TT Electronics plc (TTG) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining this call at such short notice. I'm here with Mark Hoad our CFO. I'm deeply disappointed that we need to provide this unscheduled trading update. Trading results in August have been weaker than expected as a result of two factors in our North American business. Firstly, we are experiencing ongoing operational efficiency issues in two North American sites, resulting in the requirement to significantly rework certain complex products. We have been aware of the problem, I mentioned, this as part of the Project Dynamo workstreams in August, but execution of the order book is now taking longer than expected, and we are incurring greater-than-anticipated cost of production, which is impacting both revenue and profitability. Clear plans have been put in place to rectify the issues which we expect to continue for the remainder of this year and potentially into the first quarter of 2025, including root cause corrective actions, improved factory planning and factory layout. However, these are not expected to sufficiently mitigate the impact in '24. Secondly, over the course of August and so far in September, whilst our overall order intake has continued to show the positive trends we described at the interim, the order intake for execution in 2024 in our higher-margin components business has been materially weaker than anticipated. The orders received in Q3 have been more weighted for delivering throughout 2025, and recovery is slow and steady. So overall, given these two issues, we now expect North American revenue for 2024 to be around GBP 15 million to GBP 20 million lower in the second half. With the impact of high drop-through and significant product re-work costs, the North American regional operating profit is expected to be around GBP 13 million to GBP 18 million lower than previously forecast. The rest of the group continues to perform broadly in line with expectations. However, taking into account the impact of the performance of our North American business, Group adjusted operating profit for full year '24 is now expected to be in the range of GBP 37 million to GBP 42 million. With the lower operating profit, there will be a reduction in free cash flow for 2024, resulting in net debt to adjusted EBITDA which is now expected to be around or marginally above the top end of our 1x to 2x range at December 2024. This setback is very frustrating, particularly given the scale of the opportunities under Project Dynamo to improve our execution, as I shared with you recently. As you might expect, we are very focused on immediate and mitigating actions. The operations team had already identified a number of improvements that are required part of Project Dynamo and based on the current performance, implementation of these improvements will now move at a greater pace to deliver the operational change required. The Board remains confident in the group's medium-term targets, which included 12% operating margin in 2026. I will hand now you back to the operator, and Mark and I will take your questions.

[Operator Instructions] We will take the first question from Stephan Klepp from HSBC.

I mean, as you said, very frustrating, particularly in light of the last update. Is it as simple as you fix those issues and return back to your organic sales growth path? And what would that sales growth path be given those issues that encounter in beyond 2024? And then, is it as simple as that, you fix those, you get back to 12% margin, but at a much lower top line level because everything is pushed out further?

I think the 12% actually is a mixture of different things as well. We said even at the interims that we anticipated the components business will be a longer recovery and a slower recovery, and we had expected that into next year. Other parts of the business are performing well. And if we think about these operational issues, there is a high drop-through, because this is the high-margin work and therefore, the impact on profit is high when it's not either you use the revenue or you have issues with it in terms of rework. But of course, if you fix those problems, that will also come through. So fixing the problems, making ourselves more efficient and a recovery not to like 2022 levels necessarily for the components, but an improving performance in the components business will get us to the 12%. So again, the visibility is there of the things that are in our capability to fix, but it takes time to fix them.

Yes. My question was rather related to the top line level. I get it. That's obviously things are important.

Stephan, I think, perhaps the way to think about it is that the split of the revenue mix is pretty evenly weighted between the two things, the operational execution issues and the component shortfall. The operational execution issues, that's for existing order book, and therefore, that revenue does move to the right, and it's obviously just a question of how long it takes us to address the issues. The component stuff clearly means we're coming off a slightly lower base. And then it becomes a question of the rate of recovery. And clearly, at the moment, the order intake, as we've said previously is pointing to a slow and steady recovery because we need to see the inventory burn down.

We will take the next question from the line Mark Davis Jones from Stifel.

Firstly, can you tell us a bit more detail in terms of what these operational issues actually are and what the customer response to that is? Because obviously, if this is a performance issue on your part, the risk is that business doesn't stick around or it goes elsewhere or the customer relationship damage. And then, in terms of the incoming orders, obviously, this is happening pretty real time, but do you have any sense whether this is destocking deepening lasting longer? Or is this really end demand beginning to show through?

Let me start with the last one. I think, nothing's really changed, I suppose, from the message we gave at the interims in as much that, the order intake is still not where we would like it to be for the components, but it's an improving trend. So it's the timing, what's different is what's in for this year and what we expected in terms of, because it's a short cycle and what's in for next year. So it is improving, but actually, it's improving much slower than we had wanted. But that's the same message we gave at the interim. So nothing's really changed. It's just the timing. And for the production issues, I think these are -- as I said, these are complex parts, these are difficult things to make. It's impacting the customers may be from a delivery time. But actually, we are working with the customers, and we're working with things. I don't really believe that that's going to be a major impact. It's moving it out. But the rework costs clearly are -- so the timing issue when we deliver is an impact to the customer, but the rework cost is our issue. And so that's not impacting the customer at all. So the inefficiencies of actually getting the customer the parts is the issue. So they may have the delivery time concern. I mean, some of the issues are customer related as well in terms of some of the challenges that we've got. So they're part of the discussion. These are complex things to manufacture, but we are working our way through that. So I don't think it's a major issue. It's because we need to fix it and improve the performance.

Okay. And do you understand what's going wrong and so there is a decent amount of clarity on how long it will take to fix it? Or is it still sort of investigation time?

As I said at the half year, we recognize we have the certain issues, and we are putting work together to try and really understand the root cause rather than just accepting those inefficiencies going on and on. So we are finding more out as we're going. As I said, we're going to accelerate some of that disclosure, but also improvements that we need to make. So some of them we thought were easier to fix than maybe than they are in the particular sites. So we see more work on that, and the team needs to be focused on that to deliver the improvements. There's a range of things, Mark. It's not one thing. It's a range of things. So it's more complex than that.

[Operator Instructions] We will take the next question from Vanessa Jeffriess from Jefferies.

Could I just expand on Mark's question? I mean, what's your degree of confidence in fixing these by mid-2025? Just -- you're talking about finding more issues. And I guess, we're in September already. And you talk about 1Q '25 in the update. So what's the degree of confidence there?

Yes. We've got more work to do, Vanessa. I think, it's fair to say. I think, we understand from the work that's already been going on, where some of the inefficiencies and focus needs to be, but we need to work on how to making sure that -- and we have plans in place to improve some of those. So we need to accelerate that, but we also need to just make sure that we're covering everything. We have got a new leadership team in North America that's focusing on this. And of course, as we've changed the functional leadership with the operational teams are also embedding and getting focused on some of these things, which have been long -- some of them are long lasting, but it may be -- we haven't seen the full impact of those, because of the performance in other parts of the business. So focusing on them and improving them is very much part of the new functional and the new regional team as well. So I'm still more comfortable. But -- and I think, we've given a range on revenue and profit and the reason for that is that if on the high end, we would expect to improve the performance of some of those operational issues, and we will be focused on trying to do that. So I believe from what I understand at the moment that they are all fixable, but some of them just will take time.

Okay. And then, just wondering if you could talk about trends in the rest of the business. I think, you say, they're broadly in line. Is there anywhere else you're seeing kind of more deterioration or improvement maybe?

I mean, in each region, we've got different product mix and things like that. So where we've got some similar products, let's for instance, in Europe, which has got some of the components business. Obviously, there is some impact there as well, because it's not just impacting North America. But the factories where we're making the majority of the products is North America, so they're seeing a bigger impact. But there's other parts of Europe that are doing better. So you've got the ups and the downs. So broadly, between Asia and Europe, we still believe that they will be in line with our expectations. And the issue about why we're missing is really a North American issue.

We will take the next question from Harry Philips from Peel Hunt.

A couple of questions, please. Could you just elaborate as to which sites or can you tell us which sites these are? And particularly interested in the products, are these new products recently launched products where the issues are or these products that have been in the portfolio for a while? And then just in terms of the order book commentary, just wondering, is there -- is the delivery for '25 a consequence of customers recognizing there are issues within your plant and therefore, not wanting to take delivery or seek delivery in the balance of this year and putting it into '25 simply recognizing there could be a delay if they were to put that order on for the balance of the current year, please?

Harry, can you just repeat the first question again for me please?

Yes. No, the first question really is, I'm just curious if you can say which sites you are having issues? And if you can't, I sort of understand that. But more of the products in components where you are having these particular issues, are these new-ish product launches? Or are these mature products where something has gone sort of awry in the sort of manufacturing process.

So in terms of the products that we're manufacturing these -- these aren't new products. It's not a new issue. These are issues that we had before. I think, there are -- there's mix in terms of volume and different things going on within that, but we are seeing a higher impact or we saw a higher impact in August and the forecast is that, that will be a higher impact in the remainder of the year than we had anticipated. We had expected some improvements in some of our operational performance. And we've not seen that coming through yet. And so we need to double our efforts on that for those particular products. They are complex products. But you often can get some variation in activity and so on, is my understanding. But we have to make it a more robust situation in terms of the delivery of that. In terms of the components -- the -- you've got a mix of different components. There's a lot of different types of parts and variables that are in there from what the customer needs. I think, in essence, we're seeing some of those product lines improving faster than others, within the components business. So there are signs of an improvement in some and others are slower recovery. So again, that mix plays a part in the -- in what we're trying to say. And we're trying to keep it a relatively simple message. But of course, there are a number of moving parts.

And then, Harry, I guess, on your question about, is these customers effectively anticipating that our lead times will be longer than they say we are. I don't think we know that for sure, but that would not be normal behavior if we quote a lead time, the customers would typically order to that lead time and hold us to account. But we -- I don't think we have that level of insight.

We haven't seen any issues related to that, to be honest, Harry, it's just -- that's their request that they're ordering it and that's the requested date.

And I mean, on the site, Harry, to be clear, the volume -- the order-related volume that is related to our component site. The operational execution issues are not in the component sites there in a couple of the other North American sites.

Right. So sorry, just to be clear, so the operational issues are not in...

Not -- in components.

In components. Okay. And then, and I suppose that just coming back to cross-reference that with Stephan's, one of the answer to Stephan's questions, which is the revenue being sort of evenly split between this execution issue and the sort of rework issue. Okay. I've got it now.

Yes. So the execution issues relates to the businesses where we have much longer order book visibility. So this is the stuff where we have the orders -- and therefore, as we execute, the products will ship.

[Operator Instructions] We will take the next question from Lin Mark Fielding from RBC.

Yes. Can I just elaborate a bit more -- I'll ask you to elaborate a bit more on a couple of things. I suppose firstly, and I think, I started to feel like not with that answer to Harry. But I'm just curious if any of the operational impacts actually have been made worse by anything that you've been doing. And I don't mean that in a bad way, but obviously, there's a lot of reorganization and restructuring trying to happen across the group, big reduction in workforce, et cetera. Whether that's made it harder to actually deal with stuff in the short term? And maybe just talk about it first and then I've got another question.

Yes. No, I think that, that one is relatively easy to answer. We haven't changed anything in the sites where these issues are in terms of the re-org and what we're doing. In fact, what we've done is, with the re-org and the function -- with moving to the function, what we're actually doing is targeting where the issues are and what we need to do to improve them. And so, we are uncovering some things that we need to do better, and we're finding more things that we need to do better. And that's the thing. The reduction in workforce is actually in the component side of the business, which is not the same as where we're having the operational efficiency. In the components part of the business, it's just revenue related rather than performance related in the majority of the site, and that's not what the major issue is. So no, I don't think any of the restructuring is impacting that or the reduction in staff is impacting that. I think it's simply the fact, if anything -- this move to a function is giving us some visibility on some of the ongoing challenges that we have.

Great. And then, can I then ask about, I suppose, the path to the reiterated 12%. I mean, because we're going to be talking a margin here this year at sort of nearer to 7%. Does that obviously, the target for this year before we even talked about 12%, was initially the 10% margin. Are we comfortable that we should be able to get things fixed and be 10% or better margin business next year? Or are we leaving even more of that progression to the 12% out to sort of 2026.

Well, as Mark said earlier, I mean, we see some of these issues and the component side of it will take longer to recover through '25. We need to fix some of the operational issues, but that was part of the plan, anyway to get there. We've got the identified savings in Project Dynamo, which we are working. So that all helps. And we're anticipating that the normal kind of growth level. So without a very aggressive view of the future, we believe that by taking the actions that are in our control to take and doing things in a better way that we can get to the 12% medium targets. So we feel confident that we can do that.

I guess, Mark, clearly, there will be some impact of this from into '25. But as we said, as we fix the execution issues, that revenue comes back and the sort of the reversal of the issue will be of a similar magnitude to what we're feeling now. And then, we are looking at additional cost actions as well that would benefit 2025.

Order intake, I suppose is the other point to just for add -- which we said at the half year, which is still positive versus the prior year and in terms of the growth rate, that continues and so that support. But that -- and so even in the component, which is slightly better than last year on order intake, it's still not where we want it to be. So that would come up. But the other part of the business is strong.

[Operator Instructions] There are no further questions at this time. I'll hand it back over to our CEO, Peter France to conclude today's conference. Thank you.

Thank you very much, and thank you for your questions, and thank you for your time this morning. Clearly, a disappointing message that we have to give, but we are committed to working through the issues that we've identified and achieving the shareholder value that we believe is there for everyone going forward. So we will continue to make those improvements and do what we need to do. But clearly, we are available for calls or for meetings if people would like. So for that, we'll let you go. Thank you very much for your time this morning.