Flowtech Fluidpower plc (FLO) Earnings Call Transcript & Summary

Morning, everyone, and thanks for joining the Flowtech Fluidpower plc results investor presentation. <<operator_script>> Just a reminder as well that this presentation is being recorded. Before we get started, we'd like you to take part in the poll below, and if you're able to hear it, we'd really appreciate your attention. At this point, I'll pass things over to Bryce Brooks, CEO, and Russell Cash, CFO, of Flowtech Fluidpower. Good morning to you both.

Yes. Good morning.

Morning, everyone, and thanks for joining us today. It's our first time using the Investor Meet company portal. From the list of people who've signed up for this presentation, it looks like we have a mix of 1 or 2 who've followed us for a good while and so know the story well. But equally, there are a number of people who may be learning about Flowtech for the first time. So in the first 5 minutes or so, I'll quickly try to bring everyone up to speed a little on who we are. That's why we're beginning with the slide deck in the appendix. After that, I'll move into the main bulk of our presentation. That main part will broadly cover 3 areas. We'll briefly discuss how COVID-19 has affected the organization. Then we'll talk to some degree about the financial outputs from that, which are obviously quite different from our normal financial performance. And then I'll focus on some of the key strategic decisions we've made and how we're developing our strategy as we hopefully evolve out of the COVID year and move forward into 2021 and into 2022.

Let me give you some background on the organization and a bit about our leadership team. Obviously, there's me. I've been at Flowtech for 10 years. I joined the organization in 2010. It was already a well-established business, previously family-owned, that had moved into a private equity world. The private equity investments spanned the initial financial crash. So it had challenges in its balance sheet in 2010, but fundamentally, it was a very strong business. So I was the CFO at that time, working with Chief Executive, Sean Fennon. And we developed the business from 2010 to 2014, we've halted it on the A market. I stepped up to Chief Exec in 2018 when Sean retired. And I was joined by Russell Cash. So maybe you should give yourself an introduction?

Yes. And regarding being up in a little bit — an odd surname for an accountant, when my parents, once upon a time, must have had a sense of humor. I've got a fairly, I suppose, with respect to a different type of background to most CFOs of quoted companies and that I spent over 1/4 of the century, I've seen the world of turnaround and restructuring. So joining Bryce at Flowtech 2.5 years ago was actually my first venture into industry. But I didn't know it at the time, but obviously, some of the challenges that our friend, COVID threw at us, I was able to dust off some of the turnaround, it's not the right word, but you know where I'm coming from this steady head and stabilization type, but staying quite useful. So in my DNA, I guess, there is a lot of stuff around controlling cash and controlling costs. And I think 2.5 years on, if you follow the story, you'll begin to see some of that coming through quite strongly.

So it turns out that the rest of the Nonexecutive team was headed by Roger McDowell, who served as Chairman from 2014 until the change in 2020. We have Malcolm Diamond as Chairman, and he brings broad experience. He was Former Chairman of the Year and is Chairman of Trifast, which is his main legacy business. But Roger stepped up when Malcolm retired last year. Roger has wide-ranging experience across a number of businesses. He has served as chair in all 3 of the organizations. And style-wise, there is probably a shift in style from under Malcolm to under Roger — very process-driven, very proactive and active in our management style, and that is something that certainly Russell and I welcome. Nigel Richens has been a continuity person right the way through from Flow, and he was previously an audit partner with PwC in charge of their technical department before retiring 6 or 7 years ago. So Nigel chairs our audit remuneration side of things. And then, more laterally, we have the appointments of Paul Gedman. This is Paul's only plc appointment, but his heritage is firmly any business. He was one of the key protagonists in the developments of The Hut Group, working with the Chief Executive there, Matt Moulding. He left The Hawk Group as part of its flotation last year and is now establishing his own portfolio of interest, all with an e-business and data element to it.

And hopefully, that's something you'll notice going forward. As for the broader context of the group, we're a specialist niche industrial distribution company centered on the fluid power market — that means hydraulics and pneumatics. We distribute on behalf of the vast majority of the major global brands, and we have roughly 620 employees across the U.K., Ireland, and in the Netherlands and the Benelux. But the bulk of our business — the vast majority — sits in the U.K. and Ireland. Right now, we operate out of about 19 sites. That's down considerably, though, from 27 sites 3 years ago, when we closed our last acquisition, as part of an M&A program. So we're working through a reduction of our overall footprint, and obviously there are improvements in operational efficiency that flow from that. From a reporting standpoint, and very much from a management standpoint, we've split into 2 discrete divisions. There have been some developments there that I'll cover in the main book of the presentation. But component distribution, with a lot of technical added value requirements that come with it, is the core of what we do. So yes, some parts of it are fast-paced and high-service-driven.

But at the same time, some parts of it demand deep technical expertise to help an OEM, say, with designing a new hydraulic circuit for a piece of construction equipment. Alongside that sits a Services division, mostly concerned with making power packs and humidifiers, plus on-site work, particularly in hydraulics. So we have a Services division that complements our core components business. On overall market size, in the U.K., the fluid power sector is put at roughly GBP 1 billion at pre-COVID levels. Of course, as with many sectors, there were some difficulties during 2020. Even so, the view in the market is that a return to normal levels will come in the period 2022, 2023. So it is a sizable market, and we are the largest player thanks to substantial growth after our float in 2014, in the U.K. and Irish markets. Across Europe overall, circa GBP 13 billion. Globally, GBP 46 billion in most westernized economies. And in total, I have seen some commentators speak of a GBP 100 billion market. On the right-hand side of this slide, you can see it is very broadly framed in terms of its key areas of focus.

Construction presents a steeper decline when viewed as electronic general engineering. In our view, we also function as a substantial distributor across other distribution channels. That makes it very much a resale-driven market. The main points to draw from this: Flowtech is a sizeable business — the biggest participant across its home territories of the U.K. and Ireland, at roughly GBP 100 million in current volumes. Yet it holds only around 10% market share. As for what is addressable for a pure distribution operation, that could be as little as 30 equal to size 50%, depending on which precise criteria you use. So once more, we sit at roughly 20%, perhaps, of that addressable market. A large market, then, with plenty of room for us to grow from that standpoint. Okay. Hopefully that gives viewers a feel for the backdrop. So the sector overall shows a flattish curve in our distribution-focused business, which carries plenty of value-added elements — services, technical support, a strong service offering from that angle. On the key features of our proposition from an investment standpoint: we operate as the biggest player in a fragmented marketplace, and our footprint is substantial, both in pure geography and in the reach we have with all the major global manufacturers.

Eaton, Danfoss, Parker, and Bosch Rexroth are still multibillion global manufacturers that demand highly efficient technical competence and a strong e-business digital-based distribution network. And a great deal of our growth potential sits in the organic growth we can deliver from that position. But over time, and as we have done historically, complementary acquisitions can be added. And it goes without saying that our leadership team, we believe, is quite well experienced and ambitious, and is now strengthened by some developments we've completed this year, adding to the bandwidth and skill set we possess. COVID-19. Obviously, we all are aware of this and its effects, and we want to just enshrine on one slide perhaps the key effects, and Russell is going to lead when it comes to the financial aspects of this.

Thanks, Bryce. Bryce just employed the term I earlier described as having five letters and starting with c. On this slide's lower graph, the dark bar represents 2019, a typical year. The lighter bar stands for the annus horribilis—I'll borrow the queen's phrase there. To put some figures in your mind regarding how the 4 quarters unfolded: Q1 actually shows an 11% decrease versus 2019. We felt fairly happy about our trajectory at that point, though naturally the first nationwide lockdown on the 23rd of March—the final 8 days of that quarter—somewhat depressed the figures for the whole quarter. Q2 was the quarter horribilis, with us 33% lower overall. Inside that, April came in at 41%, 4-1 percent, lower. Conditions improved considerably, or became less bad—depending on whether you see the glass as half empty—we were 14%, 1-4 percent, lower in Q3, and in Q4 just 5% lower. So we've experienced, in a sense, a pleasant gradient along our road to recovery, and pleasingly that has carried on into Q1 of 2021. Yet—and the wording on this slide was picked carefully and presented deliberately—in summary, recovering rather than fully recovered from COVID.

You have to keep in mind that the Q4 figure, down 5%, is actually measured against a weak comparative. And as I mentioned, Q1 of this year has gotten off to a good start, though we remain, you know, well below where Q1 stood in a typical year like 2019. Second thing, before I pass it back to Bryce to handle the remaining 3. It's fairly obvious, but we went out — looked for the chance to renew our banking facilities with Barclays Bank. That was done last November. We now have another 3 years of facilities on the same aggregate GBP 25 million deposit pound notes. And naturally, and quite sensibly, we used the opportunity to go back over the key governance. Specifically, we reset the leverage covenant, which would have stripped us up had we not done that, again, clearly, owing to the absence of underlying profitability brought about by the 5-letter word starting with c. So one more item before I hand over to Bryce, just for those of you who have tracked us, you'll notice that at the close of 2020, roughly a small rounding element, but roughly, we are carrying 50% of the debt burden we had 2 years earlier.

When it comes to how COVID has affected operations, we've spent thousands of hours of management time, as many companies have, handling the issues we have to handle. One aspect of our business — we run from Cork to Belfast to Rotterdam and a number of places in between, but we have 2 major sites in Skelmersdale and Leicester, and both of those, as you may remember, sat right in the middle of COVID-19 outbreak hotspots back in the good old days of the tiered system. We're very pleased that both of those sites stayed open the whole way through. No operational days were lost. Every one of our sites managed to reach full safety compliance with all the protocols a modern business like ours was required to follow, and we're happy with how that has worked out — we'll discuss our employee engagement scores later in this presentation. But one point probably worth noting is that we'll recover commercially from this particular aspect. Right now there are significant knock-on effects on the global supply chain. Some of that is for very good reasons — demand is rising quite substantially when it comes to refilling that stock hopper, so to speak.

However, our supply chain leans heavily on Europe, and like every supply chain, it also has a broader global dimension, especially sourcing from the far East. As a result, we are noticing some drag effects from that during Q1 and now into Q2 when it comes to stock availability in certain areas. It is not hugely material right now, and we are handling it in a very positive way. Still, some drag does exist, and so for the rest of this year, we believe the outlook will certainly continue to include these kinds of drag effects.

Alright, weak figures. On revenue, we've likely covered it enough. As I mentioned, the beginning of 2021 gives us encouragement. One view is that some confidence is building in the U.K. thanks to the vaccine rollout's relative success, and equally, perhaps paired with a degree of worry among certain customers regarding supply chain and relative type. In fact, some of our customers may currently be stocking their own shelves or inventory a bit. But certainly, for an early mover in a bubble-type stretch, what we're seeing definitely encourages us. And that ties to the gross margin point. It isn't just revenue, which we grew, it's the quality of our gross margin. On the surface, this single slide viewed alone shows a 146 basis point drop in our GP. But don't let that alarm you. The points I'll make are that in 2017, we stood at 33.8%. And across a 2-year span, we felt we did a pretty solid job of transitioning and already a very strong margin reaching 35.7% that you see in the right-hand column. And the fact that it has dipped slightly is fully accounted for by 3 key reasons.

This — 2019 benefited from margin help thanks to some income generated by selling our hard copy catalogs to a number of customers. Bryce will return to that — maybe that's a bit old-fashioned looking ahead. Second, the detail about the cost we place above the gross profit line, it does include some direct labor costs. And I suppose the audience will appreciate that "direct" might be somewhat of a misnomer given the fixed nature of certain elements of that in a year when your volumes suffer. And third, the mechanics, I really won't bore you with this one, but the mechanics of our consistently acquired stock provision mean that, again, the lower volume caused by that 5-letter word, beginning with c, does us no favors. But all in all, we're pretty proud of that margin and within — and all of our DNA is not sacrificing margin whilst in the pursuit of revenue. So on costs, again, those who have followed us would have seen our ambition to take old world inefficient costs out of our businesses. And then two, fairly obviously, that was centered around people and properties.

On the personnel side, our headcount came down 7%, which is 45 heads during 2020, and that compares with a payroll bill of roughly GBP 20 million. So 7% of GBP 3 million. In a similar vein, we've exited 5 properties, and those are typically sites where we'd bought the previously rather inefficient warehousing picking operations and moved them into our far more efficient locations in Skelmersdale and Leicester. So of what we set out to do, we've delivered the significant majority. There are still pieces left for us to finish over the coming 12, 18 months. And perhaps there are certain items we're starting to spot that could add to that up pop in the fullness of time — stressing the fullness of time. So if we've taken, if you like, what I'd describe as the old world, inefficient cost down, we've sensibly chosen to put money into some new world investment areas. Bryce will cover these a few slides from now, but I'll just headline the business and digital agenda — the e-business rather than the e-commerce. Bryce will explain how we see the difference there. And equally, and importantly, we've brought in 4 or 5 senior people — top quality people sitting immediately below the plc Board level — and significantly strengthened our management team.

Regarding the debt, on a like-for-like basis, it's down by GBP 5 million in 2020. And as my profession would lead me to do, I can add it up — the gap between those first and last bars comes to GBP 5.9 million. That GBP 0.9 million is the piece that's support from revenue and customs. You're probably aware they permitted U.K. go through solely to make a further payment of the Q1 2020 BFPA. So GBP 5 million on a like-for-like basis. I think what seeps out here, of course — I mean, it equally comes out in the 2019 equivalent bridge — is that across the 2 years, we've pulled GBP 12 million, GBP 13 million out of our working capital. And that's among the main reasons we're running at debt of roughly 50% of what we carried 2 years ago. If we were to build a go-forward bridge, a really key point, and in some ways a very plain one, is that it's working capital, and a lot has been digging green over the last 2 years. It's going to be quite a bit in the red in 2021. And clearly, as volumes start coming back, an increase in our receivables goes hand-in-hand with that.

And similarly, from a position of comparative strength against our rather fragmented competitor base in the U.K., we do think it makes sense to put a bit of stock back onto our shelves so we can capitalize on perhaps some spurts of demand, and to be sure we limit those instances where we haven't got sufficient -- quite sufficient stock on our own channel. So we consider that a sensible investment of the headroom we've generated within our banking facility. For 2021, those of you who look at either this usual finnCap analyst notes will have observed that we aren't expecting much in the way of debt reduction in 2021. As a matter of fact, it's fair to say the only green blob, hopefully, will be a considerably larger green blob, namely tax generated from operations; everything else will be red. And that green will really equal the sum of the reds. So minimal debt reduction in 2021 is the red line.

When it comes to how I'd vet things for investors who are just getting familiar with our position, as Russell laid out, one discipline governs how we run the business: an absolute focus on gross profit percentage. Every day, all of our businesses send us reports covering day GP, multi-day GP, how it compares with last year's GP, and how it compares with current year GP. That is the absolute DNA of how we operate. Investors should therefore take some degree of confidence that the 35 percentage points of GP represents the consistent output this particular sector delivers, and we see it as a significant strength. Underneath that, we are very disciplined about cost per transaction — cost per drop, cost per pick, cost per order — the fundamental flow of operational cost, and a key part of what we've worked through over the past couple of years, whether in our KPIs, our reporting, our actions, or our management, is all built around making sure we tighten as much as possible the cost of handling our per-transaction elements. At the same time, we've chosen to take the benefits we attained from that and build additional resources and specialisms that are building the platform for us to move the business forward significantly from an organic perspective.

Also, back when we first entered the market, some commentators took issue with how we handled working capital. And with any luck, looking at the annus horribilis of the last 2 years, as Russell mentioned, GBP 15 million to GBP 16 million came out of our working capital investment — part of that from the natural COVID-19 reduction — and that's another area of discipline where we're very strong. Turning to how our overall group strategy is developing, and as part of the new constitution of the plc Board, we prepared an outline strategy paper toward the end, and it went through full analysis with Roger McDowell and the rest of the NEDs. The key aspects of it I'll now walk you through. Our belief is that this builds the platform for organic growth and a cash-generative goal over the long term. On branding styles, historically we've run independent traded profit centers with local brands that in fact carry long-term heritage. But for 2 reasons — the amortization of life and the progressive shift to online platforms — having multiple, separate trading branding styles doesn't resonate in an online world. And second, the demands of our customer base.

From where we sit as the biggest participant in this market, that's plainly what we're seeing. We serve the same customer through several different businesses. Take any one customer—we might still have 4, 5 accounts active there. So we've made the call to move forward with 2 branding sales, Flowtech and Fluidpower Group. Flowtech is going to carry our high-service proposition, which historically leaned toward catalog, though it's shifting more and more toward online operations. Its heritage rests on high service, wide stock availability, and solid technical competence. That said, it's tied quite tightly to that kind of proposition. On the Fluidpower Group side, the heritage is strong technical competency built largely around OEMs, and we've picked the reasonably broad branding approach of the Fluidpower Group. Of course, Flowtech Fluidpower Group is the name of our plc. All of this will sit beneath one e-business architecture. So over the coming year and 2 years, we'll transition commercially to 2 brands, at differing speeds depending on what's happening in each individual business. When it comes to our reporting segments, though, we report 3 segments in turn. We divide Fluidpower Group into 2. One shares operational resources heavily, with its heritage in the Flowtech operation. The other is our Services business. So from the commercial market's perspective, there will be 2 brands.

For those of you in our investor community, you'll see 3 trading segments. Two of those — Flowtech Fluidpower Group solutions — are the components that have historically been reported, so there ought to be a reporting chain that's clear and that people can follow. As we've discussed beneath that, we have made a substantial investment in e-business platforms. So what separates e-commerce from e-business? Well, Flowtech has long been regarded as the top name in the e-commerce space. That portal is an older one, where we hold a broad range of stock, and our customers can go in and search on it. However, it isn't what you'd describe as a cutting-edge offering in today's world. We're going to move out of that e-commerce setting and into a fully fledged e-business setting. That will involve a vastly enlarged product set, both held in stock and integrated with our own supply systems, plus search capabilities that are, once again, in line with the modern world and a major step up from what exists today. Underneath that, yes, there will be my dashboard capabilities, contemporary aesthetics when it comes to how the site looks, so it appeals to the increasingly younger buying community that we're serving in this particular area. And beyond that, there's an aspect of future proofing.

Right now, our websites are hard coded into our legacy ERP systems, and we'll discuss more of our developments on that in due course. But what we're investing in here will be a much more flexible, future-proofed result. We have around 11,000 live accounts tradables in 2020. Over the last 3 to 4 years, we've put as many as 17,000 different accounts over that period who interact with the business. So an enormous amount of data coming into the organization. And when we couple that with the development in a new customer data platform, we believe that there's significant value that can be extracted from this. We'll create the golden record at a single view of a customer. Behind that, on the insight, we're going to get at a product set, a supplier set geographically. These are going to be of immense value tools, and we believe that will have commercial use for us in developing organic sales with our current customer set into new customers, equally sharing the benefits of that with our major supply and customer partners. So rather than being a link in a chain which distributors have historically taken, we'll be a key part of that particular jigsaw.