Hensoldt AG (HAG) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome, and thank you for joining the HENSOLDT AG H1 Results 2023 Analyst Call. [Operator Instructions] I would now like to turn the conference over to Veronika Endres, Head of IR. Please go ahead.

Thank you, and good afternoon, everybody, and a warm welcome to HENSOLDT's H1 2023 Results Call. Thank you all for joining us today. I'm Veronika Endres, Head of Investor Relations at HENSOLDT. And with me are our CEO, Thomas Muller; and our CFO, Christian Ladurner. Thomas and Christian will guide you through this presentation today, which is followed as always, by a Q&A session. And with that, I hand over to you, Thomas.

Thank you very much, Veronika. Good afternoon, everyone. Thanks for joining our earnings call today in which we would like to present our once again strong results. Let me start by giving you a brief update on strategic topics and key business highlights then Christian will guide you through our strong financial performance of the first half 2023. And as always, following our presentation, as Veronika already mentioned, we are happy to answer your questions. So ladies and gentlemen, first, let us have a look at a few strategic topics. At the NATO Summit in Lithuania, the alliance members not only paved the way for the accession of Sweden and reconfirmed the support for Ukraine, but also committed to 2% GDP spending on defense at the lower limit. While this is certainly a political statement, it also increases the pressure on individual governments to give priority to defense in their budgeting processes. While the regular defense budget sees a modest increase by EUR 1.7 billion to EUR 51.8 billion for 2024. Germany will reach a 2% target with a special fund in 2024 and 2025. And the discussion on increases in the outer years intensifies. Just as an example, the Minister of Defense Boris Pistorius pledged EUR 20 billion for the purchase of ammunition by 2031, and I'm convinced that the budget discussion will become more dynamic in the coming months. And as some of you may have mentioned or realized this morning, the German Minister of Finance has also confirmed that Germany will stay at a minimum of 2% even after the specific budget has run out in 2025. The recently released German national security strategy clearly underlines the need for well-equipped [indiscernible] and I think the important that the strategy also addresses defense exports and highlights their strategic function. We see renewed dynamic in European programs. A recent meeting of Boris Pistorius and his French colleague, Sébastien Lecornu, removed some of the blocking points in MGCS, the major ground combat system, and we are confident to see progress in this program later this year. As with the future combat air system, FCAS, we, HENSOLDT, are very well positioned with our leading sensor and self-protection technology for the future armored platforms in Europe and beyond. Looking at this slide, has become a staple in our quarterly presentation by now. And we like to continue showing it for an important reason. Despite the daily discussions on scheduling of individual progress -- projects, the overall outlook for HENSOLDT regarding the German programs is in the short and medium term, has solidified once again, and HENSOLDT will contribute its leading technologies to many German programs in all domains. Yes, there are the usual timing shifts with some programs being accelerated, while others are delayed. We have highlighted the programs with positive dynamic for HENSOLDT in slate gray. HENSOLDT is very well positioned for a significant number of projects that will drive our business significantly for many years to come. And to be a little bit more concrete even, we expect a medium to high single-digit billion euro contribution from Germany to our order intake in the coming years. In the sea, in our half year figures for 2023, that this materializing -- that this is materializing more and more. And please, ladies and gentlemen, dear investors and analysts, take into account that Germany for us is the reference market to be successful in Europe and the rest of the world. Now in the first half of this year, for example, we have received top orders. For example, we have received orders for optronic sights and self-protection of the German Puma infantry fighting vehicle, and we have contracted 6 TRML-4D radars for the German share in the European Sky Shield Initiative. The 6 TRML-4D for Ukraine, I had announced in our 3M call in May, are booked now, and we expect further orders in the coming months. This is underlined by a letter we received recently from the commander of the Ukrainian air defense forces who commended the outstanding performance of our radar. This makes us proud and reinforces our commitment to save the largest of Ukrainian citizens. We have also booked orders for self-protection systems of Ukrainian helicopters and for Optronics for new Leopard 2 by Norway and Sweden as well as Periscopes and optronic mast systems for the Norwegian Ula Class submarines. In total, these orders amount to more than EUR 1 billion, a record figure for our baseline business. Before I hand over to Christian, I would like to react to and also firmly reject the allegations raised by the German youth magazine Der Spiegel in May about improper business practices and insufficient internal controls. The magazine's accusation absolutely lacked factual basis. Our internal control mechanisms are functioning at all levels. However, we have initiated an internal investigation to identify any potential weak points. Ladies and gentlemen, at HENSOLDT, we strive for best-in-class compliance approach, toe the lines with our growth ambition and integrity culture. And our compliance program ensures that business practice comply with applicable laws and regulations, and our high ethical standards. A key element of this program addresses corruption risks when working with partners. We are fully aware of corruption risks in our business and follow a business-oriented and risk-appropriate compliance approach, especially in selecting and assessing local representatives and agents. And we are absolutely confident that with all anticorruption measures shown on this slide, we have mitigated any systematic compliance risk to the absolute minimum. Ladies and gentlemen, HENSOLDT for compliance. We have a 0 tolerance in our company. And with this, I hand over to Christian and our strong financials in the first half.

Thank you very much, Thomas. I am happy to provide you now with the details on our financials for the first half year 2023. We again were able to realize significant growth in our top line in the first 6 months of this year. Our order intake summed up to more than EUR 1 billion. This performance was driven by our strong baseline business as well as the orders for TRML-4D radars and systems for the Puma and Leopard tanks. The distribution of incoming orders was very well balanced between our home market, Germany, and Europe. Our sales increased by more than 6% to EUR 726 million with an excellent development in both segments and more importantly, with a substantial increase in core revenue of 17%, resulting in an improved quality of revenues. This is driven by the excellent development of our baseline business and a decline of pass-through revenue. The key programs, Eurofighter Mk1 and PEGASUS developed as planned with a further successful milestone achievement in the Pegasus program, which I will elaborate on further. All this, again, is reflected in a very strong order backlog. At the end of the first half of 2023, our order backlog reached a new record high of almost EUR 5.7 billion. This covers 3x of our guided revenue for 2023 and therefore, continues to provide us with an excellent revenue visibility. We did not only grow in our top line. We also delivered on profitability. Adjusted EBITDA increased by 35% year-on-year to EUR 82 million with an adjusted EBITDA margin of 11.3%. Our core margin, excluding pass-through, increased as well to 12.8%. Adjusted EBIT amounted to EUR 45 million with an adjusted EBIT margin of 6.2%, respectively, 7.1%, excluding partial business, an increase of more than 2 percentage points compared to H1 2022. The significant increase was mainly driven by high volumes and the excellent growth of our core revenue as described earlier. On top, we were able to realize economies of scale in some programs, such as the TRML-4D. This development was partly offset by investments in our growth ahead and by an ambitious product mix. Adjusted pretax and levered free cash flow amounted to minus EUR 136 million. As you know, the typical profile of our business is very much weighted to the second half of the year. The development was characterized by investments in working capital to prepare for the planned revenue recognition in the second half of the year. Despite higher investments compared to last year, we managed to improve our cash position year-on-year. So let me point out our overall bottom line developed as planned. Let's now have a look at our segments. In the Sensors segment, order intake developed as planned with orders booked for TRML-4D radars for Ukraine and the German armed forces and the MUSS self-protection system for the Puma. In total, the Sensors segment was able to even exceed the high order intake from previous year's period. As a reminder, last year's figure included the F126 and the free service contract orders with a total volume of more than EUR 400 million. Revenue in the Sensors segment increased by 5% to EUR 603 million. And again, I want to highlight that our core revenue increased even stronger by 17%. This is due to a declining share of pass revenue and most importantly, by an excellent development of our baseline business. Our key programs, Eurofighter Mk1 and PEGASUS are progressing as planned. In the PEGASUS program, the critical design review has been successfully passed in June at the Bombardier site in Wichita, U.S.A. At this important milestone, the detailed design to adapt the aircraft with various reconnaissance antennas and supplemental cooling capabilities has been reviewed from technical, performance and certification aspects and approved. Based on that, Bombardier Defense has now started to modify the first aircraft. The margin performance of the Sensors segment was excellent with an increase in adjusted EBITDA of 65% to EUR 86 million. The uplift in absolute margin was driven by higher volumes and by economies of scale and some programs, for example, the TRML-4D. But please be reminded that scaling in our business is limited since lot sizes are rather small. In case of the TRML-4D, for instance, we talk about a production of 9, respectively, 15 radars this and next year. In the Optronics segment, order intake showed the expected strong momentum in the second quarter of the year and therefore, increased significantly. Main order intake drivers were the Puma second batch and the Puma retrofit. The Leopard 2 for Norway in Sweden as well as Periscopes and optical mast systems for the Norwegian Ula-class submarines. Revenue grew by 15% to EUR 125 million, driven by our South African entity, which is benefiting now from the investments in capacity expansions made in previous years. but also the FFM business, periscopes and optronic mast systems for submarines as well as the laser rangefinder for the M1 Abrams main battle tank contributed to the growth. Adjusted EBITDA in Optronics amounted to minus EUR 4 million. And let me give you more color on this development. On the one hand, we are investing in the ramp-up of the production as well as into the digitalization of the Optronics portfolio to secure the planned growth. On the other hand, the increased revenue volume was affected by a less beneficial product mix in the first 6 months of this year. This is a temporary effect, which will phase out in the course of the year. So let me point out the growth effects that currently weigh on our Optronics margin are not a structural nature, but necessary to secure plans. Let me give you now an update on our net debt development. As you can see, we have significantly reduced net debt over the past years. Our net leverage decreased from 2.6% in 2020 to 1.2% at the end of the last year. To prepare for the significant growth ahead of us, we have decided to prolongate some of our existing real estate lease contracts in order to secure our production capacities in advance. This leads to an increase of our lease liabilities according to IFRS 16. And as a result, we now expect a net leverage of less or equal 1 by the end of 2023. However, this accounting effect has no impact on our cash and financial liabilities. And according to our guidance, we further plan to increase our cash position in 2023 in the years to come. So now let's talk about our guidance for the full year 2023 as well as our midterm outlook. First and foremost, we remain on track to deliver on our full year targets. Due to a higher visibility, we are able to specify our revenue guidance for 2023 to around EUR 1.85 billion with a continued stronger growth in core revenue, resulting in an improved quality. For net leverage, we now expect a level of lower or equal 1 driven by the lease liabilities effect as explained before. For all other KPIs, we confirm our positive guidance for the full year 2023 as well as for the midterm. Dear ladies and gentlemen, let me now give you an update on the key enablers, which will help us to handle the growth ahead of us. Early this week, we have decided which measures for the third wave of our efficiency program, HENSOLDT GO!, we will implement in the coming months. The first block of measures deals with increasing our engineering efficiency to meet higher demand and growth. To let our highly skilled HENSOLDT engineers focused on high-value core competencies and on-time delivery, we will work with external engineering service providers to outsource standard work packages as much as possible. We will also put emphasis on the modularization of our core components. This ranges from more complex topics like using the same transmit and receive modules in different radar antennas or using one common power supply designs for all our products, up to more standard elements such as common connectors or semiconductors. The second block of measures focuses on the industrialization of our production process to deliver on time, on cost and on quality. This already starts in engineering where we will embed scalability in production at the very beginning of our design processes and give more responsibility to our engineers for production preparation. Russia's war against the Ukraine has strongly driven demand for our products, and we start to see positive effects in economies of scale. Therefore, we will raise production efficiency of our key products like TRML-4D through standardization and the use of plug-and-play components. This will be crucial to increase the production rate up to 15 radars in 2024. Last but not least, our third block of measures revolves around supply chain robustness, which is key to ensure the availability of our products. As an example, we have created a supply chain digital twin of our key products, which creates a heat map that shows which components have the highest impact on our value chain. This will help us to identify alternative suppliers for key components and thus reduce dependencies. This goes hand-in-hand with a strength and procurement approach that will focus on strategic and high value-add activities. Dear analysts and investors, cybersecurity is and will also remain a core priority for us. In recent months, we have been working intensively on further optimizing our cybersecurity standards by taking global action. To measure our performance, we are audited on a regular basis by a renowned cybersecurity ratings agency. And we are proud to announce that we recently took over the top position in the cybersecurity benchmark within our peer group. And of course, we will not rest on this going forward and our goal is to further improve in order to give hackers no attack surface. The second important enabler is the rollout of our harmonized global S/4HANA. This will allow us to handle the next growth wave smoothly and most efficiency -- and most efficiently across all our entities and regions. As you know, we started the implementation at the beginning of this year. And I'm very pleased that the project is on schedule and progressing as planned. We are fully aware that this is not a simple rollout process. Consequently, we put several measures in place in order to mitigate the major risks of such a large transformation program. Therefore, we have decided to have one major business and system integration partner who serves as main support for consultancy, realization and rollout throughout all program phases. This partner will get complemented and challenged by, firstly, a value assurance partner as independent adviser instance and secondly, by the software vendor SAP, who provides technical advisory for the solution. This ensures that the entire transformation program keeps a strong focus on the agreed program target, such as time line, costs and quality, but also about standardization ratio. Another very common reason for delays or failure of such programs is lacking availability of the required experts. This is why we have secured the availability of the best experts for this transformation at an early stage with a strong backfilling agreement of more than 80 FTEs. Furthermore, we invested over 18 months in advance to prepare HENSOLDT for this transformation. Together with external advisors, we sharpened and critically reviewed the whole approach without any additional bigger expenses. And finally, the program targets of the OneSAPnow transformation are incorporated into incentives plans of our executive management in order to ensure a strong involvement and focus. Coming to a conclusion, let me mention the following key financial takeaways. In the first 6 months of this year, we have achieved an outstanding performance that will form the basis for a successful year 2023. We secured again a strong order intake, resulting in a new record order backlog of EUR 5.7 billion. This continues to provide us with a great revenue visibility for the years to come. Our efficient project execution supports our excellent profitability. And in addition, our core revenue increased significantly. Therefore, we overall confirm our full year 2023 guidance with a specified, respectively, updated revenue and net leverage guidance as explained. Our outlook remains promising, and we are strongly positioned for the upcoming growth. The procurement plan of the German government is accelerating, and we expect further orders in the short term. We continue to be in close exchange with the German customer regarding the programs and opportunities from the special fund, and this will generate long-term sustainable growth. And now we are happy to take your questions.

[Operator Instructions] Our first question comes from Carlos Iranzo Peris from Bank of America.

I actually have 2. First one on your M&A strategy, we have seen strong M&A activity through the last quarter. Could you provide some update on your M&A strategy. I just wonder if they will double sales by 2027, including M&A is still in place? And then the second one on Optronics., It looks like margins came a bit weaker than anticipated due to revenue mix. How should we think about Optronics margins for the second half of the year and in 2024. I just wonder if 1H23 margins are a one-off on the Optronics margin trajectory.

Carlos, it's Thomas speaking. Yes, for sure. As we said, you remember that we will double our revenues in the next years. And yes, for sure, if you take the 10%, we have to add some M&A. And it is -- well, I think there are some very nice targets in the pipeline. We will see. But for sure, we can't talk about it. And this underlines our strategy and we will clearly follow our strategy. But as you know, M&A always takes some time. And you never know if finally you are successful, but we will follow our operational performance. I think this is always a basis and key for successful development and performance in the future.

Carlos, I take over the second question regarding margins. First of all, it is a kind of a one-off due to the revenue mix. We see that this will somehow phase out until end of the year. But what we can say that we see around 2%, 2.5% lower adjusted EBITDA margins in this year and also in the next 1 to 2 years because we will now really strongly invest into our future. And this will be offset by a stronger margin mix we see in the sensor segment because here, we see these economies of scale already. And this is how you should think about it. And maybe to remind you, in the last 2 to 3 years, we were investing heavily in South Africa. And we had a same pattern on that, but it's really paid off. And this is why we now go for these investments in optronics due to also a more short-cycle business in order to realize our growth we see in our backlog.

Our next question comes from Christophe Menard from Deutsche Bank.

Yes. I had, well, 3 questions now because optronics was indeed of importance, but your answer was very clear. First, the book-to-bill of 1.1 to 1.2 in the year. In the call, you're hinting or you were hinting at the fact that there are a number of orders to be signed soon. So question number one is, is that book-to-bill of 1.1 to 1.2 not a little bit conservative in the light of what you're seeing unfolding in Germany and elsewhere? Second question is, well, correct me if I'm wrong, but have you quantified the benefits of HENSOLDT GO! wave 3 more in details? I mean it's clearly of interest but any kind of time line for the benefits? And last question is on the impairment. What appears in your accounts, the impairment of acquired assets from HENSOLDT fiber and OneSAP. Can you just give us a little bit more details on this and the reason for those impairments?

Yes. Thank you very much for the question, order intake, 1.1 to 1.2, if you take the range 1.2499 and if you take 1.1, you can calculate that there is quite a big, I would say, a big range. But going to the upper end would most probably be the right one, the 1.2, I think. We can certainly go in this direction concerning what we have seen. But it will be anyhow in between 1.1 and the 1.2.