Oxford Instruments PLC

LSE:OXIG

Earnings Call Transcript 2023-Q2

[Ian Barkshire, executive]

Hello, and welcome to Oxford Instruments half year results. I'm Ian Barkshire, Chief Executive, and I'll begin today by summarizing the highlights and covering our investment case, our performance in the half and our progress on sustainability. I will then hand over to Gavin Hill, our CFO, for the financial results and operational review. I will return to talk to the structural drivers for our end markets and share some examples of how we are accelerating our customers' progress, closing with a summary and outlook.

Moving straight to highlights. The group delivered a strong financial performance with strong order, revenue and profit growth, reflecting our strategic positioning in structural growth markets. We have delivered continued growth momentum with our business model, found in our market intimacy and relentless product innovation providing resilience to the global headwinds all businesses have faced over the past few years. We are performing strongly across all our major end markets and in Asia, Europe and North America with growth from both commercial and academic customers. Significant order growth to commercial customers is in line with our strategy to expand into larger and adjacent markets.

We've been proactive in managing external challenges, implementing price rises to address inflationary pressures and investing in increased inventory, which has partly mitigated supply chain disruption. With innovation at the heart of our strategy, we have increased investment in R&D as well as investing in further operational capacity to support our future growth.

Let me remind you of the key elements of our investment case to deliver sustainable growth and increased margins. Our purpose as a group is to enable a greener, healthier, more connected advanced society. Through our strategy, we have built scale and differentiation within our carefully chosen markets. Each have long-term structural growth drivers, underpinned by the need to transition away from fossil fuels to improve health care and to forge the digital connectivity, which powers our modern world.

In these markets, our technologies and services provide leading capabilities to image, analyze and manipulate materials down to the atomic and molecular level. These capabilities accelerate our customers' road maps, helping many of the world's leading companies and foremost scientific communities to make the bold leaps that will further global progress. The unique combination of our deep focus on understanding our customers and the drivers of our end markets, what we call our market intimacy, and our significant investment in product development, enable us to anticipate and deliver the transformational shifts which delight our customers To augment our organic growth, we will continue to add complementary acquisitions that create value within our markets.

Looking at strategic progress in the period. Our market intimacy, together with our focus on disruptive innovation and product development, has supported strong growth with recently launched products to both our existing customers and expansion into new and adjacent markets with particularly strong growth to commercial customers. We continue to fuel organic growth through increased R&D investments, representing 9% of revenue in the period. Our ongoing operational excellence program has supported our first half performance. And in the period, we have strengthened relationships with our strategic suppliers, increased inventory levels to support customer deliveries as well as investing in increased capacity and automation to support future growth. In customer support, our continued consolidation of regional service teams and our increased range of tailored products, including remote digital services, drove growth and increased productivity.

Looking at acquisitions, I'm delighted with the progress of WITec, which is performing ahead of our expectations as we drive revenue synergies across our portfolio. With our strong balance sheet, we have continued to build an attractive pipeline of potential future acquisitions. Looking forward, we can see significant opportunities for further gains from the continued execution of our strategy.

Moving to a more detailed look at our end market performance in the half. Our focus on structural growth markets have supported constant currency order growth of 13% with double-digit order growth across our key segments of Semiconductor & Communications, Advanced Materials, Energy & Environment and Quantum Technologies. Within Healthcare & Life Science, strong double-digit order growth across our optical microscopy portfolio was offset by the timing of OEM framework orders for scientific cameras and x-ray tubes.

The strength of our portfolio has enabled us to increase prices to protect margins in the face of inflationary pressures with benefit to flow through in the second half due to the length of our order book. We have continued to expand our customer base with higher growth to commercial customers representing 53% of orders compared to 45% back in 2019. Revenue in the period was impacted by supply chain disruption, ongoing COVID-related restrictions at customer sites and delays in the processing of export licenses for China. Despite these challenges, the group delivered 10.2% constant currency revenue growth with strong growth in each of our primary markets. apart from Semiconductors & Communications, where supply chain issues held back revenue. In Research & Fundamental Science, revenue declined in line with our managed move away from bespoke one of complex systems.

Turning to look at our progress on sustainability. Our purpose underpins our wholehearted commitment to making a positive impact on the world through our products, through our own operations and by behaving as a responsible business. From an environmental perspective, having significantly reduced the emissions from our own operations, they now constitute a small proportion of our overall environmental footprint. Whilst continuing to drive these down, we are now increasing our attention to the emissions within our supply chain and from customers' use of our own products.

In the period, we have engaged with our strategic suppliers to better understand how their programs can support our journey to net zero, and we are reviewing how we can reduce the environmental impact of our future products. We remain on track to outline our short-, medium- and long-term carbon reduction targets at the end of this financial year.

In terms of our social impact, we are committed to being a positive, diverse and inclusive place to work. Through living our values, increasing employee communications and instigating new employee engagement groups, we have high advising employee engagement scores. As an example, our values informed our decision last month to make a one-off cost of living payment to employees earning up to GBP 40,000. I would like to take this opportunity to thank all of our employees for their commitment and contribution to our continued positive progress.

I will now hand over to Gavin for the finance and operational review.

[Gavin Hill, executive]

We saw good growth in orders of 13% at constant currency. Revenue growth of 10.2% at constant currency has been moderated by global supply chain disruption and U.K. export license delays. Reported adjusted operating profit grew by 20.3% to GBP 36.8 million, equivalent to a constant currency increase of 4.6%. Constant currency margin has fallen by 90 basis points to 17.1% from 18% last year. This is because of prices not yet offsetting inflationary pressures due to phasing of the order book and lower shipment growth than anticipated not supporting investment in head count, made to drive growth and deliver improvements to operations.

We have benefited from a currency tailwind primarily due to the strong U.S. dollar. Reported adjusted operating profit grew by 20.3% with the operating margin rising to 18.4%. Adjusting items include amortization of acquired intangibles of GBP 4.3 million, the increase reflecting the additional amortization of intangibles following the acquisition of WITec. A charge of GBP 6.1 million reflects the mark-to-market movements in the revaluation of forward contracts hedging future cash flows, which we entered into prior to the recent weakness in sterling. Adjusted profit before tax increased by 23.5% to GBP 37.3 million. Adjusted basic EPS increased by 23.3% to 50.8p. The interim dividend of 4.6p per share reflects an increase of 4.5%.

I will now briefly look at the high-level revenue and adjusted operating profit movements by sector before turning to each sector in more detail. Supply chain and operational disruption have impacted both the Materials & Characterisation and Research & Discovery segments to different degrees. Materials & Characterisation grew by just under 20% at constant currency with supply chain disruption holding back shipments into the compound semiconductor market. Excluding the impact of WITec, organic constant currency growth was 10.8%.

Supply chain and operational disruption, along with the delay in export licenses, have impacted Research & Discovery more heavily, resulting in a fall in the level of shipments. We are still unwinding some complex bespoke cryogenic and magnet system orders. These are expected to be completed and shipped by the year-end. The WITec acquisition has been fully combined into our regional and segmental business model, creating additional revenue through sales synergies. The business delivered revenue of GBP 9.7 million over the period. The strengthening dollar resulted in a currency tailwind of GBP 13 million.

Reported group adjusting operating profit increased by 20.3% to GBP 36.8 million, equivalent to a margin of 18.4%, up from 18% in the prior period. Constant currency adjusted operating profit grew strongly from Materials & Characterisation and Service & Healthcare. The reduction in profitability and margin in Research & Discovery is attributable to the level of shipments in the half not being sufficient to cover investments made in head count in addition to order book phasing. We expect an increase in operational output in the second half.

We have seen good double-digit order growth driven by investment in silicon semiconductor production and demand for compound semiconductor processing systems. However, revenue was held back by supply chain disruption, limiting the number of etch and deposition processing systems that we shipped in the period. Our portfolio of imaging and analysis systems include our market-leading x-ray and electron analysis systems used in conjunction with electron microscopes as well as our performance-leading atomic force microscopes. These are used within the manufacturing processes to measure composition and structure.

We have also seen continued investment in materials research and battery technology, supporting demand, particularly for our imaging and analysis systems. WITec and its Raman imaging technology is supporting growth across all our end markets.

Investment in health care research has led to good demand for our scientific cameras and confocal microscopes. Our benchtop microscopy systems, along with dedicated analytical software, have been designed to offer leading health care research capability. For example, these are being used in cancer and dementia research given their leading imaging capabilities and intuitive ease of use. Operational disruption and export license delays have tempered revenue growth in the period for Healthcare & Life Science.

Demand for our cryogenic systems and scientific cameras is being driven by an increase in research in quantum computing as governments and commercial enterprises accelerate their research as they strive to deliver transformational changes for adoption of the technology. The tightening of export control to China in the quantum sector has led us to reorientate our resources towards North America and Europe. We continue to reduce the proportion of bespoke complex cryogenic and magnet systems for use in Research & Fundamental Science applications, resulting in a reduction in this market segment.

We have been increasing head count to drive future growth and deliver improvements to our operational capacity and processes. During the half year, price rises have not fully translated into revenue owed to phasing of the order book. Because of a lower level of anticipated shipments due to operational issues and export license delays, profit and margin have both fallen for the segment.

We've seen good growth in our service segment, supported by implementation of a regionally led service model. Analytical software sales into life science applications have performed well in the period driven by tailored packages to specific applications. In addition, we have seen healthy conversion of free introductory licenses offered during the pandemic to those that are now fee-paying. Our business in Japan for MRI health care customers continues to deliver excellent levels of quality service and support. The improvement in margin is supported by in-year contract efficiencies in Healthcare & Life Science.

We've seen good revenue growth across our primary regions. Revenue at constant currency grew by 12% in new Europe driven by growth in our electron analyzers and semiconductor process systems, along with the incorporation of fee-side revenue. Strong demand for our semiconductor processing systems and new Raman technology supported strong constant currency growth in North America of 23%. Constant currency growth in Asia of 4% reflected good growth across Materials & Characterisation partially offset by lower shipments into China for the compound semiconductor market and a strategic reorientation away from the China quantum market owing to difficulties in obtaining export licenses. Total group revenue in China grew 3% constant currency against last year.

With respect to orders, we have seen good growth across Europe, North America and Asia for all our end markets. With total orders in the half year of GBP 235 million, our book-to-bill ratio was 117%. The total order book of GBP 316 million has grown by 29% against this time last year on a constant currency basis, providing good visibility for the remainder of the financial year. The order book has grown by 15% in constant currency since March 2022. We have witnessed very strong growth across all Materials & Characterisation constituent businesses with organic constant currency growth of 47%. Research & Discovery grew by 17% with strong demand for our imaging and microscopy products, particularly in the second half of last year.

Turning now to the cash flow. Working capital increased by GBP 12.6 million. This reflects an increase in inventories due to our focus on ensuring we are able to continue to make deliveries to customers and an increase in finished goods awaiting export license clearance. In addition, high level of shipments closed the half year-end due to late supply deliveries has increased receivables. Good growth in orders has delivered an improvement in our level of customer deposits.

Cash conversion was 65% on a normalized basis, which excludes expenditure relating to the new semiconductor facility. This is an improvement on last year's conversion of 53% on the same basis. Capital expenditure of GBP 11.5 million includes GBP 6.4 million relating to construction of our new semiconductor facility. In the second half of the year, we expect additional payments of GBP 12 million as we progress with the fit-out of the facility with a further GBP 10 million the year after.

Deficit recovery payments of GBP 4.1 million were made to the U.K. defined benefit pension scheme. We are recording an accounting asset of circa GBP 25 million. And despite the fall in the asset value due to rising gilt yields, our LDI investment strategy is working well, maintaining the quantum of the actuarial deficit, and we remain on track to attain funding self-sufficiency in 2025.

Net cash was GBP 97.1 million at the end of September up from GBP 85.9 million as at the 31st of March. In October this year here, we advanced GBP 4 million into the U.K. defined pension scheme to meet collateral calls in case gilt yields worsened. It is not expected that these funds will be required given the relatively cautious investment strategy adopted by the scheme. The company maintains [indiscernible] to recover them in the future. During this month, we will pay the full earnout consideration for WITec of EUR 5 million.

As we presented, this business has a large exposure to foreign currency fluctuations. This chart shows a long positions for our major trading currencies as well as a short sterling position. As you can infer from the previous slide, the group's financial results are subject to currency fluctuations. We maintain a hedging program to mitigate currency movements up to 18 months forward from the next reporting date, covering up to 80% of forecast transaction exposures.

In the year, we recorded a favorable currency impact of GBP 13.1 million to revenue and GBP 4.8 million to operating profit. Looking ahead to the full year, our assessment of the currency impact is based on hedges currently in place and forecast FX rates, an increase in revenue and operating profit of approximately GBP 28 million and GBP 3.5 million, respectively, the full year profit impact being lower than at the half year due to a higher proportion of out-of-the-money forward contracts crystallizing in the second half of the year.

Currencies have been particularly volatile this half year. Forecast rates used are 1.17 for sterling and dollar; 1.16 for sterling:euro and 1.70 for sterling:yen. Looking further ahead to the financial year '23, '24 using the same currency rate assumptions, we would expect a broadly neutral impact to revenue and a GBP 1.8 million benefit to operating profit. The actual currency impacts will be dependent on currency volumes and mix as well as currency related to the timing of shipments and customer acceptances and is, therefore, subject to a high degree of uncertainty.

To summarize key financial highlights from the year, we have seen good growth in orders of 13% at constant currency, and despite disruption to shipments, revenue grew by 10% at constant currency. Along with this disruption, the phasing of pricing increases to combat inflationary pressures contributed to margin dilution at constant currency. We expect some alleviation in the second half as price rises feed into revenue.

The business delivered strong adjusted EPS growth of 23% supported by currency benefit. An increase in net cash of GBP 97.1 million further strengthens our balance sheet to support future growth in the business through organic investment and acquisition opportunities. We anticipate that the geopolitical environment will continue to result in the tightening of export license regimes with respect to China, and unexpected supply chain disruption remains an operational risk to the business. Nevertheless, we ended the half year with a strong order book and pipeline, providing good visibility in the future.

I'm now handing back to Ian.

[Ian Barkshire, executive]

Thank you, Gavin. I will now provide an overview of the key drivers shaping our end markets and share some examples of how we are supporting our customers. The health and [indiscernible] of our end markets has played a critical role in the positive performance of the group. And as customers seek to accelerate their progress towards a more sustainable future, we've seen the structural growth drivers across our markets reinforced. This has stimulated demand and increased funding across both academic and commercial customers.

In Healthcare & Life Science, the pace of discovery is accelerating, as scientists seek to gain ever more detailed insights in fundamental disease mechanisms and the development of new treatments and more effective medicines at much reduced costs. Digital connectivity is shaping the society of the future and transforming sectors and industries globally. The resulting demand for data, increased connectivity and ever more sophisticated electronics is fueling rapid growth in our Semiconductor & Communications markets.

In Advanced Materials, our products are playing a vital part in helping customers develop and optimize the new materials, which form the building blocks of modern society. Likewise, in Energy & Environment, the need to transition away from fossil fuels and to provide food and water security in the face of climate change offers a powerful driver to create more sustainable solutions. Investment in quantum technology continues to increase across governments and commercial companies due to its potential to enable transformational disruption of established end markets such as pharmaceuticals, logistics and finance. Activity in Research & Fundamental Science drives longer-term economic and social progress through developing technologies over the future. We were delighted to hear that this year, the winners of the Nobel Prizes for both the chemistry and physics are customers of Oxford Instruments, using our products in their transformational research.

Looking at some specific examples of where our products are used, and starting with the understanding of fundamental disease mechanisms and the acceleration of drug delivery. Our ability to analyze cells, organs and tissues down to the nano scale is supporting rapid growth across our optical microscopy products. Through our investments, we have developed a portfolio to reach every life scientist. This spans from our high-end instruments for fundamental research with the ultimate performance achievable due to our disruptive benchtop systems, which offer, for the very first time, research-level capability for the wider life science community.

Our newly launched Dragonfly 600, for example, seen here on the left of the slide, is part of our flagship high-end microscopy range. It has the ability to see both the big picture as well as to zoom in Google Earth style to see the fine details. This allows imaging of large samples such as whole organs to capture statistically meaningful data as well as the ability to zoom in to observe the nanoscale molecular machines that perform the fundamental biological functions and, importantly, how diseases impact and change their performance. This example shows a nuclear pool, whose performance is a gatekeeper for the movement of molecules within cells is critical to their health.

Our recently launched benchtop microscope has been designed to enable researchers and pharmaceutical companies to look at the impact of new medicines and treatments in much larger cell systems or parts of the body. Intuitive, easy and fast to operate at an attractive price point, it provides research quality performance with high throughput available to every life scientist. To further improve our customers' productivity and to generate meaningful insights from the increasingly complex data, we've developed proprietary AI-powered software solutions that automate the interpretation and analysis with dedicated packages for cancer, cell and neuroscience applications.

Our focus on supporting customers at every stage of research and delivery also extends to the battery market. With energy demand growing and the imperative to transition away from fossil fuels, there is increasing investment to create higher performing, lower cost batteries, which are less reliant on precious and scarce resources. We've developed tailored products to support customers throughout the full battery life cycle from research through each stage of production to failure analysis and recycling.

With the active elements of a battery operating at a nanoscale, our range of materials analysis techniques is helping researchers better understand the fundamental chemistry and properties that affect capacity, charging rate and lifetime. Our solutions are also used to ensure quality control, detecting potentially harmful contamination within raw materials and through the manufacturing process to prevent critical failures, which can lead to battery catching fire. The unique breadth of our portfolio and tailored solutions makes us a partner of choice in this rapidly growing market.

And as a final example, looking at how we are supporting the transformation within communications markets. Here, we are seeing increased demand for our compound semiconductor systems driven by the rise in digital data flow, surging demand for connectivity and the increased deployment of human machine interfaces, such as facial recognition. We focus on providing the etch and deposition solutions for the critical layers and structures within devices, which have the biggest impact on their end performance, such as the specialized slanted ratings, which generate the displays within augmented reality systems. We also provide the critical layers and process steps for the manufacture of the 3D and proximity sensors, which are increasingly being deployed across mobile phones, cars and cameras, for applications such as facial recognition, heads-up displays and contactless payments.

Within the transformation of modern communications, a broad range of applications from autonomous vehicles to connected factories are driving the need for increased bandwidth, capacity and speed. Here, we are enabling the development and efficient manufacture of high-performance optical devices, such as the lasers and optical sensors used across communication networks and within hyperscale data centers.

Our solutions are being adopted by customers for their ability to enhance performance and increase yield at a lower cost per wafer, accelerating global progress towards a more connected world. These examples are just a handful of the areas in which we are helping our customers, but I hope that they provide a flavor of how we are continuing to deliver against our strategy.

Moving to our summary and outlook. We have continued to deliver strong growth momentum despite the challenging external landscape. Our purpose to enable a greener, healthier, more connected, advanced society, together with our customer-centric market-focused strategy, is driving increasing demand from structural growth from our markets. Our pipeline remains robust across all our end markets. We anticipate higher production in the second half, combined with the positive impact of recent price increases as we convert our record order book. This provides good visibility for an expected improvement in trading in the second half with full year trading at constant currency remaining in line with expectations.

While we are mindful of the increasingly uncertain macroeconomic and geopolitical landscape, our record order book demonstrates our positive trajectory and underpins our confidence in our future growth potential. Our strong balance sheet positions us well to invest in the business and consider further acquisitions, and we've continued to selectively review a pipeline of acquisition opportunities. That concludes our half year results presentation.