Oxford Instruments plc (OXIG) Earnings Call Transcript & Summary

Hello everyone, and thanks for joining our call today. Hopefully, most of you had a chance to view the presentation. I'm here with Gavin Hill, who all of you know. But before we get started with some questions, let me just run through some headlines. And as most of you know, is a leading variety of differentiated technology and expertise to the world's foremost commercial companies and the scientific research communities around the world. We're well positioned within long-term structural growth markets, and these include: life science, semiconductor, advanced materials, energy environment and content technologies. These are all in line with our purpose to enable a greener, healthier, more connected advance society, and our capabilities to image, analyze and nitrate materials all the way down to the atomic and molecular level. Enable our customers to tackle some of the most pressing global challenges of our time. Now a key part of our business model is our investment in a deep understanding of our clients and our markets and also cut the technology life cycle. And this enables us to develop a range of products and services with ease and versatility and customer productivity at the core and to sell an increasing range of these products to both existing customers and importantly, expand into new and adjacent markets. Now these factors were combined with our commitment to innovation and operational excellence, key elements of our well embedded horizon strategy have supported another year of strong results, which have underpinned the continuing confidence and investment in the business for future growth. Let me just summarize some performance numbers for the period. We delivered strong order revenue and profit growth with margin maintained in line with the previous year despite the inflationary environment, supply chain challenges and the investments that we've made as in the group to support future growth. We also saw positive momentum in the second half as we converted our order book and realize the benefits of new pricing structures put in place earlier in the year. Constant currency revenue was up 14%, largely driven by volume with constant currency order growth of 14.2%, reflecting increasing demand across all of our key markets and particularly strong growth in Advanced Materials, quantum, Semiconductor and Health Care areas. We also increased our focus on attractive markets in North America and Europe as we see increasing funding from governments and commercial organizations into these regions. In China, we saw strong order growth, but revenue was in line with last year despite the increased number of export license refusals that we received and also the disruptions through most of the first half due to COVID lockdowns. Net cash increased GBP 100 million further strengthening our balance sheet and enables us to invest in future growth and also augment that organic growth with future acquisition opportunities. And finally, we announced a new 2045 net zero commitments building on the 55% (sic) 23% reduction in voluntary emissions since our 2019 baseline year. So with that, overall, a good set of numbers in the year. I'd like to open the call to any questions you might have.

[Operator Instructions] The first question from Henry Carver from Peel Hunt.

Just one from me around the sort of the shape of the order book. I just want to get a feel for the sort of underlying growth in the order book there. Is obviously, it's at a good level, but how -- to what extent is sort of supply chain issues and perhaps some of those -- the export licenses to China being reviewed, is that inflating the order book at all? Just any sort of sense of shape there? And then just any indications of how the first quarter has been so far this year? What sort of growth rates you're seeing both in, I guess, revenues and order book I'll start with those.

Thanks, Henry. Order book is up across the group. Now obviously, order book is up despite the strong revenue growth that we delivered in the year, if we haven't had the supply chain challenges with [indiscernible], which did ease lease -- to be perfectly second half, we would probably have delivered some more revenue in the year. But we see they're pretty much plateaued those supply chain challenges, but they're certainly not all disappeared. Unlike most organizations, we will continue to manage our way through them. We did see an increased number of export licenses in the year, and we continue to see that same level this year. what we're doing in China is pivoty. We're continuing to move into markets such as life science and advanced materials and other areas within semiconductors, where there are not so much the export license issues going forwards. I don't think either of those particularly inflated the order book. And each year, we've been growing the order book. But this is why only we've been investing in the business to increase our manufacturing capacity and reduce lead times. So that we can support the growth that we're driving in the business.

Great. And then just the Q1 growth so far?

So we see growth so far in the year is pretty much in line with our expectations. Markets on the whole haven't changed dramatically. And since our reporting.

Great. And then just a last one, just sort of follow up on that China point and just redirecting and pivoting the business into easier actually do business. What does that sort of entail practically? Is it actually quite a big task? Or is it something that's going to be fairly easy to just replace those revenues with.

Well, maybe last year, we pivoted away from content in China because we knew that would be an area where we would see significant restrictions. So the order growth that we saw last year, the 11% at constant currency in China or do you collect some of that pivoting away into life science, advance market materials and other markets already. China remains the largest spend regionally on R&D outspends the U.S. and other areas. But we are very mindful that areas like quantum and strongly and in some other key markets like that where we have seen strong growth in the past. We will not likely get export latencies for those, but there we made strong opportunities in other markets where our products are directly relevant towards medicine.

Henry, this is Gavin here. We're not expecting -- again, what we're doing at the moment can partially mitigate the impact of export license refusals to China. We're not expecting to see particularly strong -- where we're not expecting to see order growth in China this year. China was about 24% of orders this year. I expect next year that to fall down to around 21% of the group as it becomes a slightly smaller portion because of the export license constraints we have.

The next question comes from Calum Battersby from Berenberg.

Three questions for me, please. So firstly, could you please give an update on how much pricing there is in the order book now? And then related, if we should expect any gross margin benefit in FY '24 as that pricing comes through and quite clearly should lapse component inflation place in the prior year? And then secondly, given you've put some increased commentary on the growth in quantum [indiscernible] research, I wonder if you could just talk a bit more about the company's exact offering in that space in terms of your cryogenic platform, say, where the majority of your sales today? What's the competitive set look like? Are there other products in that market that you look to sell in time? Any commentary, that would be helpful. And then lastly, on the export license rejections, just the follow-up, I wonder if you could talk about how that issue has progressed since April. I know a couple of months back, you weren't sure if kind of the level of rejections were going to continue as they had been at the start of the calendar year for the remainder of the year. So then if you have more than you know.

Let me start. I can do the pricing next Calum. Calum, so pricing, yes, we are expecting a benefit from pricing into GM next year. So I'm expecting basic pricing and scale because we are anticipating revenue volume growth next year as well to feed into about a 1%, 1.5% improvement in underlying margin next year. However, we are investing in the group. We're investing in overhead to support our ability to grow. That's covering R&D, sales and marketing and service as well as IT as well, improving the systems and infrastructure. So I expect that plus a small currency headwind to offset the improvement in gross margin in order to support the growth that we're seeing. So I'm expecting actual operating margin to be broadly at the same level next year as it has been this year. In terms of just -- is that -- you're happy with that answer your question on gross margin and pricing?

No, that's really clear.

In terms of -- I'll jump to export license and Ian will take your Quantum question. We -- our run rate on export license rejections is around GBP 8 million for the first 2 months of the year. That is flatlining, but partly because actually, we're getting better visibility now of the areas that we know we're going to get rejections, end users and companies that are on the U.S. entity list or the Australian equivalent are pretty much of failed for us. So it helps point to areas where we feel there will be fewer restrictions. So we're not expecting that to get worse, but it is a challenge that we are managing.

Sorry,Gavin, just to be clear on that. So as in you think the full year run rate impact based on the first 2 months was about an GBP 8 million headwind to revenues. Is that me understanding what you said correctly?

Well, about GBP 8 million of export in that year. It's not necessarily a headwind because we have refusals every year, and that's the level that we're seeing the map.

Yes. It's 8 million for the first 2 months, Calum. As we talked about, we will partially mitigate that by pushing into areas where we're pushing our sales efforts into areas where we see fewer constraints. As well as opportunities in other territories. So it's -- that's not all going to be falling away from the top line. As I mentioned to Henry at the very beginning, we're expecting a year-on-year neutral position for order growth in China this year due to the constraints that we have.

The next question comes from question [indiscernible].

We haven't answered your quantum question. I think -- I didn't actually hear it. I could say what the question was. Something to do with the Quantum.

Yes. It is really just asking for kind of a bit more color on the offering in the space, ambitions, what the competitor set looks like there is more color there. So where are the majority of sales today kind of is the competitor set similar to other business lines? There are products in that market to look and sell in time. So a fairly wide-ranging question, but just any more color there would be really helpful.

We sell a broad range of products into quantum as a market. Our highest volume into our cryogenic refrigerators. And this is because predominantly content computers require extremely low temperatures in order for the quantum regime to dominate. We've seen particularly strong growth in Europe and in the U.S. for our systems to both commercial and academic customers and also into Japan. And this is because we now have every leading region investing significantly into content with government announcing tens of billions of dollars of investments into quantum technologies for their national programs. And increasingly a large number of Tier 1 technology corporates investing in content technologies to drive the market through to commercialization. And that's why we're seeing based on growth. As I mentioned earlier, we have pivoted away from cost on sales into China. In addition to the cryogenics, we sell our semiconductor processing systems, which are being used to help our customers fabricate the cubic content devices that are the active components within a quantum computer. And we then exploit our imaging and analysis systems to help our customers debug and characterize and understand the properties of those systems. So we're addressing the full life cycle production cycle for quantum technologies, and it's a growing and interesting market for us.

The next question from Richard Paige from Numis.

Just a couple of questions from me, please. On the new product investment and wider investment in the group. I think in your [indiscernible] you point to the here addressing much please. And also on the CapEx going into Belfast. What that was [indiscernible].

Sorry,Rich, I didn't quite catch the first part of your question.

Okay. The first part is on new product development within the Life Sciences. I think in your presentation, you talked about the BC43 in particular, dramatically larger addressable markets within that, just a bit more on how quickly we might start seeing some of these new products deliver? And also on the CapEx investment going into Belfast, what that adds in terms of capability and capacity on that plant? And then just a second smaller one, just the first half, second half weighting, is there anything unusual we should expect or not in the year ahead, please?

Okay. I'll pick up the first part then. At [indiscernible] In the optical Life Science portfolio as an example, but we have been developing and investing in a broad range of disruptive technologies across the whole group and that's what's been driving a strong uplift in orders over the years, and you've seen that accelerate. So whilst there's been 9% CAGR over 6 years, it's about 15% over the last 3 years, these disruptive products come into more attractive and larger markets for us. The optical imcroscopy portfolio, which we developed completely organically. We've taken our very high and research product, which goes to people who are optical microscopy specialists within life science. And we built all of the capabilities into that. So such that all of us on this call could get the same level of research great resorts with only an hour of training and no microscopy knowledge and we export so much faster to use. It doesn't need a specialized optical laser safety laboratory, as completely sealed system. It's simple to operate as a nice coffee maker that you may have at home. What this means is we can now sell this system, which is a significantly lower price point to a much larger range of customers who would previously have used central research laboratories or outsource their preclinical work. They can now do that themselves. So we're now able to sell this to customers that we have known that we wouldn't have reached before. There's nothing like it on the market at this stage, and we're seeing very rapid growth. And that's one of the reasons we're investing in our facility in Belfast is to have the manufacturing capacity to support the demand for this and the scientific cameras that go along with them. What I would also say is that there is a very healthy pipeline within our 5- to 10-year technology road maps and these products will be continuing to come out over the next few years, and they will continue to increase the gross margin of our portfolio but it also expanders into new and attractive markets. Gavin, do you want to pick up the CapEx point on...

Yes. So this is the expansion there. So we've taken on -- bought the new building pretty close to our current existing facility. As Ian mentioned, Richard, that's to support Life Science, particularly the BC43 and Dragonfly product range. I'm expecting we'll invest over the next 18 months or so, something in the region of GBP 12 million to GBP 15 million. on that. So -- which brings total CapEx, if you include what we need to do to finish up the semiconductor facility in Bristol this year and the around GBP 20 million to GBP 24 million worth of CapEx this year, which will be lower than we did last year, and that will drop further forward as capital expenditure on tangible assets decreases back to sort of normalized levels of around GBP 7 million or so.

Okay. And just anything on first half, second half weighting in terms of [indiscernible].

Yes. We were a little heavy on second half weighting in the year we've just had due to the supply chain constraints we had in the first half I would expect some alleviation of that this year. So I would expect an improvement in weighting, but it will be second half weighted as normal.

The next question comes from Erik Salz from JPMorgan.

I think most of the questions actually have actually been answered, but maybe on the balance sheet and potential M&A, balance sheet very strong, significant net cash position. Can you maybe give us a little color on what you have been seeing in terms of the healthy M&A market? Have you been looking at different things and how do you see -- how do you see valuations and potential expansion through M&A.

Erik. Yes, Gavin here. Yes, we are looking at opportunities very close to what we do in adjacent markets. And we do have some good opportunities that are under investigation and analysis at the moment, and we will port on that as and when. As you know, we're not going to overpay for assets. and we will look for assets that strategically fit in well and provide synergies with the rest of the group.

[Operator Instructions] We will take the next question from David Farrell from Jefferies.

I've got three. Firstly, if I look at the volatility Index that you published annually, it's fallen from 39% in 2020 and 2021. down to 30%. Is that a level we should kind of expect going forward and kind of reflective of a ramp-up in the R&D spend? Or is there anything else in there? My second question is a bit boring, but just a little on tax rate, where do you see that going? And then I just kind of wondered in terms of kind of the strategy to shift into kind of more commercial end markets. With one of your competitors last week and they're seeing a similar or turn down to take a similar shift in Raman spectoscopy. Is it a move you're seeing more broadly from your competitors trying to move out of the R&D field and then to the commercial markets.

The third question was on volatility index. Yes. Volatility Index, mainly is a good mega to sort of see longer-term trends. I wouldn't over worry or guide to too much an innovative technology company like ours. You want it somewhere within that 20% to sort of the 40% range if it's too high, it means you've got no longevity in your products that you're developing. And if it's too low, you're not bringing anything new to market. One of the things that we've been very successful at is taking our technologies and tailoring them. This doesn't take a lot of cost or engineering time, but using our market insights to take products that we've been selling into one market and selling them into another market. Of course, that doesn't then add to the volatility index, but it is extending and driving growth across that portfolio. And things like taking our microscopy products that we got very dedicated particle analysis solutions to semiconductor. We've been able to adapt those so they can start to study environmental aspects such as airborne pollution or microplastics is taking technology people already got today, and it does drive really good growth opportunities for us. Talking about expansion into commercial markets, this is about the drive to take very high-end technology capabilities, which were used in the past to be used only by universities or the central research labs and with ease of use connectivity at the center of every development we do. We can now take these products like I talked around BC43 and provide them to a much larger markets and user profiles. This is what we've been doing across our electron microscopy portfolio for many years and very successfully, and we're now adapting that across the rest of the portfolio in the group. I think other organizations will also see that commercial companies will want and need the technologies that we have in order to accelerate their own road maps. And that's probably why you're seeing other do it as well.

David, we expect tax rate, I'm assuming an effective tax rate on an adjusted basis to 24% this year based on primarily because of a distribution of profits, but more importantly because of the increase in the U.K. corporation tax rate. I suspect we may be a little underneath that by the end of the year due to the R&D tax credits we get and also we are well provided on some of the risks that I see dissipating. So 24% is a fairly cautious estimate.

Okay. And then the full impact of the U.K. rises, it fully felt in this financial year, right?

I would -- I'm assuming 25% the year after and then holding static, again, I'd say that's a cautious. But that's a high-end assumption. I don't expect it to do any higher.

Okay. Great. Well, congrats on a really good set of results.

Thanks.

Thanks. As there are no further phone questions, I will hand over to Amelia for any webcast questions.

thank you, Marian. Our first question comes from Akhil Patel from Shore Capital. Given the issues around export refusals to China and China being see 24% of group revenue. How do you see that the market developing for you? Also thinking about geopolitics, would you demand increase elsewhere?

I think we pretty much cut in China fairly well. I think for this year, because of the quantum market dissipating for us in China. We're expecting flat year-on-year orders in China. As we've talked about, we're pursuing opportunities in other markets and areas in China, such as life science that we would expect to return to growth thereafter. But we have -- we do expect a proportion of orders in China to decrease from around 24% down to the low 20s to reflect this.

And a follow-up question from Akhil Patel. Given the strong net cash position, what is the capital allocation framework over the medium term? Are there M&A opportunities available? Are valuations too strong at the moment, hence, you waiting for the right opportunity.

We are pursuing M&A opportunities and we will continue to do so and valuation will always form part of our thinking as to whether to proceed or not. In terms of capital allocation, we're not constrained in capital allocation. We've got some really good organic opportunities, which we are funding and we look at all opportunities and assess them on a risk return basis, but we're not particularly capital constrained as you can see.

Great. And then we have our last question from Robin Speakman from Shore Capital Markets. Is there any margin implication from challenges to sales to China?

As I talked at the beginning, we're not expecting margin reduction due to the impact from China. In fact, I'm expecting margin growth for the group. But I did talk about that that's at the gross margin level, but we are investing to support the business, as we talked about, specifically for our semiconductor business in Bristol and also the Life Science business and microscopy business, the Optical Imaging business up in Belfast. Those two are seeing good investment as we are across the region. Those investments, which will support growth going forward plus a small currency headwind means we're expecting a fairly neutral net margin at adjusted operating profit level year-on-year in the short term before we start recovering and seeing some margin improvement going forward.

Perfect. Thank you. I will now hand over to the team for any closing remarks.

Well, thanks for joining the call today. I think we covered most of the key points in the summary going forward. And as always, if you've got further questions later on in the week, Gavin and I are always very willing to take them. And I think- Gavin, is there anything else you want to add to?

No.

Okay. Well, thank you again for making the time to join the call today.