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

Thank you for standing by, and welcome to the Electro Optic Systems Holdings Limited Investor Call. [Operator Instructions] I would now like to hand the conference over to Dr. Andreas Schwer, Group CEO. Please go ahead.

Good morning, ladies and gentlemen, dear investors. My name is Andreas Schwer, I'm CEO and Managing Director of EOS, Electro Optic Systems. Some words to my background. I'm an aerospace and defense engineer working for more than 30 years in the global defense and space and market. I'm German citizen. I'm working for EOS in this position of Group CEO since August 2022. Before I start on the content of this presentation, I'm happy to hand over to Clive Cuthell.

Thank you, Andreas. Hello, everyone. My name is Clive and I'm the CFO and COO of EOS. I've been a CFO for 20 years, and I joined, like Andreas, in the middle of 2022. On today's call, we are going to cover some information on recent contract wins and the cash flow announcements that we made yesterday. We have filed a presentation with the Australian Stock Exchange this morning that we will be using and referring to during the course of this call. And Page 5 of that presentation sets out the subjects that we're going to cover that I've just mentioned. We will talk for probably a little bit under 20 minutes on the things I've just mentioned. And then we will open the call for Q&A. One thing that we will not be covering is we have not announced the 2023 income statement, revenue or profit for the year. And these will be announced at the end of February. So that subject is off limits for today. But we will be covering, as I said, market developments, cash flow and other matters that come up in Q&A. So with that, I'm going to pass back to Andreas, and he is going to start with a market update, looking at Page 6 of the presentation that we filed on the ASX this morning.

Yes. Thank you, Clive. So the market overall is very bullish and it will remain very bullish throughout the year 2024 according to our expectation. Within the bullish market, EOS is benefiting from several macro trends. The most severe macro trend for EOS is the trend towards counter-UAS applications, an application which became quite popular already in the course of 2023 and even the most recent events, so the attack of the Iranian forces on the American camp in the Middle East, is showcasing that what type of weapon system is a weapon system of choice to defeat in flying drones, drones which are not highly sophisticated, but drones which are, say, commercialized, drones which coming in sometimes because [ drones ], which lead to an oversaturation of the aerospace. In such situations, the kind of conventional missile-based air defense is simply unaffordable and they don't have enough stations or launching pads in order to defeat those kind of incoming threats. More and more NATO countries has referred to us asking for our advice and asking for our systems to get first tested and then hopefully field it in large quantities to complement missile-based air defense to make our system part of an indicated multilayer air defense system. We've been approached by countries even though the ones which have very sophisticated systems in the marketplace, countries where we thought that they are not on our short- and medium-term target list. So this market is extremely promising. And our products are right for that because of our key criteria and key performance criteria which is precision, high reliability, firepower. And we have an interface, which easily allows our system to be indicated again in an overarching C4I network system. So this Counter-UAS market segment where we have also -- where we were talking in a minute about some recent successes, we expect to grow significantly over the next 2 years and where our market introduction of the product called Slinger was right at the spot. The second market trend is a trend towards remote battlefield operation, robotic battlefield operation. More and more clients want to introduce in smaller quantities, automated robotic battlefield vehicles both on [ track and field ] platforms. Our system is very much sought after because of high reliability, very high first hit probability. And here, there is a major role because there is nobody on board. There is no [ solution ] to reload the canon. So we have to survive for the amount of ammunition, which is on board. And here, again, our high hit probability is helping the mission to be completed successfully. That's the reason why EOS remote weapon stations are, for most of the operators, the choice #1. So that's a mega trend, which will be valid for several years to come. It's just at the starting point. The third mega trend, which we are seeing right now has some kind of context with the Counter-UAS business. It is linked towards laser systems. We have been approached by various countries over the last few months about our laser system capabilities. And just to recall, we did a significant investment last year in August and deployed our 36-kilowatt high-power laser system in the Australian desert. And we were shooting down drones, Class 1 and Class 2 for our clients. It was a kind of trigger point for several clients and the markets to revert back to us and to see and discuss with us what we can do with them. That is the stage #2 in the kind of integrated remote Counter-UAS system in the market. We expect 2024 to be the year where we hopefully will get in the first 2 contracts in order to commercialize those products and to get into the market and to convert this kind of business, which was so far a subsidized business into a profit-making business. In the laser segment, we distinguished between the high and medium power segment, which is from, let's say, 20 kilowatts to 200 kilowatts, where we have currently been offering in the range of 36 to 54 kilowatt, but we want to go higher. And the so-called low-power laser segment, which are lasers, which can be integrated on other weapon platforms in order to predominantly dazzler sensors of incoming targets like drones. We have showcased this in October with the first indication of such a 1-kilowatt laser on an R800 system, and we got huge market resonating on that one. This is not a product which is currently fully qualified. It's a prototype stage, but we can easily qualify this within this business here and make it a very nice and interesting differentiator of our weapon systems, our RWS on the marketplace. So those are the key market trends in terms of innovations. We have introduced this year, the R400 Slinger as a major Counter-UAS canon-based air defense system. We've introduced the R150, our small system in the weapon station market, to serve the mass market. And we have introduced at AUSA, the Washington-based defense show in October, the R800, our high-end weapon system, which can compete against full turret systems, but at a much lower price and a much lower weight point with a large 30-millimeter caliber canon. And again, on this R800, which is a platform which can carry not only kinetic or ballistic system weapons, but also other kind of effectors like missile heads, anti-tank missile heads, air defense missile heads. But it can also carry multi-rocket-launcher systems or as I was just mentioning, there was laser dazzlers. And again, this is the [ key discriminate ] on the marketplace. There's nobody else being able to offer a nice combination of those laser technologies with a classical conventional weapon station. So on the innovation side, again, we have brought to the market 2 new product lines, the R150 and the R800, to complement our best-seller, the R400, on the marketplace, which is giving us a significant growth perspective for the years to come. I would like to go now to Page #7 and discuss a little bit about our recent contract wins. Those contract wins a few out of many, many discussions and negotiations we are conducting with various clients around the world. Most of those negotiations take some time, but we are very confident to be able to announce over the next few months some further contract wins. Important for us is that we have succeeded in enlarging our customer base and by that -- by diluting or mitigating our business risk. We are in negotiations with various NATO customers. We are in discussions with various customers, new customers in the Far East and in the Middle East, which hopefully will result in some further contracts this year, which we broaden up significantly our customer base, and again, giving us much more potential for the future. So those 3 systems or 3 wins which we have realized over the last few weeks here are just a little subset of out of all those and of discussions and negotiations ongoing. The first one, which we signed on November 13, is our well-established R600 remote weapon station for a client in Southeastern Asia. This is a client with a very established R600 fleet, and he wants to continue investing into it and upgrading into it. And this contract is one in a series of contracts with him in the future to come. The next one which we have signed end of last year, December 27, is the contract on R400 systems. It's a contract signed with a Western European government, which does not want to be mentioned here. The government is a major donator to Ukraine. So those weapon stations will go to Ukraine on M113 platforms, and will go to the battlefield instantaneously once they are rising there. It is the second contract with the government. The first contract has been signed in the mid of last year. Those systems have been all delivered. The contract is coming to an end pretty soon and those systems are already in Ukraine. The last one is a contract we just [ franchised ] a few days ago. It is Slinger, our Counter-UAS system, which we have sold to a German company called Diehl. Diehl is our partner for the German markets. Diehl is a defense company being active very much in the missile defense. They are the OEM for the so-called IRIS-T SLM, which is the backbone system for air defense to protect Kyiv. It was donated by the German government. And it is a plan now to protect those kind of systems, those kind of launching pads, radar stations in Kyiv and also for the other clients and other countries against incoming drones. Some background information on that one. Over the last few months, those kind of installations in Ukraine have suffered severe attacks by drones. And suffered from severe damages. So the German government has decided to protect those stations with EOS-based remote weapon stations. This is for EOS, a breakthrough, even if the number of the system -- of the revenue is -- the revenue of this contract is very small, it is a breakthrough for us because it's a breakthrough into a new market segment, a segment of defending missile-based air defense systems. And it's a breakthrough into the German market, which is a huge, probably the most dominant European defense market. So we expect that this contract will be delivered over the next few months, we'll see go into operation in Ukraine. And hopefully, everybody will see in its operational phase that it is a major asset and hopefully, not only the German government, but also other governments, [ we hold ] this example and install a similar type of systems, U.S. systems to protect their own assets. In this kind of context, we are also in discussions with various other Western European NATO customers, potential customers to do similar kind of self-defense installations. So that's the reason why those 3 contracts, even if they are quite modest in size, are very strategic, and we believe they can be acting as door openers for many other contracts to come over the next several years. That's what I wanted to say on the recent business wins, the innovation in the last quarter of last year and the overall market trend. I would like to hand over now to Clive to give us an update on the cash flow situation.

Thanks, Andreas. So on Slide 8 in the presentation that we filed this morning is some information on the fourth quarter cash flow for 2023. And I'll comment briefly on this and then move on to the bigger picture for all of '23 on the next page. But in the fourth quarter, we obviously had $105 million of receipts from customers, and that included a combination of both cash realization with our major customer in the Middle East and also cash received on contracts that were won during the 2023 year, including some cash generated from the EM Solutions contract with the Australian Navy for SATCOM terminals. So these receipts reflect just nothing more than the continuation of our disciplined approach to manage customer contracts, particularly in the Middle East, but also new ones. Our focus on ensuring that new contracts have the right cash flow profile and finally, we've been continuing to manage the overhead cost base. And the net result of all of that is a positive $34 million operating cash flow during the quarter. If I turn to Page 9, which shows the picture for 2023 full year cash flow, and I'll just talk through the aspects of this. So obviously, customer receipts highlighted $325 million for the year, which is the highest the business has ever achieved. And the operating cash flow from the year of $113 million, which is also the highest the business has achieved. And this -- there's no magic in this. This has been done by delivering on the actions that we have outlined on these calls over the last 12 or 15 months. So we did say that we would amend the contract in the Middle East, which we did in February last year, and we would collect the cash and we said that we would sign cash-positive contracts. And obviously, that has -- both of these have contributed significantly. And we've continued to manage the performance of our contract book diligently. We also said we would manage cost. We had a significant head count reduction in -- at the end of calendar 2022. And we've been managing our overhead cost base carefully over all of last year. So the result is the operating cash flow of $113 million. We know that the company has significant intellectual property and turning that into revenue, profit and cash in the future requires ongoing discipline today. So we've been disciplined with the application of the cash flow that we've generated. The CapEx that you can see in the cash flow detail that we filed, which is a minimal CapEx from the year of about $3 million. As we've said before, the business does not need significant CapEx to scale up, and we are focused on monetizing our previous investments in product development rather than flowing very large amounts into new product development. And I think as a lot of people know, we ceased the investment in the space link venture in calendar '22. So calendar '23 did not have any impact from that venture. We did invest $32 million during the year in guarantee deposits which support the growth of our business. But what that means is that, in addition to the $71 million cash we had in the bank in December, we have a further $67 million of cash in security deposits with guarantee providers. And much of that -- not all of it, but a lot of that will return to the business in calendar '24 and '25. And that's an investment we continue to manage carefully as we negotiate new contracts. So with that approach to investing remaining disciplined, we were in a position to repay $27 million of debt in September '23. And our intention is to continue reducing debt that we've incurred as we go forward. And Page 10 sets out the debt profile of the group, which I know people have seen before. So at the top of Page 10 is the first slice of debt that was repaid in September '23 and then the 2 remaining debt slices of $20 million -- well, $50 million principal, $20 million to be repaid in April '24 and $35 million of principal with $52 million to be repaid in about 20 months in October 2025. So we have run this business for cash using the realization of working capital during the year to repay debt, run the business and allow us to diversify the products and customer base of the business. That will remain the focus going forward. So I'll pass back to Andreas now, who's going to touch on some -- the last couple of slides that we'll talk about today. Andreas, over to you.

Yes. Thanks, Clive. So I want to reiterate once more our key statement which we have used when we started in our new positions here, CFO and CEO. Let me start with that, that we will always remind you that we always say what -- or we always do what we say and we are 100% transparent to all of our investors. And this [ Page 8 ] is all about it. I mean you will then remind this page -- remember this page, we came up with this one in our very early days. And we told you that's the kind of action plan ahead of us for the next 12 months. And today, we want to show you that this is more than what we have done over the last 12 months, we have delivered what we were promising. And we'll continue following this kind of basic business principle, we will give you some kind of outlook. We will tell you what we intend to do over the next 12 months. And then time after time, we will come back on those and show you how we have ticked the boxes or in case you missed 1 box, we will explain to you why we missed it or why things takes a little bit longer than expected, also that could happen. I have to admit over the last 12 months or 18 months since we started. It went exceptionally good, even better than what Clive and I expected. And as a result, I mean, the cash flow is quite outstanding, the cash flow by end of 2023. And we want to continue on that. So cash was king and cash will remain king for the company. So if you look to this page, when we started in August 2024, we started with formulating a new company strategy to focus on the core business. You might remember our 4 key pillars. One is the remote weapon station business, one is EM Solutions, our satellite communication terminal business. Those are our 2 cash cows as of today. And then we have the 2 significant growth market, the very strategic growth markets, the #3 here, [ the third pillar ] is the first strategic growth market. It's the directed energy market with our laser weapon systems, where again, we want to convert this year from a subsidized business into a profitable business, and we have very good hope to be able to do that. And the fourth one is space warfare where we have converted the space awareness business into a kind of defense business, space warfare to engage against satellites in space, which will take a little bit more time. Those 2 strategic elements would require a significant investment, and you can see some of those data in the appendix to this presentation. We told you in the beginning that EOS, we've stopped under our leadership to invest our own money into huge product development activities, and we stick to our word. We are seeking for external funding, external partners to do that. And again, we are quite close in having a solution for the directed energy pillar on that one. So the new strategy is in place, and we are already benefiting from that one. We've increased efficiency, as Clive was mentioning. We have been very innovative. We have launched core products with the Slinger with R150, with R800, we have shown to the market the laser dazzler as a key complement to our weapon station field and we will come in 2024 with more innovation on the remote weapon station segment. But again, just by adding the R150 and the R800, which both go into production this year, we have a much higher revenue potential than just basing our business on the R400 and the R600 as a kind of long-standing value tools -- product lines from the very past. So we have managed to grow the business and to diversify our sales. We have gained new customers mainly in the NATO market. We expect several new clients to enter the table with signed contracts this year. This is a process which doesn't come overnight. It takes longer time. We need to introduce EOS to all of those clients. And the European market, for example, is a very fragmented market. It takes lots of effort to talk to all those governments in order to get into business. First, it goes into product demonstrations and then, after a long time, maybe order a few pieces and then they go into the battle field testing and then it goes into a larger framework procurement program. All that takes time and effort. In the course of that, we have decided to open this year an EOS European entity. We need to have our boots on ground in Europe. We need to have an entity there in order to be closer to the client to better understand the market needs and to have an on-ground logistics center for our clients, which then are not accepting logistic chains all over the globe products coming out of Australia. Spare parts needs to be -- spare parts that needs to be located in Europe. All that we want to do in 2024, which will add some kind of CapEx to the line. So we have to expect that in 2024, we will use a little bit more CapEx than in 2023. But it is important. So going into the European market will be a landmark decision, and will open up for us new horizons for the company. This will not replace our partnership approach, even if they have our own European entity for the major clients in Europe. That means for the Tier 1 countries like France, Germany and maybe U.K. We will still have partners with which we will enter into those markets to minimize time-to-market and to minimize our CapEx exposure. But again, the European market is extremely fragmented. We are talking in total to more than 20 countries and that meets our own establishment in Europe. Our U.S. footprint will come on to play into 2024 as not only because of some contracts which we have signed, where we are producing in the U.S. like the R600. We expect to sign to see if some contracts for clients, which we insist on having the production done in the U.S., and we might be even in a position to become a member often so called U.S. FMS program the manufacturing in the U.S. will be mandatory. So our U.S. installation in Huntsville will become more and more key to U.S. in the next future. Working capital, Clive has mentioned that, how successful we've operated in that domain as well as on the last point, our repay of debt and the focus on cash overall. So overall, we think that we can tick all those boxes, all the promises have been fulfilled. We will define new targets for this year and the time coming after this year, and we will meet you in the course of this year through all those achievements, and we will tell you how we operate and which boxes we can tick and which one we might not be able to tick as expected. But overall, and again, in summary, the business has been very successful. We are quite satisfied with the achievements and we are very optimistic if you look to the further future. I turn now to Page #12. So to come to a conclusion what relates to our own presentation. So we've given you an overview about the full year 2023 results. All the details you could read in our published paperwork. And now it's the time for you to raise questions to Clive and myself. Thank you so much for your attention.

[Operator Instructions] Your first question comes from Owen Humphrey with CGF.

For normal turnarounds from my perspective, well done, I guess, just getting started. Just to understand huge working capital levers throughout the year, the contract asset falling materially down to well below last year. I'd be interested to know, is that now -- is there a working capital swing the other way expected in FY '24? Or is this now a steady state from a working capital perspective.

Clive, I think that's for you.

Yes. Thanks, Owen. So that's correct. During the year, we had -- what we see in December '22, we had AUD 160 million invested in contract assets, and we reduced that by AUD 100 million to about AUD 65 million by the end of December '23, and that's largely from the contract in the Middle East. There is room for further reduction in that, albeit it will take time. So most of the balance that is remaining or a big chunk, about 2/3 of it relates to the 10% retention on our big contract in the Middle East. So that -- we do not -- we expect to get that back in calendar '25 when the deliverables under the contract are completed in the first half of calendar 2025. So we'll get some realization, but it will take a little bit of time. We will continue to focus on contract discipline and managing that aspect on other contracts so that we do not have a huge accumulation in the company that suffered in the past. And we do have some significant inventory of parts that we use in the manufacturing process and some of that mitigates against supply chain risk. And we would expect to see some reduction in inventory working capital also over the forward couple of year period, particularly as supply chain conditions approved around the world. So I hope that answers the question Owen.

That does sounds like as a further over a 2-year period, maybe a further AUD 30 million to AUD 40 million working capital swing, back to you guys.

Yes, that's -- that's probably right.

And therefore, going forward, earnings and free cash flow will more closely align.

They should be more closely aligned. I mean one of the issues the company has faced in the past is that we're dealing with strategically is that we've had a high concentration amongst a small number of customers. And clearly, as you can see from the recent trend, we're making some headway on diversifying the customer base and that will reduce the lumpiness in the contract business. And as a result, we would expect to see a closer alignment between EBITDA and cash flow as you suggest.

And then just a question around the backlog of work. Now you guys obviously sounds like you're tendering on a number of contracts. I'll be interested in the expected materiality of these contracts? Is the expectation that the order book will be larger at the end of this year than it is at the beginning?

So I'll make a couple of comments and then I will pass to Andreas just to comment a little bit on the market. So the order book in our last report, the backlog order book at the end of June was AUD 645 million and that includes some conditional contracts with Ukraine, which Andreas will touch on in a second. The market, as Andreas has mentioned is very strong. And as a result, we would expect to continue signing work and our aim for the business is to secure more orders than revenue each year and continue to build the book. I would say on the contracts tend to be large and binary. So if you sign a contract for AUD 100 million in October or February, it can make a big difference to the order book at the end of the year. But leaving aside that kind of thing, the direction that we aim to travel in is to continue growing the order book. We won't be giving guidance on what to expect at the end of '24 in terms of the order book, but I think you can tell from our comments on the market and other things that we'll be working very hard to make sure that it's growing, not shrinking. Andreas, do you want to comment on the Ukraine conditional contracts that we've mentioned previously?

Yes. Certainly. Before I come to that point, maybe some other comments. The order book and the order book growth expectation for this business here now is twofold. With the distinguished contracts, which are coming in for immediate execution, those kind of contracts are predominant tailoring 2 regions or 2 conflict areas. One is Ukraine, as everybody was expecting. The other one is the conflict zone in Middle East, the conflict around Israel and Gaza and some of its neighbors. That is a conflict which came up only very recently, but a conflict, which is also raising demand, immediate demand where we can benefit from. So this kind of -- type of contract will hopefully materialize in order intake and revenue short term in 2024, which has given us lots of good hope and optimism. And then we have the ongoing negotiations on other type of contracts, contracts which are not directly linked to those kind of conflicts, but which are the indirect consequence of a kind of overall more becoming more critical overall market, contracts which we hope to be able to sign so start in smaller quantities and then going to bigger quantities once we feel that the first smaller units or the first batches, those contract will be designed this year and to be delivered then not immediately, but in normal contractual terms after 12, 24 months. That's the second batch. And we are in negotiation with some clients on large quantity orders for more strategic opportunities. Those kind of contracts are similar to the other main one contract and hopefully are in a position to continue to have 1 of or 2 of those contracts in the order book as a kind of baseline for the future business growth. So those are the 3 segments we are talking about. And again, the key for short-term growth are the conflict-related direct sales. And the baseline for the long-term growth, obviously, are all the [indiscernible] contracts coming up or the increase of war stock contracts coming up and those kind of strategic contract I was mentioning at the end of my words. So coming back to Ukraine now. Ukraine, we signed last year 2 conditional contracts, which we're planning on first to qualify the product in Ukraine and second then look at actual purchase orders on those contracts. It is a very complicated process, more complicated than we wish to see. So as a first step, obviously, we are focusing on getting our products formally qualified that they will end with a formal catalog of the Ukraine MoD, catalog of products which can be ordered by any Ukrainian client. And that was a process, which was linked to a full demonstration and qualification program, which we have accomplished. So the kind of live firing part we have accomplished in August last year by a big live firing campaign in the U.S. And in the course of the last few months, we have done all the paperwork in order to show all the justifications and the documentation that the products are in line and compliant to Ukranian qualification requirements are that has been achieved. So our R400 product line is now formally listed in this catalog and our clients can now start ordering against those catalog requirements. That has just been achieved. What is very specific to the 2 contracts, which we have signed last year is beyond to this kind of catalogization, we need to conduct a test, live firing test in Ukraine. So we are first hoping look at the export licenses from Australia and from the U.S. to deliver the cannon ammunition and the battle station through Australia or from Australia to Ukraine. This turned out to be almost impossible because of the cascading requirement in terms of export licenses. And it might look simple, but it is very complicated to deliver a system to Ukraine where part of it like ammunition will not come back because it's simply a consumable. But other parts and components like the cannon, which is the U.S. product and the depreciation, mainly an Australian product has to come back because it's a business development unit which we give them for this demonstration. All this is very complicated from a pure administrative perspective. So we've decided in November last year to change the process and to go the other way around to deliver from Australia to the U.S. and to deliver from the U.S. to Ukraine. This is now work in progress and we hopefully are able to deliver this kind of demonstrating unit in the first quarter of this year to Ukraine to do then the qualification demonstration in Ukraine and to be able to deliver the products once we have received the first purchase order, hopefully, in the course of this business year. So that is awfully complicated, but that's the kind of process everybody has to conduct. And as our system is based on the U.S. and Australian export licenses, it is unfortunately very complicated. But we are optimistic now to have found the right path, the right method in order to get this done over the next few months ahead of us. But again, just the kind of the formal induction of our system into the catalog of battle systems in Ukraine is already quite an achievement. So overall direct sales in Ukraine will remain complicated and I want to mention that those 2 contracts are not the only 2 elements we are working on in terms of direct sales to the Ukraine. We have ongoing negotiations with multiple institutions in Ukraine to provide them battle systems. And also here, the trend is going away from conventional ground-to-ground interactions condo U.S. applications. So we have multiple discussions ongoing with institutions in Ukraine, who want to protect their assets, try to get the infrastructure against attacks coming in from drones. So hopefully, here, we'll realize some business towards in the course of this business year. So that's the update on the direct Ukraine business. Again, this is not -- I was not referring to all the other contracts Western Nations, which led to need products to Ukraine. That's a different and much easier story. I hope that answers the question.

Yes. I think -- hopefully, that covers Owen's question. So we'll hand back to Melanie now.