Cohort plc - Investor Presentation (Half Year Results) - December 2023

Good afternoon. I'm Andy Thomas, I'm the chief executive at Cohort PLC, and I'm here with Simon Walther, Cohort's Finance Director, to take you through our results for the six-month period ending 31st October this year. So I'm going to start by giving you the highlights and then Simon will provide some more detail including a divisional breakdown, and then I'm going to come back with some comments about the demand picture and about our future prospects. And the summary is that it's been a good first half, much better than the last year's. Revenue and operating profit are up strongly, and once again we've got a new record reported order book. Prospects look good, we expect to continue our growth in the full year and beyond. You can see the numbers now. As I say, revenue and profit both up strongly. Revenue up 22% to 94.3 million, adjusted operating profit up 20% to 6 million. Adjusted EPS was also up, not by quite as much for reasons that Simon will explain in a moment. It was another very good period for new orders, and of course that's the best leading indicator of future growth. The order intake of just over 9 million pounds significantly exceeded the revenue that we recognized, so the total order grew to over 350 million pounds at the year end, and that order book covers 95% of the consensus forecast of our revenue for the year. And that order winning run has continued after the period end, and in early December the order book grew to something like 365 million pounds, and that gave us even higher order cover for the year. Finally, operating cash flow is also good, it exceeded profit and that helped us to maintain a positive cash net position of 1.3 million pounds. And against that background, the board was very pleased indeed to be able to recommend an interim dividend of 4.7 pence per share, and that represents an increase of 10% on the dividend at this time last year. If we can have the next slide, Simon will give a more detailed breakdown of the performance of our two divisions, but this slide shows the main factors behind the group's performance improvement. The Communications and Intelligence Division delivered a marked increase in both revenue and profit, and that was driven by a record first half performance at our subsidiary MCL Communications, and that was a result of its unusually high opening order book at the beginning of the year. EID also saw some improvement, but Mass was slightly behind its first half performance last year as some of its higher margin work slipped into the second half. In our other division, Senses and Effectors, revenue also grew, but profit performance was slightly lower than the same period last year. Both Chess and Sea performed well, but profitability at Elac was affected by the high proportion of low margin revenue on the development work for the new Italian submarine sonar, and we're recognizing margin very prudently on what is a very complex technically developed program at the moment. But we expect a much improved performance from Sensors and Effectors in the second half. So let me hand over to Simon who's going to take you through those results in a bit.

Thank you very much. So in this section I'm going to talk about the outlook and about the factors driving demand for our products and services. I'll illustrate that with some examples of major contracts that we've won over the last six months, and then I'll talk about some of the investments that we're making in new products and technology. I'll show you how our existing order book runs off the rest of this year and beyond, and then I'll round off with a summary of the points that we've been making. So the two main driving forces for demand in defense equipment remain in place, and those are the continuing conflict in Ukraine and the influence of growing Chinese assertiveness from the Indian Ocean down to Australasia. And adding to that mix since October has been the developing violent conflict in Gaza as well. I'll start with the impact of those factors on our export markets. So the conflict in Central Europe is primarily, although not exclusively, land-based, and it's driven demand in two ways: both directly as the NATO countries seek to help Ukraine resist the Russian invasion, and it's also indirectly, it's made NATO and other countries think again about the balance of their defense forces and the equipment that they need. Now some aspects of that rethink don't really have an impact on us - we don't make 150mm ammunition and we're not about to start doing that - but other lessons that have been learned, for instance the importance of electronic warfare, the need to counter drones of all kinds, and the need for accurate and timely battlefield intelligence, have all had a positive impact on both orders and prospects for us. In Asia, Chinese assertiveness has not yet manifested itself in a violent way, but the clear threat that certainly is there, most notably Chinese behavior, has driven the creation of the tripartite AUKUS alliance between the United Kingdom, the United States, and Australia. And we fully expect to make a contribution to the new AUKUS submarines in due course, but there are also many opportunities in what is termed pillar two of AUKUS, and that's focused on developing new technologies for defense, including for underwater detection and countering hypersonic missiles, of which I'll say a little bit more later. Of course Taiwan is at risk from China, but aggressive behavior of maritime claims in the South China Sea also having a major influence on defense postures and equipment spending really throughout the region, and that's had an impact on order intake and opportunities for us in for instance Thailand, Indonesia, and the Philippines. Japan remains committed to a doubling of its national security spend as a share of GDP by 2027, and it's also joined the Anglo Italian Next Generation combat aircraft project, forging closer links with Europe when traditionally its closest defense links have been to the United States. I witnessed a very excited Japanese delegation closely examining Sea's Crate array at a large international exhibition recently. The conflict in Gaza doesn't have the same direct impact on our demand as the other factors, but it's the tip of an iceberg which is the wider tensions in the region primarily and ultimately between Iran and Saudi Arabia and its allies, and that tension is likely to drive further regional demand for defense spending in what remains one of our most important markets. Our domestic markets have seen similar effects. The UK's Defense Command Paper announced initiatives to make UK a science and technology defense superpower, and to develop a new and more strategic relationship with industry, and that complements the refreshed integrated review earlier in the year that confirmed the need to invest in responding to challenges from both Russia and China. In Germany we can see the impacts of the step change in defense spending that is taking place there. Our German businesses are already supplying specialist hydroacoustic equipment for new German surface ships and subs. And in Portugal, the long list of domestic opportunities for EID is finally gathering momentum with bids being invited for several major programs and a new military procurement law approved by the Portuguese Parliament. I was talking about the gathering momentum for the set of opportunities that our business EID is looking for in Portugal because a few weeks ago I attended the signing ceremony for the acquisition of a new multi-purpose vessel by the Portuguese Navy. And this was a pretty big event. The vessel will be a mothership for both air and sea drones, it'll be a new concept of vessel, the first new vessel that the Portuguese Navy has acquired for quite some time. And not only was the head of the Navy there, but also the Prime Minister came along and gave a speech, and that in my mind signifies that there is some real momentum behind acquiring these important new vessels.

Finally, in this section I wanted to emphasize that we're interested in growing profit not just revenue. Now I'm happy to say that the more extreme effects of COVID on our supply chain and recruitment costs are now fading, and that has helped us to keep our costs under control. We've also taken action to improve margins, for instance at Chess by improving pricing and by bearing down on some of their problem projects. We expect margin to improve sharply at Elac when we get through the challenging development stage of the Italian submarine sonar, which is its largest project. And for the group as a whole, especially at Sea and EID, we'll keep control of overheads so that margin will improve as revenue grows. Now the group operating margin is currently hovering at around 10%, and our aim is to drive that up to the mid-teens in the next few years. And taken together with the growth that's going to be driven by the demand that I've described, that offers a period of really considerable opportunity for Cohort. So I want to highlight some recent contract wins to demonstrate the real impact of these geopolitical events on our day-to-day operations. And I thought I'd focus in doing that on the maritime area. So taking a few of these examples: In August we announced that Sea received a 17 million pound contract from the UK Ministry of Defense to provide the communication system for the new Dreadnought ballistic missile submarines. Now that's a clear vote of confidence in Sea which has provided similar systems for UK's Trafalgar class, Astute class, and Vanguard class submarines in the past. And as well as being incredibly valuable in its own right, puts us in a really good position to do the same thing for the next and largest ever class of nuclear submarine to be produced in the UK, the AUKUS boats for the UK and Australia. Next, earlier this month it was confirmed that Elac had been contracted to supply a third submarine sonar suite to the Italian Navy with a value of 16 million euros. Now that provides confirmation that we are providing a world-class system for a NATO Navy that has access to the best technology available, and we're very proud of that. Back in May, Sea won a 26 million pound contract to upgrade the communications on board two of the Royal New Zealand Navy's frigates. Now that's a clear sign of how regional tension is influencing even relatively low defense spenders like New Zealand to enhance their naval capacity. Also in May, Sea won a 7 million pound contract to provide its Crate sense submarine detection system for two ships of a Southeast Asian navy. Now that's a first win for the new Crate sense system, which is based on a relatively new Crate array towed sonar which has been produced and designed by Sea, and that purchase is a perfect illustration of how navies in the Southeast Asia region are equipping themselves to counter the growing Chinese submarine threat. Moving on, Chess has won a 5 million pound contract to supply its Fork and Kelt cameras to BAE for the Type 26 frigate for the Royal Navy, and that's a precursor to what we expect to be a much larger contract for Chess to incorporate things into its stabilized fire control systems for the ships. And finally, Elac underwater communication systems are widely used and they've sold to many many customers recently including Japan, Germany, and Italy. I'm picking one particular order here which was 4 million euros as a particularly substantial one, but there are many more I can mention, and that product is on the way to become something like a worldwide standard. Now of course there are many other contracts as well, but I think that these give a good illustration of the importance customers place on their maritime capability and the capability and competitiveness of our offerings as well. Looking forward, the pipeline of opportunities is as strong as ever.

Now against that encouraging background we are maintaining our spend on technology and product development to meet the evolving needs of our customers. Many of the products that we invest in are very sensitive, but I can share some of these examples with you. To deal with what is perceived to be an ever increasing drone threat, Chess has developed the multisensor unit or MSU which is able to detect and track small airborne targets. Now that MSU has been integrated with a medium caliber weapon from Eran, which is a Swiss defense company part of the Rheinmetall group, to create what is one of the world's most potent counter-drone weapon systems. And it was announced just yesterday, the 12th of December, that 28 of those systems have been ordered by Austria, and a few months earlier they were also ordered by Denmark. And the seriousness of the drone threat, which has been so well illustrated by events in Ukraine, is likely to result in many more orders for this system in the coming months and years for Eran and for Chess as well. Now moving on, from Asia Pacific right through to the Atlantic, one of the greatest security challenges is driven by the need to detect and deter hostile submarines, and the best way of course to detect and track a submarine is to use another submarine. Elac has developed a new digital submarine sonar suit that allows more accurate detection and location than ever before. And perhaps the most advanced element of the suit is the flank array, which should be visible to you on the drawing of the submarine that you can see there, based along the side of the sub, and that's made up of panels of sensors and electronics attached to the side of the sub. Now I can't show a picture of the actual panels because the German security authorities have said that we mustn't, but I can tell you that each panel weighs several hundred kilos and it measures about two meters by a meter, and a fit of one submarine could include over a hundred of those panels. Elac is currently contracted now to provide three submarine fits, so that gives you an idea of the scale of the task that they're embarked on and just how busy that new facility is going to be. Now finally, a key technology for AUKUS pillar 2 and a vital capability for anyone facing Russian or Chinese forces at sea is going to be the ability to counter hypersonic missiles. The essential technique in dealing with anti-ship missiles is to launch decoys into just the right place to seduce and confuse the missiles. Now in the past that has relied on the ship maneuvering to be head on to the attack with fixed launchers to dispense the decoys in exactly the right direction, and that works fine at subsonic or just supersonic missiles perhaps approaching with a speed of 600 miles an hour. When a missile is approaching at something like a mile a second, that simply isn't feasible to make such a maneuver. And with support from Chess, Sea has developed a system called Ancilia that can train and launch the decoys at precisely the right angle and elevation in a matter of seconds. Now this product has already generated a significant amount of interest, and we believe that many nations will see this as an essential upgrade as well as an essential fit for new ships. Now to demonstrate that this is more than just a PowerPoint presentation, I'm going to show you a short video, I hope on the next slide, showing the Ancilia prototype in action. To give you an idea of the scale of the system, about 2 meters tall and fully loaded it's going to weigh about two tons. And the very fast slew and elevation that it does will allow ships to counter multiple simultaneous attacks from different directions, which frighteningly is a likely planning scenario that they'll have to face. To round off on the subjective investment and no less importantly, we maintain our strategy of seeking and investing in value-adding positions. We're very selective about those and we won't acquire a business unless we are convinced that it will add value and growth in the long term. But we do have an experienced acquisition team and we have no shortage of opportunities to review, that's for sure.

So I've talked so far in broad terms about markets and capabilities and demand. This slide shows the tangible results of the demand picture that I've described. And at over 350 million pounds, Cohort's period end order was stronger than ever before. It includes a very substantial element that will directly feed into revenue this year and next. You would see over 90 million for the second half of the year, and over 117 million already on order for next year. But it also includes over 145 million pounds of order cover for 2025-26 and beyond, guaranteeing a solid flow of revenue for a decade. As I mentioned earlier, since the end of October the order has continued to grow and it's now over 365 million, and that gives us over about 95% cover. Looking at the colors, you can see that the larger part of the order book now sits with Sensors and Effectors. Sea makes a very substantial contribution to this number, it's received a further boost to its order book in the period as you've seen, it has more opportunities to win new large long-term orders in the months ahead. Elac and Chess also add significantly to that total. In Communications and Intelligence, well MCL tends to operate naturally on a very short-term order book so its contribution to the total is quite modest. Mass's order book though is substantial but it only increases significantly in years when its large long-term service contracts are renewed or advanced. EID's order book is relatively poor at the moment, but there are some very important attractive opportunities with its domestic naval and military customers and with as I've explained the Portuguese Navy gathering some momentum on its new ship purchases. I think there is some room for optimism there. If we can move to the next slide, I will show you the first column of that chart in number form together with a comparison against the same position last year, and you can see that total growth in order book from 304 million to 354 million, which is 16%, and that's a very strong indicator of the potential for future revenue growth. The two shaded colors show the revenue already on order for the second half of the year, and that's compared to the same position in 2022. And in Communications and Intelligence we can see that the underpinning is a little behind where it was last year. MCL's ability to win and deliver new business in the year will have a big impact on the division's eventual performance, which we expect to be broadly in line with its performance last year. By comparison, in Sensors and Effectors, the underpinning for the year has risen from 43 million to over 60 million, which is an increase of 41%, and that positions us very well to meet external expectations for the year. Now that brings me almost to the end of our presentation, and to a summary of points that I wanted to make. It's been another pleasing year in terms of our performance. We're not resting on our laurels but we're very pleased indeed to be growing the size and strength of our group. Maybe more important, we've achieved another record order book and we see an excellent pipeline of opportunities ahead. And that order book as I mentioned now over 365 million in December, and achieving order intake in a period of a third higher than revenue is a very strong leading indicator of future growth. It clearly shows that there is strong demand and that our products are competitive in what is a market that is very capable against national peers. Our strong balance sheet enables us to invest in the products and capabilities that our customers will need as they look to keep themselves safe in what is becoming a more challenging global security environment, and I've shown you some examples of that. If we can, we'll accelerate our growth through targeted acquisitions of good businesses. We continue to expect to grow this year, and I've tried to explain a bit of what's behind that view in our presentation this afternoon. And beyond that, based on our order book and based on prospects that we can see, we expect that growth to accelerate. As a result of our performance and our prospects, the board has felt confident to increase the dividend once more by 10%. We've grown the dividend every year since our IPO back in 2006. So in closing, I want to take the opportunity to thank our management teams and employees for all of their hard work in the first half of the year and the success that they delivered. If we can switch to the final slide, let me leave you with this as a snapshot of how we see ourselves developing in future years. We've made considerable progress towards this vision since our earliest days in the market back in 2006, and our strategy continues to be to generate growth organically and where possible through acquisitions, while paying a dividend that reflects our successful financial performance. We believe this offers the best long-term returns for investors while creating high value employment and enhancing the security of the UK. That's all that we wanted to say. Thank you very much for your attention. If you have questions, we'll try and deal with you. We have plenty already, so let's dive in.

Simon, two or three questions. I'll try to roll together into recruitment, so I hope you can remember them all. Firstly, you've taken on a lot of people in the period. Is there any one or two or three particular subsidiaries that have been taking up the bulk of that intake? Secondly, if you're going after technicians or quality engineers, have they been easy and expensive to find? And then the last one, sorry for three, is do you expect this piece of recruitment to extend into the second half or even further?

I think it does, and there's never any harm in investing for the future.

Simon, Andy, M&A. Again rolling a couple of questions together. You know the group has completed successful acquisitions in the past. One question: are there particular regional areas or are you likely to look at products, add-ons if the opportunity is right? And second question: is it, I suppose unfortunately for the rest of us but good for defense companies, a difficult geopolitical background at the moment. Is that affecting prices of businesses that you might be looking at? And related to that, how do the two of you look at the financial criteria to apply to an acquisition?

No, not really.

Perfect, okay. Oh, you're not getting away that lightly, Simon. A possibly related question is about paying for it. I think a question on working capital and there are quite significant movements through previous years, and you've just detailed the successful on-budget investment in Kiel and the assets there. But the question is, within those peaks and troughs, how do the two of you look at assessing the capital required for R&D as well as what that leaves you in terms of the scale of M&A opportunity?

Yeah, very important point. And probably the last question related to EV, more of a judgment call for the two of you looking ahead. On that sort of three to five year period you've just mentioned Simon, is it the question from a shareholder is it reasonable to assume that strong organic growth is the main plank in that period and that you would hope to find suitable lemonade to accelerate that growth if it comes along, but if it doesn't you're still very happy with prospects?

Good. Just a little bit on current and prospective clients. We've got a question in. You quite rightly majored on the strong position that you have with members of NATO and now the AUKUS group. The question is: is that an exclusive group for exporting to? And related to that, are you confident or hopeful that the members of AUKUS will grow over time given the tensions in the region that you've alluded to?

Well, that's an interesting question. I'm not sure I'm the right person to answer that second part. But although I mean there clearly is some interest being expressed in certain capitals about this alliance and whether it might be open to additional parties. But I would say in answer to the first question, no, most certainly not. I mean we are a very wide exporter. We export strongly to the Middle East and to Southeast Asia, two very important regions for us. To a lesser extent but still important to South America as well, and to some extent into North America too, Canada. And we do a bit in the US, although it's a pretty difficult market to break into in defense. So we're a worldwide exporter, although the UK is our largest customer.

Yeah, and it's probably fair to say that it's a topical matter, but growth in the numbers of members of NATO is a distinct possibility as well. I would say it is well, I mean there is a very strong possibility that Sweden's going to join, it's nearly there. Finland already has. Those are two countries where we have a very good relationship, Sweden in particular, where they are both a market for us and a supplier of certain equipment to a very good defense industry.

Yeah, good. And then just, you know, perhaps the last one. You featured maritime border flow and the recent events have certainly raised the awareness of the importance of assets such as undersea cables and pipelines for strategic reasons. The question is: are you already seeing order flow? How do you see the time lag or response from governments who suddenly become aware of vulnerability? How many months or does it still take years for significant spending patterns to emerge?

I think when the government sees stark risks which are being thrown up by the Ukraine conflict, the response can be very fast indeed, and that's been manifested in the order intake that we've seen. In times where risk is less obvious and less stark, then things tend indeed to slow down a little bit, and the emphasis becomes on sort of long-term strategic decisions rather than responding to an immediate threat. But we've seen how governments not only in the UK but elsewhere can respond to a rapidly changing situation, and that is pretty impressive. And we've, you know, it's been our mission to respond just as fast to the requirements.

Very good. Very last one for you, Simon. We've got a comment here that I echo: it's very nice to go through a presentation without hearing about logistic and supply chain problems. So you obviously seem to be in control of the situation. Is it fair to say there are no material residual problems?

Right, excellent. Well, thanks very much to our audience for a wide range of interesting questions. A quick reminder that not only this deck but ultimately the recording and a recent research report out from Mike J Equity Development is available on our site, will be available on our site and on the Cohort website soon. Thank you very much to our presenters, and we wish you all the best for H2 and the many years where you have forward visibility of orders. May it all turn into cash. Thank you, Andy. Thank you.