Edited Transcript of TTG.L earnings conference call or presentation 6-Aug-20 7:30am GMT

Our new acquisitions have been integrated quickly and are performing well, and we are now working on a new list of opportunities, which we would like to continue to build on. So we have new opportunities emerging, good market positions confirmed and the team operationally on top of COVID. We are continuing to invest in technology, operational improvement and customers, all giving us confidence in the future potential of the business from here.

Through the pandemic, our employees and the wider community have been our #1 priority. We learned how to manage the risk of COVID early in 2020 at our facilities in China. And we were, therefore, on the case in advance of local government advice and rolled out a comprehensive set of controls and new ways of working at our sites worldwide. We asked our employees to work from home where possible, which ended up being about 12% of the workforce.

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.

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Operator [4]

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Good day, and welcome to the TT Electronics Plc Interim Results Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Richard Tyson, Chief Executive Officer. Please go ahead, sir.

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [5]

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Thanks, Kyle. Good morning, everyone. I hope you’ve had a chance to, at least, go and listened to and looked at the presentation we put up first thing this morning. And thanks for joining us here virtually. Clearly, this is quite a different set of results as well as the format that we’re doing it in. And so before we get into Q&A, let me just summarize the main points for you.

The team has responded exceptionally well, both operationally and financially. And TT has entered the pandemic in better shape, thanks to the actions we’ve taken over the last 5 years. And we don’t have any meaningful trends yet, but the business has stabilized and is returning to normal. We expect to see improvement from here in the second half, and we have plenty of opportunities, and we are confident of our medium-term outlook.

So on to Q&A. I’m going to hand back to the moderator, Kyle, who’s going to facilitate questions from you. So I’ll just hand back to Kyle. Thanks.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We’ll take our first question from Andrew Douglas from Jefferies.

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Andrew Douglas, Jefferies LLC, Research Division – Equity Analyst [2]

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You guys did a great job on operational gearing in the first half. I think you said 26% or 27%. Can we just have a quick walk through how that evolves into the second half? Clearly, we’ll have some temporary costs unwinding and some permanent costs coming on the way. So I’m just trying to figure out if you can give us some help on the second half. But I guess also importantly, next year, again, we’re going to have the same thing happening again where we have some temporary costs kind of coming back in, some permanent costs coming back out. So I don’t know how you want to play it kind of like a gross number or a net number. Or just if you can give us a feel for that.

And just secondly on — or thirdly, on civil aerospace. Clearly, that’s going to be tougher in the second half and probably into next year. Can you just give us an indication of how you’re seeing that market, your thoughts, I guess, some form of guidance, and when do you think we can get back to ’19 levels?

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

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Sure, Andy, yes. So obviously, I should — I’ve got Mark in here with me. So again, Mark can cover off the gearing point. As you say, we’ve been very pleased as well that gearing finished in the first half. So let me do civil aero first. So civil aero was 15% of the portfolio at the end of last year. We are anticipating the overall market to be in the range of 30% to 50% down. And that’s obviously a blended factor of wide body and narrow body, with narrow bodies faring a bit better. I think as you know, we’re more Airbus-focused than Boeing from the narrow body perspective.

And so what we’ve done is essentially, we’re really — tried to move really quickly with the customer base to get the production lines reset and reed, and we’re taking the costs out accordingly. So we’re clearly, therefore, expecting civil aero to — in the revenues, to be lower through H2 and then be at a kind of run rate effectively as a kind of Q2 exit run rate through H2, and then that will be the kind of sort of proxy for next year in our minds. Don’t expect much recovery next year based on our — the platforms we’re on. And then a steady recovery from there through to — we’re anticipating back to ’19 by kind of ’23, early ’24 kind of time frame. So I guess — well, first, we’ve rebased, got the capacity lined up against that and expect it to be a decent sort of slow-growing market from here.

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Andrew Douglas, Jefferies LLC, Research Division – Equity Analyst [4]

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And sorry to just interrupt you. On next year, I’m assuming that it’s going to be down a bit in the first half, up a bit in the second half. Is that kind of trajectory correct?

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [5]

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Yes. Yes, really, Andy. Obviously, it was better in Q1, right, so you have a bit of that comparative to work through, yes. But essentially, our production — our run rates are now where they should be and the customers’ sort of demand in order book stabilized.

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Mark Hoad, TT Electronics plc – CFO & Director [6]

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And in terms of sort of costs and drop-through, Andy, so obviously, at these higher levels of organic decline, you get — you have a higher drop-through effect. I think the way to think about it is, in this year, the drop-through sort of before any discretionary cost savings or the projects that you start to get in the second half would be in the order of around 40%.

The cost savings that we’ve sort of — that we’ve delivered in the first half to mitigate that is there for the order of GBP 5 million. That will be more like another GBP 3 million in the second half, something like that. And we get a couple million pounds of project benefits start to come through in the second half of the year. And then next year, all other things being equal, some of those discretionary savings will start to have to get layered back in, but it wouldn’t be the full GBP 8 million from this year. It’s probably GBP 4 million or GBP 5 million, and then a bit more than next year. Clearly, how much we allow to go back in will depend on the rate of recovery.

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Andrew Douglas, Jefferies LLC, Research Division – Equity Analyst [7]

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Okay. And will you guys put costs back in ahead of revenue? Or is it revenue first and then you’ll kind of put cost back in?

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Mark Hoad, TT Electronics plc – CFO & Director [8]

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No, it’s…

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [9]

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It would be revenue visibility first, and it’s probably right [to put cost, yes].

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Mark Hoad, TT Electronics plc – CFO & Director [10]

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And then only other thing is, we’re clearly not expecting a V-shaped recovery. And therefore, the drop-through we would see going forward on the growth, because the growth will be not at 14%. It’s probably more like 30%, 35% as things start to come back.

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Operator [11]

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We’ll take our next question from Mark Davies Jones from Stifel.

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Mark Davies Jones, Stifel, Nicolaus & Company, Incorporated, Research Division – Associate [12]

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A couple of questions from me, please. First, can you just remind us the time line on the — achieving the savings is quite a protracted one. Obviously, there are some site closures involved, which I imagine is part of that. Is that also a question of relocating production? Why is it taking out to ’23 to get the full benefit of what you’re doing? Do you want to take that one first and I’ll come back for a second?

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Mark Hoad, TT Electronics plc – CFO & Director [13]

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Yes. I mean, as you say, because it involves site closures, it involves some aerospace products that require recertification, that sort of thing. So obviously, you’ve seen in the slide, we’ve set it out. There’s the benefits to accrue a reasonable rate and we get the bulk of it by 2022.

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Mark Davies Jones, Stifel, Nicolaus & Company, Incorporated, Research Division – Associate [14]

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Then could you talk a little bit about your industrial end markets? Because those sometimes are the least visible and the most complex in some ways. So what should we look at there in terms of the balance between the better bits and the more struggling bits? And in terms of the indicators that we should be watching for improvement, is that [PMI]? Is it industrial CapEx? Machine tool orders? What do you think is most meaningful as a guide of the trajectory of recovery there?

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [15]

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Big picture, PMIs. But I would be watching CapEx, industrial CapEx. And to some degree, tools. So anywhere in — certainly in robotics. So I think — I don’t know if you had a chance to listen to the presentation this morning, but I talked about — we’ve certainly seen continued strong demand for our optical sensors all the way through. And that’s circa 25% of Sensors and Specialist Components. And the semi business is going well, GMS business for semi customers, as do the sensors guys.

So that is — that has been definitely robust to strong. And then the broader market general demand is really on economic dynamics and also the stocking dynamics in the distributors. So at the moment, [broad line] kind of distribution is holding up reasonably well, I’d say. So it’s only 15-ish percent off where it was last year. So I think that’s a reflection there’s actually is a reasonable amount of destocking that started to happen.

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Mark Davies Jones, Stifel, Nicolaus & Company, Incorporated, Research Division – Associate [16]

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Great. And if it’s not greedy, can I just ask one final one on working cap? That was, I guess, the one number that didn’t look quite as strong in the first half. But Mark, I heard your comments about inventory. What do you think we should look for, for cash conversion at the full year stage?

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Mark Hoad, TT Electronics plc – CFO & Director [17]

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So I mean, we’re definitely expecting working capital improvement in the second half of the year. Whether or not we’ll get it all the way back to neutral is clearly a number that can vary a bit, but that would be our aim. But I think we’re probably neutral to small outflows is a reasonable assumption. That means that sort of cash conversion would be certainly back into the 90% plus territory.

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Operator [18]

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We’ll take our next question from Rory Smith from Investec.

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Rory Smith, Investec Bank plc, Research Division – Research Analyst [19]

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Two questions from me, if I may. Just within the 22% of revenues from aerospace and defense generally. What was the split between civil aero and defense in the first half given sort of recent acquisitions, maybe more on the defense side? And how is that different across the divisions? Could you remind me, please?

And the second question, just on visibility, what’s the sort of level of visibility now across the divisions? And also, as a second part of that question, what are you seeing in terms of customer inventory levels and how that might impact demand, sort of through Q3 into Q4?

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Mark Hoad, TT Electronics plc – CFO & Director [20]

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So in terms of the split, Rory, for the group, aerospace — commercial aerospace is 10% and defense is 12%. But obviously, that’s sort of swung around compared to last year. Everyone understands the weakness in commercial for us. Defense has been very strong. Obviously, we’ve added a bit through acquisition, but actually, organically, it’s been very strong for us as well. Which is why, in total, is still up at the 22% level.

Across the different divisions, you’ve got Power and Connectivity: 19% aerospace, 24% defense. GMS is 4% aerospace, 10% defense. And Sensors and Specialist Components is broadly aerospace. There’s very little defense in that.

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [21]

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So in terms of visibility, Rory. So I guess, sort of visibility for I think what we described earlier on today has an expected improvement through H2 is looking okay. Across GMS, it’s kind of, what I call it, sort of normal levels. So not much left to book subject to no customers moving any more order book around. And then in the other 2 divisions, there’s sort of — there’s a bit more book-and-shift dynamics in both Power and Connectivity and Sensors and Specialist Components. So we’ve still got probably 2 to 3 months of the second half to book. Obviously, a bit of that will come in, in July. So it’s still a bit of — that’s why I sort of said there’s still a bit of a range of outcomes on the year. But actually, those visibility dynamics are what I’d call reasonably normal to the assumption that we will improve revenues in H2.

And then I think you asked about customer inventory levels. So we had destocking happening in the distributors last year. That was still — we’re still above what we would call the norms when we went into the crisis. That’s come down a little bit, but not all the way down to where we would have been sort of full run rate. So there could be a little bit more to go there. And people are obviously, constantly looking at their overall demand pattern in their inventory. So again, that’s another sort of dynamic that it’s got some moving pieces potentially.

And we have civil aerospace customers who are working through, clearly, more inventory that they would have been carrying for higher run rates. So we have got a couple of larger customers in there that will — that could be up to 60% down this year. So that’s an inventory effect as well as the updated run rate for platform build. But there’s other areas where people are building up for strong demand. So defense has been excellent. I think as Mark has sort of referred to there, we’ve had customers placing 2-year demand in one go. Biggest order we’ve got a hold on was the — were in the (inaudible) in North America. So some really good stuff in there.

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Operator [22]

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(Operator Instructions) We take our next question from Richard Paige from Numis.

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Richard Paul Paige, Numis Securities Limited, Research Division – Analyst [23]

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A couple of questions from me, please. North America performance looks very strong in terms of the sales numbers you’ve provided back there. I know there’s obviously some benefit from acquisitions in there. Could you just talk through, sort of, dynamics in — over there, please? And then secondly, on the medical side, you’ve obviously highlighted those deferrals in terms of installations into next year. You obviously also had benefits from some of the COVID-related measures. Can you just, again, talk about the sort of timing dynamics on both sides of that equation, please?

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [24]

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Do you want to take that?

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Mark Hoad, TT Electronics plc – CFO & Director [25]

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Yes. So, Rich, in terms of North American growth, as you say, we have added some stuff into acquisition. But organically, America was up 5% in the first half. The growth there is in Power and Connectivity and in GMS. So Power and Connectivity, Richard just referred to some of the wins we’ve been having, getting some really good growth there from the businesses that we’ve acquired over the last couple of years, which I think is really demonstrating the strategy there to grow our power electronics capability in North America is really gaining traction. And then GMS was the other area where we saw real growth in North America. We talked last year about them having a number of sort of contract wins, and that they were ramping up in the first half of the year.

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [26]

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Yes. So a couple of those contract wins have come with specific customers that I think we’ve talked about in the results presentations that we’ve been focused on and targeting on those key customers, improving [price] and giving us more work. So that’s been really nice to see.

On the medical front, Rich, the — we have — so it’s been multiple dynamics going on in this market in the first half. So we’ve had some super strong demand for urgent operational needs for frontline, well-trailed, well-publicized ventilator stuff, but not just U.K. but an awful lot of it in the U.S. as well, where we do a bunch of parts. And we took part in a whole range of those projects in the U.K. in cross-sector project teams. But it’s not just that, it’s also things like refrigeration units, with the testing that we do as well that was really strong. So the guys did a fantastic job reconfiguring capacity to ensure we can deliver all of that.

But then offsetting that is we also did quite some stuff in oncology, life sciences, big pieces of customer equipment, where installations have been just not possible through COVID. So either hospital reprioritizing to deal with COVID or just the fact thing to shut down. So those are clearly moving into next year and beyond. But that just means, for us, we think this was a good market for us to be in, good growth dynamics. And I think this gives us even more confidence in that going through ’21 and ’22.

And in addition, we’re still working on things, a few projects and to see how they’ve come along with the sort of the latest things that are needed to fight the next phase of COVID. So there’s definitely been opportunities that have come out of this for us. And customers who did not know TT and have not seen our — my team in action have really been pretty impressed, and we’re getting stuff coming out of the other side of that.

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Operator [27]

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We take our next question from Mark Fielding from RBC.

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Mark Lewis Fielding, RBC Capital Markets, Research Division – MD & Head of Capital Goods Research [28]

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Just in terms of the cost reduction program and the savings program, you mentioned in the presentation GBP 10 million to GBP 15 million of end-of-life revenues. Just curious about the time line on that, are those profitable today? Just how do we think about that phasing in. Maybe [take that] one first.

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Mark Hoad, TT Electronics plc – CFO & Director [29]

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Yes. So I mean, they are profitable, but it’s part of — I guess, it’s a mixture of something that’s a slightly lower margin and something that we just have to do to access the overhead reduction savings. The lion’s share of that would come out next year and then maybe a little bit in the following year. So obviously, that will put a slight break on any other growth — against the growth that we’d otherwise see next year.

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [30]

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Yes. So — and that’s — it’s an ongoing evaluation, while it’s not an estimate at this stage. But we’re taking the opportunity to remove stuff that is also less profitable to us and it’s just not worth us moving to other places.

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Mark Lewis Fielding, RBC Capital Markets, Research Division – MD & Head of Capital Goods Research [31]

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Great. And then just separately, obviously, good cash flow performance remain well within your target range. What’s your thought process on acquisitions from here in this slightly unusual backdrop that we’re in? And how is the pipeline looking?

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [32]

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Well, so on acquisitions, I suppose the first thing to say, and we tried to convey this morning in the sense of the releases, things stabilizing the business through Q2 from a March, April time where it was very focused on operational execution. And we’ve really been on the front foot looking forward opportunities since the back end of Q2, really looking to drive out the other side of this situation.

As we just said, acquisitions that we brought in are performing well. We feel like we’ve got the bandwidth now to go against. So if I then talk about the pipeline, I would describe it as being more active than it has been. And there’s more things coming into it, which feels like it’s the dynamic that’s one that’s a result of the crisis. There’s more assets potentially becoming available. It’s still like who knows at what specific timing, but there’s more conversations going on and we’re encouraged by that.

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Mark Hoad, TT Electronics plc – CFO & Director [33]

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Yes. I mean — and then just to deal with the kind of capacity point, we’ve talked before about being comfortable in principle going up towards 2x — up to 2x levels. At this point, in the evolution of all of this, I think where the balance sheet is today is where we are is where we are comfortable. And I think as things evolve and as we hopefully get greater clarity and certainty over time, we would gradually become more comfortable within — we’re moving back up through the range.

So — I mean the amount of M&A capacity that we’ll have will clearly, therefore, be dependent on when things — if and when things come to fruition. You know that we take a relatively prudent view of the balance sheet. And therefore, we will we would evaluate the opportunities as they come up and think about the best way to finance them at that point in time.

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Operator [34]

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(Operator Instructions) We take our next question from Harry Philips from Peel Hunt.

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Harry Philips, Peel Hunt LLP, Research Division – Analyst [35]

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Again, looking at the capital allocation slide. Obviously, Mark has just asked a question about M&A. So I suppose some commentary around your dividend comments today. And in the new world, what does progressive actually mean?

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [36]

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Yes. So I mean, what we’re basically saying today, Harry, is that our focus has been on the strength of the balance sheet and making sure that all of the actions we’re doing to retain that. And — but we’re obviously mindful that the dividend is an important part of the investment proposition and our capital allocation policy. So what we’re indicating here is clearly that there is still some uncertainties around us and how the pandemic will evolve in H2. But assuming things continue as they are, we feel it’s the right time to consider the dividend is at the end of the year once we’ve seen the outcome. And it’s our intention to get back on the dividend-paying trail.

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Mark Hoad, TT Electronics plc – CFO & Director [37]

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Yes. And I think, Harry, when it comes to progressive, obviously, that in normal circumstances that means that with growth, you’d expect growth in the dividend. I think that, that remains, in principle, our view. I think the other thing I would say though is, yes — and also that, ideally, we like [they] didn’t cover 2x plus. That said, we’ve demonstrated in the past that we’re prepared to look through cycle, so we’re not — we won’t necessarily slavishly be tied to 2x cover.

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Operator [38]

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It appears there are no further questions at this time. I would like to turn the conference back to you, Mr. Tyson, for any additional or closing remarks.

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Richard Tyson, TT Electronics plc – Group CEO & Executive Director [39]

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Okay. Kyle, thanks. Well, thanks, everyone. Really appreciate you joining us this morning to hear what we’ve been getting on. And I guess, as I said at the start and summarized that by we came into the crisis in a much improved position. The team we’ve got here has executed really well operationally and financially, and we’re in good shape and we’re on the front foot.

So thanks all. Look forward to seeing you again soon, hopefully in person.