SDI Group plc (SD0.F) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen, and welcome to the SDI Group plc Final Results Investor Presentation. [Operator Instructions]. The company may not be in a position to answer every question it receives during the meeting itself. However, the company can review all questions submitted today, and we'll publish our responses, where it's appropriate to do so. Before we begin, we would just like to submit the following poll. And as usual, if you would give that your kind attention, I'm sure the company would be most grateful. And I would now like to hand you over to CEO, Stephen Brown. Stephen, good afternoon, sir.

Good afternoon. I would like to welcome you on behalf of myself and Group CFO, Ami Sharma. It is a pleasure to be hosting my first set of full results as CEO of SDI Group for FY '24, which had been somewhat of a tale of 2 halves, with a stronger second half. For those of you who I have not spoken to before, I joined the business at the tail end of September 2023, initially as Chief Operating Officer. In that role, I had a clear brief. Not only to accelerate M&A, but to get under the skin of each of the portfolio businesses and understand what was working across the portfolio and what could be improved. I visited each of the businesses in multiple occasions, spending time with the management teams to understand them, the markets in which they operate, their positioning within those markets and potential opportunities. When Mike Creedon stepped down in January, I became CEO, and now the opportunity to not only pick some low-hanging fruit, but to develop a forward-looking strategy based on the thorough understanding of the portfolio that I built during my time as COO. Alongside a review of FY '24, much of which we cover today, we'll be explaining our refined strategy for the business and how we're going to deliver sustainable growth going forward. In terms of agenda, I will do an overview of the group, our model and our portfolio. Ami and I will then provide an overview of FY '24. The financial results will then be covered in more detail by Ami. Ami will hand back to me to provide a strategy update. I will then wrap up with a brief summary and run through the outlook for the future. We will, of course, leave plenty of time for Q&A at the end of the presentation. So please submit your questions as we progress. The message here is that we are not intending to radically change the existing SDI model, but it is reset time. It's a new dawn, a new phase for SDI. We have clarity about what SDI is going forward and the true value proposition. The key takeaway from this slide is that the group is now a sustainable and robust platform on which to build the next generation of SDI. We can simply define our strategy in 2 parts: organic growth, and inorganic growth. We see organic as our ability to sustain and build growth from our strong portfolio of existing businesses, and inorganic has our ability to identify and execute incremental acquisitions. We have a clear plan for both halves of the strategy, and we'll also outline how they support each other to deliver future value. The 8 boxes you can see here show how we deliver. These combine the best of what we are doing in the past with new actions that we will deliver in our strategy to the future and drive growth. We continue to be a buy-and-build business with an excellent track record of delivering value-enhancing acquisitions. We now have a very clear set of criteria for acquisitions and focus on opportunities that will add more to the group and just earnings enhancement. Diversification of the portfolio becomes even more important to us to capitalize on opportunities across multiple sectors, markets and geographies. The value-add, what we can deliver, twofold. Firstly, focusing our acquisition strategy on businesses that give us a double bump. But not only delivering earnings, but also enhancing the value of the existing portfolio, for example, by opening new markets for existing portfolio businesses. Secondly, by facilitating enhanced growth opportunities for the portfolio of companies by being part of the group and collaborating with others within the portfolio. Our focus on high-growth remains either targeting acquisitions in high-growth markets, supporting portfolio businesses within high-growth markets or helping portfolio companies to access those high-growth markets. We will retain our lean structure and agility at the group level, empowering the management teams in our portfolio companies to innovate and drive growth whilst ensuring the group retains the functions it needs to deliver our strategy. When looking at the growth loop, the fundamental point here is on the focus on unlocking organic growth. For example, by bringing businesses together to target certain markets. This, in combination of the acquisition strategy I've already outlined, creates a virtuous loop of opportunities for the group. With a strategy in place and the resources available to deliver it, this comes together to deliver a sustainable platform for growth going forward, enabling us to continue to create value for shareholders. As we have carried out our strategic review, understanding the drivers of the portfolio of businesses and the opportunities open to them, we have decided to resegment the portfolio into 3 target areas: the first is Lab Equipment; second is Industrial & Scientific Sensors; and the third is Industrial & Scientific Products. We see the growth potential in each of these target markets, have a strong portfolio of businesses in each of them already, and see real synergies in grouping the businesses to work together in clear specialist areas. This focused segmentation supports both our organic and inorganic strategy, leveraging our existing portfolio, and through acquisitions that achieved a double bump we referenced earlier. With this slide, we wanted to show the global markets in which our portfolio businesses operate, with more than 40% of our current revenue coming from exports. This shows the diversification of revenues we highlighted earlier, and we are looking to grow these going forward. We have a predominantly U.K. focus with the businesses in the portfolio, and those which we will acquire in the short term going forward. However, the various high-growth sectors in which we operate, highlighted at the bottom of the slide, are global in nature, providing diversification of income and strong market opportunities in an exporter such as the SDI Group. So moving on to an overview of FY '24, I will hand to Ami to take you through the financials for the year.

Thank you, Stephen. Good afternoon, everyone. You'd have seen the numbers this morning, so I won't spend a lot of time on this slide, as I will talk about them in a little bit more detail later on in the presentation. In summary, it was a robust performance given the challenging macroeconomic background and the difficult comparative numbers, which included a considerable amount of COVID-related revenue. When you exclude that COVID-related revenue from the prior year, the business was largely flat organically, whilst inorganic growth was up nearly 11%, representing GBP 7.2 million. Most importantly, we generated a significant amount of cash over the period. With cash generated from operations being GBP 9.4 million, which was down GBP 1.5 million year-on-year, but were significantly lower than the profit reduction of circa GBP 3 million. As Stephen mentioned earlier, we delivered a much stronger half with improvements in revenue, profit and cash. Finally, just to note, the tax rate has increased for everyone, from 19% to 25%, and that has had an impact on adjusted diluted EPS. So I'll now hand back to Stephen, who will detail the operational delivery during the year.

Thank you, Ami. This is a reflection on the year just gone, during which, as Ami said, we have delivered robust results despite the headwinds faced, particularly in the first half of the year. These included the unwinding of COVID-related orders, our related destocking by key customers and the higher cost of debt, the financial implications of which Ami will review later in the presentation. We did deliver a much stronger second half to the year with the changes to the SDI management team and revised strategy in place. We took proactive actions in a number of areas, including transitioning from a reactive to a proactive approach and gaining commercial traction within the portfolio, which delivered improved performance in the second half. We also delivered a new acquisition midyear, Peak Sensors, which contributed GBP 1 million in sales. As Ami has mentioned, we delivered strong cash generation whilst continuing to invest and enhance capabilities during the year. Looking forward, this year has been about building a platform for sustainable growth going forward, and we achieved a great deal. Our new strategic framework is in place, and we're already seeing successful collaboration between our portfolio companies. We have continued to invest in development of the businesses with GBP 1.8 million has been spent in R&D and product development, largely in Synoptics, Fraser, Chell and Atik. We now have dedicated resources to continue to drive our organic growth strategy and a renewed focus for inorganic growth strategy. We have a strong active M&A pipeline in place, with a demonstrated track record of delivering on these opportunities and financial headroom to execute. With our focus on sustainable future growth, we have taken a more conservative approach to forecasting client contracts and guidance. As a result, we have adjusted our EBIT guidance for FY '25 from GBP 11.5 million to GBP 9.7 million. This change is driven by 3 factors, financially equally portioned: the first is a proactive decision to implement a new incentive scheme for our portfolio management to align targets and drive future growth; renewal of a significant new contract at LTE; and a center of change at Atik. Whilst we mentioned this at the half year results, just a reminder that we did complete one M&A transaction during the year, Peak Sensors. The business fits well within our Industrial & Scientific Sensors segment and has contributed GBP 1 million in sales. I will now hand you back to Ami, who will look at our financial results in more detail.

Thanks, Stephen. So turning to the income statement. As I mentioned earlier, revenues were broadly flat year-on-year at GBP 7.2 million of revenues from acquisitions/disposals, being offset by the loss of GBP 8.5 million of COVID-related revenues. Pleasingly, we have increased gross margins on a like-for-like basis, although on a reported basis, they were flat. Adjusted operating profit for the year has reduced, largely driven by the loss of gross margin from the aforementioned COVID-related revenue, which totaled GBP 5.6 million. Adjusted PBT has been impacted by interest charges of circa GBP 1.6 million for the year, higher, as we had a full year of increased debt levels versus FY '23. Reported profit before tax fell by just over 3%. The comparative included an impairment, and I'm pleased to report that there are no impairments this year. As you can see, the adjusted diluted EPS has fallen by slightly more than the reduction in the adjusted profit before tax. This is as a result of the increased tax rate I mentioned earlier. This slide illustrates the many moving parts of SDI's revenues. In FY '24, we had GBP 6.2 million of revenues from FY '23 acquisitions and GBP 1 million from Peak Sensors. You can see the reduction from the COVID-related revenues of GBP 8.5 million and a small reduction in the organic column, so largely flat year-on-year. We talked about the resegmentation of the business earlier on. Here, we have highlighted the key numbers within the old segmentation structure to help you track against previous results. In the largest division, Sensors & Control, we saw revenues increase by 17.6%. All of the acquisition revenues were in this segment, and we delivered 2% organic growth. There was an increase in operating profit, and we saw particularly good performances at Scientific Vacuum Systems and Monmouth, the latter who delivered a particularly strong second half. In the Digital Imaging segment, which includes Atik Cameras, Synoptics and Graticules, sales dropped by circa GBP 10 million. If you strip out COVID-related comparatives, the organic decline was 11%. As we mentioned at the half year, there was a significant destocking by one of Atik Cameras' largest OEM customers, not the COVID-related customer. And this led to reduced revenues of nearly GBP 1 million. As a result, adjusted operating profit reduced to GBP 2 million from GBP 6.9 million for the previous year. Whilst relevant going forward, we thought it would be helpful to present the FY '24 results in the new segment structure as well. In Lab Equipment, we had revenue growth of nearly 8%, including a full year contribution from LTE Scientific. When adjusting for LTE's nonorganic revenues, we had an organic decline of 1.6%. Adjusted operating profit grew to GBP 3.2 million. Looking at the detail underlying that, we saw strong demand at Safelab for their fume cabinets and Monmouth clean rooms, which, as we mentioned earlier, saw strong demand in the second half. This was offset by a slower end market for LTE Scientific as the NHS reduced its pace of spending. In Industrial & Scientific Sensors, revenues grew by nearly 2%, with peak providing GBP 1 million of revenues. When that is taken out, we had an organic decline of 4%. Adjusted operating profit was largely flat in this segment. And looking at the underlying detail, the main movers were Chell, which saw a strong demand for its DAQ products; and Sentek, which saw some destocking after a record FY '23, a reduction that was expected, but nonetheless, contributed to the organic decline. Looking at the product segment, this is where the COVID-related revenues fall. And therefore, unsurprisingly, revenues declined by nearly 15%. However, when you strip those out, as well as a nonorganic element of the contribution from FAST, which was an FY '23 acquisition, we delivered organic growth of 3.5%. Adjusted operating profit fell with the comparatives, including the COVID-related gross margin. The big driver in this segment were Scientific Vacuum Systems, which delivered 1 large system in the year and started work on 2 others. As I said at the half year, focus was going to be on reducing working capital in the second half, and that's what we've done. Inventories reduced by GBP 3.3 million across multiple businesses as we destocked, reflecting our customer base. The reduction in customer advances, which have been a feature over the past couple of years, fell by GBP 2.7 million to GBP 2.1 million, but I'm pleased to say that we haven't seen any further reduction since the half year. We generated GBP 3.8 million of free cash flow in the second half of the year, a very strong performance given I currently expect about GBP 6 million of free cash flow across the course of a normal financial year, and this contributed to net debt being flat. That free cash flow was used to finance the acquisition of Peak Sensors at GBP 2.4 million, and the GBP 1 million paid in December for SVS, which was the last deferred consideration on our balance sheet. So looking at our net debt position, we're at GBP 13.2 million, which was flat compared to the half year and FY '23. We've extended our revolving credit facility by a year, and we had headroom of GBP 10.4 million at the end of the financial year. That has increased to GBP 11.5 million of headroom at the end of June, and we're expecting headroom to increase yet further by the end of July. In addition, we have a GBP 5 million accordion option available to us at the discretion of HSBC. This slide just illustrates the various cash flow movements I talked about on the previous slide, and that we ended up in the same position at the end of FY '24 as we were at the end of FY '23. With that, I will now hand back to Stephen.

Thanks, Ami. I now wanted to talk a bit more detail about our refined strategy, both organic and inorganic, and how we are focused, and clear strategies to drive growth through both. This is not a radical change to the established direction of SDI. The resegmentation of our businesses' industry-specialist areas will support and speed up growth whilst portfolio addition is important. However, the retention of the independent brands and cultures of our portfolio businesses is key to our success. We empower our individual leadership teams and give them direct ownership of performance, culture and robustness of their businesses. We also recognize that one size does not fit all. And that in a portfolio of this size, we have businesses with different support needs, depending on which stage of the growth trajectory thereon. The key to our organic growth strategy, therefore, is ensuring each business has a growth and sustainability plan relevant to the individual business and the dynamics of the market in which they operate, and then as the skills and resources required to deliver on that plan and take proactive actions to gain strong market traction. We talked earlier about the importance of our inorganic growth strategy, our renewed approach and clear focus on delivery. We are rightly proud of our track record in delivering earnings-enhanced acquisitions. And going forward, we retain the core criteria listed here as key for potential targets. What is new is our focus on businesses that will also give the double bump mentioned earlier, where integration into the group can provide new growth opportunities for existing portfolio of businesses and provide diversification of our customer base. Earlier in the presentation, we talked you through the 3 new segments of the businesses based upon specialisms and potential target markets. The main purpose of doing this is to encourage synergies amongst those businesses and help accelerate the growth plans of the individual businesses within them. The focus of these activities can then be seen here and includes improved collaboration, improved routes to market and sharing resources. This enables the group to capitalize on those synergies and drive organic growth across segments and target markets rather than just on a business-by-business basis. This is not a radical change to the established direction of SDI, but an improvement by adding increased governance to the portfolio of businesses and positively impacting their effectiveness without changing the underlying ethos that has served SDI well in the past. You can see on the left of the screen a summary of everything we talked about in relation to FY '24. I'm very proud of all of the team from across the portfolio for their hard work, delivering a robust set of results despite a number of challenges, particularly in the first half of the year. At the same time, we have a refreshed SDI management team and started to implement our refined strategy for growth going forward. Turning to the future. We have a refocused acquisition strategy, a healthy balance sheet, alongside strong access to capital. The group is supported by a number of long-term growth drivers. As I articulated earlier, we have revised our market guidance to reflect a more conservative approach to forecasting client contracts. We have put in place operational efficiency initiatives to support margin growth. We have an extended central team capacity to support strategic delivery, both organic and inorganic. We have a highly active M&A pipeline and firepower to execute and continued strong cash generation. All of those things give us confidence in delivering sustainable long-term organic growth of 5% to 8%. So that concludes the presentation part of the meeting. So I'll hand to Ami, who will oversee the Q&A.

Thank you, Stephen. Okay. So we start taking from the top. How big in size do you think you can make an acquisition in FY '25? Also, will you maintain target EBIT 4x to 6x multiples for acquired companies? Do you want to answer that one, Stephen?

Absolutely. So we will be looking at acquisitions larger than the last one that we did, Peak Sensors. And the EBIT target will be roughly 3x the size of that, but we will maintain our flexibility. In terms of multiples, the 4 to 6 is still our target, and that multiple is based on the enterprise value or the goodwill value of the business, and that remains constant. So the SDI model, those maintain. The difference is the size of target.

Okay. Is the focus still to pay off all debt before more acquisitions? If so, how long will it take to pay off debt? Well, if we were to continue to pay off debt, it would take around 2 years to fully pay off the debt. I think the guidance suggests that we would pay it off within -- net debt will be around GBP 7 million at the end of FY '25, so another year. The focus is not to pay a full debt. We are still actively looking at M&A. And so, no. The answer to your question is no, we won't pay off all debt before more acquisitions. And the target, really, is to stay within the net debt-to-EBITDA range of between 1x and 1.5x. That's kind of -- that's where we have said previously where we would like to be from a debt -- from a leverage standpoint. In H1, Digital Imaging suffered from high comparables, onetime COVID, but also due to customer concentration. Can you provide details on customer concentration for each of the businesses or at least the aggregate? Well, we don't go through everyone in detail because we have 14 disparate businesses, all of them doing different things, would be here a while. But what I can tell you is that the biggest customer, which was the same group that we had the destocking from, is circa about 3% of revenues. And then we have a bunch of customers that are around 2%. So -- and then it trails off quite dramatically. So it's not a very big concentration. So it's not very significant, I would say, in terms of the top 10. Following on from the customer concentration, Stephen mentioned in the half 1 call that he would work on reducing customer concentration, especially Atik Cameras. What have you done so far in this regard? And what is the plan looking ahead 2 to 3 years? Stephen, do want to go for that one?

So specifically, this referred to Atik Cameras. Atik Cameras has been subject to management interaction intervention. So we have focused on that business quite considerably. There is a KPI for that business to bring on further OEM customers to dilute. They have a heavy reliance on what we reported earlier. We also, on the H1 results last year, we spoke about diversification of market. So we spoke about going into the professional astronomy market also. We have now been successful in doing that, and we've won a significant order in that market segment. And so that's been a success, but the drive continues. So we are seeing success, but it remains a strong KPI for that business going forward.

Okay. In today's notes and results, Ken Ford mentions the Board has decided not to pay a dividend. Is there external pressure on SDI to distribute dividend? The answer is no, there's no external pressure. We just do evaluate this annually. It's just part of our processes. So no. Just to answer that question specifically, there is no pressure. And if -- I think there is further -- the question elaborates that the net debt is 1.67x, net debt to EBITDA. It's not. It's 1.07x, so it's under 1.1x. So we're not highly leveraged, so as the question initially suggests. So I hope that answers that one. So this one is around our former CEO. Were his shares placed when he left? Or is he still a shareholder? My understanding is he is still a shareholder. So hopefully, that answers that question. Okay. While our FY '25 earnings expectation, set today by Kevin, is progressing just above FY '24, when you will have a full year impact of operational improvements and cost savings, acquisitions and synergies? So first of all, we don't include acquisitions in any guidance because we don't know when they're going to happen. Cost savings and synergies, do you want to answer that?

Yes, absolutely. So we're seeing FY '24 as very much a reset here. Yes, there will be cost savings put in place, but it takes a little time to percolate through the group. So we're seeing very much as FY '25 as a reset year. And we are -- as we said in the presentation, we are looking to make the guidance more conservative going forward, and that's what we intend to do.

Okay. Congratulations for half 2 FY '24. I wanted to ask you about FY '25 capital allocation. Have you seen hard negotiations with sellers related with price?

Again, with a diverse portfolio we've got, that's a difficult question to answer, specifically. Some businesses are seeing some fairly hard negotiations taking place.

In terms of M&A.

Yes, if we're talking about M&A, are they changing? Not really. If I'm honest, it's part of the, I think, the strength of SDI, where we can get an acquired -- a target at the right stage. And in terms of driving the price, we're not really seeing much difference.

Okay. Can you say more about where R&D investment has been targeted? Are there tangible new products delivered from the spend, which will be salable this year?

Yes, there has been. So most of the -- so if we look at the businesses where we invested in most, Synoptics has got a new AutoCOL product. Fraser Anti-Static have launched their X-SERIES bar, for instance. Atik Cameras has continued the CCD-CMOS transition. So all of which are on the market this year. So the answer to that is yes. How much we're going to sell this financial year, I think, it remains to be seen because they are very much new to the market, and there are new products in the marketplace. So how much we're going to realize of that this year, I think, remains to be seen.

How do you perceive a balance sheet with NTAV of GBP 3.4 million as healthy? I think the comment around being a healthy balance sheet is more around the leverage at 1x. We're not heavily levered. I think that's kind of how we perceive it. So I'm -- I appreciate the ratio that this question has quoted, but it's -- we -- the comment is around the leverage levels that we have. Okay. What have highly acquisitive companies such as Judges or Diploma done differently or better than SDI in the past? And what can you learn from it going forward?

That's a very long question.

That's a toughie.

We can be talking all day with that one.

Yes, we could be.

I think if we look at it on the present day, Judges and Diploma go after much larger targets. The multiples are considerably higher. So the model does differ somewhat as we continue to grow, and our strategy, which we just presented to you, shows that we will be growing and continue to grow. What the future looks like for us and how that's going to transition, I think, it remains to be same. But certainly, for the foreseeable years, we certainly, we've got some vision of. We're going to be looking at acquisitions smaller than Judges', where we can control our multiples going forward.

And the other comment I would like to add to that is that Judges had focused their acquisitions on supporting existing businesses within the portfolio. They've refined their M&A strategy, and I think that's kind of what we are doing as well, as you've heard us commenting on today. So we have -- although we're more focused on what we do, it is more similar to what Judges are doing nowadays.

Yes. And we are monitoring all the buy-and-build models out there at the moment and hopefully learning from them. So we -- the strategy we have just presented to you is hopefully not -- it's taking consideration, learnings and successes in the marketplace as well.

Could the company confirm that they will continue to fund acquisitions out of debt and cash flow and not undertake a placing at such a depressed share price? I mean our focus is to use our free cash flow to fund acquisitions. That's kind of what we would do, and we will continue to do. And we know the comment around the share price. Okay. Two questions. So two questions. SDI had a strategy in the past 5 to 7 years to focus expansion on sensors, betting on the industrial trend of automation. But the organic growth in this area has been average. So what do you think of this? Do you have any sector-focused further M&A going forward?

The M&A focus will be to fit into the new segmentation, which we have communicated. The sensor side of the business, it does have some planned automation, but albeit limited. The sensor play in the automotive space is highly competitive. We typically go to niche or regulatory-driven industries going forward. So I think within our sensors divisions, they're very diverse in nature in terms of markets they play in. So we are looking at a potential refocusing and looking at some diversification in some of our sensor businesses, but I think it's very much work in progress.

Okay. How would you quantify the risk of further impairments as a result of the current very high intangibles of more than GBP 42 million? So I'll answer that one. Well, we had no impairments this year, as I stated in our meeting or explanation of the results. We do an annual exercise to assess impairments. We have plenty of headroom in most of them. And you do this exercise every 12 months. As a buy-and-build company, we will -- that intangible balance will increase, simply because we do pay a goodwill for the acquisitions that we make. Some of that will be classified as goodwill. Some of that will be classified as customer relationships and other intangibles, which is amortized. So you do see an amortization. What's the quantified risk? Well, there isn't any impairments as we speak today, but the way that the impairment calculation works is that you do it every 12 months, and you look forward another 5 years. So I would say that the risk is low, but it's never impossible, but I think unlikely as of today. Okay. We don't have any more questions today. So I think that's it.

If I may just jump back in there, thank you very much indeed for addressing all of those questions that came in from investors this afternoon. And of course, if there are any further questions that do come through, we'll make these available to you immediately after the presentation has ended, just for you to review then, and add any additional responses, of course, where it's appropriate to do so, and we'll publish all those responses out on the platform. But Stephen, perhaps before really just looking to redirect those on the call to provide you their feedback, which I know is particularly important to yourself and the company, if I could please just ask you for a few closing comments to wrap up with, that would be great.

All I can say is thank you again for your time today and look forward to seeing you again in the future.

Thank you.

Thank you very much.

Perfect. That's great. Stephen, Ami, thank you once again for updating investors this afternoon. Could I please ask investors not to close this session as you'll now be automatically redirected for the opportunity to provide your feedback in order of the management team can really better understand your views and expectations. This will only take a few moments to complete, but I'm sure it'll be greatly valued by the company. On behalf of the management team of SDI Group plc, we would like to thank you for attending today's presentation. That now concludes today's session. So good afternoon to you all.