Gooch & Housego PLC (GHH) Earnings Call Transcript & Summary

Good afternoon, and welcome to the Gooch & Housego PLC Interim Results Investor Presentation. [Operator Instructions] The company may not be in a position to answer every question received in the meeting itself. However, the company can review questions submitted today and publish responses where it's appropriate to do so. Before we begin, I'd like to submit the following poll. I'd now like to hand you over to CEO, Charlie Peppiatt. Good afternoon to you, sir.

Yes. Thank you very much. Welcome to everybody. Thank you for joining G&H's interim results presentation for the half year ended March 31, 2025. Chris and I will be following the agenda shown on the screen. After I've covered the highlights section, Chris will cover the group's first half results, including a segmental review, and then I will provide a progress update on the implementation and delivery of our strategy, including an outlook for the group. We will open up the floor to Q&A at the end of the presentation. During the first half of the financial year, we made further positive progress implementing the changes required across the business to deliver our strategic plan. I'm pleased to be able to report on the strong performance achieved in H1 against a challenging macroeconomic background. This is a testament to the progress the group is making delivering our strategy and the resilience and depth of experience across our leadership team in navigating complex market dynamics. I'd also like to take this opportunity to thank our customers for their continued and growing confidence in G&H. And secondly, to extend my sincere thanks to all our employees around the world for their hard work and highlight the positive way the workforce is adapting to the fluid global challenges we face, many of which are beyond our control, whilst proactively embracing the changes needed to influence those that are within our control and doing so at speed. As reported in our trading update in April, whilst H1 activity levels in the group's industrial laser and semiconductor markets remained subdued, demand from our aerospace and defense and life sciences markets was strong and revenues from our fiber optic products used in subsea data cable networks also grew in the period. Revenues for the first half of the year increased by 11.4% to GBP 70.9 million compared to GBP 63.6 million in the prior period. Adjusted operating profit for the period increased by 60.5% to GBP 6.2 million compared to GBP 3.8 million in the first half of the prior year. Following the acquisition of Phoenix Optical at the beginning of our financial year, I can report that the integration of this business is proceeding to plan with commercial synergies already being realized. And last month, aligned to our strategy, we were pleased to announce the addition of Global Photonics to the group, significantly extending our aerospace and defense offering and capabilities in North America. I will provide more detail on this later in the presentation. The group's order book increased to GBP 121.5 million compared to GBP 104.5 million at the year-end, with Phoenix Optical bringing approximately GBP 7 million of this increase. We saw a positive book-to-bill ratio in the first half of the year, which has continued into H2. G&H generated net cash from operations of GBP 2.6 million compared with GBP 2.5 million in the same period of 2024 and reflecting the strategic investments made by the group, net debt increased to GBP 35.5 million compared to GBP 25.8 million at the prior year-end with a leverage ratio of 1.3x. The Board has declared an interim dividend of 4.9p and our expectations for full year performance of the group remain unchanged, although in the current unprecedented environment of macroeconomic uncertainty and fluidity, near-term execution risks have increased. G&H has strong prospects for profitable growth in the coming years, underpinned by positive underlying tailwinds from our technologies and capabilities that remain present in all of our target end markets, supported by the progress we are making to accelerate the delivery of our strategy. I will now pass you across to Chris to take you through the financial results for the first half of our year 2025 in more detail.

Thanks, Charlie. So as you've heard from Charlie, the group's revenues grew strongly by 7.5% on an organic constant currency basis, driven very much by the performance of our A&D segment, which more than compensated for a delay in the recovery of our Industrial segment. Adding the contribution of the acquired Phoenix business, reported revenues grew by 11.4% to GBP 70.9 million for the 6 months period. Thanks to the additional volume and the benefits of our strategic actions, gross margins improved to 30.4%. The outsourcing of selected product lines to our low-cost region suppliers, operational improvements in our factories and a growing proportion of our revenue coming from more complex margin-accretive products all contributed to that improvement. Our spend in R&D was maintained at similar levels to the first half of 2024. Primary areas of focus for our R&D teams in the period were fiber optic module assemblies used for both telecoms and sensing applications and further development of complex electro-optic assemblies, which are used in both land and air platforms. The additional volumes and the benefits of our margin accretive actions drove adjusted operating profit up 60.5% to GBP 6.2 million for the 6 months period. The adjusted effective tax rate was 22.9%, which is consistent with the group's expected medium-term rate of around 25%. Adjusted profit before tax was GBP 5.1 million and the adjusted basic earnings per share of 15p. Non-underlying charges excluded from our adjusted profit totaled GBP 2.2 million, of which cash was GBP 1.1 million arising from our M&A and restructuring activities. Whilst the new U.S. tariff regime didn't take effect until after the end of the reporting period, we've notified our customers that we intend to pass on any incremental costs to them, an approach they have confirmed is in line with our industry peers. We've developed new reporting tools to enable us to quickly assess the impact on existing customer orders so that we can apply a tariff surcharge where required and protect the group's margins. We're also actively resourcing our supply of certain raw materials required in our production processes where availability has been restricted by the Chinese retaliating against the new tariffs. Given the group's considerable U.S.-based manufacturing presence, we believe the new tariff regime could, over time, be a benefit to some parts of our business against their non-U.S. competitors. Turning now to cash flow, which is on Slide 5. Net cash flow from operating activities totaled GBP 2.6 million. Working capital levels increased by GBP 6.7 million from the end of 2024. This was driven by a growth in receivables given high levels of invoicing in March, which has since been converted to cash in the first months of the second half. The group's inventory also grew by GBP 5.3 million. This will support the group's higher trading levels in the second half. But in addition, we have decided deliberately to increase our inventory of some materials such as germanium in response to new uncertainties in the availability of these materials. Capital expenditure on tangible and intangible assets was GBP 3.4 million. Principal areas of investment in the 6 months period were in our fiber optic facility in Turkey, where we continued our investment in new fiber optic module assembly lines as programs migrate to their production phase. We also invested in additional heavy water for our Cleveland facility in order to increase their crystal growth capacity. This investment was accelerated from the second half in order to take receipt of those materials in advance of the new tariff that came into effect at the beginning of April. Net cash outflow on the acquisition of the Phoenix business totaled GBP 2.7 million. That comprised consideration paid of GBP 2.9 million less cash received of the business of GBP 200,000. Transaction fees totaled GBP 300,000. Deferred contingent consideration of up to GBP 3.35 million is payable based upon the financial performance of the business in the 3 years ended June 30, 2027. We've assessed the present value of the deferred consideration liability at March 31 to be GBP 1.7 million. Net debt, excluding lease liabilities at the end of March was GBP 24 million, rising to GBP 35.5 million when lease liabilities are added. Our leverage ratio, as measured for our banking covenants was 1.3x compared to the facility cap of 2.5x. On a pro forma basis, once the Global Photonics acquisition completes, our net debt-to-EBITDA ratio is expected to rise to around 1.6x and is then expected to fall in the rest of the second half based upon our forecast trading. On the March 31, the group had drawn $38.4 million on its revolving credit facility. On the April 1, we extended that facility out to March 2030, increased the committed facility from $50 million to $55 million and secured a margin improvement of 15 basis points across the margin grid. Following the completion of the Global Photonics acquisition, a further $5 million will be converted from the accordion to the committed facility, resulted in a final facility of $60 million and an uncommitted accordion of $10 million. Turning now to Slide 6 in our Industrial segment. So sales into our industrial market declined by 6.5% on an organic constant currency basis. Recovery in our industrial laser and semiconductor markets remains delayed and indeed, production call-offs of some products used in the latest deep and extreme ultraviolet photolithography machines are reducing as our end customer trims their build rates. The uncertainty generated by the fast-changing U.S. tariff regime is impacting confidence and delaying the recovery of these markets. Offsetting to some extent, these reductions, we saw further growth in revenue from the subsea data cable market. Deliveries of our newly developed complex amplifier assemblies grew as we supported our end customers' delivery of their new cable networks. The ramp-up in build rates of these more complex fiber optic assemblies has been enabled by the full transfer to our contract manufacturing partners of the build of our high-reliability fiber couplers, allowing our own production facilities and skilled operators to be transitioned to this new more complex work. Despite reduced revenue in this segment, adjusted operating profit grew by 10.2%, compared with the first half of 2024 to GBP 3.8 million and the adjusted return on sales percentage increased to 12.7%. This was thanks to the benefits of a higher proportion of complex assemblers, which command better margins within the segment's revenue, together with the benefits of margin accretion that comes from the transfer of high-reliability fiber couplers and other acoustic optic products to our low-cost contract manufacturing partners. Moving on then to our A&D segment on Slide 7. Revenues grew very strongly by 30% on an organic constant currency basis compared to the first half of '24. The conflict in Ukraine is together with a recognition by many Western NATO countries that they need to increase their defense spending is generating high levels of demand for the group's precision optics systems, which are a critical element within most modern defense systems. In addition, the combination of our recently acquired Artemis and Phoenix businesses with the existing capabilities of the G&H Group means that we are now able to offer more comprehensive product offerings to our customers and win new business. Deliveries of our super polished optical components, which are used in ring laser gyros, increased again, thanks to our end customers' programs growing, but also as a result of the improvements we have made at our Moopark, California facility to increase production throughput and yield, thereby allowing us to capture more of our customers' overall demand. Additional volumes in this segment, together with our operational efficiency improvements resulted in the segment generating a profit in the period of GBP 600,000, evidence of the early stage turnaround of this segment. The integration of the Phoenix business is proceeding to plan. The acquisition has already allowed the group to secure new customer orders and combined capacity planning between Phoenix and the group's other precision optics sites is supporting the Phoenix business in delivering its record order book. The group has moved quickly to identify alternative sources of germanium following the Chinese government's decision to restrict supply to Western countries. Germanium is used in many of our products supplied into the defense market, and we believe our newly established supply chain relationship for the provision of this material provides us with a competitive advantage. Moving on to Slide 8. Our Life Sciences revenues grew by 14.2% on an organic constant currency basis. Revenues from our medical diagnostic markets grew compared to the first half of 2024, thanks to strong end market demand for one of our customers' instruments. We're also pleased to see the launch of the first 2 instrument production programs in our recently established life sciences facility in Rochester, New York State. There was recovery in volumes of our Pockels cells that are used in medical lasers from their very low levels in the first half of 2024. But given the increasing competition we are facing from low-cost Chinese suppliers, we've made the decision to end of life the majority of our product lines in this market, which on average account for around GBP 4 million to GBP 5 million of group revenues. We've invited our customers to place last time buy orders with us, which we will deliver over the coming 18 months, at which point our Cleveland, Ohio facility, where those Pockels cells are manufactured, will transition to further develop its capacity for the growth of crystals used both within our group and sold directly to our end customers. Despite the growth in revenues in this segment, margins declined to 12%. In our Medical Diagnostics business, prenegotiated lower production pricing came into effect on one of our instrument programs as volumes increased, while pricing for our Pockels cells came under pressure as a result of the increased competition from local suppliers that I've just described. We expect margins in this segment to recover as we secure the benefits of more revenue through our Life Sciences facility in Rochester and some selective outsourcing of other product lines to our own low-cost suppliers. Thank you. I'll now hand you back to Charlie.

Thank you, Chris. In June 2023, I announced our new strategy focused on delivering sustainable margin growth and explained the clear executable path that we are following to deliver mid-teen returns over the medium term. G&H's strategy to become an innovative customer-focused technology company delivered responsibly by making a better world with Photonics continues to progress positively, and the foundational building blocks are now in place. We remain laser-focused on ensuring G&H becomes and remains the first choice for all our stakeholders, including our employees, customers, shareholders, our ecosystem partners and the communities in which we operate. We will achieve this by offering differentiated performance through focusing on the 4 key strategic priorities you see outlined on the slide through our people by creating a high-performance purpose-led culture across the whole company, from self-help activities to improve customer experience and operational execution. Through technology, deploying our advanced photonics engineering talent and know-how more effectively to accelerate our time to market for new technologies into commercially attractive applications. And finally, by applying greater discipline and rigor in the allocation of resources to deliver accretive growth both organically and inorganically. We have refocused the business to invest in higher-margin products and sectors at the same time as addressing nonperformers in combination with making several exciting speed-to-value acquisitions. On the next slide, I would like to provide an update on the contribution we expect from the 5 primary building blocks to deliver the step-up to mid-teens returns that we are targeting by 2028. 100 basis points from better utilization of our well-invested factories from increased volumes, 250 basis points from proactively expanding our outsourcing activities at an earlier stage in the product life cycle to our proven contract manufacturing partners. 200 basis points through productivity gains from cost of quality reduction and other efficiency improvements, 100 basis points from the successful introduction of higher-margin new products and the increased mix of subsystem solutions with greater G&H technology content. And finally, 150 basis points of accretion from portfolio enhancement through noncore product rationalization and accretive bolt-on M&A. On the next slide, I would like to provide an update on the progress that has already been made in our Aerospace and Defense business unit since we launched our new strategy. When I joined G&H in September 2022, the group's A&D business was not in good shape. As well as being loss-making, there was also severe problems around customer service and the size and quality of the new business opportunity pipeline was weak. Through the focused deployment of our new strategy, I'm pleased to report that the overhaul and turnaround of our A&D business is progressing well. The return on sales in this segment has improved by over 1,100 basis points and is expected to continue to increase during H2 2025 and over the coming years. G&H's refocused and upgraded customer-led aerospace and defense team are delivering these planned benefits through operational improvements, productivity gains, supply chain action, disciplined NPI and R&D activities. This has been accelerated by the successful implementation of our portfolio strategy, focused on divesting noncore parts of the business and adding carefully selected complementary speed-to-value bolt-on acquisitions. The group's A&D business is now uniquely positioned to meet increased demand from existing customers, capture new business opportunities and become a full optical system solution provider for defense primes in the U.S., U.K., Europe and the rest of the world. On outsourcing, we are proactively implementing our previously announced plan to use lower-cost region manufacturing partners for certain stable product lines at an earlier stage in their product life cycle where technological sovereignty where they're made, is not a differentiator. We expect the proportion of the group's revenues built by contract manufacturing partners to increase from less than 5% in 2022, up to circa 25% by 2028. During the first half of this last financial year, we continue to make good progress with implementing this plan. A dedicated leadership and upgraded supply chain function are in place across the business, including the expansion of our capable G&H team embedded in Thailand. We've expanded the outsourcing of additional acousto-optic products to include our 80 megahertz product line, and we have now successfully ramped up full volume production of high-reliability submarine fiber optic couplers with our partner in Thailand, including the receipt of additional customer approvals for the manufacture of these products at this location. After closing our factory in Shanghai last year, we've expanded our approved low-cost region manufacturing partners to now include factories in Thailand, India and the Czech Republic. And the qualification of additional product lines across all these locations is underway for more transfers in the second half of this year and into 2026. On value creation from our technology focus on the next slide, we continue to refine our customer-focused technology roadmaps to deploy platform design solutions, accelerating time to market where G&H has technology-led differentiation. Let me provide an update of some of the progress that's been made and the status after the first half of this year. Spending on R&D of GBP 3.5 million in the first half was broadly in line with the prior year. Our strengthened acousto-optic engineering and product line management team are making positive progress with the development and commercialization of optimized germanium-based modulators for advanced CO2 lasers that are used in cutting-edge semiconductor fabrication and metrology. The refocused fiber optics engineering group are seeing successful customer take-up on next-generation fiber optic modules for extreme ultraviolet 13.5 nanometer wavelength semiconductor fabrication as well as high-reliability submarine amplifiers, environmental sensing and medical diagnostics. Our precision optics and optical systems development team continue to design novel imaging and sighting solutions for land, air and naval defense systems complemented by our advanced thin-film coating and laser protection filter offering. And we also formally opened our new Life Sciences innovation hub in Rochester, New York at the beginning of May. As you've already heard from Chris, during the first half of the year, we took the decision to reduce our technology road map focus from 7 to 6 key areas. We've decided to proactively exit the design and manufacture of Pockels cells for the medical lasers market due to the increasing competition we are seeing from lower-cost Chinese suppliers. However, over the medium term, we still expect these 6 remaining R&D work streams to deliver the more than GBP 50 million margin accretive new business from next-generation product introductions we outlined at the launch of our strategy. On the next slide, I would like to share an update on a new product success in our Life Sciences business. OrganOx's incredible machines are revolutionizing the world of donor organ transplantation to deliver more reliable transplant outcomes for patients and ensure improved logistics and operational effectiveness for hospitals. Our Life Sciences business headquartered in Ashford in Kent, was awarded the design for manufacture, regulatory qualification support and volume production contract for OrganOx's Metra liver transplant equipment as pictured on the slide. This is a highly complex medical device, delivering life-changing machine perfusion. In the first half of the year, G&H successfully ramped up production to meet the increased demand for this product following their successful FDA regulatory approval for access into the U.S. market. Our experienced medical and diagnostic device R&D team are also supporting the development of OrganOx's next-generation kidney transplant machine. This partnership is expected to unlock multimillion pound new business opportunities for the group over the coming years through our unique medical and IVD design -- device, design and manufacturing capability that we are now able to offer from both the U.K. and North America. On the May14, in line with our strategy of speed-to-value acquisitions, we announced that the group had entered into an agreement to acquire U.S.-based Global Photonics, previously known as Meopta U.S. From its well-invested facilities near Tampa, Florida, an image is shown on the slide, this highly regarded Global Photonics team supplies optical systems for military land applications, including periscopes, fire control systems as well as avionics instrumentation and other advanced precision optics. This acquisition brings expertise in complex optical assembly, clean room lithography, photolithographic reticle fabrication, ion beam etching and advanced thin film coatings that complement G&H's existing manufacturing capabilities and significantly enhance the group's offering into the North American market. The transaction represents another exciting speed-to-value bolt-on deal by G&H. Global Photonics is a strong strategic and operational fit for the group, bringing deep application expertise, strong relationships with U.S. defense primes and complementary manufacturing capabilities to our growing Optical Systems division. The acquisition accelerates our plan to become the partner of choice for high-precision optical systems in the U.K., Europe and North America. It opens exciting new growth channels in the U.S., accelerating the creation of a scalable U.S. laser protection coating center of excellence for the group and offers a credible high-volume Made in North America manufacturing center for our imaging and sighting systems that are designed at our facility in Keene, New Hampshire. The establishment of a full optical systems engineering and manufacturing capability in the U.S. for the aerospace and defense market mirrors our successful strategy for the U.S. health care sector following the recent opening of our G&H innovation hub for Life Sciences in Rochester, New York. The strategic rationale for this deal is clear and compelling. Revenue synergies through our combined commercial pipeline have already been identified and the initial customer feedback I'm pleased to report has been very encouraging. Global Photonics as part of G&H brings together industry-leading optical know-how and capability that would accelerate value creation for the group in North America. On the next slide, a full year outlook update. The group's order book remains strong, particularly for our A&D businesses. However, following the announcement of a new global trading policy by the U.S. administration in April and the consequent retaliatory measures from China and other nations, we are seeing an increase in near-term uncertainty from many customers in our industrial, semiconductor and life sciences markets. This has resulted in a softening demand levels from our industrial market persisting longer than we had expected, and we are seeing new delays in some infrastructure and life sciences projects. However, to emphasize, the positive book-to-bill ratio I spoke about earlier that we saw in the first half and continues into the second half of the year shows that our order book is continuing to grow. As outlined at the last bullet on the slide, it currently stands above GBP 125 million, providing more than 95% cover to deliver our expected full year 2025 expected outturn. So in summary, on the final slide, as a result of the operational and supply chain improvements made over the last couple of years, the group is well positioned to benefit from recovering demand levels in the semiconductor and other markets. Our design engineering resources are refocused on delivering a customer-led vital fuel list of next-generation development projects. Value creation synergies from recent acquisitions are being realized and the addition of Global Photonics will only accelerate this activity. While we are mindful of the current uncertain macroeconomic and geopolitical landscape, G&H's healthy growing order book, strengthening market positions and differentiated photonics expertise aligned to structural growth drivers from megatrends, all provide confidence in the group's ability to deliver further progress on our journey to mid-teen returns and over the medium and longer term, deliver value for all of our stakeholders. So that brings the presentation material to a close.

That's great. Charlie, Chris, thank you very much for your. [Operator Instructions] But just while the company take a few moments to review the questions that have been submitted today, I'd like to remind you a recording of this presentation, along with a copy of the slides and the published Q&A can be accessed via your investor dashboard. As you can see, we have received a number of questions, both pre-submitted and throughout today's live presentation. And Charlie and Chris, what I'd do is I'll just hand back to you to read out the questions, and I'll pick up from you at the end.

Okay. I think there's a couple of pre-submitted ones, which I can answer. I mean how are you using AI in the business. So for some time now, we've been using AI actually in our finance areas to identify sort of anomalous transactions in the finance bookings. Our people also tend to use AI tools for the generation of some written reports, for example, technical publications and things like job specs. The thing that I'm quite excited about actually is we're then developing our own in-house kind of AI toolkit that I think we can use a little bit more in a predictive manner to try and predict the, for example, the trends in some of the demands perhaps from some of the submarkets into which we play. And then there was a second pre-submitted one, which was what is management Board stock ownership like? So at the moment, the Board members hold directly around 76,000 of G&H shares. I think probably more significant is myself and Charlie and many members of the senior management team at G&H, a part of a long-term incentive plan, which is in the form of nil cost stock options. So yes, those -- that hopefully gives you a flavor in terms of how we are in those areas. There's one here around do you expect earnings to cover the cost of the dividend in FY '25? Yes, we do. I expect the dividend cover to be north of 2.5x for financial year '25. Next one, what are the key operational drivers such as yield improvement, product mix that will support progress towards your mid-teen return on sales targets by 2028? Again, in the material, I think Charlie spoke to as we were going through. I mean we tried to set out the steps that get us from 7%, 8% return on sales to those mid-teens. The -- we try to allocate based on our latest strategic plans, how each of those steps will contribute. So certainly, yield improvement is considered to be an important step. I think we attributed around 2%, 2.5% to that particular -- to those particular activities. We're already seeing the benefits of that coming through. I mentioned earlier in the presentation, our Moopark, California facility was one that was in 2024 was suffering from fairly poor yield and scrap rates as a result of certainly, the additional training that we've done of our employees in that facility and also, frankly, some support in terms of better on the shop floor management, production engineering, we've been able to reduce our scrap rates quite significantly. So that's a nice example, hopefully, to you for the margin accretion that can come from some of the operational improvements we're driving through our factories. On the product mix side, again, that's going to be important for us. And an example we've given in the past actually is the product we supply into the subsea data cables. And historically, we've provided high reliability fiber couplers. But what we're doing is migrating to provide more complex amplifier modules to our customers. Those kind of modules, they're more complex. They command better pricing and therefore, better margins. So again, hopefully, 2 nice examples for you of how those kind of things support our journey to being a more profitable business and getting to mid-teen returns by 2028.

This next one is, is the emerging MicroLED technology relevant to any of your optical products or applications? Is it on your road map? Again, I think with regard to this question, I think particularly the whole subject of miniaturization of our technology in photonics is constantly being addressed by our R&D teams. And our fiber optics team definitely have exposure to MicroLED technology in the solutions that they're providing.

Charlie, Chris, I think that actually covers all of the questions that you've received. Of course, the company can review any further questions submitted today, and we will publish responses on the Investor Meet Company platform. But just before redirecting investors to provide you with their feedback, which is particularly important to the company, Charlie, could I just ask you for a few closing comments?

Yes. I mean firstly, thank you very much for joining this call for our results. I think I'd like to emphasize how the medium-term market dynamics for our technologies and capabilities are looking very positive in all of our target markets. And this is only being complemented by the progress that we're making in the delivery of our new strategy across the group. So we are confident and positive about the future prospects for G&H. Thank you.

That's great. Charlie, Chris, thank you once again for updating investors today. Could I please ask investors not to close this session. I should now be automatically redirected to provide your feedback in order the management team can better understand your views and expectations. On behalf of the management team of Gooch & Housego PLC, we'd like to thank you for attending today's presentation, and good afternoon to you all.