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

Good morning, ladies and gentlemen, and welcome to the Dialight plc Interim Results Investor Presentation. [Operator Instructions]. Before we begin, we would like to submit the following poll. If you could give that your kind attention, I'm sure the company would be most grateful. And I would now like to hand you over to the executive management team from Dialight plc, Steve, Mark, good morning.

Good morning, and thank you, everybody, for joining. We're going to go through this fairly rapidly, but I thought I'd start by giving you a little bit of history of Dialight on the basis that you may not all be aware of where Dialight has come from. So Dialight has been supplying LED products at the individual product level for about 50 years. And we continue to supply those products today. And in fact, it was the fastest-growing part of our business year-on-year in the first half. But in the early 2000s, Dialight saw a first-mover opportunity to move into industrial LED lighting. And this was particularly in hazardous locations where protection of plants and people by having adequate lighting for safety purposes was really important. And so we had the first-mover advantage. And over the period sort of mid-2000s up until 2014, the business grew very rapidly, reaching a positive cash position, inventory around the $35 million mark and profitability around about the 17% return on sales. So everything was going very well for Dialight at that point. On this slide, you can see a couple of examples. Bottom right is a mine and top left is a wastewater treatment facility. But you can see the quality of the lighting is really important to make sure that people and personnel are safe on those sites. So we had a very good market position, very good brand recognition. And then the business lost its way a little bit between 2014 and 2024. So I stepped into the CEO role in February '24, at which point we had a net debt of $24 million. We had a legal case with the Sanmina Corporation hanging over our heads. We weren't growing and we weren't making any profit. Now there were many reasons for that. Largely, a lot of complexity had come into the business, really created by the rapid growth in the early days when the proliferation of SKUs, both at the finished goods level and at the subassembly level meant that we were a very high mix but very low volume manufacturer. And that is always a very, very difficult place to be. It makes demand planning very difficult. It makes understanding what the market requires very difficult. And in terms of manufacturing, it means you have very, very low efficiency in manufacturing because you're continually changing the different types of product that you're manufacturing. So when I stepped in, we set off on a program really of simplification and complexity reduction. In any business, complexity equals cost. And our first quarter call, which really galvanized all of the other changes in the business was reducing the SKU count so that we could focus on profitability and selling products that we could make money on and stop selling those products that really made no money. And just to give you an example of the progress we've made over the last 18 months, we manufacture power supplies. We manufacture light engines that drive the LEDs. We manufacture the LED circuit boards and optics, and we design and manufacture the houses. Over the last 18 months, we've reduced all of those components by 83%. So an example is the power supply. We were manufacturing 126 different power supplies 18 months ago. We're now manufacturing 12. That sort of reduction really improves our efficiency in the factory. It means we're changing lines less often. It means that we have much greater buying power. It also means that our demand planning is easier. And all of these changes have really brought benefit to the business. And I'm going to move to the next slide and just show you some of the progress we've made. So we've started delivering profit. We've started generating cash. And there's a long way to go with the annualization of the savings and the improvements that we've made as well as what we'd be doing in the future to further improve the business. So the transformation plan, which is what we put together when I first joined is all about improving the basic fundamentals of the business to deliver profit and cash to pay down debt and allow us to invest in growth in the future. Now what you'll see from the financial performance is that year-on-year, our revenue has declined. Partly that is due to the tariff impact and the global economic climate, not that we can't manage it, but because it brings uncertainty with some of our bigger clients who are contemplating large capital projects, because of the tariffs on steel, aluminum, copper and the like, their investment decisions can swing wildly depending on the tariff situation. So what we've seen on these larger projects is a bit of a slowdown, which has impacted our revenue. But that said, our approach has been to bring quality of earnings to the business in anticipation of preparing for growth when the market allows. So I think you'll see from the financial performance that we've gone from a very difficult place to a far, far better position in terms of our net debt, in terms of our profitability, in terms of our return on sales and in our ability to generate cash. We have a number of key strengths as a business. I mentioned about a fantastic customer base who recognize our brand and understand that we were the market leader, and in the hazardous space continue to be the market leader. We offer a 10-year warranty. So essentially for any customer, it's fit our product and literally forget about it. We control our own designs, particularly around the power supplies, which give us the confidence to then offer that 10-year warranty. And certainly, all of the testing we've done and all of the in-service -- the in-service application of the products have shown that our warranty claims are very low. And therefore, the quality of the products that we're supplying can actually meet and exceed that 10-year warranty. We've got good access to the customer base and a tremendous set of people. And that's really -- it's the quality of the people and their knowledge of the industry and our business that has really helped us quickly turn around the performance of the business. I talked about the transformation plan. And fundamentally, it's built around 5 key pillars. The first is all about winning hearts and minds. If you can't convince people in your organization that your strategy is the right strategy and you're moving in the right direction, it's going to be very difficult to bring around -- to bring a turnaround. And as I said, we've got tremendous people, and they have really bought into the idea that generating margin, generating cash, thus allowing us to reinvest in the business is the way forward. Historically, the emphasis has been on top line growth, and that really didn't help the business over that 10-year period. So now we're really focusing on quality of the underlying business. And as I said, when growth or when the market is more amenable to growth, we expect to be able to grow with high leverage on that additional revenue. We then turn to sales transformation. As I said, historically, we've been selling on the basis of volume and not really very much emphasis on margin. We have now changed the emphasis. Margin is as important as volume, and we're rewarding our salespeople based on a combination of both revenue and margin. And we'll be rolling that out fully at the start of the new financial year. But already, we're seeing the way that the salespeople are thinking is moving towards that balance between decent revenue, but good margin because that is what is allowing us to improve the quality in the business. The third element is the operations transformation. So how do we make the engine of the business as efficient as possible? And certainly, reducing the SKUs has really helped us with that efficiency and reducing inventory has had a dramatic effect on our cash generation and also actually the space that we have available for growth within our factories. The fourth piece is the margin improvement and cash generation. So we've improved a lot of our processes. We brought a lot of efficiency into the overhead part of our business, and that's allowed us to reduce our cost quite considerably. Those 4 pillars of the transformation were the things we set off to do to really get the business quality back, and then within the last sort of 6 or 8 months, we turned our attention to creating a platform for future growth. And here, we're looking at short, medium and long-term opportunities for growth. We have a Board-directed committee called the Strategy and Innovation Committee, where we're looking strategically at what we do in the short term. So where are some quick wins that will allow us to get new product or new services into the market quickly. Medium term, what do we need to develop for the medium-term future in terms of product? And then longer term, just as we were a first mover with silicon-based LED technology, what might be coming next that could allow us to be a future first mover with a change in technology as technology continues to advance. So in summary, we've had a good last 18 months. We've turned from loss to profit. And as we look forward into the second half, we continue to expect to deliver strong and tangible progress on the transformation plan. We want to accelerate the transformation of our sales team and put in place support and remuneration structures that incentivize them to be more successful. We do intend to improve our working capital position, although right now, we are back to where we were in the heyday of our business. We are in December, going to settle the outstanding liability on the Sanmina contract, which will be a big step forward for us. And as a Board and as a business, we remain confident that the recently upgraded expectations we put into the market, we will fulfill and deliver for the remainder of this financial year. So hopefully, that was a useful summary and a useful introduction. And I'll hand over to Mark now to take you through some of the more financially appropriate elements of our business.

Thanks, Steve. So for those of you that didn't know, I was CFO at Dialight from 2010 to 2014, and I rejoined in January this year. So looking at the overall financial summary for the half. The group made $5.5 million of operating profit for the half, that's both up on the full year last year when we made $4.2 million of profit and the second half in which we made $3.3 million. What I think is slightly disappointing is the revenue performance in those very difficult markets, as Steve has said, the tariff impact on major CapEx projects with high tariffs on steel and copper, which make up a large part of the installation costs for a new facility, our lights are typically 1% to 2%. So it's not the cost of the lights, it's the cost of the other commodities. They have up to 50% tariffs on them currently. So that's delaying CapEx. That said, whilst overall volumes were down 4%, Signals and Components was actually up 10% and the components element, which has a very strong correlation with data centers and AI was actually up 20% in the half. As Steve said, we're focusing on the higher-margin products. The top 300 SKUs that we manufacture have about a 15% higher margin than the average across all our SKUs. So we're concentrating on those top 300. That has seen us add 230 basis points to the gross margin. In the half we generated 35.3% gross margin, and we see that increasing further going forward. We've reduced almost all lines of cost half-on-half. The overall level of labor has reduced significantly in our main facilities in both Ensenada and in Penang in Malaysia. Ensenada, particularly, we've reduced from about 560 heads, and we'll exit the year with near 400 heads. Overall, labor costs reduced from $7 million in the prior half to $6 million this half. The production overhead reduced from $14 million to $13 million, and the overhead reduced from $29 million to $25 million. So the combination of the increased gross margin and the reduced cost is what's seen a sixfold increase in the operating profit for the half. On top of that operating profit, we had a small $0.4 million profit on non-underlying items, but a very significant part of that was the receipt of $2.9 million from the U.S. IRS and this related to employee retention credits because we continued to work our engineering function through COVID, and we applied for credits for that, and we received those in the first half of the year. We've used those to afford the costs of the transformation plan and also costs of buying in our 2 main pension schemes, which were defined benefit pension schemes. A real financial highlight is the group in the last 10 years has significantly built up its level of working capital. It needed to do that particularly through COVID, but now we need to get back to the historic levels that we had in 2012, '13. So in this time, 6 months ago, we were talking to our shareholders about targeting a reduction of at least $5 million for the year, but we did say that we thought we could reduce inventory by up to $10 million. And actually, we've run ahead of that. We've saved $10.8 million in the first half alone. So just moving then to the income statement. You can see that small 4% reduction in sales. But despite that, an overall improvement in the working capital, the reduction in the overheads and the profit on the non-underlying items and closing for the half with an underlying EBITDA of just under $10 million. I hope you can all see this slide. It seems quite small to me. But over the last 2 years and closing off with the second half of last year, the gross margin for the group has improved by 10 percentage points from 28% to 38%. And you can see the group has gone from being loss-making to now generating a nice profit on an upwards increasing curve. The first half margin at 35% looks disappointing compared to the second half of last year. The reason for that is we have felt that the group has been capitalizing too much overhead into inventory. And so in the last 18 months, we've reduced the overall capitalization from about $11 million down to $6 million, and that had an impact of about $3 million in the first half of the year. If we hadn't taken that reduction, the operating profit would have been $8.5 million. And you'll see that later on a slide, but that was just, I think, to demonstrate we are making good progress. If we hadn't have had that inventory reduction in the capitalization, the margin would have been 39.1%. So the same as last year. But I should also add, this is the last half in which the group has been manufacturing traffic lights. We sold that business 12 months ago to LEOTEK, and we had to run off a manufacturing agreement, we only make a 7% margin on traffic lights. As I say, that activity is now finished. If you took out the impact of the stock valuation and the traffic light, we actually generated a gross margin in the first half of 42%, which is getting near to the target, which I'll share with you for what we want to be generating going forward. I've included this income statement just to show the last 12 months, which I guess has been really the first 12 months of the significant impact of the transformation hitting the group and the benefits of that. And you can see there that the underlying EBITDA at $17.3 million and an operating profit of $13.6 million. The current share price, we're valued at about 6x EBITDA. This is just a summary of the non-underlying costs. So these are very clear to everyone. I think the most important aspect of those is overall, we made a small profit, but more importantly, the ongoing benefit of the 2 major activities, the transformation plan costs, $1.3 million of costs. These have got a payback of about threefold. So we should see a reduction in operating costs going forward of $4 million on an annualized basis and only about $1.5 million will hit this year, an incremental $2.5 million will be next year. Then secondly, the defined benefit schemes, they have now both been brought in, and they will both be bought out in about May, June next year. In terms of the balance sheet, you can see there the inventory reduction from $40 million at year-end down to $30 million is the most -- the biggest generator to the debt reduction in the half. The net debt improved to $10.5 million at the end of the half. We've continued to generate cash. The net debt now is around $8.5 million. And it's that really which has enabled us to agree with Sanmina to pay them early. They've been good enough to give us a reduction in the amount. We should have paid them $6 million, and they've agreed to accept $5.65 million, and we'll make that payment in the second week of December. That removes the contingent liability and that draws a conclusion to that whole outsourcing and litigation. So that removes that uncertainty on the group. Overall, then with about $50 million of net assets, the group is generating a run rate of about 17% return on capital. I'll share with you later the targets for the group. We're looking to target 25% plus. And just to put that into context, back in 2012, the group was generating 50% return on capital. So we don't see any reason why we shouldn't get back to that level. In terms of the cash flow, the operating cash flow in the half was $13.9 million. Steve referred earlier on to the start of the year when I joined, we had $24 million of debt then. We've generated $14 million of cash. And as I've said, we've moved further on. We're now down to about $8.5 million. That isn't just about reducing inventories, it's reducing trade receivables as well. One aspect, though, we were squeezing our suppliers too much. And you'll see that we have caught up now on those payments and the overall level of creditors has reduced by almost $10 million as well, whilst the level of debt is obviously also reduced. Finally, I think the group has been running with capital expenditure at about $10 million a year, which was about $6 million of CapEx and $4 million of capitalized R&D. Going forward, I think we'll look to be reducing the level of actual CapEx by about half to about $3 million a year, but we will still continue to invest in R&D to have the best products in the sector because that's one of the differentiators that we have over our competitors. So this is my final slide. So the -- on the left-hand area here, this shows you the margins that the group was making in 2012. And on the right-hand side, we set these ambitions, I think, in about March. And frankly, it probably seemed slightly unbelievable to many people. But basically, what certainly I found was a business here, I sort of very much brought into Steve and Neil, the Chairman's ambition for where they wanted to take the group, the delivery of the transformation plan, and we really need to just get back to where we were. And back then, the group was generating an underlying gross margin of about 40% generating an EBITDA margin of 20%, a return on sales of 17%. The EBITDA was virtually 100% conversion to cash. Therefore, the group didn't have any debt. It paid high dividends and it generated in excess of 50% return on assets, and it was relatively working capital light. In terms of our ambition, we'd like to get to 3% to 5% growth. We are targeting to get to 45% gross margin. That actually is the same as -- it's hard to get your head around. It's the same as the gross margin of 39% in 2012, and that's because in 2012, sales commission was expensed in the gross margin, and now it's included in overheads and the sales commission is 6%. But 45% gross margin, 15% plus EBITDA margin and a return on sales of 11% to 13% plus. We expect to eliminate bank debt next year. We're going to target 25% plus return on assets. And we set out a target to achieve $35 million of inventory over 3 years. And actually, we've hit that now. So I think we probably need to revisit that. I think we will probably reduce inventory a little bit further. And in broad terms, whilst the delivery of the transformation plan is ahead of where we would expect to be at this point, we're still only about halfway toward achieving each and every one of these 3-year ambition. The transformation plan annualization, you won't see the full benefits probably until the 2027 financial year is when the full benefits will be felt. And we think we can do that very largely through self-help and the annualization of those benefits. The revenue growth of 3% to 5% would make the task of getting there easier and would enable it to be quicker. So I think that hopefully specs out where we expect the group to get to. And with that, I'll hand back to Steve.

Thank you, Mark. I think I'll summarize very quickly by saying that Dialight has always been a quality business, and it struggled a bit in that 2014 to 2024 time period, but the quality was always there. And we are now starting to bring that quality of business back. As Mark said, we're probably halfway through to where we want to be. And we have really clear plans of how we deliver progress. And if the markets allow then we'll certainly be seeing growth. That's what we're targeting. And when you have a quality business generating growth, you deliver exceptional returns. And certainly, that is where we are trying to get to. So with that, I'll hand back to Jake, and we will take any questions that you may.

Perfect. Steve, Mark, if I may just jump back in there. Thank you very much indeed for your presentations this morning. [Operator Instructions]. As we have received a number of questions, so perhaps if we dive straight into it. The first question that we have here reads as follows. What is the elasticity of customer demand with respect to pricing in your main segments?

Mark, would you like to take that?

Yes. So I think the answer to that is -- well, let's do this by segment. I think the OE segment, this is the segment we've been in for 50 years. The average sales price of an individual light is very low. However, we are the brand leader. We've been doing this for 50 years. We supply just in time to the contract equipment manufacturers. So I would say in that segment, the price is relatively elastic. We are always competing with others. But once we are in with that customer, we tend to stick. Lighting, on the other hand, and I think this comes to another question, I think we have market-leading products. The value of safety of not having to change out the lights and the energy saving that our products generate and the overall ESG impact of our lights means that the pricing isn't as elastic. And in fact, we've put the pricing up twice in the last 12 months, and we haven't seen a notable falloff. And indeed, when the whole discussion about tariffs, we received praise from our customers that we didn't immediately put our pricing up as some of our competitors did as a surcharge. And we don't believe that they have seen a major impact either. So hopefully, that answers your question. I think it probably comes to another question, which is Dialight has an outstanding reputation for the quality of the product and being pioneering. All our lights have been designed to be LED lights. That isn't always the same for all our competitors, that may well use an old technology, housing and power supply with the LED. But that said, and I think the question is, who do you compete with? Are they the same as 10 years ago? And the answer to that is yes. We have some very large, well-capitalized, very serious competitors, and we tend to come up against the same competitors. So whilst the products have been improved, prior management have continued to invest in the product development. We remain one of the top 4, 5 competitors in the space. And our market share, we think, is around the 15% to 20% mark. And the more hazardous the segment is like oil and gas and mining, the slightly higher our market share is.

Perfect. Thanks, Mark. Just turning to the next question. What would the FY '25 gross margin have been without the adverse impact of the runoff of the traffic business, i.e., what's normalized?

Yes, sure. That's a very good question. So last year, the actual traffic segment was loss-making at the gross margin level. And it was for that reason that we booked an onerous contract provision at year-end of $0.8 million. And that has been released, and that was the primary reason why it made a very small 7% gross margin this year. If traffic had not been included in the full year '25 numbers, the gross margin would have been about 39%. So quite an uplift. And I have to say we'll both be very happy to look forward to H2 without traffic in it.

Perfect. The next question asks, are you continuing to invest in the Components segment? Or are you in harvest mode?

So when I joined 2 years ago, we weren't investing in the Components segment. I was told that it would only ever grow up and down or grow and decline with the market and that there was no opportunity for growth. And so to be honest, a lot of our emphasis was on the solid-state lighting because it's the major part of the business. But just in August, I visited a customer in Asia who said, basically, look, we love what you do for us, and we do 2 million or 3 million with this customer a year, but I've got $25 million worth of other stuff that I'd be happy for you to provide as opposed to competitors. And so suddenly, overnight, having gone and actually spoken to the customer and listened, we saw that there is an opportunity in the Components segment. And we are now looking to invest. And so we've gone from a business we were running mainly for cash to actually, there may be some opportunity here. And as Mark said earlier, we saw a 10% year-on-year improvement in that business. So AI and data centers are a big element of that. That seems set to continue. But this is more about broadening our market share. And so if you'd ask me that question 6 months ago, I would say, no, we are not investing. It's a cash cow. But now we see real potential, and we will be turning our attention to selective investment to provide the best return we can.

And I should also just add on that, that the indicator business makes the highest gross margin and the highest return on sales. So the greater the mix that, that can be will overall drive up the group's return on sales.

Perfect. The next question asks, many congrats on the progress so far. Two questions, please. Has it been difficult to win staff hearts and minds whilst cutting headcount? And the second part of the question is, how has the identity of your competitors changed since 2012?

So if I take the first one, it's not been that difficult, to be honest. We have -- I think you find this in any business. You have very intelligent people who are keen to be engaged in the strategy of the business and to understand what is needed from them. And we started off very, very transparently as soon as I joined, we talked about the problems in the business. We talked about the opportunities. We talked about the strategy that would get us back to where Dialight had previously been. And we said quite clearly, there are people who will be part of that journey, and there will be people who won't be part of that journey, either because they don't want to be part of that journey or because the business can't support those functions or resources. And so people have responded extremely well to that. And even people who have left the business have left feeling they made a contribution to it. And they feel proud of that. So as I said right at the beginning, that first pillar was the key to any success. And I think looking at the results, it sort of shows that everybody stepped up. Those people who remain, I would say, are even more dedicated to Dialight. And that for any leadership team is a godsend. And I think it's gone as well as I could have expected.

And in terms of the competitors and whether they've changed since 2012, the simple answer is no, they haven't changed. So the 4 competitors are Appleton, which is a subsidiary of Emerson; Cooper Crouse, which is a subsidiary of Eaton; Holophane, which is a subsidiary of Acuity Lighting; and Killark, which is a subsidiary of Hubbell. I think what has changed is, in 2012, Dialight was 100% LED. And those 4 competitors were not as highly focused on LED. They are now a lot more focused than they were then. They had legacy traditional technology businesses. They will still sell those lights to you as well, but they'll be a much smaller part of the mix than they would have been back in 2012. We tend to come up against them on most major bids. I think one of the areas in which we have slightly underinvested more recently has been in selling to the engineering, procuring businesses, the EPCs. That is a long-term sell and the goal in that is getting specified, your products specified on new build and retrofit of facilities. So that is something that we are investing in now more heavily. That's an investment that hits the P&L initially, but then typically higher margins can be generated when those bigger projects go live. Our competitors have continued throughout the last decade to invest in that area. So there are areas in which we are not specified and our competitors are. We need to do better at that. But today, our business is between 60% and 70% MRO maintenance and repair work. That's higher than it used to be. It used to be more CapEx new project orientated. And a combination of, hopefully, tariff uncertainty removing and our investment in the EPC team, we'll see that level of activity build up again and the overall percentage of MRO to marginally reduce.

Perfect. Is wind a significant part of the U.S. obstruction business? And if so, are there revenue risks from the likely decline in new turbine orders/builds? Or is cellular/broadcast the driver?

Yes. So wind is not a driver for us at all. All of our obstruction business is tower-based, are the communication towers and the like. And so really, that is the driver for our business. I mean with 5G towers, they're not as tall. And therefore, we don't see demand for our products increasing. But as Mark said earlier, the obstruction business is a very solid, reliable business with good returns. And so we'll continue to go after that obstruction business. But no, we're absolutely not impacted by how the wind market is growing or declining.

I can see where the question comes from because in 2012 Dialight was in the wind market and had a Danish lighting business, BTI, but that has been exited in the last 5, 10 years. So no [indiscernible].

Perfect. Thanks, guys. And that actually concludes all the questions that have come in this morning. So thank you very much indeed for being so generous of your time and addressing all of those questions. And of course, if there are any further questions that do come through, we'll make these available to you after the presentation just for you to review and to then add any additional responses, of course, where it's appropriate to do so, and we'll publish those responses out on the platform. But Steve, perhaps before really now just looking to redirect those on the call to provide you with their feedback, which I know is particularly important to yourself and the company. If I could please just ask you for a few closing comments just to wrap up with, that would be great.

Thanks, Jake. I'll sort of repeat what I said at my earlier wrap-up, and that is, this is a really good quality business. We think it has much, much further to go. And we are looking for growth on top of that high-quality business, which means we expect to generate profit, cash and growth. And certainly, that is what we're targeting. And I really appreciate your time today. We're very happy to talk to as many people as possible. We think we have a really good story, and this is a really great business. So thank you for your time and attention today.

That's great. Steve, Mark, thank you once again for updating investors this morning. Could I please ask investors not to close this session as you'll now be automatically redirected for the opportunity to provide your feedback in order that the management team can really better understand your views and expectations. This will only take a few moments to complete, but I'm sure it will be greatly valued by the company. On behalf of the management team of Dialight plc, we would like to thank you for attending today's presentation. That now concludes today's session. So good morning to you all.