Spectris Limited (SXS) Earnings Call Transcript & Summary

Hello, everyone, and welcome to today's Spectris conference call. My name is Seb, and I'll be the operator for your call today. [Operator Instructions] I'll now hand the floor over to Andrew Heath, CEO, to begin. Please go ahead when you're ready.

Thank you, and good morning, everyone, and welcome to this morning's conference call. With me is Derek Harding, our CFO. This morning, we released 2 announcements: first, covering changes to our Board and Executive Committee; and the second, providing an update on current trading and outlook for the full year. Before getting to trading, I don't want to miss the opportunity to emphasize the importance of the organization announcement. As you have seen, we announced that Derek will be taking up a new role as President of our enlarged Spectris Scientific division, which now encompasses our Malvern, Panalytical, PMS and Servomex businesses. I want to say I'm very much looking forward to continuing our strong partnership with Derek. Derek will bring his usual energy and ambition to this new role and will be pivotal in realizing the full potential of our scientific division as a whole. Derek will continue in his role as CFO until the first September of this year and will remain on the board. Mark Fleiner, who is the current President of the division has decided that it is time for him to leave the group after 5 years, where he's overseen and led significant growth. I'm hugely grateful to Mark for the instrumental role that he has played in the creation and growth of the division. He is a great colleague, and I wish him all the very best for the future. I'm also delighted that Angela Noon has agreed to join the company as our new CFO. Angela will be a great addition to the team, bringing significant financial and commercial experience from the industrial and technology sectors. I'm greatly looking forward working closely with both Angela and Derek to continue to deliver on our strategic growth ambitions. Separately, we are updating the Market Day on current trading and the outlook for the full year. So firstly, let me address an issue with experience with the new ERP system. As you know the system was successfully implemented in Malvern Panalytical in April. I'm very pleased with the implementation and the overall performance of the system. However, there is a specific issue which has led to the delay in the transition and processing of some existing customer orders from the previous system into the new one, notably at our x-ray facility in Almelo in the Netherlands. As a result, we anticipate GBP 15 million worth of sales and GBP 10 million of operating profit will move into the second half. Although I stress that this will not impact the full year as we work through the outstanding orders as operations return to normal. Our teams are working to get through the backlog as quickly as we can. The overall plan for the ERP rollout remains on track, and everything we are seeing gives us confidence in achieving the benefits which if you remember, will contribute an additional 150 basis points of margin improvement as we fully implement the system across the group. Secondly, let me turn to comment on what we're seeing on trading. Additionally, in Malvern Panalytical, the combination of weaker demand in China, a significant reduction in battery development that's associated with the slowdown in sales of electric vehicles and the continued subdued trading in pharmaceuticals is expected to reduce sales by a further GBP 15 million and operating profit by GBP 10 million in H1. And we expect this trend to continue into the second half. Now we have to see a recovery in pharma. And while we are seeing growing demand in biologics, this has not been sufficient to offset continued weakness in conventional drug development. The reduction in batteries was a sharper deterioration in the quarter, and we now expect this to last through the second half. There is undoubtedly a lot of disruption in the EV market currently with growth slowing, some players exiting, and obviously is having an impact on short-term customer behaviors. However, the structural growth in this market is not in debt, but clearly, there is more volatility in the short term. The general softness in China is an exacerbation of what we saw in Q1 rather than the improvement we are expecting from the injection of new stimulus. Cost, currently, we have not seen the anticipated recovery in sectors such as academia and building materials. In addition, the overall weakness in pharma and battery development that is also being seen in China. But to be clear, trading across our other businesses, is in line with our expectations. As a result of the performance of Malvern Panalytical in the first half and our revised expectations for the second half, we now expect to deliver adjusted operating profit for the group at or marginally below the bottom end of the range of consensus public's expectations. We remain focused on managing the business against the backdrop of continued network uncertainty, whilst softness in some end markets is outside our control. We have several levers that we are deploying to manage the business tightly and reduce costs. We'll provide a full update with our half year results at the end of July. But for now, Derek and I are happy to answer your questions.

[Operator Instructions] Our first question today comes from Lushanthan Mahendrarajah from JPMorgan.

The first was just more broadly on the EV market. I guess just given a lot of disruption going on, just to get an idea of how -- what was 2023 like versus, I guess, more normalized levels? Because obviously, there seems to be quite a strong ramp up last year, and I see some of that seems to be unwinding. So just to get an idea of how strong that was last year would be quite helpful for you guys. And then I guess in terms of the sort of what are you assuming for recovery in the second half because I guess the downgrade implies H2 numbers need to come down a bit, sort of ex the sort of transition of the ERP stuff, I guess, are you sort of suggesting that sort of pharma and EV and China aren't really going to sort of pick up in the second half? Is that your new sort of base case assumption?

Lush, thanks for your question. So firstly, regarding the EV market. I mean, last year, we saw exceptional growth, we were seeing 25% plus order growth on demand for our particle analyzers and extra equipment, in particular, the normal panels that are obviously in battery material development and as you're well aware a lot of the manufacturers, a lot of the auto OEMs are investing hugely not just in EV, but particularly in battery developments, although also stretches across other sectors as well. So this is again an extremely tough comp as we came into the year Q1 was down against last year, but we always anticipate Q1 to be down, it was a very tough comp, where we have seen quite a sort of sharp pullback over the last few months. So batteries is a very tough comp, as I said, we fully expect this market to have very strong structural growth drivers for many years ahead, more than driving with application we know, batteries that we are part of. So we still remain very focused on that set to the market. It's just unfortunate in getting the short-term and volatility. And regarding the second half numbers, yes, I mean we are basically what we've announced today in terms of China, not picking up as we expected to continue sort of being subdued but -- and that's the stimulus money that I mentioned. That was announced during the year, we were expecting, as we saw last year, that sort of really started to impact opportunities in academia and grow demand in things like building materials. We've just not seen that coming through this year. And then that's obviously compounded in China by the fact that sort of further overall battery development for China to be part of that overall is down as well. And as you rightly pointed out, we've said in our statement, we expect that trend to continue to second half and such as we look forward to the full year, that's why we revised our guidance.

Our next question comes from Mark Davis Jones at Stifel.

A couple of sort of related questions really. Firstly, can you give us a bit more color about what's happened on the ERP? Because I thought we were kind of there on the Malvern Panalytical business. So why is it -- we had the surprise kind of after the event? You suggest it's fairly specific to one facility. Can you give us a bit more color about what's actually gone wrong or what's been delayed anyway? And then on the guidance, can you give us a sort of updated view on first half, second half split? It still looks like you've got an awful lot to do. So are there more cost levers that you can pull to offset that weaker revenue outlook? Because obviously, these are higher-margin businesses that are quite a lot softer than anticipated. So what's the other part of the bridge to the full year outlook?

Yes. So let me take the first part of your question on the ERP. I mean whenever you implement some precise complexity that we have done. I mean, we've implemented [indiscernible]. So that's all the sites across the world. And even in the nation chain you have appropriate to do also a full-scale rollout. And it has gone very well. The system works. We are buying components. We're receiving them. We're putting them into the stores, which is issued the shop flow, we're assembling, manufacturing the testing, we're shipping, we're invoicing, we're receiving payments, all while it's flowing very well on the new system. There are sort of 2 specific sort of challenges, one, which is the natural one is that whenever you go into the ERP implementation, you look better in the sort of a blackout period where you have to transition from one system to another. So you end up with some manual processing number of orders and issuing kits, the shop floor, et cetera. And then you have to obviously put the new system in the event that what you did manually greater than 2 weeks, you have to put in the new system and always takes a bit of time. We're pretty much through that now. We are out of sort of over the half year. But we had fully anticipated particularly on sort of a configuration of where we have some more highly configurable products, which is our x-ray products, the complication of moving from the old system to the new system was -- in reality was bigger so that as we started to issue the case to the shortfall, it wasn't as efficient, and that's impacted production capacity in throughput. And then that just takes time to cash back up. What we're signaling is we're not going to catch that up before the half year. And the teams are working diligently and we fully anticipate to get all that recovered through Q3, so it's purely a timing issue.

In terms of guidance, this is Derek, we obviously -- we knew that '24 was going to be a tough year relative to '23. We ended the year with the cost base set with that in mind. We had difficult comps through the year. Obviously, the news is going on just what we've seen in China and the battery market that Andrew talked about earlier, and our expectations of that into the second half does bring down the revenue and bring down the sort of gross margin contribution. We will, as always, be looking at our response to that and trying to make sure that we are focused on the cost and focused on opportunities to offset as much as that's possible. But -- and actually, as you say, with the higher gross margin business [indiscernible]. That's why we see the net number come off in the guidance as well.

Sure. It's still going to be a very heavy second half weighting though, even by your standards, isn't it on the guidance you're giving us now?

Well, I'm not sure that it will be very heavy. You have to look at the ERP movement in Malvern Panalytical, as we're saying there's a shift of around GBP 10 million of profit that would have been recognized in H1 normally. So if you like, H1 will be slightly understated by that GBP 10 million. And then H2 will pick it up. So that might skew the math slightly if you kind of correct to that, the shape is not out with historical shapes that we faced in terms of H1, H2.

The next question is from Jonathan Hurn at Barclays.

Just a couple of questions, please. Firstly, could you just kind of remind us where we are in terms of the ERP in dynamics? How far that's been rolled out? Obviously, you've had issues in scientific. Is there lessons to be learned in terms of rolling out the ERP and dynamics. So maybe we can avoid a repeat of what we've just seen?

It's Derek. Let's say dynamics is slightly different in the way in which it be rolled out. It will be a phased rollout because their underlying systems are more patchwork that Malvern work. So that derisks the rollout on dynamics anyone like definition. And that will start to happen over the course of the second half and then move into next year. I mean I think they're all expecting to be learned. I think it's important to note to cover the facts. The system is in our Malvern Panalytical that is working across deployment except the small change that we have in Almelo. And all new orders that are coming in post that blackout period and the whole process we take with our flowing group. So we're not in a situation where the systems not working. This is entirely a transition issue and as a transition issue that is taking slightly longer than we hoped. So we made live right at the start of the quarter in a way that we could get through this. We always knew that would be a transition issue. We always knew it takes time. These things, we don't expect [indiscernible] transition. It just takes a little bit longer than we hope, which is what pushes it out [indiscernible] into second half. But as always, there are lessons learned on a daily basis across the whole basis, and we'll take this into the next phase of the rollout.

Okay. That's very clear. And then second question, just for you Derek. Obviously, taken in respect to scientific. I mean a little bit surprising, but -- okay, you've obviously looked at the business or a division for a long time. You're going to take over. What are you going to do different? I mean what are your views there? What do you think it could change for the better? Is it sort of a plan you have going into that new role?

Yes, it's a great question. I mean, they're fantastic businesses. So I think when you look at the quality of our scientific division, Malvern Panalytical, PMS, Servomex, they're all fantastic businesses. If we look -- we gave you a pro forma number for last year, it's over GBP 800 million of revenue in that division and profit margin is over 20%. So it's a very strong group of businesses. They have a strong independent identities and we'll continue to support those strong independent identities. But as we've rolled them together, as we've completed the portfolio rationalization. Now there's an opportunity here to build a platform for further growth. There will be -- for example, the rollout of the ERP, it's a great example where we are working in Malvern Panalytical data, we can take that knowledge and that experience and roll it into PMS, roll it into Servomex, create a single ERP for the division. As we look at M&A, having the scale of businesses together gives us the opportunity to consider acquisitions that can bolt on and develop and improve. So it's an evolution rather than a revolution. We're not in a situation where we have something that's broken and we're far from it. But as we look forward and think about how we're going to grow that, that division and that business as a whole, there'll be opportunities for the businesses to work closer together and opportunities for us to look at different areas that complement those businesses really to the M&A and organically. So it's an iteration, it's the next stage of the journey. There's absolutely nothing wrong in them today, but there's opportunity to continue improving it in the future.

Right. And if I could just maybe just squeeze one in. We have, obviously, operationally, there's things going on that's like there's cost-cutting actions that they need to go through. But obviously, the focus is on that. Does that, in any way affect how you look at the balance sheet right now and what you're going to do there? Does that potentially if you are going to go down M&A? Does that push that further out? Does it sort of cause a little bit of a pause in terms of sort of activities that are going on?

Jonathan, M&A remains a key part of our strategy. I mean, clearly, we look at trading and market environment and other factors where we're looking to do M&A. We remain committed to our strategy as ever, we are actively pursuing a number of opportunities today that we think it will be exciting additions to the group that would absolutely be strong strategic fit, highly accretive and with absolutely speed to our compound growth story. So we remain focused on that.

Our next question comes from Bruno Gjani at Exane BNP Paribas.

Just coming back to battery. I was just wondering how big it was in 2023 in terms of sales or percentage of group sales or percentage of material sales, it will be helpful to get a context of just the overall absolute size of the business.

Well, Bruno, I mean it's in the single digits range from the group perspective, slightly high single digits from that sort of Malvern Panalytical perspective. So as I said earlier, it's part of the Malvern Panalytical last year that was growing really strongly and we [indiscernible].

Yes. And just in terms of geographical exposure of that battery business, what percentage is China, Asia? Is it above 50%, 60%, 70% or -- just some color there.

It's -- I would say it is more -- there is probably more activity in China relative to other regions. But we are selling heavily into European manufacturers and developers. So it's organic as well. But this goes across the whole supply chain. So we look at everything from the sort of fine chemistry that's going into the development of the batteries through to looking at the structural integrity and things like the internet layer, the anode, the cathodes, all the way through the full batteries. So there's quite a complex and significant supply chain supporting battery development at the moment. Clearly, a lot of the end-user demand is in China. So it's not -- it ripples from China elsewhere as well.

Got it. And in terms of the quite -- the sharp pullback that you noted in the quarter in Q2, where would you say demand is today relative to a more normal year? So I don't know, maybe call it 2022, are we back to 2022 levels of demand? Are we sharply below those levels today -- yes, just any color here.

Bruno, [indiscernible] in batteries because it's been such a rapidly developing sort of piece of the market for the last 4 or 5 years. So I mean I think we sold a lot of equipment into factory development last year. And I think given the volatility and some of the uncertainty in the short term, people just held back with making further investments and just leveraging the equipment to go, I would say.

Okay. Got it. And if we put battery to the side or I guess if we're thinking about overall group orders or demand, the delta and batteries, is that enough to -- what does that mean for orders sequentially essentially, was it enough to mean that it deteriorated in Q2? Or were there offsets in the group to mean that orders are likely stable Q2 over Q1 or maybe were slightly up? Just some color in terms of how you see order development.

Yes. So to give you much more color at the half year. This is just so let me speak day today. As we said at the Q1 trading things, we provided guidance and we very much dependent on the rate of order intake that we were going to see through Q2 and the early summer. And what we're seeing today is that clearly, that has not been as strong as we anticipated as they focused on Malvern Panalytical. And given the earlier points around the high-growth margins in the business. And therefore, the negative operating leverage you get from a pullback in demand on sales in the short term, it's something that we had anticipated when we did the Q1 trading update. But as we said then, it was very much dependent on the [indiscernible] demand we see over the coming months, and we're seeing that was just a bit weaker. But importantly, for the rest of the group, those of our businesses are performing in line with our expectations as we also said.

Got it. Just finally on China stimulus. Have these stimulus plans been firmed? Are funds flowing to your customers? It's just some peers, rather, sorry, are talking about a Q3 or Q4 moment when these funds start to flow to customers. All our customers today are in a planning phase. So I'm just wondering if it's customers are in a weighted theme today, making plans for those stimulus measures and so therefore, that's having or distorting demand today for you guys. So just any color around those factors?

Yes. So I think we -- if you compare to the '23 to this year with a stimulus line, we saw a pretty immediate impact last year. We have not seen that immediacy this year. So there's clearly more growth in China. I mean there's also a lot of chatter in China about how much stimulus money is actually going in and ex the overall economy, is that just generating capacity but not demand. So it -- the supply has increased with the margin. So I think customers are being a bit more cautious. We may see some uptick from that coming through in the second half, but I think it's a bit too early to call.

The next question is from Rory Smith at UBS.

It's Rory at UBS. I just wanted to ask on China, which particular market segments you're expecting to pick up that haven't. On EV batteries, do you expect the slowdown in EV sales to impact the automotive exposure in dynamics? And why do you think conventional drug discovery in pharma is not where you thought it would be the recovery in biologics and more consumables?

Quite a bit in there, Rory. So I think the first part of your point on China, I think we've answered the question pretty much. I mean -- so EV is as clear as the pullback on batches it talks about that. We were expecting from the seamless money, as I said, sort of academia and particularly building materials to pick up in China. That hasn't happened. We've seen a decline on both on academia, it was against an incredibly tough comp again last year. And then on sort of far more generally, I mean, really, we said that the full year and recover the trading that we expected pharma suffering back in the second half. What we're seeing is yes, biologics, biopharma is picking up. We're seeing that both in terms of the drug discovery and development phase that impacts more on parcel to a policy. We are seeing it very positively in PMS in our particle measuring system business, where we provide the aseptic monitoring solutions for clean rooms for life science applications. So there's definitely strong demand coming through there, which is an increase in capacity in clean room manufacturing really support the development of biologics, but also a lot of new drugs coming through like weight loss drugs, that is driving demand on the sort of manufacturing operation side of things. But we just -- we're still not seeing the upswing come through in sort of more conventional drug discovery and development. which we always anticipated more of an H2 weighting, but equally we see that we're still not seeing the signs in really any meaningful signs of that picking up. Whether we were in the second half, I think it's in a bit of wait-and-see mode. And then your question on dynamics, I think you -- if I understood you correctly you were sort of just trying to correlate what was our impact on EVs, factory developments into dynamics. The answer is yes. I mean the amount of physical test demand and sales going into the EV, battery developers has come off in the first half of the year. So clearly coincidentally and synchronize what we're seeing in Almelo management side. But we are actually up on automotive orders for the year, even despite the strong year last year. And that's because we are being very successful in our simulation software virtual test business, which is growing very strongly and orders can take this well up this year, which just points to everything that we showed you in [indiscernible] in June last year around what we're doing in that space and just how excited customers are about the prospects of using our solutions to reduce time to market, reduce the time it takes to develop -- go from the sort of additional twin to the full scale on their own vehicle, reduce that sort of prototyping phase, we can half the time and reduce costs by at least 20% through use of our tools, and we're seeing continued adoption across the auto OEMs across the tire manufacturers, but now increasingly into some of the sub-tier developers as well in terms of, say, think about being subsystems and hardware the-loop application. So we're very pleased and excited about the opportunities in that space. So that's helping to more than offset the sort of weakness we're seeing on the sort of battery EV side and dynamics at the moment.

Great. And if I could just squeeze in one -- final one. Thinking about that GBP 15 million sales impact in the first half for Malvern Panalytical, I don't suppose you'd be willing to portion that out across the areas that you flagged?

No. I think we could gain too much granularity and detail doing that. I think it's the amalgam of the factors that we talked about, Rory.

Okay. At this time, we have no further questions in the queue.

All right. Well, thank you very much for joining this morning. As I said, we're excited about the organization changes that we made in today. It's unfortunate we have a trading update that coincides with this, but that's just clearly coincidence and the timing of the 2 things happening together. But clearly, we see lots of opportunities for the Scientific division as a whole going forward. I am delighted that Derek's accepted offer to -- the Board's offer to lead the division going forward from here. And in terms of trading, we'll provide further color in the half year results at the end of July. So thanks very much for joining, and we'll speak then.

Thank you. This concludes today's conference call. You may now disconnect.