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Edited Transcript of TTG.L earnings conference call or presentation 7-Aug-19 7:00am GMT

Half Year 2019 TT electronics PLC Earnings Presentation

London Aug 11, 2019 (Thomson StreetEvents) -- Edited Transcript of TT electronics PLC earnings conference call or presentation Wednesday, August 7, 2019 at 7:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Mark Hoad

TT Electronics plc - CFO & Director

* Richard Tyson

TT Electronics plc - Group CEO & Executive Director

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Conference Call Participants

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* Brian Thomlinson

* Mark Davies Jones

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

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Presentation

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Richard Tyson, TT Electronics plc - Group CEO & Executive Director [1]

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Welcome to our half year results presentation. This morning, on the back of an excellent 2018, we have a great set of results to take you through.

We've delivered very strong organic growth of 8%. More new customers, coupled with growth from our strategic accounts, and now we're seeing an increased level of cross-selling, both in the reported organic growth and plenty of opportunities in the pipeline. I'll come on to this later, but this is a result of our focus on structural growth markets that benefit from electronics being required everywhere.

This year, we've won a number of new contracts that secure multimillion-pound recurring with sales, further improving the quality of our revenue stream. We have engineered TT to a much higher quality business.

45% of the revenues now come from aerospace, defense and medical markets, and revenues from these sectors grew a staggering 27% organically in the first half of the year, a result of our actions that show the strategy is working.

Projects are in progress to close 5 smaller facilities, consolidating them into our existing footprint, making TT a leaner, more cost-effective business.

And margins are now 8.1%. And as we've said before, there is more to go for.

I'm delighted that we've managed to continue the momentum of last year with a strong first half performance, despite a more challenging market backdrop, and we fully expect to make further progress in the rest of 2019 and beyond.

So with that, I'll hand over to Mark to take you through another really strong set of numbers.

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Mark Hoad, TT Electronics plc - CFO & Director [2]

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Thank you, Richard, and good morning, everyone.

So as Richard said, we've delivered another good half with strong revenue and profit growth as well as further margin improvement. Revenue increased by 20% at constant currency and by 8% organically. Operating margin is now above 8%, and earnings per share grew by more than 20%. Cash conversion was low by our standards at 28%, but this reflected the strong growth that we're delivering. Importantly, our main value-creation metric, return on invested capital, once again, stepped forward on a like-for-like basis. And with these strong results, the Board has declared an 8% increase in the dividend.

So looking at summary of group's performance. The metrics reflect a period of very strong growth as well as a lot of work to support margins. We delivered organic revenue growth of 8%. This was driven by good growth in Power and Connectivity and stellar growth in Global Manufacturing Solutions, which more than offset a slight decline in Sensors and Specialist Components, as previously highlighted, due to softer market conditions and tough comps.

On the back of this growth, operating profit increased by 27% at constant currency with the acquisitions also contributing well. Operating margins increased by 50 basis points to 8.1% with all of the improvement organic.

Exceptional and one-off items totaled GBP 12.3 million. This includes GBP 7.2 million of restructuring related to footprint change to drive efficiency and deliver synergy programs. Acquisition-related costs were GBP 4.1 million, and the total cash exceptionals amounted to GBP 3.2 million.

As I said, cash conversion of 28% reflects the high levels of growth we've delivered as well as some first half seasonality. We expect this to normalize in the second half and to deliver target levels of cash conversion for the year.

Net debt is up from year-end with GBP 20 million of that is explained by the adoption of IFRS 16. The leverage metric here excludes the impact of IFRS 16, as this is consistent with how we calculate our bank covenant and is the measure that's relevant for assessing M&A capacity, which remains very strong. IFRS 16 also impacts the calculation of return on invested capital, as it brings more assets onto the balance sheet. So for this year, we're showing the calculation on a pre- and post-IFRS 16 basis, so you can see the like-for-like comparison, which is up by 20 basis points compared to year-end.

So for the group, overall, a really good performance with revenue growing and profit improving even with more mixed market conditions.

Following 2 years of high single-digit organic growth and a backdrop of strong market conditions, Sensors and Specialist Components experienced a softening of end market demand, which was compounded by destocking in the supply chain. And as a result, revenues declined by 2% organically. Operating profit declined by 15% to GBP 7.5 million, impacted by the revenue decline as well as cost headwinds, including a doubling of minimum wage in Mexico. Margins fell by 180 basis points at constant currency to the bottom end of the target range for this division. All the visibility, as you know, is shortest in this division. We're not anticipating improved intake in the second half, so we've moved quickly, accelerating cost actions to correct the cost base. These actions include the closure of 2 facilities and reducing more than 10% of headcount in the division, and we expect benefits to start to occur in the second half of the year flowing through to margins.

Even with a tougher backdrop, we have those who had successes, including a nice cross-sell win with a U.S. defense prime, which came from selling into one of Precision's customers.

Moving on to Power and Connectivity, where revenue increased by 4% organically and by 40% at constant currency, with Stadium and Precision having both now been part of the group just over a year. The incremental acquisition contribution to revenue was GBP 17.3 million. The underlying profit performance here was very impressive, up by 80% to GBP 7.2 million with last year's investment in process and efficiency improvement really starting to pay dividends.

After a couple of years, where there've been a lot of moving parts, this division is now reaching critical mass and, with margins up by 240 basis points to 10.7%, is starting to move quite quickly through our short- to medium-term target margin range of 10% to 12%.

As well as the financial performance, we've also made a lot of strategic progress here. At the start of the year, we transferred our Malaysian magnetics business from Sensors and Specialist Components to Power and Connectivity, bringing all of our electromagnetic capabilities together in one division. This means we can optimize our manufacturing strategy and our footprint. Richard will talk to you shortly about our investment in Power solution products and the results that's bringing.

Aircraft electrification continues to drive demand, and we saw good growth in power products and defense and civil programs as well as satellite and space projects. We also secured a new space customer for satellite navigation solutions.

As well as helping our financial performance, our operational improvements are also benefiting our customers. In the first half, Honeywell recognized this with the quality award for 0 defects at our Beddington facility. Precision and Stadium are now fully integrated into the group, and delivery against the enhanced synergy plans that we told you about in March are on track.

Finally, in this division, we acquired Power Partners in the first half for $1.6 million. Now clearly, that's a small business, but think of it as an organic play. We bought it because it adds to our technical capabilities and U.S. market reach, particularly in medical.

And then finally, for the divisions, Global Manufacturing Solutions, which has once again exceeded all expectations, delivering organic revenue growth of 17% with growth across all 3 regions. It's here that we're really seeing the benefit of our business development approach, targeting the right customers who value the complex engineering solutions that we increasingly provide.

Now the growth is clearly great, but what we're really pleased about is that the division is increasing the quality of its order book. As well as the order book being a record level, we also have longer forward visibility than ever before with some contracts and relationships now spanning multiple years.

Operating profit increased by 33% at constant currency to GBP 8 million as a result of operational leverage and efficiency improvements in our main U.K. facility, in particular. With margins at 7.5% in the first half, we're sustaining the high margins that we first delivered last year, reflecting the transformation of the business from one focused on printed circuit board manufacturer to one increasingly providing value-added services to our customers. These services now represent nearly 60% of the division's revenues.

We achieved strong growth with existing customers as well as winning 4 new customers spread across the 3 regions. A nice example of this is a 3-year contract for printed circuit board assemblies, cables and box build with a customer that was previously doing everything in-house, but is now outsourced to our Xuzhou facility. Rich is going to give you some more color on our business development success in the next section of the presentation.

So taking those divisional performances, you can see here how we've driven the improvement in operating profit. There was a GBP 0.5 million foreign exchange tailwinds with further weakness of sterling against the U.S. dollar. Operational leverage on the revenue growth, combined with efficiency improvements, added GBP 2.5 million for operating profit and accounted for all of the underlying margin improvement. And acquisitions added a further GBP 1.6 million to operating profit.

So moving on then to cash flow and net debt. I've already highlighted the cash conversion, which, as I said, is a reflection of the strong growth dynamics in the business. Power and Connectivity and Global Manufacturing Solutions, as I said, have delivered good to exceptional growth in the first half and have a lot of growth in their order books, and this is being reflected in working capital. And these are the 2 divisions that consume the most working capital.

In addition, there is some first half seasonality that will reverse in the second half. And as I said, we still expect to deliver a normal level of conversion for the year.

Capital and development expenditure in the first half increased to GBP 9.3 million as planned, as we invested to support the growth, to upgrade our Beddington facility as well as continuing to increase our cash spend on research and development. This level of spend is 1x depreciation and amortization or 1.3x, excluding the depreciation on leased assets.

As I highlighted earlier, cash exceptionals totaled GBP 3.2 million related to footprint production to support efficiency and synergy programs as well as acquisition-related costs.

The lease liability repayment line here has been introduced to deal with IFRS 16 and ensure that the free cash flow measure is comparable with the pre-IFRS 16 number for the prior period.

Net debt has increased in the period, with the GBP 20 million of this relates to the adoption of IFRS 16 for which there was no prior year restatement. With the return to a more normal level of cash conversion for the year, you can also expect to see a reduction in the level of net debt in the second half.

Our net debt to EBITDA is shown here in line with the way we calculate it for our bank covenant test, so excluding the impact of IFRS 16 and with a pro forma adjustment for full year contribution from acquisitions.

So before I hand back to Richard, I want to show you how I think we've transformed the quality of this business over the last 5 years. These charts show the benefits of our actions to change the portfolio and shift more towards structural growth markets. We've combined this with a fresh approach to business development, support growth and ongoing operational efficiency actions. We've built a business, which is now growing revenue consistently and increasing absolute profitability and operating margin. TT today is a fundamentally different business, and we aren't stopping here.

With that, I'll hand back to Richard. Thank you.

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

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Thanks, Mark. So it's been a great journey so far, but one with more opportunity ahead. So let me tell you what we're doing to drive organic growth and further margin improvement.

We've increased our position in long-term structural growth markets. It's in these growth areas that we focus our investment and create differentiated capabilities. We're now becoming an increasingly strategic partner to our customers, helping them solve their toughest electronics challenges. And it's our execution on a changed business development approach, more R&D investment in the right areas to give us maximum opportunity, driving operational improvement and supplementing this with value-enhancing acquisitions that has led to this team delivering some excellent results.

So how are we doing it? Let's take our customers first. And on this slide, I thought I'd give you 3 prime examples of how we develop targets, build relationships and how this results in material success for us.

So first off, we formed a strategic alliance with a multibillion-dollar U.S. aerospace and defense company, L3. This is a great result with good potential for TT. We started work on this back in 2015, identifying them as a potential partner to outsource tens of millions of dollars of electronics across their divisions. We started to work with one of their business units on a new commercial electronics project. We produced rapid prototypes, working closely with our engineering team and delivered the initial production run in the U.S., all of this whilst offering them a low-cost full rate production solution option in China. This enabled us to demonstrate to many people and their organization what we are capable of and that we are prepared to invest in their success. As a result, we got further into the fabric of the organization, and we were able to turn this into an important partnership that will deliver significant recurring revenue. This has now been formalized into a strategic alliance, and we have won a contract to support a substantial electronics manufacturing initiative for a key military program with L3 Aviation Products. We're delighted with this new alliance and are now working with them to support the ramp-up of the program over the next year or so.

Next up, something similar with the U.K. Tier 1 system integrator. Here we were just selling through a small -- we were just a small existing supplier to one part of the group. As they drove a new strategy to consolidate their supply chain, we convinced them to select us as one of a small number of strategic partners based on our investment strategy, commercial efficiency and our performance. We secured a multiyear contract in 2017 to support a key electronics product for one of their major commercial aerospace programs. This contract is just in its initial growth phase now with good growth for 2019 and volume ramp-up happening next year. The partnership is great for us, and we believe we can make it much bigger.

And it's not just in aerospace and defense, in Global Manufacturing Solutions, we've been working to develop more local customers in China for our Xuzhou business, so they'll be less reliant on being a low-cost source for Europe or the U.S. They succeeded in securing a major Chinese rail customer, where growth is driven by the need for more infrastructure. The Chinese government this year approved the belt and road initiative with $125 billion of investment into rail projects. This is a really good example of how we identify the right customer in the right markets that we can grow with. Here we assist the customer with engineering support for manufacturing and build complex electronic assemblies through rail signaling equipment, delivering strong double-digit growth for us this year.

Developing relationships over time with these customers in good markets is now paying off with an increasing number of high-value multiyear revenue. But we also need the right products, and R&D investment is key to that, not just increasing the spend, which we've obviously done, now 5.4% of revenues, but also building on these strategic partnerships with customers to ensure we are developing the right products and technology for the future. The R&D spend is being focused on power solutions for aerospace and medical applications, connectivity solutions for the industrial Internet of Things and specialist sensing capabilities that can be applied across all of our target markets.

On this slide are some examples of TT's power capabilities that we are working on in aerospace. Top right of the chart, here, we're setting up an advanced technology center in the U.K., focused on power product solutions. Last year, we got the team up and running. And already in 2019, we have produced our first product, a 1.5 kilowatt power converter prototype, which offers superior performance to the competition. The unit was launched at the Paris Air Show back in mid-June. And as you know, power is a scarce resource on an airplane. And for the future, controlling power more efficiently is more and more important. And that's what we're doing here, but also at a lower cost with less weight, utilizing our core component technology experience. Achieving success here adds more value to our customers and, at the same time, it is taking us from selling a few hundred pounds worth of components to units costing a few thousand.

As a result of improving relationships and business capability, we are now involved as a partner on a number of next-generation technology projects. So moving to the bottom of the chart, here, we describe project activity, where we are working with some of the top customers in the market and other industry bodies, such as ATI and Innovate U.K. These projects focus on higher power and more efficiency and look at more extreme environments for electronics, ensuring reliability and safety. Example shown here are ENCASE, a project for starter generators on engines. Our involvement is as the leading electromagnetics expert.

We're also on other projects. On the -- we also have other projects on the go to deliver a new generation of component technology, like solid-state power, removing mechanical switches and optimizing the performance of high-power -- in high-power scenarios where more electric or hybrid electric technologies are required. TT is now beginning to realize its potential, positioned in the right projects and meeting the demands of our customers for the future.

Operational excellence and continuous improvement is another pillar of our strategy. Over the last year, we've carried out major improvement projects at our Devon and South Wales facilities. This has led to a strong improvement in customer performance, but also organic growth at better margin.

At our South Wales facility, the improvement has also contributed to winning 2 brand-new customers. And more generally, the improvements have been noted in recognition awards from Honeywell for quality and also from Rolls-Royce as their most improved supplier.

Furthermore, we are progressing a number of projects to address our footprint. Focusing initially on 5 of our smaller facilities, these sites are in the process of being closed and consolidated into existing TT facilities; 3 of these were identified as part of the integrations of Stadium and Precision. And in addition, we pushed harder on self-help opportunities in the Sensors division to accelerate cost reduction as we saw demand softening in Q2.

We continue to see further self-help opportunities available to us, and we will pursue these as required to ensure that we keep the business rightsized to market demand, while maintaining our focus on growing the business overall.

So part of the strategy is about organic growth, but it is also about adding to our product, technology and market reach through value-enhancing acquisitions. We are only partway through redeploying the significant proceeds from the disposal of the Transportation business. This was transformational, both in its scale and the impact on the portfolio of the disposal and the subsequent acquisitions. And we're now building a track record of adding value through a successful acquisition program.

On this slide, I'll go through a bit of what we've done and some of how we go about it. We have a structured approach that starts with integration. We've completed all integration projects on or ahead of schedule. Through this, we work to impart management discipline, implement new controls, processes and systems, as required, depending on the acquired businesses' capabilities. And we also look to leverage TT's back office resource and expertise.

We focus on a clear set of synergy opportunities identified early with owners and our action plans established immediately to maximize potential. This, coupled with our supply chain scale, is presenting nice opportunities to improve margins and business performance. The acquisitions themselves, enhance our capabilities with a wider product offering. And in turn, we look to invest for future growth to ensure that we leverage the wider TT capabilities and talent depth.

Finally, we look to acquire businesses with good organic growth potential and higher margins. With improved market access for them and us, we are gaining more cross-selling opportunities and, ultimately, more organic growth potential.

I'm really excited about the potential for TT with these new capabilities. And we have GBP 70 million to GBP 80 million with the balance sheet capacity still, we continue to target complementary acquisitions that will accelerate our strategy.

So pulling all this together, we are growing organically, up 8% in the first half, despite the difficult market conditions and increased uncertainty. We're growing our profits, up 27% with margins now above 8%. We are a better business with better quality and sustainability of earnings and an increased proportion of the revenues from aerospace, defense and medical, where we have more positions on multiyear projects.

And we're delivering successful acquisition integrations and driving value. We're in a good place, as we said in today's announcement. We are positioned to make further progress in 2019 and beyond, which feels pretty good to me.

Thank you very much. We'll be delighted to take some questions now. So if you can hand up and take the mic and please introduce yourself in advance for the benefit of the webcast. Thank you.

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Questions and Answers

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Richard Tyson, TT Electronics plc - Group CEO & Executive Director [1]

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Yes, Mark?

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Mark Davies Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [2]

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Mark Davies Jones of Stifel. A few, if I may. If we start in the Sensors business, what are you seeing in the industrial end markets there? Is there any risk that rather than not getting better, it actually gets worse through the balance of the year? And can you comment a bit about the evolution of the tariff situation in China and how that's impacting you or not?

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

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Sure. Yes. And so in Sensors, as we said, we saw -- and I think we commented it on our trading update, we saw demand softening through the sort of first half of the year, more so in Q2. And we're not seeing any indication of any pickup. It's really down to destocking, general market demand environment and industrial and, I guess, confidence in investment more broadly. And so we're kind of assuming that it stays at the sort of current level for the balance of the year and not any sort of major recovery through 2020. Because we've talked to a lot of customers and peers over the last, I guess, a couple of months, and I think people are generally assuming that destocking starts to happen now into 2020. And so more of the same, I guess, is the best way to describe that.

And in terms of tariff, there's a small amount of tariff affecting our Sensors division. That's broadly been passed on into the market, and that really is very small for that division. And we continue to have a tariff risk, I guess, around some of the manufacturing solutions business in China where we sell to U.S. medical customers in China. So it's those customers that have the tariff impact themselves. But clearly, the business between those numbers affected it, that's around GBP 25 million of their revenue, so 5% to 6% of the group. So we're in constant dialogue with those customers about what they want to do. For them, in particular, I've personally been involved in debates about options and alternatives, so we can offer some of those. And they have the option to take their business back into the U.S., for example, and we can make it for them. That would be cheaper than the tariff overall. So those are being evaluated on an ongoing basis, I would say. But us -- so far for us, there's been no specific decisions there that would change anything.

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Mark Davies Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [4]

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And one for Mark, if I may. The working capital, encouraging to see the outlook of an improvement in the back end of the year. But you said that the 2 smaller divisions tend to be higher working capital businesses. There seems to be a little bit of a structural shift in mix towards those 2. So what can you do over time to stop sort of a structural trend up in the amount of working capital you need to carry?

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Mark Hoad, TT Electronics plc - CFO & Director [5]

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Yes. So those 2 persist are structurally higher working capital, that's principally in debtors rather than inventory. They typically do with much bigger customers in aerospace and defense and medical. I think the relative balance now is where it is likely to stay. So I think it's less about ongoing shift and more just about the level of working capital that comes with growth. But I think, overall, it means that, probably, with growth, this -- the outlook we've given first of modest outflow in working capital for the year as a whole is probably what it would look like going forward as well.

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Brian Thomlinson, [6]

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Brian Thomlinson from Fiske. You gave some guidance in terms of the margins on the power unit. I just wanted to know, on the Global Manufacturing Solutions, given the sort of longer visibility of the order book, better quality of the order book, presumably, you have a somewhat better idea as to how those margins can move from here.

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Richard Tyson, TT Electronics plc - Group CEO & Executive Director [7]

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Do you want to take that?

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

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Yes. So in the past, we've talked about benchmark margins in this division being 4% to 6%. Clearly, we're now doing somewhat better than that, and that reflects the shift in mix of the business that I talked about towards more value-added solutions. Clearly, we're delighted with the business generating 7.5% margin. I think that is better than anyone ever thought it would get to. So I think, going forward, if we can sustain mid- to high single-digit growth and maintain those kind of margins, I think we'd all be delighted.

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Brian Thomlinson, [9]

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Just on that one. I mean you still got the Stadium business in there, which are sort of breakeven. So arguably, there's some more potential to come in margin from that business. And then secondly, the GBP 2 million of savings that you're taking, I think, in SSC, are those -- were those enacted in the first half? Or is that a 2020 that we'd get those savings start to come through?

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

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Shall I?

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Richard Tyson, TT Electronics plc - Group CEO & Executive Director [11]

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Why not?

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Mark Hoad, TT Electronics plc - CFO & Director [12]

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So yes, the Stadium part of the GMS margins are lower than the main business. They are -- the EMS work that is done in the old Stadium business is lower complexity than the sort of the aerospace and defense and medical type work that we're doing in the original TT business and, therefore, inherently attracts lower margins. It's also relatively small and it's really -- it's main -- the main reason for being there is to support production of products for the connectivity part of the business. And those customers are there because we think that there's potential over the longer term to turn them into product customers. So yes, the same part of things will be better than breakeven, but they're not going to, I think, get absolute wider GMS margins.

And then on the Sensor and Specialist Components, yes, a lot of it was enacted in the first half. And so we'll see benefit in the second half and that should help margins.

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Richard Tyson, TT Electronics plc - Group CEO & Executive Director [13]

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Yes, Brian.

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Brian Thomlinson, [14]

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So just one more.

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

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It's okay.

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Brian Thomlinson, [16]

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Given the footprint rationalization program, the closing of 5 facilities, can you sort of allude to what the sort of capacity utilization is? And do you -- is it going to be sort of an issue maybe going forward? Or can you allude to what's the work like this in those facilities?

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Richard Tyson, TT Electronics plc - Group CEO & Executive Director [17]

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So I guess, I'll start by saying you've seen the level of organic growth in the first half and over the last, I guess, 18 months now. We're managing to deliver that organic growth relatively easily within the overall footprint. And there's definitely the capacity for that 5 relatively small facilities. And to do that, we're still in a position where we don't feel that we need a broader, bigger footprint to deliver both growth or, indeed, some of the further self-help that we might choose to do in the future. So I think right now, we're feeling comfortable with that, right, Mark?

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Mark Hoad, TT Electronics plc - CFO & Director [18]

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Yes.

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Richard Tyson, TT Electronics plc - Group CEO & Executive Director [19]

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Okay. Very good. It seems like we've dried up on the questions. Thank you all very much for coming. I know you got a busy morning. I appreciate your time. Thank you.