Edited Transcript of TTG.L earnings conference call or presentation 6-Aug-20 6:00am GMT

And to ensure our facilities remained operational, we implemented additional controls including daily temperature checks, social distancing and staggered shifts, enhancing cleaning and disinfection routines as well as site self-assessments and audit requirements. Where there have been vulnerable employees, we have put in place shielding protocols and have continued to support pay and provide everyone with full benefits. We did make limited use of U.K. government support but have stopped it from the end of June.

I’ve been incredibly proud to lead such an excellent team through this period. They have worked tirelessly to stay operational and COVID secure, delivering critical products to our customers and respond with agility and pace to new urgent operational requirements for the frontline. It has been a humbling experience to see it firsthand our culture in action, and how well the team have executed in response to the many COVID-related challenges we faced.

We equally were very pleased to participate and support a number of projects targeted at urgent operational needs focused on the fight against COVID in the U.K. and elsewhere in the world. Answering calls for increased production of ventilators and other medical equipment, we’ve also manufactured and donated much needed PPE equipment to the frontline staff through a number of local initiatives.

Our target market focus meant that we have been designated an essential business by governments and customers around the world, reflecting the critical nature of our technology and products. Consequently, we continued operating throughout the period, albeit at low capacity. In addition, we managed our costs very closely and have been prudent with cash management to retain flexibility with the balance sheet. At the same time, we have looked to the future of the business by continuing to invest in R&D and extending our self-help program.

We said in the statement that we are confident in the future. So let me give you a flavor of recent trading developments on an albeit limited data set so far, and then I’ll move on to talk through the market dynamics and the path of recovery.

So first, recent trading. As I mentioned before, our engagement with key customers following our business development initiatives over the last couple of years is so much better now. It has meant that we’ve had much clearer insights on our markets and on our customer requirements as we move through Q2, with visibility and order book starting to stabilize in the divisions.

With the current order book for H2, we continue to expect improvement through the second half. And this, coupled with the cost reduction actions and self-help program, will support margin improvement as volume recovers.

Overall then, we have GMS in good shape and performing well, with margins holding up. Power and Connectivity, impacted by the commercial aerospace but the acquisition is performing, and defense and medical opportunities looking good with margin improvement to come. In Sensors and Specialist Components, some really positive parts and others that have moved with the economic decline in the short term, but the self-help program will start to deliver improvement and efficiency.

Turning to strategic development. I’m particularly excited about our power supply strategy in North America, which is gaining good traction. In Covina, our new acquisition, the management team has already won its first program with us. The team is rapidly building a good reputation with key customers. And through the integration program, the team are now sharing technology where they can, leading to new opportunities in Europe. And they secured a significant new aircraft power converter program with a U.K. defense contractor as a result.

So now that overall group business activity feels more stable, we should improve from here, with our self-help program supporting margin recovery and positioning the business well to accelerate as revenue growth returns.

So now let me take you into the details of the markets. I think it’s important that you get a sense of what’s been going on, but remembering that it’s too early to identify meaningful trends. In aerospace and defense, there’s been a divergence in fortunes. There’s been a sharp decline in air travel globally, with a knock-on effect of new commercial aircraft production. Build rates are being reset with production volumes down 30% to 50%, with narrow body production faring somewhat better than wide body.

In defense, though, we’re seeing continued strong demand. Budgets remain robust and U.S. spending, in particular, is continuing to flow. Within this market, we’ve been winning some good new contracts, particularly on U.S. programs, and the proportion of group revenues in aerospace and defense, therefore, remains significant at 22%.

In medical markets, we’ve seen very strong demand for COVID-related products, not just ventilators but also products used for other applications, including refrigeration and testing. We are engaged in some cross-sector projects, evaluating urgent operational needs in the U.S. and the U.K. to fight COVID. And we’re working on additional opportunities as new customers begin to understand the breadth of our capabilities and the experience our impressive teams in action.

Offsetting this, there have been a number of delays for big laboratory and hospital installations. These have been put on hold due to the lack of site access or a change in priorities. We’ve seen a postponement, not cancellation, of elective surgeries, meaning these orders are also moving to next year. This does point, however, to positive order momentum beyond the end of this year for this market.

In our broader industrial segments, we have seen different dynamics at play. There have been demand reductions in order deferrals in more capital expenditure-focused market segments as customers manage their cash. And the U.K. industrial and consumer market for single-board computing and standard power supplies is also soft. However, we’ve seen strength in our semiconductor markets and in optical sensors, which continues to grow well, partially offsetting weaker areas of demand.

So let’s now look at how these markets will develop over the medium term and why we are confident. You may remember the content from this slide is from our full year results. I included it again today to remind you of the sustainability drivers of our long-term growth, that is the demand for cleaner, smarter products and for improved wellbeing. In a post-COVID world, I firmly believe these drivers remain intact and probably even more relevant. In fact, it’s clear that technology-led solutions will be needed more than ever and will support further growth in our markets. So let me show you what leads me to this conclusion.

First, its clear commercial aerospace markets will need several years to recover to 2019 levels. And as a result, we are resetting our cost base to reflect this. Defense markets, on the other hand, should remain strong for the next few years, being driven by more geopolitical considerations. In both cases, our electronic capabilities and our ability to make smaller, lighter and less power-consuming products will remain a priority. In other words, ever more capable but cleaner and more fuel-efficient products.

On to medical. Recent experience demonstrates people and governments will have to be investing in more electronics-based solutions for testing, tracking, tracing and remote diagnostics as well as the overall infrastructure. So the need for more electronics-enabled medical capabilities is likely to be a fixture, and we are well placed to benefit.

The impact of COVID has been to temporarily constrain more general demand, and we expect this pause in growth to drive increasing deliveries from next year. In addition, the need to enhance existing medical capabilities has been reinforced by our recent experience, with remote monitoring, diagnosis and connectivity an obvious route for investment, as it increases efficiency as well as deemphasizes some of the aspects of face-to-face medical intervention, very, very important in the new normal.

Similarly, in the industrial space, automation and robotics, along with smart products and infrastructure, create efficiencies, reducing customers’ costs. This has long been a driver in these markets. What COVID has done has demonstrated the need and benefit of being able to access and monitor assets remotely, with automation, robotics and smart technologies reducing the need for physical presence on a site.

The advantages of being able to connect people, systems and infrastructure is more self-evident than ever. It’s really exciting to be leading a company with this strategy at this time given the potential growth from these markets.

So having taken you through why we are confident in the market growth going forward, let’s now look at what we’re doing to drive improvement in the business. Our medium-term organic growth prospects are excellent. We are increasingly well positioned in markets with sustainable growth drivers. We’ve invested in the business, in customers, in technology and in people to keep our capabilities relevant. And organic growth remains a significant part of the journey to get to a higher quality business and reach double-digit margins.

However, we’ve always said that operational efficiency was an important part of improving the business and our margins. And this year, we commenced a significant self-help program, investing in the business and reducing the fixed cost base. We’ve extended the scope, and we are expecting GBP 11 million to GBP 12 million worth of run rate benefits in 2023. The benefits will commence this year and when complete, will deliver a step change in our overhead efficiency.

In addition, we’ve built a good acquisition and integration track record. We understand our target markets, and we buy carefully and remain disciplined. We’re really pleased with the performance of our recent acquisitions, Power Partners and the Covina power supply business. Covina, our new power business in North America, is already providing exciting opportunities and demonstrating its potential. And now we also have the bandwidth to act, and we are actively monitoring what has been an improving pipeline of potential opportunities.

Now clearly, the short-term disruption from COVID is likely to extend the time frame of our margin journey a bit. But it has not dented our belief that there is a significant opportunity ahead for TT, and that we will achieve it.

So with that, I’ll hand you over to Mark now to take you through the shape of the half year numbers and the divisional dynamics.

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Mark Hoad, TT Electronics plc – CFO & Director [2]

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Thank you, Richard, and good morning. Clearly, it’s been a difficult half for everyone. But in the context of such significant market disruption, our performance has been very resilient.

Revenues declined by 12% at constant currency and by 14% on an organic basis. But our actions to reduce costs meant that the operational leverage on that revenue reduction was limited to 26%, and therefore, the reduction in margin was kept to 270 basis points. Our tax rate was 17.5%, and underlying earnings per share in the half were 4.8p. The exceptional and one-off items largely related to this self-help program we announced in March, and I’ll share some more detail on this program in a later slide.

Along with protecting our employees and meeting customer needs, one of our top priorities has been ensuring that we have plenty of covenant facility headroom. As part of this, we decided to suspend the final 2019 dividend, and at this stage, we’re not paying an interim dividend. We intend to declare a dividend with the final 2020 results, and this will take account of the performance for 2020 as a whole. This and our other actions to minimize cash spend mean that we finished the half with a leverage of 1.6x, well within our target range of 1 to 2x net debt to EBITDA.

Finally, with the reduction in operating profit, clearly, we’ve seen a reduction in return on invested capital. But our capital discipline remains. And as profit recovers, so return on invested capital will recover, too.

As you know, the initial impact of COVID was on our Chinese facilities. But once it became clear that this was a global event, we took a number of steps to mitigate its impact on our financial performance and balance sheet position.

To protect profitability, we stopped all discretionary spend and put a freeze on all hiring and travel. Pay increases were stopped for all but the lowest paid employees, and the Board took a temporary 20% reduction in pay. We did receive around GBP 1 million of U.K. government support to cover the cost of people not at work, but will not be claiming any more of this post the 30th of June and do not intend to apply for the return to work bonus being offered.

In terms of protecting our balance sheet strength, we’ve reduced CapEx through central spend more than halving what we’d originally planned to spend. We’ve been very focused on ensuring working capital was closely controlled. And not paying dividends has clearly been part of the overall effort, but we absolutely recognize the importance of dividends to shareholders and intend to resume payments in calendar 2021. All of this means we finished the half with leverage of 1.6x. And at the end of June, we had GBP 94 million of available cash and facility headroom on facilities which were in place until late 2023.

The pension scheme has also fared well, demonstrating the robustness of our investment and hedging strategy. The scheme was fully funded at the time of the last valuation in April 2019. And although the funding level did dip during the first half, it was back to fully funded at the end of June.

On to divisions and starting with Power and Connectivity. Revenue reduced by 12% on a constant currency basis, including a GBP 4.9 million revenue contribution from Power Partners and Covina acquisitions. On an organic basis, revenue declined by 19%. Commercial aerospace and industrial demand was down, but defense revenues held up well. Here, we were also impacted by 2 temporary site closures, mainly in Kuantan, Malaysia. On these lower revenues, operating profit reduced by 40% at constant currency, and margins declined to 7.3%.

The team proactively engaged with customers to ensure production schedules are reset in an orderly and predictable way. We’re addressing a reduction in revenues and rightsizing the business for the reset in commercial aviation demand by closing our Lutterworth facility in the U.K., and we’ve made headcount reductions in our facilities in Barnstaple, U.K., and Kuantan, Malaysia.

But even with everything else they’ve been contending with, the team continues to make good progress in technology development and customer wins. The division secured its largest ever order from a U.S. defense prime for electromagnetic products for Precision guidance systems. And in the U.K., we secured an aircraft power converter program with the U.K. defense contractor. We’ve also been supporting the development of a nonclinical virus testing device, which is currently undergoing field trials.

The Covina business, which we acquired in early January, has been integrated and has already had its first win under our ownership. This early success really confirms our belief in our strategy to build out our power electronics capabilities in the U.S. in particular, and our ability to add value to these types of businesses.

Next, Global Manufacturing Solutions, where revenues were down by 10% at constant currency and organically. Medical demand was mixed with reduced installation-based revenues but higher demand in COVID-related products, such as units for storing vaccines. Commercial aerospace revenues were down as in other divisions, but industrial and defense demand held up well as GMS benefited from the ramp-up in revenues on contracts won last year. The team did a great job mitigating the impacts of the revenue reductions and limited the operating profit reduction to 18% at constant currency, and operating margins only declined by 60 basis points to 6.8%.

As part of the wider self-help program, in our Cardiff facility, we’re realigning the product portfolio and focusing on customers with more advanced technology requirements. Some products are being moved into lower-cost facilities, and in other areas we’re exiting lines of business.

In the first half, we’ve established additional box-build capacity in Asia, but outside of China, to offer greater choice to our customers. This new capability has been set up inside our existing facility in Kuantan, Malaysia and is now operational. GMS also passed first article sign-up on 2 major programs in the first half despite the constraints around people being able to meet face to face. Even with everything else they’ve had to deal with, they’ve also continued to win new customer awards, particularly in defense.

Finally, Sensors and Specialist Components. Here, revenue was down by 16% at constant currency and organically, with industrial market demand the main driver. Although here, we’ve also had to contend with 3 temporary site closures, and Mexico keeping the vulnerable workforce out for an extended period of time. In this division, operating profit fell by 51% and margins reduced by 480 basis points. As part of the overall self-help program, we’re closing facilities in Barbados and in Corpus Christi, Texas, as well as taking other headcount reduction steps.

During the half, Sensors and Specialist Components received a multiyear award from a defense customer to supply power resistor assemblies for a fifth-generation fighter aircraft, and was awarded preferred supply status by an existing technology and innovation customer, recognizing the high level of service we’ve delivered over many years.

So moving on then to cash flow and net debt. As I said earlier, we’ve been very focused on protecting our covenants and liquidity and ended the period with leverage of 1.6x and GBP 94 million of cash and facility headroom. You can see that we had a working capital outflow of GBP 9.4 million in the first half. With revenues down, we’ve had a reduction in payables and at the same time we’ve been paying close attention to controlling receivables, and in the period, actually reduced overdues.

The reduction in revenue and deferral of orders has meant, though, that we haven’t been able to drive inventory reduction as we planned. For the second half, we do expect improvement in the working capital position. Capital expenditure has been kept to central spend only. And as a result, we spent half of what we spent in the first half of last year. We started to spend on restructuring projects in the first half. That was a GBP 4.7 million outflow. And interest, tax and pension payments have continued as normal.

The Covina acquisition completed in January, increasing net debt by just over GBP 14 million, and you can see that this was the main driver of the increase in net debt.

In March, we announced the launch of a self-help program. Once the extent of the COVID pandemic became clear, we paused while we ensured our balance sheet position remained robust. Having done so, we then extended the program to address some of the revenue reductions we’ve experienced and kicked the program off in late Q2. The program entails 3 main facility closures that I’ve already touched on as well as significant headcount reductions elsewhere. Net, we’re reducing headcount by around 500 FTEs or 11% of the total workforce.

As part of this, there are a number of products that we will take end of life, reducing revenues by GBP 10 million to GBP 15 million. As well as helping to mitigate some of the demand reduction we’re experiencing in the short term, this program will be a significant contributor to our journey to double-digit margins. And you can see on the right of this slide, the profile of the cash spend as well as how we see benefits accruing over the life of the project.

So clearly, like all, we faced a challenging market backdrop. But in that context, I believe that our performance has been resilient, we’ve taken decisive actions and we’re well set for the future.

With that, I’ll hand back to Richard.

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [3]

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Great. Thanks, Mark. So in extremely challenging circumstances, we have had a good first half, strong execution and a resilient performance. This reflects the excellent team we have, the actions we’ve taken to improve our operations and reshape the business to position it in sustainable and higher technology markets.

We expanded our self-help program to improve efficiency, support margin improvement and position the business for a strong recovery. Having said that, it’s the early stages of recovery and return to normal, and so there may be a range of outcomes for the year.

Whilst COVID has created disruption, it has also presented us with some opportunities. And with a better business at TT, I’m confident that our team will continue to be nimble and respond to the changing needs of our customers and markets. We will also continue to invest in R&D and added value technology through selected acquisitions.

We’re excited about our new power business in North America, and the integration of the Covina business is going well. Across the business, we have new wins, a number of defense and medical opportunities to pursue as well as an improving pipeline of acquisitions. And the actions we’ve taken on cash and costs mean the balance sheet is robust, and we are now focusing on the future. So the gradual improvement in Q2 revenues, stabilization of our order book, a return to full production capacity through the second half will help us deliver improvement from here.

Overall, we’re in good shape, confident in the future of the group and we’re on the front foot.