Earnings Transcript for SDI.L - Q4 Fiscal Year 2024

Operator: [Abrupt Start] Investor Presentation. [Operator Instructions] The company may not be in a position to answer every question it receives during the meeting itself. However, the company can review all questions submitted today and will publish those responses where it’s appropriate to do so. Before we begin, we would just like to submit the following poll. And as usual, if you would give that your kind attention, I’m sure the company would be most grateful. And I would now like to hand you over to CEO, Stephen Brown. Stephen, good afternoon, sir.

Stephen Brown: Good afternoon. I would like to welcome you on behalf of myself and Group CFO, Amit Sharma. It is a pleasure to be hosting my first set of full results as CEO of SDI Group for FY ‘24 which had been somewhat of a tale of two halves with a stronger second half. For those of who I have not spoken to before, I joined the business at the tail end of September 2023 initially as Chief Operating Officer. In that role, I had a clear brief, not only to accelerate M&A, but to get under the skin of each of the portfolio businesses and understand what was working across the portfolio and what could be improved. I visited each of the businesses on multiple occasions, spending time with the management teams to understand them, the markets in which they operate their positioning within those markets, and potential opportunities. When Mike Creedon stepped down in January, I became CEO and now the opportunity to not only pick some low hanging fruit, but to develop a forward-looking strategy based on the thorough understanding of the portfolio that I had built during my time as COO. Alongside a review of FY ‘24 much of which we covered today will be explaining our refined strategy for the business and how we are going to deliver sustainable growth going forward. In terms of an agenda, I will do an overview of the group, our model and our portfolio. Amit and I will then provide an overview of FY ‘24. The financial results will then be covered in more detail by Amit. Amit will then hand back to me to provide a strategy update. I will then wrap up with a brief summary and run through the outlook for the future. We will of course leave plenty of time for Q&A at the end of the presentation. So please submit your questions as we progress. The message here is that we are not intended to radically change the existing SDI model, but it is reset time. It’s a new dawn, a new phase for SDI. We have clarity about what SDI is going forward and the true value proposition. The key takeaway from this slide is that the group is now a sustainable and robust platform on which to build the next generation of SDI. We can simply define our strategy in two parts

Amit Sharma: Thank you. Stephen, Good afternoon, everyone .You’ll have seen the numbers this morning, so I don’t spend a lot of time on this slide, as I will talk about them in a little bit more detail later on in the presentation. In summary, it was a robust performance given the challenging macroeconomic background and the difficult comparative numbers, which included a considerable amount of COVID-related revenue. When you exclude that COVID related revenue from the prior year, the business was largely flat organically, whilst inorganic growth was up nearly 11% representing £7.2 million. Most importantly, we generated a significant amount of cash over the period. With cash generated from operations being £9.4 million, which was down £1.5 million year-on-year, but was significantly lower in the profits reduction of circa £3 million. As Stephen mentioned earlier, we delivered a much stronger half with improvements in revenue, profit and cash. Finally, just to note, the tax rate has increased for everyone from 19% to 25% and that has had an impact on adjusted diluted EPS. So I’ll now hand back to Stephen, who will detail the operational delivery during the year.

Stephen Brown: Thank you, Amit. This is a reflection on the year just gone during which, as Amit said, we have delivered robust results despite the headwinds faced particularly in the first half of the year. These included the unwinding of COVID related orders are related destocking by key customers and the higher cost of debt. The financial implications of which, Amit will review later in the presentation. We did deliver a much stronger second-half to the year with the changes to the SDI management team and revised strategy in place. We took proactive actions in a number of areas, including transitioning from a reactive to a proactive approach and gaining commercial traction within the portfolio, which delivered improved performance in the second-half. We also delivered a new acquisition mid-year Peak sensors, which contributed £1million in sales. As Amit has mentioned, we delivered strong cash generation whilst continuing to invest in enhanced capabilities during the year. Looking forward, this year has been about building the platform for sustainable growth going forward and we achieved a great deal. Our new strategic framework is in place, Amit already seeing successful collaboration between our portfolio companies. We have continued to invest in development of the businesses with £1.8 million has been spent in R&D and product development, largely in Synoptics, Fraser, Chell and Atik. We now have dedicated resources to continue to drive our organic growth strategy and a renewed focus for inorganic growth strategy. We have a strong active M&A pipeline in place with a demonstrated track record of delivering on these opportunities and financial headroom to execute. With our focus on sustainable future growth, we have taken a more conservative approach to forecasting client contracts and guidance. As a result, we have adjusted our EBIT guidance for FY ‘25 from £11.5 million to £9.7 million. This change is driven by three factors financially equally portioned. The first is a proactive decision to implement a new incentive scheme for our portfolio management to align targets and drive future growth. The removal of a significant new contract at LTE and a similar change at Atik. Whilst we mentioned this is the half year results, just a reminder that we did complete one M&A transaction during the year Peak sensors. The business fits well within our industrial and scientific sensor segment and has contributed £1 million in sales. I will now hand you back to Amit, who will look at our financial results in more detail.

Amit Sharma: Thanks, Stephen. Sorry, turning to the income statement. As I mentioned earlier, revenues were broadly flat year-on-year with £7.2 million of revenues from acquisition stroke disposals being offset by the loss of £8.5 million of COVID-related revenues. Pleasingly, we have increased gross margins and are like for like basis, although on a reported basis, they were flat. Adjusted operating profit for the year is reduced, largely driven by the loss of gross margin from the aforementioned COVID related revenue, which totalled £5.6 million adjusted PBT, has been impacted by interest charges of circa £1.6 million for the year, higher as we had a full year of increased debt levels versus FY ‘23. Reported profit before tax fell by just over 3%. The comparative included an impairment and I’m pleased to report that there are no impairments this year. As you can see, the adjusted diluted EPS has fallen by slightly more than the reduction in the adjusted profit before tax. This is as a result of the increased tax rate I mentioned earlier. This slide illustrates the many moving parts of SDI’s revenues. In FY ‘24, we had £6.2 million of revenues from FY ‘23 acquisitions and £1 million from Peak sensors. You can see the reduction from the COVID related revenues of £8.5 million and a small reduction in the organic column, so largely flat year-on-year. We talked about the re segmentation of the business earlier on. Here we have highlighted the key numbers within the old segmentation structure to help you track against previous results and the largest division sensors and control this all revenues increased by 17.6%. All of the acquisition revenues were in this segment and they delivered 2% organic growth. There was an increase in operating profit and we saw particularly good performances at scientific vacuum systems and Monmouth, the latter who delivered a particularly strong second-half. In the digital imaging segment, which include Atik Cameras, Synoptics and Graticules, sales dropped by circa £10 million. If you strip out COVID related comparatives, the organic decline was 11%. As you mentioned at the half year, there was a significant destocking by one of Atik Cameras largest OEM customers, not the COVID related customer. And this led to reduced revenues of nearly £1 million. As a result, adjusted operating profit reduced to £2 million from £6.9 million for the previous year. Whilst relevant going forward, we thought it would be helpful to present the FY ‘24 results in the new segment structure as well. In lab equipment, we had revenue growth of nearly 8%, including a full year contribution from LTE scientific. When adjusting for LTE’s non-organic revenues were an organic decline of 1.6%. Adjusted operating profit grew to £3.2 million. Looking at the detail underlying that, we saw strong demand at Safelab for their fume cabinets and Monmouth clean rooms, which as we mentioned earlier saw strong demand in the second-half. This was offset by a slower end market for LTE scientific as the NHS reduced its pace of spending. In industrial and scientific sensors, revenues grew by nearly 2% with peak providing £1 million of revenues. When that is taken out, you have an organic decline of 4%. Operating profit was largely flat in this segment. And looking at the underlying detail the main movers were Chell, we saw a strong demand for its back product and Sentek, we saw some destocking after a record FY ‘23 a reduction that was expected but nonetheless contributed to the organic decline. Looking at the product segment, this is where the COVID related revenues fall and therefore unsurprisingly, revenues declined by nearly 15%. However, when we strip those out, as well as a non-organic element of the contribution from fast which was an FY ‘23 acquisition, we delivered organic growth of 3.5%. Adjusted operating profit fell with the comparatives including the COVID-related gross margin. The big driver in the segment the scientific vacuum systems which delivered one large system in the year and started work on two others. As I said at the half year, focus was going to be on reducing working capital in the second-half and that’s what we’ve done, and which is reduced by £3.3 million across multiple businesses as we de stocked, we reflecting our customer base. The reduction in customer advances, which have been a feature of the past couple of years, fell by £2.7 million to £2.1 million. But I’m pleased to say that we haven’t seen any further reduction since the half year. We generated £3.8 million of free cash flow in the second-half of the year. A very strong performance given our current expects about £6 million of free cash flow across the course of a normal financial year. And this contributed to net debt being flat. That free cash flow was used to finance the acquisition of Peak sensors at £2.4 million and the £1 million paid in December for SVS which was the last deferred consideration on our balance sheet. So looking at our net debt position. We are at £13.2 million, which was flat compared to the half year – compared to the half year and FY ‘23. We’ve extended our revolving credit facility by a year and we had headroom of £10.4 million at the end of the financial year. That has increased to £11.5 million of headroom at the end of June and we’re expecting headwind to increase yet further by the end of July. In addition, we have a £5 million accordion option available to us at the discretion of HSBC. This slide just illustrates the various cash flow movements I talked about on the previous slide and that we ended up in the same position at the end of the FY ‘24 as we were at the end of the FY ‘23. With that, I will now hand back to Stephen.

Stephen Brown: Thanks, Amit. I now wanted to talk a bit more detail about our refined strategy, both organic and inorganic on how we have focused and clear strategies to drive growth through both. This is not a radical change to the established direction of SDI. The re segmentation of our businesses into three specialist areas will support and speed up growth, whilst portfolio adhesion is important. However, the retention of the independent brands and culture of our portfolio businesses is key to our success. We empower our individual leadership teams and give them direct ownership of performance, culture and robustness of their businesses. We also recognize that one size does not fit all and that in a portfolio of the size we have businesses with differing support needs depending on which stage of the growth trajectory they’re on. The key to our organic growth strategy, therefore, is ensuring each business has a growth and the sustainability plan relevant to the individual business and the dynamics of the market in which they operate. And then has the skills to deliver on that plan and take proactive actions to gain, strong market traction. We talked earlier about the importance of our inorganic growth strategy, our renewed approach and clear focus on delivery. We are rightly proud of our track record in delivering earnings enhanced acquisitions. And going forward, we retain the core criteria listed here as key for potential targets. What is new is our focus on businesses that will also give the double bump mentioned earlier, where integration into the group can provide new growth opportunities for existing portfolio of businesses and provide diversification of our customer base. Earlier in the presentation, we talked you through the three new segments of the businesses based upon specialisms and potential target markets. The main purpose of doing this is to encourage synergies amongst those businesses and help accelerate the growth plans of the individual businesses within them. The focus of these activities can then be seen here and includes improved collaboration, improve with the market and sharing resources. This enables a group to capitalize on those synergies and drive organic growth across segments and target markets rather than just on a business by business basis. This is not a radical change to the established direction of SDI, but an improvement by adding increased governance to the portfolio of businesses and positively impacting their effectiveness without changing the underlying ethos that has served SDI well in the past. You can see on the left of the screen a summary of everything we have talked about in relation to FY ‘24. I am very proud of all of the team from across the portfolio for the hard work, delivering a robust set of results despite the number of challenges, particularly in the first half of the year. At the same time, we have a refreshed SDI management team and started to implement our refined strategy for growth going forward. Turning to the future, we have our first we focused acquisition strategy, a healthy balance sheet alongside strong access to capital. The group is supported by a number of long-term growth drivers. As articulated earlier, we have revised our market guidance to reflect a more conservative approach to forecasting client contracts. We have put in place operational efficiency initiatives to support margin growth. We have an extended central team capacity to support strategic delivery, both organic and inorganic. We have a highly active M&A pipeline and fire power to execute and continued strong cash generation. All of those things give us confidence in delivering sustainable long-term organic growth of 5% to 8%. So, that concludes the presentation part of the meeting. So, we will hand to Amit, who will oversee the Q&A.

A - Amit Sharma: Thank you, Stephen. Okay, we will start talking from the top. How big in the size do you think you can make an acquisition in FY ‘25? Also, will you maintain target EBIT 4x to 6x multiples for acquired companies? Do you want to answer that one, Stephen?

Stephen Brown: Absolutely. So, we will be looking at acquisitions larger than the last one that we did of big sensors. And the EBIT target will be roughly 3x the size of that, but we will maintain our flexibility. In terms of multiples, the four to six is still our target and that multiple is based on the enterprise value or the goodwill value of the business and that remains constant. So, the SDI model does maintain the difference is the size of the target.

Amit Sharma: Okay. Is the focus still to pay-off all debt from your acquisitions? If so, how long will it take to pay-off debt? Well, if we want to continue to pay-off debt, it will take around 2 years to fully pay off the debt. I think the guidance suggests that we would pay it off within net gap will be around GBP7 million at the end of FY ‘25, so another year. The focus is not to pay a full debt. We are still actively looking at M&A and so, no, the answer to your question is no, we won’t pay-off all debt before more acquisitions. And the target really is to stay within the net debt to EBITDA range of between 1x and 1.5x. That’s kind of – that’s where we have said previously where we would like to be from a debt from a leverage standpoint. In H1, digital imaging suffered from high comparables, one time, COVID, but also due to customer concentration. Can you provide details and customer concentration for each of the businesses or at least the aggregate? Well, we don’t go through everyone in detail cause we have 14 disparate businesses, all of whom doing do different things would be here a while. But what I can tell you is that the biggest customer which was the same group that we had the destocking from was like about 3% of revenues. And then we have venture customers at around 2%. So and then it trails off quite dramatically. So, it’s not a very big concentration. And so it’s not very significant, I will say in terms of the top 10. Following on from the customer concentrations, Stephen mentioned, half one call that he would work on reducing customer concentration, especially Attic Cameras. What have you done so far in this regard? And what is the plan looking ahead 2 years to 3 years? Stephen, do you want to go on for that one?

Stephen Brown: So, specifically this referred to Attic Cameras. Attic Cameras has been subject to management, interaction, intervention. So, we have focused on our business quite considerably. There is a KPI for that business to bring on further OEM customers, to dilute, they have the reliance that we reported earlier. We also on the H1 results last year we spoke about diversification of market. So, we spoke about going into the professional astronomy market, also. We have now been successful in doing that and we have won a significant order in that market segment. And so that’s been a success, but the drive continues. So, we are seeing success, but it remains a strong KPI for that business going forward.

Amit Sharma: Okay. In today’s notes and results, Ken Ford mentions the Board has decided not to pay a dividend. Is there external pressure on SDI to distribute dividend? Wants to know, there is no external pressure, we just do evaluate this annually, it’s just part of our processes. So, no, just to answer that question specifically, we – there is no pressure. And if I think there is for the question elaborates that the net debt is 1.67x net debt to EBITDA, it’s not, it’s 1.07x, so it’s under 1.1x. So, we are not highly leveraged. So, the question initially suggests. So, I hope that answers that one. So, this one is around our former CEO, were shares placed when he left, or is he still a shareholder? My understanding is he is still a shareholder. So, hopefully that answers that question. Okay, why are FY ‘25 earnings expectations set today by Cavendish-Progressive just above FY ‘24, when you will have a full year impact of operational improvements in cost savings, acquisitions and synergies? So, first of all, we don’t include acquisitions in any guidance because we don’t know when they are going to happen. Cost savings and synergies, do you want to answer?

Stephen Brown: Yes, absolutely. So, we are seeing FY ‘24 is very much a reset here. Yes, there will be cost savings put in place, but it takes a little time to percolate through the group. So, we are saying very much as FY ‘25 as a reset year. And we are, as we said in the presentation, we are looking to make it, to make a guidance more conservative going forward, and that’s what we intend to do.

Amit Sharma: Okay. Congratulations for half two, FY ‘24. I wanted to ask you about FY ‘25 capital allocation. Have you seen hard negotiations with sellers related with price?

Stephen Brown: Again with a diverse portfolio we have got, that’s a difficult question to answer specifically. Some businesses are saying some very hard negotiations taking place.

Amit Sharma: In terms of M&A?

Stephen Brown: Yes. If we are talking about M&A, are they changing, not really. If I am honest, it’s part of the – I think that the strength of SDI, where we can get an – acquired a target at the right stage. And in terms of driving the price, we are not really seeing much difference.

Amit Sharma: Okay. Can you say more about where our end investment has been targeted? Are there tangible new products delivered from the spend which will be saleable this year?

Stephen Brown: Yes, there has been so, so most of the – so if we look at the businesses where we invested in most, Synoptics has got a new article product. Fraser Anti Static have launched their X-Series bar for instance, the camera has continued the CCD CMOS transition. So and all of which are on the market this year. So, the answer to that is yes, how much we are going to sell this financial year thing remains to be seen because we have very much view the market and their new products in the marketplace. So, how much we are going to realize of that this year, I think remains to be seen.

Amit Sharma: How do you perceive the balance sheet with NTAV of GBP3.4 million as healthy? I think the common around being a healthy balance is more around leverage at one time. So, we are not heavily levered. I think that’s kind of how we perceive it. So, I appreciate the ratio that that this question is quoted, but it’s we – the comment is around the leverage levels that we have. What have highly acquisitive companies such as judges and diploma done differently or better than SDI in the past, than what can you learn from it going forward?

Stephen Brown: So, a very long question, we could be talking all day about that one.

Amit Sharma: Yes, we could do.

Stephen Brown: And I think if you look at it on the present day judges and diploma go after much larger targets, they do. The multiples are considerably higher, so the model it does differ somewhat. As we continue to grow and our strategy which we just presented to you shows that we will be growing and continue to grow. What the future looks like for us and how that’s going to transition, I think remains to be seen, but certainly for the foreseeable years that we certainly we have got some vision of. We are going to be Adam. We are going to be looking at acquisitions smaller, then judges where we can control our multiples going forward.

Amit Sharma: And the other comment I would like to add to that is that judges have focus their acquisitions on supporting existing businesses within the portfolio. They will find their M&A strategy. And I think that’s kind of what we are doing as well, as you heard us commenting on today. So, we have let, well, they were more focused than what we do. It is more similar to what judges would do nowadays.

Stephen Brown: Yes. And we are monitoring all the buy and build models out there at the moment and hopefully learning from them, so absolutely. So, the strategy we have just presented to you is hopefully not it’s taking consideration learnings and successes out in the marketplace as well.

Amit Sharma: Could the company confirm that they will continue to fund acquisitions out of debt and cash flow and not undertake it placing at such a depressed share price? I mean our focus is to use our free cash flow to fund acquisitions. That’s kind of what we will do and we will continue to do and we know the comment around the share price. Okay, two questions. So, two questions. SDI, the strategy in the past 5 years to 7 years to focus expansion on sensors, betting on the industrial trend of automation, but the organic growth in this area has been average. So, what do you think of this? Do you have any sector focus for their M&A going forward?

Stephen Brown: The M&A focus will be to feed into the new segmentation, which we have communicated. The sensors side of the business, it does have some plan automation, but albeit limited. The sensor play in the automotive space is highly competitive. We typically go to niche or regulatory driven industries going forward. So, I think within our sensors divisions, they are very diverse in nature in terms of markets they play in. So, we will – we are looking at a potential refocusing and looking some diversification, some of our sensor businesses. But I think it’s very much work in progress.

Amit Sharma: Okay. How would you quantify the risk of further impairments as a result of the current very high intangibles of more than GBP42 million? So, I will answer that one. We have no impairments this year as I stated in my in our meeting or explanation of the results. We do an annual exercise to assess in payment. We have plenty of headroom and most of them and you do this exercise every 12 months. As a buy and build company, we will – that intangible balance will increase simply because we do pay a goodwill for the acquisitions that we make, some of that will be classified as goodwill, some of that will be classified as customer relationships and other intangibles, which is amortized. So, you do see an amortization. So, what’s the quantified the risk, well, there isn’t any independent as we speak today, but the way that the impairment calculation works is that you do it every 12 months and you look forward another 5 years. So, I would say that the risk is low, but it’s never impossible. But I think it, it unlikely added today. Okay. We don’t have any more questions today. So, I think that’s it.

Stephen Brown: Yes.

Amit Sharma: I mean if I may just jump back in there and thank you very much indeed for addressing all of those questions that came in from investors this afternoon. And of course, if there are any further questions that do come through, we will make these available to you immediately after the presentation has ended. Just for you to review to then add any additional responses, of course, where it’s appropriate to do so and we will publish all those responses out on the platform. But Stephen, perhaps before really just looking to redirect those on the call to provide you their feedback, which are those particularly important to yourself and the company. If I could please just ask you for a few closing comments to wrap up with. That would be great.

Stephen Brown: And all I can say is thank you again for your time today and look forward to seeing you again in the future.

Amit Sharma: Thank you.

Stephen Brown: Thank you very much.

Operator: Perfect. That’s great. Stephen, Amit, thank you once again for updating investors this afternoon. Could I please ask investors not to close this session as you will now be automatically redirected for the opportunity to provide your feedback in order the management team can better understand your views and expectations. This will only take a few moments to complete, but I am sure will be greatly valued by the company. On behalf of management team with SDI Group Plc, we would like to thank you for attending today’s presentation. That now concludes today’s session, so good afternoon to you all.