Electro Optic Systems Holdings Limited (EOS) Earnings Call Transcript & Summary

I'm here to speak briefly about the announcements we've made this morning and also to take questions from the meeting relating to what we had to say today. 3 key issues we've discussed today coming out of a trading halt. And I guess I should briefly explain, the trading halt was because we had a significant confluence of quite strong developments within the business. And the EOS and the ASX jointly decided that it was best to make them -- come together, given that they were coming together within space of about 24 hours anyway. Now I want to talk very quickly about 3 key issues. The first one is cash. I guess getting straight to the bottom line, the company has available to it today in excess of $100 million cash. And we -- the purpose of this -- for application of this cash are for use in the normal course of EOS business for new business opportunities and generally excluding SpaceLink. So we've basically made it very clear that we're maintaining the guidance we've given the market for 16 months now that SpaceLink project costs, which will -- everyone -- I think knows will be about $1 billion will be funded outside the normal course of free cash flow and outside -- principally outside the hedge stock itself. So the key point here is, of course, that COVID struck we're talking about 20 months ago, and we have invested progressively [ $238 ] million in the contract asset for one particular contract just so we could maintain steady production in the plant to keep it at a reasonable efficiency. That contract asset has been won back now by $95 million, and is now essentially in the normal range of investment for contract asset for a program, which is approximately $0.5 billion in value over 3 or 4 years. So we understand that the market, for whatever reason, has had some concern about that scale of investment in contract asset. I guess the thing I would say very quickly is the company made a decision that we had complete confidence in that contract and in the customer. And there is no way that the company of our scale will invest $138 million of it's cash in the program against that contract unless we had complete confidence. Now I think we can draw the line under this conversation with the market now by saying, with a bit of a hindsight, the company was right. Those funds have been recovered, and we're moving on. And of course, with the recovery of those funds from the capital raise that was made in April of 2020, the company has enough cash to meet its foreseeable requirements for some time. The second significant announcement was to do with revision of guidance, a downgrade in EBIT. And the downgrade basically says the EBIT before considering SpaceLink and other abnormal items that have arisen recently, the EBIT range is going to be $4 million to $8 million positive. But bottom line is, of course, the main forecast for EBIT before ForEx and including all other outlays is minus $12 million. That's roughly in the middle of the range that we put out today. And I think the first reaction in the market is understandable. I think the first reaction I would have us look at that and say, look, on $220 million of revenue, we would expect $22 million of profit regardless. And so at minus 12%, EOS is about $35 million off the base. Against that, I'd say there is 2 things. One is, the company is investing this year $19 million in SpaceLink. And above and beyond our normal R&D programs, something of the order of $12 to $15 million in lead programs, which we received partial funding on significant contracts. Those large contracts won't be ordered until next year. So if we take those 2, what I would call abnormals, we're in the range of $30 million. And so these -- the comment I made about EOS being at $35 million off the base is EBIT, seems to be reasonably well offset by those 2 numbers. The other thing I would point out very quickly is that, that is, without taking any consideration whatsoever that we've asked -- 2 of our most important customers have asked for deferrals of deliveries and activities in December. But basically 3 weeks of activities in December can be wiped and pushed into next year. And as I said, that rationale about the $35 million shortfall is regardless of that. So on top of that, we've had $11 million pushed in -- profit pushed in the next year by customer decisions. And those who are most familiar with the company will know that our delivery in invoicing and revenue booking rates essentially increasing tempo throughout the year, and November, December are always our most productive months. And that's just the nature of the business and the nature of the customers. So I'm not trying to say the EBIT result is great or even acceptable, but what I'm saying is the bottom line number is really minus $12 million before ForEx. And I'd say that as we sit here today, our ForEx gains are about $12 million. So even with this announcement, the company is running today at about a wash. But if you take into account the proper elements that are absolutely abnormal, which are really investments the company is making, remember the SpaceLink is being held out of the company valuation and off our balance sheet. So the company really is making, at least, the margins that we expect in a very, very difficult year. And I'm not saying that's an excuse, because we don't need an excuse. The company has really delivered very good EBIT margin on the goods it's produced. So -- and to achieve that in what were difficult circumstances this year because we -- I don't think any company expected COVID to run 2 years in terms of its impact on supply chain efficiency. This company very unexpectedly had to go to split shifts again this year. We had to do work from home for a significant proportion of the year and so on. Again, we don't need those excuses because if you look at the numbers, in a very objective way, the underlying performance is not as bad as some would have us believe. But I guess the third thing I want to touch on is basically activity. I told shareholders a year ago that SpaceLInk costs would be of the order of $1 billion. That's the project cost, that's not the $20 million a year that we invest to stand up a program and to put forward the project to prospectively invest and do about $1 billion we forecast. In fact, originally, the first number went out at the AGM in 2020. The SpaceLink team under Glen Tindall has done a magnificent job of developing a satellite design, which exceeds the performance that we expected a year ago, and bringing it in 2 contracts from a vendor at a price below what we expected last year. So in rough figures, the SpaceLink project is going to cost, the program funding costs about USD 700 million and roughly half in satellite costs and the other half in nonhardware costs to do with all the costs running up to positive cash flow for the program. And so what we have is a significantly better investment proposition for the marketplace than we had even a year ago and honestly even 6 months ago. So SpaceLink has really made a terrific progress. And we now have negotiations in place to complete the first tranche of pre-IPO convertible notes issued by SpaceLink itself into the marketplace. And those notes -- we'll be saying something more about those notes before the end of the year. So I guess on -- in terms of the cash and the SpaceLInk development, I think the -- unquestionably very positive developments. Although to be fair in cash area, it's nothing outside the normal expectation of the company, but we do understand that for whatever reason, which -- for whatever reason, be it something the market have been concerned about our cash position, the company has never completely shared that view. And as I said, the Board and the company would never have committed $138 million of investment in contract asset for a customer that we didn't have an impeccable relationship. So -- and on the third issue, which is the EBIT downgrade, clearly not good. But please look at the fundamental numbers, and fundamental numbers on the margins are very sound. And as I say, just accept the $11 million of profit deferred to next year, forget about that. We don't need that as an excuse. Look at the numbers, including that consideration, and it's -- the numbers are not -- they don't speak to a company that had problems with its margins or has problems managing its cash flow or problems with, in fact, getting products to market now, notwithstanding certain dislocations in the marketplace. So that's my view across the 3 items we've initially -- we've announced progress on today. I guess, an overarching comment is that the company is -- has been making enhancements for some time about major programs that are in. And we are not talking about speculation on our part. We're talking about documented, funded programs and the Tier 1 customers, such as U.S., Australia and other customers who have a very strong record of delivering revenue and profits to this company. What we see in the company is that currently just deferrals on some of those program awards are coming to an end. And so there will be a significant number of awards made next year that we deferred, in some cases from 2020, and in other cases from 2021. And so the whole conversation with the market about our backlog and our pipeline, I think, we'll get an interesting update in the next 2 or 3 months as we see that process unwind. So if there is a conversation to be had about that, we will be coming to market as soon as possible and there's close -- those developments with those key customers. But I guess one thing I should say back about something I said a little earlier is that we have raised above and beyond normal and we don't have quite a high R&D spend. We raised significantly above normal by at least $12 million to $15 million. Our commitments to -- this year to rapidly accelerate counter-drone, directed energy and other advanced technologies that the customers and the market need. In most cases, we don't do that with our customers, at least putting skin in the game. So we have some tens of millions dollars of commitment from those customers already. In terms of firm contracts executed, that would lead us to believe that those programs are moving forward as we had forecast. So it might be -- Neil, is there a way we can take questions from this audience?

Yes, Ben. So I invite visitors on the call to put questions into the Q&A panel on WebEx. So I'll curate the questions and pass them through to Ben. So Ben question from [ Jack Cherry ]. Did the cash come from the contract coming from the client? Or via a finance intermediary? For Michael.

Well, I can answer that directly because I was face-to-face with the client only 6 weeks ago. The funds came in exactly the normal course of the business, through the letter of credit. Remember, this is a $450 million program. It's fully funded under international global letter of credit, where the confirming bank in Westpac. The funds have been paid to us by Westpac in the normal course. There's been no financial intermediary whatsoever.

Yes. And Westpac was paid by the customer?

Yes. Yes.

Yes. Correct. Okay. A question from [ Mark Gaiman ]. Are you saying that going forward, a normal margin profile for the business should be in the range of 10% to 15%?

Correct.

Correct. Yes. Okay. Another question. I'm still unclear as to the 2 contract deferrals if they're customer initiated? Then are these cost of contract changes or are they nil costs? And if so, why?

So the -- I apologize -- our intention has been that [ 4C ] would be launched before we end this conversation. There is -- company is launching its 4C, appendix 4C today...

It is now. it is up now, Ben.

Okay. So there is a broader discussion about some of these issues in the 4C. But our 4C will again demonstrate that even at 30 September, the company had more than enough cash. So going back to the question, the deferrals are roughly the equal proportion between one major foreign customer and Commonwealth Australia. Both of them had their own disruptions due to personnel in their ability to receive goods. And effectively, both of them in uncoordinated way have effectively requested that we defer the December deliveries and activity to late January. So the -- in terms of what -- the specific question was, what's the overall impact do we -- are we entitled to have a contract change proposed? The answer is no. Deferral of the month is not a sufficient ground for a contract change proposal for increasing fee.

Great. Okay. Now we've got a few questions about actual contract wins. So I'm going to kind of bundle these together. So I hope I captured this from old the questions. So some programs have been alluded to in the past, the T2000 program, that the Dutch contract and another RWS contract of $1 billion. What's the status of the tender programs, Ben?

In reverse order, the $1 billion program is still under negotiation. Those negotiations have gone well with the end user. In fact, they've concluded with the end user, and we're now negotiating directly with the end users contracting entity. And so that has moved forward. And we are very satisfied with the discussions we've had with the end user. And so we are now in discussion with the contracting entity for that user. I will say that, that program is fully funded. It is in the forward estimates for that customer. So the 2 key issues we would expect to have resolved by now certainty of funding and the customer need and willingness and requirement and reaching accord with the customer about the general parameters of the program in terms of what the annual delivery rates would be and so on. And so there is a process now in negotiation with the contracting entity. So we're well into that program. And I guess I brought that front because that's very much in front of mind for me because we're involved in almost daily basis. The Dutch program was a much smaller program and that program has been deferred into next year and has no material impact on our revenue guidance forecast or expectations for next year anyway. But what was the third one? Neil, remind me?

The large RWS -- $1 billion potential RWS contract.

That was -- I did that one first.

Sorry, the T2000...

The T2000. So the T2000, the entire bid and tender process and competitive evaluation completed a few weeks ago, and the customer -- this is for Commonwealth Australia. The Department of Defense is now writing up a report for submission to cabinet. Its cabinet decision. In fact, its National Security Committee cabinet decision on the award of that contract. We have -- we're confident that the award will be made to somebody within the next 90 days because we know the process, and where it is in the process makes that almost inevitable. And we still believe that we are being one of only 2 contenders, and having seen the product performed really quite well in those trials. And we're quite confident that we're not less than 50-50 [indiscernible] that program. So those are the dealings specifically with those 3 questions.

And the deferrals that you've seen from Q4 into next year. Will they be additive to 2022? Or will that put some of the 2022 deliveries into 2023? A question from [ Hamish ] [indiscernible].

Look, [ Hamish ], that's a very good question I asked myself when it happened on Friday night. Look, the issue for me is all other things being equal, and I do see kind of a vaccine-led recovery to something more close to our normal business environment next year. But as long as that continues, I'd expect most of the deferrals to be additive to '22 and not push stuff out the other end.

Great. A question from Julian Walter. Is Huntsville manufacturing at present? Or is all production coming out of Canberra?

Huntsville is producing at the moment. Huntsville is producing for some of our commitments -- contracts and commitments around the world. Huntsville has become more -- because we have a significant facility in Huntsville with deep level of expertise, Huntsville has turned out to be a great asset for us in the last 6 months because U.S. citizens have not been subject to quarantine coming home. And so we've been using our U.S. staff extensively for our business development and testing and shooting trials and demonstration all around the world.

Any -- this is Robert King, any news on contracts in the counter-drone space?

Yes. The situation of the counter-drone is, we are still negotiating with the customer on the basis that the competition has closed, and we are the preferred candidate. I think I've said in another forum earlier this year if it was Australia being a preferred candidate, mean you would be about 90% to 95% certain of closing the contract. In that particular domain, which is not in Australia, it's -- the odds are a little less. We're making good progress in the negotiations. These are quite complex systems. I'm not talking about the customer being different people in any way, but these are quite complex systems. And for example, the -- I think we can speak publicly known information about this particular program. It's an infrastructure protection program. It's not technically for the protection of military assets. It's for the protection of revenue-earning infrastructure for the country involved. And it has to integrate, in an unusual way, with the nation's air defense system and with other national security elements of apparatus. And so these are quite complex. We -- I would expect -- we will have same team going back to -- for the next stage of negotiations within the next 6 weeks, and we would think that Q1 is a reasonable time for us to expect to close that. Bear in mind, just the reality of it is that most countries around the world will roll into new fiscal year on 1 January, and I'd expect to, given this -- how close we are to the end of the year, that particular program will be unlikely to contract before 31 December.

Great. Now we have a series of questions related to SpaceLink. And obviously, we've got the SpaceLink presentation and we will be having the SpaceLink management team, doing investor webinar on Friday. So I encourage you all to tune into that. But I'll just fire off a few of these questions that you've been. How independent is SpaceLink from EOS to parent in terms of outcomes? If one goes badly, the other one goes well, how strongly are linked to the 2 [indiscernible]?

Well, let's talk about the 2 different directions. If SpaceLink was to shut down tomorrow, EOS has expensed its outlays in SpaceLink, so it has no impact on the EOS at all. Okay? And the reverse is probably also true. If EOS was to close shop tomorrow, SpaceLink has such strong momentum in its own market now. It's so widely recognized within its customer base and within the financial community, that I would expect SpaceLink would have a life of its own. That's as it should be. I mean if one thinks about this carefully, we couldn't be proposing an IPO on a major stock exchange within 12 to 20 months for SpaceLink, if it didn't have a life of its own.

Yes. So some questions about the tranche 1 funding for SpaceLink, and I think we will elaborate on this a little bit on Friday. And you can see that we proposed that we are talking to investors. We're in very advanced discussions about a pre-IPO con note with the wide range of investors, and those discussions are going on in the U.S., in Australia and in Europe. So it's a global capital raise. There's another question here from debt -- about debt sorry. What sort of companies provide debt financing for projects like SpaceLink? Maybe it's on Michael, you could talk to.

Yes. So SpaceLink in the debt capital market seems -- is being very much seen with an infrastructure investment. Yes, it has a technical edge, but most of the interest we're seeing comes from really quite leading infrastructure-related funds. We're also seeing interest from export credit agencies, so government credit agencies in the respective countries.

Yes. If I could also add, we're talking about Tier 1 lenders only as baseline.

Yes. Okay. Great. And I think we'll get into more SpaceLink stuff on Friday. So finally, I think, is EOS still expecting to win and announce to the market a new contract this year, other than the potential for T2000 win?

I expect is a strong word. So we've got 2 -- we've got major programs coming to award over the next 60 to 120 days. Whether that falls before Christmas or not is very much in the hands of the customers. So we -- even though I understand the question, and I understand the intent behind it, we're very close to the end of the year, what other users coming. We -- in the normal course, it's too close to call.

Yes. Okay. Richard Hamersley says please explain how revenue deferral of $15 million to $20 million translates to EBIT deferral of $11 million, implies EBIT margins of 50% to 70%, which is much higher than typical contract margins?

Good question, and I was expecting it. Thank you for asking it. The company runs -- so the company is balanced -- and you'll read this in more detail in the 4C, which is now published. The company has scaled itself around a particular breakeven position, which is actually well below the expected revenues that we've designed the company for. And so in fact, revenues, once we cross $200 million in revenue, the profitability of that revenue is much, much higher.

Yes. I think the difference in gross margin and EBIT margin is something for Richard to have a think about that. [indiscernible] asks what's the reason that EOS raised $35 million debt in this quarter when the cash balance is in excess of $100 million?

Quick correction. Cash balance is in excess of $100 million, including the $35 million we raised. So -- and the reason is quite simple. Firstly, we've been criticized, and I think quite rightly, for some years for being completely debt averse in company. And the company, as we've announced this quite formally in documents to the market, that the company was prudently and carefully reversing that position. And we were opening ourselves up to the use of debt rather than what the market would probably call more expensive capital from other sources. And so the company made a determination that it wanted to have it about this time of year in excess of $100 million at its disposal because there are things that we would like to be able to consider. And the $100 million, you might consider an arbitrary number. But in retrospect, it's quite clear that the market that we knew that the $65 million was coming in. And we scaled our -- what I think is very, very minor debt facility. Very important but minor debt facility to $35 million. So we would reach that psychological level of $100 million, which is, in the absence of any other revenue, is well over the 6 months cash burn in the company. So that's the answer. We're moving towards being more familiar with use of debt instruments.

Yes. Back on SpaceLink, we you have a question about whether the OHB USD 25 million cornerstone investment will be received this year, and the answer to that is, yes. And then sort of follow-up part of the question, which is, do you expect to offset the OpEx costs of SpaceLink next year?

Short answer to that is, yes. The transition will happen sometime next year, probably early in the year.

Yes. And I think final question because we've kind of run out of time, from Peter Atkinson, and we're running out of questions as well. How confident are you in a T2000 announcement, since NSC will be happening December or January, but then we likely got election. So will that push the T2000 announcement until after the election?

It would be -- again, this is just me speaking from my own experience, it would be extraordinary for government having made the decision not to announce it before an election. That would be extraordinary. So if -- and no one knows when the election will be, I think the Prime Minister has got a range of choices from December, which is very unbelievably, unlikely to the February, May time frame. So we -- that's one of the things that would lead me believe an announcement. And I repeat, we regard ourselves as 50-50 chance an announcement will happen before the election, no later in February, and possibly before Christmas.

Yes. Okay. Richard Hamersley just followed up with his previous questions, saying gross margin isn't normally as high as 50% to 70%? Or is it? Given gross margins...

It can be. Yes, it can be.

Yes, exactly. And then last question from Robert King. In previous talks, you've mentioned tech that EOS has developed that doesn't have the market currently available. Has any markets been found for any of this tech?

The first thing that comes to mind because we've been working on it for the last couple of months is the government bought forward its announcement on spend of $100 billion. But people talk a lot about submarine program being $90 billion. The missile program for the Australian government is at $100 billion between now and 2040. EOS has had, for some time, secret technology on very advanced missiles. That's one of the categories of technology we've never spoken about. We can now because the government put forward by 12 months, almost 12 months, it's announcement. So the government formally announced that they were launching their missile program. What the government calls their Sovereign Missile Enterprise. And the enterprise concept is one from government, which involves a coalition of Australian companies that will deliver the $100 billion. And I want to be very clear, EOS does not consider itself a candidate to be primary factor or even have a significant slice of that $100 billion. But it depends on what you mean by significant. Our technology is applicable to about 15% of that market. And so we call that a niche. Some people will say $15 billion is a lot of money. It is over 20 years, and the bulk of the niche that we will be addressing falls in the second decade of the 20-year program. And so we would expect this -- I use the word expect when it is more than 50% likely in my mind. We would expect to receive contracts from Commonwealth within the next 6 months to start progressing towards that $15 billion market segment. And I'm not saying we're going to win the $15 billion. I said our technology is applicable to that with the right partners, and we've announced a joint venture, that's on the record. We've announced a joint venture with Nova Systems because one of the biggest problems, and very few people ask me to see how -- what are my biggest problems. The biggest problem I have right now is we can't get enough of the right people. The skill personnel market in Australia is very, very tight. But we've made a joint venture with Nova Systems, who have more engineers, more technologists than we have. And that combination of their technology and human resources and our technology and human resources gives us a quite incredible shot at that market niche that we talked about. Sorry, I only talked about one category of technology, but I know we are running hard up against time, but that is a typical example of something which we really reserved for years. The markets has come forward and we've announced it.

Yes. Great. Thank you, Ben. Okay. Well, listen, thank you, everyone, for your -- for coming into this call. And hopefully, we will see you all on Thursday for Dave Bettinger and the U.S. SpaceLink team, Friday 11:00 a.m. for that webinar as well.