Chemring Group PLC (CHG) Earnings Call Transcript

Good morning, and welcome to the presentation of Chemring's results for the half year to the 30th of April 2021. Whilst we remain working in the COVID restrictions, we have again decided that the safest and most effective way of communicating with our investment community is virtually rather than our usual face-to-face meeting. I am, as usual, joined today by Andrew Lewis, our Group Finance Director. I will provide a brief overview of the group's highlights for the half year. Andrew will then take you through the financial results. And I will then provide some more general comments on the market environment, our investment priorities and the progress we have made in the first half. Starting with a brief overview of our performance during the first half of FY '21. Against what has remained a challenging and changing environment, it is pleasing to report a strong first half performance, which demonstrates the progress that we continue to make in building a higher-quality technology-based group. Despite the foreign exchange headwind caused by the weakening U.S. dollar, both segments performed in line with our expectations. Revenue was up 4% to GBP 198.5 million, operating profit up 10% to GBP 28.1 million and earnings per share up 20% to 8.3p. In light of our first half performance and the progress made by the group in the past couple of years, the Board now believes it is appropriate for the group to target a medium-term dividend cover of circa 2.5x underlying earnings per share. This provides a 23% increase in the interim dividend to 1.6p per share. With strong order cover for the full year, the group remains on track to deliver year-on-year growth, and the Board's expectations remain unchanged. Separately, Chemring has announced today the acquisition of Cubica Group. This is a small but important step in building greater scale to our growing Roke business and is further evidence of the group delivering against its strategy. I will talk more on this later in the presentation. Safety is and always will be a core value within Chemring. The implementation of our HSE strategy continues as does our focus on achieving 0 harm. Our safety performance in terms of recordable injuries or total recordable injury frequency rate at 0.66 versus 1.13, shows a 42% decrease on the same period last year. A key part of our HSE strategy is the collection and analysis of data at every level of our operations, and we continue to focus on our ability to identify and eliminate underlying causes of incidents. This is a key enabler for decision-making at all levels of our organization. In addition, we are extending our enterprise data platforms to better assess the environmental impact of our operations and the limits we need to set in support of our wider ESG commitments. That concludes my overview. I will now hand over to Andrew to take you through the financial results.

Thanks, Mick, and good morning, everyone. I'm delighted to be presenting a strong set of financial results for the first half of 2021, which have been delivered in spite of the significant FX headwind in the period. The results have been driven by a strong performance in both sectors, with Sensors & Information showing strong growth and Countermeasures & Energetics showing good improvement in operational performance. The key messages from this period's results. Revenue was up 4%, operating profit growth of 10% to GBP 28.1 million. Our operating margin improved 80 basis points from 13.4% to 14.2%, which is a continuation of the trend of margin progression as we progress to our medium-term objective of mid- to high-teen segmental margins. The 36% reduction in the interest charge was driven by the continued focus on the management of day-to-day working capital. Operating cash conversion in the period was strong at 96% of EBITDA, and this left net debt down 36% at GBP 39 million. Diluted earnings per share was up 20% to 8.3p. And the Board has declared an interim dividend for 2021 of 1.6p, up 23%, and announced a medium-term objective of progressively moving to 2.5x dividend cover. Operationally, the strong performance in Sensors & Information was delivered from another strong period at Roke, which saw double-digit growth in order intake, revenue and operating profit and the delivery of further HMDS orders on the U.S. program of record. The closing order book is GBP 450 million, of which GBP 199 million is expected to be delivered in the second half of 2021, which covers 92% of expected second half revenue. As the impact of foreign exchange has been significant in this period, this slide shows key metrics at constant currency and provides some sensitivity analysis to assist future modeling. On a constant currency basis, revenue was up 8%, operating profit up 16% and EPS up 28%. With just over half of our revenue in U.S. dollars, the full year translation effect of a $0.10 movement in the U.S. dollar is approximately 14 million at a revenue level and 3 million at an operating profit level. The next slide shows a more detailed income statement. I've covered most of the highlights already, so I will just pull out the fall in the underlying tax rate for the period to 12.1%. This was driven by the recognition of a deferred tax asset in respect of potential future interest deductions in the U.S. It does not reflect the change in the U.K. corporation tax rate announced in the recent budget, which will result in a charge of approximately GBP 1 million for the full year as deferred tax liabilities will be revalued in the second half of the year when the legislation is substantively enacted. Thus, for 2021 and looking forward into 2022 and 2023, we expect the group effective tax rate to sit in the mid- to high teens. Beyond 2023, the change to the U.K. corporation tax rate will impact the annual current tax charge, and this is expected to increase the group effective tax rate into the low 20s. The revenue and profit bridges show the key drivers of the group's results this period. At a revenue level, Sensors & Information was positively impacted by the strong market conditions for Roke and the growth in the HMDS program. Countermeasures & Energetics saw significant progression from the Australian site being fully revenue generating in this period against the comparative period, where it was in ramp-up. At an operating profit level, we see the revenue growth dropping through as expected, supplemented in Countermeasures & Energetics by improved operational performance at the Salisbury site. As already noted, foreign exchange was a reasonably significant headwind this period. Moving to the segmental results and starting with Sensors & Information. The results show revenue up 11% to GBP 74 million and operating profit up 15% to GBP 15.3 million, reflecting the impact of the growth in the HMDS program and the strong period at Roke, which delivered another period of double-digit growth and strong margins. Roke's information security and data science business operating in the U.K. national security and defense markets continues to grow to position Roke well for continued future growth. We are ensuring we invest in resource, skills, product development and infrastructure. In the U.S., the customer placed orders of $63 million under the previously announced $200 million HMDS IDIQ contract, which provides good visibility under this program well into 2022. Low rate initial production deliveries for the EMBD program progressed as planned, with a full rate production transition still expected in the second half of 2021. The AVCAD and JBTDS programs progressed as planned, with the next customer procurement decision not expected on these until early in 2022. Moving on to Countermeasures & Energetics. The result benefited from improved operational efficiency at the Salisbury site and the Australian site being revenue generating for the full period. This has moved the margin forward significantly from 14.2% to 15.6%, which represents excellent progress towards our medium-term goal of achieving mid- to high-teens margins in this segment. The investment in capacity expansion and automation at our Tennessee facility to support expected U.S. extruded flare requirements remains on track to produce its first revenues in the second half of 2022. On the Energetics side of the business, our specialist devices business in Chicago strengthened its position in the space market. Its products played critical roles on NASA's latest mission to Mars, where we had 233 mission-critical devices on the Atlas 5 launch vehicle and the Mars Perseverance rover. Having already touched on FX at a group level, this slide shows the impact of the weaker dollar on the segmental results. With a little over half of group revenues dollar denominated, all key metrics are better on a constant currency basis. The cash flow shows the group's net debt at the end of the period at GBP 38.7 million, a reduction of GBP 9.5 million since year-end, which has been driven by strong operating cash conversion. The operating cash conversion ratio in the period was 96% of EBITDA. Indeed, across the last 2 years, operating cash conversion has been 105% of EBITDA, demonstrating the improvement in business practices is permanent and sustainable. The significant non-trading item in the period was CapEx, which given the impact of COVID is expected to be second half weighted in 2021 but is expected to fall within the guided annual range of GBP 40 million to GBP 50 million per annum as the investment in Tennessee continues. This level of spend is expected to continue in 2022 before starting to trend back towards depreciation in 2023. On to the balance sheet. Our net debt-to-EBITDA ratio decreased from 0.8x to 0.5x. Clearly, all reported balances have been impacted by FX translation at period end, but the main items of note are working capital has decreased since year-end by GBP 2 million despite a 4% increase in revenue. This drove a reduction in the working capital as a percentage of revenue metric from 21% to 20%, reflecting a continuation of the trend as more disciplined commercial management has been embedded throughout the organization, reducing the ratio from 28% 2 years ago. Finally, the pension scheme. The scheme remains in surplus on an IAS 19 basis and has done so throughout the last 12 months, which demonstrates the defensive strength of the investment strategy in volatile market conditions. No cash payments were required in the first half or are expected in the second. The triennial actuarial valuation is currently underway, and we expect to have more information about any funding requirements for the next 3 years at the time of our year-end results. With net debt at GBP 39 million at period end and a net debt-to-EBITDA ratio of 0.5x, which compares to our banking covenant of 3x, our balance sheet is robust, which positions the group well to continue to invest for growth. Finally, looking at the order book. At a group level, the closing order book was GBP 450 million, with GBP 199 million expected to be delivered in the second half of 2021, giving 92% cover of expected second half revenue. In both segments, we continue to work on improving the quality of the order book leveraging deep, strong, long-term customer relationships. Turning to each segment and starting with Sensors & Information. Order intake was up 15%, and book-to-bill was 135%. The order book in this segment tends to be shorter cycle. And of the GBP 109 million order book, GBP 59 million is expected to be delivered in the second half in addition to orders won and delivered in the period, giving 80% cover of expected revenue. In Countermeasures & Energetics, order intake was GBP 90 million, and book-to-bill was 72%, reflecting the delivery of the 2-year F-35 countermeasure order received in the comparative period. The closing order book of GBP 341 million, GBP 140 million of which is for delivery in the second half of 2021, giving 98% cover of expected second half revenue. With that, I'll hand you back to Mick. Thank you.

Thank you, Andrew. During the past 6 months, alongside the COVID-19 pandemic, there have been a number of national events that are of consequence to our 2 main home markets. These include the change of presidential administration in the U.S.; and in the U.K., the publication of the integrated review of security, defense, development and foreign policy. I will cover these in more detail in a moment. Whilst there may be some macro uncertainty surrounding the level and timing of defense spending as a result of the COVID-19 pandemic, global defense and national security spending is projected to be robust given continued geopolitical tensions and customers investing to increase their resilience against an ever-changing threat landscape. We therefore believe that solid demand will remain and that our multiple market-leading positions and investment in high-technology niches will provide attractive long-term growth opportunities. The U.S. remains the largest defense and security market in the world. And with the group's special security agreement with the U.S. DoD, we are well positioned to grow in this market. The President's FY '22 budget request for the U.S. Department of Defense is for $715 billion and identifies the need to modernize information and cybersecurity system has a focus on research and development for new technologies and specifically highlights the need to counter emerging biological threats. With our capabilities across our U.S. Sensors and Roke businesses, we are well placed to benefit from these emerging requirements. Our strategy for Energetics remains to focus on the high-value differentiated areas of the market where we see demand as robust, and our Chicago business is anticipated benefit from the growth in the space domain. In the U.K., the integrated review defense command paper and defense and security industrial strategy were all published in March. These documents provide a comprehensive view of the threats and challenges faced in the U.K. and collectively aggregate to produce a resilience-based policy framework blending defense and security imperatives with wider prosperity drivers. The group's capabilities are well aligned to the U.K.'s modernization priorities and for tackling the identified threats and challenges. The emphasis placed on science and technology, artificial intelligence, data science, autonomy and both cybersecurity and active cyber effects should provide opportunities for our Roke business to deploy its high-end capabilities and technologies at greater scale. Our decision to open a Roke facility in Manchester aligns with our customers' focus on establishing a hub for national security in that area. The increased investment for developing U.K. electronic warfare capability signaled in these documents may also generate further opportunities for Roke. World-leading technology is a critical enabler for our customers, and it is central to our strategic development of the group. We are investing to ensure that our products and solutions remain at the cutting edge. Network and information security, advanced sensors and data science will all be sources of key advantage in addressing the new challenges and threats that our customers are facing. Our Sensors & Information sector has highly relevant capabilities in this domain, and our continued investments will ensure that we will remain well positioned to take advantage of what we see as an important area for growth. Protection solutions against more conventional threats in the traditional domains of ASC and land remain vital and are important areas for the group to maintain technology leadership. Two priority areas for development of the next generation of ground-based electronic countermeasures to protect individuals and assets from the threat of radio frequency-initiated improvised explosive devices; and in the air domain, multi-shot countermeasures that combine multiple payloads in one flare body to deliver enhanced aircraft protection. Each one of Chemring's people plays an integral role in delivering our commitments to our customers and supporting their vital missions, so investing to develop in our people is a critical part of our group strategy. We have introduced a group-wide development framework that is focused on attracting, retaining and nurturing talent and helps build the internal networks vital for sharing knowledge and experience both within and across business units. Both the development framework and the early careers framework that was initially launched in 2019 create groups of colleagues at similar stages of their career and provide the appropriate support for them to develop both formally through online and in-person training and informally through the creation of peer networks. Roke's cyber launchpad is a good illustration of these initiatives being launched to provide opportunities for apprentices, graduates and early career hires to develop a wide array of cyber skills. We are clear that talent may not conveniently exist where we have facilities, so our location strategy and our workplace approach, including hybrid and flexible working that embraces the skills that we have learned as a result of the pandemic, supports our requirements for attracting and retaining the talent we require. The opening of the Roke Manchester facility is an excellent example of this in action. In these extraordinary times we find ourselves living in, mental health and well-being has continued to be at the heart of our people-focused activities. Well-being through mental, physical, emotional and financial support is addressed through a number of mechanisms and regular communications across all parts of our organization. We are clear the quality of our business relies on the quality and efforts of all of our people. Whilst our modernization and operational excellence programs will continue, as will our focus on organic growth, the actions taken over the past 3 years have resulted in a significantly strengthened balance sheet, and this provides the flexibility to pursue selective inorganic bolt-on growth opportunities. Any acquisition opportunity must meet a strict set of criteria, including market differentiating intellectual property, strong customer relationships, proven track record and cultural fit. They must also enhance shareholder value and fit with our wider growth plans. These criteria must be evenly matched by our internal capabilities to ensure that we are much fit to receive and integrate any acquisition successfully. With these criteria in mind, it's very pleasing to be announcing today the acquisition of Cubica Group. With a focus on innovative protective technologies and outstanding delivery in support of its U.K. government, law enforcement and international customers, the acquisition of Cubica Group, a business we know well, is a valuable addition to Chemring's portfolio. Cubica Group's leading capabilities in artificial intelligence, machine learning, data fusion and autonomy, together with its differentiated technology, providing state-of-the-art solutions to help online platforms and law enforcement agencies detect imagery related to child sexual exploitation across the globe make it an excellent strategic and cultural fit with our Roke business. It will not only provide further scale to our Roke business but will also offer additional research and development expertise as we invest in next-generation technologies and expand our product, service and capability offerings. The acquisition of Cubica Group is a small but important first step in our inorganic growth plans and is further evidence of the group delivering against its strategy. ESG is an area of increasing focus on one where we are committed to being a socially and environmentally responsible business. During the first half of FY '21, we have built on the good progress we made last year as we manage our sustainability agenda. A core activity in the first half has been to continue the process of gathering and validating data in order to enable us to set appropriate near and medium-term targets. This has been coupled with an assessment to identify topics, which are material for our employees, customers, suppliers and investors and to identify those areas and activities where our actions will have the greatest impact. Focus areas include health and safety, diversity and inclusion, reducing climate change and employee engagement and well-being. Our goal is to announce these targets in our FY '21 annual report in accounts so that as we enter FY '22, our strategy and intent is clearly understood. We are committed to building a sustainable company, of which all our stakeholders can be proud both now and in the future. In conclusion, we have continued to make strong progress in the first half of the year as we build a high-quality technology-based business that can deliver sustainable performance and growth. Over the past 2.5 years, we have built strong foundations based on our shared values of safety, excellence and innovation. Whilst our modernization and operational excellence programs will continue, our focus is now shifting towards the growth of our Sensors & Information sector, where our market-leading positions and investment in world-leading technologies positions us well in this growing area of customer need. With 92% of expected H2 revenue covered by the order book, the group remains on track to deliver year-on-year growth, and the Board's expectations for the full year remain unchanged. Whilst there may be some macroeconomic uncertainties surrounding the level and timing of defense spending as a result of the COVID-19 pandemic, our multiple market-leading positions and investment in high-technology niches provides attractive growth opportunities and Chemring's long-term prospects remain strong. So that concludes the presentation. If you do have any questions, please do get in touch with us either directly or through our advisers. As the COVID restrictions in the U.K. begin to lift over the coming months, we look forward to hopefully seeing you more face-to-face. But in the meantime, stay safe, stay well, and thank you for joining us.