TT Electronics plc (TTG) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining me for the TT Electronics 2022 Interim Results Presentation. The usual format with me today is our CFO, Mark Hoad, will run you through the presentation and then open up for your questions. I'd like to start by saying that I'm really pleased with our performance in the first half. Double-digit revenue growth, order intake continues at record levels and line of sight for strong profit improvement. The team has done a really great job in difficult conditions. Around the world, they have worked tirelessly to manage these issues, working closely with our customers to satisfy demand and get the product they need. And I'd like to thank our team for a great contribution. Everywhere I look in these results, I can see a lot of evidence of the successful implementation of our strategy. At the heart of this is considerable momentum across the business in both revenue growth and order intake, and this has come from the combination of our strategy to focus on structural growth markets, targeting customers that are growing in those markets and driven by great execution from the team that I've mentioned. Revenue grew by 8% organically with excellent growth in Sensors and Specialist Components and GMS also very strong at 17%. GMS is on track to be almost double the revenue of 5 years ago. As we told you earlier in the year, the Power and Connectivity business will be H2 weighted due to the timing of revenues and the COVID shutdown in Asia. The pipeline of new business opportunities include significant new wins on multiyear projects and further new customers added to our key account list. Order intake has continued at record levels with so far no sign of softening. Our book-to-bill in the first 6 months was 144%, significantly extending revenue visibility with our order book now more than double pre-pandemic levels. We have all the order cover for our planned second half revenue growth. So to be clear, these are numbers, we're not relying on any improvement in demand from macro conditions. The growth is locked in. It's all about managing the supply chain and any further COVID issues. Not only that, but we're already more than half of next year's planned revenues covered by orders. In the first half, we have secured 23 significant new contract wins, which will deliver over GBP 60 million of multiyear revenues. One of these comes from Ferranti, which we bought in January and is already working well with the rest of the group. As inflationary pressure started last year, we took action on pricing. This is ongoing, and we're recovering costs and expect to see some more benefits in H2. We continue to progress our ESG initiatives. We set a clear target to halve cumulative emissions by the end of 2023 and to achieve Net 0 for our Scope 1 and 2 emissions by 2035. On carbon reduction, we have been switching to renewable tariffs wherever possible, and we've been shutting older facilities, replacing them with more energy-efficient ones. A good example being our new Plano site, all part of our self-help program. Cash spend on this program will be completed in this financial year. From the benefits of the footprint rationalization also underpin margin improvement in the second half and into 2023. Importantly, we have clear line of sight to achieve our unchanged full-year expectations through growth, pricing and self-help benefits. So with that, I'll hand over to Mark to take you through the financial performance for the half.

Thank you, Richard, and good morning, everyone. We've had a strong first 6 months and are making good progress despite the challenging conditions. Revenue is up. We've continued to grow our order book, creating a step change in forward visibility, and we positioned the business to deliver strong profit growth in the second half and for the year as a whole. In the first half of the year, we grew revenue by 8% organically, roughly 2/3 of that was pricing and material pass-through and 1/3 volume. We delivered good growth in GMS and Sensors and Specialist Components, while Power and Connectivity was impacted by timing of program revenues and parts availability. Operating profit was up by 5% at constant currency, and operating margins were 6.8%. First half margins reflect some revenue delays, COVID inefficiencies and the impact of supply chain constraints. On the next slide, I'll show you the moving parts. Earnings per share declined by 8% at constant currency, impacted by a higher interest expense and an increased tax rate of 22.8%, with a greater proportion of profits coming out of higher rate jurisdictions. There was a GBP 23.5 million free cash outflow in the first half. Working capital increased as we continue to invest in inventory to support very significant growth in our order book, and this was amplified by supply chain constraints causing us to hold inventory for longer. It is this investment in inventory that gives us confidence in the delivery of the order book. As a result and as expected, we had a temporary increase in leverage to 2.4x at the 30th of June. Within the improvement in profit along with higher cash generation in the second half, we expect to be back within our target range of 1 to 2x net debt to EBITDA by year-end. Given the positive outlook for the second half of the year and beyond, the Board is declaring an 11% increase in the interim dividend to GBP 0.02 per share. Here, you can see the key elements of the change in operating margin in the period. Adjusting for FX and the one-off costs of the Virolens project, last year's first half margins were 8.3%. Ferranti is performing well, delivering high-teen margins, enhancing the group's margins by 20 basis points. We've described before the past reflect in GMS, where they're transparently passing on material cost inflation to customers with no markup. This inflating the revenues in the first half by around GBP 10 million and depressed margins by 30 basis points. While we've delivered growth in the first half, margins were impacted by COVID inefficiencies, supply chain constraints and the mix of revenues. The combined impact of these effects was 150 basis points. We see these effects now moderating, and therefore, we expect this margin impact to improve in the second half of the year as revenues increase and agreed price increases take effect. Our self-help program added 50 basis points and the rebuild of discretionary spend continued as planned. As we look into the second half, we see revenues increasing, agreed price increases taking effect and further self-help benefits coming through. And with that, expect improved margins for the second half of the year. Moving on then to see how that revenue and profit performance has played out in the divisions. In Power and Connectivity, revenue decreased by 2% on a constant currency basis and by 7% organically. There are a number of factors that impacted the revenue performance, timing of aerospace and defense program revenues, which do tend to be lumpy, parts availability, pushing product shipment from the first half into the second half and the COVID related closure of our factory in Dongguan. However, we're now seeing an improved order book for the second half and the product that was delayed out of the first half will ship in the second half. We've also had a healthy number of multiyear contract wins that underpin our positive view for this division. As I've already mentioned, Ferranti is performing well and contributed GBP 3.7 million of revenue and GBP 0.7 million of operating profit in the first half. Operating profit declined by 48% at constant currency due to the organic reduction in revenues and some lag on repricing given ongoing inflationary pressures. With higher revenues, associated efficiencies and the impact of price increases already agreed with customers, we have clear line of sight to a substantial improvement in profit and margin in the second half of the year. Global Manufacturing Solutions delivered organic revenue growth of 17%, of which half related to pass-through costs. Demand was particularly strong in the U.S. and in Asia, while Europe was impacted by parts availability, which held back revenues despite an increased order book. The GMS order book overall continues to grow at a pace. And as a result, the division is already booking orders for the second half of 2023. Adjusted operating profit was broadly unchanged on a constant currency basis. Margins declined by 120 basis points, but half of this is explained by the GBP 10 million of cost to pass through with no markup. GMS has had to work hard to manage supply chain and COVID disruption, and there has been some lag in repricing, which we expect to reverse in H2. With an acceleration in growth and as agreed price increases continue to take effect, we anticipate margins improving in the second half of the year. Finally, Sensors and Specialist Components. Here, we grew revenue by 8% organically with strong demand from distribution customers in particular. As you'll hear from Richard, this demand is to satisfy their end customers rather than for any meaningful build in their inventory levels. In the face of long industry lead times, we are working with customers to secure committed orders. The order book for this division is up by more than half compared to a year ago. And this business, which in the past typically only had 8 to 12 weeks of order visibility is now booking orders for Q2 next year. The profit performance has been very strong with good operational leverage on revenue growth and self-help benefits continuing to come through. Adjusted operating profit grew by 34% at constant currency and margins are up 320 basis points to 16.3%. There is some tailwind in the first half from favorable product mix, but this is a record level for S&SC margins, more than 200 basis points up on the previous high of 14.1%. Moving on to cash flow. As you can see, the main dynamic here is working capital. As we flagged earlier in the year, with the material growth in order book and ongoing standard lead times, we've continued to invest in inventory. This has been compounded by parts availability, impacting our ability to ship product, which means it's taking longer to convert inventory to cash and has also pushed revenue and the EBITDA into the second half. In the first half, there was a GBP 33 million working capital outflow. We agreed improved terms to some customers in the first half to mitigate the impact of the working capital investment. This will start to take effect in H2, and we expect to deliver modest improvement in working capital in the second half. There were no pension deficit contributions in the first half of the year. We do expect to catch these up in the second half and pay the planned GBP 5.7 million plan contribution for the year, all in the second half. But given the very strong funding position of the scheme, we're putting in place a new escrow arrangement for contributions to go into rather than paying them into the scheme and risking a trapped surplus in the future. With the free cash outflow of GBP 23.5 million and lower first half EBITDA weighting, there was a temporary increase in leverage as anticipated to 2.4x. We expect this to mechanically return to within our 1x to 2x target range by year-end as both EBITDA and cash generation improved in the second half. Finally, we've recently completed the refinancing of our bank debt facility. The new RCF with our core relationship bank group is for 4 years with the option to extend by 1 year and complement the long-term private placement notes we completed late last year. Lastly, I wanted to give you an update on our self-help program that is now close to completion. We're delighted that we're on track to deliver the full benefits as planned. We've closed 6 sites so far, Barbados, Carrollton, Corpus Christi, Lutterworth, Tunisia and Akron. Last year, we opened our new facility in Plano, Texas. Line qualification is being progressed, albeit it's taken longer than planned, in part due to the prioritization of resources to meet the very high levels of customer demand that we've been experiencing. We expect the qualification process to be completed in H2. The reconfiguration of the Bedlington site is close to completion. And one of the last big steps, setting up new furnace room is underway as we speak. The final piece of the overall program is the integration of Covina into the Torotel site at Kansas City. This is also now well underway. We've continued to manufacture in the site to meet increased customer demand but remain on track to complete the move and the overall self-help program by the end of the year. Overall, we remain absolutely on track to deliver full project benefits next year. With the delayed Plano qualification, overall project costs have increased slightly. But as we approach the end of the project, the team has done a great job to deliver it while dealing with growth and supply chain challenges, and we're delighted with the overall contribution from the project. So hopefully, that's given you a good sense that with a strong order book, great customer relationships and ongoing self-help actions, we're in good shape for a strong second half. With that, I'll hand back to Richard.

Great. Thanks, Mark. So let me take you through why I'm confident about the second half and why I'm really excited about the opportunities for the future. To remind you, our strong performance is a direct result of our strategy to position the group in markets with long-term structural growth, investing in self-help initiatives, business development and R&D and good execution. Our customers are winners in their markets. They place a high value on a strategic partnership with us. This translates into order momentum, giving us more visibility. And our strong relationships allow us to mitigate material and cost inflation by passing on price increases in consultation with our customers. This slide is a reminder of the growth rates in the markets where we operate. The combination of our business development success and the structural growth evident in each end market are supportive of even higher growth rates. We grew our top line by 8% organically in the first half and now expect this growth rate to increase to double-digit levels for the year as a whole. Taking each in turn. In health care, electronics is playing a critical role in advancing medical technology. The growth in surgical navigation for minimally invasive, digital and robotic surgery is right in our sweet spot. Our products enable the development of smaller, lighter and more precise surgical devices, meaning smaller incisions, shorter recovery times and better patient outcomes. Revenue growth rates from our larger health care customers are already above 10%. In aerospace and defense, current events in Ukraine demonstrate the need for strong defense capabilities. NATO members are increasing budget commitments, supportive of long-term growth from this market. The need for these that have provided equipment to Ukraine to replace their stock as they provide more assistance will also drive growth. Commercial aerospace is also beginning to pick up. We are seeing orders starting to come through and more urgent requests for products. Production in Airbus single-aisle is now recovering rapidly, and we expect a steady improvement in widebody volumes. Together, this means we could exceed these aerospace and defense growth rates over the next few years. In automation and electrification, investment is expected across the supply chain to offset capacity constraints and rising costs as well as creating U.S. and European capacity locally instead of relying on supply from Asia. Demand for automation is diversified across all end markets, and the current drivers of growth should be more resilient to any recession impacts. This is because structural growth is being driven by electrification, power efficiency, improved productivity and environmental requirements. So short-term dynamics are driving more growth opportunities and new projects. Now I want to show you a few examples of how we're capturing demand in these end markets and winning new business. First, health care. In surgical navigation, we've won an GBP 8 million contract over 5 years with a medical device and health care company for electromagnetic tracking sensors for use in cardiac surgery. We have invested in the development of an innovative new sensor in surgical navigation that can measure 6 degrees of freedom another step forward in the technology delivering higher accuracy for the surgeon. On the back of this success, we have subsequently been awarded the patent for it. We're working with med tech companies to provide integrated solutions, which incorporate TT sensors into higher-level catheter assemblies. This again moves us up the value chain. And we've also invested in expanding our Minneapolis clean room capacity in response to increased customer demand. This comes on stream in the second half, supporting revenue growth from Power and Connectivity. Secondly, in defense. Following the win for power converters on the U.K. Boxer army vehicle program, we have been awarded additional contracts for electrical cable harnesses, taking our work on the program to GBP 16 million over the next few years, significantly increasing content. We've had further success with the award of similar work for the Challenger 2 tank development project. TT will lead the design, development, manufacturing and initial fitment trials in a contract that extends out to 2024. I also want to mention a very recent win announced a few weeks ago at Farnborough with Honeywell Aerospace for an upgrade to the navigation system used in military aircraft with a new power supply technology developed by TT. In aerospace, recently acquired Ferranti has been successful winning a design contract for a power converter for a new business jet. This 7-year contract involves 2 years of development and will result in TT owning the IP. After that, it's 5 years of production, all worth over GBP 6 million with the potential for more dependence on the demand for the jet. To capture the essence of our new aerospace and defense capabilities in Power and Connectivity and demonstrates how we've moved up the value chain from components to assemblies to entire product solutions. We launched a new marketing campaign at Farnborough, and you can see this in a video on our Investor website. I would encourage you all to take a look and see why I'm excited about the capabilities we brought together and our opportunities for the future from significantly enhanced IP in TT based in the U.K. and in the U.S. In Automation and Electrification, in March, we talked about a new optical encoder sensor we had developed called FlexSense for customized high-end sensors, which can be configured for high resolution, faster response, all in a compact unit. We've had our first success and FlexSense is now designed in and being tested in a robotic arm for factory automation. This is an example of how we invest in IP for new products in our Sensors business. We launched this product last year. We now have the opportunity to monetize the IP by adapting and designing it across multiple applications. We've talked in the past about our work to develop our connectivity products, creating more value from our technology. In the first half, we secured a multiyear GBP 8 million contract for a market-leading stair lift provider, clear evidence of our importance to them and their new product range. Let's take a look at how this growth is reflected in the order book. There is real strength and momentum in our order book, reflecting the buoyant markets we have targeted and our business development focus on winning market share on new programs with our targeted customers. We've talked about the 144% book-to-bill in the first half with no signs of letting up. Our 2022 planned revenue growth is now fully covered. Proactive focus on pricing since last year is recovering inflation, and we are transparently passing through any extreme cost increases. Clearly, as the inflationary environment continues, we need to keep on top of cost increases and inevitably there will be some lag in recovery in some areas. What is encouraging is that even with this effect in some parts of the business that Mark referred to in the first half, we have maintained gross profit levels, demonstrating we are recovering the inflation overall and knowing there is more price to come through. It's worth repeating. Our largest customers are growing ahead of market growth rates in the current environment, their mindsets are more longer term. They are giving us increased visibility as we work together to manage the supply chain challenges and inventory requirements. So now to give you an idea of how the strong order book helps us with visibility. You can see the order book growth in the first chart. Our order book has now grown to GBP 666 million, up 55% on this time last year and more than double pre-pandemic levels. This includes an additional GBP 35 million of customer backlog, which if we were able to ship customers would take immediately. To support our customers and maximize growth, we have continued to invest in inventory. That inventory investment is order-based, not speculative. It is needed to deliver on contracts and maintain good customer relationships. It is also needed to address the supply chain impacts on parts availability, which has been extreme for many months now. And it is this inventory that is enabling us to have the confidence in delivering the order book. And as Mark pointed out, we are having constructive conversations with our customers around the funding of the inventory. The second chart shows that as a percentage of our order book, inventory levels are now only marginally higher than June 2021 and actually 600 basis points lower than June 2020. We have been increasing prices, as I have mentioned, and in some cases, actually repricing the orders already booked. Approximately 80% of the June 2022 order book is already repriced. This, coupled with changing commercial terms to be noncancelable, nonrefundable and sometimes nonreschedulable gives us strong confidence in the fixed nature of the demand and the extended visibility. We're also monitoring what inventory looks like across the supply chain. We have engaged our largest customers to understand their inventory position, and they are reporting that inventory levels are low or merely adequate. No one is reporting being overstocked. Our distribution partners give us regular visibility of their stock levels. This covers 20% of group sales. Here, their inventory is still 5% lower than pre-pandemic levels, and they continue to sell through any product that is made available. Again, no evidence of inventory buildup. So the order book is providing a step change in visibility to 2023 revenue growth, even in traditionally shorter lead time businesses. We are already 55% covered for next year. Everything we've seen in the first half gives us confidence our journey to transform the business is intact. Nothing has changed in our expectations for margin progression over the next few years. And looking at the building blocks on this slide in turn. On self-help, S&SC margins are now in the mid-teens. In GMS, the long-term margin performance and the outlook continues to be very encouraging. And in P&C, we expect an improvement in the operating margin in the second half. The self-help program has been and continues to be an important contributor. Secondly, organic growth. We are in a good place. The new programs, new customers and market demand have driven a record order book, underpinning growth and operational leverage. Finally, acquisitions. The acquisition of Ferranti Power & Control, a high-teens margin business further enhances our power business in Europe. In short, we are confident that we can reach double-digit margins. So putting this all together, we are in a good position for the future. Order and sales momentum continues with 2022 expected revenues fully covered and great visibility for 2023. This puts us in a strong position, although of course, we're conscious of today's wider macro environment and supply chain dynamics. We expect to continue to offset inflationary pressures through pricing and operational efficiencies. And our net debt to adjusted EBITDA is expected to be back within our 1 to 2x range by year-end. We have a clear line of sight to unchanged full-year expectations with the group performance continuing to benefit from growth, pricing and self-help. With good customer wins, strength in our target markets, we believe the group is well positioned for further growth and margin improvement. Thank you very much. That concludes the presentation. So now we'll open up the call for questions. So over to the operator.

[Operator Instructions] We will now take our first question from Michael Tyndall from HSBC.

Just a couple for me, if I can. Can we talk a little bit about the revenue at P&C. Just can you split it a little bit in terms of how much has to do with Lutterworth, how much to do with the lockdown in China? How much do you expect to be recovered in the second half? And then the second question, just around pricing. If I remember rightly, full year, we were talking maybe about 3% to 4% for the full year. But based on the numbers you just gave us for GMS, it looks like it's more like 9%. So can we talk about how much pricing there was in the first half and what that looks like for the rest of the year, please?

Yes. Sure, do you want to…

Yes. So on P&C, Mike, there are a few things. But in relatively simple terms, the step-up in H2, there's both Lutterworth that you mentioned where the new clean room in Bedlington comes on stream as well as a new clean room coming on stream in Minneapolis, where Rich mentioned, we've invested, we've gone through because of customer demand. And there -- and that's at the order of GBP 3 million in our group between the 2. The Dongguan shutdown moved about $2 million, so about GBP 1.5 million of revenue from H1 into H2. And then there are some U.S. government contracts that, again, just timing-related will ship in the second half. It's about another GBP 3 million.

Okay. Your other question, Mike on pricing, I think you must be referring to some element of the pass-through costs that we talked about that particularly go through GMS. So we've got kind of around GBP 20 million of that in GMS going through in the full year. It's around 50-50. Yes.

So that's about a 4% increase in both the first half and in the second half year.

And then yes.

And then the other pricing, I mean, of course, the pass-through is pricing, it does have to be proof for customers. But the other pricing is about a 1% impact in the first half. But we -- for the group, we've agreed a range of price increase in customers that continue to flow into the second half. And so in the second half, that pricing effect stepped up to more like 3% across the group.

We will now take our next question from Mark Davies Jones from Stifel.

Can I come back to your comments around inventory and the fact that this is real demand that it's serving, there isn't a load of entry building up. I take the point, but obviously, within your own numbers and within the reporting of just about everybody else we've been looking at over the last couple of weeks, everybody seems to be building quite a lot of unusually high inventory. Do you think some of that is more structural. People are just going to run with high levels, given the ongoing issues in the supply chain? Or is the risk that perhaps there's inventory somewhere down the channel at the end customer rather than in the intermediaries?

Sure. Just to be clear, are you referring to our own inventory or the overall supply chain, this is 2 different dynamics there.

Yes. No, I was talking about the overall supply chain, but you are -- some then example of what's happening in that supply chain.

Sure. I guess let's just reiterate on our own inventory position. I think we feel very clear and firm about what we've been doing in terms of investing in the inventory to support our customers deliver their demand and the growth that we're experiencing. You've seen strong growth in H1, accelerating growth in H2 and an order book that's got incredible levels of visibility. But as I said just now in the presentation, where we've been clear on that order book, we've been working all the time to change commercial terms to ensure that we are sure it is a robust and as far as possible fixed order book. So high confidence that the inventory levels that we've got are in line with what we need. And also, as you can see as a percentage of the order book are actually more efficient than they were. And from the supply chain perspective, I guess, I point to a few different dynamics that I mentioned in the presentation. First one on the distribution channels, which is probably where we start to see that whole thing play out first. Inventory levels are still 5% below pre-pandemic levels in our distributors. Anything we get to them, they're selling through immediately. So that's number one. And then we post, if you like, post survey all of our major customers, everyone is reporting low or adequate levels of inventory. And then finally, within that order book, as I mentioned, we have GBP 35 million worth of demand that people would take from us tomorrow that we cannot forecast into our output in the short term. And that number has risen in the first half from more like GBP 20 million at the end of the year. So I think that is telling you that there is a need for this product and the strong growth on top of the growth that we've been delivering. And so I think you've got to look at, are you growing, what's the order book? Is it fixed? And what's in the customer chain above you.

And I wonder if Mark give us a bit more detail around the refinancing and the terms of that in terms of the sort of average interest rate, how much of it is fixed, what the covenants are? Anything you can give us on that would be helpful.

Yes. So it's a full year facility with an option to extend by 1 year once we're a year into the facility. And covenants are as they were previously, so covenant maximum of -- leverage maximum of 3x. It's an entirely floating facility. You remember, we put private placement debt in place last year. So that gives us that sort of fixed versus variable sort of blends that we look for. And rates is -- I'm not really allowed to say. But I think suffice to say, we have refinanced it on terms that are a, competitive and b, just a very modest increase over the expiring facility.

And in the first half finance cost number, there were some arrangement costs and fundings were the…

Because we did the refinancing early. So the old facility was due to expire at the end of next year. There was some -- there's about GBP 0.5 million of unamortized fees that we wrote off in June.

We will now take our next question from Mark Fielding from RBC.

Firstly, there's a bit of a clarification from, I think, Mike's question earlier on just about pricing in the second half and also the volume catch up. So when you're talking about growth accelerating to 10% from 8%, my interpretation of that, that sort of half of that probably is price and half of that is a little bit higher volumes being allowed by some of these changes, particularly around P&C. But if you could just confirm that or tell me that I'm wrong, if that's not the case.

So in terms of acceleration, we expect -- so as we said, pass-through element is about 4%. And then we expect the growth from other pricing and volume for the full year for the year to get up towards high-single digits, if not touching 10%, they will actually be into the -- in aggregate pricing pass-through volume, and we'll be getting up into the low teens. Organic.