IMI plc (IMI) Earnings Call Transcript & Summary

Right. Good morning, ladies and gentlemen, and welcome to IMI's 2019 results presentation. I am pleased to report that our results for 2019 are above market expectations, after what has been an important year of change for the group. As most of you know, I took over as CEO in May last year. And in November, we launched a new strategy for IMI, along with some immediate near-term profit improvement activities. And later in this presentation, I will talk more about the actions that we've already taken as well as update you on the exciting plans we have to create increasing and sustainable value for our stakeholders by fulfilling our purpose, breakthrough engineering for a better world. As far as the results themselves are concerned, the final quarter of the year ended as we had expected when we spoke back in November. Second half margins were 60 basis points above the second half of 2018, despite the industrial market downturn. The margin improvement was a direct result of progress being made on our immediate profitability improvement initiatives launched last year, including GBP 27 million of rationalization benefits in 2019. Cash generation was also strong at GBP 234 million. Our strategic projects are also progressing well. These bold plans envisage a further GBP 45 million of rationalization charges in 2020, and we will deliver a total of GBP 25 million of benefits in this year, another key step towards our strategic ambitions. With that, I'm going to hand you over to Dan, who will take you through the results.

Thank you, Roy, and good morning, everyone. I'm very pleased to be able to take you through the full year results today. As Roy already said, our results are above market expectations, and cash delivery was particularly strong. Now you'll all be aware of the new lease accounting standard. And given there is no restatement of 2018, the organic metrics I will provide are on the old way, on a like-for-like basis. A summary slide is included in the appendix, so you can see the impact following the transition to the new standard. You will see on this slide the detail of our results on both an adjusted and organic constant currency basis. In terms of revenue, we had a positive exchange rate impact of $12 million or 1%, driven primarily by the strengthening of the U.S. dollar. The M&A adjustment shown on the slide reflects the January 2018 Bimba performance ahead of the acquisition. On an organic basis, revenue of GBP 1.9 billion decreased 3%, making adjusted revenue down by 2. Adjusted operating profit of GBP 266 million was flat with 2018. When you adjust for acquisitions and foreign exchange, organic profits were lower by 3%. Corporate costs of GBP 29 million were higher than 2018 due to the elimination of the GBP 2 million benefit from notional rent charges to the divisions. The profit margin for the year at 14.2% was slightly higher than last year, and we did see good margin progression in the second half as our profit improvement actions delivered. Moving to the detailed income statement. Our net interest expense increased by GBP 2 million as a result of the lease accounting change. Restructuring costs, including impairment losses, totaled GBP 53 million in the year and I'll provide more detail on the next slide. You'll also see another gain recorded for special pension events as we continue to actively manage our position. I've included in the appendix our summary pension slide, where you'll see that the U.K. scheme increased its surplus position to GBP 48 million. The acquired intangibles charge reduced to GBP 21 million as certain Bimba positions fully amortized. This slide provides an update on our restructuring activities. As Roy detailed in the strategy presentation last year, we will deliver enhanced competitiveness for the long term and continue to make the necessary restructuring investments to reposition the business. For 2019, our charge was largely as expected at GBP 53 million, while benefits came in higher mostly due to faster delivery from initiatives in Critical. For 2020, we currently anticipate a charge of roughly GBP 45 million, which includes GBP 30 million within Precision related to the GBP 75 million program announced last year. The cash impact for the year is estimated at GBP 60 million and includes outflows for some of the 2019 charge. Benefits in 2020 are estimated at GBP 25 million. We continue to expect our rationalization spend overall will deliver a payback within 2.5 years. Moving to operating cash flow. This slide, again, shows the 2019 figures after the accounting change. You will see that we had a significant turnaround in working capital versus last year. This improvement of GBP 63 million is a combination of some overhang from 2018 and the current cycle, but does reflect our continued focus on this part of our balance sheet. Debtor management was particularly good with debtor days reducing by 4 in the year. Inventories grew by GBP 15 million due to the increase in Critical's order book and to a lesser extent, GBP 3 million of Brexit safety stock building in Precision. Capital expenditure of GBP 66 million was GBP 8 million higher than last year, largely due to the construction of the new Critical facility in Japan, which was fully funded by the sale of the old site. We continue to see good capital investment opportunities within our existing businesses, so expect CapEx to continue at these levels. Overall, adjusted operating cash flow improved significantly to GBP 299 million. Regarding net cash flow, you'll see that the increase in operational cash enabled IMI to more than cover its investments and other commitments during the year, including paying the dividend and acquiring PBM in September. Net debt increased to GBP 438 million at the end of December, but this is entirely due to the additional GBP 90 million in lease liabilities. Nonetheless, our key financial ratio, net debt-to-EBITDA, improved versus 2018 to 1.2x. Our cash outflow for adjusting items increased to GBP 26 million in 2019, in line with the restructuring activity. So as we get into the detailed performance for each division, given the uncertainty driven by coronavirus, all our outlook comments are provided, assuming no material worsening of the current situation. So we'll start with Precision. Revenue of GBP 907 million was 1% lower than 2018 and after adjusting for an additional month of Bimba in 2018, and GBP 11 million of foreign exchange, 3% lower on an organic basis. The sales reduction was largely down to the continued slowing within Industrial Automation, which was down 6% in the year. Commercial Vehicle was also lower in the year as the expected truck production slowdown impacted second half orders and sales. The division's other verticals all delivered growth in the year. You will see on the slide, we have broken Industrial Automation down into Factory Automation and Process Fluid Control, in line with our strategic restructuring. Operating profit of GBP 148 million was 3% lower than 2018. And when excluding foreign exchange and the extra Bimba month, 6% lower on an organic basis when compared to the prior year. Lower volumes led to the profit decline, although the drop-through impact was limited to 33% as the division's restructuring initiatives and value pricing delivered significant benefits. Overall, margins dropped slightly to 16.3%. In terms of outlook for the division, given the current weakness in both the Factory Automation and Commercial Vehicle segments, we expect organic sales and profits in the first half of the year to be roughly 7% to 10% lower than the same period in 2019. Next up is Critical Engineering. Order input for the year at GBP 697 million was 5% higher on an organic basis and included robust growth across a number of our subsegments. New construction orders at GBP 333 million were 10% higher than 2018. Oil & Gas orders returned to growth as we capitalized on the current LNG investment wave. Our Fossil Power orders reduced 25% to GBP 47 million, reflecting a market that remains in structural decline, although we continue to win the most attractive opportunities available. On top of the good wins in LNG, the division's ability to develop new markets and applications has underpinned the full year orders, as significant growth was achieved in the Marine segment. In Aftermarket, order input of GBP 364 million was 2% higher with both the Petrochem and Nuclear segments performing well. Power Aftermarket declined 8% to GBP 136 million due to one-off commissioning spares in 2018. Upgrade orders grew 9% in the year as Critical continues to be successful in replacing competitor valves with our better-performing solutions. The order book at the end of December was GBP 516 million, reflecting an increase of 9% versus the same point last year. Looking now at revenue. As expected, Critical delivered lower overall sales, in line with the 2019 opening order book. Revenue of GBP 651 million was 6% lower on an organic basis. And when including GBP 3 million of currency benefit and the first months of PBM, 5% lower on an adjusted basis when compared to 2018. New Construction sales of GBP 277 million were 24% lower, reflective of the softness in Power and Oil & Gas. Aftermarket sales of GBP 374 million were 13% higher with good growth in both upgrades and spare parts. Operating profit was GBP 90 million, which was a reduction of GBP 1 million organically but meant that the division was able to improve operating margin by 90 basis points compared to the prior year despite the top line reduction. Although supported by higher Aftermarket mix, this was still an excellent outcome and reflects the division's successful execution of its restructuring, cost containment and value engineering initiatives. In terms of outlook, the division expects to achieve some organic sales growth in the first half of the year. Margins are expected to improve, supported by the top line growth and further benefits from restructuring. Turning now to Hydronic. Revenue of GBP 315 million was 2% higher on an adjusted basis, and when excluding the impact of foreign exchange, 3% higher on an organic basis. The division's core markets continued to perform well. Sales of TA balancing and control increased 1%, with good growth in Europe offsetting the impact of exiting the noncore Turkish market last year. Sales of Heimeier thermostatic control products were also 1% higher, with continued good growth seen in the brand's key German market. Sales of Pneumatex water quality products increased 6%, which benefited from good growth in its core Swiss market as well as successful cross-selling into other European regions. Operating profit of GBP 57 million was 5% higher on an organic basis, resulting in a 120 basis point improvement in operating margin to 18%. The division continues to focus on improving margin through its profitable growth initiatives. Regarding outlook, based on current market conditions, we expect first half organic revenue to show some growth versus the first half of 2019, with margin improvement delivered through further efficiency gains. So before turning to the group outlook, I want to give an update on IMI's activity regarding the coronavirus outbreak. As you'd expect, our first priority has been the health and safety of our employees. We continue to instruct our sites to follow all local health recommendations. In addition, we are minimizing travel and postponing or canceling internal conferences where appropriate. Many employees are continuing to work from home in the most affected geographies. We did, however, in coordination with the local government, allow certain Precision China employees to return to work ahead of the 10th of February in order to complete and ship components to those life science equipment manufacturers that are directly involved in supporting the recovery and cure efforts. This enabled, in one instance, for a key customer to accelerate deliveries of respirators to the hospitals being constructed across China to fight the disease. Our estimated exposure to the China market, both direct and indirect, is shown on the slide. The indirect figure is obviously an estimate but gives an order of magnitude and does not include the impact our customers may experience from disruption of their supply chains. The overall exposure is largely split between our Critical and Precision businesses. Given the nature of the business, we'd expect Critical may see delays to certain projects rather than absolute cancellations. Precision will be more impacted by any macro effects on the global economy and has certainly seen China demand weaken in the beginning of the year. We have included in the appendix a breakdown of our sales by country to give you further information on our geographic profile. All businesses are working with suppliers and customers to minimize the overall disruption. The impact to IMI, its suppliers and customers will ultimately be tied to the time needed to contain the outbreak such that normal economic activity is resumed globally. So now turning to the outlook for the group for 2020. It is difficult to predict the ultimate impact the coronavirus will have on global supply chains and demand. Based on no worsening of the current situation, we expect first half organic revenues to be lower than the first half of 2019, given the end market weakness in the Factory Automation and Commercial Vehicle sectors. Our continuing business improvement initiatives are expected to enable us to maintain our margins in the first half of the year. We will continue to monitor the situation and will respond as necessary to protect our people, our partners and our businesses. So with that, let me turn back to Roy for an update on the strategic initiatives.

Thank you, Dan. This next section of our presentation covers 3 key areas: first, an update on our strategic plans; second, some more detail on how we will achieve our margin targets; and third, some examples of how we are winning by focusing on our most attractive market segments and our most attractive opportunities by improving our operational effectiveness. The good news is that the new organizational structures in both Precision and Critical are starting to bed in nicely and create a strong commercial focus in IMI. In the second half, this focus helped create average price increases that were over twice the previous 4-year average as well as GBP 8 million in productivity and net material savings in the year. We now have 12 sprint teams, which are progressing well with pitch events in all 3 divisions resulting in innovative ideas being taken forward for more extensive market testing. Critical also won its first 3 small orders from the program and as we have said, apart from the potential to generate growth directly, the shifting culture that these teams represent is crucial, particularly the organizational energy and the customer focus that they're already creating. The multiyear GBP 75 million restructuring program in Precision is on track to deliver GBP 35 million of annual benefits, with 2 factories already consolidated and 2 more to be completed by the half year. In 2020, this program is forecast to deliver further GBP 20 million of incremental benefits. Today, we are also announcing a further program for IMI Critical, which will deliver GBP 5 million of annual benefits at a one-off rationalization cost of GBP 10 million. The 20% to 30% of IMI Critical's lower margin revenue that we announced was under review in November is still under review and in rapid improvement mode. And this next slide shows the major building blocks for each division to deliver their margin targets. For Precision, we need to execute the footprint rationalization plan and realize the GBP 35 million of annualized benefits. At the same time, we must beat inflation through productivity improvements, material cost reduction and value pricing, just as we did in the second half of last year. Over the medium term, we will sustain higher margins through the introduction of new products that provide both excellent customer value and improved margins for IMI. For Critical, we need to execute on its footprint optimization plan announced today to realize the targeted GBP 5 million in annual savings. We also need to dramatically improve the margins of the 20% to 30% of Critical that is currently acting as a drag on the division's financial performance or dispose of those businesses if they cannot meet our aspirations. And we need to beat inflation through value engineering, material cost reduction, productivity improvement and pricing in the aftermarket. 17% to 20% margins for Critical will be sustained through growth in the very profitable aftermarket and expansion into more attractive market segments like pharma, food and naval marine. For Hydronic, we will book GBP 5 million of rationalization costs this year to realize GBP 3 million of annualized benefit. We will continue to beat inflation through value pricing, productivity gains and value engineering, and deliver sustainable 20% margins through investments in our pull model, including customer training as well as cross-selling and new products. To stimulate growth, I've previously explained that we are building on the operational improvements made over the last 6 years by greatly increasing our customer focus. The good news is that we won 3 very prestigious car supplier awards from key customers in the second half of the year. We have also included customer satisfaction in the 2020 bonuses for the IMI leadership group and our new customer-focused organizational structures are starting to bed in nicely. Lastly, the Growth Accelerator teams are generating literally hundreds of customer interactions, more than 1,500 so far, building considerable market insight for new product developments and rapidly increasing the commercial skills of our future leaders. I am absolutely convinced that this will help deliver a much stronger business and customer-focused culture at IMI. So this next slide shows 3 recent examples of IMI winning through applications engineering and customer focus. In Precision, we worked with a medical device OEM to reduce testing times for disease diagnostics. 23 of IMI's proprietary solenoid valves with tolerances of less than a few micrometers, which is less than the width of a human hair, were designed into a bonded acrylic manifold system with an integrated printed circuit board. The project was a great success, and our customers' device can now diagnose over 100 pathogens for infectious diseases. The device rapidly detects viruses, bacteria and parasites within 60 minutes compared with several weeks that traditional laboratory tests would have taken. Clearly, in some circumstances, this faster diagnosis is a potentially lifesaving. In Critical, we worked with a major international pharmaceutical company to improve its manufacturing processes for vaccines. Multiple vaccines are made using bioreactor vessels, which have to be drained and flushed in a way which is completely clean and reliable. The valves at the bottom of the vessels are mission-critical to the manufacturing process. And due to the poor design, the competitor's diaphragms were cracking, resulting in lost time and lost product. We partnered with a customer to develop bespoke valves, which are more robust and reliable and improve the flow characteristics of the whole system. Partnership with this customer is key to IMI as more production facilities are being built and enhanced to accommodate more new drugs and product line extensions. We continue to see strong R&D spend in this sector. Worldwide prescription drug sales are expected to reach over $1 trillion by 2024. In Hydronic, we worked with Taiwan's leading technology research institute to improve the energy efficiency of its HVAC systems to support its green campus program. According to statistics collected by the Bureau of Energy in Taiwan, over 40% of the energy used by commercial buildings is consumed in heating and cooling. IMI's Hydronic College developed a complete system-level solution incorporating proprietary differential controllers and balancing valves, which delivered an average energy saving of 15%, delighting the customer and showcasing IMI's capabilities in Taiwan. And this next slide shows 3 recent examples of operational improvements that underpin our growth strategy. The Precision Engineering example shows how our great Life Science team in Las Vegas used lean techniques to reduce customer lead times by 15 days to just 5 days, twice as good as the best competitor can currently offer. The Critical example is from our excellent Remosa team in Sardinia, who used value stream mapping to improve manufacturing flow and materials planning. This customer lead times was reduced by 131 days to just 49 days. And finally, the Hydronic example shows how one of our very best lean teams in Poland improved the assembly and test production processes to achieve a productivity improvement of one of our core products, reducing customer lead times by almost half and reducing stocks by GBP 500,000. And these are just 3 of the many examples that I could use to demonstrate IMI's continuous improvement culture and our determination to serve customers better every single day. ESG forms an increasingly important element of the investment process, and we believe that IMI's credentials are strong for 2 principal reasons: First, our products have a direct and positive impact on the world. Whether that is from helping to reduce commercial vehicle emissions, significantly reducing the carbon footprint of buildings or improving the energy efficiency of the energy supply chain, we make a measurable difference. Secondly, ESG has been an important part of IMI's management ethos and values for many years. Diversity, health and safety, community support and well-established protocols for governance and risk management all contribute to IMI's robust, sustainable and ethical business model. Okay. So to summarize, the key takeaways from this presentation are that second half margins did improve by 60 basis points over the second half of 2018. Our increasing commercial focus and accountability are building on our platform of operational excellence and resulting in some key wins. IMI's Growth Accelerator is starting to generate market-led innovation and a few small orders in the second half of 2019. We do have a clear route to achieve our published margin targets for each division, which will generate strong and sustainable returns for our shareholders. Our increased customer focus, complexity reduction, operational excellence and our new approach to create market pull new products will all enable faster growth. Okay. With that, I'm going to stop there and we're going to take some questions.

This is Max from Crédit Suisse. Just my first question is on the Critical order outlook. If you look at, obviously, what you reported this year, the Marine segment essentially drove most of the growth. So I just wanted to understand what is the outlook for that part of the business, given you seem to have some one-off orders in there? And is that part of the business sustainable going into next year?

Yes. Good question, Max. I think it's Marine and LNG. I mean you don't remember that our LNG orders more than doubled. In fact, we went from GBP 15 million to over GBP 37 million orders of LNG. And just on that, actually, we've already got -- Jackie has already got over GBP 20 million of LNG orders already up until the end of February this year. So I mean LNG is strong, continues to be strong and is really helping to drive some of that growth. As you say, Critical orders were 5% up. The order book was 9% up. It was Marine and LNG. Yes, the really nice thing about naval marine is defense. And when we [ told ] Jackie to our biggest customer, they've got plans out for 2 decades. So we are really excited. I think we said before back in November that we have doubled -- Jackie has doubled the content and more than doubled. It's 2.5x the content on the latest submarine than the previous submarine. So yes, we see lots of opportunities to continue to grow naval marine. Now obviously, the orders will come in batches and there will be some ups and downs, but you probably saw that naval marine is now a bigger sector for us than fossil power in terms of new construction. And it's just one example of where we're going after new sectors that will help convert Critical into much more of a growth business in line with the strategy that we announced in November last year.

Is it one particular country that it's going into? Or is it sort of broadly across a number of countries, programs?

Yes. So that's another interesting question, Max. So at the moment, it is heavily U.K.-based business. But there are clearly a lot of opportunities in other Commonwealth countries and even outside some of the Commonwealth countries where we've got U.K. government licenses to operate. So we just got a really attractive order actually from Asia, didn't we, Jackie? So yes, we're building it from that platform.

Okay. Just my second question is on Precision. And if you look at -- by the end of this year, kind of Precision margin should be 16-ish percent, depending on how the rest of the year plays out. But most of the cost savings will then be behind us. So we're then looking to kind of bridge the gap from 16% up to 20% for the target. What kind of growth environment, when you talk about the peak of the cycle, would you need to make that 400 basis point step-up? Or are there more cost-saving actions on top of what is already done to bridge that gap?

I think Max, there's definitely more improvement actions. I think if you just look at a normal Precision cycle, a normal Precision cycle, so if you ignore 2009 and say that's a bit of an outlier -- I hope it's a bit of an outlier. But if you look at a normal Precision cycle, the volumes can come off 10% to 15%, pretty much as they seem to be doing at the moment and obviously then rebuild that Precision and then grow at sort of 3% or 4% once they've recovered. So depending on the recession, we'll get a recovery of 10% to 15% in terms of sales and then start growing at 3%, 4% for the rest of the cycle. That will be more than enough to help us hit that margin target when you add in the other initiatives that I talked about around material cost reduction, value pricing and efficiency improvement around SG&A.

So then could you do 3 or 4 years at 3% or 4% growth and get there, 100 bps a year. Is that the right way, Roy, to think about it?

Yes. I mean roughly speaking, 3 bps would add GBP 27 million and probably drop through at 35% to 40%. So if you model that on top of the cost savings, yes, you'll pretty quickly get there.

It's quite a big mix shift in the revenues within Critical this year in favor of aftermarket, which obviously supported the margin. What's the outlook for the mix there as that order book flows through? And does that create something of a headwind, offsetting the restructuring benefit, margin-wise?

You're right. I mean mix did help us this year. What we like is, and I did refer to this in November as well, is that the New Construction orders are now at better margins, and that's a positive mix effect because our mix -- our margins in naval marine and LNG are better than the margins of the other segments. So that's why we're confident that this year, we'll see some sales growth from the order book, obviously, and some more margin improvement, despite the fact that Aftermarket might be slightly less in the mix. We'll see because obviously, Aftermarket is obviously booked to ship as well as what we've got in the Aftermarket in the order book already.

Petrochem business within the Aftermarket, is that holding up well?

Yes. That actually grew. The Aftermarket in Petrochem actually grew. So we are starting -- this is really one of the big strategic issues, right? Jackie has done a fantastic job of converting Remosa to be much more of an Aftermarket business, really go after the installed base. This has become one of our most profitable and fastest-growing business over the last 3 or 4 years. And that's really the job for those Petrochem businesses is to make sure they can do that and get after the installed base. So yes, we feel reasonable about the Petrochem Aftermarket. It should be reasonably good.

I want to -- can you talk a little bit about -- maybe it's Massimo. Can you talk a little bit about the truck cycle? I know it's very obvious that it's a quite deep cycle. But I'd just like to hear what you're seeing from the OEMs, the communication you're getting and maybe some of the sort of the trajectory of how we see that develop over the next, what, 6 months, I suppose, on the basis that, that's the guidance that you've given? And then as a follow-up. With the IMS last year, you talked about pricing -- or achieving twice the price, I think, it was the number you used. I just wondered if you can talk a little bit about pricing, that would be really helpful.