Orbital Corporation Limited (OEC) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Orbital Corporation Limited FY '21 Full Year Financial Results Call. [Operator Instructions] I would now like to hand the conference over to Mr. Todd Alder, CEO and Managing Director. Please go ahead.

Thanks very much, Darcy. Good morning, everyone, and thank you for joining us on the call today. As introduced, my name is Todd Alder, and I am the CEO and Managing Director of Orbital UAV. Today, I have David Bonomini, our CFO and Company Secretary, joining us. The purpose of the call is to present Orbital UAV's full year results for the 12 months ending 30 June 2021. David and I will be running through the investor presentation that was released on the ASX today, and which can be followed via the Open Briefing webcast. I note our cautionary statement, and we'll now turn to Slide 3 of the presentation. Orbital UAV is the world leader in the design and manufacture of integrated engine systems for military drones, specifically tactical unmanned aerial vehicles, or UAV. These UAV platforms are used by global defense forces to support their intelligence, surveillance and reconnaissance missions. Today's presentation will provide an overview of our FY '21 financial results and outlook for FY '22 and FY '23. Specifically, FY '21 revenue was $31.2 million. And the work completed in the second half of FY '21 will deliver FY '22 profitability through the maintaining of our gross margin of 40%, a lower overhead cost base by some $3 million, and a strengthened working capital position on the back of the renegotiated legacy WA government loan. I note that we are the primary engine supplier to Boeing Insitu, and that our customer diversification strategy to mitigate future revenue concentration risk continues to progress. Engine development programs with Textron, and one of Singapore's largest defense companies, progresses towards production in early FY '23. With the company moving from 2 engine production lines to 5 engine production lines over the next 12 months, we will see material revenue growth returning, as I said, in early FY '23. The growing defense market presents additional Tier 1 customer opportunities, both globally and here in Australia. With that, I'll hand over to our CFO, David Bonomini, who will take us through the financial results.

Thanks, Todd, and hello, everyone. FY '21 has been my first full year as CFO of Orbital UAV and has proven to be a year of 2 halves. I'll now take you through some of the key events that influenced our results, and highlight some of the actions we've taken as a Board and executive to ensure our company is structured appropriately and best positioned strategically to continue to deliver on our long-term market opportunity. $31.2 million revenue was achieved in FY '21, underpinned by the long-term agreement we have in place with our key customer, Boeing Insitu. During the year, we had 2 engine modules for Boeing Insitu in production. We announced in February a reduction in shipping volumes from 1 of these engine production lines subsequent to receiving purchase order cancellations from Boeing Insitu. While revenue is heavily concentrated around Boeing Insitu, these order cancellations required Board and the executive to take corrective action, of which I'll walk you through in the coming slides. Management were aware of the revenue concentration risk, and as such, have been pursuing a customer diversification strategy, which has progressed further in March when we announced a new agreement with Textron subsidiary, Lycoming Engines, one of the largest suppliers of tactical UAVs in the U.S. market. On this, I'm happy to report that our new customer engine development programs are all progressing well. Finally, we continue to receive support from the state and federal government. During the year, we received grants to the value of $680,000. And on the 12th of August 2021, we received confirmation of the restructured WA government loan, which provides the opportunity to offset the full amount of the $10 million legacy loan against operational milestones, which I will also talk to in the coming slides. Moving on to the profit and loss statement FY '21 revenue of $31.2 million was impacted by Boeing Insitu's volume downgrade in H2. Gross margin at 42% is an improvement of 3% on FY '20. Overheads have been reduced in H2 to align to our current production volumes, with FY '22 to realize the full benefit of the cost reduction. Our overheads are now at $10 million. Orbital's underlying EBITDA of $1.2 million has been adjusted for U.S. asset impairment of $2.5 million and accounting noncash adjustment. Our U.S. assets and operations are retained and remain critical to the delivery of our long-term strategic objectives. One-off engine reworks of $2.4 million, plus a rework provision of $1.7 million was made in FY '21. Restructure costs of $600,000 and a net FX loss of $1 million on the conversion of our U.S. dollar intercompany loan to Australian dollars at the year-end. Our FY '21 reported net loss of $11.5 million also includes U.S. deferred tax asset write-off of $1.2 million in the first half of FY '21 and the renegotiated WA government interest-free loan triggered an accounting noncash interest expense of $600,000. Moving on to the balance sheet. Our FY net working capital of $5.8 million saw inventory increase by $3.4 million as a result of Boeing Insitu's volume downgrade. The excess inventory will be utilized in the production of our 3 engines over the FY '22 period. As this inventory has already been paid for, it will have a positive impact on FY '22's cash flow. The deferred revenue increase is for the customer advanced payments for the production of our third engine in Boeing Insitu. Engineering reworks provision of 1.7 is captured in the $5.4 million provision and lease liabilities. Our FY '21 capital employed of $8.4 million, I note, property, plant and equipment of $1.6 million, includes the impairment of the U.S. assets. The deferred tax asset movement is due to the USD 1.3 million deferred tax asset write-down, and the intangibles of $2 million includes the investment in new product development. In relation to the borrowing, in early 2021, Orbital commence renegotiations of its $9.9 million WA government loan and received formal confirmation of the due variation on the 12th of August 2021. The restructured loan agreement includes an extended repayment schedule over the next 4 years, and the repayment offset options that are contingent on the company achieving operational milestones aligned with increasing our engine production in Western Australia over that period. The repayment offset options provide the potential to forgive the entire value of the loan. As the loan negotiations were concluded after the 2021 financial year-end, compliance with accounting standards required the full value of the WA government loan to be temporarily classified as a current liability. This revised agreement restores balance sheet strength that supports the company's growth aspiration, specifically the near-term expansion of the production lines in, Balcatta, Western Australia. In FY '22, the first year of the full year period, $4 million of the $9.9 million loan is expected to be offset due to the achievement of operational milestones. And finally, we'll now have a look at cash flow. Orbital's FY '21 net cash outflow from operating activities of $1.6 million includes the reworks of $2.4 million, restructure cost of $600,000, the purchase of excess inventory of $6.5 million due to Boeing Insitu canceled purchase orders. FY '21 net investment activities include new product development of $1.3 million and plant, property and equipment of $800,000. Net cash and financing activities of $1.2 million relates to the U.S. and Australian property leases. The $3.1 million cash position at the end of FY '21 provides us with sufficient working capital for our operations in FY '22. Finally, we'll touch on the current capital structure and what we are focusing on from a financial perspective in FY '22. As at the 30th of June 2021, Orbital UAV had $77.7 million fully paid ordinary shares on issue. We closed the financial year with the share price at $0.83 and a market cap of $64.5 million. With the counsel of our experienced Board and the support of cornerstone shareholders, we have a clear focus on what we must deliver in FY '22. That focus is a return to profitability, getting the third engine module for Boeing Insitu into production, investment in new production lines, generating positive operational cash flow and delivering shareholder value. I will now hand back to Todd for a strategic look at the year ahead.

Thanks, David. I think it's worth reiterating the significance work undertaken over the past 6 months to reposition the company for success this year. On a similar revenue outlook to FY '21, we'll deliver net profitability for FY '22, as David said, through the maintenance of our gross margin at 40% lower overhead cost base, and into lowering of that cost base by $3 million or more, and that strengthened working capital position on the back of our renegotiated WA government loan, which is a significant milestone for us. In addition, progress on our new customer engine production lines provides both revenue diversification and significant growth or revenue growth opportunities in early FY '23. I'll move specifically to FY '22 now. I'll just note that some of the key operational milestones for us over that next 12-month period includes that third engine into production and shipping in this half, and then also announcing the fourth engine development program for Boeing Insitu. Textron engine production line to be commissioned and ready for early FY '23 shipments. The Singapore defense customer engine production line commissioned and ready for early FY '23 shipments. The award of additional engine development contracts, I'm expecting in both H1 and H2 of this year. Accelerated in-house R&D programs on some opportunities that we've identified, but also including that Northrop Grumman hybrid heavy fuel engine project. So FY '22 revenue will be in line with FY '21. However, the company will return to net profitability, and the work outlined will position us for accelerated revenue growth in FY '23. So -- set back early in this year from Boeing Insitu, they remain a key strategic partner of ours. And underpinning that strategic partnership is, of course, the Orbital Boeing long-term supply agreement. Under this agreement, Orbital UAV has been designated the primary engine supplier. So that's us supplying Insitu's entire fleet of tactical drones. In that respect, we have 2 of the 5 planned engine production lines in operation. As I said before, key milestone this year is getting that third engine production line operational. It is scheduled to commence in this half. And then we'll be announcing shortly thereafter, the fourth engine development program with Boeing Insitu. So David mentioned our work on customer diversification. So in addition to our Boeing Insitu customer, we have a number of additional customer engineering programs underway. Specifically, we are focused on engine development programs for Textron Systems, our Singapore Defense customer, and as before said, Northrop Grumman. We delivered the first prototype engine to Textron in May. The second production representative prototype will be delivered to Textron in December. We'll then commission the production facility in H2 of this financial year. Ready for first engine shipments in early FY '23. Our Singapore customer received its first prototype engine in June. A second prototype engine will be delivered in Q1 of this year. Before we also then start to commission the production facility ready for first engine shipments to our Singapore customer in early FY '23. Our work continues on the hybrid engine solution for Northrop Grumman with a demonstration system due in H2 of this year. And I note that all these customer development programs are on track against the original customer production milestones. This development work sees our production volumes expanding significantly in that early FY '23 period. So in the next 12 months, we expect to have 5 engine production lines in operation. This increasing number is the result of the customer diversification strategy we've been pursuing over the last 24 months. The engine development programs for our global defense customers represent significant long-term revenue growth opportunity for us. In addition, I expect to bring in, as I said, further Tier 1 defense customers in this half and the second half. With a growing portfolio of Tier 1 customers and a strong pipeline of work, we continue to demonstrate, I think, over the UAV's status as the world leader in heavy fuel engines for tactical unmanned aerial vehicles. This growing global reputation has also gained traction, I should say, domestically, and we continue to track 2 major Australian defense force programs, which are currently in progress. The LAND129 Phase 3 program will identify the Australian Army's new tactical unmanned aircraft system. According to reports, Insitu Pacific and Textron Australia are the final 2 suppliers shortlisted for this award. Insitu Pacific solution is for their integrated UAV, their platform, while Textron Systems is the Aerosonde platform. I note, both of which will carry Orbital engines. A decision on the winner of this program is expected in this financial year, largely the first half of this financial year. The winner of this LAND129 will also inform or influence the Royal Australian Navy's SEA129 Phase 5 program, which is currently running about 12 months behind the LAND129 program. Again, Orbital UAV's existing relationships with Insitu, Textron and Northrop Grumman, all down selected suppliers, will ensure we are well positioned to deliver our unique sovereign capability into this program. These opportunities are just a small part of a much broader and robust defense industry and which Orbital UAV has the opportunity, I believe, to build its position and defense supplier credentials. Again, I note that global defense spending reached around $1.83 trillion in 2020, a 3.9% annual uplift. North America still obviously represents the largest contributor to this. Accounting for around 41% of total spend. Worldwide UAV production forecast at $95.5 billion over the 2020 to 2029 period, with UAVs becoming increasingly strategic within the global defense forces. Technology advancements has led to an increased deployment of UAVs in the field. We look now at the Australian defense budget, which will grow over the next decade, with anticipated annual spend up from around $40 billion to $70 billion in 2030. Total spending over the next 10 years is expected to be around $575 billion, of which $270 billion is on new programs and equipment. This is unprecedented, but what's also unprecedented is the focus on Australian content and improving industry capability to support this spend. Here, with Orbital's unique capabilities and our global reputation within the growing UAV market, we believe that the company is well positioned to capitalize on this forecasted growth. So that marks the close of the presentation. And as such, David and I would now like to open it up for any questions.

[Operator Instructions] Your first question comes from Heath Andrews from PAC Partners.

My question is really around if we can narrow the time frame on the third engine, can you -- can we expect that to be this quarter or more like Q2? And sort of a follow-up on that is that sort of previously, we've sort of thought about each in securing unit sort of $15 million to $20 million, has that value changed at all since the -- since they have downgraded orders? Or should we expect that sort of level going forward when it's fully ramped?

So thanks, Heath. Todd here. So first of all, start of production, we've deliberately called it H1 because we still face customer decisions on the design of that engine. I'm happy to report that they've all now been finalized. So we're now looking at a late Q1, early Q2 start of production, and then we'll have the typical ramp-up. And then as we've said before, with Boeing Insitu typically $20 million. Obviously, Insitu facing some headwinds at the moment, we think they'll take 12 to 18 months to get through those before they return to that nice robust $20 million on each engine. So we've got somewhere between $10 million and $20 million on each one of their engines, right? So we'll be starting production in around September, October, and then you need to factor in the headwinds for Insitu and looking at somewhere between $10 million and $20 million, so I'd be looking at around sort of a $10 million figure on that third engine for annual revenues.

Yes. And in terms of the fourth engine, if you start the design phase, is that a sort of an 18-month time frame before that is likely to hit production?

Yes. Heath, that's correct. Yes, that's correct.

Your next question comes from Brendon Agius from Curran & Co.

Todd, look, just obviously, you've given an update on the Australian Defense Force UAV programs. I was just wondering if you could give some color on the Shadow replacement program undertaken in the U.S.?

Thanks, Brendon. Obviously, the -- for the other listeners, the Shadow is the larger vehicle that Textron runs. It's a significant global program, the Shadow was first in operation, I think, around 2011 or earlier. There is a program for the U.S. Army called the FTUAS program. That's a program that's looking to ultimately replace the Shadow platform. And we have and we keep close contact with those that are involved with that program and the contestants. We've had in previous presentations that the original down-selected contestants on that program we're Northrop Grumman, we're Textron, Martin UAV and L3Harris. There is what they call an early expeditionary award, in which those 4 companies have each been provided a small number of platforms to issue to the Army for evaluation over the next couple of years. That will determine the specifics for the longer-term award. As we are led to believe, payload and the size of the vehicle is suddenly being recalibrated. So they're looking at something a little larger to carry more payload now. So we see that there is at least 2 to 3 years before there will be a further shortlisted group of candidates. And then from there, there will probably be another, I would say, 5 -- somewhere between 3 to 5 years before an award is given to the one program or the one U.S. defense contractor for the replacement of that Shadow.

Okay. Great. And as far as you're obviously still in discussion with the other parties other than kind of Martin UAV, which I believe has been acquired, to supply an engine potentially to those drones?