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Edited Transcript of DLAR.L earnings conference call or presentation 26-Nov-19 9:00am GMT

Half Year 2020 De La Rue PLC Earnings Call

Basingstoke Nov 27, 2019 (Thomson StreetEvents) -- Edited Transcript of De La Rue PLC earnings conference call or presentation Tuesday, November 26, 2019 at 9:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Clive Graham Vacher

De La Rue plc - CEO & Executive Director

* Helen Margaret Willis

De La Rue plc - CFO & Executive Director

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Conference Call Participants

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* Alexander Mees

JP Morgan Chase & Co, Research Division - Head of UK Small and Mid Cap Research

* Andrew Chambers

Edison Investment Research Limited - Analyst

* Michael Allen

Zeus Capital Limited, Research Division - Head of Research

* Thomas Andrew Rands

Investec Bank plc, Research Division - Industrials Research Analyst

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Presentation

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Clive Graham Vacher, De La Rue plc - CEO & Executive Director [1]

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Okay. Good morning, and welcome to the De La Rue First Half 2019/'20 Results. I'm Clive Vacher, the CEO of De La Rue.

Today, I'd like to give you an overview of the first half, including actions we are taking in light of our performance as well as to provide a high-level business update. Then our CFO, Helen Willis, will look at our financial results in more detail. I will then cover the operational performance of our reporting segments and then how we plan to move forward as a business in more detail.

In the first half of 2019/'20, we have seen significant changes since the start of the financial year in the market for Currency, which has resulted in reduced overall demand in our markets and price pressure.

Adjusted revenue for Currency was down 29.5% year-on-year, and we expect this will take some time for the market to normalize.

At the same time, we've seen a strong growth in our Product Authentication & Traceability business, up 70.1% year-on-year, which, however, has not offset the headwinds that we have seen from Currency.

Overall, that has resulted in a reduction of group profitability for the first half to an adjusted operating profit of GBP 2.2 million.

As a result of this performance and to allow us to undertake the actions required to turn around and stabilize the company, the Board has decided to suspend future dividends.

In addition, we have already taken a number of actions to refocus the business, and there will be more to come. We have seen a large number of management changes, with a new Chairman and CEO in place, and the majority of the executive team leaving or resigning in the period, which has led to inconsistency in quality and speed of execution. The Board is looking to stabilize the management team.

On the 4th of November, we moved to 2 divisions, Authentication and Currency, which will allow us to better meet the requirements of the 2 different customer groups.

Given the new structure, from the full year, we will be reporting the revenue and gross margins for each division as well as SG&A for the whole company. For now, we will be reporting using the old structure of Currency, Product Authentication & Traceability and Identity Solutions.

We completed the sale of the Identity Solutions business on the 14th of October for GBP 42 million. This was completed after the end of the reporting period and is not reflected in our numbers.

We are currently reviewing the operations of the company and putting in place a turnaround plan, which we expect to complete and report back on during the next quarter.

Importantly, we are also undertaking a set of actions focused on cash, and I would like to cover that in more detail later.

Now I'd like to pass over to Helen.

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Helen Margaret Willis, De La Rue plc - CFO & Executive Director [2]

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Thank you, Clive. Good morning, everyone. First of all, I'd like to take you through the key points on the income statement.

The full year adjusted revenue reduced by 14.9% compared to first half last year and that's at GBP 205.9 million. Adjusted operating profit was down 87% at GBP 2.2 million, and adjusted operating profit margin reduced from 7% to 1.1%. I'll take you through a more detailed explanation of those movements in the following slides.

IFRS operating loss of GBP 9.2 million was a reduction of 191% against the IFRS operating profit of GBP 10.1 million in the first half of last year as the current year is stated after significant restructuring charges related to the reorganization announced in May 2019.

Adjusted EPS, down 12.7% and a loss of 1.5p. The effective tax rate of 16.4% was consistent against 16.7% in the prior period.

Moving on to the revenue bridge. The chart shows revenue decreasing from GBP 242 million to GBP 205.9 million, as I just mentioned, a decrease of 14.9%.

Currency revenues were GBP 53.8 million lower in the first half of this year, a reduction of 29.5%, reflecting a decline in banknote and security features, volumes and price, although we did have good growth in polymer volumes.

Identity revenues were up GBP 4.1 million, an increase of 10%, and that's driven by increased volumes within our UK Passport business.

Product Authentication revenues increased by GBP 13.6 million, significant year-on-year increase of 70% due to growing volumes in U.A.E. and KSA, and obviously, the ongoing sales to Microsoft.

Moving on to the operating profit bridge. The chart shows adjusted operating profit reduced from GBP 17 million in the first half last year to GBP 2.2 million this year, a decrease of 87% or GBP 14.8 million.

Currency saw a decline in adjusted profit from the GBP 6.5 million in H1 last year to GBP 12.5 million loss in H1 this year due to the reduction in banknotes and security feature volumes and price, along with an adverse product mix and the impact of lower absorption of factory fixed costs into inventory due to lower production volumes.

Identity Solutions profits are largely flat on H1 last year.

Product Authentication adjusted operating profit growth of GBP 4.1 million was driven by growth in those tax volumes, partially offset by upfront operating expenses associated with new contracts.

Net debt increased by GBP 63.2 million from last year. There was working capital outflows of GBP 35.1 million, and the main drivers are as follows: a build in inventory; a negative impact of GBP 21.8 million, mainly within Currency and partly attributable to changes in production schedules by customers; an increase in receivables with a negative impact of GBP 5.8 million due to growth in PA&T volumes and higher receivables in Currency due to the timing of payments around those production schedules. Our proportion of those reported and paid in the second half.

A reduction in payables, negative impact of GBP 7.5 million, resulting from a net reduction in advanced payments and settlement of year-end employee-related accruals, and the adverse impact of which was partially offset by the timing of some trade creditor payments.

CapEx spend was GBP 9.7 million, and that's consistent with the first half of last year. Pension contributions of GBP 10.7 million and according to the special payment plan agreed at the last triennial valuation in 2016. And the dividend outflow was GBP 17.3 million in the first half.

On the next slide, working capital is really a reflection of the movements I've just gone through. You'll see the movements in inventory moving up to -- sorry, the working capital is just flipped on. Sorry, technical issue.

Cash flow slide. Just pulling out the elements of cash flow that I just mentioned, the building of GBP 21.8 million and timing in receivables of GBP 5.8 million.

And now moving to pension. Pulling out here the retirement benefit obligations. And in the statement, that's equated to GBP 39.9 million. We're pulling out the U.K. element of it here at GBP 37.9 million, and that reduction to the end of this half is largely driven by a positive asset performance, giving a gain of GBP 29 million as well as funding contributions of GBP 10.7 million in the half.

The triennial valuation process started in April 2018 and is continuing in a steady dialogue between the company and the trustees.

In the meantime, the company is honoring the payment plan that was agreed in 2016, and the total contributions for FY '20 will be GBP 21.3 billion.

Now to net debt. The group net debt increased to GBP 170.7 million at the end of September from GBP 107.5 million at 30th of March 2019. This net debt position does not include the benefit of proceeds of GBP 42 million from the sale of the International Identity Solutions, which were received just after the end of the reporting period.

Our covenant ratios were 2.72x net debt-to-EBITDA and EBIT to net debt was 9.9x, both of which are within our limits and have been driven by the cash flow drivers that I just previously mentioned.

I note that we received the GBP 42 million proceeds of the sales 2 weeks after the end of the reporting period. We also received circa GBP 8 million from a major customer in week 1 of the second half, unfortunately, just missing our half year cutoff.

The Board has reviewed a plan for the remainder of this year that shows that the group will operate within its banking covenants.

With that, I'll hand back to Clive.

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Clive Graham Vacher, De La Rue plc - CEO & Executive Director [3]

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Great. Thank you, Helen. I'm going to go on to the operational review.

As I mentioned in my introduction, we have seen rapid changes in the overspill market since the start of the year, with volatile buying patterns in Currency.

Currency adjusted revenue was GBP 128.7 million, down from GBP 182.5 million for the same period last year. This revenue decline was due to rapid changes in the overspill market, resulting in a decline in banknote and security feature volumes and price. At the same time, we did see growth in our polymer volumes which exceed our expectations.

We moved to an adjusted operating loss in Currency of GBP 12.5 million from a profit of GBP 6.5 million a year ago. This was due to the decline in volumes and adverse product mix, the impact of lower production volumes from the absorption of true fixed costs and our inventory. Given this performance, we are moving to increase our focus on how we meet the challenges of the market. We have moved to a new divisional structure with the aim of increasing focus and accountability. Our new security feature, Ignite, will be shipping to our first customer next year. We are reviewing how we optimize our production footprint to match the environment we find ourselves in. And we are looking to reduce cost of goods sold through renegotiations with our suppliers.

Turning to Product Authentication & Traceability. Revenue has increased significantly year-on-year from GBP 19.4 million to GBP 33 million. We have delivered growing volumes for our government revenue solutions customers with contracts including the U.A.E. and Kingdom of Saudi Arabia. We see good ongoing sales to our current customer base.

During the first half, we signed an exclusive distribution agreement with KushCo for North America in legalized cannabis markets for anti-counterfeit labels. We continue to invest in our capabilities in this area and the transfer from Gateshead to Malta for our PA&T operations is complete. We continue to expect growth from PA&T. We continue to stand by our prediction that it will double from FY '18/'19 to FY '20/'21, as we have previously stated.

On the Identity Solutions, revenue of Identity Solutions grew from GBP 40.1 million to GBP 44.2 million, mainly driven by volumes for the U.K. Passport contract. We expect to see revenue contract to be at the same level during the second half of this year. And as we've noted earlier, we sold the Identity Solutions business in October 2019 for $42 million after the end of the reporting period.

I would like now to move on to the company turnaround activities. As a result of the rapid changes we have seen in company performance, we're undertaking a series of measures to stabilize the business. We have seen a lot of executive and Board turnover, which has impacted the performance of the company, and the Board is working to stabilize the management team. We have also, earlier this month, reorganized the company into 2 divisions, which I expect will optimize operations and accountability. We are also undertaking a review of operations. While led by the management team and myself, I'm encouraging all of the company to participate so that we have one plan that we will buy into.

I will focus the review on cash in addition to profitability, and we are taking immediate actions. They include a reduction in our discretionary spend; deeper control of cash items such as inventory management, accounts receivable and operational efficiency drivers; an acceleration of our restructuring plan; a review of our H2 actions with a view to reducing operational risk and delivering to our commitments, both in terms of revenue and cash; and I'm examining all leadership at all levels of the group. Taken together, these should result in cost savings and additional operational focus during the second half of the year.

Going forward, my aim is to complete the turnaround plan in the next quarter. The areas we will be focusing on include our market position and sales strategy for each product; being more focused on R&D spend, with a particular focus on commercialization of innovation; optimizing our site footprint in the light of market demand and pricing; reviewing our contracts with suppliers with a view to reducing cost of goods sold; reviewing our contract bid strategy and the viability of our historic contracts.

Overall, the review aims to go beyond the previously announced GBP 20 million of saving and accelerating the time frame in which savings are realized, bring a new targeted set of security features to the market faster, increase our operational efficiency and continue to grow our Authentication division. And all of this is so that we can meet our liabilities as they fall due.

De La Rue has a great history. There is a depth of knowledge and capability in the company which can be built upon. By taking a rigorous process and data-driven approach to the review and our actions, I believe we can create a leaner, more efficient company. I look forward to giving you more information on the review, the turnaround and our progress next quarter.

Turning to the outlook for this year. We expect the significant changes in banknote print and security features market to continue. We expect continuing growth in Authentication and to see the benefit of cost savings in the second half of the year. As a result, we expect full year 2019/'20 adjusted operating profit of between GBP 20 million and GBP 25 million.

Now we'll be happy to take any questions that you may have. And I would request, please, if you could identify yourself and your organization before asking the question.

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Questions and Answers

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Alexander Mees, JP Morgan Chase & Co, Research Division - Head of UK Small and Mid Cap Research [1]

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It's Alex Mees from JPMorgan. I have more, but I'll only ask three. Firstly, just with regard to the guidance for this year's operating profit of GBP 20 million to GBP 25 million. I just wonder what your assumptions are there for the profitability of the Currency division within that.

Secondly, clearly, against the backdrop of volatile buying patterns in recent months, I wonder if you have a sense as to whether you'd maintain market share or is it too early to say?

And finally, just on the inventory, I wonder if you could just clarify what's happened to inventory since the period end and your expectations for the full year balance.

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Clive Graham Vacher, De La Rue plc - CEO & Executive Director [2]

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Okay. So within the GBP 20 million to GBP 25 million, I'm actually going to give you a complete breakdown because that is a multitude of factors that are moving parts at the moment. I think we have made a very thorough review of what we can this year, and with all the moving parts, we are comfortable to say that we will be within GBP 20 million to GBP 25 million on the adjusted operating profit.

In relation to our market share, we remain the #1 currency provider in the world. We have not, unfortunately, kept the order book up, as you can see, to the levels that we'd like to, which is one of the reasons why I mentioned that we are reviewing our bid strategy and certainly taking significant actions on our cost base. The currency market out there, it's no secret that it is becoming tougher as there is overcapacity in the market. But I do believe that we can compete effectively, but it does require a different approach to the market and it does require us to get our costs in line with that shrinking demand.

In terms of inventory, we will expect that to improve in the second half. A lot of that is related to timing of customer deliveries, I think it's probably the biggest single chunk in there. And we have already performed a very thorough review with the team on the operational performance of the second half to ensure that we are laser focused on delivering to customers, as I said, both from a revenue and cash collection perspective.

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Helen Margaret Willis, De La Rue plc - CFO & Executive Director [3]

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But really, that number has come down from slightly GBP 10 million. We're driving for more in that space entirely on that production scheduling.

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Andrew Chambers, Edison Investment Research Limited - Analyst [4]

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Sorry, Andy Chambers from Edison. Just one small question to start with International ID. What did that contribute in the first half of the year? And can you maybe flesh out your existing structure in growing, so you're accelerating that? Obviously, cash flow is very important for the second half of the year. Can you tell us what the cash costs of that program is going to be in the second half of the year and how those benefits should flow through timing-wise hereafter?

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Helen Margaret Willis, De La Rue plc - CFO & Executive Director [5]

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So on the International Identity Business, when we announced the sale of the business, we guided with a business of about GBP 2 million EBIT annually. So if you took that as a base point, that wouldn't be too far wrong profit. On the cash cost of restructuring, probably between 5 and 10 still to go in the balance of this year. We've provided 11 in the exceptionals. There's a balance of that cash still to go, and that's fully forecasted in the guidance that we've given.

We're still working through the plans.

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Michael Allen, Zeus Capital Limited, Research Division - Head of Research [6]

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It's Mike Allen from Zeus Capital. Just a quick one on the cost savings plan, you say about GBP 20 million. Are you able to give us a feel for your brand of that? Is there more cost that you can identify beyond the GBP 20 million? Are you able to put a number on that, please?

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Clive Graham Vacher, De La Rue plc - CEO & Executive Director [7]

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So the GBP 20 million was a previously announced number sometime ago, and it was a 3-year number. What I can say at this moment is that I'm very comfortable of hitting that number. I'm also comfortable at hitting that number earlier than the time frame that was previously set out. I also believe that we will exceed it. However, there's too much detail still to be done on that to be able to give you a number yet. As we go forward, I hope to be able to give you much more color on that in future reports.

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Michael Allen, Zeus Capital Limited, Research Division - Head of Research [8]

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At year-end?

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Clive Graham Vacher, De La Rue plc - CEO & Executive Director [9]

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I will certainly give you an update on where we stand at it, yes. That happens.

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Alexander Mees, JP Morgan Chase & Co, Research Division - Head of UK Small and Mid Cap Research [10]

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It's Alex Mees of JPMorgan again. Firstly, just with regard to the triennial valuation, when does that get finalized? And to the extent to which you can say, is there a possibility of the cash contributions being suspended on that?

And secondly, and apologies, it's a bit fluffy, but the morale at De La Rue, how would you describe it at present?

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Helen Margaret Willis, De La Rue plc - CFO & Executive Director [11]

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I'll take pension, you take morale. I would account for that, I'll go through that. So the triennial, obviously, I mentioned that we've been assessing the trustees since the middle of last year. Those discussions are continuing. We're talking in great detail, sharing our plans with them, as you might expect, and we've got a follow-up meeting in a few weeks' time. I'll continue to work through it.

The statement given by (inaudible) later is that they like dividends to match contributions. Clearly, today's announcement is going to be a rather different flavor on that debate. But we're comfortable that we're in actually a very positive position with the trustees, and we'll continue to work to reach a solution. Meanwhile, we are paying significant amounts against the deficit, GBP 21.3 million this year that's against the plan that was agreed in 2016. So it sees us reducing the deficit over a very short period.

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Clive Graham Vacher, De La Rue plc - CEO & Executive Director [12]

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Great. And then on your question on morale at De La Rue, I had the luxury of coming from a number of different turnaround experiences, where I've turned around either companies or divisions of larger companies and so I have a nice contrast there. I would say that there obviously is concern in the company, that it would be strange not to have some concern. However, what I have observed in this company is that there's a real depth of capability, and there's real passion amongst the employees for the business. And I believe the ingredients are there to turn the company around. So I think the morale was one of concern when I arrived. I would say that I think there's quite a lot of hope in the organization at this point. But we actually can do this and emerge stronger over time.

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Thomas Andrew Rands, Investec Bank plc, Research Division - Industrials Research Analyst [13]

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Thomas Rands from Investec. Two questions, please. Just on Currency, given the overcapacity in the market at the moment, have any of your competitors made any noises around taking capacity out at all? That's the first question.

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Clive Graham Vacher, De La Rue plc - CEO & Executive Director [14]

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I actually have not had enough insight into our competitors to be able to answer that question. I don't know, Helen, if you have any information.

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Helen Margaret Willis, De La Rue plc - CFO & Executive Director [15]

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I'm not aware of any.

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Clive Graham Vacher, De La Rue plc - CEO & Executive Director [16]

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There's nothing obvious out there that we've heard of at the moment. But I imagine that they will be in the same position as us in terms of making sure that their footprint and activities are commensurate with the shrinking market.

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Thomas Andrew Rands, Investec Bank plc, Research Division - Industrials Research Analyst [17]

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And secondly, you mentioned more volatile customer ordering patterns. Is that any more volatile or lumpy than in history in the past? Or is this a changing kind of customer characteristic? And if it is, do you have any kind of color as to why you think that may be happening now?

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Clive Graham Vacher, De La Rue plc - CEO & Executive Director [18]

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Well, I think the way I'd answer that is I'd say that volatility has always been there in the Currency markets, but we are fighting harder for each contract. So how that actually manifests itself in our numbers probably seems to make it feel more volatile, although the volatility has always been there. So the way I want to deal with that, I do believe you can make money in currency. I want to have a business that makes money when the market is down, makes a lot of money when the market is up. And also to look across the company to see what activities we can engage in, what parts of our business we can develop to try to cushion some of that volatility on the currency side.

Okay. Any other questions? If not, then I'll thank you very much for your time this morning, and have a great day.