain uncertain. Although we are seeing an increase in quoting activity in 2021, we are operating on the basis that the group will continue to be impacted by COVID-19 during 2021 so there is a range of outcomes for the full year 2021. Finally, I'm immensely grateful for the strong personal support of our Dialight family as we navigate through this challenging environment. I have been inspired by the positive and collaborative attitude of our team and this, more than anything, drives our confidence in Dialight's future.