Kromek Group plc (KMK) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen, and welcome to the Kromek Group plc Final Results Investor Q&A session. [Operator Instructions] Before we begin, we would like to submit the following poll. And if you give that your kind attention, I'm sure the company would be most grateful. And I would now like to hand over to the executive management team from Kromek Group plc. Arnab, good afternoon, sir.

Very good afternoon. Thank you for that. I'm Arnab Basu, just for a quick introduction, CEO of Kromek, and I've got...

Claire Burgess, I'm the CFO.

Thank you very much. I hope you have seen the presentation that was put on last week following our results announcement last Tuesday.

So I'll straight go into the Q&A, and I will read out the questions and then either I'll answer it, or I'll hand it over to Claire as appropriate. So the first question, have you sold your IP too cheaply to Siemens? Can you elaborate on the Siemens deal? I'll handle that question. Look, Siemens was a transformational deal for us. That enablement deal, and I'll go back -- go into the little detail on the structure of the individual components within the overall deal that we did with Siemens. But Siemens enabled us to transform the business from where we were to where we are today. We -- our revenues grew, we became profitable. And ultimately, we were able to transform the balance sheet, made it into a very -- we cleared off all our debt. So it was a pivotal moment for the business itself. Now in terms of the value, we address 2 markets in the Medical Imaging space where this deal was actually done for. One is CT and the other is SPECT. SPECT is a nuclear medicine modality and CT is, of course, a very common modality for diagnostic imaging. Now SPECT is a smaller of the market than CT as we quantify our addressable market in this CT is about 15x larger than SPECT. So the Siemens deal was constructed for licensing our IP for Siemens to use to manufacture CZT for use in the SPECT market, which is the smaller of the 2 markets. And when you look at the actual value of the deal, the $37.5 million that was the sort of deal value for the enablement and the IP licensing, at that time, that was pretty much the market cap of the company itself. So in terms of the value, I think we got a very good value for what we did in that particular enablement deal. And of course, we -- when you look at the overall structure of the deal, there is a third component to it on top of the IP licensing and the enablement is the supply contract. So there is a supply contract which where we will be supplying CZT detectors to Siemens for their use for at least 4-year period for which we are contracted to at the moment. But my expectation would be that may extend beyond that 4-year period. So 3 clear elements to the deal. The enablement and the IP licensing were $37.5 million. Over a 4-year period, we have received $25 million in cash payment at the point of signature. Then we received a second payment for the second milestone of $5 million, and then there is another $7.5 million to get over the next 2 years. And the revenue recognition, of course, doesn't follow the cash, but that was elaborated in our presentation. So in terms of the overall structure of the deal, what we will get not only from the enablement piece, but also from the supply contract, we believe this was a very, very good deal for the business and the shareholders. So -- but also, it demonstrated a very key important piece. What we have built over the last 20 years or so in terms of IP, in terms of capability, in terms of our products, we showed an ability to monetize that IP through the Siemens deal. And that's an important milestone, I think, for the business itself on top of the financial milestones that this deal helped us to deliver as well. I'll move on to the next question. Is there another deal to be had that's similar to the Siemens deal? I'll take that as well. The Siemens deal doesn't preclude us because it is a nonexclusive IP and enablement deal. So it doesn't preclude us in doing a similar deal in the market. We will be evaluating where -- what's the market -- where the market is going. And as we have articulated within our strategy, the bigger of the 2 markets, the CT market is where we are going to put a lot of effort in capturing that market. We already have the Tier 1 contract in that market in place. We are working with a number of companies in the CT market, while we are supplying into the spec market into Spectrum Dynamics. So it remains open, and we will evaluate as we go through. But the Siemens deal, of course, doesn't preclude us from doing a similar deal to that. The third question, the biological threat detection system has been in development for quite some time now. What can we see -- when can we see the commercialization of these systems? And is there a real market for them? Thank you for this question. Rightly, we haven't really talked about the biological security part of the business a lot over the last few years. Now just taking a step back where it all started, we finished a very successful program with DARPA in 2018, the U.S. -- part of the U.S. Department of Defense, which is the Innovation Agency of U.S. Department of Defense, where we supply 10,000 detectors to which today are active in New York City, which is the main security system or information system against nuclear threats. At that point, DARPA moved that program on to add a biological and a chemical detection capability on a network basis to have information or to prevent nuclear, chemical and biological terrorism. So the nuclear part of completed in 2018 and the biological and the chemical part of the program started. We won the biological program in those days, simply because of our track record of what we did in the radiological program with DARPA. So it started on a $1 million contract over the following 3 years. That contract enabled us to get to certain milestones and about $10 million total contract was awarded under the DARPA program. And now today, we have 2 programs that are running in the business. So one is with the U.K. government agency, which is a GBP 5 million program, and the other was a follow-on program from U.S. Department of Homeland Security, DHS, which was a $6 million program. Now both those programs are developing specific products for the user group that are funding us to develop those. The U.K. government program is a development but also a product delivery program. So what we are going to develop and what we have developed, we are going to supply certain units into the U.S. government agency, not for evaluation or trials, but for real field use, real deployment. And that program is coming to an end around middle of calendar 2026 or early fiscal 2027. And that's where the commercialization journey begins because when you look at the revenue model of this particular business, it is a little bit like printed cartridge model. So we supply a base unit. And then each time a sample is analyzed for presence to understand the presence of viruses or bacteria, there is a disposable cartridge almost, which is where the testing is done. And each time they -- you have to buy a new one or one -- it's a onetime test for each of the cartridge. Now how we are different, the technology that we are developing under this program is very simple. Today, if you are looking for something a specific item, be it a particular virus or bacteria, you can do PCR tests like if you're doing for COVID, you can buy a home kit or do a PCR test. But -- or even if you're looking for 2 or 3 things in conjunction, you can look at multiplex PCRs. But the use case that these products -- what we are developing is where you don't have any knowledge of what is there in the air or the water sample. So you don't have any prior knowledge. It can be a novel virus; it can be a novel bacteria. It can be an unknown virus or a mutated virus. So we are using the DNA and RNA sequencing technology, which means you don't have to be doing a targeted analysis, but it's a full broad spectrum. So if you encounter a sample in the field where you have got no prior knowledge of what you're looking for, it enables you to do that. And in the U.S. program context, where this is being done to monitor cities and the environment, both for bioterrorism, but also emergence of new and novel bacteria viruses. This is, again, with no prime knowledge. So you need to know everything that is there. And so we are developing a globally unique capability that is going into commercialization middle of next year with a very, very attractive business model. So yes, we haven't talked about biology very much. But all this IP, all these products, all these technology has been developed in a completely self-funded manner where we have not invested any shareholder funds to develop this but has been paid for by our end customers. And those end customers at the start of the commercialization program because they are quite large customers in the sector we are operating in. Hopefully, that answers your question on that one.

I think it's also quite important to say that although the shareholders haven't funded the development, the benefit of the revenue coming out of the development will come back to shareholders.

Absolutely, absolutely. The next question is, are your sales teams seeing more CBRN inquiries from NATO countries -- country members as defense budgets rise? Let me answer that as well. Look, the defense budgets are rising, and we talk about the megatrends. So if you look at the megatrends within the CBRN, I don't have to tell you that the world's -- the number of conflicts around the world are increasing and increasing in areas where there are nuclear capable countries and nuclear material is freely available, like in the Middle East or in the India-Pakistan region or in Taiwan, China region or the Korean Peninsula or anywhere else. And that actually puts a real -- the threat level from nuclear incidents or accidents or even dirty bomb terrorism incidents, the threat level is definitely higher, much higher than any time before, and we are seeing that. So -- and that is really what is driving the spend, not only just in the nuclear detection capability or bio-detection capability, but the overall defense spending, of course, is going up. Even our U.K.'s strategic defense review talks about the threat from nuclear as one of the major threats, which is -- which you have -- I'm sure you've picked up. So yes, we are seeing more traction. Our core markets of U.K. and the U.S. are paying dividends as we have won the key contracts in the U.K. last year, which was the framework contract with the U.K. Home Office, the U.K. MOD placing the contract for the mainstream use of D5 into our U.K. Armed Forces, which is now the chosen radiation detector, the Blue Light Framework contract, which we won last year as well. So on top of the IDIQ contracts we have got with the U.S. DOE and various other agencies in the U.K. -- in the U.S. So the core U.K. and U.S. markets, we have got structural contracts in place, which will enable us to grow in that market. But of course, we are seeing increasing activity in this whole area from NATO countries, but also from other parts of the world. And to capture that, we appointed our Strategy and Commercial Director, which is Michael Stephenson, who joined us from Johnson & Johnson earlier this year, heading sales and marketing activity within the CBRN segment of Kromek, and he has got an -- he's reviewing, expanding his sales team. And we are starting to see the pipeline developing, and we already have a pipeline which is about GBP 300 million, as we indicated in the presentation, mainly from U.K. and the U.S. through programs that are visible. But we have also made early sales in a lot of countries where the increased sales force is going to enable us to expand the sales opportunities within those countries and drive growth within this sector. The next question is, profit guidance issued last Friday seemed very positive. Crucial to Kromek's future results will be its gross margin on other revenue, excluding Siemens Healthineers. Assuming that those other revenues rise, does the Kromek -- does the company believe that it can also increase its gross margin? Claire, I'll let you answer this one.

Thank you. So absolutely, the underlying business is critical to the growth of Kromek as we move forward. The Siemens revenue will be recognized over a number of years. So this year, we had GBP 16.5 million next year, as in financial year '26, I expect that to be around GBP 9 million. And then in the third and fourth year, that amount will reduce. But the revenue of the underlying business in that time, including revenue from the Siemens supply contracts, but lots of other contracts that we've got ongoing at the moment will then start to rise. So we don't ever expect to see a dip in revenue as we move forward. We expect to grow, and our midterm forecast that we shared at Capital Market Day will continue. In terms of gross profit margin, that's a really, really important question because this year, our gross profit margin was 81%. Last year, it was 55%. 55% across the 2 businesses with the product mix we've got is about right. I don't share the absolute gross profit for each of the divisions, and that's for a very strong reason. We want to make sure that we're protecting our customers, suppliers and shareholders by not divulging that specific information. But the underlying gross margins of each of the businesses are staying consistent. And I expect those to stay consistent or grow as we move into the future. CBRN is a little bit more of a mature market in terms of we've got that settled on the Advanced Imaging as we grow and we grow the volumes, I expect that gross margin to start to increase over time.

Thank you. I think the next question is for you as well, Claire. It's why have you arranged a RCF if you are now profitable?

Okay. So RCF for those that don't know, I'm sure most of you do, is a revolving credit facility. So we've negotiated a GBP 6 million revolving credit facility committed for a 3-year period with HSBC on particularly favorable terms. The company is forecasting to be profitable as we move forward. And absolutely, we will do that. That will be cash generative, but we have a lot of large contracts and particularly on the Advanced Imaging side of the business, there's quite a lot of working capital involved. So as we grow and we go through those cycles, the working capital flows, even though it's going up in a trajectory, that revolving credit facility will allow us to manage the cash flows on a short-term basis within the business. It's a revolving credit facility because it will go up and then it will come down, and we will manage that over the next 3 years. We've set out now to make sure that the business is firmly underpinned for the next foreseeable future and that we are not going to be coming back to shareholders to ask for additional funds.

Thank you, Claire. The next question is, what experience have you had in doing M&A? When are you likely to do your first M&A? Let me take that. I think this question stems from -- we clearly stated our strategy during our Capital Markets Day, where we stated that our clear focus will be on organic growth, capturing the very large CT market where CZT is being adopted and that structural change from black and white CT into photon counting CT is happening. And we are right in the middle of that change that is going on. So that is going to be a key focus within the organic growth. And the second is expanding our footprint within the CBRN business, where we are investing in sales and marketing, building that pipeline and everything that we talked about. Now on top, we have articulated that where we see opportunities, in CBRN business, we are going to do bolt-on M&As, but in a very disciplined manner. And that discipline applies to both the criteria of the companies that we would be looking at for M&A, but also the fiscal rules that we have established for debt ceilings and so on and so forth, which we articulated in the presentation again. Now we actually have done 2 very successful M&As in the past of the 2 of our U.S. businesses we acquired in 2010 and 2013. We identified particularly the one that we did in 2013 of EV products. At that time, Kromek and EV products were of very similar size. So we identified -- we did the acquisitions at a very good -- in a very good deal and then integrated, nurtured those businesses and ultimately created value. And the Siemens deal is a demonstration of how we have extracted value out of an M&A that we actually did, which added to what Kromek already had. So yes, we have got some experience in doing it. We have got experience in identifying, executing, integrating and ultimately nurturing and creating value. So the current targets will be smaller to start off with because these will be really bolt-on. These will be profitable companies, either addressing gaps in our product portfolio or in the CBRN segment or really giving us access to markets. So look, we see deals -- we get visibility of opportunities coming across our desk quite regularly, and we have seen that for the last so many years. But we are going to look at those much more seriously now. And there are plenty of opportunities in this segment where we can do really, really good quality M&As, which can be good for the shareholders and the value of the business itself. But we can't give you exact timings when the first one will be executed. The next question. Why is your share price so low? I have lost so much money after buying your shares. Look, this is quite an important question. And I think it's absolutely right to say that we are doing everything to ensure that the business is on the right path, and we are executing on the strategy that we have articulated. We have seen some positive reaction to the share price, of course, post results, but there is -- we believe there's a long way to go. As a management of the business and of course, the Board of Directors, we are very keenly focused on creating shareholder value. And what we can do and what you can expect from us is to deliver on the strategy that we have articulated, profitable, sustainable growth with a very clear midterm target that we have articulated in our Capital Markets Day. So we are on the right track. As I say, from a growth point of view, we have demonstrated how that -- how we are going to deliver that growth, and we'll be continuously executing. And hopefully, we are going to come back to the market on a regular basis to update you how we are doing on that journey and keep you updated. So we believe that the share -- that effort and that execution will be recognized by the market and the share price will follow. I've got the next question is -- sorry, I was late. So if these questions have been asked. In the latest RNS, we suggest that the Siemens deals impacted the sales cycle of other opportunities. Is this the case going forward? Or are we now positioned to provisioned so pipelines are not mutually exclusive? It's a great question. Thank you. It's what actually happened in the Siemens deal is reasonably simple to understand. I think it's a very small sort of -- when we look at the AI market, the advanced imaging market for us, the Medical Imaging, we -- the customer base is extremely concentrated. So it's a pretty small community of -- there are 4 Tier 1 players in Western Tier 1 players in that market and a handful of Tier 2 players. So when we were embarking on that journey towards that enablement, IP licensing, the market, the industrial market, our customer segment was all aware that there was something going on. Of course, we couldn't update the stock market and our shareholders. But what it meant was there was a lot of nervousness among our customer base of what is going to happen to their supply chain because the type of deal we were constructing was not very clear, of course, because that was between us and the other party. So everybody kind of took a step back and took a pause for a period of time. But we saw a very strong rebound post the Siemens deal. We saw a very strong rebound in second half, which will continue in the first half of this year. So we are -- it's -- that bid is over. So the market has got clarity in what we are doing. It's -- the deal is a nonexclusive deal, which means we are able to supply to everybody. We are able to license even if we wanted to. So I don't think that will affect pipeline or revenues going forward. I think it's a second question from this -- so the house broker forecast show a reversion to small revenues over the next couple of years. Yet I have a belief there are more Siemens style orders out there and why can we not factor that into the house broker estimates?

Great question. And I completely agree, there are other opportunities out there. I think what we need to be clear about is from here on out, we will be putting forecast upgrades out once we have things and they're in the bag. I'm not going to put speculative forecast out if a deal isn't done. The forecast market expectations as they stand there completely, completely stand behind. As the Siemens revenue comes off, the underlying business continues to grow. Are there other opportunities out there that we haven't got baked into the forecast? Absolutely, there are opportunities. And as those opportunities solidify, we will then start to share them with you, and we will then present an upgrade to those numbers.

The next question, working capital still seems problematic. Continuing bad debt provisions stop over 1 year's turnover.

So working capital, I think, in any business is always a challenge. I wouldn't say it's problematic as such. Yes, I've taken the opportunity. I've taken a one-off bad debt provision. That isn't a reflection of the customers per se. It's a reflection of the markets that they're in and things that are changing and budgets that are changing more than anything else. It's a one-off. I don't anticipate it happening again, and it's done. I think now is the right time to do it. Let's go back up to the question. Stock. So stock is transient stock. We are growing, particularly on the Advanced Imaging side. We're growing the business. There's whip as it moves through the CBRN business, there are some kind of stocking up for contracts that were won that were coming down. I think as we move forward, you will start to see those stock numbers start -- I don't think you will start to see those stock numbers starting to decrease as we move forward. But let me just caveat that in that the Advanced Imaging has a very long working capital cycle. So actually, from an Advanced Imaging standpoint, if -- as we grow, there is a stock increase. So when you're looking at the stock as particularly on the Advanced Imaging side, you need to review it as a function of revenue as well as that business is growing. So as a percentage, it will come down.

After stating the Chinese issues would quickly and easily be reversed, nothing has happened. Is the stock are fully written off?

So I might need -- now took -- I mean there's quite a lot of predating me. I joined -- for those of you that don't know, I joined the business in May and took over as CFO on the 1st of June. So the Chinese business is ongoing. We continue to have good relationship with our Chinese counterparts. There is some stock that is continuing to go out to them. I think...

And we -- yes, I mean, this write-off is for products that actually are very usable and is being used for the same purpose, and it is actually getting recovered but slower than what we expected. So again, this is not really something that in the balance sheet, of course, it's written off, but we are recovering as we're going forward. And there are products being made out of this. So in the mid- to long term, this will remain a very good opportunity for -- from a business point of view. So -- the next question, Siemens Healthineers, what is the timeline for the remaining Siemens Healthineers payment? And how will these funds be used? Profitable? Do you want to answer this?

So the remainder of the $7.5 million that's due, I've said in the RNS, I'll try to clear some comments for you. So we've got another $2.5 million that will be coming next year and then the following -- the final $5 million will come the year after.

And the other part of that question is -- and how will the funds be used?

So the funds will be invested back into the business. They may contribute towards the M&A. They may contribute towards the working capital need to minimize the drawing on the RCF. It will be used to basically maximize the return on the business and make sure that we can drive as high a return for shareholders as possible.

Profitability. What are the main risks to maintaining profitability after your first annual profit?

I think we've got a clear path to profitability. I think with having large contracts, timing is always a factor and always will be a factor in any business that has large contracts. So making sure that those timings are coming. From an overhead standpoint, we're keeping a very, very tight handle on our overheads. We're not overspending. I've got a very clear path to make sure that we maintain a profitable business moving forward. We're not jumping into things. We're not jumping ahead in any way, shape or form. We've got very strict kind of fiscal rules that we are going to stick to, to make sure that, that profitability stays there within the business.

Government contracts. Can you clarify the expected values and delivery schedule for the new U.K. Government framework contract? I can answer that. Yes. So the Government framework contract, I think the one that you're referring to is the $84 million framework contract that was awarded earlier this -- last year under the Home Office RN network contract. So the GBP 84 million is for 3 different categories of products for which we qualified, and we are selected as the vendors alongside a handful of other vendors. So we -- you have to be prequalified. And we already announced the first win under one of the framework -- one of the items, which was a GBP 1.7 million sort of tender, which we won and we are in the process of delivering at the moment. We expect that contracts will start to come in reasonable sizes in an increasing manner. It's a typical of government spending in terms of starting small and then as the contract goes through, they start to spend more. It's -- of course, that framework contract is over 4 years. So we expect the revenue -- whatever revenue to -- that we win to actually be over 4 years. And we have always stated that we don't expect to win 100% of that revenue, but we expect to win a healthy portion of that GBP 84 million spend that is planned and frameworked under that contract. So we have a -- what we have in Kromek at the moment, and I think this is what Claire was mentioning, too, that we have got a lot of structural elements of how we are going to grow, like the framework contract under which we expect to win because in some cases, we have got the best offering. Some of the cases, we are the incumbents on some of these expansion programs that are happening. So we have got a -- we will win a healthy portion of that contract. But giving timings is difficult. But that is how we have constructed our forecast so that we take some of these timing risks out of the forecasting sort of regime at the moment. So CBRN detection. Are there plans to expand your CBRN detection business internationally? Very much so. We -- if you refer back to the slide in the presentation, one number that we quote is the number of countries we have sold our CBRN products into. Now our 2 key markets where majority of our big revenues at the moment coming from are U.K. and the U.S. And of course, Ukraine has been a driver within our business. But what we have done in these international markets have actually made early sales to key customer bases. And I mentioned in an earlier answer that we have expanded our -- we have brought new leadership within our sales and marketing area within CBRN. The team is expanding within that, and we are going to continue to work very hard to develop some of these early sales into pipeline, tangible pipelines, which we can convert and grow. But in the very short term, we are not expecting massive growth in these international markets. Our short-term growth is very much -- will be driven by what we already have in the bag in the U.K., in the U.S., in the IDIQ. And these international markets, as and when they mature into serious revenues, we are generating reasonable revenues, but serious revenues. These will be bolt-ons, and that's what's going to drive our midterm growth in this business. Biosecurity, what are the next steps for commercializing your biosecurity technology beyond government contracts? Look, at the moment, I think I touched on it. We have got 2 contracts. One of the contracts, the U.K. government contract is a delivery -- development and delivery that goes into delivery, not for early valuation, but real deployment and use. And that is going to be start of the commercialization process with a very interesting revenue model, which is a recurring revenue model, and we expect that to expand. We believe there is substantial opportunities beyond that stage within the government market in security and defense. But of course, there are other application areas in food security and probably medical world. But our focus today remains very much in this security and defense and also sort of monitoring of emerging threats, which in government terms, it still remains within -- in customer terms, it still remains within those government realms of large area monitoring for monitoring emergence of new viruses or bacteria. So we see a very large opportunity within that. The commercialization process starts next year. Advanced Imaging, what are the main drivers for growth in your Advanced Imaging segments? And how do you differentiate from our competitors? Look, Advanced Imaging, we have a strategically very important position within the market. It's -- we are the only independent CZT supplier. There are 3 other suppliers, which are embedded within large OEMs through which they were acquired as their internal supply chain. Siemens acquired a company back in 2011 for their CT business. GE acquired a company for their nuclear medicine business in 2008 and Canon acquired Redlen in 2021 for their -- mainly for their CT business. That leaves Kromek as the only other independent player for supplying to the rest of the market, including Siemens' SPECT business and other OEMs. So in this market, this is a long sort of process of getting qualified embedded, and we are already supplying commercially into Spectrum Dynamics, one of the Tier 2, where we have a $59 million contract, and that's going well. We announced a Tier 1 contract in CT back in 2020, 2 years back, and that goes, we expect to get commercial. And we are, of course, going to have a supply contract with Siemens as part of the overall deal we did with Siemens earlier this year. So we are positioned extremely well. We have proven technology, which the enablement program demonstrated the value of that where Siemens paid $37.5 million, similar to our market cap at that point for licensing, for use of our technology in the smaller of the 2 markets we address. So we have a good position. We have an absolute laser-focused strategy for growth, which is capturing supplying into the spec market as we are doing and capturing that CT market where, again, we are structurally very well positioned with contracts and what we have in there. So yes, we expect to grow in this market very, very well. And that growth is over a very long period of time, sustainable because the product life cycle in this market is 20-plus years. So once you get into that supply chain, you are generally sole sourced or maybe dual sourced in extreme cases, but you are there with that partner for a very long time to come and you continuously supply into that with a very good visibility of revenue. The next part is shareholder value. Are there any plans for dividends, share buybacks or any other measures to return value to shareholders?

So I'll take that one. I think first and foremost, what we need to focus on is driving shareholder value in whichever way is most appropriate at the time. So I think for the here and now, what we're focusing on is shareholder value, so we increase the share price, and we get that revenue. In terms of the long term, yes, we're considering different options as we go through to maximize shareholder value and maximize shareholder return depending on what's happened. Somebody has already mentioned, could there be another Siemens enablement type deal? Absolutely, they could. Coming out of that, there may be one solution. If it's a growth on contracts, we may do something else. But what we want to make sure that we do, do is we're working within the shareholder interest as a whole moving forward and that we make sure the business has the resource to grow and drive that value forward for you.