TT Electronics plc (TTG) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining the call this morning. This is Peter. And as we did in September, Mark and I, we thought it will be helpful to hold a call to update you on the trading and then update you on the North American improvement plans before opening up for your questions. So if we start by looking at the numbers for H2 so far. For the 4 months from July to the end of October, group revenue was 1% lower than last year on an organic constant currency basis, excluding the unwind of pass-through revenue. The regional mix was consistent with the first 6 months with a good performance in both Europe, which was up 10%; and Asia, which was up 11%. But this was more than offset by a 16% reduction in North America, which was mainly due to the subdued components market. Order intake in the period was 2% higher than the previous year on an organic constant currency basis. For the 10 months to the end of October, order intake is 10% higher with all regions showing progress. And in September, we announced that we were having operational performance issues in 2 North American sites. There remains a significant focus on the challenges identified. We have identified a number of improvements that we need to make, but we have a clear remediation plan and have already initiated various work streams. Our plans do not require significant investments and are in our control. At the center of the challenges we've had is the productivity levels in both of the sites, which are below where we need them to be. Previously, this was masked by having a simpler product mix, but that product mix has evolved over the last 2 years and is now more complex in nature. The increased volumes experienced and the success of the 2 sites has also exasperated the situation. So we are in the process of bolstering the management team and our focus is on an improving performance in areas such as operating practices, inventory and planning management and ultimately, process efficiency. As part of the work streams, we have brought in specialist resource as required, some externally and some from other parts of the group, including roles such as continuous improvement and a service bank technology specialist. We have identified the need for additional training, partly caused by high staff turnover in these 2 sites, and we will be making a factory layout improvements in both locations. All of these measures will improve the efficiency and streamline our processes to address the issues we have identified. On the component side of the business, in H1, we outlined the significant swift cost action taken to reduce heads by some 400 people, saving annual costs of GBP 9 million. Given the ongoing challenges in the components market, we have recently made further headcount reductions, and we will provide a full update on the savings impact with our March results. As a result of continued subdued demand in North American components market and the operational improvement plans only benefiting financial results from 2025, the Board expects full year '24 adjusted operating profit to be at the lower end of our previously stated range of GBP 37 million to GBP 42 million. Full year '24 leverage guidance is unchanged and is expected to be around or marginally above the top end of our stated target range of 1x to 2x. Looking ahead into 2025, the plans to increase productivity and streamline our processes in the 2 North American sites will provide a positive improved performance in 2025. We have good order books in these 2 sites, and we need to execute and deliver the revenue. While the end of the destocking cycle and the timing of the recovery in components remains difficult to predict, we continue to be prudent in our assumptions and assume a slow recovery for 2025. We are therefore well positioned to benefit from any volume improvements in the components market. All of the improvement plans I've outlined today, combined with the benefits from all the Project Dynamo work streams and the operational execution improvements, position the group well for 2025 and beyond. Leverage is expected to be back well within the stated range of 1x to 2x by the end of 2025. The Board continues to have confidence, assuming a reasonable recovery in the components market in the medium-term financial framework, including a 12% operating margin by 2026, which is underpinned by the good momentum in our European and Asian businesses alongside the impact of Project Dynamo. You've also seen this morning that we made another announcement about Mark's future plans. And as I said in my quote, I would like to thank Mark for his support and significant contribution to TT Electronics over the last 10 years. Mark's financial leadership and counsel has been instrumental in transforming the business and creating the platform that we have today. And on a personal note, it's been a pleasure working with Mark over the last year and I fully understand his desire to spend more time with his family. Importantly, and what you might expect from Mark, I'm really pleased that he will stay with us over the coming months, as we navigate the issues we are facing. He has been an integral part of me -- of helping me find the solution to fix our operational issues. Many of you would have known him for a lot longer than me. But like me and anyone who has dealt with him over the last 10 years, we will miss him. When the time comes for him to hand over to his successor, that will be when it will be, but he's got plenty to do before then. So I would like to now hand back to the operator to take your questions, please.

[Operator Instructions] And first, we have Vanessa Jeffriess from Jefferies.

Just wondering when you talk about these productivity issues for the complex products that have been risen in the last 2 years, are these the same as you thought they were 2 months ago when you last spoke to us or is there a lot more that's been uncovered and is there a lot more that you think could be uncovered throughout '25?

No. We think we've got a full handle on it. The issue is that the -- it's the same issues. It's the output of the underlying problems that we are dealing with. So before, when we were looking at it, we were seeing the effects of the underlying problems. And so we were thinking that there were things that we needed to do. But by getting into really the problem and really understanding what's really affecting the problem we can see that it affects us in a number of different ways, but it's the same problem really, which is the productivity. And by getting the productivity and sorting that out, there will be various improvements across the business. So it's a various outputs, but one main problem that we are trying to solve. But we see the effect in lots of different ways. But basically, we're underproductive in those locations from what we anticipate. And therefore, although we've got the revenue, we're not seeing the profit coming through from the activity.

Okay. And when you talk about being confident in the 12% margin by '26, obviously, that's a pretty big step up from where you are now. Is most of that to come in '26, given that you don't see any quick recovery in the components market next year and presumably still have to fix a lot of these issues next year, so should we see most of that in '26?

It's a variety of reasons. I mean an improvement in the component market is part of the thought process to get to where we expect to be in 2026. So that is true. So a reasonable recovery in that. But also, there's the other part of this, which is the improvement -- the operational improvements as they jump through 2025 and then will also benefit 2026. Clearly, we've got some benefits of Project Dynamo and the things that we're doing there as well, which will also work their way through '25 and so give us a full year benefit of '26. So if we look at the bridge and we look at the stepping stones, we can see the path to where we need to be in 2026.

I think, Vanessa, clearly, '25, we're saying we're only assuming a slow recovery. But there are other factors that support profit improvement in 2025. Obviously, we've talked about the headcount reductions that we've made and the benefits that flow from that into 2025. We've got activities around Dynamo and then clearly, we'd be anticipating growth in the other parts of the business.

Okay. Makes sense. And then just finally, obviously, Europe is still pretty strong, even if it's not as strong as the first half. I was wondering with the volatility that we're seeing in the aerospace market recently, if you've seen some slowing?

I think we're still seeing good growth, Vanessa. It's just an averaging down because the first half was so strong. So that remains good for us.

Mark, we're really sad to see you go.

Thanks. That's very kind of you.

And next, we have Harry Philips from Peel Hunt.

Several questions, please. Just thinking about obviously the steer to the bottom end is obviously featured in the statement. I'm just thinking back at the September call, you said that the issues were sort of evenly split between components and sort of productivity, if you like. Is it evenly split in that sort of additional drop or is there one particular aspect that has sort of lowered it again? And then just -- sorry to be a pain about '25, but I appreciate you sort of assumed -- you're assuming a slower recovery. But can you give at least some hints as to the annualized impact of the headcount reductions and Dynamo in there because some Dynamo is sort of growth dependent, just thinking about the sort of growth initiatives and things like that. And then just on the debt comment or the leverage comment for '25 being sort of comfortably back into the range. I'm sort of thinking with all this issue going on, you probably -- working capital is going to be quite hard work. And therefore, is the leverage comment sort of a higher profit, therefore, lower leverage? Or is working capital a big factor in that as well, please?

Sure. Okay. So Harry, in terms of being at the lower end, if I take -- if I go back to what we said in September, I think we're relatively clear in saying that the higher end would have required us to see improved in-taking components demand in relation to product that people wanted delivered in 2024 and we have required improved operational execution compared to what we had seen until then. And so neither have happened, clearly, as Peter said, we're getting our arms around the operational issues, but the financial benefit will only occur in '25 and then the components demand we've talked about. So that's really the delta there. In terms of the '25 numbers, so the headcount reductions we talked about previously, we said there would be GBP 4.5 million to GBP 5 million benefit coming through in 2025. As we said -- as Peter said, we have now initiated some more headcount reductions. There's about 100 people, give or take, more that we've taken out and the annualized benefit of that, that we would see coming through in 2025 is of the order of GBP 2 million, and we'll give a sort of a more comprehensive update on that when we do. That's kind of the order of magnitude. On Dynamo, well, the Dynamo SG&A savings, I think we said previously that of the GBP 6 million that we would realize a GBP 1 million to GBP 2 million this year and by next year would be up to about GBP 5 million out of the GBP 6 million. There's about a GBP 3 million to GBP 4 million benefit there. And then we would obviously also start -- we would anticipate getting some operational execution profit benefits coming through as well.

That's really clear. And then just on the sort of debt variables, obviously, you get those numbers in a big increase on profit...

Yes. So you're right. We're going to have to continue to work hard at working capital. I mean if we can get the components piece, soft demand will not help there. The other part of the business is we're clearly anticipating growth and that will support inventory reduction. So yes, we'll have to work hard at it, but we don't expect it to be a massive anchor, but nor a massive kicker necessarily. But it will be a combination of improved profitability and then applying good discipline to capital spend and those sorts of things to ensure that the profitability converts into free cash flow. And clearly, we don't have the drag from pension anymore or anything like that. So we would still anticipate healthy free cash flow next year.

And then -- sorry, one final quick one. Just in terms of the sort of competitive environment because, obviously, in these sort of situations, how sort of sole source, if that's a proper word are you on the components which are proving to be problematic? And how early can customers find alternative suppliers for them?

So I mean, if we're talking about the components market, Harry, is that what you mean in terms of the...

Yes.

So on the components market, I mean, the big issue is the inventory levels that we can see in the distribution channel. So a couple of things will happen, right, we anticipate. The way that, that changes and our order intake starts to improve, is if the market picks up, and so that's the maybe the industrial market, general market at a faster pace, so that the burn off of those inventory levels in the distribution channels happens quicker. We can see that dropping off. We saw it dropping off the peak really for us was in December '23. It dropped off to June. We anticipated it to continue to drop off. It actually went back up again and then it's come back down again and it's back down to the levels that we were in June, and we see that now carrying on coming down. So that's why we're anticipating a slower recovery. But if the market picks up, and therefore, that burn is quicker, we will see a quicker return to the market. So it's not really about the product. It's about just the amount of products in the market at the moment.

[Operator Instructions] And next, we take a question from James Bayliss from Berenberg.

Question 1 is now that you understand the moving parts around those 2 North American sites a bit more. Does that change any of your thinking around any of your other operating sites portfolio, whether there's any process optimization to be done around the edges there or are you still very much happy that this remains kind of solely confined to those 2 sites in North America per September 16. And then the second question, just on those headcount reductions, so I think you suggested it was around GBP 2.5 million of costs coming out. I appreciate you'll give more clarity at a later date. But should we be thinking about that as a more temporary reaction to the current low industry volumes we're seeing, where the cost then goes back in as the market recovers or are those sort of more permanent savings falling broadly into the remit of some of those project Dynamo efficiencies?

Yes. If I take that second one first, James, it's about 100 heads and about GBP 2 million of annualized benefit. I think they would sort of -- they would fall into the same category as sort of the 400 heads. So they are a response to activity levels, and therefore, as volume recovers, the heads will go back in. But I think the comment that we also made previously remains true that we will be looking at ways of operating more effectively and sort of seeing if we can manage to not introduce all of it, and retain some of the savings. But that's something that will play out over time.

And just to add to that, I think when we get to March, the anticipation is that obviously, we will give a little bit more color on some of that because we've got -- within Dynamo, we've got 9 sort of work streams. So there's a number of moving parts that we will want to share with you some more detail on that and the progress that we're making across the board, which we'll give you a bit more color on that. But those 100 heads that Mark is talking about are activity based ones rather than improvement. And then going to your first question on the other side. If you remember way back at the -- I don't know if it was half year results or before then, actually, we said we had 4 sites that we were -- where we had productivity issues that were lower than we had anticipated, and we were looking into that. And as I said before, so we then started to make some improvements, but it wasn't having the improvements that we expected. And so we hadn't really got to the real crux of the underlying problem. What I think is the situation is we have got lots of improvements still to make, James, across the board to get to real operational excellence. We've got pockets of good performance. But this is just that general improvement that we're talking about. These particular -- I'm very, very frustrated at the moment about these 2 sites in particular because it should be better than it is. And we are causing some of our own challenges, and so we've got to fix them. But the good thing for me is that, that's all within our control. These are all things that we can do better and get to where we need. But we just needed to understand what was the cause of the issues. I think we've got a very, very, very good understanding now of why we're seeing the impacts that we are and now we've got to fix them. And that's what we've got to do.

As there are currently no further questions in the queue, I would like to hand the call back over to you, Mr. France for any additional or closing remarks.

Well, I think that's it for this morning. Thank you all for joining us, and we look forward to updating you further in March. And clearly, if anybody has any other questions, just let us know. Thank you very much.

Thanks, everyone.