XP Power Limited (XPP) Earnings Call Transcript & Summary

Okay. Good morning, everyone. Thank you for joining us today whether in person or online. I will start with the highlights from 2024, and the key takeaways underpin our confidence that we will emerge stronger from what has been the challenging period. Matt will then cover the financial performance, and then I'll give more information and details on our trading performance by sector, an update on progress we have made across our business. So as I've said before, our focus in 2024, was in the areas we could control and on improving our operational performance, whilst preparing for the market recovery, and that is exactly what we've done. We've improved our supply chain and operational execution, while continuing to win with customers. This is against a backdrop of unusually challenging trading where we've seen a slowdown across all 3 sectors. Semi revenues were down in the period, but now back in order and revenue growth. The impact of destocking on the Industrial Tech and Healthcare sectors, we have started to see easing, but we're not yet in full recovery. And more recently, we have seen a further headwind in Asia where the export controls that U.S. has placed on China has been impacting our business in the Chinese semi space. And following changes imposed by the Biden administration, we have taken the decision to focus on more attractive areas in China. We are starting to see positive signs in all 3 sectors, and we expect a stronger second half of 2025 after a weak first half, but the precise timing of the recovery remains difficult to call. This gives a wide range of outcomes for 2025, and we've therefore taken steps to ensure our balance sheet remains resilient in all scenarios. We completed a GBP 40 million placing this morning, and we've also agreed revised banking covenants covering 2025 and 2026. Our focus remains on our execution and being ready to support our customers through the anticipated market recovery. I just wanted to spend a couple of minutes talking 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 have navigated the challenges of recent years, and we've made further progress in 2024. Just focusing on the 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. Interest levels remain strong for our portfolio, and we remain confident we can continue to deliver double-digit organic growth across the cycle. In the second box, we are focused on working closely with our customers where we bring our extensive specialist knowledge to solve their power problems. Building on these strong relationships will give growth over the medium term. We've continued to invest in our business to ensure we can deliver on our medium-term potential. During 2024, we opened our Customer Innovation Center in Silicon Valley, close to many of our customers, and we believe a key differentiator for us that will further support growth. Our people are key to our strategy, improving the skills of existing teams while adding key talent in the right area is critical. Whilst we have reduced overheads in 2023 and 2024, we've ensured we've protected the key capabilities that were critical for our success. We continue to make progress in sustainability, which I'll cover later. And the point I would leave you with is that we have consistently applied this strategy, and this has enabled us to deliver growth ahead of the market, and we believe we remain in a strong position to deliver our ambitions in the medium to longer term. Just as a reminder, we continue to focus on structural growth markets where we have leading positions. As you know, each of the Semi, Healthcare, and Industrial Tech markets have faced challenges in recent times, but the fundamental drivers underpinning their long-term growth trajectories remain firmly in place. The semiconductor industry is definitely turning. The end market has returned to growth, and this will translate into WFE equipment growth in the near term. The destocking in Healthcare and Industrial Tech sectors is easing, and it will return customer by customer. Some are already back to normal order patterns while others will take more time. When the markets recovered, we believe we are well positioned to benefit from the tailwinds with recent customer wins and new products coming to market, adding to this. And then finally, just before I hand over to Matt, I just wanted to -- we believe the market recovery, combined with the delivery of our strategy will yield strong financial returns. Our model outlined on this page remains valid and intact. As a reminder, over the medium to longer term, we are targeting to deliver 10% revenue growth across the cycle, driven by market growth, new customer wins, and new products coming to market. We are confident we will improve -- we're confident margins will improve driven by the market recovery and the associated operational leverage, and with this, combined with our ongoing cost and productivity focus and the transfer of further production to our low-cost sites in Asia will further support margin improvement. This, combined with continued strong cash conversion will enable us to reduce debt levels to the 1x to 2x EBITDA in the short term and below 1x in the medium term, which we believe is the right level for us. On that note, I will hand over to Matt to cover the financial performance.

Okay. Thanks, Gavin. Good morning, everyone. So let's just review the numbers starting with the headlines. So order intake totaled GBP 181.6 million and was 10% lower than the prior year. The decline reflects unprecedented industry-wide customer destocking within the Industrial Technology and Healthcare sectors, but we were pleased to see a return to strong order growth within the Semiconductor Manufacturing Equipment sector. Full year revenue of GBP 247.3 million was 20% lower than the prior year, again, largely reflecting destocking within Industrial Technology and Healthcare. Sales into the Semi sector generally performed better despite some geopolitical headwinds in Asia that I'll come back to you later. Lower revenue normally means lower margins as fixed costs within the business are less well utilized, but the relatively modest margin reductions you can see here speak to the concerted effort we have made throughout the year to rightsize our cost base to the conditions, and I'll speak more about that in a minute. The slowdown in revenue inevitably led to a year-on-year reduction in operating profit albeit the size of it was significantly narrowed by the program of cost reductions I've just referred to. We will retain tight cost discipline as our top line recovers to accelerate our return to target margins. Whilst unusually tough market conditions precluded a strong profit performance, we were very pleased with our cash performance. Cash conversion reached a record 261%, thanks to tight control of working capital, which helped to reduce borrowings to GBP 93.5 million. Overall, market conditions in 2024 were undoubtedly tough for the entire industry, but we were pleased with the way we took proactive action throughout the year to maximize our performance in challenging conditions. Okay. So let's just turn to the income statement. As I mentioned, revenue reduced by 20% in constant currency and by a further 2% due to currency movements. Further down the P&L, you can see how we responded to this. Gross margin reduced by 50 basis points to 41%, far less than would be expected given that our factory fixed cost base was less well utilized. The impact of factory underutilization was largely offset by underlying cost efficiencies, which I'll speak more about in a minute. Indeed, these cost efficiencies helped to drive an improvement in gross margin from the first half to the second. Operating expenses were rightsized to the conditions. We responded to a 20% reduction in revenue with an 18% reduction in overheads with most of the actions taken early in the year. Net finance expense was held broadly flat with bank interest savings from reduced borrowing levels, offset by IFRS 16 lease interest from our new Silicon Valley facility. The tax rate was reduced from nearly 37% in 2023, down to just under 25% in 2024 as a consequence of better tax planning as we committed to do. All of this resulted in adjusted EPS of 42.9p. Okay. So just turning to orders. We saw intake reduced by 10% to GBP 181.6 million. We were pleased to see orders from the semis market return to growth, they were up 37% year-over-year and by 22% sequentially from the first half to the second. A change in U.S. export rules at the end of 2024 prevents us from serving China's semis market going forward, impacting just under 10% of sector revenue. But there is no doubt that the global Semiconductor Manufacturing Equipment sector is now in an up cycle. Orders from the Industrial Technology and Healthcare sectors declined year-over-year due to channel destocking, which took hold during the first quarter. Thereafter, ordering patterns were fairly stable, but showed some early signs of improvement late in the year. However, at this stage, it is clear that destocking is going to carry on into the first half of 2025 before dissipating thereafter. Let me add some color to the revenue performance. Group revenue slowed slightly from the first half to the second as it took some time for destocking to work its way from reduced orders into reduced revenue. We exited the year with steady revenue of GBP 60 million per quarter. Sales into the semi market returned to growth in H2 as the industry moved into up cycle, which we were pleased to see, and we were also delighted with the performance of our High Voltage High Power business acquired in 2018. Okay. So this slide underlines the impact of our self-help initiatives in the year. As the chart in the top left shows OpEx reductions roughly half the impact of revenue reduction on profit. There was also cost efficiencies within cost of sales, which I'll explain later. Savings of this magnitude inevitably mean role reductions, and I have summarized in the bottom left how headcount has evolved since our funding plan launched in late 2023. We are operating the business today with 23% fewer roles in response to a 20% reduction in volume. The business today is leaner and more agile, and I am confident that having retained roles such as product development and customer-facing positions that are critical to our long-term success, we are well positioned to maximize the upside of market recovery. We will continue to keep our cost base under close review. Okay. So cash was undoubtedly the highlight of the year. We converted GBP 25.1 million of operating profit into GBP 65.6 million of operating cash by using working capital, particularly inventory. This has been achieved whilst also speeding up deliveries to customers, and we have not allowed any compromises with customer service. Physical CapEx reduced by 2/3 year-on-year to just over GBP 10 million, with the majority of that being spent on completion of our Silicon Valley Customer Innovation Center. Regards Malaysia, we plan to complete construction by the end of 2025, by which point, we would have stretched an original 18-month project into a 3-year build. Clearly, cash preservation remains a priority until our markets recover, but the project is very important for our future, and we must also fulfill our contractual obligations. Okay. Before we talk about the actions we are taking today to strengthen our capital structure, I thought it would be helpful to summarize what has already been done. We launched our funding plan in early November 2023 at the start of the market slowdown. An important element of that plan was actions we could take ourselves to reduce costs and maximize cash. The slide shows that we have gone much further than was originally planned. As you can see, we have delivered more than double the cost reductions that we originally committed to. We have also delivered more than triple the original inventory reduction target. We have also worked hard to improve our supply chain efficiency. As I mentioned earlier, lower revenue means lower factory utilization. As shown on the top right, all other things being equal, this should have reduced our gross margin by 290 basis points in 2024. The fact that gross margin reduction has been limited to 50 basis points, illustrates the underlying efficiency gains we have made, totaling 240 basis points through numerous initiatives, reducing factory fixed costs, better sourcing deals, better purchasing, better logistics, better manufacturing efficiency to name but a few. This puts us in a good position to expand our margin as demand recovers. As can be seen in the bottom right, all of this has helped to keep our leverage below 2.5x as we committed to do. And this has been achieved despite market conditions being more challenging than we originally expected. Okay. Before I get into the detail of this slide, let me start by saying the Board is fully committed to achieving the long-term leverage targets of 0 to 1x EBITDA, which is foundational for long-term value creation. We are confident that we have the right strategy and the right business model to rapidly delever our balance sheet in normal market conditions and that normal market conditions will inevitably resume. Our challenge is that it's hard to be precise about when normality will resume in particular, when destocking will end. In the meantime, despite our best efforts, we are operating with higher-than-normal leverage, which makes it harder to absorb unforeseen events. And we have had some unforeseen events recently as shown in the graph. Judgment in respect to the Comet legal case, which was more costly than we expected, new export rules that deny us access to semis customers in China. These events, combined with a small step down in EBITDA from the first half to the second in 2024, had the potential to increase our leverage to covenant limits, which is why we acted last month to amend these limits with our banks. Extra covenant headroom is, of course, helpful but the Board concluded that a GBP 40 million share placing, offered better balance sheet resilience and would support the scheduled refinancing of our bank facilities later this year. This decision was not taken lightly, but we believe it is in the long-term interest of shareholders, allowing the group to navigate the coming months with confidence and make the very most of the recovery. As the market recovers, any excess proceeds raised from this placing will, of course, be returned to shareholders. Okay. Some quick comments on 2025 modeling, which Gavin will expand upon when covering the outlook. We expect H1 to be weak due to destocking and headwinds from the China semis market. Q1 revenue will be unusually slow due to the timing of deliveries, but our order book suggests revenue will pick up in Q2. We expect conditions to improve in H2, but it is difficult to be precise about the timing until we are further into this year, which makes for a wide range of full year outcomes. We expect overhead growth of 5% due to a combination of inflation and other factors as stated on the slide. We would not be adding heads until conditions improve. Regards cash, conversion is expected to remain above 100% and total CapEx will be between GBP 20 million and GBP 25 million, including Malaysia. So with the numbers done, I will hand you back to Gavin.

Thanks, Matt. I'd like to now cover our end markets and what we are seeing in each of them, starting with Industrial Technology. As you know, the Industrial Technology sector is a very diverse sector for us. It's a broad cross-section of accounts with no large individual programs even though we work with many large blue-chip industrial customers. Latest forecasts suggest the market will grow at circa 7.5% over the medium term. If you look at the graph, you can see the impact of the stock build in 2023 and the destocking in 2024. When this is complete, we expect the market to return to more normal growth patterns going forward. A key driver of this growth is innovation by our customers. Our customers' applications are becoming increasingly more complicated and connected, and our focus has been in making our products digital to support our customers' requirement. Within Industrial Tech, we focus on subsectors with good long-term growth potential and attractive niches. Typical applications in Industrial Tech are in areas such as robotics, analytical instruments, test and measurement, and additive printing. As we've said, 2024 was 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 in 2025, but at different speeds with North America and Europe leading Asia. Looking at the Semiconductor Manufacturing Equipment sector, despite what we are doing in China, the sector 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. Forecasts suggest AI and data will drive the end market to above $1 trillion by 2030. And now while the market has been going through a well-documented down cycle, the end semiconductor market has returned to growth in 2024 and we are starting to see recovery. This end market growth, combined with the government-supported spending is fueling investment and the global industry is adding more fabs with 18 new construction projects starting in 2025 on top of the many more already in construction. And there is strong suggestions that the fabs under construction are expected to be installing equipment in the current year. So we're through the trough and now expect the market to recover, and we have increasing confidence in 2025. This market remains a great opportunity for XP and we're seeing new product wins across the industry and across the differing processes with new and existing clients. We remain confident we can take share and grow ahead of the end market and over the medium term as the market recovers. And then finally, the Healthcare sector, which is a long-term growth opportunity for XP. The end market remains strong, and our customers are seeing good levels of demand so that the underlying demand is being masked by destocking and is stronger than our reported results suggest. Medical end market -- medical device end market is also showing strong growth, which is forecast to continue above 6% out to 2030 using the external data we have. What's driving this? 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 also starting to see the AI impact on medical impact -- medical imaging and patient treatment device. Supporting these trends not only requires innovative, reliable power solutions, but also customers need a power technology partner. So an attractive area for XP with both new and existing customers. In summary, we expect demand to recover as inventory is used up and growth to return during 2025. I just want to take a few slides just to highlight some of the progress we're making on delivering on our strategy. As I've said, having a market-leading product portfolio is key and the high level of customer wins illustrate the appeal that we are seeing. We've been stepping up our innovation over recent years. And on this page, you can see some of the products we have brought to market in 2024. They combined with our existing portfolio and enable us to work with customers to address the power opportunities they have in their portfolio and support their innovation agenda, which is key to our growth. Another key part of our strategy is target accounts where XP can add value, and I wanted to highlight this with a case study. The global surgical robotics market is projected to grow at over 17%, surpassing $20 billion by 2030. This growth is fueled by increasing demand by minimally invasive surgeries and advancements in robotic technology. Surgical robotics -- robots are revolutionizing health care, enhancing precision, reducing recovery times and boosting patient safety. Their advanced functions require reliable, high-performance power solutions for an interacted operation and critical procedures. We work with customers in all 3 regions in robotic surgery. Recently, a surgical robotics systems manufacturer approached us to address their power-related challenges in their next-generation surgical robot. The robot featured multiple robotic arms and a central control unit, this demanded high-performance medically compliant power solutions, and the customer was facing several pain points with their existing setup, which we had to work through with them. We proposed a customized power architecture. Our technical team collaborated closely with the customers' R&D team working extensively to analyze the system, troubleshoot challenges and refine the solution. The case study underscores XP Power's leadership in addressing complex challenges within high-growth markets like surgical robotics, leveraging our diverse product portfolio, including low voltage, high voltage, and programmable solutions and configurable power supplies, we are equipped to meet the evolving demands of not only in health care but also in the semiconductor and industrial markets. The next part of strategy update, I wanted to discuss how we develop our relationships with our customers. This page shows how we've become a trusted power solutions partner for one of the world's largest manufacturers of analytical instruments and lab equipment, and we've been able to gain share and deliver on our goal of achieving organic growth above the 10% through the market cycle with this customer. As you can see, we supply a diverse range of power solutions from our entire portfolio to support their wide range of products. Examples include programmable power supplies to power mass spec, desktop and open frame medical power supplies to drive centrifuges, configurable power supplies to provide flexible solutions for liquid chromatography, high-voltage DC-DC modules in mass spec. And finally, on the right-hand side, we're taking a product from FuG our recent acquisition, this is used in thermal ionization applications and demonstrates the immediate value these acquisitions have brought to our customer base. We are actively -- and further we are actively collaborating with this customer on additional projects to deliver tailored solutions. These collaborations further cement our role as the customer's power solutions partner. Our long-standing partnership with this customer illustrates the effectiveness of our strategy, positioning XP for continued growth and success in the global marketplace. I just want to now turn from strategy to operational performance and the progress we're making. In our product portfolio, as I said, we've been stepping up our focus and this is starting to pay off. We launched 30 new product families in 2024 and expect to release more than double this in 2025. And these are predominantly addressing white space in our portfolio and will deliver further growth in the medium term. With customers, our project pipeline is growing in both volume and value, and we are sampling more and seeing growth in the overall value of the sales funnel, and customers are liking what they're seeing from XP with our customer Net Promoter Score improving across all 3 regions. Our supply chain is performing well. The lead time is reduced as well as inventory, and we're shipping more product by sea. On the people front, we're seeing fewer lost time injuries and our staff engagement score has held up despite the challenges we faced in 2024. And we've continued to deliver on the environmental side. The key point, we've been working to improve our business, both strategic and in operation while we prepare for the market recovery. Turning to sustainability. Our commitment to sustainable principles is a key part of our strategy. Sustainability is one of the most critical items on our customers' agenda, and we are confident that we're still leading the market. We're ahead of our targets that were approved in February 2024, and we continue to make progress on the agenda, reducing our carbon footprint. 100% of our electricity in our EU operations is provided from renewable sources. We achieved the EcoVadis Bronze Medal status in the year, an improvement on the prior year, placing us approximately in the top 1/3 of businesses assessed. All our sites are now single-use plastics free, and sustainability is further embedded in our innovation process with new internal carbon rating of products, which our customers have been requesting. Customer feedback shows we are still ahead of the market, and we believe we are still leading our industry in sustainability. It's not only the right thing to do, but it will bring significant benefits to XP Power in both cost reduction and in customer engagement. And then finally, turning to our outlook. The markets are definitely improving, but it remains difficult to predict exact timing of the recovery, which brings the wide range of outcomes to 2025. The share placing has strengthened our balance sheet, so we are prepared for all outcomes, and we will look to return this to shareholders as soon as we're in a position to do so. Looking forward, we are well prepared for the market recovery. We're confident the end markets 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 further operational efficiency, so in summary, we're well positioned for growth as the market and order levels recovery. On that note, I'll open up to Q&A. Start with questions in the room before taking questions online. [Operator Instructions].

Lydia Kenny, Investec. Just two quick questions from me. How are you managing tariffs? Obviously, you referred to the Biden administration, but just the Trump situation as well. And then on Malaysia, could you give us more information on the costs revolving to do with this, when is the expected completion and how quickly capacity could ramp up there? And if you're going to transfer any of the North American, I guess, manufacturing to Malaysia as a result of what's going on?

Okay. Should I take the first one and you take the second?

Yes.

So tariffs, we went through -- so the Biden administration was focused on limiting the progress the Chinese semiconductor industry would make, and they've been reasonably successful in it. They introduced -- they added 130 customers to their entity list in December 2024. We had 5 direct customers on there, and we had 2 customers, 1 in Japan, 1 in Taiwan that had their end customer on their entity list. You need a license to supply these customers. We have it only for 1 customer, which will expire in August this year. So that's the controls on the [ end ]. The next stage will be tariffs, which the Trump administration we're placing in. We supply very little product from China into the U.S. following the tariffs that put in place in 2018, the majority of our U.S. customers qualified Vietnam. And essentially, we use Vietnam to supply the U.S. If there are any -- so the tariffs came in on China today, we will look to fully recover those from customers, which we successfully did in 2018. So I'm duly not concerned about that. Yes, probably.

Regards to Malaysia. So construction has restarted. And the plan would be to finish the construction of the building itself by the end of this year. We wouldn't, though, be paying for all of it this year because we do get payment terms from the general contractor. If I was to estimate, I would say of the GBP 10 million that we still have to spend roughly GBP 7 million this year, GBP 3 million in 2026. Once we go building complete, obviously, we then need to fit it with plant machinery and fully commission the site. Obviously, we can go as fast or slow with that as we wish to. I mean it would take 3 to 6 months. So theoretically, we can have a fully functioning facility by the end of the first half of 2026. Regards transfer, we're proceeding with that anyway. So it's not conditional upon Malaysia. Plan A is to move at least a chunk of that currently U.S. volume into Vietnam, but still to produce some of the items in the U.S. because that is a sort of requirement of the customer. Obviously, any items that we do make in Vietnam or Malaysia for that matter would come with a lower production cost. So it's a helpful leg to our kind of continued gross margin recovery.

Tom Elgar, Deutsche and Numis. Two for me. Just wanted to unpack the color you gave on the industrial technology piece around the different regions. So North America and EU ahead of Asia. So anything you could give on that would be great. And the second was around the commentary you mentioned around sort of the high drop-throughs in terms of the recovery and obviously, the cost actions that you guys have had and obviously monitoring that situation and maybe perhaps sort of dig into that and when it comes and how that will look, given on the downside, we've had 50% drop-through is what you could have like on the upside.

On industrial tech by region, we're seeing Europe and North America recover quicker. Reality, the ongoing controls in Asia, in China, China is the rice ball of Asia. If that market is sluggish, then that does impact the overall piece. We're still being -- we're still seeing wins. We're still seeing progress. It's just -- it feels like it's behind North America and Europe. We've all read the well-documented issues in China. I still think it's an attractive market, I still think it will drive good growth for us in other sectors predominantly in Industrial Tech, but also in Healthcare. So we still think it's a good opportunity. And wider in Asia, we're seeing good momentum in India. We've just taken our largest order in the healthcare industry. So it's been there circa 10 years and it's now starting to deliver higher revenues. In Korea, the currency challenges versus Japan is probably the thing that's holding us back. But overall, we're seeing it's just slightly behind what we're seeing in Europe and North America.

Regards drop-through. I think you're being a little unfair with the 50% drop-through on the way down. It was profit reduction versus revenue reduction, the drop-through was a great deal. Yes. Yes. It would have been 50% drop through. Were it not for the overhead reduction that we made. I mean I think the good news is on the way back. I don't really feel like there's a lot of cost that needs to be added back. Obviously, we're flagging 5% sort of mostly inflation increase for 2025. If you were to ask me, is there additional resources or heads that we really need in the business as volume recovers, aside from direct labor, I would say no. Materially, no. If that answers your question. So I think that is the promise of the recovery is that it will really drive us towards much better margins overall.

David Farrell from Jefferies. I'll probably go one by one, if that's okay. In terms of the Asian semiconductor numbers, you've called out that big GBP 8 million of revenue. If I look at the net debt to EBITDA bridge, it's about 0.35x, which is GBP 15 million. So can you kind of bridge that mask for me, please?

Yes. It's not quite that -- I'm not sure that math is quite right, David, but I can tell you exactly how it's calculated if that's helpful. So you're right with the GBP 8 million. broadly. The drop-through on the GBP 8 million is essentially 60%. And the reason why it's 60% is because the business itself, the margin is quite healthy, and there is an element of factory fixed cost that stays fixed. So if you do those best, trust me, it does come to be 0.35x.

Okay. Then maybe just to push you on the weakness in Q1 revenue and why that would be surprisingly weak, I can't remember exactly what you -- how you termed it, but, I suggest it wouldn't be normal.

Yes. So I think the -- I'd say that I didn't come in the orders. The orders look better. The revenue sometimes is affected by the phasing of deliveries, particularly when the quarter starts with a holiday period. So I think there's too much to read into that Q1, but I just wanted to release flag it to you before we get to the end of Q1, that it might look a little bit weaker due to the timing of deliveries.