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

Good morning, ladies and gentlemen, dear investors. I am sitting here with Clive Cuthell, our CFO, and we will lead you through the full year results 2022 investor presentation. I hope that you have opened the investor presentation, which we've uploaded and published this morning on our EOS platform. We will leave you slide by slide through this presentation. I'll start with Page #5. U.S. has had significant changes in its leadership team. We have welcomed, from November 24 last year onwards, Garry Hounsell as our lead Chairman. Garry has very extensive experience in corporate finance, business leadership and management. He was long in his long start standing board member of many high-profile Australian companies. So Garry coming with a very strong business argument. And to get to myself, Andreas Schwer, I have more than 30 years of experience in global defence and space companies, most of them stock listed and publicly traded. My CFO, Clive Cuthell, joined us in September last year. Clive has more than 15 years of experience as CFO in Global Industries, most of them was A6 experience. Clive is a chartered accountant for more than 25 years. I had to hand over now to Clive to lead us through those sales of 2022. Clive?

Good morning, everyone. Thank you for joining again. I am going to lead us through a few slides on the financial results, and I'm now looking at Page 6 of the slide deck that we uploaded to the ASX this morning. As the slide indicates, we have been managing several challenges over the last 6 months and making progress in some important areas that we will talk about. As you can see from the page, revenue during the calendar year of 2022 was $137.9 million, and we will explain a little bit more about that in a minute. You can also see from this slide that we have split the loss for the year between continuing operations, which is our going forward business and the part of the business called SpaceLink that we exited in November 2022. As you can see, SpaceLink recorded a loss of $61.9 million during the calendar year, and that included the impact of the $47 million impairment that was reported at half year. We will talk a little bit more about this in a moment. But as you can see, exiting the SpaceLink business is a big step forward for EOS for our profitability and importantly, for our cash flow. We'll touch on that a little bit more shortly. The other items list here highlight the net cash used in operations and investment of $79.8 million was significant, and that included just under $27 million of cash that we spent during the year on the SpaceLink business that is no longer continue. Finally, on the table, we have highlighted the contract asset balance, which is a net balance of $142 million. This, as discussed in previous calls, is a significant matter for the company and realizing this asset, collecting cash, primarily from our biggest customer in the Middle East is something we've been very focused on. We're pleased to report this morning that in this month, in February, we have amended the contract with the customer in the Middle East to help deal with some of the problems that have caused the delayed cash realization on this project, and we'll talk a little bit more about that in a moment. I'm going to turn now to Page 7, which looks a little bit more at the underlying performance drivers that drove our core continuing business result for the year. Main factors impacting our results in 2022 where revenue was lower than the previous year, and the cost base was higher for reasons that I will outline. On revenue, as indicated previously, we have seen delays in the market during '21 and '22 that meant that new business growth during calendar 2022 was limited. This was driven by a number of factors, including the impact of COVID in 2021 and 2022 as it related to the process of customers awarding new contracts. In addition, the Defence Strategic Review in Australia meant that some project announcements were delayed from 2022 into 2023. And we'll talk a little bit more about that one. More significantly on revenue, the company experienced the impact of global supply chain challenges in 2022. Specifically, this has impacted the ability of customers and some big project customers to make available the vehicles on which our systems are installed, and that has delayed some of our ability to complete work for customers, which has impacted revenue and to some extent, cash flow. We've been work on that, as I said earlier, and we'll come back to that in a moment. The cost base for 2022 was higher than it is today. As we've announced previously, the company impacted a restructuring to reduce the cost base by $25 million, and that restructuring would impact was implemented in quarter 4 of 2022. However, there were 9 months of a higher cost base in the result before we progressively impacted -- have fully progressively implemented that restructuring in Q4. In addition, we also have the U.S. facility, which is growing, but is not yet profitable. So there's a cost associated with the ramp-up process of our United States facility. And finally, clearly, we've had a relatively fixed cost base that has revenue that is significantly lower than the previous year, and that flows through to an adverse impact on EBITDA. Andreas is going to talk in a few minutes about some of the things that we've been doing to address this recently and as we go forward. I'm going to turn now to Slide 8, which shows the results for our individual business segments. As you can see, the table on Page 8 shows the results, the revenue and the underlying EBITDA profitable for our Defence business and our Space business. The Defence business result was primarily impacted by the lower revenues that I mentioned earlier and the cost base. In Space, this business includes our EM Solutions business, which is growing very strongly. The growth in our EM Solutions business is 22% revenue growth year-on-year, and this is a consistent delivery of growth by this business. And that's what's driving the increase in the overall Space revenue on Slide 8. The EBITDA for Space as a whole has gone down year-on-year, not because of EM Solutions, which continues to grow, but because of the impact in 2022 of various central costs that the group encouraged and have been allocated to the Space business as well as the Defence business. That's all I was going to say on the individual businesses. Turning to the important matter of cash flow. Slide 9 shows the cash flows separately for 2022 for our continuing go-forward business and the business of SpaceLink, which was exited in November 2022. As you can see, in 2022, the SpaceLink activity had a cash outflow for the group of just under $27 million. So the exit of this business, which we undertook in Q4 2022 is a big step forward because that means our group cash flow will not have this drain in the future. Also shown is the cash flow for our continuing operations. The negative operating cash flow is driven by a number of the factors that I've already mentioned. The most important of which is our collection of cash from customers, in particular, the contract asset that I mentioned earlier. I'm going to turn now to the funding position of the group outlined on Slide 10. This slide summarizes the report 2022 refinancing that the company undertook. In October 2022, a long-standing equity investor in the company, Washington H. Soul Pattinson, invested $70 million in date into the company. And that was a very positive step that allows the company time to improve its performance. A key task in 2023 is the repayment of the first slides of that debt. The repayment as indicated in the top line of the table on Slide 10 is $26.9 million, and that is repayable in September 2023. There are details of our funding arrangements set out on this page, and golden details also set out in the appendix. The most important thing that EOS is focused on at the moment and in 2023, is improving our cash flow so that we can repay that debt in September. The initiatives to improve cash flow are listed on the bottom of that Slide 10. They include the things I've already mentioned, terminating SpaceLink venture and reducing headcount and costs by $25 million. There's a lot of work going on in the company at the moment to improve cash collection from customers. In particular, this has included renegotiating part of the contract with a large customer in the Middle East that renegotiation and the signing of a contract amendment was completed this month in February. The effect of that amendment is to allow EOS to collect cash on this important project earlier than would otherwise be the case. As you can imagine, we are pleased about this, and it's a big focus of our activity for the rest of 2023. In addition, we are working on securing additional cash positive sales contracts. And as we've outlined previously, we continue to focus on managing costs and managing CapEx in a very disciplined way. We continue to be very focused on cash flow and the Board continues to regularly review this matter so that it gets the scrutiny at desires. On the next few pages, Andreas is going to talk about the outlook. We have not included specific guidance on revenue or profit for 2023. The company will provide its next updates on our performance. At the end of April, when we file our quarter 1 seat on the ASX and at the Annual Meeting of the company, which is planned for the end of May. I'll now hand over to Andreas, who will talk a little bit more about our initiatives and how business is going and the outlook.

Dear investors, after my arrival as group CEO to the company in August last year, we started to conduct a strategic review, which was focusing not on particular elements of the company, but which had a focus on a complete rebuild of the company. We have decided to cut cost to and, in particular, SpaceLink and to stop any loss-making business. The restructuring program of the company was fully rolled out and implemented and accomplished in the second half of last year. Throughout this process, we had to let go more than 30% of our total workforce, mainly in indirect positions in overhead and management. We also simplified our organizational structure to be much more efficient and lean in our own operations. This is leading to cost saving of $25 million per year. And again, that has been implemented, so it's effective from now on. As I was mentioning, SpaceLink was our biggest cash drain in the last years. We have ceased the investment, and we have exited SpaceLink in quarter 4 of last year. SpaceLink has been put into a process called ABC, Assignment for the Benefit of Creditors, and that becomes history of the company. This will significantly improve our cash flow for the actual business year. Our focus, as Clive was mentioning, is pretty much on cash receipts to reduce contract assets to liquidate our inventory that remain, thanks to the 2 amendments which we have signed, which was a big breakthrough because those contracts have been amended to the disadvantage of the client and to our advantage. We are putting much more focus on very concrete sales opportunities. This will hopefully lead to secure some new contracts throughout this year. And obviously, we apply very disciplined management on cost, CapEx and OpEx. Any kind of expenditure is very carefully considered. This will lead to a very strong commercial culture in the company through all the levels from the CEO down to the last engineer down to a last technician and manufacturing guy. We are in the process of setting up potential strategic partnerships with foreign OEMs and national champions. For those partnerships, we will be able to access future growth markets, which are so far not accessible for us. Those partnerships might include capital transactions or equity transactions in the case of noncorporate or also incorporated structures. I will move now on to Slide #12. Let's have a look to the market governments and the outlook. The world is currently characterized by a lot of upcoming threats, most notably the conflict between China and U.S. and the contract in Ukraine coming with increased geopolitical tensions around. This leads to an increased focus on national security and an increase in defence spending all over the world. So our defence markets will be facing a very strong market growth over the next 5 years. So it is for U.S. a very healthy business perspective. If you look at the evolution of technology, there's a very strong trend towards unmanned platforms and all those unmanned platforms need the most double stations, which is our core product line. So we see big opportunities there. Ukraine has shown that drones and counter drone business is becoming more and more important. Those kind of new sets need to be engaged, in particular, with new high energy laser systems. -- Last but not least Space warfare is the upcoming new market segment where U.S. is best positioned. Nevertheless, if we learn from a Ukraine voice, the customer has to focus much more on cost. Cost has drone the cost per missile kill. Just to give you one example, in the hot times of the Ukraine war, Ukraine was shooting up to more than 5,000 stores of missiles per month that are shot in most cases by counter missiles, each of which were the cost of $300- $500,000. This becomes unaffordable. That means new engagement in sectors like high energy labor weapons, where the cost of a shop is at about $0.10 only, just the cost of the energy, it become more and more popular. We believe that higher labor that needs to be become a very significant business contributor to the U.S. business in the future. And here, U.S. has lots of competitive advantages. Let's move on to the importance of secure and reliable communications. Cyber warfare is becoming more and more a subject of interest for all forces around the world. With our affiliate company, EM Solutions, we are best positioned as the leading-edge technology solutions for satellite communication terminals. And last but not least, accessibility to Space is of extreme importance. The dominant Space he become the most decisive factor in the better feel of the future in a party who can best control base assets it has a unique strategic advantage. Our space capability are best suited to enter into this type of military-based domain. So overall, if I may summarize the Slide #12, the market outlook is extremely positive for U.S. I move on to Slide #13. I want to give you an update on Defence Systems. As you were mentioning before, the priority is to maximize customer resets to generate cash. Cash is king. We had by the end of last year, net contract assets of more than AUD 139 million. Those assets need to be converted now into cash. And as it was mentioned before, we put all contractual baselines in place, which will allow us now to cash in those amounts and to improve our cash position throughout this year. Second, revenue growth, the Defence Strategic Review outcome pending. We expect first information coming out by mid of March. This is very important for the future of our business within Australia. International markets, like the one in Ukraine are booming. And I want to inform you about a business trip, which I did together with our EVP, Defence, [indiscernible]. We were traveling there 3 weeks ago, and we were meeting with all decision makers and the negotiating some deals which are very promising. So we have done this as we believe into the coal marketing of Ukraine and some short-term benefits for the company in the U.S. As mentioned before, leading up partnerships is also in our focus in our go-to-market approach. What the U.S. has done in the past, entering a new market by its own like in the U.S., this was coming with big cost and a long lead time. We do not want to copy this into other regions like the European region. Here, we want to build up on partnerships to have a good access and to limit our capital expense. If you look at our products, we have done the product launch of our 150 lightweight product, the most lightweight attestation in the market. We see significant order growth for the R600 with some product or contracts coming up in the next future. And we will finalize the development and industrialization of the R600, our very happy demonstration before end of this year. We also obtained at the end of last year the clearance of our U.S. facility, which will allow us to beat now for classified U.S. programs. So all that is very, very positive. And again, we will put a very strong focus on discipline in terms of expenditures, OpEx and CapEx. I move on to Slide #14. Slide number 14 is talking about Space Systems. EM Solutions delivered another strong year of growth. We have achieved 22% of growth by EM Solutions last year and the growth will continue to happen also throughout this year. EM Solutions is well positioned to acquire further contracts and EM Solutions is well positioned to extend its product base into other product areas, which are very promising in the future. We have continued delivery for sailing and several European naval fleets, and we have achieved significant sustainment contracts for the Royal Australian Navy. Again, EM Solutions is our ground jewels, and we have very great hope in the end solutions. Space Technologies, we have long-standing and laser expertise in this domain, which we deliver first intelligence and then space control, space control, which is the cornerstone and the backbone of space warfare. We expect a very strong growth in global market, as mentioned before, as the military have identified space as very strategic for the future by the field. So we expect to commercialize those products in the coming years and to achieve significant growth in this market segment. But we need to mention that it will take some time. This is not a short-term objective. This is a medium-term objective. It will take us 2 to 3 years to develop those commercialized products and to get the growth realized. But again, it is very strategic for the company. I come to Slide #15, conclusions and actions. All the initial steps have been successfully completed, and we have a bear focus now on the year 2023 and following on. We have a new leadership team in place with much more focus on business and commercial aspects. We have completed the refinancing of the group. We have successfully finished the SpaceLink activities, and we put in place all cost-reduction measures. We are on a good day with the definition and identification of strategic partnerships, and we see lots of opportunities there. And all that is based on a global market outlook, which is very promising and improving day by day. However, the key actions for 2023 will be cash collections, to secure new sale contracts and all those sale contracts must be cash positive from day one on. And we continue applying a very disciplined approach to reduce expenditures and to keep an eye on CapEx and OpEx. And last but not least, we will repay our debt as promised. So overall, we have lots of confidence in what we are doing, and we are very optimistic if you look on the way ahead of us. Coming to the questions, and let me check with my colleague Clive, whether we received some questions online?

I think, Sari, our operator will now remind people the process for taking questions. So Sari?

[Operator Instructions] I've just got one question coming through from James Lennon from Petra Capital.

Congratulations. Just 2 questions from me. First one, you might have mentioned it, so apologies if you have the contract assets, are we expecting those to come down noticeably in the next year or so.

It's Clive here. We have not given specific guidance on cash flow for the year. What I can say is that the net contract asset, which is $142 million, there are a number of initiatives in place to collect substantial cash from that. We would like to see the amount of that come down, and that depends on 2 things. Obviously, that depends on how successful we are at collecting cash. And it also depends on new contracts signed. And as Andreas said, new contracts are intended to be cash positive, and we're working to collect. So if we do that, then we'll get the right outcome on the contract asset.

Great. So maybe another way of asking it, if you sign new contracts or maybe this contract going forward. What's the sort of -- what level of contract efforts would you expect to have the percentage of sales? Or how should we look at it going forward?

Yes. So going forward, we are looking for a substantially reduced level of contract asset on new contracts. So the company has unfortunately been in the position in the past where the contracts that have been signed have required significant working capital investment. Our go-forward approach that we've been working on with new contract sales is to have very little contract asset on new projects.

Great. And just one more. I couldn't see it in the account tax losses, what's the -- is there a level of utilization going forward? Can you give an update on the tax situation?

Sure. The company has obviously had a very difficult year in 2022 and is in the process of completing its tax returns for the 2022 year. And we have got tax losses as some members of the audience may be aware, the new government rules on carryback of losses means that if we made a tax loss in 2022, we can carry it back and get a refund, and we will be looking to do that.

[Operator Instructions] At the moment, we have a question from Sam Watkins from PMICO (sic) [ PIMCO ].

I'm just referring here to the delays that we've seen around the announcement of the strategic review of defence. And I want to understand whether or not management has a view on the change in the funding position that EOS has seen over, let's call it, the last 12 to 18 months and whether there's a view that, that underlines some of the strategic positioning to win contracts as a result.

So we expect as part of the package and announcement on Land 400 Phase II, which is a multibillion-dollar product to introduce a new track based [indiscernible] platform to the Australian forces. As you know, EOS has participating in one of the 2 down selected bidders' teams. And obviously, we hope to get down selected with our partners and to be in a position to participate to this huge program. The discussion is ongoing about the potential reduction in the number of vehicles to be introduced. So we believe this is likely to happen. But even then, the contract is still a very significant value and contribute significantly to the growth of our company.

Your next question is from [ Ryan Kane ] who is a private investor.

My question relates to potential sales for the remote weapons in Ukraine. Do you have an expected time frame of when that would be confirmed? And an is, at the moment, looking like a one-off purchase or for an ongoing series of purchases?

We needed undoubtedly a very strong demand in our remote weapons in Ukraine. However, the situation in Ukraine is changing day by day, week by week. Currently, Ukraine is more in the defensive mode in defence in more high-age, Clive, that the systems like 155-millimeter are core systems -- once Ukraine is coming into the offerings, they need more infective fighting vehicles with our type systems. So the situation is very volatile and extremely depending on the military action in the battlefield. So this was almost impossible to predict when those contracts be liking as those contracts are not driven by strategic needs and long-term demands that are driven by the needs of the actual battlefield, and the decisions are made by Ukraine more on a day-by-day basis. So I kindly ask for your understanding that we cannot give a very solid particular.

And sorry, on the second question, Ryan, you asked about whether things are recurring. Look, I think you have the same information that we do, which is the situation is evolving very quickly. It could be the case that there is business that could run for an extended period of time or maybe not. So it's not -- we're not in a situation where we're talking solely about the one-off possibility. I'll put it that way. The other thing I would add is that the market outlook for national security national security products in particularly in Europe, has changed completely in the last 12 months, and we are seeing a significant investment and investment plans by many national governments into national security. So we expect a higher rate of growth in the market over the next 5 to 10 years than there has been in the last.

If I could quickly ask one question. ERS is involved in the sovereign SL alliance. I know the DSR is happening now. If there is an emphasis on sovereign production of components would EOS stand a benefit? And is there an estimated time frame on that?

So yes, we expect a bar role in the upcoming air defence misuses to development in Australia and consecutive production phase. It is too early to say what our details will be. It may depend on the selection of the system by the trailing government. And what are all the systems not off-the-shelf U.S. systems or what the government will put some of its budget into the development of these localization of existing systems to the play the benefit Australian industry. So -- but yes, we expect to get some share in that one. But again, this is nothing which will play a significant revenue role in this year or the next year. It is more for the mid and long term.

Thank you. There are no further questions in queue at this time. I'll now hand back to Dr. Andreas Schwer for closing remarks. Please go ahead.

Yes. So I want to close the session by giving a big, big thank you to all of our investors for staying loyal to us for staying with us through very challenging times. Again, we are very confident if you look to the future of this company with the new leadership in place and where the market evolutions and our strong product base and strong innovation and IT base, we are very convinced to make this company a big success story in the future. We kindly invite you to stay with us and to continue without the journey, they're looking forward for further discussions with you and further announcements to come. Thank you very much to everybody.

That does conclude our conference for today. Thank you for participating. You may now disconnect.