Cohort PLC

LSE:CHRT

Q2-2025 Earnings Call

[Andrew Thomis, executive]

Right. Well, good morning, everybody. Very nice to see you this morning. Good morning also to those joining us online. For anyone who doesn't know me, I'm Andy Thomis, Chief Executive at Cohort plc. And I'm here with Simon Walther, who's Cohort's Finance Director, to take you through our results for the 6-month period ending on the 31st of October this year.

So I'm going to start by giving you the highlights. Simon will provide more detail, including a divisional breakdown. Then I'll return with some comments about the demand picture, about our future prospects, and there will be an opportunity for questions at the end. But first of all, a reminder of who we are and how we aim to create value for shareholders.

So Cohort is a group of 6 businesses, soon to be 7, providing technology-based products and services to the U.K. and its allies around the world. And our business model aims to maximize the autonomy and independence of our businesses, consistent with good financial and regulatory governance. And that means that decisions are taken quickly and close to the customer. It maximizes agility and innovation while supporting our businesses with a strong balance sheet and the market reach that we have as a wider group. And we have no layer of overhead between our small but experienced headquarters team and the operational management, and that gives us a real cost advantage, too.

We've got a strong record of growth, both organically and by acquisition since our IPO back in 2006. And a few weeks ago, we announced the acquisition of our seventh business, EM Solutions, which we expect to push that growth to the next stage, and I'll have a little more to say about that later.

Organically, our growth has accelerated since 2022 when the Russian invasion of Ukraine shocked NATO Europe into a step change in defense spending. And tensions in the Middle East and in the Indo-Pacific region are also contributing to growth in spending in our key markets. And one result of that is that a strong pipeline of opportunities has emerged, and we're following up on many sales prospects, and we're frequently bidding for contracts in the U.K. and around the world.

And of course, the evidence of that is our growing order book. And as you'll see in a moment, it hit a new record at the end of the first half, and it's about to be boosted significantly when the EM Solutions acquisition completes. That acquisition was funded using a combination of our strong cash resources, bank debt and support from our investors in the form of a GBP 40 million placing. And the result is that we've retained a very strong balance sheet with low gearing and that gives our customers confidence. It allows us to invest in product development, capacity building and potentially in further acquisitions.

And finally, I should mention our progressive dividend policy. We've grown the dividend every year since the IPO back in 2006. Of course, that's valuable income for our shareholders. But just as importantly, it's a signal that we're not just developing interesting technology, but that we're a successful and cash-generative business. So that is the theory now for how well that has worked in practice over the last half year.

The summary is that it's been a good first half, much better than last year's. Revenue and operating profit are up strongly. Once again, we have a new record reported order book. Our prospects look good, and we expect to continue our growth in the full year and beyond.

So here are the numbers. Revenue and profit, both up strongly. Revenue 25% up; adjusted operating profit, 69% up and adjusted EPS even more strongly.

It was another good period for new orders, which are, of course, the best leading indicator of future growth. Order intake of GBP 139 million significantly exceeded the revenue that we recognized. So the total order book had grown to over GBP 540 million at the year -- at the period end. And that order book covers more than 99% of the consensus forecast of our revenue for the year and it will be generating revenue for us well into the 2030s.

Finally, operating cash flow is very strong, too, significantly exceeding profit and helping us to push our positive net cash position up to nearly GBP 38 million. And against that positive background, the Board has declared an interim dividend of 5.25p per share, once again representing an increase of 10% on last year's.

Now Simon will give a more detailed breakdown of the performance of our divisions, but this slide shows some of the operational highlights of the first half. Both divisions generated increased revenue and profit in the period. Within Communications and Intelligence, MCL in particular, has been intensely busy dealing with urgent operational requirements from the U.K. Ministry of Defense. It has been quite an interesting start for their new Managing Director, Claire King.

MASS has performed steadily, showing solid growth. At EID, performance has not been stellar, but the big news has been the strong order intake, and we expect that to feed through into revenue and profit in the second half.

In the Sensors and Effectors division, SEA has been making good progress on its largest project, the Ancilia Missile Defense System for the Royal Navy. And the critical design review for that is coming up in March, which is a really vital milestone in the program. ELAC SONAR has also seen good progress on its most important project, the Italian submarine SONAR. Some of the most important and complex items in this large project are now in production. And this month sees the first factory acceptance test of actual deliverables to the customer.

And finally, CHESS had rather a slow start to the year with some production issues affecting deliveries, but we're expecting a strong acceleration in the second half. So with the strong order cover already in place, as you've seen, delivery is going to be very important for all of our businesses in the second half. But it's worth mentioning that the opportunity pipeline is still very strong, and we're expecting more significant orders as well.

So let me now hand over to Simon to take you through those financial results in more detail.

[Simon Walther, executive]

Thank you, Andy, and good morning to you all. As Andy has already said, and I reiterate, the record first half performance for the group was ahead of our most recent guidance. I turn to the income statement. The higher revenue was driven by both divisions. The operating margin was 8.5%, above last year's 6.4% despite a slightly weaker revenue mix. This supports our strategy of a steady rise in that net margin over the next 3 to 5 years to a full target of a low to mid-teen percentage for the group.

Wrapping in EM Solutions in the second half, we expect to see a stronger net margin for the year compared with last year despite that weaker mix. As a result of the increase in the order book, we've continued to invest in our people, continuing the trend seen at last year-end with a rise in headcount from just over 1,300 in April to now over 1,400 this October, an 8% increase in 6 months. Just for interest, EM Solutions will bring around about 115 to 120 people into the group.

Also for the analysts in the room, I guide at this point that the tax rate applying to our adjusted earnings is around 20%, excluding EM Solutions. Including EM Solutions, I expect a tax rate for the group for the full year April '25 of around 21%.

Now looking at the divisions in a bit more detail. As already mentioned, improved performance in both. In Communications Intelligence, we saw a 25% increase in revenue and a 42% increase in adjusted operating profit. This reflected a very strong first half at MCL and a solid performance at MASS. The improved order book was mostly from EID, which secured some very long-awaited orders in the first half, but not soon enough, unfortunately, to make a difference to its first half performance, which was again a loss. However, the second half will benefit from this order intake at EID, and we expect Communications Intelligence to deliver a much stronger performance than last year with a net margin of over 16% for the year.

In Sensors and Effectors, the revenue increase was also up 25%. And the adjusted operating profit was more than double as a result of strong performances at ELAC SONAR and SEA. CHESS saw some slippage of deliveries, which are expected to recover in the second half. Again, we're expecting a stronger second half from Sensors and Effectors, delivering a net margin overall for the year of around 11%.

Now turning to the funds. These have been very strong, a record performance for the first half, delivering a record level of closing net funds. The cash inflow was basically driven by good trading performance and customer advances, especially within Sensors and Effectors. Excluding the impact of EM Solutions, we expect the second half to see a net cash outflow as we progress the investment in ELAC's new facility and the unwinding of some customer advances we've seen in the first half.

Including EM Solutions, I'm still guiding towards a small debt position at 30th of April '25. But as I always say, and I reiterate, our cash flows can be erratic, hence, why we retain a strong balance sheet. Summing up, a record first half for the group, strong underpinning to the second half, and we expect to make progress in both the second half and the medium term. With that, I'll hand back to Andy.

[Andrew Thomis, executive]

Yes. Thanks, Simon. And now in this section, I'm going to talk about the outlook and the factors driving demand for our products and services. I'll show you how our existing order book runs off over the rest of the year and beyond, and then I'll round off with a summary.

So the two main driving forces for demand for defense equipment remain very much in place, the continuing conflict in Ukraine and the influence of growing Chinese assertiveness from the Indian Ocean to Australasia. And adding to that mix is the widening instability and conflict in the Middle East. And I'll start with the impact of these factors on our export markets.

The conflict in Central Europe has driven demand directly as the NATO countries seek to help Ukraine resist the Russian invasion. And it's also made NATO and other countries think again about the balance of their defense forces and equipment. Many of the lessons learned are relevant to us. The increasing importance of electronic warfare, the need to counter drones of all kinds, the need for accurate and timely battlefield intelligence have all had a positive effect on both orders and prospects. The conflicts in the Middle East don't have the same direct impact as the other factors, but they're symptomatic of wider tensions in that region, primarily between Iran and Saudi Arabia and its allies, and that's likely to drive further regional defense spending in what remains one of our most important markets.

In Asia, Chinese assertiveness hasn't yet manifested itself in outright warfare, but the clear threat is there, and they've instigated violent episodes around the South China Sea. And that behavior has had a galvanizing effect on defense policy and defense spending across the Indo-Pacific region. One result has been the creation of the tripartite AUKUS alliance between the U.K., the U.S. and Australia. And we fully expect to contribute to the new AUKUS nuclear submarines in due course. And our new close relationship with Australia can only help with that.

There are also many opportunities in Pillar 2 of AUKUS, which is focused on new technologies, including, for example, for underwater detection and for countering hypersonic missiles. Chinese aggression and investment in its defense forces has had an impact on our order intake and opportunities elsewhere in the region, for example, in Thailand, Indonesia and the Philippines. Japan also remains committed to a doubling of its national security spending as a share of GDP by 2027. It's also joined the Anglo Italian next-generation combat aircraft project, and that bodes well for the opening up of a market that has historically been dominated by the United States.

Our domestic markets have seen similar effects. The U.K.'s defense review is ongoing. We expect to see its conclusions next year, but the government has already committed to increasing defense spending to 2.5% of GDP.

And in Germany, we can see the impact of the step change in defense spending that was announced and is now taking place. So our German business is already supplying hydroacoustic equipment for new German surface ships and submarines. And we're optimistic that it will be able to take on a more prominent role with the German Navy in the coming months.

And in Portugal, as we've mentioned, we've finally seen some long-awaited orders coming in, and we're optimistic that there are more to come. I want to emphasize that we are investing to respond to these changes in demand patterns. We're increasing capacity at both CHESS and SEA by expanding and reorganizing our facilities. And ELAC will be moving into a brand-new custom-built facility next autumn. You may remember this picture taken last year in a snowy keel showing a large hole in the ground. The work has moved on rather significantly since then.

Yes, as you can see, the construction has come on a long way. You can see the main office building there on the left. And on the right, the test tank building, which sits over that large hole in the ground, where the new digital Sonars will be tested. And we're on course for ELAC to be ready to move into the new building in the autumn of 2025.

Now notwithstanding these investments, our overheads will not increase in proportion to our growing revenue. And so we expect to see further margin improvements in the years ahead. I mentioned that we continue to see some good opportunities, and I wanted to share a few of them with you. At ELAC, we're expecting to receive an order for the sonar suite for the fourth of the 4 new Italian submarines being built early next year.

We already have orders for the first 3 and together with some other changes that are being requested, this will bring the total contract value to around EUR 100 million. ELAC is trading that contract very cautiously at the moment. But as we get closer to delivery, we hope to be able to release some of the risk contingencies. And the addition of a fourth boat will give another boost to the overall contract margin.

ELAC is also in discussions with the German Navy about upgrades to anti-submarine sonars on some of its surface ships, and that would be an important step forward with its domestic customer because most of ELAC's recent large orders have been for export customers. And it's also focusing on some major submarine programs in Europe, in Canada and in Asia.

EID, having won some large orders earlier in the year, is in discussion with the Portuguese Navy to provide communications for its new fleet of offshore patrol vessels. And it also sees some promising naval export opportunities, not least through a growing partnership with Dutch shipyard government. And following its initial success in Asia, SEA has multiple opportunities to provide its KraitSense Towed array sonar system to export customers.

It's also in discussion with BAE Systems and others about contributing to the next generation of the U.K. and Australia's nuclear submarines. They're also in discussions with several other customers about the Ancilia Decoy launch system, and they've recently announced a partnership with a Danish company, Terma to offer a complete anti-missile system for naval ships.

MCL sees several large potential prospects from urgent operational requirements. MASS is in discussions for a new iteration of its long-term contract to design and run large-scale military exercises. CHESS sees considerable short-term opportunity for its optical tracking systems for countering drones. It has a very successful partnership with Rheinmetall, and it is building other partnerships, too. And in the slightly longer term, Chess's combined radar and optical tracker for naval users is creating a lot of interest in the market.

With the interest -- with the acquisition of EM Solutions likely to complete in the near future, we'll be looking to investigate new opportunities with them as well. We know that they already have a very promising list in Australia, Europe and East Asia.

Now I should emphasize that these are all prospects rather than orders. So the value and timing of these is uncertain and the probability of actually winning them varies. But I hope what this does is to paint a picture that we see of strong demand and opportunity for the group.

So I've talked in broader terms about markets and opportunities, and this slide shows the tangible results of the demand picture that I've described. At over GBP 540 million, Cohort's period-end order book is stronger than ever before. It includes a very substantial element that will feed directly into revenue this year and next, as you can see, but it also includes over GBP 280 million of order cover for '26, '27 and beyond, guaranteeing a solid flow of revenue well into the next decade.

The larger part of our order book, as you can see, continues to sit with the Sensors and Effectors division. That's the blue color. In Communications and Intelligence, MCL tends to operate naturally on a short-term order book, so its contribution to the total is quite modest. MASS is order book, is substantial, but only increases significantly in years when its large long-term service contracts are renewed.

And EID's order book has strengthened considerably in the last half year. And there are still some good opportunities with its domestic and export customers, as I've mentioned. The picture that you see here will be significantly enhanced when EM Solutions joins the group. And EM Solutions will become part of the Communications and Intelligence division and will bring with it a large order book and a strong opportunity pipeline.

Now here, you can see the first column of the chart that I've just shown together with a comparison against the same position last year. The growth in the total order book from GBP 354 million at this time last year to GBP 541 million. That's a 53% increase is a strong indicator of the potential for future revenue growth. And the 2 shaded columns show the revenue that is already on order for the second half compared to the same position in 2022.

And you can see from those numbers that both divisions have significantly better underpinning than was the case last year. There's a 15% improvement in Sensors and Effectors, but it's especially dramatic in Communications and Intelligence, where the order cover for the second half has grown by more than 70%. And overall, more than 99% of the consensus revenue forecast for the year is now either delivered or on order.

I've mentioned EM Solutions few times. The financial results that we've spoken about so far refer entirely to the group -- the existing group of 6 businesses reporting through our 2 divisions. But as I say, we fully expect to see an important contribution in our second half from this exciting acquisition that we announced last month. And it's a very significant transaction for us. It will have a big impact on our product range, our technological capability, our geographical footprint and our financial performance.

EM Solutions provides highly capable satellite communications terminals, primarily for naval surface ships. And it's a challenging technology to develop. The terminals need to stay locked on to satellites as a ship moves potentially really quite violently in heavy seas. And these products are fully complementary to the group's existing offerings, and they even interface directly to products that are offered by EID and SEA.

Demand for satellite communications is growing, particularly for advanced navies like those in Australia and the NATO countries. And this acquisition will be the first time that we've been involved in defense space technology, and it will give us access to this important new growth stream. Over time, the balance of the output from the group has moved more and more towards the maritime market, and this acquisition will add another family of naval products to the portfolio, and that will enable us to offer enhanced packages of systems to shipbuilders and integrators.

And very importantly, bringing EM Solutions into the group will have geography-based advantages in both directions. Our position as a domestic supplier in 3 NATO nations and our strong export relationships will help them in markets that have become very important to them. And for the existing group, having a footprint in Australia and being part of the sovereign Australian defense industry will greatly enhance our access to that important customer.

Now we're optimistic that the transaction could complete as early as the end of this month and if not, we hope soon after. Simon and I visited Australia at the end of November to meet with the management and employees of EM Solutions and for talks with the Navy and the Australian Defense Procurement Agency. And we're looking forward very much to bringing this great new member of the group. And much more information about EM Solutions, I should say, is available on our website, if anyone would like to have a look at that.

So in closing, I'd like to take the opportunity to thank our management teams and employees for their continued hard work and professionalism. We are very much a people business, and it's our great team of people that is behind the good results that we've presented today. It has been another pleasing period in terms of financial performance that sets us up well for the year as a whole. We're not resting on our laurels, but we're very pleased to be continuing to build the size and strength of the group. And one consequence, of course, of this is that we've been able to increase our interim dividend once more by 10%.

The acquisition of EM Solutions will take Cohort to the next stage of its development, a good deal financially, materially accretive to adjusted EPS in the first full year of ownership. It will broaden our product range, our technical capacity and our geographical footprint, as I said, in a very beneficial way. We're very grateful for the support we received from investors at our placing, and that's enabled us to do this acquisition without weakening our balance sheet. And that gives us the flexibility to invest in facilities, in product development and if more good ones emerge in future value-adding acquisitions, too.

And finally, and perhaps most importantly, we've achieved another record order book, and we see an excellent pipeline of future opportunities ahead. Achieving order intake, which is materially higher than revenue is a strong leading indicator of future growth. And it clearly shows that there is strong demand and that our products are competitive in what is a market of very capable players. That is all I have to say. Thank you very much indeed for your attention and if you have any questions, Simon and I will endeavor to answer them now. Thank you.

[Unknown Analyst]

If I ask three questions, if I may. The first is, can you just remind us of ELAC's margin profile as they progress through the Italian submarine work?

[Andrew Thomis, executive]

Sure. Simon, would you like to take...

[Simon Walther, executive]

Yes. I mean, at the moment, Ben, the business -- obviously, the net margin of the business is lower than what we expect in the long term because of the cautious trading on Italy. The Italian revenue at the moment is around about 1/3 of ELAC's business. And as Andy touched on, if we get through these factory acceptance tests in the coming months, we are into production now. I think once we deliver successfully the first boat set, I would expect that 1/3 of revenue to start trading at much better margins. And it should. I mean, we've certainly seen projections that ELAC's net margin should move to those mid-teens in the sort of 2- to 3-year window.

[Unknown Analyst]

Regarding MCL, what are the opportunities for that business post the benefit of [indiscernible]? And what lessons have they learned over the last 2 years, please?

[Andrew Thomis, executive]

Sure. Let me take that one. Yes. As I mentioned, MCL has a new Managing Director who is coping extremely well with what has been a pretty intense period over the last -- well, the last year, but especially this first half. But alongside that, MCL has been reviewing its strategy. We announced at the full year results last year that it just completed an acquisition of a company called ITS, which provides technical authoring services and technical support services and that's going rather well.

It's also embarked on some other technical development programs, slightly away from its historic center of gravity. So to give 2 examples, it has produced a control card for first-person view drones, which, as you can imagine, are very much in demand at the moment. And that replaces a product which has had -- has previously been sourced mostly from China and where there are now export controls. So we see that as a significant opportunity. It's also developed a specialist jamming product as well to help counter drones. Both of these done doing its own using its own engineering and so we see these as, if you like, extensions of MCL's business model, which we hope will put it on to a growth path even when this current intense period of urgent operational requirements comes to an end.

[Unknown Analyst]

Perfect. That part answers my last question, but really, overall, how would you summarize the answer to the question that what insulates the group from the U.K. SDSR, particularly at math?

[Andrew Thomis, executive]

Well, the answer to that is that we have a lot of long-term contracts with the MOD and our second half is not especially reliant on new contracts from the MOD. So I mean, we're conscious that MOD has -- we've become conscious in the last few weeks that MOD has put in place some controls on new expenditure commitments and we noticed these in some small areas such as work for the Defense Science and Technology laboratory. But we don't expect them to have a significant impact on the second half because as I say, we've got such strong order cover already. More widely, of course, a little over half of our revenue is derived from the United Kingdom. And by no means all of that from the U.K. MOD, a lot of it goes to prime contractors as well. And we expect that proportion to reduce over time, notably with the acquisition of EM Solutions.

[Unknown Analyst]

Jamie Murray from Shore Capital. On Slide 5, you mentioned there's a critical design review for the Ancilia product in March. Could you just provide a little bit more color about what that entails and any challenges that might occur?

[Andrew Thomis, executive]

Progress is good at the moment is the answer. The critical design review is the most important point in the development of the new product because that involves a detailed review of the full design and approval by the customer. So after that point, the design is effectively complete, and we start to move into production. That's why it's a critical point. Further questions? Any questions from the online?

[Simon Walther, executive]

No questions from the webcast at the moment. Andy, so maybe back to you for any closing remarks.

[Andrew Thomis, executive]

Okay. Well, I think I'd just like to thank everyone for coming today. Thank you for your attention. It's been a good first half. The order book position, the order cover position, the market demand and the pipeline of opportunities all bode well for the second half and beyond. We look forward to seeing you all in July to talk about the full year. Thanks again.