XP Power Limited (XPP) Earnings Call Transcript & Summary

Okay. All right. Good morning, everyone. Thank you for joining us today, whether in person or via the webcast. I'll start with the highlights from the first half and the key takeaways that underpin our confidence that we will emerge stronger from what has been a tough 12 months. Matt will then cover the financial performance. I'll give more information on our trading performance by sector and update on progress we have made across the business. Finally, we'll then move to Q&A. [Operator Instructions] Thank you. So in March, we stated our focus for 2024 was on controlling the controllables for XP. Thank you. Good spot -- focus -- controlling the controllables for XP Power, while we waited for the market recovery, and that is exactly what we have done. Our overall performance for the first half was better than our expectations we set in March. This is against a backdrop of unusually challenging trading. We have seen a slowdown across all 3 sectors. Semi revenues down in the period, but orders are back in growth and the impact of destocking on industrial tech and healthcare, which we do see easing during the second half of 2024. Despite this, we've delivered revenue in line with expectations with profit ahead. We took internal actions to support our trading results, which has rightsized our business to the market conditions we are seeing today and expect over the next 12 to 18 months. This will ensure we are set up to benefit with the market recovery when it comes. We've also managed our inventory tightly and reduced it by a further GBP 10 million, which brings the total reduction from the peak levels by a reduction of GBP 25 million. So we've traded well in these tough conditions, maintaining double-digit margins, which reinforces the resilience of the business and clear potential when the market does recover. Looking at the wider market, there is no doubt that trading has been difficult for all of us, and our competitors are seeing exactly the same thing as we have in the first half. While we're not seeing the recovery in orders as yet, we are seeing early signs that the markets are recovering, and we are well positioned to benefit from this. I just want to take a couple of minutes and talk about our strategy and how our consistent application of it positions XP for a strong future. We've continued to deliver on all elements of our strategy as we've navigated the challenges of recent years, and we've made further progress in 2024. Just focusing on key points. Our focus is on organic growth. We have a market-leading product portfolio, which we have further enhanced in the year through new product launches and customer-specific products. Demand remains strong for our portfolio and we remain confident we can continue to deliver double-digit organic growth across the cycle. We're focused on working closely with our customers, bringing our specialist power knowledge as well as the want to solve their problems. Building on these strong relationships is driving our growth. We continue to invest in our business to ensure we can deliver on our longer-term potential. During 2024, we opened our customer innovation center in Silicon Valley, close to many of our key customers, and we believe a key differentiator for us that will support our growth. Our people are key to our strategy. Improving the skills of existing teams, while adding key talent in the right areas is critical. Whilst we have reduced overheads in 2023 and 2024, we have ensured we have kept the capabilities critical for our success. We continue to make progress on sustainability, which I will cover later. The point I would add is that we have consistently applied this strategy, and this has enabled us to deliver growth ahead of our markets, and we believe remain in a strong position to deliver our ambitions in the medium to longer term. We continue to focus on structural growth markets where we have leading positions. This is a key part of our strategy, and it is working. As you know, each of the Semi, Healthcare and Industrial tech sectors have faced challenges in recent times, but we see them poised to resume their long-term growth trajectories. The semiconductor industry is at an inflection point. The end market has returned to growth, and this will translate into wafer fabrication equipment growth later this year. The destocking in health care and industrial tech is easing. It will turn customer by customer, and some are returning to more normal order patterns, while others will take more time. When the markets recover, we are well positioned to benefit from the tailwinds with recent customer wins and new products coming to the market adding to this. We believe the market recovery, combined with the delivery of our strategy, will yield strong financial returns. Our model, outlined on this page, is intact and valid. As a reminder, over the medium to longer term, we are targeting to deliver 10% revenue growth across the cycle, driven by the market growth, new customer wins and new products coming to the market. We're confident margins will improve, driven by the business and market recovery and the operational leverage associated with this, combined with our ongoing cost and productivity focus and transferring further production to our low-cost sites in Asia. This, combined with strong cash conversion, will enable us to reduce debt levels to the 1 to 2x EBITDA range in the short term and below 1x in the medium term, which we believe is the right level for us. On that, I will hand over Matt -- hand over to Matt to cover our financial performance.

Okay. Thank you, Gavin. Morning, everyone. So let's just turn to the numbers, starting with the headlines. So order intake totaled GBP 87.9 million and was 22% lower year-on-year. This reflects a degree of normalization after particularly strong performances in 2021 and 2022 as well as continued destocking within the sales channel. First half revenue was in line with our expectations at GBP 127.1 million, which was 18% lower than the comparative period. The year-on-year decline was driven by an unusual simultaneous slowdown in all 3 of our market sectors, which I'll describe in more detail in a moment. Gross margin was 40.6% and was 120 basis points lower than the comparative period, as lower activity led to an under-recovery of factory overheads, but our performance also benefited from input cost savings and underlying production efficiency gains. The slowdown in revenue inevitably led to a year-on-year reduction in operating profit, but the size of it was significantly narrowed by a broad program of cost reduction to rightsize our overhead base to the demand conditions. Actions on costs left first half adjusted operating profit slightly ahead of our expectations of GBP 13.5 million, slightly derisking but not changing our full year expectations. Our efforts to maximize our performance in challenging conditions also extended to the balance sheet. We achieved record operating cash conversion of 259% by reducing working capital, helping us to pay down debt. In summary, these numbers reflect the proactive management of an unprecedented slowdown. Our long-term prospects are clear and compelling, but it is inevitably hard to be exact about the timing and path to market recovery. This places a premium on organizational proactiveness and agility, attributes that I believe that we have demonstrated in the first half. Okay. So let me just describe the profit performance in a bit more detail. As I mentioned, revenue reduced by 18% in constant currency and by a further 3% due to currency movements as a result of the recent strength of sterling. The slowdown in revenue occurred across all 3 market sectors, but particularly within healthcare and industrial technology as customers in these sectors from restocking in the first half of 2023 to destocking in the first half of 2024. We were pleased with our gross margin performance. Gross margin of 40.6% was 120 basis points lower than the first half of last year, but only 60 basis points lower than the second half of last year. Lower activity levels led to lower utilization of factory overheads, reducing our gross margin by circa 200 basis points, but we offset a good proportion of this with lower input costs and better underlying production efficiency. Another positive element of our performance in the half was overhead management. So we responded to an 18% reduction in revenue, with a 16% reduction in overheads. This reflects the actions set out in our funding plan as announced in the fourth quarter of last year as well as a further round of cost reduction implemented during the half. Our actions have protected our short-term performance, but leave us with the resources that we need to deliver our strategy. Actions to protect our profitability resulted in adjusted operating profit of GBP 13.5 million, and operating margins were resiliently in double digits. Net finance expense was lowered by our efforts to reduce borrowing, but increased by IFRS 16 lease interest relating to our new world-class Silicon Valley facility, leaving interest costs in total, broadly flat year-on-year. We committed to lowering our effective tax rate in 2024 through better tax structuring, and we're pleased with the progress that we've made to date. Our effective tax rate reduced from nearly 13 -- sorry, 37% for full year 2023, down to 22% for this half. All of this resulted in adjusted EPS of 24.4p. Okay. So turning to orders. We saw intake reduced by 22% to GBP 87.9 million. As you can see on the top left, our order intake has remained fairly consistent since the third quarter of 2023 at circa GBP 45 million per quarter. As can be seen in the bottom left, this consistency is a function of an improvement in order intake within the semi fab sector, offset by slower ordering within health care and industrial tech as customers destocked in response to normalized supply chain conditions. We have said before that it's difficult to be -- to precisely predict the end of destocking due to the broad range of markets we serve, and the unprecedented nature of the inventory cycle that we have seen. Others in the capital goods sector have faced similar challenges. We had assumed that destocking would largely be complete by the end of Q2, which would be [ prefaced ] by improved order intake during Q2. As can be seen in the top left, we've not seen that improvement yet, meaning destocking is likely to carry-on until the end of Q3, based on the latest information we have from our customers. Our cost reduction plan anticipated this outcome, meaning that our full year profit expectations remain unchanged despite the later recovery. I would also highlight that we continue to shorten delivery lead times, allowing customers to order progressively later. This inevitably reduced order intake during the half, but this should normalize in H2. Okay. So let me add some color to the revenue performance. Our H1 performance was fairly consistent by quarter, as shown in the top left. This suggests a degree of stabilization to demand conditions. Our performance by sector, shown in the bottom left, underlines that we saw a slowdown in all 3 sectors. They are distinct, geographically diverse and economically independent markets. This, combined with our annuity revenue model, makes a simultaneous slowdown like this unprecedented. It reflects the final economic echo from the pandemic and is, I believe, unlikely to repeat. So where does that leave us in terms of the order book? Well, it reduced by GBP 42 million in the half, down to GBP 150 million. The order book that we've now is equal to about 7 months of forward orders and it is slightly higher than historic norms. We are likely to see a further reduction in order book size in H2 as lead times continue to reduce, meaning book-to-bill will remain below 1 during this period before increasing thereafter. Okay. So turning to the profit performance. The chart on the left illustrates not only the impact of the market slowdown but also our robust response. As the market slowdown became apparent, we acted decisively. Overheads were GBP 7.1 million lower than the comparative period. Our total headcount, including factory operator positions, has reduced by approximately 20% since the start of the market down cycle last year, and this includes the elimination of 120 overhead roles. Our cost base is now rightsized for current activity levels, but we remain vigilant and ready to respond to whatever circumstances we may face. Okay. Organizational resilience and agility is also evident within our cash performance. We converted GBP 13.5 million of operating profit into very nearly GBP 35 million of operating cash by reducing working capital, particularly inventory. We've now reduced our inventory by GBP 25.3 million or 24% since the start of the funding plan. I would expect progress to slow naturally as we get into the second half. CapEx of GBP 7.8 million largely consisted of residual payments relating to our new Silicon Valley facility and for construction of our Malaysia facility prior to the suspension of work. Malaysia remains part of our long-term manufacturing plan, but will not be restarted until 2025 as the capacity is not currently required. Maximization of operating cash and tight control of CapEx allowed us to reduce net debt by GBP 8.5 million in the period. Okay. So this slide shows how the program of actions that I've referenced throughout this presentation have improved the resilience of our balance sheet despite the market trough. One year ago, at the end of the first half of 2023, the business was operating with about GBP 150 million of net debt, equivalent to 2.3x LTM EBITDA at that time. Over the last 12 months, the group has experienced an unprecedented market slowdown, which has reduced LTM EBITDA by 26%, down to GBP 47.9 million, as you can see. In response to funding plan launched in the second half of 2023, which included new equity and a sharp focus on maximizing cash from operations, has reduced our net by -- debt by 30% in the same period. In addition, our EBITDA has been supported by significant cost reduction, as I have mentioned. Through these actions, balance sheet leverage has been maintained in the low 2s and borrowing liquidity has increased. We expect our balance sheet strength to continue to improve over time, particularly as our markets recover. This means we expect increasing levels of borrowing liquidity and covenant headroom. But needless to say, we must also ensure the group's balance sheet is fully resilient to downside risks, whether expected or not as we navigate this period of deleveraging during a market downturn. We have, therefore, successfully negotiated a temporary relaxation of our interest cover covenants to ensure full covenant compliance even in the event of a severe but plausible downside case. These changes, which include a facility extension, were made a modest cost and with unanimous bank support. Okay. So just some quick comments on 2024 modeling, which Gavin will expand upon when covering the outlook. So for Q3, we expect revenue to be similar to Q2 as destocking continues. For Q4, we expect revenue to increase as destocking begins to slow. To illustrate the progress on costs, we have previously guided to high single-digit reduction in full year overheads. We're now guiding to a circa 17% reduction. Progress made on tax structuring allows us to guide to a full year effective tax rate of circa 25%. We should continue to convert more than 100% of our operating profit into cash in the second half and keep full year CapEx, including product development, to between GBP 20 million and GBP 25 million. I continue to expect leverage at or below 2.5x by year-end, subject to FX. And so now with the numbers done, I will hand you back to Gavin.

Thanks very much, Matt. Okay. So at the outset, I just wanted to cover -- to remind you all of what XP Power is today. We design and manufacture a comprehensive portfolio of power supplies and power solutions and provide our customers with unrivaled customer service and support. We focus on sectors where power is mission-critical and failure is not an option. Our enduring customer relationships are built on hard-earned reputation for quality and support. We're committed to invest in innovation, both in power supplies and with our customers, as we support their development journeys with the next generation of technologies. We work across the globe with over 4,500 customers, either directly or indirectly, and our products add value through the functionality they bring, be it leading class power density, interconnectivity, efficiency, ease of use or built-in intelligence. So that's XP Power today. If we look at the sectors we focus on, it's clear why they are the attractive parts of the power market. So in turn, industrial tech forecast suggests the market will grow at circa 7% to $6 billion in 2027. The semiconductor end market has already returned to growth, growing at 18% to 20% in 2024, and this is expected to continue to deliver double-digit growth from the 2024 point of inflection to over $1 trillion by 2030. That's the end market. To deliver this, we'll require similar growth in WFE spending, but with a lag. And finally, the medical device end market is also showing strong growth, which forecasts continue above 6% out to 2030 using the external data we have. The destocking we've seen during 2023 and 2024 in Industrial Tech and Healthcare are atypical. And as you can see, the markets are expected to return to more normal growth patterns going forward. With our order book resetting to more historic levels of 3 to 4 months that we operated at pre-COVID, as our lead times have now reduced, we expect more consistent order patterns in line with the market growth going forward. This market growth, combined with our proven ability to gain share, will propel our growth in coming years. Now let me take you through what we're seeing in each of the sectors, starting with Industrial Tech. Industrial Technology is such a diverse sector for us. It's a cross-section of accounts with no large individual programs even though we work with many blue-chip industrial customers. Within Industrial Tech, we focus on subsectors with good long-term growth potential and attractive niches. We spend a lot of time analyzing the opportunity before we commit and we commit, we intend to qualify it hard and to win. Typical applications are in such sectors, areas as robotics, analytical instruments, test and measurement and 3D printing. But these applications are becoming increasingly more complicated and increasingly connected. Our new products that we bring to market are much more digitally controlled, allowing us to provide the complete power solution, and we are increasingly becoming part of our customers' ecosystems. As I've said, 2024 is an atypical year for the market, where we've seen destocking. This is coming to an end customer by customer, and we expect this sector to recover by 2025, but at different speeds, with North America leading Europe and then Asia. Looking at the Semiconductor Manufacturing Equipment sector. This remains an exciting and important area for the group. Semiconductors are the foundation of the digital economy, making them more strategically and economically important than ever before. Artificial intelligence and data is driving the market to more than -- north of $1 trillion by 2030. Now the market has been going through a well-documented down cycle, but the end semiconductor market, as I said, has now returned to growth in 2024. While we still remain in a quiet period, we are seeing improving utilization of fabs as semiconductor demand picks up, which is driving increasing demand for spares and services, and we have seen orders for some of our products for the first time in 12 months as that market recovers. This is always the precursor to an upcycle in this market. Now the end market growth, combined with CHIPS act spending across the globe, is fueling investment, and the global industry is adding more fabs. 70 new construction projects will start between 2023 and 2025. And this, combined with the 92 fabs, starting -- started construction from 2020 to 2022 will dominate fab equipment spending out until at least 2027. So our view, we are through the trough and now expect the markets to recover with increasing confidence in 2025. This market remains a great opportunity for XP, and we are confident we can take share and grow ahead of the end market over the medium term as the market recovers. And then Healthcare. This is a long-term growth opportunity for XP. The end market remains strong, and our customers are seeing good demand levels. So underlying demand is stronger than our reported results. What's driving it? Growth driven by the mega trends of aging global population and innovation in medical technology. We are seeing ongoing infrastructure upgrades and innovation for new products in many areas, such as robotic surgery, automated monitoring, advanced diagnostics and the innovative use of technology for patient treatment. We're at the start of the AI impact on medical imaging and patient treatment devices, and we expect this to be a significant growth area going forward. But -- and we're also seeing growth in new treatment technologies driving real innovation. Supporting these trends not only requires innovative, reliable power solutions, but also customers need a power technology partner, and that's so a very attractive area for XP with both new and existing customers. We expect demand to recover as [ infantry ] is used up and growth to return during late 2024 or early 2025. So in summary, we're seeing temporary market challenges in each sector. We expect each market to continue to recover during the second half ahead of 2025. Timing of this remains unclear, but we do expect H2 2024 order intake to be stronger than the first half. At this point, I just want to step back and cover why we will continue to win in the markets going forward. We've not covered this before, but it's important to remind our stakeholders of why we win. First, it's our DNA. Speed, flexibility, customer focus are 3 of our core values. Combining this with the right first-time mentality and approach is very hard for our competitors to replicate. We have highly experienced teams across the globe, and they are able to provide customers with a range of solutions from standard power products to customize solutions to solve their challenging power problems. We have proven capabilities to quickly go from prototypes to volume manufacturing and we can get our customers to market quickly with low-risk proven solutions. We continue to make progress in this area, working closely with our customers on many new projects. Having a market-leading product set and strong customer relationships is only part of the story. It's critical we can deliver on our innovation, and we have invested in a new customer innovation center in the heart of Silicon Valley, the heartland of technology and home to many of our customers. The new center is a world-class design and engineering facility to enable effective customer collaboration. We've invested in tools and infrastructure to address all the challenges we have seen, so we can ensure we can effectively partner with all of our customers. We've invested in in-house reliability and environmental testing. We have our own Plasma Chamber and EMI chambers to test new products and replicate field and technical challenges. We have on-site production and warehousing to provide rapid prototyping and support rapid customer deployment, and we have room for capacity increase to support the future growth. We're receiving very positive customer feedback and we are confident this will drive future growth at XP. With the right mix -- we believe we have the right mix of high-volume manufacturing sites in Asia and local resources close to our customers to ensure we can deliver the right solutions. Turning to sustainability. Our commitment to sustainable principles is a key part of our strategy, and we continue to lead our market in this area, and we've made further progress in 2024. We published our net-zero transition plan in August 2023, and our targets were approved by science-based target initiative in February. We continue to make progress on the sustainability agenda and reducing our carbon footprint. Our 2023 carbon footprint reduced ahead of target, driven mainly by lower sales and purchases. But since then, we've made further progress. Our European business is now purchasing 100% renewable energy, and we've eliminated single-use plastics from our operations. Customer feedback shows we are still ahead of our market. And we believe leading our industry in sustainability is not only the right thing to do, it will bring significant benefits in both cost reduction and customer engagement to XP. And finally, turning to our outlook, which remains unchanged for 2024. The markets are definitely stabilizing, but it remains difficult to predict exact timing of the recovery. The cost reductions we've done have helped underpin our 2024 expectations, which have been derisked by the first half performance. Looking forward, we are well prepared for market recovery. We are confident that end markets will resume their long-term growth trajectories. Our well-established customer relationships in the right sectors provide clear growth opportunities, and we have a healthy pipeline of new product launches and design wins. Our supply chain and manufacturing teams are focused on driving operational efficiency and cost reductions. So in summary, we're positioned -- we're well positioned for growth as the market and order levels recover. On that note, we'll take your questions. We'll start with questions in the room before taking questions online. [Operator Instructions].

Great opening. Jay?

James Bayliss from Berenberg. Two questions, if I may. Just on the cost savings, you talked about the guidance going up from high single digits to about 17% of the overhead base. How should we be thinking about that in terms of variable cost savings in response to the market conditions versus a permanent layer of fixed cost coming out? And then ultimately, into a recovery, what can you sustainably hold on to versus what you need to get back to, to ensure you're meeting demand? And then second question on the Malaysia Plant, can you just remind us how far through the program of work you were before you paused the spend? And how we should be thinking about how much incremental CapEx needs to go in to get that fully commissioned in '25?

You want to take that?

Yes. So yes, on the cost saves, there's no sort of variable elements really included in that. These are sort of permanent reductions in cost. I mean we're going to try as best we can as we recover to stick to 2024's overhead. I mean there would naturally be some inflation, but we're going to try as best we can not to add overhead back in. I think that's a key component of us getting back to the kind of operating margins we achieved before. In respect to Malaysia, we have basically GBP 10 million still to spend.

Thomas Rands from Davy. Three questions. First one, just following on from James' question. 120 people headcount taken out. I think that's slightly up on the original 100. Could you just remind us where those heads came from because that's quite a big percentage of your total kind of group headcount? Shall come on to the second?

2 or 3.

Okay. And then the second question is just around semi fab growth. Obviously, you've got 2 big customers there. What have you seen those customers versus the longer tail of growth in orders through the recent months? But also how of conversations gone with those customers for the trajectory through the second half? And then third question, order intake trends in July. Maybe you've got the data from July. How has that trended assuming similar to Q2 or there any kind of signs of positivity?

On the headcount, so it was in the original funding line, 40 of those were within COGS. So they were factory related. There was 60 that was overhead related. So effectively, what we've done is double the number of overhead-related headcount reductions from 60 to 120. In respect to where, I would say, everywhere except for product development heads that are engineering in nature and everywhere except for customer-facing roles. And when you deliver headcount reduction like that, it needs to be kind of everywhere, except for those areas that are long-term strategic in nature.

Yes, semi customers. They're all talking the market up. They're all wanting to focus on when the recovery will come, and they're making sure are we ready. They're auditing our recovery plan, auditing our ramp plans, most of them don't quote order intake publicly. The 2 that do ASMI who, in Q2 were up 56% in orders and ASML who are up about 30% by recollection, so that's the general sentiment of what they're seeing in the market. And it's all AI and data is big comments. SEMICON West was a recent show in July in San Francisco, and some things coming out of it. Just the amount of data center requirement is expected to double to be able to support the AI requirements by 2030. So you just look at the investments going in. So there is very positive rhetoric there all talking when it turns. And we're seeing the early signs at this point, but not that sustained recovery. And it's the same if you look at outcome with our competitors. They're saying seeing exactly the same thing. Then order intake for July, yes, we have had order intake for July. It was -- we were pretty -- as Matt said, we were pretty steady through for order and revenue through the first half. July was slightly ahead from an order perspective, but it's not ability to say a trend yet.